Why Do We Need Fair Trade Coffee?

[Jay Kilby]

This is the first in a five-part series of articles that compare three alternatives to the traditional coffee trade industry: fair trade, direct trade, and Starbucks’ C.A.F.E. program. However, before we compare these three alternatives to one another, let’s take a look at why fair trade coffee was created in the first place. What conditions in the traditional coffee industry have created the need for fair trade, or some alternative that resembles it?

Over the past fifteen years, prices paid to the small farmers who produce coffee have dropped precipitously. In 2002, Oxfam reported that in real dollars, prices paid to coffee growers had reached a 100-year low, with prices dropping throughout Latin America and Africa. For example, the average price paid to Mexican producers in 1994 was $1.49 per pound. By 2000, the price had dipped to 47 cents per pound. These price declines were not affecting roasters in consuming countries in the same way that they were affecting the producers. In 1970, an average of 20% of total income generated along the coffee chain was retained by producers, with an average of 53% going to consuming countries. By 1995, the proportion of income going to producers had fallen to 13%, while consuming countries were retaining 78%. As green coffee prices on the international market declined by half from 1999 to 2001, the average U.S. retail price dropped by less than 4% (Ponte, 14-15).

Nearly three-quarters of the world’s coffee is grown by small farmers on plots of 25 acres or less. They have born the brunt of the decline in falling prices. The Wall Street Journal reported that this collapse in coffee prices paid to producers was contributing to “societal meltdowns affecting 125 million people” (Fritch, 2002).

What caused this drop in prices and increasing disparity in income generated in producing and consuming countries? From 1962-1989, the production and sale of coffee was regulated under the International Coffee Agreements (ICA’s), to which most consuming and producing countries had agreed. Under this system, target prices were set and export quotas allocated to producing countries. When prices rose above a certain agreed-upon target, quotas (coffee supplies available for trade) were increased to bring the price down, and when prices fell below the agreed-upon standard, quotas were decreased in order to raise prices. The system provided price stability, but was not without problems. Money from coffee had to be spent on state regulatory institutions, quota allocations were sometimes based on politics, corruption was common, and growers often received only a small portion of the export income. However, when the ICA’s were eliminated in 1989, this did not improve the situation for farmers.

Rather, the removal of the ICA’s meant the removal of limitations upon supply. Vietnam entered the coffee producing market in the 1990's, creating a dramatic increase in supply. Prices have dropped, price instability has increased, and there has been a shift of power and wealth from governments and regulatory bodies in producing countries to a small number of transnational corporations that import and roast the coffee in consuming countries.

During the 1980’s, mergers and acquisitions in the coffee industry were encouraged by deregulation under the Reagan administration. By the 21st century, a few major manufacturers controlled over 60% of coffee sales: Nestle’, Philip Morris, Sara Lee, and Procter and Gamble (Talbot, 220-224). Similarly, fewer trading companies acquired greater shares of the business of importing coffee to the consuming countries, with Neumann, Volcafe, ED&F Man, Cargill, and Goldman, Sachs controlling over 40% of world imports by the early 1990’s.

These large corporations have distinct advantages over smaller companies. During the banking deregulation of the 1980’s, the line between large traders and banks became increasingly blurred. Traders became more involved in the commodity futures market and added financial services to their trading practices, while some banks, such as Goldman, Sachs, became importers of commodities like coffee. The resulting large trading/financial institutions were able to quickly move funds from one commodity to another in response to price changes, protecting themselves against volatility and quickly taking advantage of profit opportunities.

During the 1990’s, the price of coffee was increasingly driven by speculators investing in coffee futures based on market movement rather than projections of future supply and demand. Access to accurate information and expertise in analyzing data became critical for coffee investors. Success increasingly depended upon rapid interpretation of information about crop forecasts, political conditions in producing countries, trade policies, exchange rates, and market analysis of alternative investment opportunities. The large transnational corporations that now manufacture and trade coffee have distinct advantages in accessing the expertise and information needed to accurately predict changes in price (Talbot, 234-236). Their resources enable them to foresee and profit from temporary price increases, and to predict and hedge against future declines.

However, local farmers who produce the coffee do not have access to these resources for profiting from the commodities market and hedging against price declines. Their cooperatives have difficulty competing with the local subsidiaries of large trading firms (Ponte, 31). The free trade market that now exists in the coffee industry is a system in which a few, large companies can compete and win. But the farmers who produce the coffee are losing badly and cannot hope to succeed without fundamental change. In our next article, we will examine the pros and cons of fair trade as an alternative for improving the livelihood of coffee growers.

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Fritch, Peter. 2002. "Bitter Brew: An Oversupply of Coffee Beans Deepens Latin America's Woes." Wall Street Journal, Vol CCXL, No. 5: A1, July 8.

Murray, Douglas, Raynolds, Laura T., Taylor, Peter Leigh. 2003. "One Cup at a Time: Poverty Alleviation and Fair Trade Coffee in Latin America." Colorado State University: Fair Trade Research Group.

Ponte, Stefano. 2001. "The 'Latte Revolution'? Winners and Losers in the Restructuring of the Global Coffee Marketing Chain." CDR Working Paper 01.3. Copenhagen: Centre for Research Development.

Talbot, John. 2002. "Information, Finance and the New International Inequality: the Case of Coffee." Journal of World-Systems Research, VIII, 2, Spring 2002, 214-250.

[Jay Kilby]

Got it.

[Jeff]

Okay, that makes sense. Cartels restrict supply, thus driving up prices (to the extent that demand will permit it). Subsidies squeeze out competition by enabling producers to underprice without having to eat the difference. Both activities distort prices that otherwise would be determined by the market.

Do I have that right?

[Jay Kilby]

Regarding Natalie's comment: A number of coffee products will say "fairly traded" or some such thing without displaying the FLO certification label (in the U.S., this is the Transfair USA label). "Fairly traded" without the label certifies nothing. However, if you see the FLO label, this certifies that the farmer is receiving a minimum price (presently $1.25 per pound plus an additional 10 cent social premium for community improvements and an additional 20 cents if the coffee is organic). There are abuses of the system, but no evidence to my knowledge that they are widespread. I'll submit a subsequent article with more details about Fair Trade shortly.

Jeff: Subsidies are quite different from cartels. When the U.S. subsidizes corn, they are paying farmers a chunk of money for every bushel, enabling the farmers to sell below cost and cornering the market. The coffee countries are too poor to do this to protect their farmers' coffee exports. A cartel is an agreement among countries to set a certain price (higher than the market price). Coffee countries have tried this in the past, but there are so many coffee countries (unlike OPEC) that this arrangement is impossible to sustain. Even if you got all of Latin America and Africa to agree to such an arrangement, Vietnam or some such country, would sell below the cartel price.

[Jeff]

Re: Subsidies. Let's say a single coffee-producing country or OPEC-like coffee cartel were to become capable of controlling prices. The tendency would be to drive prices up, right? Rather than down, as U.S. and European subsidies do? Supply/demand I get; the economics of subsidies totally baffle me.

[Jeff]

Glad you liked it. If you have any videos you find particularly useful and relevant, please feel free to post them in our video area. The more content users provide, the more robust conversations we can have. I don't know if you've perused our members' profiles -- we have some really interesting folks from all around the world.

[Jay Kilby]

Thanks for the video clip suggestion--provides a great summary. I'll use it with my students.

[Jay Kilby]

Northern, industrialized countries have an enormous advantage over countries in the sourthern hemisphere in being able to subsidize their crops, such as corn, which is subsidized by the U.S. government and sold on the international market at 25% below the cost of producing it, making it impossible for corn farmers in countries such as Mexico to compete with U.S. produced corn. However, countries that produce coffee do not have sufficient wealth to retaliate against such northern subsidies. No single coffee-producing country can control the price of coffee as the U.S. does corn. Therefore, it is the international market and lack of alternatives for farmers in very poor regions that keep the price of coffee low.

[Jeff]

Also, for anyone interested in learning more about fair trade, check out this clip.

[Jeff]

Nice article, Jay. I look forward to reading the rest. One question, though (and maybe it's addressed in the future articles): This article emphasizes the role of free trade in depressing prices, thus making it hard for the small producers to compete -- but what about the role of government subsidies? I don't know enough about the coffee industry, but I know subsidies are a huge deal in artificially depressing the prices of other agricultural commodities.