Fair Trade and Free Entry: The Dissipation of Producer Benefits in a Disequilibrium Market

The Fair Trade (FT) initiative has been hugely popular with coffee consumers around the world, and yet the creation of durable producer rents is challenging in a competitive market environment. We model the FT premium actually received by producers and suggest that rents are in fact dissipated, but that this occurs in ways that are quite obscure to consumers. First, over-certification dilutes the effective premium even during years in which the nominal FT premium is high. Then, the use of a quality-invariant FT floor price in the very heterogeneous market for coffee creates a second, completely unrelated mechanism through which producer benefit is eroded. We use unique data from a large association of coffee cooperatives in Central America to measure nominal FT premiums received by member cooperatives, comparing coffee of the exact same quality sold with and without the FT label. We confirm that nominal premiums are dissipated by over-certification and unrewarded quality differentials. In effect, FT membership is priced like a put option: producers are willing to lose a small amount through participation during years in which the market price is high in order to retain future access to the FT floor price. We conclude by discussing ways in which the FT mechanism could be adjusted to take advantage of ethical consumers’ willingness to pay in order to achieve the desired transfers of rents to smallholder producers.