Bad Coffee is Usually Bad Economics

Bad Coffee is Usually Bad Economics

Alexander C. Cartwright ‘13

            There has been plenty excitement on campus about our new food service.  Aside from a re-modeled Tiger Inn and a completely revised menu, there is a series of new decorations in the commons. Next to the windows that overlook Chalgrove Lake is a poster promoting “Fair Trade” coffee. Fair Trade products, especially coffee, are more and more popular, yet few people understand what “Fair Trade” actually entails. Some basic economics can help us understand why it’s confusing that buying “Fair Trade” is counterproductive to what the practice seeks to achieve.

            “Fair Trade” is a relatively simple idea.  Fair Trade cooperatives agree to put their certification logo on a coffee producers’ products if the producers agrees to meet certain social and environmental standards. These usually include paying a specified minimum wage, and using certain harvesting practices. In return for complying with the Fair Trade cooperative, the coffee producers receive a premium for their coffee, which is typically the market price plus a certain percentage. Additionally, if the market price falls, fair trade producers are guaranteed a minimum price. Ultimately, the program aims to raise wages for poor coffee producers in the developing world, and encourage them to produce coffee in a more socially productive way. A better livelihood for coffee producers and an increased capacity to hire new them to higher new employees are certainly noble goals.

            Unfortunately good intentions don’t necessitate good results; there is great deal of unsettled debate around the benefits of fair trade. In fact, there is a large lack of accounting on how of the fair trade premium the actual coffee workers get; some suspect that most of the premium is collected by the fair trade cooperative themselves. Of the few estimates that exist, all of the one’s I found cite that coffee producers are actually receiving less than 10% of the fair trade premium. However, this is an empirical argument. Just because a small percentage of the premium actually gets to the hands of the poor coffee workers, doesn’t not discredit the free trade movement, it just question’s the movement’s effectiveness.

            Aside from being potentially ineffective, free trade advocates don’t seem to understand basic economics. Simply paying coffee producers higher prices can’t lead to more profits without an increase in consumer demand.[i] The standard supply and demand graph can easily help us visualize how an artificially higher price leads to decreased quantity demanded by consumers. Because there is no actual increase in demand on the consumer side, an artificially higher price for coffee will necessitate a lower quantity demanded. If less coffee is bought, fair trade certified or not, the coffee producers will be selling less and subsequently won’t be better off.

            Interestingly under fair trade, just because there might be less coffee sold does not mean there will be less coffee produced. Because members of a fair trade cooperative are guaranteed a minimum price independent of the market price for coffee, they have an incentive to over produce. If fair trade producers know that they will always be guaranteed a certain price for coffee, they can maximize their own profits by continually producing, even as the price for coffee falls. By guaranteeing a minimum price and incentivizing producers to over-produce, fair trade producers could flood the market to a point where it’s hard to sell any coffee.  
            A bigger problem with guaranteeing the coffee producers a minimum price is that it insulates fair trade producers from competition. By knowing that, regardless of their product’s quality they will receive a certain minimum price, producers have a marginally lower incentive to care about product quality.  After the fair trade cooperative pays a higher price for the (lower quality) coffee that meets the cooperative requirements, consumers that buy the coffee are actually paying a higher price for a lower quality product.

            Fair trade advocates maintain that even if the coffee is a little lower in quality, and even if the producers end up only getting a small amount of the fair trade premium, buying fair trade is still a worthwhile way to support working conditions for coffee workers. This position accurately recognizes that better working conditions require a higher cost, but fails to recognize that producers can more easily substitute out labor for capital with a higher coffee price. Thus assuming that fair trade actually convinces consumers to pay higher prices for coffee, it is certain that fewer workers will be employed as working conditions are improved[ii].

            Still the fair trade proponents maintain that the only alternative to artificially raising prices is to let some poor coffee producers go out of business. Yes- they are correct, and that is the appropriate alterative. Even though allowing producers to go out of business seems like a heartless response from someone outside of the developing world, the fair trade program will make coffee producers even worse off. The fair trade system encourages producers to produce coffee when the market isn’t demanding it, and it encourages lower quality coffee that market prices aren’t signaling demand for. If allowing businesses to go under is heartless, I can’t imagine what the makes the people who support a program that perpetuates and institutionalizes loosing.

            Advocates of fair trade certainly want a world that is more just and prosperous for all, but their program won’t produce either.  In the meantime, coffee chains and grocery stores are glad to capitalize on selling lower quality produces at higher prices so long as consumers demand the fair trade label. The only benefit that seems to come from fair trade is the good-feeling that a consumers gets from buying something with the fair trade label- a feeling that is unjustified. The very term “Fair Trade” illustrates that proponents do not understand how markets work. Markets do not adversely favor the rich over the poor, nor are prices fair or unfair, just or unjust. Prices are signals that communicate countless pieces of knowledge like the relative demand, substitutes, and scarcity of a product to nearly countless numbers of producers who use that information to modify production. They cannot be fair or unfair- they are signals determined by consumer demand- not a decree of the rich and powerful. We don’t need to ignore poor coffee producers in the developing world; we need to remember that justice and prosperity are the result of economic freedom, not fair trade.

[i] Callahan, Gene. “Is Fair Trade a Fair Deal?: Fair Trade Means Well, but Ignores Some Economic and Political Realities” The Freeman. March 2008 • Volume: 58 • Issue: 2.

[ii] See I

Tax Cuts: Not a Universal Panacea

Tax Cuts: Not a Universal Panacea

 Alex Cartwright ’13 & Dylan DelliSanti ’14

            Conservatives almost always use “cutting taxes for the rich” as a policy-panacea for economic woes, big and small. For instance, in the article “How poor is ‘poor’” Robert Rector at National Review writes that, “What can be done to increase self-sufficiency and reduce official “poverty”? In the short term, the number of jobs should be increased by easing the threat of excessive taxes and greater regulation on employers and investors who create jobs." While there’s little doubt that cutting taxes will lead to growth over a long period, the potency of tax cuts should not be oversold. The almost universal policy suggestion of cutting taxes has been pushed as a solution to such a wide variety of issues that it should be no mystery why those on the left tend to believe that markets inherently favor the wealthy.
            Rector, and right-wingers like him, aren’t making any progress with their well cited research when they cite tax cuts as an alternative to expanding welfare. Welfare and Tax-Cuts aren’t obvious substitutes, and actually aren’t very substitutable at all.  There are much more direct ways to reduce poverty than either expanding welfare or cutting taxes: reducing occupational licensing requirements and the minimum wage, scaling back the War on Drugs, and allowing for more charter schools.
            With some of the highest corporate taxes in the world, there is little doubt that tax cuts would encourage economic growth, but the effects are likely to be long-run; and moreover, they are not easily apparent. For instance, when low taxes encourage investment in new projects or raise corporate profits, the connection between the lower taxes and the better economic results might be difficult to perceive. Additionally, in an uncertain economic environment companies are more likely so sit on the extra cash they have as a result of tax cuts, instead of hiring more workers.
             Instead, those who wish to seriously engage the dialogue against trying to end poverty by the ancient (and disastrous) method of transferring wealth, ought to advocate policies that are not only consistent with long-term economic growth, but also directly help people who are often neglected in the tax-cut dialogue, such as the poor or young people- exactly those who welfare aims to help. Doing this would help the ideas of economic freedom reach new ears.
            One such policy might be to reduce occupational licensing. Occupational licensing, such as taxi cab medallion systems, licenses to braid hair, wax eye-brows, build coffins, decorate homes interiors, or to arrange flowers (no, this one is not a joke) are in effect taxes and regulations that directly affect the poor and are used by the established businesses to insulate themselves from competition and make it impossible for new entrepreneurs to enter the market.
            Minimum wage laws increase the cost of employing young people, thus reducing companies demand for labor and leaving many without work. While the wages these, typically young, people miss out on are often meager, the real loss is in missing out on valuable work experience and skills that could teach young people to invest in themselves and in their future.
            Efforts to scale back the War on Drugs could have a similar effect. Currently, the War on Drugs has made it profitable for young people to sell drugs rather than find normal work. After all, with low-income and high unemployment, the opportunity cost of not breaking the law (via criminal activities) becomes a lot higher. By decriminalizing drugs, we could remove the locus of drug distribution from the criminal world, thus preventing young people from involving themselves in organized crime.
            Allowing for more charter schools is another way of directly improving the lives of those who are less well-off. Charter schools introduce an element of competition to public schooling. In doing so, it allows forces school administrations to take a vested interest in their child’s education. If one school does not satisfy their child’s needs, then they can take their children to a different school. Thus schools work to improve, and specialize to meet the needs of different students seeking different academic programing. Higher quality education tailored to one’s needs and interests makes expanding charter schools an appealing way to reduce poverty- at no additional public cost.  
            The combination of the difficulty to perceive the long run benefits of tax cuts combined with the little prudence many Conservative policy analysts employ regarding using such a policy, many on the left come to regard tax cuts as an exclusive benefit for the well-to-do. For instance, in 2010 Rachel Maddow showed how the Bush era tax cuts were larger for the rich and from there attempted to argue that tax cuts disproportionately favor the rich. Tax cuts that adversely help the well off encourage a flawed reasoning that assumes wealth is a fixed pie. Many people think that if some people get tax cuts, than they must be receiving them at the expense of others. Continuing to argue for tax-cuts as the ‘free-market’ solution to all policies aimed at stimulating the economy encourages ‘big-government’ advocates to view tax-cuts as something that only helps the rich; given that tax-breaks and welfare aren’t close substitutes, this position is warranted.
            This is just a sampling of policy positions that advocates of markets should pursue other than the blanket position of “cutting taxes.” These policies have an effect that is much more visible than tax cuts, thus broadening the base of people who can be included in the market paradigm. Unfortunately, the supposed political advocates of markets, Republicans, don’t often cater to policies that effect the less well-off. The rich aren’t as interested in voting to de-regulate occupational licensing, legalize drugs, or improve education as they are in getting tax breaks. Nevertheless, there is much stronger case to be made for economic-freedom than just citing the benefits tax breaks have on the economy.  

Do Markets only work when the Sky is Blue?

Do Markets only work when the Sky is Blue?
Alexander C. Cartwright & Dylan DelliSanti
            As hurricane Isaac captured our country’s attention and delayed the Republican National Convention, state and local governments were receiving persistent media attention highlighting what each government was doing to protect public safety. Tampa’s mayor proudly advertised that part of the hurricane preparation process includes a hotline where consumers can report price gouging. Price gouging occurs when a price advertised 30 days prior to an emergency being declared is extremely different price the price of the same good during an emergency.[i] Already 160 Floridians have used the hotline and investigations are in process.[ii] Ironically, price-gouging laws might punish more people than those who are actually prosecuted.
            Price gouging laws are the result of public outrage at increased prices during natural disasters. During times of emergency, consumers buy more batteries, gasoline, food, perhaps hardware store materials for protection, and other necessary items to help them weather the storm. The increase in demand for goods that people need during an emergency, leads business owners to raise prices. Citizens desperately trying to preserve their property, and often their lives, during an emergency, feel slighted by price increases; understandably so. The last thing anyone wants when trying to fill-up his car in order to evacuate his home to avoid a hurricane, is to find $6.00 per gallon gas prices.
            To remedy citizen’s dilemmas, these unhappy consumers have paired up with vote-maximizing politicians to create laws against price gouging so that businesses can’t “abuse” increased profit opportunities during natural disasters. Unfortunately, price-gouging laws only leave the politicians with more votes and the consumers in more danger.
            During a disaster, like a hurricane, businesses also have to operate under the effects of storms. In order to produce goods during a time of emergency, keep the businesses open, pay employees to work during storms, and ship in products from out of town under harsh weather conditions, businesses have to demand a higher price to cover higher operating costs. The freedom for businesses to raise their prices in order to provide products during a disaster is a good thing, because the alternative is not that pre-disaster prices are maintained, but that no goods are sold, and no additional goods are brought in to meet the increased demand. Higher prices allow companies to get us the products we need in the quantity we need them during difficult conditions.
             Moreover, higher prices tend to discourage consumption that might be considered frivolous. When prices rise, consumers will restrict consumption to those most highly valued uses.  When prices are restricted, the allocation of goods becomes arbitrary as opposed to guided by prices. For instance, in 2003 price caps on batteries during Hurricane Isabel lead stores to give them out first come, first serve[iii]. This rationing system lead to some consumers having many batteries for less valuable uses and other consumers having no batteries at all. Moreover, if stores are forced to give products away, they might not be likely to prevent looting, which could erode the established social order.
            Some will object to price increases on the grounds that products already in stores shouldn’t be subjected to price increases since they were in stock and being sold for lower prices before the emergency. This position fails to recognize that there is a cost to time and place. Once time and weather changes, the opportunity cost on stores’ inventories is more expensive; this new opportunity cost is reflected in price changes.
            Price gouging laws have long been proven to be ineffective at achieving their intended end, yet the laws still exists; we pay government officials to punish business owners and make us worse off during times of emergency. Interestingly, we choose to allow markets to provide us with all the services we need in our daily lives, but magically believe that government is capable of doing what it cannot just because the weather gets bad.

[i]  Golden, Roger. “Gas Price Gouging Laws in Florida”
[ii] Gehrke-White, Donna. “Scores of Floridians complaining of price gouging since Isaac” The sun Sentinel.,0,2520242.story
[iii] Meyer, David W. “The Virtues of Gouging.”

Economic Development Subsidies: Helpful or Radioactive?

In testifying to the Arkansas House and Senate Committees on Revenue and Taxation yesterday, Grant Tennille (the head of the Arkansas Economic Development Commission) explained yesterday that Arkansas’s reliance on corporate welfare is like a nuclear weapon.
Tennille said:
“I say this all the time. I hate incentives. I don’t think we ever should pay a dime to anybody to do anything. But I feel about incentives the same way I feel about nuclear weapons. I will happily be the second guy to put mine down”
or, Tennille explained, to resort to their use.  He added:
“As long as Bobby Jindal pays $56 million for a chicken plant, I can’t sit here and say that we’re going to be too good to do that.”
This remarkable metaphor is perhaps more revealing than Tennille intended. A central justification of nuclear weapons is that they are better used as threats than as tactics; when we get to the point that nuclear weapons are used on a regular basis, most people will conclude that something, somewhere, has gone wrong. One name for what has gone wrong in that case is mutually assured destruction. Maybe it’s true that we should compare corporate welfare to nuclear weapons, but if so we ought to keep in mind that the substantial damage that corporate welfare can do — taxpayer-funded subsidies to businesses that apparently can’t make it on their own — is already taking place.
Regrettably, it is not even clear that the money that taxpayers are spending on economic development is having its promised effects: an Arkansas Democrat-Gazette analysis last month demonstrated that there is no way for the public to verify that economic-development expenditures actually result in jobs. When asked about this at the hearing, Tennille responded that he is confident that most companies have delivered on their promise, but “a lot of it is an article of faith because it’s really tough for us to say with absolute certainty … that yeah, they’ve done what they said they were going to do and hired this many people.”
At the hearing, a number of legislators asked Tennille some probing questions that implied some skepticism about the value of corporate welfare in general:
Rep. Stephen Meeks asked what the return on investment was on the governor’s Quick Action Closing Fund, which prompted Tennille to discuss his thoughts on faith and evidence as reproduced immediately above. Instead of supplying the requested figure, Tennille gave the example, near Meeks’s district, of Hewlett-Packard’s taxpayer-funded economic development success – in my opinion, an explanation similar to that of a poker player who is intent on relating anecdotes about the big hands he won but who is less talkative about his losses. Meeks responded to Tennille’s invocation of Hewlett-Packard by asking if Tennille thought his anecdote was the exception or the rule, pointedly underscoring that we won’t be able to discuss these matters meaningfully until we have actual numbers.  Tennille then replied with more anecdotes.
Rep. Andrea Lea asked how we tell whether the economic development assistance that is funded by taxpayers is providing any return on investment at all, and whether AEDC provides any information on the question of what benefit its actions provide to the public. Tennille answered “We do … we actually prepare those reports for you.” Under questioning by Lea, however, Tennille conceded that those reports only contain predictions, and the only evidence of actual achievements is hidden in the tax returns that corporate welfare recipients provide to the state; when Lea asked further if there is anything that provides after-the-fact evaluation of how well these programs work, she was told by AEDC staffer Morris Jenkins that AEDC “would love to know” the answer to these questions and that “there is some language” in legislative draft form that would address them. Further questioning by Lea resulted in Jenkins’s admission that he had no knowledge of any legislators working on the issue, followed by Tennille’s invitation to Lea to carry such a bill, to which Lea responded “I’d love to carry the bill, if I can agree with the language.”
Rep. Charlie Collins suggested that AEDC’s mission was based less on individual choice and more on central planning; given the historically-demonstrated defects of central planning, Collins asked, are AEDC’s methods the correct ones? Tennille responded at some length that he had discovered over time that some of the strongest advocates in Arkansas of getting government out of the business of corporate welfare were on the state dole: “They’re entrepreneurs, but when it came right down to it, they showed up at our door, and we’re toting their note.” Collins responded to this non sequitur by saying “I agree with you that if you put a pile of sugar cubes in the middle of a field, every horse in the field will eat them.” I think this was a particularly concise way of noting that what we want to do is to think about what happens when we get the sugar cubes out of the field, and that Tennille’s revelation that many businesses have received corporate welfare was essentially unrelated to that question.
Rep. Linda Collins-Smith noted that it wouldn’t seem hard to her to require recipients of corporate welfare to disclose what they are getting and what they are providing, saying “I would like to know how many jobs we have purchased with taxpayer dollars.” Tennille responded by suggesting that he’d need to know what was meant by “purchased,” asking if any incentive would count as a purchase. Rep. Collins-Smith fired back, noting that lawmakers had been supplied so little information about the details of Arkansas’s existing economic development programs that it was difficult to respond with appropriate criteria to Tennille’s question. It was around this time that Tennille explained that business incentives are like nuclear weapons, a metaphor which is (depending on one’s perspective) either highly regrettable or highly revealing. If these legislators continue to attend to this issue, there will likely be continuing fallout.

Alex Cartwright is an Economic Policy Analyst at the Advance Arkansas Institute.
A version of this article originally appeared on the blog, “The Arkansas Project” on 7/20/12.