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HOW FAIR IS FAIR TRADE? **

BY

ROBBERT MASELAND AND ALBERT DE VAAL*

Summary

This paper investigates to what extent fair trade programmes, are indeed ‘fair.’ This is accomplishedby comparing fair trade with free trade and protectionist trade regimes on their compliance of thecriteria set by the fair trade movement itself. This comparison is made using comparative cost basedmodels and economies of scale models. It is found that whether or not fair trade is superior to freetrade or protectionism is highly dependent on a number of characteristics of the products to whichfair trade is applied as well as on the context within which international trade takes place.

1 INTRODUCTION

A long-standing debate in development economics has been the one between ad-vocates of free trade and proponents of protectionism in developing countries.While the former argued that free trade would offer large opportunities for poorcountries to improve their situation, the latter considered trade to be harmful topoorer countries and typically preferred a combination of protectionism and de-velopment aid. This opposition tended to dominate the discussion about the roleof international trade in the Third World. �Bhagwati �1993�, Krueger �1990��

However, in recent years, a third position has come up. This position main-tains that international trade can be beneficial to developing countries as long asit is performed in a just manner. The idea behind this is that, in conducting trade,we have a moral obligation to pay decent prices for products that have been pro-duced under decent conditions. In many western countries organisations haveemerged which conduct trade in such a way and which succeed in selling prod-ucts for a price above market level, because of their guarantee that the extramoney is directly going to the producers. Such organisations, which include forexample Oxfam in the United Kingdom, Max Havelaar in the Netherlands orSolidar’monde in France, have become known as Fair Trade Organisations

* University of Nijmegen. Mailing Address: A. de Vaal, Nijmegen School of Management, Univer-sity of Nijmegen, PO Box 9108, 6500 HK Nijmegen, the Netherlands; [email protected].** The authors would like to thank Marcel Wissenburg, Harry Garretsen, Eelke de Jong, RichardNahuis, and three anonymous referees for their helpful comments on an earlier version of this paper.

DE ECONOMIST 150, NO. 3, 2002

De Economist 150, 251–272, 2002.© 2002 Kluwer Academic Publishers. Printed in the Netherlands.

�FTO’s�.1 The past two decades saw a strong growth of the market share of theseorganisations as well as of the range of products they offer. In addition, the typeof conduct they embody – fair trade – has succeeded in gaining widespread ac-ceptance among the public as being an effective tool for alleviating poverty anda reasonable alternative to aid and free trade �Beuningen �2000��.2

The idea that paying higher prices for products from Third World countrieswill help developing countries may have a certain intuitive appeal, but if onelooks beyond the direct income transfer effect, it is far from evident that thiswould be the case. One can imagine that the practice of fair trade organisationsmight lead to market distortions that cause adverse effects if one takes on a morebroad perspective. In spite of this, these organisations claim that trade conductedthe way they do is fair, which is a view that is widely shared among the public.In this paper we would like to study the validity of this claim.

In order to do this we first need to make clear what fair trade exactly is. Con-fusing in this respect is the fact that the term ‘fair trade’ nowadays is used toindicate two entirely different positions. The first of these is the fair trade thatcalls for protectionist measures by developed countries against products that havebeen produced in poorer countries at prices developed countries cannot competewith because of their different economic circumstances. Protectionism is de-fended by arguing that trade should only be conducted on a level-playing field.Products that have been produced cheaper in a country because of specificfavourable circumstances have to be excluded from trade in this view. Taken tothe extreme, this would mean that all trade based upon comparative advantageshould be abolished; in practice, the argument is mostly used to protect domesticindustries in developed economies against cheaper imports from countries withlow labour costs. This argument has been attacked convincingly in Bhagwati�1993�.

This protectionist stance is completely different from the concept of fair tradewe will discuss. The fair trade with which we will deal here is a manner of con-duct by consumers, engaged in pro-poor trade with developing countries. Insteadof prohibiting trade in products produced with, for example, cheaper labour indeveloping countries, this kind of fair trade attempts to redress the income con-sequences of such differences through trade. ‘Fair trade’ in this paper refers tothe consumer movement that has come up in several Western countries in thepast decades, in which people feel obliged to pay prices above market level forproducts produced under certain conditions in Third World countries. Crucial inthis practice is that restricting oneself to goods produced under these conditions

1 Although this movement is a relatively recent phenomenon, it shows some resemblance with mucholder �pre-capitalist� ideas about economy and society. The idea of a morally just price, for example,was one of the hurdles capitalism had to take before becoming established in Western Europe. See,for example, Thompson �1971�.2 Although recently the growth seems to have stagnated, as can be deduced from following themedia.

252 R. MASELAND AND A. DE VAAL

and paying higher prices are both considered to be moral obligations rather thanpreferences; only this type of conduct is considered to be just. The fact that fair-trading is a moral obligation means that there is no trade-off possible betweenthese principles and consumer preferences. This could be compared with certainreligious prohibitions: the prohibition to eat pork for a Muslim, for example, isabsolute, and it will hold no matter how much utility could be gained by eatingpork. Such principles can be seen as ‘ideological constraints,’ analogous to a bud-get constraint; preferences have to be weighed within such constraints, which arethemselves not part of a utility function.

The moral obligation to act in this fair trade manner stems from an idea ofjustice that lies underneath the fair trade concept. The conduct called fair trade,in other words, is an operationalisation of an idea of what just trade would be.Whether this underlying idea of justice is correct or not is a question that lies farbeyond the scope of economics and we will therefore not address it here. Onecould question, however, whether fair trade’s operationalisation of the idea of jus-tice in trade is correct or not; does the practice of fair trade indeed comply withthe ideas of justice behind the fair trade concept? In other words, is fair tradefair according to its own standards in comparison with free trade and protection-ism?

This question will be studied from the two analytical angles that are centralstage in international trade theory. First, we will answer it using a Heckscher-Ohlin framework, focusing on comparative cost based inter-industry trade. In suchmodels, trade is typically superior to no-trade on a country level of analysis, butthere are strong effects on the income distribution within countries. Second, wewill discuss the question from the point of view of trade models where intra-industry trade and scale economies play a role. In such models, income distribu-tion effects within countries are generally absent �unless they also incorporatecomparative advantage elements�, but then the gains from trade on a country levelare not always positive.3

The outline of this paper will be as follows. In section 2 we discuss ideas ofjustice behind the fair trade concept. Section 3 is devoted to the question whetherfair trade constitutes an improvement to free trade and protectionism in compara-tive cost based models. In section 4 we deal with the same question for modelsbased on scale economies. Section 5, finally, concludes.

3 This is mainly true for models that incorporate external economies of scale, which are either di-rectly modelled �e.g. Ethier �1979��, or come about as a result of pecuniary externalities that aregenerated by the interaction of returns to scale at the firm level and the existence of transportationcosts �e.g. Krugman �1991�, Krugman and Venables �1995��.

253HOW FAIR IS FAIR TRADE?

2 THE IDEAS BEHIND THE FAIR TRADE CONCEPT

To answer the question whether fair trade is fair according to its own standardswe first need to make clear which ideas of justice lie underneath the fair tradeapproach. A problem with this is that adherents of fair trade are organised in amyriad of organisations, which all have their own particular understanding ofwhat fairness in trade constitutes or should constitute. Upon inspection of manyof the arguments raised it is possible though to come up with a crude categori-sation of fair trade arguments in: �a� arguments that relate to certain conditionsunder which trade, and the production of traded goods, should minimally takeplace, and �b� arguments that deal with the consequences of trade.4

With respect to the first group of arguments, the main arguments are that thereare moral prohibitions against for example employing child labour, causing dam-age to the environment, and any actions that deny people a life of freedom anddignity. Trade by itself is not bad, but it should be conducted in compliance withthese basic prohibitions. If it does this, trade will be considered fair in its method.

It is immediately clear that only a strict refusal to buy any goods not pro-duced under these conditions truly fulfils this demand, so that in this respect fairtrade is better than both free trade and protectionism. The reasoning follows outof the Kantian distinction between acting in accord with rules and acting out ofregard for rules. To be merely acting in accord with rules might be the result ofweighed preferences, or even an unintended side-effect of an action, but it is nota recognition of the absolute character of rules. Applied to the case, the absenceof child labour is not the same as the fulfilment of the prohibition of child la-bour; for that to be the case, child labour should not only be absent, it should notbe an option at all.

Free trade can cause an absence of child labour or environmentally harmfulproduction methods, but since it lacks a self-regulating mechanism to ensuretheir absence, this outcome would always be dependent on certain conditions.Their absence is a matter of weighed preferences only, and not of a recognitionof the ban on them. This is thus at odds with the fundamental nature of a pro-hibition, which is that a prohibited action is not an option at all.

Turning to protectionism, the principle of the prohibition of coercion is de-fied.5 Moreover, since protectionism only amounts to a shift of trade from the

4 This categorisation is based on a comparison of the information brochures and home pages of anumber of alternative trade organisations and/or their umbrella organisations, e.g. the InternationalFederation for Alternative Trade �IFAT, www.ifat.org� and the Fairtrade Foundation �www.fairtrade-.org.uk�. The main arguments we mention are those that seem to be common understanding for mostof these organisations.5 Note that this also applies to the co-ordinated protectionism of the GATT/WTO framework. Eventhough national governments consent in keeping particular protectionist measures in place, it still con-strains the freedom of individual agents.


international to the domestic arena, it offers no basic changes in the conditions oftrade and is therefore subject to the same objections as free trade.

In other words, with respect to the conditions of production and trade, fairtrade indeed offers the best operationalisation of justice. Whether it does so withrespect to the consequences of trade – the second group of ideas about justice –is a more difficult question. As the fair trade movement opposes to the currentpractice of international trade because of its consequences, it does so on the basisof a rejection of efficiency as the main criterion. Fair traders propose anothercriterion to judge the consequences of international trade, which is called �rathervaguely� fairness. What is efficient, they argue, may not be fair for consider-ations of equality. The fair trade movement does not resist the market mechanismnor inequality in principle, but objects to inequality in outcomes as a result ofunjustified unequal starting positions.6 It argues that inequality caused by systemsand institutions that reward people differently on basis of natural or social differ-ences rather than by differences in effort, is not morally defendable. The fact thatthe current international division of labour does result in such inequality makes ita problematic and unjustifiable system, according to fair trade advocates.

There are two possible answers to this problem; the first one is that one couldredistribute input factors to eliminate inequalities as a result of differences in en-dowments. This is the traditional answer of socialism, which is problematic for anumber of reasons. First, in removing differences in endowments, one takes awaya main reason for trade, thereby reducing trade and its benefits significantly. Sec-ondly, as a result, this solution may lead to an equality by which nobody gains;everybody may enjoy an equal income, but this might be lower than the incomethe poorest segments of world society enjoyed before redistribution. Third, to re-distribute ‘social’ input factors is one thing, but genuine equality of opportunitywould demand an equal distribution of natural characteristics as well, which isimpossible.

Fair trade, on the other hand, opts for the second possibility; changing theinstitutions that reward differently on the basis of inequality in endowments. In aworld of inequalities in initial position, fair trade proposes to conduct trade insuch a way that no one is harmed by inequalities in initial position; in other

6 This is perhaps the one and only argument that the fair trade approach has in common with therecent discussion on harmonisation as a prerequisite for free trade, which has been extensively dealtwith in Bhagwati and Hudec �1996� and which in the public debate is also dubbed fair trade. How-ever, as will be shown, the focus of the fair trade approach goes beyond a simple harmonisation ofthe rules of the game �‘levelling the playing field’�. Fair trade, as understood by Bhagwati, is con-cerned with so-called ‘equality before the law’; trade should be limited to products produced andtraded under similar circumstances. Fair trade, in the sense as it is conducted by FTOs, is concernedwith ‘equality after the law’; they attempt to conduct trade in such a way that consequences of dif-ferences in circumstances are redressed.


words, not the inequalities themselves are redressed, but the negative conse-quences of them.7

In the words of the Fair Trade Foundation,‘by requiring companies to pay above market prices, fair trade addresses the

injustices of conventional trade, which traditionally discriminates against thepoorest, weakest producers.’8

The demand that no one is harmed by initial inequalities does not rule outinequality in outcome whatsoever; it only rules out those outcomes that are dis-advantageous to the poorest groups in society. In other words, if a certain mannerof trade results in inequalities in outcome, but comprises an improvement to theleast advantaged, it is not considered unjust. The fair trade movement thus arguesthat international trade constitutes an improvement if it has beneficial conse-quences for the poorest groups in the world. This is the moral criterion fair tradeuses to judge the consequences of trade.9

Now we have established a criterion for judging the consequences of trade,the question arises whether the fair trade practice of paying prices above marketlevel for goods produced in Third World countries is indeed the best way in thisrespect. This question we will address in the remainder of this paper; is fair tradefair in its consequences, in comparison with free trade and protectionism?

In the comparison we will limit ourselves in two ways. First, we study onlythe effect of the fair trade practice of paying higher prices. We do this because,in the fair trade concept, this practice is motivated by the alleged effects it hason income, whereas the other elements of fair trade practice are considered to beboundary conditions with an intrinsic value. In our comparative analysis we willtherefore only consider trade within these boundary conditions. After all, if theprohibitions on trade in goods produced using child labour, coercion or environ-mentally damaging production methods are not met, it makes no sense to talkabout fairness in the first place. Second, we will limit ourselves in focusing onlyon income effects of trade. We choose to go by on the effects that internationaltrade might have on other factors, that are not expressed in real income terms but

7 In other words, fair trade programmes see the way trade takes place as the heart of the problem.Obviously, there are many other reasons one could think of to explain the adverse position of thepoor in developing countries �e.g. market failure�. In our analysis, we will ignore this issue and fol-low the fair trade angle. This is not to say that we principally disagree with other opinions on thismatter.8 http://www.fairtrade.org.uk9 This position has some similarity with the ideas of John Rawls about social justice. Rawls rejectsinequality of reward on basis of natural or social differences between people, since one cannot at-tribute these differences to people’s efforts or intentions. He states that the only inequality a rationalindividual would accept is the minimum inequality necessary to improve the situation of the leastwell off in society. An important difference, however, is that Rawls combines the demand of Paretooptimality with this idea rather than replacing it. Furthermore, Rawls notion of justice is more fun-damental as he is concerned with the basic structure of society, whereas fair trade ideas consider onlythe distribution of income. See Rawls �1971�.


do influence well-being, such as consequences for environment or health. Thislimitation is defendable by the fact that it is the angle taken by most internationaltrade models, and by the fact that it can be shown that distribution problems dueto such externalities of economic action in principle can be solved by creatingmarketable property rights for these factors.10

3 FAIR TRADE AND COMPARATIVE ADVANTAGE TRADE MODELS

To investigate the fairness of fair trade, we first consider it in models where tradeis based on comparative cost differences between countries. It is well-known thatin such models trade is mutually beneficial at a macro level, but that at the microlevel not everyone will gain from trade.11 These income distribution effects showup most clearly in a Heckscher-Ohlin type of world and are summarised by theStolper-Samuelson theorem. This theorem states that in a world where trade issolely based on differences in factor endowments between countries, a country’sabundant factor will gain from opening up to trade, both in nominal terms and inreal terms, whereas the scarce factor will lose.12

The presence of income distribution effects, makes the Heckscher-Ohlin modela suitable framework to investigate the fairness of fair trade. All we have to do isto verify whether the income distribution effects of fair trade are in favour of theleast well-off in the world.13 If this is the case, we can conclude that fair trade isfair. This does not imply, however, that fair trade is best for the least well-off,since this depends on how they would have fared in a world without fair tradeprinciples. A full comprehension of the fairness of fair trade therefore not onlyincludes a judgement on the consequence fairness of fair trade per se, but also onits superiority with respect to free trade. The rules we thereby follow are verysimple: If fair trade leads to consequence fairness, whereas free trade does not,

10 See Coase �1966�.11 See e.g. Ethier �1995� for a basic text book treatment of these issues. An advanced treatment canbe found in Bhagwati and Srinivasan �1983� and Bowen et al. �1998�.12 A country will export �import� the good that uses its abundant �scarce� production factor rela-tively intensively. Trade therefore increases demand for a country’s abundant production factor,whereas the demand for its scarce production factor declines. Factor market clearing then requires anominal increase in the reward for the abundant factor and a nominal decrease in the scarce factor’sreward. By linking these changes to the price changes of goods due to trade, one can show that alsoin real terms the abundant factor gains and the scarce factor loses.13 By focussing on the income group that is actually worst off in the world before trade we stay asclosely as possible to the basic idea of consequence fairness that trade should benefit the least-welloff in the global society. One could also opt for a way to look at the consequence fairness of tradethat is more in line with the operationalisation of this concept by the fair trade movement, viz. thattrade should be fair for those least well-off in the poor countries in the world. As will become clear,the particular set-up of our analysis makes this distinction to a large extent redundant. See Maselandand De Vaal �2001� for an explicit account how the verdict on the consequence fairness of �freeand/or fair� trade depends on the particular view chosen.


then we will call fair trade superior to free trade. If, however, both fair trade andfree trade lead to the same outcome in terms of consequence fairness, say bothare fair, then we will call the one superior that leads to the highest gain for theinitially worst off.

We will restrict our analysis to a standard formulation of the Heckscher-Ohlinmodel, which exhibits 2 goods, 2 factors and 2 countries. This is done not onlyto facilitate tractability, but also since many of the theorems that are linked to theHeckscher-Ohlin model do not straightforwardly generalise to a more-factor,more-country, more-good framework.14 Moreover, to gear the analysis to the prac-tice of fair trade, we will assume that one of the countries in the model is ‘rich,’while the other one is ‘poor.’ That is, we assume that next to differences in rela-tive endowments between the two countries – the basis for trade in the model –one country also has a higher total income. In a Heckscher-Ohlin setting this im-plies that we assume that the relative factor endowments are such that the realreward of the rich country’s abundant factor is higher �before trade� than that ofthe poor country’s abundant factor. This also implies that we know that beforetrade commences the least well off are always the owners of the abundant pro-duction factor in the poor country.15 To facilitate the analysis on the consequencefairness of fair trade, we furthermore assume that the fair trade principles areadhered to only in the rich country and that these principles apply to the productsthat are imported from the poor country.16 Moreover, we assume that all peoplein the rich country adhere to the fair trade principles. Moral obligations can beseen as a reflection of societal norms and values, which can be seen as being thesame within the confines of country borders. As a consequence, the duty to pay adecent price is invariant to differences in income or professional activity. We alsoassume that the decent price to be paid is higher than the price that would resultfrom the free interplay of market forces.17 Note that this decent price is an ab-solute measure and is therefore only qualitatively related to the actual level ofthe free market price.

14 See Ethier �1984� for an overview and discussion of the higher-dimensional issues of the Heck-scher-Ohlin model.15 This follows from the one-to-one relation that exists in the Heckscher-Ohlin model between thephysical definition of factor abundance and the price definition of factor abundance, which impliesthat it must always be the owners of an abundant production factor somewhere that face the lowestreal reward before trade. Our definition of ‘poorness’ then implies that this must be the abundantfactor in the poor country.16 This assumption makes sense, since these products use the poor country’s abundant factor inten-sively. Fair trade would not focus on a sector in another country, if the owners of the factor of pro-duction used intensively in this sector would be worse off in one’s own country.17 Obviously, such a definition can be criticised, and rightfully so!, on lacking any analytical foun-dation whatsoever. At the same time it does justice to the feelings that are widespread among adher-ents of the fair trade movement, i.e. that market forces do not lead to the ‘right’ prices. Therefore, ifwe put fair trade on the stand, then it is also plausible to use their �implied� opinion on what a decentprice is.


To compare free trade, protectionism and fair trade on how they fare on theconsequence fairness criterion of the fair trade movement, we note that by ap-plying the Stolper-Samuelson theorem, it immediately follows that free trade isfair in its consequences as it improves the situation of the abundant factors of theworld, thus also that of the poor country’s abundant factor. Moreover, free tradeis always superior to protectionism, as the latter would always lead to a lowergain to the abundant factor of the country one imports from than free trade does�compared to autarky�. This is not to say, however, that protectionism is unfair.Provided the level of protection is non-prohibitive, even protectionism is goodfor the abundant factors of a country.

For a part, we can apply the same type of reasoning to the comparison be-tween free trade and fair trade. Paying a higher price for the export products ofthe poor country has more or less the same effects as imposing an import quotafor this product. Whereas under free trade the poor country would start to exportthe goods which use its abundant factor intensively until price differences be-tween the countries would be completely eliminated, now it can only export untilthe price in the rich country has fallen to the fair trade level. Exports and inter-national trade are thus limited by the fair trade programme. The effects of thisfor the income positions of the abundant factor in the poor country then alsofollow from the Stolper-Samuelson theorem. Trade leads to gains for the abun-dant factors and losses for the scarce factors, so limitations of trade lead to limi-tations of these gains and losses. In comparison to free trade the abundant factorsare therefore hurt by fair trade, whereas the scarce factors win. As was the casefor protectionism, however, this does not imply that fair trade is unfair in itsconsequences. Provided some trade still occurs, also fair trade is fair.

This line of reasoning ignores the fact, however, that apart from the negativeincome effect of reduced trade, the poor country’s abundant factor also capturesthe rents of the fair trade measure. Whether or not this positive factor outweighsthe negative effects of the reduction in trade depends on the specific price elas-ticity of demand for the product in question. If this elasticity is sufficiently low,the abundant factor in the poor country is better off with fair trade than with freetrade. This implies that the superiority of fair trade hinges on the particular typeof product it targets at. This is not the case when we compare fair trade withprotectionism, since under a regime of protectionism the rents accrue to the own-ers of the scarce factor in the rich country.

For the Heckscher-Ohlin model of trade we therefore conclude that fair tradeis always superior to protectionism, but that its superiority to free trade dependson the price elasticity of demand of the product it targets at. Unless this is speci-fied, we cannot be sure whether or not fair trade is the fairer option.


4 FAIR TRADE IN NEW TRADE MODELS

In this section we analyse the fairness of trade in models where intra-industrytrade and economies of scale play a role. The model we will use for our pur-poses is the static version of the economic geography model of Fujita et al.�1999�. We choose this particular model since it not only incorporates scaleeconomies at the firm level and intra-industry trade, but also economies of scalethat are external to the firm. As such, the model is a good representation of newtrade theory.18 We explicitly note that we use the static version of the model, aswe will discuss the impact of trade on the income distribution within countriesfor a given distribution of labour over countries. That is, we deliberately ignorethe consequences of �potentially emerging� core-periphery patterns on wageswhen labour is allowed to move between countries. To underscore this, we willhenceforth refer to the model as either a new economic geography trade modelor as a static economic geography model.

The standard exposition of the model sees the world as consisting of two re-gions �or countries, we will use these terms interchangeably�, which each pro-duce a homogenous agricultural good, which serves as numéraire, and a hetero-geneous manufactured good. The agricultural good is produced under constantreturns to scale, whereas the manufactured good incurs positive scale economies.Labour is sector-specific and �in the short run, which we confine ourselves to�also immobile between regions. Trade in agricultural products is costless, buttrade in manufactured goods incurs transportation costs. Both regions are equallylarge in terms of agricultural labour, but typically not in manufacturing labour.The standard result in such a setting is that free trade always means higher �nomi-nal� manufacturing wages in the large country and, by symmetry, vice versa forthe small country, but that the exact post-trade wage level depends highly on thelevel of transportation costs. In fact, for the large country manufacturing wagesare an inverse U-shaped function of falling transportation costs, such that whentrade is completely free, nominal wages are the same in both countries.19 Therelation between real manufacturing wages and transportation costs only partly

18 The trade literature that deals with scale economies typically makes a distinction between tradebased on internal economies of scale and trade based on external economies of scale. Among otherthings, this distinction is important for the welfare effects of free trade on a country level. Whereas inmodels where trade is solely based on internal scale economies, trade is beneficial for all countriesinvolved, this not longer holds true when trade is based on external economies of scale. Due to pathdependency issues, trade is not necessarily welfare improving in the latter type of models. The prob-lem with these types of models, however, is that while it is ‘history’ that matters, ‘history’ is notspecified. In addition, these models do not specify the external economies of scale. Both of thesedrawbacks are mended for in new economic geography models.19 The results of the standard setting carry over to more complicated versions of new economicgeography trade models as well. It is beyond the scope of this paper to give a detailed explanation ofthe reasons behind this pattern. See Fujita et al. �1999�, Neary �2001� and Peeters �2001� for a de-tailed analytical account.


reflects this pattern, as then we also have to acknowledge the impact of the fall-ing transportation costs on the price index of manufactured goods. In fact,whereas for a given level of transportation costs the price index is always lowerin the larger region – because of its lower dependence on transportation costsincluding imports, see Neary �2001� – this advantage for the larger region de-clines when transportation costs decrease. Thus, real wages are bound to startconverging at a higher level of transportation costs than was the case for nominalwages. The same applies to real wages in agriculture: given the constant nominalwage of agricultural labour �numéraire�, the development of the price indices inboth countries when transportation costs fall implies that also agricultural realwages become equal at completely free trade.

This is exactly what is shown in Figure 1, in which manufacturing real wagesand agricultural real wages are depicted as a function of falling transportationcosts. Figure 1 is based on simulation results for the standard version of the eco-nomic geography model as presented in Fujita et al. �1999, chapter 5�, includingthe normalisations they have chosen.20 The parameter configuration underlyingFigure 1 is such that both regions are equally large in terms of the numérairesector, but that region 1 is the larger region in terms of manufacturing labour.The share of manufacturing labour in total labour supply is 60%. The economiesof scale in manufacturing are intermediate �substitution elasticity of 5�, whereasconsumers in both regions spend 60% of their income on manufactured goods.

Figure 1 gives the results for one parameter configuration only, but extensivesensitivity analysis shows that the particular curvature of the real wage curves isindeed as general as the brief description of the main results from the economicgeography literature above indicates. However, the relative position of the realwage curves depends to a large extent on the parameter configuration chosen.Especially the share of manufacturing in consumption is important in this respect�as has been widely acknowledged in the new economic geography literature�, inparticular the fact that it is assumed equal to the share of manufacturing in thetotal labour supply.21 22 For our analysis this is important, since it will dependon the exact parameter configuration chosen which group is worst-off beforetrade. In Figure 1 this is clearly agricultural labour in the small region, but a

20 See the appendix for a brief exposition of the model. Note that due to several non-convexities itis impossible to derive analytical results in new economic geography trade models. Numerical simu-lations are therefore part of the standard tool kit of new economic geographers.21 Also the substitution elasticity in consumption of manufactured goods has been acknowledged asbeing an important parameter. However, changes therein do not affect the relative position of the realwage curves.22 When the expenditure share on manufactured goods increases, this will drive up �down� nominalwages in the large �small� region. The concomitant change in the price index is obviously a weightedaverage of these wage developments, but it depends on the level of transportation costs whether ornot in a certain region this change is positive or negative. A priori it is therefore unclear how realwages are affected and whether or not these developments are in the same direction in both regions.


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relatively small change in the share of manufacturing labour in the world from60% to 70%, ceteris paribus, would make manufacturing labour in the large re-gion initially worst off. The small region’s overall real income is always lowerthan that of the large region, though.23 The reason for this is that the small re-gion’s price index is always lower than that of the larger region. As a conse-quence, the real income earned in the agricultural sector of the small region islower than that in the large region. Being numéraire, the nominal rewards are thesame in both regions, whereas both regions are equally large in agricultural la-bour. The difference in price indices also works to the disadvantage of real wagesin the small region’s manufacturing sector. However, this effect may be mitigatedby a higher nominal reward, depending on the level of transportation costs. It ispossible therefore that the real manufacturing wage is higher in the small region,but if this is the case it will be a relatively small advantage. Moreover, the im-pact of this potentially higher real wage on the small region’s total income isreduced as the manufacturing sector is relatively small �since that is what makesthe small region small�.

For the way we operationalise the fair trade principles, this implies that weagain assume that all consumers in the large, rich region are willing to pay ahigher price for products they import from the small, poor region. We further-more assume that these higher prices are paid on agricultural imports, which is inline with the main thrust of fair trade programmes. The above then already makesclear that this focus on agricultural products is not necessarily the right one forfair trade programmes. As we have discussed above, a slight permutation in theparameter configuration could even make manufacturing labour in the rich coun-try initially worst off. In that case, even within the poor country agricultural la-bour is not worst off initially, since also there manufacturing labour has the low-est real income before trade.

This qualification is important when comparing the consequence fairness offree trade, fair trade and protectionism. To make the comparison, we will there-fore consider two parameter configurations, viz. the benchmark parameter con-figuration underlying Figure 1 and the alternative parameter configuration whichinstead features a manufacturing share in the world’s labour supply of 70%.

Before we can make the comparison, we have to calculate real wages for thesituation in which consumers in the large region adhere to the fair trade prin-ciples. This requires an amendment of the model in the sense that we have toalter our choice of numéraire. Due to zero transportation costs in agriculturalproducts, price differences between agricultural products across the world werenot possible in the original model. Thus, in the fair trade version of the model

23 That is, for all parameter configurations we have investigated. Since the model cannot be ana-lytically solved we cannot be sure that the small region always has the lower real income. By linea-rising around the symmetric equilibrium, as in Fujita et al. �1999�, it can be shown that the reasoningfollowed in the main text at least holds for small differences in size between regions.


we choose the agricultural product in the large region as numéraire, with a priceone, so that the price of agricultural goods in the small region can yield a dif-ferent price. Next, we assume that the latter are consumed by consumers in thelarge region only – by virtue of their principles – while consumers in the smallcountry simply buy agricultural goods where it is cheapest �which will be thelarge region�.24 These assumptions imply that consumers in both regions maxi-mise utility under the �additional� constraint that they only buy agricultural goodsfrom the other region.25 With agricultural goods in the large region numéraire,the market for agricultural goods clears via adjustments in the wage rate of ag-ricultural labour in the small region. The price of agricultural products in thesmall region is therefore endogenous.26 As, in our set-up, agricultural labour isevenly spread across countries, whereas for the parameter configuration underanalysis the large region has the higher income, the market for agricultural goodsalways clears at a price level for the poor region’s agricultural produce that iswell above one.

To judge whether or not fair trade is superior to free trade and/or protection-ism, we have plotted in Figure 2 the development of real wages in the smallregion as a function of falling transportation costs for the standard trade versionof the static economic geography model �reiteration of results in Figure 1� andfor the fair trade version of the model. In Panel A we do so for the benchmarkparameter configuration underlying Figure 1; in Panel B we present the resultsfor the alternative parameter configuration. Though for the latter parameter con-figuration it is actually manufacturing labour in the large country that is initiallyworst off, we momentarily ignore this fact for expositional reasons and focus onthe distribution effects of the fair trade programme in the small, poor region. Atthe end of our exposition we will come back to this point, though.

A quick glance at both panels of Figure 2 then makes clear that fair trade isalways superior to free trade in the poor region. For any non-prohibitive level of

24 As a consequence, all agricultural produce of the small country is exported to the large countryand all produce of the larger region will go to consumers of the small region. As the transportationcosts of agricultural goods are zero, this only seems a waste of resources.25 Due to their fair trade principles consumers in the large region do no longer see agriculturalproducts as homogenous goods. For them, agricultural products from poor countries are clearly dif-ferent from agricultural products produced at home, in the sense that the former is entitled to receivea decent price. We therefore do not explicitly model a choice between home and foreign agriculturalgoods for consumers in the large country. Our assumption that consumers in both regions only buy inthe other region is in line with this reasoning, and with the fact that consumers in the poor regionbase their choice on comparing prices, but also serves to circumvent the modelling of intricate ra-tioning schemes when the supply of agricultural produce in one region is insufficient to meet thedemands of consumers of the other region.26 This is therefore not in line with the fair trade practice to pay an absolute decent price. Ideally,one should therefore posit a fixed, minimum price to be paid for agricultural products from the poorcountry. Such could be easily accomplished, however, by making agricultural goods in the small re-gion numéraire. For the results this �obviously� does not matter.


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transportation cost, fair trade leads to a higher real wage position for both in-come groups in the poor region. Even when the fair trade programmes do nottarget the sector that is initially worst off in the poor region �manufacturing�, itnevertheless improves the real wage position in that sector. This makes sense asfair trade increases agricultural wages in the small country. As an initial effect,this will increase the costs of living in the large country and real wages theredecline. In the small country, there is no initial impact on the costs of living asconsumers buy agricultural goods at the same �nominal� price as before. Thisimplies that the higher wage for agricultural labour directly translates into a higherreal wage. Manufacturing labour in the small region also profits from the higheragricultural wages due to increased local demand. As Figure 2 makes clear, theextent to which this is the case depends on the level of transportation costs.Roughly speaking, the wedge between real wages in the fair trade case and thestandard case increases up till a certain level of transportation costs, to remainconstant thereafter. This reflects the changing balance of standard geography ef-fects when transportation costs change. When transportation costs are high, bothcountries are relatively insulated from cross-border real income effects. This be-comes less when transportation costs decline. Ultimately, when transportationcosts are zero, there are full cross-border spillovers of income effects and thewedge can be fully explained by the initial impacts addressed above.

Fair trade is not always superior to protectionism. To see that, we note thatprotectionism can be interpreted as any move to the left along the standard tradecurve. Transportation costs are partly due to artificial barriers to trade �protec-tionist measures� and partly due to natural barriers to trade �distance per se�. Asa consequence, free trade can be seen as a reduction in the overall transportationcosts, whereas protectionism can be seen as an increase in it. This also impliesthat free trade – the complete removal of artificial barriers to trade – can be seenas a move from a prohibitive level of transportation costs to any non-prohibitivelevel of transportation costs �depending how big the remaining natural barriers totrade are�.27 For the comparison of protectionism with free trade, we then onlyhave to consider how the real wages of those that were initially worst off areaffected by a move to the left along the standard trade curve. For the comparison

27 As the agricultural sector is the numéraire sector and bears no transportation costs, the openingup to trade in manufacturing goods always implies a complete opening up to trade in agriculturalgoods. Likewise, autarky in manufacturing goods implies autarky in agricultural goods as well. More-over, we leave aside the issue how much of the total transportation costs is due to natural barriers totrade and how much is due to artificial barriers to trade. As such, when free trade implies a jumpfrom prohibitive transportation costs to zero transportation costs, we implicitly assume that the wholeof transportation costs consists of artificial barriers to trade. When, alternatively, there would be noartificial barriers to trade at all, autarky is actually the natural state of affairs. In our analysis, we willonly consider situations in between these two extremes. Note also that in line with the purpose of ouranalysis, we always consider a move towards free trade, that is from autarky to a non-prohibitivelevel of transportation costs. We will not consider a move towards freer trade, that is a reduction intransportation costs in general.


of protectionism with fair trade, we must compare the real wage position of thoseinitially worst off somewhere at the fair trade curve with a point on the standardtrade curve more to the left.

For the benchmark parameter configuration in Panel A we then see that pro-tectionism is never superior to either free trade or fair trade, since the standardtrade curve is monotonically rising in the decline of transportation costs.28 Forthe alternative parameter configuration in Panel B, however, it depends on theremaining �natural� barriers to trade whether or not protectionism is superior toeither of the two trade alternatives. When the remaining barriers to trade are neg-ligible, panel B shows free trade to be superior to protectionism. When the re-maining barriers to trade are, say, intermediate, protectionism is superior to freetrade though. The same applies, but to a lesser extent, for the comparison be-tween protectionism and fair trade. The range of natural trading barriers for whichprotectionism might be a better option diminishes when there is fair trade.

To summarise our results, it thus follows that for the income distribution inthe poor region fair trade is superior to free trade, but that it depends on theparticular parameter configuration under analysis whether or not it does betterthan protectionism as well. This makes the verdict on the superiority of fair tradehighly case dependent. This is even more so when we take a global perspectiveon the income distribution. We recall that for the alternative parameter configu-ration it was actually manufacturing labour in the rich country that was initiallyworst off. Our calculations then show that their position deteriorates more withfair trade than with free trade. It is therefore fair to conclude that in models whereboth internal and external economies of scale play a role, the verdict on the su-periority of fair trade hinges even more on the way the world looks like and onthe products fair trade programmes target at than it did in comparative cost basedmodels.

5 SUMMARY AND CONCLUDING REMARKS

This paper has put the fair trade concept on the stand by comparing its allegedfairness with the fairness of other approaches to trade, such as free trade andprotectionism. The notion of fairness we thereby used stems from the fair trademovement itself and says that trade is fair when it comes to the advantage of theleast well off in society. Fair trade adherents feel morally obliged to live up tothis notion of consequence fairness, which is typically put into practice by pay-ing a higher, decent price for certain commodities of less developed countries.The other notion of fairness behind the fair trade movement – an absolute pro-

28 This is also why we did not introduce transportation costs in the Heckscher-Ohlin model of tradein the previous section. In comparative cost based models the real wage impact of a move fromautarky to free trade does not qualitatively depend on whether or not there are natural barriers totrade.


hibition of certain types of behaviour in production – has been ignored in thispaper, since these are boundary conditions for trade, beyond which it is not use-ful to talk about fairness in the first place.

We addressed the question on the fairness of fair trade from the two mainanalytical angles that comprise contemporary trade theory. First, we asked whetherfree trade, fair trade or protectionism was the better option in the comparativecost based Heckscher-Ohlin model of trade. Secondly, we discussed the relativeperformance of the three approaches in a model where economies of scale play acentral role, more precisely the static version of a standard new economic geog-raphy model.

In both models it became clear that fair trade is clearly not always a goodoption; fair trade sometimes has effects that actually consist of a deteriorationaccording to its own criterion of consequence fairness. On the other hand, neitherfree trade nor protectionism has been shown to be optimal in all cases either;there are cases in which fair trade is the better option. Perhaps the most strikingresult therefore is that in most cases it is not possible to say a priori whetherfree trade, fair trade or protectionism is an improvement or not. The effects offair trade were shown to be highly dependent on the characteristics of the sectorin question. In the Heckscher-Ohlin model, for instance, the effects were to alarge extent determined by the characteristics of the goods traded. Fair trade wasfound to be always superior to protectionism, but its superiority with respect tofree trade depended on the price elasticity of demand of the product it targets at.In the static version of the economic geography model, the remaining level oftransportation costs appeared to be a key variable, whereas the results also de-pended highly on other characteristics, such as the expenditure share on manu-facturing goods. The verdict on the superiority of fair trade was found to behighly case dependent.

The overall conclusion must therefore be that it is by no means clear that fairtrade initiatives are always fairer than other options. However, it is also clear thatthere are cases in which this is true. These conclusions bring important implica-tions for the policies of fair trade organisations with them. Fair trade organisa-tions have a valuable concept to offer to producers in developing countries; insome cases, fair trade is a superior alternative to the options of free trade andprotectionism. However, instead of taking it for granted that fair trade is alwaysgood, fair trade organisations should study the characteristics of the markets theyconsider to enter and assess whether fair trade would mean an improvement ornot. If this is not the case, these organisations would do better to focus on othermarkets. Of course, there are strong moral arguments for the other element of thefair trade practice, refusing on principle to trade in products not produced underminimal decent conditions. However, this is not a reason to pursue the secondelement, i.e. the payment of prices above market level, as well. Instead, fair tradeorganisations might consider a second line of action for some products, in which


these products are sold against market prices but with the guarantee that somebasic principles are respected.29

Two remarks should yet be made, however. In our analysis of consequencefairness, we have only studied the short run effects of fair trade programmes.Fair trade organisations, however, point to the longer run benefits of their pro-grammes as well. These may indeed very well exist; trade itself might have anegative effect on transaction costs, for example due to the reduction of culturalbarriers or the establishment of networks, which would make fair trade in thelong run a better solution to divergence problems. This way, fair trade pro-grammes could be seen as a vehicle for developing countries to exploit their com-parative advantage. On the other hand, a problem with the inception of fair tradeprogrammes might be that it changes the relative position of income groups insociety, which could make the continuation of fair trade programmes unfair. Thosethat were worst off initially are not necessarily the ones who are worst off now.Moreover, since the dynamic effects of fair trade might alter the circumstancesunder which trade takes place, a continuous reassessment of the focus of fairtrade programmes is warranted.

Secondly, we have studied the effects of fair trade programs only in two spe-cific general equilibrium models of international trade. Although these two mod-els form the heart of contemporary trade theory, they have little attention for thespecific circumstances under which production by small-scale producers in ThirdWorld countries takes place. When one considers these circumstances, it is imag-inable that fair trade has a function in redressing the structural market failuresthat characterise the agrarian economy in many developing countries. Before giv-ing a definite verdict on the fairness of fair trade, it would therefore be justifiedto analyse these possibilities in future research.

APPENDIX: THE STANDARD ECONOMIC GEOGRAPHY MODEL

This appendix gives the equilibrium conditions of the standard economic geog-raphy model by Krugman �1991� and as employed in chapter 5 by Fujita et al.�1999�. The world it describes consists of two regions �or countries; these termscan be used interchangeably�, which each can produce two types of goods. Onegood is a constant returns to scale, homogeneous agricultural good; the other goodis a heterogenous manufacturing good, which exhibits increasing returns to scale.Both goods are produced with sector specific factors of production that are infixed supply, that is: each region has a fixed amount of agricultural and manu-facturing labour and in the instantaneous equilibrium there is neither cross-regionnor cross-sector factor mobility. Consumers in both regions have identical pref-

29 Or for which the higher price only reflects the extra cost respecting these principles brings alongand is not an instrument to raise income.


erences which are Cobb-Douglas regarding the choice between the two types ofgoods and Dixit-Stiglitz CES regarding the choice between different varieties ofthe manufactured goods �including imported varieties�. The agricultural productis costlessly tradeable and serves as numéraire; varieties of the manufactured goodcarry iceberg-type of transportation cost, that is: upon transportation to the otherregion, part of the good ’melts’ away. This is to avoid the modelling of a sepa-rate transportation industry. Agricultural labour is divided equally among regions;the amount of manufacturing labour may differ between regions.

Equilibrium is contained in the following set of equations �for i, j � 1,2 andi � j�:

Pii � bwi /� � Pij � bwi /�� A.1�

�mii /mij� � �pii /pij��1 / �1�� A.2�

fwi / �1�� pii mii � pij mij �A.3�

fNi / �1�� i lL �A.4�

� �wi �i lL � �1�l � L/2� � Ni pii mii � Nj pji mji �A.5�

In these equations wi denotes the wage rate of manufacturing labour in region i;pij and mij, respectively, denote the f.o.b. price and f.o.b. quantity delivered by amanufacturing producer from region i that sells in region j, and Ni denotes thenumber of manufacturing varieties produced in region i. Total labour supply inthe world is L, of which a share l is manufacturing labour and a share �il manu-facturing labour in region i ��i � 1�. Agricultural labour is equally divided be-tween regions. The parameters b and f are, respectively, the marginal and fixedlabour cost of manufacturing production; � is the share of expenditures on manu-facturing goods; � denotes substitutability in consumption between differentmanufacturing varieties �0 � � � 1 and 1/�1�� 1 is the elasticity of substitu-tion�; and � � 1 denotes the iceberg-type of transportation costs. The equilibriumconditions represent goods market and labour market equilibrium, while takinginto account optimum producer and consumer decisions and the fact that free en-try and exit in industry imply zero profits for manufacturing producers. In oursimulations �benchmark�, we have chosen the following normalisations �follow-ing Fujita et al. �1999�� and parameter values: � � l � 0.6; b � � � 0.8;f � � / �1�� 3; �1 � 0.6; �2 � 0.4 and L � 1.

The fair trade version of our model is obtained by substituting �A.5� by

� �w1 �1 lL � �1�l � L/2� � N1 p11 m11 � N2 p21 m21 �A.6a�

� �w2 �2 lL � �1�l � Lw2A/2� � N2 p22 m22 � N1 p12 m12 �A.6b�


where w2A is now the �endogenous� wage rate of agricultural labour in region 2

�the small region�, and adding

�1�� w1 �1 lL � �1�l � L/2� � �1�l � Lw2A/2 �A.7�

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