Solving the Price Crisis in Coffee

THE OPINIONS EXPRESSED BELOW ARE THOSE OF MARK RESPINGER AND DO NOT NECESSARILY REPRESENT THOSE OF MANLAO RIVER COFFEE

It seems that in the coffee industry are constantly bombarded with talk of coffee being in a price crisis. Often this is accompanied by discussions of making sure that we are paying farmers a fair price and that living wages are mandated at farms that we work with. 

I think this logic is deeply flawed and is actually causing many of the pricing problems we are seeing in the industry today. Fair pricing schemes, like those of various NGOs and that of the Brazilian government, distort the market to the disadvantage of all but the biggest players exploiting various respective schemes.

So what are we really talking about?

A fair wage for the workers?

  • Do we just mean the people physically picking the coffee?
  • Do we include the people processing the coffee?
  • Should managers and co-op leaders also have a fair wage?

What about the farm owners?

  • Should a small plot owner be able to make enough off their land to support their family?
  • Is one tree enough? If not, how many trees and how much land do they need before this becomes valid?
  • Is there a point where they have too many trees? Does someone with a million coffee trees deserve the same protections?
  • What about investment groups and hedge funds who own land? Should they receive a comparable minimum ROI to be fair?

Even just looking over the questions above, the problems start to become apparent. With a limited definition of what we are actually trying to achieve it is difficult to form a logically consistent strategy to address the issues. I’m not going to dwell on these definitions but instead look at the broader problem of market disequilibrium that permeates them.

The means of production – A fair wage for the people

To me, a fair wage seems to be another way of describing a minimum wage. There is already plenty written on the topic of minimum wages with the benefits and drawbacks for workers and the economy. 

Advantages Disadvantages
  • Higher living standard for employed workers
    – Some protection from abusive employment conditions
  • Some income stability to facilitate financing while employment conditions remain
  • Increased unemployment caused by moving wages out of equilibrium (see chart)
  • Makes businesses less able to weather low pricing or economic downturns due to high fixed costs

For the the sake of openness and to frame my arguments, my political views lie in the centre. I believe that 

Effect of a Minimum Wage on Labour Supply and Demand
  • a minimum wages together with unemployment benefits are a net positive for society; and
  • a viable alternative may be the universal basic income (UBI) concept with no additional unemployment benefits and no minimum wage.

I support these views for the following reasons 

  • that there are many highly exploitable people at the bottom of the economic pyramid with poor education and little understating of their rights. I believe a small sacrifice to support these people with their basic living expenses is important as a society. 
  • When people can pay their bills by legitimate means, they are less likely to turn to crime to support themselves illegitimately. 
  • A UBI with no minimum wage or unemployment benefits provides lower costs to businesses, lower friction to start a business and a direct incentive to undertake employment as workers do not have to sacrifice unemployment benefits to do so.

Now think about how these views contrasts with the fair wage concept. Similar to a minimum wage, the fair wage scenario will lead to higher paid employees at the expense of fewer viable coffee businesses and fewer employment opportunities within those businesses. 

The difference between the models I approve of and the fair wage concept is that the coffee industry doesn’t have the resources to provide unemployment benefits the way that a country can. This leaves vulnerable workers, who would otherwise be employed on the coffee fields, unemployed with no government benefits to support them. Due the increased supply of unemployed coffee workers, it also puts downward pressure on wages in other regional industries, such as factories or non-fair wage coffee farms. 

Essentially, a fair wage for coffee workers improves the living conditions for those employed under it but damages the living conditions for all other workers in the region, including coffee workers at non-participating farms. This probably produces some benefit for the owners of these businesses, but I doubt that improved margins through the lowering of general wages is a typical goal of fair wage scheme.

US Treasuries or coffee farms – A risk free return

To pay for a fair wage, one of the most common solutions is to establish a minimum purchase price, or a fair price, for coffee. This is most often paid a as a minimum price per pound which calculated as the cost of production plus a margin. This causes the following problems that have been discussed extensively in the industry:

  • results in quality problems as farmers will only sell cheaper non-premium coffees into the schemes due to the higher that fare trade prices available for speciality coffees anyway;
  • results in higher compliance costs that necessarily exclude many of the poorer farmers in the world from joining; and
  • slanted towards participation by large, low cost producers as smaller producers often still make a loss on the fair prices. 

What isn’t discussed often is the larger disequilibrium effect that this creates in the industry. To do this, I’m going to use Brazil as a proxy for all schemes designed to artificially inflate prices.

Despite protests complaining that they are not making money and that the minimum price isn’t high enough, Brazilians coffee farmers are part of the world’s largest fair price coffee scheme. This provides them with unparalleled stability to access finance for investments to grow their businesses. The unfortunate reality of the scheme is that, with high costs and limited education, small holders are still likely to be out of the money. 

At the large scale end of the industry, big players are the ones making investments in new technologies and economies of scale that drive costs down with the government hedging their risk of being out of the money. It is these large producers who have boosted the nation’s overall production even as prices have continued to decline. From 2014 to 2018, Brazilian production increased by as much as Guatemala, Nicaragua, Costa Rica, El Salvador and Ecuador’s 2018 combined total production.

ICE Coffee Futures Price Chart

Similar to the fair wage side-effects, a fair price for coffee has supported the largest producers in Brazil with a larger market share, lower risk and higher profits at the expense of all other producers. Also like a fair wage, the impact is felt by non-coffee workers in coffee producing areas as employment opportunities are diminished and downward pressure is put on wages.

Schemes that promote fair minimum prices for coffee are essentially taking the Brazilian model and spreading it around the world. It feels good at the household level where you can see the difference of paying a little extra, but imagine the impact of scaling this program up to a national or global scale. We are again faced with the problem of large scale industrial farmers in the program able to make investments to increase production and reduce their costs while farmers outside the program face a glut of subsided coffee in a market that they are unable to access on a level playing field. 

Even in the case of producers having equal access (such as in Brazil), larger producers who scale up to take advantage of the massively reduced risk drive down the overall market price below the level where small scale producers can compete (such as in Brazil). As with other failed agricultural support programs, this leads to the necessary disposal of supply surpluses as production growth continues unabated.

To be clear, I don’t have a problem with larger, more efficient producers rising to the top and taking on larger market shares. What I do have a problem with is that they are being subsidised to do so.

But, but, but…

I anticipate the question: “what if we only use the project to support small holders?”. To which I would reply: “At what scale? Should we only include a handful of small land holder too tiny to make a pact the market? If so, what is the point of doing it all?”. 

Romantic as the ideas behind these schemes sound,, small holder’s cost of production is much higher than larger producers for the same quality. Should we as an industry be paying twice the price for the same thing just because the producer is smaller? Why wouldn’t a larger business not simply carve itself up to take advantage of these higher prices if size is what excludes them?

We pay premium prices for the coffee we buy because it is premium coffee. I honestly don’t think the producers we deal with wouId sell me coffee below what they think they could make elsewhere anyway. They also understand that they need to get rid of their lowquality coffee to cover costs too. It is not always profitable, but they adjust their production and pricing to do the best from the market each season. These adjustments are what keeps everyone’s production in line with the market.

While using a minimum price scheme may feel good on a personal level, what they are really doing is exacerbating the very problems that caused the low market price in the first place.

I want to do something.. can we actually do anything?

Spread awareness

As an adherent of free market economics, I’m against trade barriers in any form. What Brazil and fair price schemes are doing is distorting the market for the benefit of their large producers while everyone else suffers. 

Colombians are now petitioning their government for a similar program. Such a program would likely end up further driving down market prices, supporting the large producers and leaving the small holders worse off. 

Spreading awareness about the negative side affects of these well-intentioned schemes is important. The more countries that end up manipulating the coffee markets, the less balanced the global trade will become.

Break down the barriers

Punitive tariffs on Brazilian coffee may help pressure the nation to change its ways but, given that most coffee consuming countries are not also producers, this is an economic lose-lose option. Heads, tariffs are imposed causing coffee consumption prices increases, or tails, Brazil removes its subsidies causing coffee consumption prices increases. I don’t see this winning much political support in consuming nations.

To address this, the International Coffee Organization (ICO) could be used as a platform by member states to put pressure on Brazil to end its marketdistorting activities. Brazil has done fantastic work in terms of boosting coffee production productivity and domestic Brazilian coffee consumption. Perhaps a coffee free trade agreement among producing nations and a commitment to promote coffee to their respective domestic populations would be an attractive enough inducement to change their ways. This would create stable domestic markets for producers as well as boost trade and investment amongst themselves. For Brazil, their opportunity lies in their wealth of experience, technology and capital that could greatly benefit production in other coffee origins.

Promote efficiency over subsidy

Traders get a lot of flack in the industry due to the additional costs they add. Additional costs, however, don’t mean they actually cost more. Consider the following advantages and disadvantages of dealing with a trader:

Advantages Disadvantages
  • A trader can spread their sourcing and logistics overheads over more coffee than a small buyer to reduced delivered cost per pound.
  • Traders can often buy up all of a producer’s stock in one contract allowing the producer to minimise their sales overheads.
  • Coffee production warehouses are often not ideal for long term storage of coffee. Traders can take on the quality risk in a coffee and move coffee to better facilities to increase longevity.
  • Traders often deal with several producers in one region and have many customers to sell to. This provides stability of supply to buyers and sales to the producer. A small buyer facing a business disruption can cripple a producer if they can’t take their usual allocation.
  • Traders need to make a margin which increases the cost of coffee. Are they increasing the cost more than the equivalent cost per pound of direct sourcing small lots?
  • Transparency of origin can be lost or tainted by having coffee pass through many hands to reach them, though is becoming less of an issue with blockchain traceable coffees becoming more common.
  • Producers and end users can often achieve better prices by dealing directly with each other, though both sides also take on higher costs to facilitate these small transactions.

One of the keys to improving the well-being of coffee producers is to make the process of trading and distribution more efficient. Modern online marketplaces with sophisticated backend logistics systems can significantly bring down the cost of brokering coffee. By becoming more efficient, traders are able to move the supply and demand curves closer to equilibrium benefiting both buyer and seller, while also maintaining a margin.

A direct buyer who takes on costs over and above the margin of the trader will end up a) taking a hit on their own margin or b) passing on the additional costs to their customers. Basic economics tells us that additional costs to the end consumer will result in fewer purchases and will necessarily shift the demand supply curve such that the producer sells less for a given price per pound. 

A highefficiency trading system does the reverse. It provides end consumers with a better price for the same product which then shifts the demand supply curve such that the producer sells more at that same price.

Commit to the future

Think about establishing a long term multi-season supply contracts with producers. Signing a contract to buy coffee at an inflationadjusted price over many years will allow your producers to access better financing, to manage their production around your needs and to focus on tasks other than marketing. You’ll have to consider how to handle non-performance on quality and/or quantity, but will make a much bigger difference to your producers than participating in a minimum price scheme on an ad hoc basis. Coffee production is a long term process so, when I buyer is committed, quality and quantities can be adjusted to meet the demand. When producers don’t have a stable outlet for their product, a  buyer’s change of heart or change of fashion in the industry can destroy a farmer’s livelihood. 

Final thoughts

Too much conversation regarding coffee farmers speaks as if they are participants some sort of global welfare program. However, I don’t think I have ever met a coffee farmer who would prefer to be thought of as a charity case than a business partner. 

By committing to the long term, investing in technologies and processes that make coffee purchasing, distribution and marketing more efficient and not supporting marketdistorting behaviour, we shift the demand supply curve in the direction of improving global coffee consumption to the benefit of all. 

By implementing price floors and minimum wage controls without a state-backed safety net, all we are doing is supporting the big coffee producers while we drop some of the world’s most vulnerable citizens through the cracks.

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