Fair Trade and Free Entry: Can a Disequilibrium Market Serve as a Development Tool?

The Fair Trade coffee initiative attempts to channel charity from consumers to poor producers via increased prices. Though widely heralded, we show that the rules of the Fair Trade system permit complete arbitraging away of rents due to costly excess certification of output. Using data from an association of coffee cooperatives in Central America, we verify that arbitrage on this margin causes almost complete dissipation of producer rents, and that realized producer benefits are negative when the floor price does not bind. Our results illustrate how free entry undermines the attempt at extending charity via a price distortion in an otherwise competitive market.