Trading Fair

The slippery slope of industry self-regulation.

Although we spend a great deal of time teaching children to think critically, it actually does not take a great deal of insight or education to uncover moral flaws in the world around us. For example, when it comes to the market economy, no one has much difficulty coming up with an objection to the arrangement under which affluent western consumers line up to pay $3 for a fancy cup of coffee, while the farmers who grow the coffee beans earn less than that in a day.

Indeed, the hard part is not really spotting these problems, but figuring out what to do about them. Some people are quite optimistic that solutions can be found. The great economist Kenneth Arrow once declared that “when the market fails to achieve an optimal state, society will, to some extent at least, recognize the gap and non-market social institutions will arise attempting to bridge it.” Would that it were so!

Arrow made this remark in 1963, in the context of a prescient discussion of health care, where he pointed out that the combination of uncertainty and ignorance made it very difficult for ordinary commercial transactions to take place in this area. (As a patient, you have little choice but to trust your doctor. But if your doctor is just trying to make money, like Adam Smith’s infamous “butcher and baker,” then why ever would you trust your doctor?)

Arrow’s response to this was in many ways typical of mid 20th-century optimism about our capacity to respond effectively to market failure. With respect to health care, his thought was that some people genuinely do have specialized medical knowledge, and other people are not only in need of this knowledge but are willing to pay good money for it. Thus there is a mutually beneficial transaction that is simply waiting to occur. If the parties are unable to organize this transaction using the resources of ordinary commercial law, then they will begin casting about for other institutional arrangements that can make it happen.

What is striking about the example of doctors and healthcare services is that the “non-market” institution that arises, which allows the parties to work around the market failure, does not require government intervention. In this respect health care is quite different from other markets. To the extent that you trust the butcher, it is because you know that there is a government inspector in every single slaughterhouse, with the power to close down the entire operation in response to even a single infraction. The trust that you have in your doctor, by contrast, is not achieved primarily through government regulation and oversight, but rather through professional self-regulation on the part of doctors.

This serves as an important reminder that not every market failure needs to be resolved by the state. Market actors themselves often have an interest in correcting these failures (or can be persuaded to develop such an interest). So the mere fact that there is pollution, or safety problems, or exploitation, does not automatically mean that the government needs to get involved. It is far too easy to make the jump from saying “Someone should do something about this!” to saying “The government should do something about this!”

This observation is one that acquired greater significance toward the end the 20th century and into the 21st, thanks to waning enthusiasm for the regulatory state and, beginning in the 1980s, the growing power of political actors committed to deregulation. In part this was due to the very success of regulation, particularly in the areas of environmental and consumer protection. Since the low-hanging fruit was the first to be picked—the regulations that would produce the greatest benefit at the lowest cost were the first to be implemented—over time regulation began to extend into areas where the ratio of benefits to costs did not favour state action quite so obviously.

The problems are well known: the law is a blunt instrument; compliance and enforcement costs can be significant; regulation creates rigidities, making it difficult for market actors to respond flexibly to new circumstances. Furthermore, with increased international trade, market actors began to encounter problems stemming directly from the limits of state power. (Canada can set the terms for logging in its own forests, but it has no power over the way that timber is cut in Indonesia.) As a result of these forces, western governments became both less willing and less capable of regulating. Social activists therefore became more and more interested in working around the state, in many cases trying to deal directly with private actors to resolve some of the problems caused by poorly structured markets.

This confluence of circumstances gave rise to the development of what is known as private governance—namely, initiatives taken by private actors that start with the bare bones rules that govern market exchange, then layer over them a more demanding set of constraints aimed at improving environmental stewardship, improving labour standards, and so on. Perhaps the most important form of private governance to emerge in the past few decades has been the voluntary certification systems in certain sectors. Most consumers are aware of these because of fair trade coffee (and, to a lesser extent, organic vegetables). But voluntary certification has also been an important force in forestry and seafood.

Some of the pioneering academic work on the subject of self-regulation has been done by a klatch of Canadians: Ben Cashore, Graeme Auld and Steven Bernstein. Auld’s new book, Constructing Private Governance: The Rise and Evolution of Forest, Coffee and Fisheries Certification, is a comparative study of the rise of voluntary certification. Although aimed at an academic audience, it contains material and analysis that will also be of interest to anyone with a practical commitment to improving and extending business self-regulation. This is primarily because private governance has not been an unequivocal success in any of these areas, and so it is useful to compare the different sectors to see what patterns can be found, and which strategies have proven more or less effective.

In order for any of this private governance to get off the ground, there must be some deviation from the intensely competitive conditions that govern a standard commodity market. If products are entirely undifferentiated, then the only thing left to compete on is price, which in turn does not leave much room for social responsibility. The lowest-cost producer simply wins.

There are, however, many markets where these conditions do not prevail, and so producers have some respite from the tyranny of the lowest price. The first deviation occurs in markets where there is significant international trade. As is well known, states impose a wide range of restrictions on goods that are exchanged internationally, and so market competition is almost never straightforward. Furthermore, different states impose vastly different regulatory conditions, with developing countries often having much laxer standards. This provides an important point d’appui for the emergence of certification standards, since not only western consumers, but often western retailers, not to mention western governments, are less than enthusiastic about purchasing goods that are produced under conditions that would be illegal domestically.

Because of this, an arrangement similar to the popular ISO standards (issued by the International Organization for Standardization) provides one template for the emergence of certification systems. This is the model that has developed most clearly in the forestry sector, for example, with the Forest Stewardship Council certification program, which provides one instance of what Auld refers to as a “global-first” initiative.

The second major deviation from the competitiveness of standard commodity markets involves the role that brands play in consumer markets. It has often been observed that, although tap water is free, consumers have demonstrated a willingness to pay as much as $8 per litre for tap water that has been filtered and bottled by the Coca-Cola Company. So obviously price competition is not the major driving force in this market. This gives rise, quite naturally, to the idea that “ethical” sourcing or production might become a part of brand identity, or that it might even become the brand.

Thus the second major template for the emergence of a certification system is that it might function like a brand—underwritten, ultimately, by the willingness of consumers to pay a premium for products that have the certification. This is the business model that has predominated in the coffee sector, particularly with the various fair trade programs, which are an instance of what Auld refers to as a local-first initiative.

Now, of course both timber and coffee are traded internationally, the latter in great quantities. The primary difference in strategy, Auld observes, is that forestry is subject to significant barriers to entry in both production and retail, which means that it is very difficult for new firms to get into the business. Coffee, on the other hand, has very low barriers to entry at every level, in growing, roasting and retail. Fishing, by contrast, is more like forestry, because even though the industry has relatively low capital requirements, most states manage access through long-term permits or quotas, which are already fully allocated.

It is obvious once Auld says it—but only after he says it—that these barriers to entry are going to be a crucial determinant of which strategy is effective. With low barriers to entry, certification systems can emerge like brands, in a local-first way, simply because there is very little to stop someone from setting up a coffee shop, roasting their own beans, sourcing them from suppliers who produce it under conditions that they approve of. With forestry, by contrast, because of barriers to entry, there is little choice but to work with existing firms. Thus one must approach the entire initiative from a different angle, in order to get buy-in from the major industry players.

This is just one of many insights to be gained from Auld’s book, which contains a wealth of material, all presented in a cogent and accessible format. He has done an admirable job of separating out the different threads that make up the complex skein of initiatives and interests in each of these different sectors. If there is any criticism to be made, it is perhaps that he takes the social science thing too far, producing an analysis so dispassionate that it is difficult to tell which overall approach he favours. I came away with the sense that he leans in the direction of the forestry model, because it has achieved an outcome closer to what regulation might achieve. The local-up initiatives, by contrast, are not only plagued by a hodgepodge of overlapping labels and certification systems, but are also often limited in their ambitions.

If Auld plays his cards a bit too close to his chest, Gavin Fridell is very much the opposite. His recent book, Coffee, which appeared in Polity Press’s “Resources” series, is actually not so much about coffee as it is about the injustice of the world, as illustrated by the case of coffee. Fridell is the sort of writer who finds it important to observe that the hardships suffered by farmers as a result of failures in the Central American coffee crop, ostensibly caused by leaf rust, are actually the consequence of “an unequal and unjust global coffee economy forged through the actions of imperialist and autocratic states over hundreds of years of colonialism, slavery, and the expansion of the capitalist world system.”

Perhaps needless to say, Fridell does not have much enthusiasm for the forms of private governance that interest Auld. Indeed, he tips his hand at the outset of the discussion, when he chooses to refer to them as “neoliberal governance” initiatives.

And yet, for a book that is entirely focused on the injustices of the world system (including, incidentally, the complicity of nation-states through the “coffee statecraft” they practise) Fridell says almost nothing about his own framework of assessment. One gets the sense that his visceral reaction to the contrast between affluent western consumers and impoverished coffee farmers is so strong that it relieves him of any sense of the need to produce an argument to show that the former are exploiting the latter.

More problematically, Fridell does not feel any need to show that the inequalities at work in the coffee sector are somehow greater, or more egregious, than the inequalities that characterize the production of any other agricultural good. Even a simple comparison chart between coffee and, say, corn, rice and maybe cacao, would have been highly informative.

Coffee does have two features that might make it at least slightly distinctive. The first, as Auld notes, is that it has very low barriers to entry. It is simply not hard to get into the coffee-growing business. This makes the market intensely competitive, and thus puts constant downward pressure on the price of green beans. The second feature is that it takes between two and five years for the bushes to reach maturity, as a result of which the market is more likely to suffer from periodic gluts and shortages.

What this all adds up to is that an individual coffee farmer, working a small plot of land, is going to be leading a poor and precarious existence, because the value of the product is not very high and the prices are volatile. And yet one is tempted to describe this, not so much as an injustice, but rather as just an immediate consequence of engaging low-productivity, non-mechanized, monocultural agriculture.

The standard prescription is to change the conditions of production, through mechanization and increased scale, intensification through green-revolution technology, and diversification to protect against volatility. Yet Fridell appears to reject all of the latter expedients, in favour of some combination of price supports and welfare-state transfers. This is a controversial position, and yet it is not clear how he gets there. Given that the entire book is motivated by social justice concerns, one would like to see the structure of the moral argument laid out explicitly.

And yet if Fridell’s ideal seems utopian, the real world of private governance that Auld describes falls desperately short of what we require. The easy optimism that Arrow expressed, when he suggested that non-market institutions will naturally arise to correct flaws in existing markets, remains more of a pious hope than an empirically supported generalization. There can be no doubt that people try to create these institutions, but the obstacles that they face are formidable.