Fair trade: a third generation welfare mechanism to make globalisation sustainable 1. CEIS Working paper n. 170

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1 air trade: a third generation elfare mechanism to make globalisation sustainable 1 CEI Working aer n. 17 Leonardo Becchetti University of Rome Tor Vergata, Deartment of Economics, Via di Tor Vergata snc, 133 Roma. becchetti@economia.uniroma2.it abrizio Adriani University of Rome Tor Vergata, Deartment of Economics, Via di Tor Vergata snc, 133 Roma. marini@economia.uniroma2.it Abstract Globalisation of roduct and labour markets has dramatically evidenced the market failure generated by the monosonistic /oligosonistic oer of buyers of labour (lo value added roducts) from unskilled orkers (subcontractors). The absence of a global benevolent lanner and unequal reresentation mechanisms in international institutions revent a reduction of this imbalance of bargaining oer beteen emloyers and orkers ith traditional elfare aroaches (such as minimum age measures). In our model e sho that, under the existence of an even minimal share of altruistic consumers in the orth, the intervention of a global benevolent lanner and the reform of international trade rules may be artially relaced by a (orth-outh consumers) Pareto imroving bottom-u elfare aroach directly romoted by consumers of the final roduct. 1 The authors thank Luca Deidda, Jean Paul itoussi, Robert Holtzmann, Luigi Paganetto, Alessandra Pelloni, urio Rosati, Pasquale caramozzino, Paul Watchel, Roberto Zecchini and all other articiants to the seminars held in OA London and in the University of Tor Vergata Rome for useful comments and suggestions. CEI financial suort is acknoledged. The usual disclaimer alies. Corresonding author: Leonardo Becchetti. Università Roma Tor Vergata, acoltà di Economia, Diartimento di Economia e Istituzioni, Via Columbia 2, 133 ROMA. Tel ax , Becchetti@economia.uniroma2.it.

2 Introduction Proer economic rices should be fixed not at the loest ossible level, but at a level sufficient to rovide roducers ith roer nutritional and other standards." (John Maynard Keynes, 1944) The rocess hich e call globalisation 2 has dramatically reduced transortation costs and deely modified geograhical atterns of trade around the orld. 3 By easing the time-sace constraints (at least in virtual communications) this technological revolution has increased interdeendence among individuals. The increased interdeendence has enhanced roblems related to global ublic goods or bads and to social costs from market failures generated by missing or insufficient global governance. A tyical emirical finding hich is artly associated ith globalisation of labour and roduct markets is increasing age skill differentials (Deadorff, 2; eenstra-hanson, 21). 4 While suerstars (and high skilled orkers) take advantage from the extension of demand and are not 2 Among the driving forces of globalisation are the sudden acceleration of orldide economic integration under the rinciles of market economy, on the real side, and the increasing freedom and seed of caital movements on the financial side. These henomena have been stimulated and accomanied by a orldide technological revolution originated by the rogressive convergence of softare and telecommunications and fostered by digital technology advancement. 3 eenstra (1999) documents the henomenon of disintegration in roduction by shoing a significant rise in the ratio of imorted to domestic intermediate inuts and in the ratio of merchandise trade to merchandise value added in OECD countries in the last decades. Other authors refer to the henomenon as de-localisation (Leamer, 1988), vertical secialisation (Hummels et al. 21) and slicing the value chain (Krugman, 1995). 4 Katz and Murhy (1992) sho that the graduate/undergraduate age ratio for orkers ith 1-5 years of orking exerience rose from 1.4 to 1.9 during the 8s. Katz and Krueger (1998) find that college orkers ages rose by 25% from 197 to 1995, against an average yearly decline of.11% beteen 194 and 197. The trade and age debate highlights to main concurrent exlanations for increasing skill age differentials ithin industries: technological innovation and outsourcing ithin industries of the least skillintensive rocesses to develoing countries (Rodrik, 1999). 2

3 harmed by the increased cometition, untalented orkers share no benefit from the enlargement of roduct markets hile aying costs for the increased cometition ith unskilled orkers from different countries. 5 In this frameork, unskilled orkers in the rimary roduct industry (above all in the agricultural and textile industries) find it difficult to ste u the skill ladder as subsistence age levels and tariff and non tariff barriers 6 imosed by develoed countries revent them to accumulate resources hich could be invested in human caital to increase their roductivity. 7 Traditional elfare aroaches are unable to solve these roblems in trade and international labour markets due to conflicts of interests among different countries and undereresentation of the interests of the oorest countries at the international level hich revents the insurgence of a Ralsian global benevolent lanner. The overty tra in hich lo skills lead to reduced bargaining oer and monosonistic labour market conditions is ell knon to economists. everal olicy roosals of redistribution of income toard lo skilled orkers have been advanced in the last to decades (Dixit and orman, 1986; Akerlof et al. 1991; Phels, 1997). The roblem is that all these schemes are conceived to be administered by domestic governments and therefore, tend to care only for 5 The toler-amuelson theorem suggests that trade integration should benefit the factor hich is locally abundant and therefore lo skilled orkers in develoing countries. This theorem holds only in case of erfect cometition and cannot be alied if urchasers of intermediate roducts from the orth have excess market oer. 6 The 22 Oxfam reort, foreorded by A. en, calculates that tariff and non tariff barriers cost to develoing countries around 1 billion dollars er year, tice as much as these countries receive in terms of international aid (Oxfam, 22). The reort also highlights that the increase by one ercent of ub-aharan countries share of orld trade could bring 12 million eole above the overty line. 7 The emirical literature confirms that secialisation in rimary roducts is harmful to groth (achs-warner, 1997; ala-i-martin, 1997) and is associated to relatively higher levels of child labour (Becchetti-Trovato, 22). 3

4 domestic unskilled orkers, hile it make sense to include the ell-being of agents in other countries ithin any elfare criterion (eenstra, 1998). Therefore it is highly likely that neither overindebted local governments, nor domestically oriented governments of industrialised countries ill take care of the elfare of unskilled orkers in develoing countries. In this aer e argue that a artial solution to this roblem may be found by devising bottom-u elfare mechanisms in hich socially resonsible consumers in the orth do the job. To understand hat e mean for bottom-u elfare consider economic develoment as deending on the interaction among three oers (firms, institutions and citizens) (igg. 1a). (Becchetti-ucito, 2) In this orld rofit maximising firms take their investment, roduction and hiring decisions ithout considering the negative externalities that may otentially be generated by their roductive activities. Individuals take their consumtion and saving decisions on the basis of a narro definition of their references hich does not include social resonsibility among their arguments. Peole in the institutions are far different from the benevolent lanners and maximise their stay in oer. In domestic institutions they try to satisfy the needs of domestic citizens-voters, hile in international institutions they tend to satisfy the needs of eole living in those countries hich have dominant voting oer in those institutions. The interaction among these three forces (firms, institutions, citizens) generates insufficient momentum for the solution of the existing market failures. 4

5 Let us no comare this ith a more virtuous icture in hich bottom-u ressures are at ork (ig. 1.b). The third illar of the system no includes a small share of voters hose voting, consuming and saving decisions are affected by social and environmental concerns. Even though they are a minority, they significantly influence the behaviour of rofit maximising firms hose economic and financial success deend on small changes in market shares, revenues and rofits. Institutions are nonetheless affected as oliticians try to reresent issues of these grous once in oer not to loose their olitical suort. To sum u, the one described above is a bottom-u elfare mechanism hich may be considered as a set including all those measures (such as ethical finance, ethical banking or fair trade) hich endogenise the active role layed by socially resonsible consumers/savers that may crucially affect the behaviour of firms and institutions ith their choices (see igures 1-2). 8 Within the above described frameork this aer aims to analyse the theoretical features of an imortant bottom-u aroach called fair trade. The aer is divided into five sections (including introduction and conclusions). In the second section e rovide a definition of fair trade and a brief descrition of its characteristics shoing ho fair trade includes a bundle of socially resonsible ansers to existing market 8 Bottom-u elfare may be vieed as a third generation elfare mechanism (coming after and comlementing the benevolent lanner, and the reform of the rules aroaches) hich is much less unrealistic than the first to. Recent history demonstrated, and many economists agree, that the benevolent lanner is a myth (Easterly, 22), hile the existence of significant market shares for socially resonsible consumtion and saving reveals that individuals ith socially resonsible references do exist in the reality. 5

6 failures ith hich civil society sulements the limits of existing trade rules. In the third section e ill sketch a simle model to investigate ho only one feature of fair trade, the determination of rices, may contribute to solve some secific market failures. In this section e sho that the resence of fairness concerns in the absence of a fair trade market may reduce elfare in the orth and in the outh, hile the creation of fair trade mechanisms may generate a Pareto imrovement for both consumers in the orth and in the outh. The introduction of fair trade is also shon to have imortant indirect effects on traditional roducers hose reaction to changes in labour suly and market demand generated by fair traders may have the effect of increasing their social resonsibility. 2. A definition of fair trade air trade is a articular trade channel in hich food and textile roducts hich have been roduced in develoing countries resecting a series of social and environmental criteria are sold in the industrialised countries. These criteria, defined by the air Trade ederation (T), are: i) aying a fair age in the local context; ii) offering emloyees oortunities for advancement; iii) roviding equal emloyment oortunities for all eole, articularly the most disadvantaged; iv) engaging in environmentally sustainable ractices; v) being oen to ublic accountability; vi) building 6

7 long-term trade relationshis; vi) roviding healthy and safe orking conditions ithin the local context; vii) roviding financial and technical assistance to roducers henever ossible. The fair age/rice criterion states that in the rice aid to roducers in the LDC countries a much higher share of the value of the roduct must be transferred to them than hat is usually the case. The fair trade organisation (TOs) achieves this goal by reducing the intermediation chain through direct imort and distribution of roducts through non rofit retailers (the orld shos ). In this ay local roducers revenues are u to 3-4 times higher than those earned through traditional trade channels. The TOs also fix a minimum rice threshold hich insures roducers from the high volatility of market rices of their roducts. The bilateral definition of a rice different from the market one has sound microeconomic grounds. We must consider in fact that, traditionally, trade in rimary roducts occurs beteen a monoolistic/oligoolistic transational comany hich buys from a large number of atomistic LDC roducers at a rice hich is affected by the relative bargaining oer of the to counterarts. The fair trade rice may therefore be ideally considered as the market rice hich ould revail if the to counterarts ould have equal bargaining oer and may therefore be vieed as a non governmental minimum age measure taken by rivate citizens in develoed countries. 9 9Minimum age under erfect cometition may have erverse elfare effects reducing labour demand and increasing unemloyment (Basu, 2). This is obviously not the case hen the age rises from its equilibrium level to the erfect cometition level in a 7

8 Using rices as a olicy instrument to transfer resources to the outh cannot be considered a market distortion also because the fair trade oens in the orth a ne market here contingent ethical roducts are sold (fair trade coffee is a different roduct from traditional coffee exactly as an umbrella hen it rains is not the same roduct as an umbrella hen it does not rain). In this sense e may argue that fair trade is a ste forard market comleteness hen consumers references include social resonsibility. Another imortant oint in fair trade rinciles is that roducts sold must be environmentally and socially comatible. In this resect e must not confuse fair trade ith ethical labelling hich often hides forms of strategic non tariff barriers from the orth to the outh. By realistically romoting orkers elfare, by transferring resources to households through the fair rice mechanism and by not banning child labour, fair trade tries to remove causes of children underinvestment in human caital ithout creating social non tariff trade barriers. A third feature of fair trade roducts is the rincile of transarency. Labels of T roducts must contain as much information as ossible on roduction costs, holesale rices and nutritional characteristics. Transarency is fundamental to maintain reutation hich is the crucial cometitive factor for ethical roducts. monosonistic labour market. Recent emirical aers confirm that, hen orkers have lo skills and are easily relaceable, labor markets tend to be monosonistic or oligosonistic. Card and Krueger (2) find that minimum age introduction has ositive imact on outut and emloyment in the fast-food market in e Yersey and Pennsylvania. heerd and Ross (2) exlain this result as the tyical effect of the introduction of a minimum age measure in a monosonist labour market. 8

9 Other imortant features of fair trade rojects are: i) anticiated financing of investment for LDC roducers; ii) the destination of the surlus rovided to local roducers through increased revenues to rojects hich reinforce the rovision of ublic goods (health, education) to local communities; 1 iii) the long run artnershi beteen the fair trader and roducers in the outh hich leads to the construction of international social caital and to the rovision of exort services and roject consultancy, thereby creating ositive learning through exort effects. Anticiated financing of roduction may be seen as a solution to the tyical roblem of credit rationing hich hassles many small non collateralised roducers. On the other hand, the referential inclusion in the fair trade list of roducts for hich this surlus is devoted to the rovision of ublic goods to local communities is an interesting examle of rivate-rivate transfers from the orth to the outh hich offset the incaacity of highly indebted governments of roviding ublic goods to their oulation. The recent history of foreign aid suggests that it is more efficient to channel resources through civil society organisations hen strategic goals of the donors are relevant and corrution of domestic governments is high (Easterly, 22). rom hat considered above the fair trade emerges as a otential solution to some imortant market failures. 11 The model hich follos ill try to 1 air trade roducts are beginning to achieve significant market shares. They catured around 2% of the ground coffee market in the EU and about 15% of the banana market in itzerland in the year In 1999 the Euroean Commission issued a document on air Trade ( COM(1999) 619. In its introduction it is stated that "air trade" is an examle of 9

10 exlain ho this may occur by analysing the effects of only one of its features: the rice. 3.1 The model Preferences Individuals in the orth consume a single good (hich e'll call x) that is internationally traded but consumed only in the orth. We assume an uniformly distributed continuum of consumers indexed by the arameter (,1). Individual references are ''ethic'' in the sense that consumers refer to consume a good hose roduction does not involve exloitation (see belo). In site of it, individuals are heterogeneous in the relative eight of their references given to the fairness of the good. More secifically, their utility is increasing in both the quantity and the fairness of the consumed good but the relative imortance of fairness and quantity varies across individuals. Therefore e assume: U(q,g,h,)=(gh) q 1- ; (,1) (3.1.1) Where q is the quantity of the consumtion good, g {1,ρ (,1)} is a qualitative variable taking value 1 if the good is considered ''fair'', ρ<1 otherise. In this section e consider ''unfair'' a good roduced by labor develoment occurring through trading relationshis and imroved commercial oortunities to bridge the ga beteen develoed and develoing countries and to facilitate the better integration of develoing countries in the orld economy. "air trade" initiatives give consumers the oortunity to contribute toards sustainable economic and social develoment in develoing countries through their urchasing references. The Commission rovided financial suort for research and education on fair trade to GOs ithin the EU (3,7 millions of Euros in 1998). More recently, in July 21, the Commission issued a Green Book COM(21) 366 to romote firm social resonsibility in the Euroean frameork. Large art of the Green Book deals ith fair trade issues. 1

11 force remunerated less than the value of its marginal roduct. h {1,θ R + } is again a qualitative variable taking value 1 if the good is roduced in the orth and θ if the good is roduced in the outh. The h variable takes into account the national comonent of altruism in the references. Therefore, e say references are ''national equality concerned'' if θ<1, i.e. consumers refer coeteris aribus the orth roduct, references are ''international equality concerned'' otherise. By insection of the references it is clear that lo individuals take their utility mainly from the quantity consumed hereas high individuals mainly from roduct fairness. Each individual in the orth is endoed ith units of labor (hich ill generate units of hatever roduct). Denote by the subscrit the variables in the orth and let be the market age for units of labor. The budget constraint is: q = (3.1.2) here = if the good is roduced in the orth and = if the good is roduced in the outh Production in the orth We assume that markets in the orth are fully cometitive. When age is equal to all the labor force is emloyed. The labor that is not allocated in the roduction of the good is allocated in other sectors of the economy. We assume constant returns to scale in the technology. Let e (,1) 11

12 denote the segment of individuals emloyed in the orth. The zero-rofit condition imlies: or: e ( ) de = (3.1.3) = (3.1.4) Production in the outh The consumtion good can also be roduced in the outh. outh roduction is erfect substitute for orth roduction (neglecting ethical concerns). Desite it, e assume that the good is not consumed there. outhern individuals consume an internationally traded good (say, y) hose rice is set equal to 1. We assume an uniformly distributed continuum of orkers in the outh. These orkers are indexed on the basis of their reservation ages. Unemloyed individuals are assumed to be self-emloyed. Desite market roductivity is assumed to be homogeneous across agents, the self-emloyment roductivity is heterogeneous. Let e (,1) denote the osition of a generic individual on the (,1) segment. The e individual is able to roduce Y(e)= e units of good y by self-emloyment. Therefore, his reservation age is (e)= e. By insection of the labor suly, there is full emloyment in the outh hen the age is =. We assume that the labor market is not fully cometitive ith ages being set by a monosonist. The monosonist's rofit maximization roblem can be stated as: 12

13 e max ( ( e )) de (3.1.5) e (,1) olving the roblem e obtain the folloing labour demand equation: e = (3.1.6) 2 The orth market for good x is a erfectly cometitive one. The Monosonist is therefore assumed to be rice taker on that market Equilibrium in Absence of air Trade In this section e assume "international equality concerned references", i.e. θ>1. This imlies that roducing the good in the orth is, to some extent, inefficient. In this case the first best solution ould be sulying and consuming only the fair outh roduct. We start by describing the aggregate demand. The indirect utility function for the individual in the orth is: 1 U ( ; ; ) = (3.1.7) In the case he buys the orth roduct or: 1 U ( ; ; ) = ( ρθ ) (3.1.8) if he buys an unfair outh roduct and: 1 U ( ; ; ) = θ (3.1.9) if he gets a fair outh Product. When = the best solution for the consumer is to consume a fair good from the outh for each individual. In the remainder of this section e sho that it is not otimal for the 13

14 monosonist to suly such a good. The monosonist has to otions. On the one hand, he can roduce a fair good by aying the marginal roduct of labor to its orkers, getting the hole demand in the orth and ruling out orth roducers from the market. On the other hand, he can roduce an unfair good, set a rice < and get only the less ethical fraction of the demand. In the latter case, the rice needs to be loer than because the orth roduct is strictly referred to an unfair outh roduct. Proosition It is otimal, for the Monosonist, to suly an unfair good, even in resence of ethical traders. Proof. uose the Monosonist sulies a fair good. In this case it must hold: = (3.1.1) ubstituting into the Monosonist's rofit function yields zero rofits. uose instead that the monosonist decides to exloit his market oer. Denote by the individual indifferent beteen consuming an unfair good at rice < and the orth good at rice, i.e.:. t. 1 1 s ( ρθ ) = (3.1.11) The market clearing condition is: e de = d (3.1.12) or: e = (3.1.13) 14

15 here the left hand is the monosonist's suly and the right hand the demand faced by him. Plugging into the otimal level of e found in the revious section and solving for the rice yields: s = ( 2 ) 1/ 2 (3.1.14) otice that < requires <1/2. We ill sho later that this condition is indeed satisfied. ubstituting e and in the rofit function e find: ( ) (2 ) 1/ s s n π = = > 2 2 n (3.1.15) n n 2 This roosition is trivial in standard textbook analysis of monosony but not in this case in hich the monosonist faces the folloing alternative: i) roducing an ''unfair roduct'' in hich ages are belo marginal roductivity or ii) roducing a fair roduct. The first choice is not necessarily referred to the second since the increased demand from consumers concerned ith fairness may comensate higher labour costs hen roducing fair roducts. Hence, the Monosonist can make ositive rofits only by sulying an unfair good. The equilibrium is therefore characterized by the resence of to rices for good x: -individuals consume the Monosonist's roduct aying a rice < and 1--individuals consume the orth roduct for a rice. Given ρθ<1, the demand faced by the Monosonist is less than the demand faced by the orth roducers. Proosition In equilibrium, it holds <1/2. 15

16 Proof. By maniulation of (the condition for the indifferent - consumer) e get: ρθ = 1 (3.1.16) ubstituting and and taking logs yields: ( ρθ ) ( 1 ) ln(2 ) 2 ln = (3.1.17) ince the left hand side is clearly less than zero, the right hand side needs to be negative as ell. This, in turns, imlies 2 < Welfare in Absence of air Trade Under international equality concerned references it can be shon that the first best solution involves the roduction and consumtion of the fair outh roduct only. Desite of it, such a roduct is not sulied and the orth roduction can survive because of the Monosonist's market oer. The elfare in the orth, denoted by J, is given by: = ( ρθ ) J + d d (3.1.18) or: J 1 ρθ ( ln( ρθ ) + ln ln ) 1 + ( ln ln ) (3.1.19) otice that elfare in the orth is not affected by changes in emloyment due to the roduction of good x in the orth. This haens because the labor demand is assumed to be erfectly elastic in that country and 16

17 unemloyed individuals are able to get a ne job for the same age in other sectors of the economy. urthermore, given the zero rofit condition, orth firms are indifferent beteen roducing and not roducing. As a result of the monosonist's market oer, the outh doesn't reach full emloyment. This becomes clear by substituting the equilibrium rice into the otimal level of labor e: 1/ 2 e = < 1 (3.1.2) 2 Therefore, individuals in the set e (,e) get the monosonist's age =e, hereas individuals in the set e (e,1) get their reservation age e. We can then comute elfare in the outh: e 1 2 ede + ed = ( 1+ e ) e J = (3.1.21) 2 and observe that it is an increasing convex function of e The air Trader uose no that a ne roducer enters the market for good x. Assume further that he is alloed to comete ith the Monosonist on the labor market in the outh but, at the same time, he is constrained to roduce a fair roduct. In this model, this imlies that he must ay a age = and he cannot make rofits. In hat follos e ill investigate to cases. The first case is hen the air Trader is alloed to reach any size he desires. The second, more realistic case, is hen the air Trader faces 17

18 some constraints on his size. This second setu corresonds to the intuition that the air Trader can better signal his fairness by remaining small. 12 In both cases, since he fixes the age ithout taking into account the monosonist's behavior and, since his roduct can be differentiated from the monosonist's roduct through fairness, it can occur that he sets a higher age than the monosonist. More recisely, he is able to roduce hatever quantity beteen and henever the rice is =. On the other hand, he is comletely free to set the age, rovided the age he ays is greater or equal than the monosonist's one. Consequently, because of the constant returns to scale setu, the air Trader controls both variables, i.e. quantity and age. We assume, therefore, that, henever is greater than the age aid by the monosonist and the quantity of labor demanded by the air Trader is greater than the suly at that age, the latter is able to ration efficiently the labor suly. By efficient rationing e mean that the air Trader is able to discriminate on the basis of the outside otion recruiting the orkers ith the loest reservation age. As it ill become clear later, the assumtion of efficient rationing is critical for our results. On the other hand, it seems reasonable if e assume the air Trader to be affected by ethical concerns regarding the orkers ith bad outside otions. It must be remarked that this assumtion does not imly any rice discrimination: both the air Trader 12 The suly of fair traders is not modeled here and therefore the size constraint is an assumtion. In the reality the market share of fair traders is constrained by the limited suly of fair traders and the limits of caacity of individual fair traders. Given the zero rofit features of this roductive activity the number of individuals ith strong fairness references choosing it is small. 18

19 and the Monosonist are constrained to ay the same age to each of their orkers Equilibrium ith air Trade orth consumers have no three alternative otions. They can consume the orth roduct aying, they can consume the unfair outh roduct aying and, finally, they can consume a fair outh roduct aying. Under "international equality concerned" references, the latter choice is strictly referred to the formers. This imlies that for = = the orth and the unfair outh roduction are ruled out from the market. We ill sho indeed that, under this kind of references, it exists an equilibrium here only the air Trader and the Monosonist remain in the market, both sulying a fair roduct. This is a nontrivial result since, given the heterogeneity of references, one can exect the Monosonist to be still able to sell an unfair roduct to the less ethic segment of consumers (the lo individuals). We'll sho, on the other hand, ho this strategy becomes no more rofitable in resence of a air Trader. ince the ne roducer is able to set the age he refers, he can alays set a age =. In this case the air Trader ill get the hole former demand for the orth roduct and a fraction of the former demand for the unfair outh roduct. On the other hand, for a age level =, there is excess labor suly unless either the air Trader hires all the orkers in the outh ( e = 1), or the Monosonist sets the same age =. 19

20 In evaluating the imact of the fair trader resence on market equilibria e formulate the folloing roosition: Proosition It exists an equilibrium here = and =. uch an equilibrium is characterised by both absence of orth roduction and e < 1. Proof. Le us denote by ^ the ne equilibrium values of the variables after the air Trader aears in the economy. rom the zero-rofit condition, setting a age = imlies that the air Trader can sell his good hen =. ince both the orth and the fair outh roduct have the = same rice, none in the orth ant to consume the orth roduct anymore. Therefore, the orth roduction is ruled out. Denote by ^ the ne fraction of individuals referring an unfair roduct to a fair roduct. Market clearing involves: ^ ^ 1 = e = 1 < 1 (3.1.22) The result stated above says that, henever the air Trader sets a age equal to the orth age, e can have to different equilibria. A rationing equilibrium in hich the Monosonist sets a age loer than and the air Trader faces excess labor suly and a market clearing equilibrium here both roducers set the age, roduce a fair good, and sell it for the same rice. We ill sho no that, if the air Trader rations the labor suly efficiently, the first equilibrium is imossible. Therefore, if the rationing is efficient there ill be no need for it in equilibrium. The 2

21 intuition is that, by efficient rationing, the air Trader is able to hire the lo outside otion orkers hereas the labor suly faced by the Monosonist is truncated in corresondence of those orkers. Consequently, the latter is bound to recruit high outside otion individuals. This, in turns, creates the need for the Monosonist to raise the age in order to hire some orkers and roduce a ositive quantity. uch effect is, in general, not offset by the fall in the demand faced by the Monosonist due to the cometition of a fair outh roduct. Proosition If the air Trader efficiently rations the labor suly, the Monosonist is bound to set a age ^ =, roduce a fair good and hire all the residual labor force, i.e. ^ e = 1. Proof. We ant to sho ho, under efficient rationing, the Monosonist's otimum is the corner solution ^ e = 1. The maximisation roblem can be stated as: max e ( e,1) ^ e e ^ ( ( e )) de (3.1.23) the Kuhn-Tucker conditions are: ^ λe 1 ; λ (3.1.24) and: ^ e e ; µ (3.1.25) µ ith at least one strict equality in both cases. The first order condition yields: 21

22 ^ e e ^ λ + e µ = 2 (3.1.26) imlying the existence of an interior solution henever ^ ^ ^ ^ (1 ) < < (1 + ) = (1 + ) (3.1.27) On the other hand, ^ ^ + henever ^, therefore, the true uer bound for ^ in order to avoid a corner solution is just Welfare under fair trade What is the effect on elfare of the fair trader s entry? The folloing roosition shos that, under reasonable assumtions, the creation of a fair trade market may be Pareto imroving for both orth and outh consumers Proosition The introduction of fair trade generates a Pareto imrovement for roducers in the outh and even for consumers in the orth if they are not national equality concerned and if the ex ante share of the monosonistic roduct is large enough. With the introduction of fair trade there are to ossible equilibria deending on the efficient/inefficient rationing of the fair trader. Under the first equilibrium (defined as equilibrium T1) the fair trader is unable to ick outh orkers ith the loest reservation age, the monosonist maintains its unfair age and the fair trader hires the excess labour 22

23 suly. Under the second equilibrium (defined as equilibrium T2) efficient rationing occurs and both the monosonist and the fair trader roduce fair roducts (see section 3.1.7). Under the first equilibrium the roduct of the orth is relaced by the fair trade roduct. The introduction of the outh fair roduct generates a shift from the monosonist roduct toard the ne roduct of consumers hich are international equality concerned or neutral beteen international or national concerns (induced by the fairness argument in their references). This shift generates a feedback effect on monosonist rices hich get loer (see ). 13 Welfare in the orth is no: J ( 1) = ( 1) ( ρθ ) d θ d + (3.1.28) ( 1) and must be comared ith (3.1.8). By insecting the to elfare functions and comaring choices e realise that consumers in the orth may fall into three situations: i) those consuming before the roduct of the orth and no the fair trade roduct are better off (orse off) if they are international (national) equality concerned (or indifferent beteen national and international roducts); ii) those ho kee on consuming the unfair roduct in the outh are better off since the roduct is less exensive given that the share of the monosonist is reduced; iii) those moving from the monosonist to the fair trader are better off by a revealed reference argument. They in fact ould be better off if consuming the old roduct (its rice is loer), they must remain better off if they decide to move to the ne roduct. 13 ince the monosonist demand elasticity is less than infinite the demand shock reduces rices in equilibrium. 23

24 24 Under the second equilibrium (fair trader efficient rationing) all consumers consume a fair trade roduct roduced either by the monosonist or by the fair trader. Consumers elfare in the outh turns into: = J θ 2) ( (3.1.29) To comare the ne and the old situation consider that this exression may be reritten as: θ θ d d J + = ) ( (3.1.3). By comaring this elfare function ith (3.1.8) e obtain that θ ρθ θ d d J J + = ) ( (3.1.31). The first art of the (3.1.31) comares the situation of those consuming ex ante the unfair and ex ost the fair roduct. The second art the situation of those consuming ex ante the orth and ex ost the outh fair roduct. In the second case consumers are better off (orse off) if they are international (national) equality concerned (or indifferent beteen national and international roducts). In the first case the situation is more comlex because the removal of unfairness is accomanied by a rice hich is higher than that of the monosonist. By considering (3.1.4) and (3.1.14) e may rerite the difference as:

25 25 ( ) θ ρ θ θ d d J J + = / 1 1 2) ( 2 1 (3.1.32) If the ex ante share of the monosonist is high and tends to.5 the fairness effect revails over the rice effect and also the elfare of those consumers is higher. This occurs because the higher the ex ante share of the monosonist, the higher the demand and the next its rice to the cometitive one. 3.2 Additional results and extensions of the model In our base model e assumed that socially resonsible consumers may only kno hether a roduct is fairly or unfairly roduced but cannot measure its degree of unfairness. Therefore e onder hat is the net effect of the existence of consumers ith ethical references in absence of fair trade. To check this e need to calculate the effects of a reduction of ρ (ith ρ<1), that is of the disutility of unfairness in references of socially resonsible consumers. 14 Our results are exressed in the folloing roosition Proosition ocially resonsible references are harmful (elfare reducing) ithout socially resonsible roduction (Or the aradox of 14 An overall reduction of ρ hich does not change the distribution of consumers over the arameter is equivalent to a general increase in the disutility of fairness given the heterogeneous beliefs of consumers on the eight to be given to fairness relative to the quantity consumed.

26 asymmetrically informed socially resonsible consumers in absence of socially resonsible roducers) By using the monotone transform of the utility funcion V=lg(U) and by considering that the equilibrium share of consumers choosing the monosonist good, the equilibrium rice and emloyment of the monosonist is given by the solution of the folloing three equation system made by: + = lg( ρθ ) (1 )lg (1 )lg (3.2.1) Ps P (or alternatively by the ), by 1/ 2 e = (3.2.2) 2 and by: s 2 n = ( 2 1/ ) (3.2.3) here (3.2.2) is obtained by lugging (3.2.3) into (3.1.6). By relacing (3.2.3) in (3.2.1) e immediately see that d/dρ> in the arameters interval for hich <.5 and ρ<1 15 since a loer ρ reduces the value of the right addend and therefore shifts the marginal consumer toard the roduct of the orth (see ig. 1). By insecting the last to equations e find that equilibrium levels of both emloyment and rice of the monosonist fall hen falls. By looking at external unfairness and by defining it as the ratio beteen the 15 This is because as ρ tends to one and tends to.5 the rice of the monosonist is equal to that of erfect cometition. Therefore there is multilicity of equilibria the univocal relationshi beteen ρ and no more holds. 26

27 monosonist age and the cometitive age (/), e find that it gets higher. Consider also that, by definition of, our model has the nice roerty that fairness coincides ith emloyment in the outh. If instead e look at internal fairness, measured as the ratio beteen the value of orkers marginal roduct and monosonist age, (/ hich, by relacing for and, may be reritten as /e) e find that it is higher but only because the dro in rices is higher than the dro in ages (just comare first derivatives ith resect to in and 3.2.3) and because e assumed constant marginal roductivity in the monosonist industry. In both cases elfare is loer in the outh (since it is a convex function of e) and also in the orth (the reduced satisfaction of consumers still buying the unfair roduct is accomanied by the indifference of those consuming ex ante and ex ost the orth roduct, hile those moving to the orth roduct are not better off by a revealed reference argument). Our results are valid because the monosonist, even in resence of ethically concerned consumers, finds it otimal to be monosonist and not to become a fair roducer. This is true since, under Proosition 3.1.1, hich still holds under a higher ρ, e found that in equilibrium, the monosonist alays finds it otimum to roduce the unfair good as <1/2 in equilibrium. The intuition behind this roosition is that the monosonist has to ossible equilibria in the range of the ossible degree of consumers fairness. If consumers fairness is very lo (ρ tends 27

28 to one and =1/2), roduct demand is very high and the monosonist level of roduction is such that there is no unfairness air trade and the role of tariff barriers Euroean and U Agricultural Policy have created tariff and non tariff barriers to agricultural goods hich are roduced outside Euroe and the U and imorted in these areas. The reduction or removal of these barriers is currently under discussion in WTO rounds. In this model e try to analyse the effects of these barriers on age and emloyment hen the imorter has some market oer (the monosonist firm in our model). We also onder ho our revious conclusions on the elfare effects of fair trade change under the consideration of tariff barriers. The frameork hich considers these barriers also allos us to analyse the effects of all those olicy measures hich may alter relative rices beteen the traditional roduct and the fair trade roduct. Examles of these olicies are i) the discussion about tax alloances for fair trade roducts in several EU countries; ii) the roosal to devolve one ercent of VAT on all food roducts to rojects suorting develoment in the outh advanced by Italian government, or iii) the reduction or removal of tariff barriers on roducts imorted from the outh. It is clear that, hile roosal i) ould lead to an reduction in the taxation of fair trade roducts relative to traditional roducts, roosal iii) ould have similar effects on both roducts. 28

29 To evaluate the imact of these olicy roosals under discussion e start by analysing the simle effect of the existence of tariff barriers in our model. The resence of rice barriers for all roducts imorted from the outh changes the monosonist s first order condition into: e ( t) s (1 t) s s = (3.2.4) 2 The introduction of the tariff therefore reduces the monosonist s labour demand. With the introduction of the tariff, and under the assumtions of our model, the T roduct cannot comete anymore ith the erfect cometition roduct of the orth and therefore is out of the market. This is because its zero rofit condition becomes ( 1 t) = and therefore the equilibrium rice is belo the rice of the roduct roduced in the orth. 16 The market clearing equilibrium for the monosonist is no s s e s ( t) = ( t ) (3.2.5) s By relacing s obtained from (3.2.7) in (3.2.6) e obtain the amount of outh orkers emloyed in equilibrium by the monosonist e ( t) = s ( t) (1 t) 2 1/ 2 (3.2.6) and the otimal equilibrium rice 16 This solution could be avoided if e assume that the roduct in the orth has some market oer, if the fair trader accets to roduce ith some degree of unfairness or if consumers references are international equality concerned. But this is not hat haens in our base case. 29

30 2 ( t ) s ( t) = 1 t 1/ 2 (3.2.7) To comare equilibrium levels of and e ith those ithout tariff e need to consider also changes in the share of consumers hich no urchase the unfair roduct in the outh. + = ( t) lg( ρθ ) (1 ( t ) )lg (1 ( t ) )lg (3.2.8) s ( t) Therefore the ne equilibrium share of consumers choosing the outh roduct, the ne levels of emloyment and rice for the monosonist ill be given by the solution of the system of the last three equations. To comare this ne situation ith that of the base model ithout fair trade relace (3.2.9) for s in (3.2.1). This makes clear that (t)< calculated in (3.1.11). ince the reduction in demand is a feedback effect of the higher rice, e can easily check that rices are higher than in the no-fair-trade equilibrium, hile emloyment in the outh is loer for to reasons: reduced demand and the tariff. The tariff definitively reduces elfare (ith resect to the no fair trade equilibrium) in the outh since the latter is a convex function of e. Welfare of consumers in the orth is also reduced because the monosonist roduct is more exensive. If e comare the ne situation ith resect to the efficient rationing equilibrium e find that the effect on elfare in the outh is again negative. The effect on elfare of consumers in the orth is also negative rovided that the fairness effect and the international equality concerns revail over a monosonist rice hich might still be loer after the tariff 3

31 than the rice of the fair roduct alternatively consumed under the no tariff benchmark. The introduction of the tariff raises the internal level of unfairness (measured as the ratio beteen the outh orkers age and the value of their marginal roduct) since it reduces emloyment and increases rices. ince in our model e assume that consumers are asymmetrically informed and only erceive hether a roduct is unfair or not, the increase in unfairness has no consequences on monosonist market demand. Under the existence of a tariff, an exemtion for the fair trade roduct hich exactly counterbalances the different taxation beteen roducts imorted from the outh and the erfect cometition roduct in the orth may restore the no tariff equilibrium described in the base model. Therefore the change in elfare is exactly the inverse of the change in elfare generated by the tariff Considerations on the relationshi beteen fair trade and child labour air trade may have consequences on elfare hich go beyond hat described so far. The relationshi beteen fair trade and elfare in the outh may be made more clear by linking ages to some social indicators. Consider for instance that, according to the luxury axiom, arents send child to ork hen household age falls belo a given subsistence level Theoretical suort for the luxury axiom may be found, among others, in Basu and Van (1998), Basu (1999) and Baland and Robinson (1998). The luxury axiom is successfully tested by Ray (21) in Peru. More generally the inverse relationshi beteen er caita income and child labour is successfully tested in almost all emirical 31

32 min and imagine that <min<. It is therefore clear that the introduction of fair trade reduces child labour in the outh and that efficient rationing described in roosition has even stronger effects on the reduction of child labour. Therefore an exlicit ban of child labour roducts (hich er se does not rise household income and does not lead arents to send children to school) may be less efficient than efficient recruiting in reducing child labour. air trade roducers may nonetheless stress the imortance of fighting child labour on their roducts since the income they ensure to roducers automatically allos the ossibility to send children to school. Therefore they may require that the luxury axiom be alied. The ban may therefore make sense ith the fair roduct but not in absence of fair roduct. Conclusions Individuals are learning that globalisation has created ne roblems but also increased their caacity to camaign and to organise olitical (voting) and economic (consuming and saving) oer. In a globalised economy the ethical concern of a minority of individuals may significantly affect the behaviour of firms and institutions and may hel to redress some market failures. This contribution is crucial in this hase in hich regulation of global ublic goods (or bads) has been made more urgent by globalisation. Bottom-u elfare measures such as air trade in fact, hile having er se beneficial effects hich have been described in this aer, may also be analyses on the determinants of child labour (see Cigno-Rosati-Guarciello (21), helburne (21), Becchetti-Trovato (22)). 32

33 the first ste for revealing the increasing ublic suort for a reform of global governance (and in articular, in the case of fair trade, for a global antitrust regulation and for a removal of uneven trade and non trade barriers). air trade is therefore an interesting attemt of rebalancing orth-outh trade armonising together in an original mix four different aroaches to social justice: i) the role of contractualism and governance (Rals, 1972) hose reform is urged and imlicitly suorted by the rise and develoment of the fair trade; ii) the role of self-organisation of citizens in an oen society ith a minimal state (ozick, 1981); iii) the imortance of local communities (McIntyre, 1993) and iv) the imortance and the cultivation of social virtues (Pieer, 1975) ithout hich institutions and rules are emty boxes and formulas and may not ensure by themselves that a society ill follo the ath of socially and environmentally comatible develoment. 33

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