What If Markets Have Always Been Distorted? Would It Then Be a Good Fix to Add Fair Trade Margins to Correct Distorted Agricultural Market Prices? [Part 1]

editors | 12 June, 2010 11:58

By Lucio Muñoz,

Independent Qualitative Comparative Researcher / Consultant, Vancouver, BC, Canada Email: munoz@interchange.ubc.ca

Abstract

It has always been assumed that we live in a world of perfect markets, where supply and demand interactions work magically in the absence of market distortions or externalities. Today we know we live in a world ruled by overproduction and overconsumption, which promote ongoing wasteful, polluting and degrading social and environmental processes. Is it possible that the traditional perfect market’s assumptions can be responsible for these negative outcomes through the creation of supply and demand scenarios that only meet at the lower pure economy price; and therefore lead to economic market flooding and waste? If yes, that means that we have been living in distorted markets all this time, market that do not reflect the right price; and these distortions need to be corrected now to ensure that the traditional perfect market reflects sustainability rules.

The general goals of this paper are: a) To introduce the notion of the right market price, the traditional market price, and the corrected market price and to show how they can be related to ensure traditional market sustainability; b)To extend this notion to the right agricultural market price, to the traditional agricultural market price, and the corrected agricultural market price and to point out how they can be linked to ensure that agricultural markets are consistent with sustainability rules; and c) To list some relevant specific and general conclusions.

Introduction

a) The market assumptions.

The main market assumptions can be summarized as follows:

i) Pure supply and demand interactions determine the price in the traditional perfect market.

You can produce and consume as much as you want as long as there are buyers and sellers, there is no scarcity, and there are no limits to growth. Prices then are determined solely by the free interaction of supply and demand; and when the world works this way, this is socially optimum.

ii) No market distortions.

As a consequence of the perfect market assumptions, there are no market distortions such as social and environmental and other costs associated with production and consumption affecting other parties. Externalities are assumed to be insignificant or zero and therefore, if they exist, they fall outside the dominion of the market.

iii) No true sustainability concerns.

Therefore, the are no true sustainability concerns under the traditional perfect market, only economic concerns matter.

iv) The same assumptions hold for the agricultural market.

The agricultural market price is determined at the point that supply and demand meet in an environment without distortions or externalities. Only economic sustainability is relevant in traditional markets, including the agricultural market.

v) In summary.

In the past, it has always been assumed that we live in a world of perfect markets, where supply and demand interactions work magically in the absence of market distortions or externalities. Amegashie(2006) points out that institutions like the World Bank follow these perfect market assumptions literally to support their decision making process and policy recommendations even so these conditions may not exist in the real world. Hence, it has always been assumed that economic sustainability has nothing to do with true sustainability. Under these assumed conditions then, it is normal to claim that any action that violate these assumptions will distort a market. For example, it is said that fair trade pricing violates traditional supply and demand rules(Callahan 2008) as these laws as mentioned above are assumed not to be distorted.

This situation makes it easy for traditional economists/planners to ignored or brush off issues just because they fall outside those market assumptions or to suggest solutions that eliminate the academic pressure or need to internalize them. In other words, if issues falling outside the assumptions like social and environmental equality and justice and related problems such as fair trade are present, they will be ignored as traditional economists/individuals consider them exogenous issues. Tarnoff(2004) expresses his frustration with the inability of traditional economic theory to deal with issues such as fair trade. The author believes that it can be argued too that because it has been assumed all this time that demand and supply in the perfect market have nothing to do with environmental issues we are now dealing with a growing global warming puzzle. It has been pointed out that to link the need to deal with global warming with the greening of agricultural activities the traditional market price in agriculture needs to be adjusted to reflect among other things a green margin making the global warming price higher than the traditional market price(Muñoz 2008); and then they will be responsive to green supply and demand pressures.

b) The practice.

A hard look at reality leads to the following facts:

i) There are market distortions.

Current knowledge indicates that there are social, environmental and other negative externalities associated with market forces and these costs on third parties are real and should also be reflected in market prices, but since they have been assumed to be minimal or nonexistent or falling outside the model, they have not yet been included. This has led to market prices that have been or are lower than they would be if externality costs or margins were added to arrive at the right market prices. This situation is not a socially optimum position.

ii) Distorted supply and distorted demand interactions have led to lower prices.

Ignoring market distortions has sent the wrong signals to the market. Not reflecting the cost of distortions or externalities means that we have markets ruled by the interactions of dirty supply and dirty demand, and therefore, leading to lower prices than if we had added the externality margins left out to the traditional market price. Dirty here means that supply and demand considerations do not reflect the cost of externalities.

iii) The results of living in a distorted market reflecting only the economic side.

Simple economic theory suggest that lower prices than they otherwise should have been would lead to more production and more consumption and to the promotion of ongoing generation of waste, pollution, degradation, and the social and environmental neglect.

iv) The same implications are true for agricultural market.

The agricultural market price is determined at the point where dirty supply and dirty demand meet as this process takes place in an environment full of distortions or externalities that are not reflected in that price. Lower agricultural prices then have led to overproduction and overconsumption in agricultural markets.

v) There are true sustainability concerns.

Today, there seems to be a consensus that we need to deal with the externalities associated to economic development, specially socially and environmental distortions, to be able to build the foundations of true sustainability.

vi) In summary:

Today we know we live in a world ruled by overproduction and overconsumption, which promote ongoing wasteful, polluting and degrading social and environmental processes; and it is clear today that this situation is not sustainable. Besides markets being poorly priced or distorted because of the traditional market assumptions mentioned above, a second wave of distortions comes when providing subsidies, which encourage not just more overproduction and overconsumption, but also commodity dumping. Dumping is leading to a third wave of market distortions as protectionist voices, justifiably or not, lead to ongoing trade unpredictability, and therefore, unsustainability. For example, Davis(2009) points out how the European Union may be relying on antidumping laws to remain competitive in areas and industries where it not longer has a comparative advantage.

In other words, we know that the economy must incorporate the cost of distortions to be truly sustainable and to promote responsible economic, social, and environmental behavior. Under these real conditions then, it is wrong to claim that actions taken to correct distorted markets will distort them more as these actions are needed to correct them. For example, we should expect that if prices allow producers to meet their economic goals while meeting their social and environmental responsibilities, then we would be encouraging positive economic behavior on all producers, not just on so called fair trade producers. Hiscox(2007) points out that fair trade works in promoting positive economic behavior because it allows profitability while being able to provide better social and environmental rights. The key to the economic structure and positive impact of fair trade on local economic, social and environmental conditions is found in the especial relationship connecting fair trade producers with ethical demand(Hayes and Moore 2005).

Under this line of thinking, corrected markets encourage responsible economic behavior leading producers towards the optimization of production or the socially optimal output, which may lead to the following: a) It will make it more difficult for traditional economists/planners to ignore or brush off issues that fall outside traditional assumptions such as fair trade margins and other externality based actions; b) It may induce them to incorporate them in their models as they would be then endogenous issues; and c) It will satisfy critics of the old economic model as now they should expect to see an adjusted economic thinking that is able to deal with all issues as endogenous issues. Actions in this direction appear to be under way. For example, now the term “sustainable consumption” is being used in OECD countries not only from its economic aspects but also from its related social and ecological aspects indicating attempts to internalize social and environmental issues in sustainable consumption policy implementation(OECD 2008).

The need to better understand the implications of poorly price and corrected markets

Current knowledge shows that there are more than just economic issues in a market, and therefore, the traditional market price, including the agricultural market price, may be distorted as they do not include externality margins. It has been recently indicated that from the point of view of sustainability, the perfect market is not sustainable(Muñoz 2001). Hence, poorly price markets would not reflect social, environmental, and other externalities, making issues such as fair trade in general and agricultural fair trade in particular fall outside the economic domain while corrected markets would make those externality issues endogenous to market economics.

Then, the following questions and their implications are relevant: What if markets, including agricultural markets, have always been distorted? Would it then be a good fix to add fair trade margins to correct distorted agricultural market prices? This paper provides a production and consumption framework that makes it possible to contemplate the market implications of living under the rule of underpriced markets and of corrected markets.

Goals of this paper

The general goals of this paper are: a) To introduce the notion of the right market price, the traditional market price, and the corrected market price and to show how they can be related to ensure traditional market sustainability; b) To extend this notion to the right agricultural market price, to the traditional agricultural market price, and the corrected agricultural market price and to point out how they can be linked to ensure that agricultural markets are consistent with sustainability rules; and c) To list some relevant specific and general conclusions.

Methodology

First, the terminology used to present the ideas in this paper is listed. Second, some operational concepts are presented, discussed and implications analyzed. Third, the notion of the real market price, its components, and implications are introduced. Fourth, it is pointed out how the traditional market price is derived from it and relevant implications are mentioned. Fifth, it is described how the traditional market price can be corrected to reflect social and environmental sustainability requirements. Sixth, the implications of different price structures and markets on production and consumption are summarized. Seventh, the idea of the clean market is pointed out graphically and analytically.

Eighth, the notion of the real market price is applied to the agricultural market. Ninth, the notion of the traditional market price is presented in the agricultural context. Tenth, the notion of the corrected market price is expressed in agricultural terms to reflect social and environmental responsibility in agriculture. Eleventh, the implications of different price structures and markets on agricultural production and consumption are summarized. Twelfth, the idea of the clean agricultural market is pointed out graphically and analytically. And thirteenth, some relevant specific and general conclusions are provided.

Terminology

The terminology used to convey the ideas in this paper are listed below.

Table 1

----------------------------------------------------------------------------------------------

SE = Social externality EE = Environmental externality

OE = Other externalities GM = Green margin

SM = Social margin OM = Other margins

FTM = Fair trade margin P = Traditional market price

RMP = Right market price DMP = Distorted market price

DM = Dirty market D = Dirty demand

S = Dirty supply DP = Dirty price

CM = Clean market D* = Clean demand

S* = Clean supply CP = Clean price

TMP = Traditional market price CMP = Corrected market price

Mi = Margin “i” RAMP = Right agricultural market price

AMi = Agricultural margin “i” TAMP = Traditional agricultural market price

RM = Right market CAMP = Corrected agricultural market price

TM = Traditional market AFTM = Agricultural fair trade margin

CoM = Corrected market Q* = Clean quantity

AMi = Agricultural margin “i” AP = Traditional agricultural price

AGM = Agricultural green margin CAM = Corrected agricultural market

ASM = Agricultural social margin TAM = Traditional agricultural market

Pi = Price “ i ” Qi = Quantity “ i “

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Journal of Sustainability

What If Markets Have Always Been Distorted? Would It Then Be a Good Fix to Add Fair Trade Margins to Correct Distorted Agricultural Market Prices? [Part 1]

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