This is part of a multi-part blog series following up on my talk at the SCA’s Re:Co Symposium. In my talk, inter alia I argued that differentiation strategies may not be enough to solve fundamental macroeconomic issues; rather, I called for a holistic ‘sprinkler solution’ to the ‘macro-economic fire’ the sector is facing. This blog post outlines one way to think about such a more systemic solution.
At the Specialty Coffee Association’s Re:Co Symposium and Coffee Expo this week, the major issue on everybody’s mind was the current price crisis. Prices for commodity coffee are the lowest they have been in the past 10 years, and producers are struggling. Having already had difficulties to cover their full costs of production in the past, many producers in today’s price climate are facing problems even covering their short-term input costs.
What does this mean in practice? They may underfertilize and neglect their coffee plants for the next growing season; let go farm workers; or seek off-farm work to avoid defaulting on loans they took out to purchase inputs. If they cut back on inputs only one year, this will lower their output for the coming year; if they do so for two years, however, plants will suffer more long-term, and yields be affected for the next 4 years. The more they delay tending to their fields, the longer lasting the negative consequences. Some farmers may also drop out of coffee entirely, rip their trees out, and graze cattle or sell their land. In the next years, this means that the supply of some coffees is likely to drop, and their price may rise, if demand stays constant. According to free market economists, this is the painful, but necessary way of the market adjusting to find the optimal levels of supply, demand, and prices. Long-run price development shows the recurrence of such booms (undersupply/high prices) and busts (oversupply/low prices), with the bust typically longer than the boom due to structural oversupply in the marketplace.
Thinking through this pattern, and its presumed necessity, reminded me of a parallel debate on the way boom and bust cycles work in a macroeconomic context: The famous debate between John Maynard Keynes and Friedrich August Hayek regarding appropriate policy responses to economic recessions and depressions that followed boom periods of rapid growth. They duked it out in the 1930s in the context of the Great Depression. The debate (and their respective personalities) is beautifully illustrated in this (highly recommended) Keynes vs. Hayek rap battle.
Their debate centered on the question on how much to intervene in the market to smooth boom and bust cycles. For our purposes, we do not need to understand all the macroeconomics and monetary theory at the heart of their argument. In brief, the sides are as follows:
Friedrich Hayek, one of most influential proponents of the free market, argued that market forces needed to be given the freedom to run their course. In the context of a fierce recession or depression, with high levels of unemployment, this meant riding it out by allowing wages to adjust downward, enabling and encouraging worker mobility across sectors and regions, allow inefficient businesses to fail, and let private investment drive the recovery by allocating capital to where it was really needed. In Hayek’s mind, the bust following an unsustainable boom was unavoidable; and the only way to avoid it was to prevent an unsustainable boom – and sectoral bubbles – in the first place (e.g. by keeping a tight control on the money supply). In the long run, market forces would prevail and straighten out misallocated resources.
“In the long run, we are all dead” was Keynes’ famous retort to this theory. He argued that taking a largely hands-off approach, as advocated by free market economists, caused unnecessary human suffering, especially as a depression can drive an economy to a medium-term situation characterized by underemployment, wages too low to enable consumer spending, and the curtailing of growth that would allow for a speedy recovery. Instead, he advocated that governments engage in ‘countercyclical’ interventions designed to counteract the boom and bust tendency of unbridled markets. In the macroeconomic context, this meant government spending – e.g. on public works programs, infrastructure, or contracting – during a recession in order to inject money into the economy that workers could turn around and spend, creating demand for consumer goods that would kickstart the economy again. During booms, Keynesian theory argued for setting higher interest rates and taxes in order to moderate the economic expansion and shore up public coffers for the next bust. Overall, Keynes was successful in convincing policy-makers of his policy advice, and it was the driver of much macroeconomic policy until the Reagan/Thatcher era, and continues to be widely used, e.g. in the last recession.
At SCA, there appeared to be a consensus that the commodity boom-and-bust is suboptimal for both specialty and commodity actors along the value chain. Demand for coffee tends to be stable and growing incrementally, and it is remarkably recession-proof: as the last experiences of the 2009 recession showed (the contraction of Starbucks none withstanding), small habitual luxuries such as the morning coffee tend to be upheld even as larger expenses are crossed off consumers’ budgets (though price sensitivity may direct consumers away from espresso-based specialty drinks and toward drip coffee).
Thus, for the industry in general, having a reliable supply of coffee and predictable prices they can price into their operations is of high value. This is particularly true for specialty buyers who are reliant on particular origins and types of coffee. Yet, the current bust makes it harder for farmers to invest in their farms and future output because they need to cut down on costs – leaving extension agents ringing their hands on how to convince farmers to keep their farms, and maintain the levels of fertilization and labor necessary for a good crop output in the future years. This drop-out of smaller origins leaves the market more exposed to weather shocks in concentrated origins such as Brazil or Vietnam, which may drive baseline prices up threefold in select years, creating cash flow problems for buyers. When such price spikes hit, farmers are incentivized to expand their production, and the next bust is just around the corner.
While the long-run adjustments through the free market may appear reasonable for the commodity sector as a whole, this continuation of booms and busts may leave the coffee world crippled in the medium term, and in the worst-case scenario may kill specialty coffee in the long-run, as the crazy price volatility affect buyers, while the long periods of low prices make supply unpredictable.
This left me wondering, marrying both Hayek’s insights on preventing unsustainable booms and a loosely Keynesian perspective on countercyclical intervention, what countercyclical tools different actors in the sector might consider that could stabilize the boom-and-bust trend by moderating boom periods and supporting producers during the bust. Here are some first ideas, but I am sure smart minds could come up with more:
Possible countercyclical actions by buyers:
- Setting minimum prices paid to farmers in price-to-be-fixed contracts (and potentially use hedging tools and options to manage their own price risk). This allows farmers to maintain investments in their farms and ensure stable outputs in future years. One necessary precondition for this is to ensure that these prices actually reach the farmer, for instance by specifying particular fees that are exporter-related in the contract itself;
- Using multi-year contracts with specified quantities that give producers yield targets that they can aim to hit through planned farm management;
- Consistently implement a range of premiumization incentives that range from quality to environmental and social sustainability;
- Explore opportunities to expand the range of products sourced from farmer groups: this goes both for various quality levels of coffee and alternative products such as honey or cocoa that could be sold in parallel in retail outlets.
Possible countercyclical actions by traders, development NGOs, and coffee institutions’ extension agents that provide farmer advice:
- Provide zero-interest loans or subsidies for inputs such as fertilizers in years of low prices (this is frequently already done);
- Educate farmers about long-run market developments and the boom-and-bust dynamic;
- Encourage farmers to use periods of higher prices to:
- Purchase farm equipment that lowers their running production costs;
- Invest in infrastructure that increases the environmental and social sustainability of their production (e.g. worker housing, water treatment plans);
- Invest in diversification of income, e.g. adding a second high value-added crop such as cocoa or avocado;
- Invest in renovation of their coffee surfaces with more resilient and/or high value-added varietals, at a similar or lower planting density (with the exception of highly inefficient production systems);
- Invest in climate-proofing their farms by planting shade trees, cover crops, intercropping nitrogen-fixing legumes;
- Discourage farmers from reacting to periods of high prices by expanding their production surface or increase their planting density by explaining the medium-level adverse consequences of such decisions;
- Invest the money available for origin projects in similar ways as above;
- Desist from encouraging and funding the large-scale establishment of new production regions, particularly in currently forested, biodiverse areas.
Possible countercyclical actions by producing-country institutions and governments:
- Re-establish or strengthen public in-country storage facilities that allow for quality-preserving storage at origin to prevent large-scale supply shortfalls;
- Improve the accuracy of publicly available information of production, internal consumption, and exports, in recognition that low-ball estimates of production as a strategy to drive prices up in the short term are likely to misguide producers as to the real demand gap supported by fundamentals;
- Strengthen the collaboration of producing-country actors in following realistic and mutually beneficial strategies of output expansion.
Possible countercyclical actions by consuming-country institutions and governments:
- Tighten restrictions on speculative activities in the futures market of soft commodities that distract from their price discovery function;
- Amend anti-trust legislation to allow supply chain actors to address collective action problems in stabilizing upstream supply conditions.
These are only a few of the many options that we could use, not to eliminate markets, but to address market failures that are specific to commodity markets. Thinking back to the Keynes-Hayek debate reminds us that intervention in markets to address market failures is commonplace, and in the past has been supported by a broad segment of society. Interventions in agricultural markets are equally commonplace in the US and Europe.
Opening up this discussion in the coffee world might be a fruitful way to think more creatively about ways forward that go beyond micro-actions such as sharing data and information, which have been the most common pledges made during the Re:Co Symposium.
What do you think?