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A cartel is a formal (explicit) agreement among firms. Cartels usually occur in an oligopolistic industry, where there are a small number of sellers and usually involve homogeneous products. Cartel members may agree on such matters as price fixing, total industry output, market shares, allocation of customers, allocation of territories, bid rigging, establishment of common sales agencies, and the division of profits or combination of these. The aim of such collusion is to increase individual member's profits by reducing competition. Competition laws forbid cartels. Identifying and breaking up cartels is an important part of the competition policy in most countries, although proving the existence of a cartel is rarely easy, as firms are usually not so careless as to put agreements to collude on paper.^[1][2]

Several economic studies and legal decisions of antitrust authorities have found that the median price increase achieved by cartels in the last 200 years is around 25%. Private international cartels (those with participants from two or more nations) had an average price increase of 28%, whereas domestic cartels averaged 18%. Less than 10% of all cartels in the sample failed to raise market prices.

Private vs Public cartel

A distinction needs to be drawn between public and private cartels. In the case of public cartels, the government may establish and enforce the rules relating to prices, output and other such matters. Export cartels and shipping conferences are examples of public cartels. In many countries, depression cartels have been permitted in industries deemed to be requiring price and production stability and/or to permit rationalization of industry structure and excess capacity. In Japan for example, such arrangements have been permitted in the steel, aluminum smelting, ship building and various chemical industries. Public cartels were also permitted in the United States during the Great Depression in the 1930s and continued to exist for some time after World War II in industries such as coal mining and oil production. Cartels have also played an extensive role in the German economy during the inter-war period. International commodity agreements covering products such as coffee, sugar, tin and more recently oil (OPEC) are examples of international cartels which have publicly entailed agreements between different national governments. Crisis cartels have also been organized by governments for various industries or products in different countries in order to fix prices and ration production and distribution in periods of acute shortages.

In contrast, private cartels entail an agreement on terms and conditions from which the members derive mutual advantage but which are not known or likely to be detected by outside parties. Private cartels in most jurisdictions are viewed as being illegal and in violation of antitrust laws.^[3]

When are Cartels more likely?

Economists have identified market conditions where cartels are more likely to appear.

Demand elasticity

If collusion is based on price fixing, then the cartel must be able to raise prices. The feasibility of a price increase will depend on the elasticity of demand which the members of the cartel will have to face after their agreement. An inelastic demand allows the cartel to heighten price increases (and therefore attain larger profits), which explains the greater incentive for cartelization in these type of markets. If the cartel faces a market with elastic demand, a price increase would provoke substantial substitution by consumers to other substitute goods, making the price increase less profitable or not profitable at all. A more elastic demand can also be caused by fringe competition whereby cartel price-fixing would allow small competitors to increase profits and expand output. In this type of markets, cartels are unable to increase prices (unless in the short term) and therefore the probability for their formation is much lower.^[4]

Agreement on prices

Agreeing to a common price for the cartel is not always easy. It will be easier the fewer the differences between the firms both in terms of their products and their production costs. The firms will find it harder to agree on a common price if the differences in their products are substantial, for example in terms of quality. This explains why economists tend to think that cartels are generally formed in markets with homogeneous goods rather than differentiated goods. If firms operate at different levels of cost, then they will have different prices at which they maximize profits, making it harder to agree on the common price.^[5]

Detection of deviation

Another factor facilitating the formation of cartels is that the benefits from colluding should outweigh the expected loss from detection. The expected loss from detection depends basically on two aspects:

1. The ability of competition authorities to detect a cartel and
2. Their degree of punishment (economic or penal) of such behaviour.

If competition authorities are capable of detecting a high share of cartels and they impose high fines, then the probability of being detected and that a huge economic fine be imposed increases, making the cartel less desirable. This explains why competition authorities are concerned with their level of cartel detection and the amount of fines imposed.^[6]

Costs of maintenance

The establishment and enforcement of cartels have associated costs which should be low enough in order not to outweigh the expected benefits from explicit collusion. The harder it is for the cartel to coordinate prices and market shares (quantities) as well as monitoring that all parts to the agreement do not deviate, the greater the costs of the cartel.^[7]

Coordination

The sustainability of a cartel depends on the ability of its members to coordinate on various variables. The ability of coordination depends, in turn, on several factors.^[8]

Number of firms

The number of firms competing in the market will clearly affect the ability of the firms in the cartel to coordinate. In general, the more firms there exist competing in the market, the more difficult it is to coordinate a cartel successfully.

Market concentration

Even if many firms exist in the market, if few firms control a large proportion of sales, then these firms may coordinate without taking into account the rest of small firms. Whether the cartel will be able to coordinate without taking into account this fringe will depend on the ability for these firms to undercut prices and expand their sales.

Nature of products

In the case of homogeneous goods, it is easier for the firms to agree on the appropriate cartel price than when products are differentiated. When products are differentiated, competition is not only based in prices but also on questions like quality, brand, etc. therefore coordination (for example on a common price) is much harder.

Existing mechanisms for coordination

It may be easier for the cartel to coordinate and meet without raising the attention of competition authorities if mechanisms such as a trade association already exist.

Long-term unsustainability of Cartels

The reason why cartels are not sustainable is well-explained by the prisoner's dilemma. The dilemma reads as follows:

Two suspects, A and B, are arrested by the police. The police have insufficient evidence for a conviction, and, having separated both prisoners, visit each of them to offer the same deal: if one testifies for the prosecution against the other and the other remains silent, the betrayer goes free and the silent accomplice receives the full 10-year sentence. If both stay silent, both prisoners are sentenced to only six months in jail for a minor charge. If each betrays the other, each receives a five-year sentence. Each prisoner must make the choice of whether to betray the other or to remain silent. However, neither prisoner knows for sure what choice the other prisoner will make. So this dilemma poses the question: How should the prisoners act?

The dilemma can be summarized thus:

	Prisoner B Stays Silent	Prisoner B Betrays
Prisoner A Stays Silent	Each serves six months	Prisoner A serves ten years Prisoner B goes free
Prisoner A Betrays	Prisoner A goes free Prisoner B serves ten years	Each serves five years

As can be seen, by staying silent (cooperating) both prisoners are better off than in the case where both decide to betray (deviate from the agreement, that is, competing). Nevertheless, if only one of the two prisoners betray while the other stays silent, the former would be free, which is still more desirable for him than having to stay in prison for six months. Exactly the same occurs in a cartel: while their members are better-off being part to the agreement than competing, deviating (for example by reducing one's price) could imply capturing a big amount of the market demand and making big profits. In other words, the members of a cartel always have an incentive to deviate from their agreement which explains why cartels are generally difficult to sustain in the long run. Empirical studies of 20th century cartels have determined that the mean duration of discovered cartels is from 5 to 8 years. However, once a cartel is broken, the incentives to form the cartel return and the cartel may be re-formed.

Whether the members of a cartel will choose to cheat on the agreement will depend on whether the short term returns to cheating outweigh the medium and long term losses which result from the possible breakdown of the cartel (this is why, also in the Prisoner's dilemma game, the equilibrium varies if the game is played once or if it is, instead, a repeated game). The relative size of these two factors depend in part on how difficult it is for firms to monitor whether the agreement is being adhered to and on the importance of short-run gains relative to the long-run gain. The longer the time firms in the cartel can cheat without detection, the greater the gains from doing so. Therefore, if monitoring is difficult, the higher the probability that some part to the agreement will cheat and the more unsustainable the cartel will be.

There are several factors that will affect the firms' ability to monitor a cartel:^[9]

1. Number of firms in the industry.
2. Characteristics of the products sold by the firms.
3. Production costs of each member.
4. Behaviour of demand.
5. Frequency of sales and their characteristics.

Number of firms in industry

The lower the number of firms in the industry, the easier for the members of the cartel to monitor the behaviour of other members. Given that detecting a price cut becomes harder as the number of firms increases, the bigger are the gains from price cutting.

The larger the number of firms the more probable one of those firms being a maverick firm, that is, a firm known for pursuing aggressive and independent pricing strategy. Even in the case of a concentrated market, with few firms, the existence of such a firm may undermine the collusive behaviour of the cartel.^[10]

Characteristics of products sold

Whether the products sold by cartels are homogeneous or differentiated also will affect the ability of monitoring and therefore the long-term sustainability of the cartel. Not only do homogeneous products make agreement on prices and/or quantities easier but also they facilitate monitoring. If goods are homogeneous, firms know that a change in their market share is more likely due to a price cut (or quantity increase) by another member. Instead, if products are differentiated, changes in quantity sold by a member may be due to changes in consumer preferences or demand. In the first case, change in one firm's demand is clearly due to cheating by another member, whereas in the second case members may well not be cheating and still demand patterns change.^[11]

Production costs

Similar cost structures by the firms in a cartel make it easier to co-ordinate given that the firms will have similar maximizing behaviour as regards prices and output. Instead, if firms have differente cost structures then each will have different maximizing behaviour and therefore will have an incentive to price or produce a different quantity. Changes in cost structure (for example when a firm introduces a new technology) also gives a cost advantage over rivals, making co-ordination and sustainability more difficult.^[12]

Behaviour of demand

If an industry is characterised by a varying demand (that is, a demand with cyclical fluctuations) this makes it more difficult for the firms in the cartel to detect whether such changes are due to demand fluctuations or to cheating by another member of the cartel. Therefore, in a market with demand fluctuations, monitoring is more difficult.^[13]

Characteristics of sales

As said, short-term gains from cheating (relative to long-term gains from collusion) make it likelier for a member to cheat. These short-term gains will partly depend on the frequency and amount of sales. If sales are not frequent (for example in some bidding markets where firms may have ten selling contracts) then the firms in a cartel may have an incentive to undercut the price of other sellers and win the contract (given that overall they know they will be few possible contracts). Moreover, the higher the amount of output to sell the higher the incentive for the firm to cheat. Therefore, low frequency of sales coupled with huge amounts of output in each of these sales make cartels less sustainable.^[14]

Antitrust law on Cartels

General view

International competition authorities forbid cartels, but the effectiveness of cartel regulation and antitrust law in general is disputed by economic libertarians. ^[15]

United States

The Sherman Antitrust Act of 1890 outlawed all contracts, combinations and conspiracies that unreasonably restrain interstate and foreign trade. This includes cartel violations, such as price fixing, bid rigging and customer allocation. Sherman Act violations involving agreements between competitors are usually punishable as criminal felonies.^[16]

European Community

The EU's competition law explicitly forbids cartels and related practices in its article 81 of the Treaty of Rome. The article reads:

1. The following shall be prohibited as incompatible with the common market: all agreements between undertakings, decisions by associations of undertakings and concerted practices which may affect trade between Member States and which have as their object or effect the prevention, restriction or distortion of competition within the common market, and in particular those which:

(a) directly or indirectly fix purchase or selling prices or any other trading conditions;

(b) limit or control production, markets, technical development, or investment;

(c) share markets or sources of supply;

(d) apply dissimilar conditions to equivalent transactions with other trading parties, thereby placing them at a competitive disadvantage;

(e) make the conclusion of contracts subject to acceptance by the other parties of supplementary obligations which, by their nature or according to commercial usage, have no connection with the subject of such contracts.

2. Any agreements or decisions prohibited pursuant to this article shall be automatically void.
3. The provisions of paragraph 1 may, however, be declared inapplicable in the case of:

- any agreement or category of agreements between undertakings,

- any decision or category of decisions by associations of undertakings,

- any concerted practice or category of concerted practices,

:(a) impose on the undertakings concerned restrictions which are not indispensable to the attainment of these objectives;

:(b) afford such undertakings the possibility of eliminating competition in respect of a substantial part of the products in question.

Article 81 explicitly forbids price fixing and limitation/control of production, the two more frequent cartel-types of collusion. The EU competition law also has regulations on the amount of fines for each type of cartel and a leniency policy by which if a firm in a cartel is the first to denounce the collusion agreement it is free of any responsibility. This mechanism has helped a lot in detecting cartel agreements in the EU.

Examples

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.

Adam Smith, The Wealth of Nations, 1776

Examples of prosecuted international cartels are lysine, citric acid, graphite electrodes and bulk vitamins. An example of a new international cartel is the one created by the members of the Asian Racing Federation and documented in the Good Neighbor Policy signed on September 1, 2003. Other well-known examples include:

• OPEC: As its name suggests, OPEC is organized by sovereign states. It cannot be held to antitrust enforcement in other jurisdictions by virtue of the doctrine of state immunity under public international law. However, members of the group do frequently break rank to increase production quotas.
• Many trade organizations, especially in industries dominated by only a few major companies, have been accused of being fronts for cartels:
• Although cartels are usually thought of as a group of corporations, some consider labor unions to be cartels, as they seek to raise the price of labor (wages) by preventing competition.http://www.cbe.csueastbay.edu/~sbesc/99septcol.html

See also

• IATA
• MPAA
• RIAA
• OPEC
• De Beers
• Collusion
• Oligopoly
• Tacit collusion
• Content cartel
• Drug cartel
• Phoebus cartel
• Zaibatsu
• Competition regulator
• Economic regulator
• Federal Reserve
• Competition law
• Anti-trust law
• Industrial organization

External links

• International Cartel History Site
• The Food and Global Agricultural Cartels of the 1990s
• Price-Fixing Overcharges

References

Bibliography

• Bishop, Simon and Mike Walker (1999): The Economics of EC Competition Law. Sweet and Maxwell.
• Connor, John M. (2001): Global Price Fixing: Our Customers Are the Enemy. Studies in Industrial Organization No. 24. Boston: Kluwer Academic (2001).
• Levenstein, Margaret C. and Valerie Y. Suslow. What Determines Cartel Success? Journal of Economic Literature 64 (March 2006): 43-95.
• Stocking, George W. and Myron W. Watkins. Cartels in Action. New York: Twentieth Century Fund (1946).
• Tirole, Jean (1988): The Theory of Industrial Organization. The MIT Press, Cambridge, Massachusetts.