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In economics, a cartel is an agreement between competing firms to control prices or exclude entry of a new competitor in a market. It is a formal organization of sellers or buyers that agree to fix selling prices, purchase prices, or reduce production using a variety of tactics. Cartels usually arise in an oligopolistic industry, where the number of sellers is small or sales are highly concentrated and the products being traded are usually commodities. Cartel members may agree on such matters as setting minimum or target prices (price fixing), reducing total industry output, fixing market shares, allocating customers, allocating territories, bid rigging, establishment of common sales agencies, altering the conditions of sale, or combination of these. The aim of such collusion (also called the cartel agreement) is to increase individual members' profits by reducing competition. If the cartelists do not agree on market shares, they must have a plan to share the extra monopoly profits generated by the cartel.
One can distinguish private cartels from public cartels. In the public cartel a government is involved to enforce the cartel agreement, and the government's sovereignty shields such cartels from legal actions. Inversely, private cartels are subject to legal liability under the antitrust laws now found in nearly every nation of the world. Furthermore, the purpose of private cartels is to benefit only those individuals who constitute it, public cartels, in theory, work to pass on benefits to the populace as a whole.
Competition laws often forbid private 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 collusion agreements on paper.
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%. Fewer than 10% of all cartels in the sample failed to raise market prices.
The term cartel originated for alliances of enterprises roughly around 1880 in Germany. The name was imported into the Anglosphere during the 1930s. Before this, other, less precise terms were common to denominate cartels, for instance: association, combination, combine or pool. In the 1940s the name cartel gained an anti-German bias, being the economic system of the enemy. Cartels were the economic structure the American antitrust campaign struggled to ban globally.
A distinction is sometimes 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 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 with 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 that provide members mutual advantage, but that are not known or likely to be detected by outside parties. Private cartels in most jurisdictions are viewed as violating antitrust laws.
Game theory suggests that cartels are inherently unstable, as the behaviour of members of a cartel is an example of a prisoner's dilemma. Each member of a cartel would be able to make more profit by breaking the agreement (producing a greater quantity or selling at a lower price than that agreed) than it could make by abiding by it. However, if all members break the agreement, all will be worse off.
The incentive to cheat 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, one private cartel operated peacefully for 134 years before disbanding. There is a danger that once a cartel is broken, the incentives to form the cartel return and the cartel may be re-formed.
Whether members of a cartel choose to cheat on the agreement depends on whether the short-term returns to cheating outweigh the long-term losses from the possible breakdown of the cartel. (The equilibrium of a prisoner's dilemma game varies according to whether it is played only once or repeatedly.) The relative size of these two factors depends in part on how difficult it is for firms to monitor whether the agreement is being adhered to by other firms. If monitoring is difficult, a member is likely to get away with cheating (and making higher profits) for longer, so members are more likely to cheat and the cartel will be more unstable.
There are several factors that will affect the firms' ability to monitor a cartel:
The fewer 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 greater the number of firms, the more probable it is that one of those firms is 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.
Cartels that sell commodities are more stable than those that sell differentiated products. Not only do homogeneous products make agreement on prices and/or quantities easier to negotiate, but also they facilitate monitoring. If goods are homogeneous, firms know that a change in their market share is probably 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.
Similar cost structures of the firms in a cartel make it easier for them to co-ordinate, as they will have similar maximizing behaviour as regards prices and output. Instead, if firms have different cost structures then each will have different maximizing behaviour, so they will have an incentive to set a different price or quantity. Changes in cost structure (for example when a firm introduces a new technology) also give a cost advantage over rivals, making co-ordination and sustainability more difficult.
If an industry is characterized by a varying demand (that is, a demand with cyclical fluctuations), it is more difficult for the firms in the cartel to detect whether any change in their sales volume is due to a demand fluctuation or to cheating by another member of the cartel. Therefore, in a market with demand fluctuations, monitoring is more difficult and cartels are less stable.
If each firm's sales consist of a small number of high-value contracts, then it can make a relatively large short-term gain from cheating on the agreement and thereby winning more of these contracts. If, instead, its sales are high-volume and low-value, then the short-term gain is smaller. Therefore, low frequency of sales coupled with high value in each of these sales make cartels less sustainable. When the demand of the product is fluctuating, parties that are in a cartel are less interested to remain in the cartel, because they are not able to make regular profit.
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 federal crimes.
The EU's competition law explicitly forbids cartels and related practices in its article 81 of the Treaty of Rome. Since the Treaty of Lisbon came into effect, the 81 EC is replaced by 101 TFEU. 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 that:
- (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 that, 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 that improve the production or distribution of goods, or promotes technical or economic progress, while allowing consumers a fair share of the resulting benefit, and that does not:
- (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.
|“||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. It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice.||”|
The most recent example of a cartel was between Unilever and Procter & Gamble who were found guilty of price fixing washing powder in eight European countries. The case that was conducted by the European Commission after a tip off from Germany company, Henkel. The resulting penalty was a €315 million fine, split between Unilever (€104m) and Procter & Gamble (€211m)
De Beers is well known for its monopoloid practices throughout the 20th century, whereby it used its dominant position to manipulate the international diamond market. The company used several methods to exercise this control over the market: Firstly, it convinced independent producers to join its single channel monopoly, it flooded the market with diamonds similar to those of producers who refused to join the cartel, and lastly, it purchased and stockpiled diamonds produced by other manufacturers in order to control prices through supply. As recently as the mid-1980s, De Beers controlled almost 90% of global rough diamond supply, but beginning in the 1990s, the emergence of new competition reduced De Beers market share to less than 40%. While De Beers still sets non-negotiable prices of their own diamonds, they no longer have the market share to fix the global diamond market as a whole.
Another example of an 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:
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