Learning objectives
This chapter covers the following topics:
n the tendency for firms to collude in oligopoly
n degrees and forms of collusion
n collusive institutions
n economic models of collusion and cartel behaviour
n factors conducive to cartel formation
n influences on cartel stability
Key terms
Buyer concentration Cartel
Degrees of collusion Explicit collusion Forms of collusion Joint venture
Seller concentration Semi-collusion
State-sponsored collusion Tacit collusion
Trade association
[P]eople 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.
(Smith, 1776, p. 128) However, price-fixing in order to boost profitability is not the only reason for firms to collude. For a group of oligopolists, collusion may represent an obvious way of dealing with the uncertainties that would otherwise arise due to their situation of interdependence. Collusion may be simply a means of easing competitive pressure and creating a manageable operating environment through unified action, rather than necessarily a strategy for maximizing joint profits. A central theme of this chapter is that many collusive agreements are highly unstable. History is littered with examples of cartels that have eventually broken down, often because individual members have succumbed to the temptation to act selfishly in pursuit of private interests, rather than adhere to arrangements aimed at furthering the collective interest of group members.
The chapter begins in Section 5.2 with a discussion of the principal forms that collusion may take. In Section 5.3 we focus on the institutions that help to shape and determine collusion. To assume that all collusion is organized through the medium of cartels is an oversimplification. Alternative vehicles, including trade associations, joint ventures and state-sponsored collusion, are also considered.
Section 5.4 examines economic models of cartel behaviour. Some of these models are based on assumptions of joint profit maximization. Others focus on issues arising when cartel members bargain over the allocation of production quotas or the distribution of joint cartel profits. In Section 5.5 we consider factors other than joint profit maximization that may motivate firms to explore avenues for coopera-tion. Section 5.6 discusses aspects of market structure that tend to be conducive to collusion and the formation of cartels. Finally, Section 5.7 examines factors that affect cartel stability or instability. As well as standard market structure variables like seller concentration, the degree of product differentiation and entry conditions, these include the effectiveness of mechanisms for monitoring compliance and punishing non-compliance on the part of cartel members. We also consider socio-logical and psychosocio-logical factors that are often ignored in the economics literature, including the quality of leadership and the degree of social cohesion among cartel members.
5.2 Collusive action and collusive forms
In the idealized free market, all firms are assumed to act independently in their desire to seek the highest economic return. However, as we saw in Chapter 4, in oligopolies characterized by interdependence and uncertainty, firms may seek to avoid taking independent action. The uncertainties and risks associated with inde-pendent action provide a spur for the firms to participate in some form of collusive arrangement.
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Unlimited competition may be a fine thing from the point of view of the political philosopher speculating about the welfare of people, but surely it is a nuisance from the point of view of most businessmen. There may be a few hardy individualists among them who enjoy vigorous competition as long as they are stronger than their opponents, can take pride in their success, and make enough money for comfort. But those that are losing ground and those that are losing money, or fear that they may lose, and all those who prefer an easy life to one of strain and strife – the majority, I dare say – regard unrestrained competition as an uncivilized way of doing business, unnecessarily costly of nervous energy and money, and disruptive of friendly relations with their fellow men.
(Machlup, 1952a, p. 434) Collusion is best seen as a way of easing competitive pressure through unified action, rather than purely as a strategy to maximize joint profits. It has been claimed that the collusive solution to the oligopoly problem is the often most obvious solution.
What, then, do oligopolists really do . . . Undoubtedly they do many things, but the specific suggestion offered here is that they frequently ‘collude’,
‘conspire’, or, otherwise ‘agree’ on coordinated policies.
(Asch, 1969, p. 5) Asch suggests three reasons for believing that collusion in oligopoly is widespread.
First, it is plausible. Collusion obviates the uncertainties of independent action, and in some weak forms it need not be illegal, or it need not be easily detected. Second, it is realistic. Evidence shows that throughout the world, competition authorities are never short of work in investigating the sharper end of collusive practices. It therefore seems probable that the weaker forms of collusion are widespread. Third, collusion is simple. Cooperation reduces the complexities of interdependence: firms no longer need to speculate about the likely reactions of rivals.
Collusion is not a uniform mode of behaviour. Machlup (1952a) draws an important distinction between degrees of collusion and forms of collusion. The first degree of collusion, the weakest, is the expectation that rivals will not act independently unless the level of business activity warrants such action. We can move up several degrees to identify states where firms, even those suffering from slack business, will refrain from independent action. In the strongest degree of collusion, each firm has complete trust that its rivals will stick to all agreements and rules of conduct, so long as the firm itself abides by such codes.
There is not necessarily any close correlation between the form of collusion and the degree of collusion. Collusion of a high degree may be based on a highly informal understanding. Conversely, highly structured forms of collusion may be developed to determine a relatively low degree of collusion. Machlup separates the forms of collusion into two: those that rely on no formal agreement or communication, and those based on explicit agreements.
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Six forms of informal collusion are identified, as follows:
1. Industry tradition: the belief, based on past observation of consistent behaviour, that rivals will act or react in a predictable way.
2. Informal expressions of opinion within the industry regarding trade practices.
3. Sales representatives from different firms exchange information about strategic decisions taken by their firms.
4. Trade association announcements regarding proposed courses of action to be taken by firms.
5. Similar announcements made by individual firms.
6. The active participation of firms in trade association activities.
In all of these cases, there is an expectation that firms will adhere to the courses of action identified by the information that is in circulation. One could argue that the six forms are differentiated by the degree of expectation as to likely conduct, the first form reflecting greater uncertainty than the second, the second reflecting greater uncertainty than the third, and so on; although to some extent this type of interpretation blurs Machlup’s original distinction between forms and degrees of collusion.
Tacit collusion is a term often used to describe a collusive outcome that requires no formal agreement, and where there is no direct communication between firms.
NERA (2003, p. 42) note that the European Court outlined three conditions which can sustain tacit coordination. First, for tacit collusion to operate there must be trans-parency, so that all firms are aware of each other’s behaviour. Second, there must be an incentive for firms to stick to a common policy. In other words, any firm that breaks the agreement is made worse off and not better off. Third, potential entry and buyer reactions should not be seen by firms as potentially destabilizing threats.
Tacit collusion may develop through personal contacts, a group ethos, or live-and-let-live attitudes. Personal and social contacts among competitors lessen rivalrous attitudes: perhaps one does not undercut or poach customers from people with whom one socializes. Social groupings, whether by social class, ethnic origin or even religion, may help stabilize an otherwise potentially unstable collusive arrangement. This feeling of belonging can be strengthened by the existence of trade associations, trade journals, conferences and social activities.
[C]lose communication and contact among the members of [the US steel]
industry had created such mutual ‘respect and affectionate regard’ that they regarded themselves as honor-bound to protect one another, and that each felt that this moral obligation was ‘more binding on him than any written or verbal contract’.
(Machlup, 1952b, p. 87) Forms of collusion based on explicit agreements include verbal and written agree-ments. A widely quoted example of the former is the so-called Gary Dinners, hosted by Judge Gary, president of US Steel, between 1907 and 1911. Leaders of the steel 164 Chapter 5 n Oligopoly: collusive models
industry met socially, but also used the opportunity to negotiate verbal agreements concerning pricing and production strategies. The colluders believed that they were operating within the law, as long as no formal agreement existed. Written agreements can be regarded as higher forms of collusion. These may be characterized as formal contracts, stipulating rights and obligations, sanctions, fines, deposition of collateral, and so on. Case study 5.1 provides a recent example of a price fixing cartel.
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