Cartel

A cartel is an agreement among independent producers to act jointly on price or output. The Austrian question about any cartel is not whether it exists but whether the state is enforcing it, because a cartel on a free market is an unstable arrangement that its own members have reason to break, while a cartel with statutory backing is stable for as long as the statute lasts.

Cartels as joint ownership

The usual vocabulary treats cartel members as colluding, and Murray N. Rothbard objected that the word smuggles in the conclusion. Strip it out and describe what happens: individual producers agree to pool assets into a common lot, a single organisation decides production and price policy for all of them, and the proceeds are allocated among the owners. That is the structure of a partnership or a merged firm. If the same act is legitimate when two owners incorporate and illegitimate when they contract, the difference is being carried by the form rather than by anything economic.

The objection most often raised is size, and Rothbard's reply is that the objection has no benchmark. We do not know, and economics cannot tell us, the optimum size of a firm in any given industry, because that depends on the concrete technological conditions and on the state of consumer demand in relation to the supply of factors here and elsewhere. Without a known optimum, "too big" is a judgement with nothing behind it.

Ludwig von Mises made the entry point: if a cartel has restricted output and the previous level really did serve consumers better, the high price is an invitation to underbid it. Those already producing steel are not responsible for the fact that other people did not enter the field.

Restriction of output

Producers restrict output whenever they find demand inelastic over the relevant range, meaning they can sell less at a higher price and take more revenue. There is nothing inherently wrong in doing so, and the ability is not unlimited, because raising the price far enough makes the demand curve elastic and the strategy stops paying.

The deeper problem is that "restricting production" is not a well-formed accusation on a free market. Factors are scarce relative to the ends they might serve, so all production involves allocating them to the more highly valued ends and withholding them from the less valued. Every product is therefore always "restricted", and a term that applies to everything distinguishes nothing.

Walter Block listed the ordinary reasons an owner sells less than he might, each of which is indistinguishable from the alleged monopolistic motive by anything observable.

• Speculation. An owner who expects a higher price next period holds back stock now, which reduces present sales and is not a restriction of output in any sinister sense.
• Time preference. An owner who discounts the future lightly can afford to wait for better offers, so his optimal selling pattern spreads sales forward. The high time preference owner sells sooner. Neither is manipulating anything.
• Conservation. An owner of a depletable resource maximises his return over the whole period during which it will be sold, not over the current one, so he holds some back. There is no observable difference between the conservationist and the monopolist here, which is a problem for anyone proposing to regulate the second.
• Leisure and consumption by the owner. A performer who could fight or play fifty times a year and chooses to do so three times may be defying the consumers, or may be tired, or may simply prefer the leisure his earnings buy. An owner of woodland who declines to cut it may be withholding timber, or may enjoy the forest. Producers are consumers too, and consuming one's own asset is not a conspiracy.

The general point is that the same observable behaviour is generated by motives that nobody proposes to prohibit, so the behaviour cannot be the thing being objected to.

Predatory pricing

It is generally not rational for a dominant firm to try to eliminate its rivals by sustained price cutting. The practice is expensive and its outcome uncertain, especially where entry is open, and even a temporary success invites the eliminated competitors back the moment prices are raised to profitable levels. The firm must fund losses across its whole output while the target funds them only across its own.

That leaves the question of what consumers are supposed to be protected from. Lower prices, for whatever reason and for whatever duration, are what consumers want. If they prefer the dominant firm's lower price they buy from it; if they prefer to sustain a higher-priced rival they can do so. D. T. Armentano's conclusion is that no antitrust intervention is justified on these grounds, because the harm the doctrine posits is not identifiable in any transaction that actually occurs. See predatory pricing and Standard Oil, the case usually offered as the historical example and which does not on inspection support the doctrine.

Why voluntary cartels break

A cartel on an open market faces three exits, and it has to survive all of them.

1. If pooling really is more profitable, the members merge and the cartel becomes a firm.
2. If it is less profitable, members leave.
3. If it earns unusual returns, outsiders enter the industry to get them.

The internal pressure falls hardest on the efficient members, who are the ones being held back by quotas written to shelter their less efficient partners, and who therefore have the most to gain from defecting. Each member also faces the standard incentive to sell beyond its quota at the cartel price, which is profitable for whoever does it first and fatal if everyone does.

Cartels the state enforces

Because voluntary cartels are unstable, the durable ones are almost always the ones a government is holding together, and the arrangement is then usually described as regulation rather than as a cartel.

Rothbard considered the international diamond cartel the most successful in history, more so than OPEC, and attributed its durability to enforcement by the government of South Africa, then the major centre of world production. Even that eroded over time. After the campaign against conflict diamonds in the late 1990s a new certification regime was organised with regulatory authority behind it, which keeps prices high by a route that attracts no antitrust attention at all.

The credit rating agencies are a cleaner case because the cartel was created by rule rather than captured afterwards. The Securities and Exchange Commission's 1975 designation of Nationally Recognized Statistical Rating Organizations named the only firms whose ratings could be used to satisfy broker-dealer net capital requirements, which made a three-firm industry out of a regulatory definition.

The Federal Reserve System is the case Rothbard treated at greatest length, arguing that a central bank solves for the banks precisely the defection problem that breaks private cartels: it standardises reserve behaviour, so no member can expand credit faster than the others and be caught out by the clearing system.

The pattern is general enough to be worth stating as a rule. Where a cartel has lasted, look for the statute.

See also

• Monopoly
• Predatory pricing
• Competition
• Standard Oil
• Regulatory capture
• Federal Reserve System
• Interventionism

Links

• Cartels as Efficient Productive Structures (pdf) by Pascal Salin, 1996
• Austrian Monopoly Theory: A Critique (pdf) by Walter Block
• The Bankers' Cartel by David Gordon, August 2009
• The Lawyer Cartel by George C. Leef, November 1998
• Is the Vitamin Cartel a Threat? A Case Study of Antitrust Failure by Yumi Kim, June 2007
• Government & Big Business by Christopher Mayer, July 2000
• A History of Privilege by William L. Anderson, January 1999
• Cartels by Andrew R. Dick, from The Concise Encyclopedia of Economics
• Cartel on Wikipedia