Cartel

What is a Cartel?

A cartel is a group of independent market participants who collude with each other in order to improve their profits and dominate the market. Cartels are usually associations in the same sphere of business, and thus an alliance of rivals. Most jurisdictions consider it anti-competitive behavior and have outlawed such practices. Cartel behavior includes price fixing, bid rigging, and reductions in output. The doctrine in economics that analyzes cartels is cartel theory. Cartels are distinguished from other forms of collusion or anti-competitive organization such as corporate mergers.

The word cartel comes from the Italian word cartello, which means a “leaf of paper” or “placard”, and is itself derived from the Latin charta meaning “card”. The Italian word became cartel in Middle French, which was borrowed into English. In English, the word was originally used for a written agreement between warring nations to regulate the treatment and exchange of prisoners from the 1690s onward. From 1899 onwards, the usage of the word became generalized as to mean any intergovernmental agreement between rival nations.

The use of the English word cartel to describe an economic group rather than international agreements was derived much later in the 1800s from the German Kartell, which also has its origins in the French cartel. It was first used between German railway companies in 1846 to describe tariff – and technical standardization efforts. The first time the word was referred to describe a kind of restriction of competition was by the Austro-Hungarian political scientist Lorenz von Stein, who wrote on tariff cartels:

There’s no more one-sided perspective than the one saying that such rate-cartels are “monopoly cartels” or cartels for the “exploitation of carriers”.

What is the Definition of Cartel?

A term “cartel” has other definitions:

  1. A combination of independent business organizations formed to regulate production, pricing, and marketing of goods by the members.
  2. A written agreement between nations at war, esp. as to the exchange of prisoners.
  3. An association of industrialists, business firms, etc. for establishing a national or international monopoly by price fixing, ownership of controlling stock, etc.; trust.
  4. A group of independent producers or sellers in a particular industry, or a group of businesses with a common interest, who have joined together to reduce competition between themselves by allocating markets, sharing knowledge, or controlling the price and production of a product or service. See also monopoly and oligopoly.
  5. A group of businesses or nations that collude to limit competition within an industry or market.
  6. An official agreement between governments at war, especially one concerning the exchange of prisoners.
  7. A group of parties, factions, or nations united in a common cause; a bloc.
  8. A political bloc in certain European countries.
  9. A group of countries or companies that work in concert to limit production of a product in order to influence the price of the product. OPEC, the Organization of Petroleum Exporting Countries, is one of the better-known cartels. Many western countries, including the United States, have laws prohibiting cartels, but many other countries don’t.
  10. A combination of political groups (notably parties) for common action.
  11. A written letter of defiance or challenge.
  12. An official agreement concerning the exchange of prisoners.
  13. A ship used to negotiate with an enemy in time of war, and to exchange prisoners.
  14. The definition of a cartel is an arrangement between people who will benefit from the arrangement, often in an illegal way.

In economics, a cartel is an organization created from a formal agreement between a group of producers of a good or service to regulate supply in order to regulate or manipulate prices. In other words, a cartel is a collection of otherwise independent businesses or countries that act together as if they were a single producer and thus can fix prices for the goods they produce and the services they render, without competition.

The most common arrangements are aimed at regulating prices or output or dividing up markets. Members of a cartel maintain their separate identities and financial independence while engaging in common policies. They have a common interest in exploiting the monopoly position that the combination helps to maintain. Combinations of cartel-like form originated at least as early as the Middle Ages, and some writers claim to have found evidence of cartels even in ancient Greece and Rome.

The main justification usually advanced for the establishment of cartels is for protection from “ruinous” competition, which, it is alleged, causes the entire industry’s profits to be too low. Cartelization is said to provide for distributing fair shares of the total market among all competing firms. The most common practices employed by cartels in maintaining and enforcing their industry’s monopoly position include the fixing of prices, the allocation of sales quotas or exclusive sales territories and productive activities among members, the guarantee of minimum profit to each member, and agreements on the conditions of sale, rebates, discounts, and terms.

History of Cartels

Cartels have existed since ancient times. Guilds in the European Middle Ages, associations of craftsmen or merchants of the same trade, have been regarded as cartel-like. Tightly organized sales cartels in the mining industry of the late Middle Ages, like the 1301 salt syndicate in France and Naples, or the Alaun cartel of 1470 between the Papal State and Naples. Both unions had common sales organizations for overall production called the Societas Communis Vendicionis (‘Common Sales Society’).

Laissez-faire (liberal) economic conditions dominated Europe and North America in the 18th and 19th centuries. Around 1870, cartels first appeared in industries formerly under free-market conditions. Although cartels existed in all economically developed countries, the core area of cartel activities was in central Europe. The German Empire and Austria-Hungary were nicknamed the “lands of the cartels”. Cartels were also widespread in the United States during the period of robber barons and industrial trusts.

The creation of cartels increased globally after World War I. They became the leading form of market organization, particularly in Europe and Japan. In the 1930s, authoritarian regimes such as Nazi Germany, Italy under Mussolini, and Spain under Franco used cartels to organize their corporatist economies. Between the late 19th century and around 1945, the United States was ambivalent about cartels and trusts. There were periods of both opposition to market concentration and relative tolerance of cartels. During World War II, the United States strictly turned away from cartels. After 1945, American-promoted market liberalism led to a worldwide cartel ban, where cartels continue to be obstructed in an increasing number of countries and circumstances.

Understanding a Cartel

A cartel begins with a group of independent entities who enter into an agreement to collude in the markets, usually with three key objectives:

  • Increasing their profits by maintaining high prices
  • Artificially regulating or restricting the supply of goods to markets
  • Establishing a monopoly to eliminate competition

Once the agreement has been established, the cartel manipulates markets by engaging in anticompetitive and often illegal activities. These can include, but are not limited to the following:

  • Collusion – Collusion is the opposite of competition. Firms in a cartel will share information and make decisions collaboratively to maximize their profits.
  • Price Fixing – If a cartel controls a large market share for an essential good, they may attempt to increase their profits through price fixing. Instead of competing with each other to deliver the lowest price to the customer, members of the cartel agree to sell their product at the same inflated price.
  • Bid Rigging – Bid rigging happens when firms in a cartel work together to manipulate the outcome of a procurement auction.
  • Market Allocation – Market allocation is an anticompetitive business practice characterized by the allocation or apportionment of markets, territories, product niches, or customer demographics between firms.
  • Supply Quotas – Cartels may limit their production to maintain high prices for their goods. Some cartels assign specific production quotas to each member firm and impose sanctions or penalties on firms who overproduce.

Key takeaways:

  • A cartel is a collection of independent businesses or organizations that collude in order to manipulate the price of a product or service.
  • Cartels are competitors in the same industry and seek to reduce that competition by controlling the price in agreement with one another.
  • Tactics used by cartels include reduction of supply, price-fixing, collusive bidding, and market carving.
  • In the majority of regions, cartels are considered illegal and promoters of anti-competitive practices.
  • The actions of cartels hurt consumers primarily through increased prices and lack of transparency.

Types of Cartels

Cartels have many structures and functions that ideally enable corporations to navigate and control market uncertainties and gain collusive profits within their industry. A typical cartel often requires what competition authorities refer to as a CAU (Contact, Agreement or Understanding). Typologies have emerged to distinguish distinct forms of cartels:

  • Selling or buying cartels unite against the cartel’s customers or suppliers, respectively. The former type is more frequent than the latter.
  • Domestic cartels only have members from one country, whereas international cartels have members from more than one country. There have been full-fledged international cartels that have comprised the whole world, such as the international steel cartel of the period between World War I and II.
  • Price cartels engage in price fixing, normally to raise prices for a commodity above the competitive price level. The loosest form of a price cartel can be recognized in tacit collusion (implicit collusion), wherein smaller enterprises individually devise their prices and market shares in response to the same market conditions, without direct communication, resulting in a less competitive outcome. This type of collusion is generally legal and can achieve a monopolistic outcome.
  • Quota cartels distribute proportional shares of the market to their members.
    Common sales cartels sell their joint output through a central selling agency (in French: comptoir). They are also known as syndicates (French: syndicat industriel).
  • Territorial cartels distribute districts of the market to be used only by individual participants, which act as monopolists.
  • Submission cartels control offers given to public tenders. They use bid rigging: bidders for a tender agree on a bid price. They then do not bid in unison, or share the return from the winning bid among themselves.
  • Technology and patent cartels share knowledge about technology or science within themselves while they limit the information from outside individuals.
  • Condition cartels unify contractual terms – the modes of payment and delivery, or warranty limits.
  • Standardization cartels implement common standards for sold or purchased products. If the members of a cartel produce different sorts or grades of a good, conversion factors are applied to calculate the value of the respective output.
  • Compulsory cartels, also called “forced cartels”, are established or maintained by external pressure. Voluntary cartels are formed by the free will of their participants.

Examples

  • The Phoebus cartel was established by lighting manufacturers in the early 20th century to control the pricing and lifespan of incandescent light bulbs.
  • The Quinine cartel existed among producers of the anti-malarial drug Quinine to control production rates and pricing, operating in the early 20th century with two incarnations. During the early years of its operation, Quinine was the only viable medical treatment for malaria.
  • The British Valve Association existed among British manufacturers of vacuum tubes to regulate the pricing, electrode structure, and part numbering system for its members.
  • The Seven Sisters was the name for the consortium of seven transnational oil companies which dominated the global petroleum industry from the 1940s to the 1970s. The contemporary equivalent is OPEC, an international organization of petroleum producing nations that sets production targets and prices among its members.
  • The Swiss Cheese Union, an industry organization of cheese producers, functioned as a cartel through the extent of its control on cheese production in the 20th century.
    Between 1995 and 2004, several of the largest elevator manufacturers operated a market-rigging cartel, including ThyssenKrupp, Kone, and Otis, which were fined by the European Union in 2001.
  • The Federation of Quebec Maple Syrup Producers, a government-sanctioned private organization that regulates the production and marketing of maple syrup in Quebec.

How Cartels Causes Inefficiencies in the Market?

One may form cartels to fix the prices, quantum, or terms of trade, allocate the trade zones, or achieve economies of scale. However, the extra revenue earned by the member is not due to additional efforts of producers or extra production supplies. Rather such agreements make the producers inefficient in the long run.

From the consumer’s perspective, they are concerned with only the prices for a specific product. Therefore, the formation of cartels affects their balanced disposable income. Since the supplies are restricted through agreement, the production capacities of large-scale producers are underutilized to the said extent. The large-scale producers may have produced more and abandoned excess production in the foreign market. However, super cartels restrict such extra export of goods in the short term.

Thus, slowly and steadily, economies of scale get reduced, which becomes one of the causes of rising inflation.

Effects

  • It has been found that the prices of commodities increase significantly due to price manipulations by Cartels. International cartels have more impact on such price increases. However, these are supported by the limitation of a few members who do not follow the agreed price and supply at lower than the mentioned price. That exposes the cost of production to the consumers. Such members may also be beyond the upper cap of the supply limit.
  • Cartels do not last long. The average duration can be assumed to be between 5 years to 8 years approximately. On the other hand, some cartels are required by the governments of various countries to safeguard their sovereignty. In such a case, can impose no dire consequences for any price manipulation or issue.

Are Cartels Illegal?

Cartels are illegal in many jurisdictions, including in the United States where they are covered under four major federal antitrust statutes: the Sherman Act Section 1, Sherman Act Section 2, the Clayton Antitrust Act, and the FTC Act.

The Sherman Act outlaws any agreement that restricts trade or competition, makes it illegal to monopolize or attempt to monopolize any industry, and sets the maximum fines for these crimes at $100 million.

The Clayton Act outlaws a number of anticompetitive practices, including price discrimination and conditioning sales on exclusive dealing. Clayton also outlaws corporate mergers or acquisitions that substantially lessen competition or may create a monopoly and interlocking directorates (an individual may not serve on the board of directors for two competing companies).

The FTC Act was passed in 1914 and created the US Federal Trade Commission, which enforces fair market competition through its Bureau of Competition. The FTC Act prohibits corporations from engaging in unfair methods of competition, as well as unfair or deceptive acts or practices.

Cartels are immoral and illegal because they not only cheat consumers and other businesses, they also restrict healthy economic growth by:

  • increasing prices for consumers and businesses through artificially inflating input and capital costs across the supply chain, including the cost of buildings and equipment rent, interest and decreased opportunities over the life of an asset
  • reducing innovation and choices by protecting their own inefficient members who no longer have to compete so don’t bother to invest in research and development
  • reducing investment by blocking new industry entrants that might invest in opportunities, economic growth and jobs
  • locking up resources because they interfere with normal supply and demand forces and can effectively lock out other operators from access to resources and distribution channels
  • destroying other businesses by controlling markets and restricting goods and services to the point where honest and well-run companies cannot survive
  • destroying consumer confidence in an entire industry sector, including creating negative consumer sentiment towards law-abiding businesses that are not involved in cartel conduct.
  • increasing taxes and reducing services by targeting the public sector and extracting extra costs paid for by all consumers through rates and taxes
  • decreasing infrastructure by rigging bids in public infrastructure projects which inflates costs and ultimately reduces the public sector capacity to invest in beneficial projects.

Possible Penalties for Individuals and Corporations Involved in a Cartel

Individuals found guilty of cartel conduct could face criminal or civil penalties, and corporations could face fines or pecuniary penalties for each criminal cartel offence or civil contravention.

It is illegal for a corporation to indemnify its officers against legal costs and any financial penalty.

Other penalties for cartel civil contraventions or criminal offences include:

  • injunctions
  • orders disqualifying a person from managing corporations
  • community service orders.

Advantages of Cartels

  • It provides monopoly-type power to the member units.
  • They can sell products at higher margins, maximizing the gross profits.
  • The cost of advertising is reduced, and the product is easily known to the customers.
  • No effect of the business cycle on the individual players.
  • They can easily manage production efficiency as per supply constraints.
  • A reasonable margin is assured for each member of the cartel.
  • Big savings are achieved on economies of scale.

Disadvantages of Cartels

  • Individual monopolies affect the disposable income of customers.
  • It creates inefficiencies in the market, which may affect the quality of the end product.
  • It may have full regulation over the member, destabilizing other members.
  • There is no motivation to increase efficiency in the market. Thus, prices of products remain at a high cost.
  • Demand will fluctuate as per customers’ needs and other economies of scale. However, that cannot regulate the market.
  • The individual members are not able to scale up their operations.

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