Cartel
A cartel is a formal agreement among competing firms in the same industry to coordinate their behaviour—typically by fixing prices, restricting output, dividing markets, or allocating customers—in order to increase their collective profits by exercising market power. Cartels are generally illegal in most jurisdictions because they harm consumers by raising prices and reducing output, though some forms of cooperation, such as export cartels among nations, have been permitted historically.
Definition
A cartel is an association of independent firms that agree to act jointly rather than competitively. The essential purpose of a cartel is to increase the profits of its members by restricting competition, and the essential mechanism is coordination of price, output, or market allocation.
Cartels are a form of collusion, and like other forms of collusion they aim to replicate the outcome of a monopoly across what would otherwise be a competitive industry. By acting together, cartel members can restrict output, raise prices, and earn higher profits than they would under competition.
Mechanisms of cartel operation
Cartels operate through several basic mechanisms.
Price fixing is the agreement to charge a common price or to follow common pricing rules. This is the most common and most visible form of collusion.
Output restrictions involve limiting production, either by setting quotas for each member or by agreeing to reduce capacity.
Market allocation divides markets geographically or by customer type, with each member assigned a segment in which it is the sole seller.
Bid rigging involves prearranging the outcome of competitive tenders, with designated firms submitting high bids or refraining from bidding so that a chosen member wins.
Collective boycotts involve refusing to deal with particular suppliers or customers.
The cartel problem: incentives to defect
Cartels face a fundamental problem: while the collective interest of members lies in maintaining high prices, the individual interest of each member may lie in cheating.
If all members restrict output to keep prices high, each individual member has an incentive to slightly undercut the agreed price or to exceed its quota in order to gain market share and increase its own profit. If enough members cheat, the agreement collapses.
This is a classic prisoner's dilemma: the collectively optimal outcome (cooperation) is not individually rational to maintain without assurance of others' compliance.
To sustain cooperation, cartels use various enforcement mechanisms. They may monitor members' behaviour through exchange of information, impose penalties on cheaters, or restructure incentives. The success of these mechanisms depends on the number of firms (fewer is easier), the homogeneity of products (more homogeneous is easier), the stability of demand and costs, and the presence of barriers to entry.
Factors affecting cartel success
Several factors influence whether a cartel can be sustained.
Number of participants: a smaller number of firms is easier to coordinate and monitor.
Product homogeneity: homogeneous products make coordination easier because a single price can be agreed.
Market concentration: highly concentrated markets facilitate collusion.
Barriers to entry: without them, high cartel prices attract new entrants who undermine the arrangement.
Cost structures: similar cost structures reduce conflicts; firms with different costs may have different preferred prices.
Demand stability: stable demand facilitates planning and reduces the incentive to cheat.
Frequency of interaction: firms that interact repeatedly have greater incentive to maintain cooperation.
Antitrust enforcement: credible deterrence reduces cartel formation.
Historical and contemporary examples
The most famous historical cartel is the Organization of the Petroleum Exporting Countries (OPEC), founded in 1960, which coordinates production among major oil-exporting countries to influence world oil prices. OPEC has achieved notable success at times, particularly in the 1970s, while at other times it has struggled to maintain discipline among members.
Other examples include various commodity cartels, such as those in diamonds (De Beers historically), coffee, and bauxite; and numerous illegal cartels in industries such as vitamins, lysine, and construction, which have been prosecuted by antitrust authorities.
Legal treatment
Cartels are prohibited in most countries. In the United States, collusion is prohibited by the Sherman Antitrust Act of 1890, and price fixing and market allocation are treated as per se violations—that is, illegal without any need to prove harm. In the European Union, cartels are prohibited by Article 101 of the Treaty on the Functioning of the European Union.
Penalties for cartel participation include substantial fines, imprisonment of executives, and civil damages. Leniency programmes, which grant immunity from prosecution to the first member to report a cartel, have proven effective in destabilising cartels by creating an incentive to defect to the authorities.
Export cartels and international cooperation
Some forms of cartel activity have been permitted or tolerated in international trade. Export cartels, which coordinate the export activities of a country's firms, have been exempted from antitrust laws in some jurisdictions. International commodity agreements have, at times, attempted to stabilise prices of primary commodities. Cooperation between national antitrust authorities has increased, through forums such as the International Competition Network, to address cross-border cartels.