Competition and the cartel crusade

Review - Institute of Public Affairs, Jan 2008 by Moran, Alan

At the heart of the Trade Practices Act is section 45. Over some 20 pages, this section explains the illegality of businesses conspiring to fix prices or otherwise diminish competition in a market. Issues concerning combines, or cartels of firms which avoid competing with each other and share the market, have been brought to prominence in Australia with the acknowledgement by Visy and Amcor that such agreements had been made and were current, at least between 2000 and 2002. This has given new impetus to the role of the Australian Competition and Consumer Commission (ACCC) in uncovering such agreements.

A phrase of Adam Smith's is frequently the starting point for people favouring government control over cartels. Smith maintained that, 'People of die same trade seldom meet togedier, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.' What those invoking Smith's authority rarely point out is that Smith went on to counsel against intervention by the authorities, saying: 'In a free trade an effectual combination cannot be established but by the unanimous consent of every single trader, and it cannot last longer than every single trader continues of the same mind.'

Over the past century, the existence of suppliers' market power, its endurance and the appropriate role for government in controlling it have been major issues for economic and political analysts.

Legal measures to control or prevent monopoly come under the title 'antitrust', an American term dating from die nineteendi century for laws that originally targeted firms such as the successful Standard oil enterprise built up by John D. Rockefeller. In fact, Standard oil was by no means the ruthless price-boosting monopoly that has been depicted. Its share of refining capacity was under pressure from major rivals such as Shell and Texaco and it fell from 82 per cent in 1899 to 64 per cent at the time of its break-up in 1911. Prices of kerosene (the main petroleum product) fell precipitously during the period of Standard oil's industry domination.

Standard oil was not the last firm to come under unjustified regulatory attack. Many high profile businesses are now seen as having been ludicrously targeted in light of the obvious lack of market power that was revealed by commercial processes. Modern-day victims of the regulatory agencies have included large firms, for example, GM and IBM, both of which faced years of scrutiny and legal action before claims about their monopolistic abuse collapsed in the face of market positions that had crumbled under the weight of competition. Microsoft and Google are now the targets of this regulatory aggression.

It is argued with some cogency that individual firms that have achieved market domination bring benefits involving economies of scale that are far less likely in the case of market domination by inter-firm agreements. Cartels are, accordingly, lacking an important attribute that an individual monopolist might have. Cartel agreements are of greatest importance in Australia where there is no provision to break up a dominant firm once it has reached such a market position (although there is provision to prevent that being achieved through takeover activity).

Economic analysis of cartel issues tends to fall within two schools. Legal authorities such as the ACCC and many economists maintain that there is a great deal of collusion taking place and diat prices across many product areas are much higher as a result. In this respect, one writer in the Australian Financial Review this year (13 October) reported the current Chairman of the ACCC to have said, 'If I can find an industry where they were not involved in, I will tell you.'

Others are sceptical. They argue that some unique circumstances are required for a cartel to hold together. Among these is an inability of firms outside the cartel (attracted by the high prices and profits that the cartel is creating) to enter the market. Such entry undermines the cartel and forces its collapse. Of course, where such entry is forbidden and the cartel enjoys other support from government, as was the case in the long-standing Australian domestic airline cartel, its existence can be enduring. Even where entry is difficult-because, for example, it requires some scale economies and the building of a reputation-cartels will often be vulnerable because the partner firms are likely to have different costs and marketing aspirations and will frequently cheat on each other.

The most comprehensive studies of cartels have been conduaed at Purdue University by John Connor and his associates. In a 2005 paper, 'Price-Fixing Overcharges', Connor examined data on 237 cartelised international markers covering 512 episodes. From this meta-analysis he estimated that overcharging was 25-30 per cent on average (one study he drew from conducted by the OECD may have been more rigorous, but still put the level at 15 per cent).

Connor believes that cartels are pervasive and he is generally in favour of more vigorous government intervention to enforce competition. His analysis does not attempt to estimate the longevity of the price distortion of the cartels-although it does suggest that some persisted for decades. Moreover, the counterfactual is not easy to assemble. How do we judge what the excessive price has been? Often industries that are relatively concentrated (as is almost mandatory for those where firms can agree to subdue their inter-firm rivalry) see some price volatility as competitors josde for market share. After an agreement has collapsed, a spate of pricecutting would be expected and prices can fall to marginal costs (and below) for certain periods.