Cartel

What Is a Cartel?

A cartel is a formal agreement among competing firms to collaborate, typically by fixing prices, limiting supply and demand, or allocating market shares. It is a specific type of collusion in which a group of independent businesses conspire to reduce competition and increase their collective profits, often at the expense of consumers. Cartels fall under the broader economic category of market structure, specifically representing a highly anticompetitive arrangement. Members of a cartel aim to achieve outcomes similar to those of a monopoly by coordinating their behavior and exercising greater market power than they would individually.

History and Origin

The concept of cartels has existed for centuries, with early forms appearing in medieval guilds and merchant associations. However, modern cartels gained prominence during the late 19th and early 20th centuries, particularly in industries with high barriers to entry and a limited number of dominant producers.

In the United States, concerns over the economic impact of trusts and cartels led to the passage of the Sherman Antitrust Act in 1890. This landmark federal statute was designed to prohibit activities that restrict interstate commerce and competition in the marketplace, explicitly outlawing "every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations."⁸ The Sherman Act remains a cornerstone of U.S. antitrust laws.

Globally, one of the most well-known and enduring examples of a cartel is the Organization of the Petroleum Exporting Countries (OPEC). Formed in Baghdad in September 1960 by Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela, OPEC's primary objective was to coordinate and unify the petroleum policies of its member countries to secure stable prices for producers, ensure a steady supply to consumers, and provide a fair return on capital for investors.⁷ This intergovernmental organization continues to play a significant role in influencing the global oil market by collectively adjusting production levels.

Key Takeaways

• A cartel is a formal agreement among competing firms to coordinate behavior, typically to control prices or output.
• Cartels reduce competition, leading to higher prices, reduced output, and limited choices for consumers.
• They are generally illegal in many jurisdictions due to their anticompetitive nature, often prosecuted under antitrust laws.
• Maintaining a cartel is challenging due to inherent incentives for members to "cheat" and the threat of new entrants.
• The formation of cartels can lead to significant deadweight loss for the economy.

Interpreting the Cartel

The existence of a cartel is primarily interpreted as a breakdown of healthy market competition and an attempt by a group of firms to achieve collective profit maximization by manipulating market forces. When a cartel successfully implements its agreements, it can artificially inflate prices above competitive levels, reduce product quality or innovation, and limit consumer choice. Economically, this leads to a misallocation of resources and a reduction in overall economic efficiency. From a legal standpoint, the detection of a cartel triggers enforcement actions by regulatory bodies aimed at restoring fair market conditions and protecting consumer surplus.

Hypothetical Example

Consider the "Global Widget Manufacturing Cartel" (GWMC), formed by the three largest widget producers: Alpha Corp, Beta Ltd., and Gamma Inc. Historically, these companies competed fiercely, driving down widget prices and leading to thin profit margins. Deciding to improve their financial performance, their CEOs secretly meet and agree to:

1. Price fixing: All three companies will sell standard widgets for exactly $100, up from the previous market average of $70.
2. Market allocation: Alpha Corp will exclusively serve North America, Beta Ltd. will cover Europe, and Gamma Inc. will handle Asia, thereby avoiding direct competition in each other's territories.
3. Production quotas: Each company will limit its annual widget production to 1 million units, ensuring that the total supply remains constrained and supports the higher price.

Initially, the GWMC successfully inflates prices and increases profits for all three members. However, customer complaints about high prices and limited availability grow. A new small manufacturer, Delta Widgets, sees the inflated prices as an opportunity and begins producing widgets at $80, quickly gaining market share by undercutting the cartel. Simultaneously, Beta Ltd. considers secretly exceeding its production quota to capture more sales in Europe at the $100 price, knowing that verifying production is difficult for the other cartel members. These internal and external pressures illustrate the inherent instability of cartel agreements.

Practical Applications

Cartels are explicitly prohibited by antitrust and competition laws in most developed economies. Government agencies, such as the Department of Justice's Antitrust Division and the Federal Trade Commission (FTC) in the U.S., actively investigate and prosecute cartel activities.⁶,⁵ These activities can include various forms of anti-competitive coordination:

• Price Fixing: Competitors agree on the prices they will charge for products or services.
• Bid rigging: Companies collude on contract bids, often by agreeing which company will submit the winning bid and what the bid amount will be.
• Output restrictions: Competitors agree to limit their production to drive up prices.
• Customer or market allocation: Competitors divide customers or geographic areas among themselves, agreeing not to compete for each other's allocated business.

For example, the FTC enforces laws that prohibit anticompetitive mergers and other business practices that could lead to higher prices, fewer choices, or less innovation, including price-fixing schemes.⁴ Penalties for engaging in cartel behavior can be severe, including substantial corporate fines, imprisonment for individuals involved, and civil lawsuits where victims can seek treble damages.³

Limitations and Criticisms

Despite the potential for substantial profits, cartels face significant limitations and are often unstable. The primary challenge stems from the inherent incentive for individual members to "cheat" on the agreement. A member can increase its own profits by secretly producing more than its agreed-upon quota or by slightly undercutting the cartel's fixed price, especially if detection is difficult. This temptation often leads to internal disputes and the eventual breakdown of the cartel.

Another major limitation is the threat of new entrants. High cartel profits attract new businesses into the market, increasing overall supply and undermining the cartel's ability to control prices. Cartels must also invest resources in monitoring members and deterring new competition, which adds to their costs and complexity. Academic research highlights that cartels are "inherently unstable" and "plagued by the temptation of their members to cheat and the challenge of deterring entry to their industry by new competitors."² Moreover, the illegality of cartels in most jurisdictions means that any agreements cannot be legally enforced, making them vulnerable to defection and legal penalties. The illegal nature forces them to operate in secrecy, exacerbating problems of cooperation and coordination among members.¹

Cartel vs. Monopoly

While both a cartel and a monopoly result in reduced market competition and higher prices for consumers, their underlying structures differ fundamentally.

A monopoly exists when a single firm completely dominates a market, becoming the sole provider of a particular good or service. This firm faces no direct competition and thus has absolute market power to set prices and control output. The monopoly achieves this position through various means, such as owning unique resources, having significant economies of scale, or holding exclusive patents.

Conversely, a cartel is a group of independent firms that agree to act collectively as if they were a single monopoly. Each member of the cartel remains a separate legal entity and theoretically still competes in the market. The monopolistic outcome is achieved through explicit or implicit agreements on pricing, production, or market division. The key difference lies in the number of independent entities controlling the market: one in a monopoly versus multiple, colluding entities in a cartel. The success of a cartel relies on the discipline and cooperation of its members, which is often difficult to maintain.

FAQs

Q: Are all cartels illegal?

A: In most developed economies, particularly those with robust antitrust or competition laws, commercial cartels are illegal. These laws aim to promote fair competition and protect consumers from anticompetitive practices. However, some international agreements between sovereign nations, like OPEC, operate as cartels but are not subject to the same national antitrust laws.

Q: How do governments detect and prosecute cartels?

A: Governments use various methods to detect cartels, including whistleblowers, leniency programs that incentivize cartel members to report illegal activities in exchange for reduced penalties, economic analysis to identify suspicious pricing patterns, and investigations. Prosecution involves substantial fines for corporations and potential imprisonment for individuals involved in price fixing or other cartel activities.

Q: What is the impact of a cartel on consumers?

A: Cartels typically harm consumers by leading to higher prices for goods and services, reduced product quality or innovation, and fewer choices. The artificial restriction of supply or manipulation of prices reduces consumer purchasing power and overall welfare.

Q: Can cartels exist outside of traditional industries?

A: While often associated with industries like oil or manufacturing, cartel-like behavior can theoretically emerge in any market where a few dominant players have an incentive to collude. This can extend to service industries or even, in some interpretations, certain labor markets where employers agree not to compete for employees.