How Cartels Endure and How They Fail: Studies of Industrial Collusion

Published by EH.NET (January 2005)

?

Peter Z. Grossman, editor, How Cartels Endure and How They Fail: Studies of Industrial Collusion. Cheltenham, UK: Edward Elgar, 2004. vi + 324 pp. $115 (cloth), ISBN: 1-85898-830-6.

Reviewed for EH.NET by Richard Sicotte, Department of Economics, University of Vermont.

In How Cartels Endure and How They Fail, Peter Z. Grossman has assembled an excellent collection of papers treating key questions in the economic analysis of cartels. The book consists of eleven chapters contributed by some of the leading scholars in the area. The chapters include case studies and cross-sectional work, as well as an outstanding survey of the literature on cartel stability. The questions addressed include: When should one judge an attempt at collusion to be successful? What are the factors leading to successful collusion? Are cartels always inimical to social welfare?

In an insightful introduction, Grossman notes that two measures of cartel success are of particular interest: the longevity of the cartel agreement and the ability to increase member firms’ profits above what they otherwise would have been. Traditionally, cartels have been seen as inherently unstable either because they are unable to prevent members from cheating or because they cannot prevent entry or competition from new products. Further, the traditional view is that cartels are inefficient to the extent that they approximate the behavior of a monopolist.

Margaret Levenstein and Valerie Suslow, in their contribution, survey the immense cross-sectional and case study literature on cartels. They find that the average duration of a cartel agreement (in the cross-sections) ranges from 3.7 to 7.5 years. But they find that in addition to the problem of cheating and enforcement, cartel success also depends on a number of other factors: demand-side characteristics, the rate of technical change, the homogeneity of member firms, and organizational factors such as the decision-making procedure, as well as government policies. They astutely make the point that many, if not all of these factors are interdependent. Levenstein and Suslow’s survey and extensive bibliography are an invaluable resource for students of cartels.

Grossman’s own chapter is an interesting comparison of two nineteenth-century U.S. cartels: the Joint Executive Committee (a railroad cartel) and the railroad express cartel. The Joint Executive Committee was comparatively unsuccessful, and Grossman finds that in addition to some of the reasons discussed by Levenstein and Suslow, there are important institutional factors that explain why. Building on his previous work, Grossman notes the railroad companies’ limited liability status and that railroad express firms were unlimited liability firms. The risks of bankruptcy and the incentives for cooperation were thus much higher.

The book includes several chapters that raise questions about whether cartels might actually enhance efficiency and aid consumers. One is a case study of costs and competition in the late nineteenth- and early twentieth-century cast iron pipe industry by George Bittlingmayer (a reprint of his 1982 article in the Journal of Law and Economics). The article makes the points that there is no competitive equilibrium in industries with decreasing average costs, that the cast iron pipe industry had decreasing average (and even marginal) cost, and that the formation of a cartel among producers is explained by the absence of a competitive equilibrium. William Sjostrom, in a superb survey of the literature on cartels in the ocean shipping industry, offers destructive competition as a possible explanation for why cartels have dominated ocean shipping routes from the late nineteenth century until relatively recently. In contrast to Bittlingmayer, this view is based on the game-theoretic concept of the core. According to the destructive competition argument, consumers benefit from collusion because it allows an industry to exist in a stable manner. In another chapter that challenges the traditional view about whether cartels are inefficient, Janice Rye Kinghorn and Randall Nielsen provide empirical evidence on several German cartels from the early twentieth century that shows that prices actually fell relative to a “predictor” good after cartelization. Could cartelization actually have led to lower costs of production that were passed on to consumers? In Andrew Dick’s chapter analyzing his data set of U.S. cartels legal under the Webb-Pomerene Act, he notes that export cartels lowered costs for member firms because they were able to share administrative costs, advertising and foreign sales agencies.

There are several chapters in the book that discuss important issues about interactions between politics and cartels. Gary Libecap and James Smith compare the role of Texas producers in the U.S. domestic petroleum cartel with the role of Saudi Arabia in OPEC. They find that political considerations and the heterogeneity of producers within Texas prevented Texas from consistently acting as a “swing producer” in the domestic cartel, whereas Saudi Arabia has often filled that role. Their paper contains many fascinating insights into the relationship between government and cartels, one of the most interesting is in their conclusion in which they state that while private cartels can gain from getting the government to help enforce their agreements, government involvement will often entail politically-driven policies that require cartel quotas to deviate substantially from joint profit maximization.

Christopher Gilbert contributes a provocative chapter on international commodity agreements. He argues that consumer (importing) countries may sign on to such agreements because the price is actually lower under the agreement than in the counterfactual agreement that only includes exporting countries. Gilbert’s model predicts that high-cost producers will opt not to join a cartel unless they are compelled to do so because consumer countries’ involvement entails the prohibition of imports from exporters that are not cartel members. The low-cost exporters prefer the consumer countries’ involvement because of this improved enforcement of fringe producers’ production and offer price concessions accordingly. Gilbert surveys recent commodity agreements and maintains that the model potentially explains the organization of the (now lapsed) International Coffee Agreement.

The volume also includes fine chapters on research joint ventures, collusion in declining industries and government policy toward cartels in Japan. Taken as a whole, the book provides fascinating insights, calls into question some traditional views, and points the way for future research. It is an extremely valuable contribution to the study of cartels.

Richard Sicotte is an Assistant Professor of Economics at the University of Vermont. He is the author of “How Brinkmanship Saved Chadbourne: Credibility and the International Sugar Agreement of 1931,” (with Alan Dye) Explorations in Economic History (forthcoming); “Exclusive Contracts and Market Power: Evidence from Ocean Shipping,” (with Pedro Mar?n) Journal of Industrial Economics (June 2003); and “American Shipping Cartels in the Pre-World War I Era,” (with George Deltas and Konstantinos Serfes) Research in Economic History (1999).

?