Cartel

A cartel is an organization comprised of members of an industry who once competed against each other. Cartel members usually agree to set production quotas, reducing total output available to the market, based on the percentage market share each participant had when the cartel was formed. By collectively reducing output, the market price for the cartel’s output will rise and cartel members’ profits will increase. Cartels, which can exist on local, regional, national, and international levels, are essentially formal agreements to restrict output, divide markets, or restrain price COMPETITION among firms in a market. As such they are illegal in the United States under the SHERMAN ANTITRUST ACT (1890). Certain market conditions are necessary for creating and maintaining a cartel.
• few participants in the industry
• significant BARRIERS TO ENTRY
• similar PRODUCTS produced
• few opportunities to keep individual actions secret
• no legal barriers to production control agreements
Cartels are not easy to coordinate; if there are many members, it is difficult to gain consensus and cooperation. If new firms can enter the market once price has been driven up, the benefit of creating a cartel will quickly disappear. Likewise, if there are similar products that can be substituted for the cartel’s product, the cartel will not be able to raise price because consumers will substitute other products. If members can cut special deals with customers, subverting the cartel agreement, the organization will quickly fall apart, and it will also disband or become an informal agreement if the agree- ment is deemed illegal in the markets where the cartel members participate. Collusion, a secret agreement to restrict competition, has the same impact as a cartel and is also illegal in the United States. Most firms belong to industry associations and meet regularly to examine common issues. Frequently these meetings lead to discussion of prices. One industrial manufacturing lawyer cringed each time his company’s executives went to annual industry gatherings, fearing they would return with secret agreements made with other executives in the industry. The most famous cartel, ORGANIZATION OF PETROLEUM EXPORTING COUNTRIES (OPEC), is a group of countries (rather than firms) which coordinates oil production. When OPEC was formed in the 1960s, oil-producing countries were receiving $1–$2 per barrel of oil. In the 1970s OPEC members restricted SUPPLY while DEMAND was increasing, thereby raising oil prices to over $30 per barrel. (Oil prices vary slightly depending on the quality of the crude oil produced in different regions of the world.) Generally cartels contain the seeds of their own destruction, because members are reducing their output below their existing potential production. Once the market price increases, each member of the cartel has the capacity to raise output relatively easily. The tendency is for cartel members to “cheat” on their quota, increasing supply to the market and lowering the market price. Most cartels are unstable agreements and quickly disband, returning the market to more competitive conditions. In the 1980s, OPEC began to fall apart, and the price of oil fell to $12 per barrel, when Saudi Arabia, the largest oil-producing country in OPEC, expanded output back to their agreed-upon OPEC quota. For most of the 1970s and 1980s, Saudi Arabia had cut its output below its quota to compensate for overproduction by other OPEC countries. This allowed OPEC to achieve the goal of higher prices but reduced Saudi Arabia’s revenue. Frustrated with cheating by other members of the cartel, Saudi Arabia increased supply, and market prices plummeted. Reduced output due to the Iraq-Kuwait war in 1990, reduced cheating by OPEC members, and increased global demand brought oil prices back up over the $30-a-barrel level during most of the 1990s. Over the years, many other cartels have been formed in tin, chrome, coffee, and diamonds. DeBeers controls the distribution of uncut diamonds, keeping prices high by restricting and coordinating supply to the market. Standard Oil—which in the 1890s gave John D. Rockefeller a near-monopoly in oil production and refining—created a cartel in petroleum distribution, shifting oil distribution among participants in the railroad cartel at agreed-upon levels. The railroads charged non-Standard Oil producers higher rates for oil distribution, facilitating Standard’s acquisition of competitors and preventing new competitors from entering the oil-refining market. The Sherman Antitrust Act was a response to Standard Oil’s monopolization activities. While cartels are generally illegal in the United States, they are often legal in other countries and are sometimes sanctioned in the United States. The National Collegiate Athletic Association (NCAA) is a cartel of colleges and universities that sets athletic rules and behavior, determines distribution of television revenue from college sporting events, and penalizes institutions that violate NCAA rules. Many agricultural COOPERATIVES are legal cartels, raising prices for members’ products or reducing costs through collective purchasing power. During bumper-crop years, one of the largest cooperatives in the United States, Sunkist, reduces market supply by mandating that members reduce production of citrus fruits. Cooperatives are legal in the United States.