Saturday, January 3, 2009

A primer on collusion

Collusion exists when oligopolistic firms agree to fix prices and to engage in other anticompetitive behavior. The firms behave as if they were a monopoly setting price and aiming at maximizing joint profits. Collusion is illegal in the US and the EU and in many other countries so firms take extreme precautions to remain undetected. Such collusion is referred to as tacit collusion. If the collusive practices are revealed then the structure is referred to as a cartel. The term cartel also refers to the rare cases of explicit collusion such as OPEC or the De Beers 'family (!) of companies' (a favorite example of my dear friend MM).

This IHT article ('Oil companies carved up the market for paraffin in style') is a beauty in its description of cartel practices:
Surrounded by a moat and four watch towers, the ancient Château d'Ermenonville is not the kind of place anyone would associate with a product as mundane as paraffin.

But the château, a discreet luxury hotel about a 40-minute drive northeast of Paris, and a circuit of others around Europe served for more than a dozen years as bases for executives from some of the biggest names in oil - Exxon Mobil; Royal Dutch Shell; Sasol, of South Africa; and Repsol YPF, of Spain - to fix prices of paraffin, the overlooked wax byproduct of crude oil, that is used in candles, paper cups, lip balm and chewing gum.
(chewing gum????? ughhhh)
The scheme drove up prices to consumers in a plot that probably touched most every household, according to the European commissioner for competition, Neelie Kroes, whose office punished nine oil companies with more than half a billion euros in penalties.
Most cartels operate in secrecy, destroying documents, encrypting e-mail messages or using prepaid phone cards to erase communication traces. But the paraffin cartel was rare in that some members - notably Tibor Toth, a manager with the Hungarian oil company MOL - kept minutes, and attendance lists.

Cartel members e-mailed invitations and sought RSVPs. They booked each other's rooms and played host to open bars. Documents found when investigators first raided the companies in April 2005 included handwritten notes on stationery from hotels on the cartel's itinerary: the five-star Kempinski in Budapest or Château de Montvillargenne in the bucolic horse country of Chantilly, France.

"Next price increase May/June 2000," a Shell executive scribbled in a note after a meeting in Paris. Toth, writing in Hungarian, recorded new prices in West German marks, or Deutsche marks. "Raise in January unless first-quarter quantities are reduced, otherwise raise in season, DM 120."

The behavior of this group and its undoing pose significant concerns.

The relaxed clubiness of the paraffin conspirators stokes worries about the hold that price-fixing cartels have on European commerce.

With Kroes cracking down on cartels involving elevators, cement, automotive glass and drugs, total annual fines in the past five years have more than tripled, reaching €2.27 billion, or $3 billion, this year. The money goes into the EU general budget.
A couple of issues here. First that perhaps fines are not enough to stop such behavior. As long as the collusive practices remain undetected the executives reap the benefits of increased profits under their direction while if the scheme is revealed then it's the company that pays the fines. Perhaps the risk of being sent to prison works better...(Read on this the article 'Well-dressed thieves: Why the threat of prison is necessary to deter cartels' here and here).

We know that cartels are unstable structures because each menber has the incentive to cheat. A cartel structure is less likely to collapse if there are few members controlling most of the industry's output, if the good is homogeneous, if cost structures are similar, if demand is buoyant etc. We notice that cartels have been operating in the elevator, cement, automotive glass and drugs industries as well as marine hose industry (used to funnel oil from tankers to storage facilities), glass and cardboard industries etc. Most involve homogeneous products that are typically used as inputs by other firms. (but, read this for a counterexample). Also, we read in the article that:
...their nine companies controlled 75 percent of the European market
which is considered big enough to pull it off (but, OPEC now controls only 40%!)

Check out the full article to get a feeling of how collusion works outside textbooks.

PS for Greek students: read this article (in Greek) from Kathimerini on the cartel situation in Greece and on the threats and pressure that the members of the competition commission face from several companies......
(But I found this brief note in the English edition::
Competition watchdog wants backing from MPs in its probes

The president of Greece’s Competition Commission, Spyros Zisimopoulos, pleaded with Parliament yesterday for the country’s politicians to support his efforts to crackdown on improper market practices. Zisimopoulos informed deputies that the competition watchdog is investigating a number of sectors of the economy, including cosmetics, cement production and fertilizers. “The commission has opened up a lot of fronts where there are some powerful interests at stake,” he told MPs, as he alleged that some companies are trying to undermine the watchdog’s work. Zisimopoulos did not name any firms.)

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