Cartels and Trade Associations
Cartels and Trade Associations
Business enterprises in the same trade collaborate with one another in numerous ways and for varied purposes. The term “cartel” characterizes those institutions or mechanisms of collaboration that serve to limit or suppress competition. Trade associations are organizations of enterprises in a particular line of business. They may function as cartels; indeed, their proliferation during the last century in advanced capitalist countries has been an important aspect of the cartel movement. But just as cartels take numerous forms, of which trade associations are but one, so trade associations engage in many activities, of which the suppression of competition is only one.
From the standpoint of both economic analysis and public policy, the important distinction is between those interfirm collaborations that significantly limit competition and those that do not. This distinction does not, however, necessarily provide sufficient basis for appraising their social impact: since free competition does not always produce optimum results, even collaborations that substantially impair competition—and, a fortiori, those that merely moderate or rechannel competitive endeavors—may in some circumstances improve the social performance of industry.
Types of cartels. The principal activities in which cartels engage are price fixing, market sharing or output limitation, joint selling, patent and process cross-licensing, and profit pooling. They do these things sometimes by simple agreement, sometimes with such enforcement procedures as penalties for exceeding production or sales quotas and subsidies for falling short, sometimes by formal organizations like joint ventures in selected markets. All agreements of the above types are not necessarily cartels: marketing cooperatives may not seek or achieve monopoly power; patent cross-licenses may be nonexclusive and unrestrictive. It is a familiar task of antimonopoly policy to determine in such instances whether the collaboration effects a substantial or merely an incidental or minor limitation of competition.
Cartels vary widely in the extent of governmental involvement, which may take the form of reinforcement by tariffs, licensure of entrants, judicial enforcement of the compacts, compulsion of membership, or of direct participation in prescribing prices or quotas. They vary also in their formality, from verbal understandings and “gentlemen’s agreements” to formal organizations— selling syndicates, comptoirs, patent holding companies—with written constitutions and prescribed powers and procedures. There is an inevitable arbitrariness in defining cartels in this respect, and usage varies. At the one limit, most authorities would require an explicit contractual organization or relationship, thus excluding the parallelism of action that may flow from mere recognition of interdependence among oligopolists. At the other extreme, the profit-pooling cartel, like the German Interessengemeinschaften, is only with some arbitrariness distinguished from the financial combination.
Origins and purposes. It is generally assumed that cartels are typically children of necessity— defensive alliances in atomistically organized industries plagued or threatened by destructive competition. It is certainly true that the more numerous the producers in an industry, the more they will need formal price-fixing or output-regulating organizations with powers of enforcement if they are to escape the vicissitudes of competition. In contrast with the situation in relatively concentrated industries, it pays no one producer to exercise self-restraint in his price or output policies in order to avoid “spoiling the market”; and the conflicts of interest between high-cost and low-cost, large and small, financially strong and financially weak, and established and newly entering producers militate against any informal acquiescence in a uniform, noncompetitive course of conduct. And so it usually takes a period of severe, industrywide distress to force upon these numerous firms a willingness to accept the restraints on individual action required by their collective interest in restraining competition and, perhaps, to induce governments to intervene. With relatively little adjustment in each instance, this skeletal description could be made to fit the intergovernmental commodity agreements in rubber, tea, coffee, sugar, tin; the British Coal Mines Act of 1930 and the Cotton Industry Reorganization Bill of 1939; the American Guffey Coal Act of 1935; and the institution of petroleum prorationing in the United States in the early 1930s.
But this explanation is far from universally valid. As for the type of industry structure conducive to cartelization, if atomistically organized industries typically have the greater need, concentrated industries have the greater opportunity. They will ordinarily find it much easier to collude effectively, and secretly if necessary, merely because their members are fewer, hence more conscious of their interdependence. Nor is their “need” typically negligible: few oligopolistic industries consistently achieve markedly supernormal profits without some direct collusion. Such moderately to highly concentrated industries as aluminum, cellophane, diamonds, dyestuffs, electrical equipment, explosives, incandescent lamps, oil (outside the United States), quebracho, synthetic rubber, and titanium dioxide all have long histories of effective cartelization. On the other hand, it is true that in some of the most highly concentrated industries —for example, nickel, molybdenum, automobiles, and (American) shoe machinery—cartels have been of minor importance because they were unnecessary.
As for the circumstances favorable to cartelization, excess capacity and subnormal profits do strengthen the incentive to bridle competition; witness, for example, the German Compulsory Cartel Law of 1934 and the American National Recovery Act of 1933. Most cartels have originated when an imbalance between capacity and demand at previously prevailing prices threatened intensified price rivalry. The modern cartel movement must be traced to the 1870s and 1880s, when improved transportation, industrialization, and freer trade threw theretofore geographically insulated companies into conflict with one another. But excess capacity also undermines cartels by tempting firms to cut prices in order to get more business. And the carrot of supernormal profits can be as effective a stimulus as the stick of subnormal ones.
It is not necessary to choose between these alternative hypotheses. Together they provide the necessary range of explanations of why practically every industry has at some time or other essayed some kind of cartelization. The purpose of all these efforts was to ward off competition, and in this sense all were defensive, by definition. But this purpose and method have recommended themselves to businesses in widely divergent situations, during prosperity and depression and in concentrated and unconcentrated, profitable as well as unprofitable, industries. At the same time, there are few industries that have not also seen cartel attempts founder because the forces impelling firms to behave competitively, each seeking to augment its own profits, proved more powerful than those impelling them to collaborate in order to augment the profits of the group. Cartelization is not a static phenomenon, and most attempts have been short-lived.
Economic consequences. The functioning and economic consequences of cartels will vary widely, depending on the character of the alliance and the structure and circumstances of the industry involved.
Price agreements in atomistic industries. The simple price agreement in an atomistic industry producing a standardized product is usually short-lived and has slight economic effect. As already indicated, it pays no individual participant to honor the agreement, and the number of participants is large. So in the absence of output controls or powerful policing devices (e.g., government stockpiling, trade union boycotts, or organized violence) prices cannot long remain above the competitive level.
Output or sales limitations in atomistic industries. Cartels in atomized industries have, therefore, either collapsed or adopted limitations on output or sales. Because of the large number and geographical dispersion of producers, this has usually necessitated government intervention. Such controls set in motion the following tendencies:
(1) Prices are raised above the marginal costs of those producers whose output is restricted.
(2) Higher profits are earned, at least transitionally.
(3) Consequently, entry of new firms, often in areas outside the cartel’s jurisdiction, and expansion of capacity by established ones are encouraged.
(4) To the extent this new capacity remains outside its jurisdiction (and the more successful the cartel, the greater the advantage of remaining outside, benefiting from the raised price without having to pay the cost of restricted output), the cartel’s members suffer a decline in market share. In any event, if the price is to be sustained, the quotas attached to existing capacity must be correspondingly reduced.
(5) Thus, excess capacity is generated, unit costs are adjusted upward to the artificially sustained price, and supernormal profits tend to be eliminated because of the encouragement to new entry and investment and the progressive curtailment of output from existing plant. Consequently these cartels rarely maximize aggregate industry profits. When the costs of existing firms differ, maximization requires, in the short run, greater cutbacks in output of the higher-cost than of the lower-cost firms and plants (until their respective marginal costs are equated); and in the long run, maximization requires restriction of investment and concentration of production in lowest-cost plants of optimum size. But achievement of this requires industry profit sharing to compensate those whose output and capacity are the most severely restricted. Such schemes have proved difficult to devise and implement in unconcentrated industries. Probably more often the very opposite happens: output of low-cost producers is restricted more severely than that of the high-cost producers in order to ensure the survival of the latter operators, which are usually smaller.
(6) In consequence, cartels of this kind tend to be self-destructive. Their major attraction to members is their promise of enhanced industry profits. When they fail to keep that promise and, instead, impose increasing burdens on established, and especially low-cost, members, the likelihood is increased that at some point a large enough group will become sufficiently dissatisfied with their allotted share to feel that they can do better by resorting to independent action. Their disaffection, reinforced by the growth of uncontrolled production, can break the cartel and usher in a regime of often violent competition. These tendencies, inherent in cartelization itself, have in practice been powerfully reinforced by fluctuations in demand, technological breakthroughs, and the opening up of new producing areas.
Do cartels, then, tend to stabilize market prices? Prices of primary products produced and marketed under competitive conditions have been exceptionally unstable historically. The reasons are complex, but the principal proximate cause is inelasticity of supply [seeAgriculture, article onprice and income policies]. Ideally, cartels seek to remedy this defect with their output and marketing controls. But in practice these stabilizing tendencies have often been more than offset by fluctuations in the strength and effectiveness of the cartels themselves. Formed in periods of glut, they push prices up. This success in turn encourages new investment and entry, and exaggerates the disparity between capacity and demand at remunerative prices, and this in turn aggravates the price declines that follow the collapse of the control schemes.
Cartels in atomistic industries with entry restrictions. Some unconcentrated, cartelized industries have escaped some of the foregoing vicissitudes because of restrictions on entry, for example, by government licensure or trade union boycott. The main distinctive characteristics of this case are the following: (1) When the cartel is internally effective, the barriers to entry prevent the erosion of monopoly profits. (2) If the licenses are transferable, the monopoly profits come to be capitalized in their purchase price, so that new entrants may earn only normal returns on their investments. (3) The overinvestment, chronic excess capacity, and instabilities of the output or sales limitation case may be to some extent avoided. (4) But the barriers to entry of new firms and competing products and the elimination of price competition typically retard technological progress and the weeding out of the inefficient. These phenomena can be observed in the building trades, the service and trucking industries (medicine, barbering, taxicabs, funeral services), and some branches of retail distribution and agriculture.
Price agreements in concentrated industries. The more concentrated the industry and the higher the barriers to entry, the greater the likelihood that simple price fixing or similar agreements (e.g., exchanges of detailed price data) can be effective in sustaining price above cost for extended periods of time. To the extent that the individual sellers, recognizing their interdependence, offer for sale only what the market will take at the quoted price, explicit output controls cease to be necessary.
Even in quite highly concentrated industries, however, such agreements are rarely fully effective in maintaining monopoly prices and profits. Conflicts of interest and opinion remain, and to the extent that the respective products are mutually substitutable, the firm that prefers the lowest price is the one whose opinion tends to prevail. Secret, usually discriminatory, price concessions may abound in periods of weak demand; and the price collusively set will be limited by such “chiseling” and the possibility of entry. Investment and innovation policies remain uncoordinated; therefore capacity will tend to be expanded to a higher level, and innovation and product development will be pressed more rapidly and in a greater variety of directions than if the industry were dominated by a single firm.
Cartels in such situations are less likely to produce the instabilities and inefficiencies of the atomized cases above—the induced overinvestment, excess capacity, and preservation of firms of inefficiently small size. On the other hand, they may generate the wastes of monopoly and excessively concentrated oligopoly—insufficient attention to cost reduction, underinvestment, conservatism in radical innovation, excessive selling expenses, and frivolous and costly changes in product design. With prices fixed, market shares come to depend principally on sales promotion and product variations that catch the buyer’s fancy.
Effective cartelization in concentrated industries. Thoroughgoing, effective cartelization is or sometimes has been found in concentrated markets where private parties control aggregations of patents (as in various chemical products or in the United States glass container industry) or strategic raw materials (as in nickel, diamonds, and world oil). In these instances, prices, profits, and efficiency sometimes come very close to those of single-firm monopoly, with all its attendant dangers and possible economies. At the same time, there remain (as in the preceding price-agreement case) important possibilities of rivalry. No such agreement remains eternally unchanged in the way it distributes its benefits, and dissatisfied members always have some possibility of going it alone. The distribution of benefits is therefore likely to bear some relation to what the participants could get outside the cartel, and any large and continued discrepancy will encourage the stronger parties to break the agreement. Therefore each member remains under pressure to innovate, accumulate patents, and secure control of raw materials and market outlets. On the other hand, the cartel will retard the competitive exploitation of these advantages and the quick passing on of their benefits to the consumer.
Do cartels contribute to stability in the economy at large? The relevant considerations are complex, and conclusive proof is unavailable. Other things being equal, price stability can be secured only at the cost of output and employment instability, i.e., by making supply more responsive to shifts in demand. But given relatively inelastic demand— and this is the situation in which collusive price fixing recommends itself—price stabilization means a tendency to stabilize the flow of money income to the cartelized industry; hence, in a one-crop, export-oriented country, to the entire national economy. This tendency is accentuated by the effect of price stabilization on buyer and producer expectations: tending to discourage speculative overbuying and underbuying on the one side, and cycles of overinvestment and underinvestment on the other.
But in diversified economies, where the effectiveness of competition differs greatly from one industry and one stage of the cycle to another, there are introduced numerous complicating factors. These factors relate to, for example, the effect of cartel-sustained prices during general recessions on the distribution of income, notably between profits and wages, hence on the propensity to consume; on the fortunes of buyers as well as sellers of the cartelized product; on incomes earned in the uncartelized sectors of the economy; on investment incentives; on the balance of payments; and on the willingness of governments to pursue expansionary macroeconomic policies.
The principal causes of economic instability in advanced market economies must be sought in the factors influencing the flow of aggregate demand; the competitiveness of markets does not rank importantly among these. Probably most economists feel that cartelization has comparatively little to contribute to macroeconomic stabilization.
Political-social consequences. Cartels almost inevitably produce a closer conjoining of political and economic centers of power. Many markets can be cartelized only with government help. Not only atomistic but also concentrated industries have sought such assistance and delegation of sovereign authority. The suppression of competition in turn makes the performance of industry a matter of direct public concern and invites regulation. Cartels are a step toward centralized planning; questions of planning by whom and for what and for whose benefit become vital political issues. There are corresponding social implications in a movement involving hierarchical and authoritarian organization of the economy.
Trade associations. Besides the direct control of competition, trade association activities include trade promotion, product standardization, exchange of price and other statistical information, industry cost analysis, technical collaboration and counseling, collective bargaining, employee training, prevention of fraud and unfair methods of competition, commercial arbitration, and providing a forum for the discussion of problems of mutual interest.
Some of these activities would seem unequivocally to bring market conditions more closely into line with the requirements of perfect competition. Yet in certain circumstances they could have just the opposite effect. For example, effective competition requires that full market information be available to buyers and sellers. But in an oligopolistic industry, the only achievable price competition may take the form of secret, discriminatory concessions. Agreements to provide detailed information of prices actually charged can, by removing the veil of secrecy and identifying price-cutters, produce more nearly the results of perfect collusion. The same possible consequences flow from compiling and sharing information about costs (average industry costs may serve as suggested uniform prices), inventories and shipments relative to production (which may serve as signals for coordinated, uniform changes in output), or uniform methods of cost accounting. Exchanges of credit information have produced suppression of competition in credit terms; and distribution of freight rate books has served as the basis of industry-wide uniform delivered pricing systems.
The efforts of trade associations to standardize products, impose quality standards, and prevent fraud all in a sense make markets more nearly perfect. Standardization enables buyers to make intelligent price comparisons; it may also reduce costs of production and distribution. Quality standards may protect buyers from their own ignorance, as well as scrupulous firms from losing business to the unscrupulous. But standardization is also essential if collusively fixed prices are to be truly uniform and may also suppress socially desirable quality competition. Particularly if they are enforced, as they sometimes are, by concerted refusals to handle the products of transgressors, quality standards may be employed to deny price cutters or product innovators access to the market. All too often trade association “codes of ethics” or of “fair competition” have really tried to suppress all effective rivalry.
Most trade association activities could be regarded also as making available to small but otherwise adequately efficient firms those economies of scale that they require for survival. Lobbying, trade promotion, the joint collection and dissemination of information, and joint research could all be so characterized. Yet, it is obvious, they may also suppress or serve as substitutes for independent, competitive efforts.
These ambiguous implications pose formidable problems for economic analysis and public policy. The basic difficulty is that the kind of imperfect competition achievable in the real world—given uncertainty, imperfect knowledge, immobilities of capital and labor, and fluctuating demand—often produces defective results, which can sometimes be improved by restraints on competition. The main defense of cartels is precisely that competition is often destructive, unstable, and wasteful. The question, then, is whether—either ever or under what circumstances—the possible contributions of cartels or trade associations in mitigating these ills outweigh their dangers, and if so, how to achieve the one while escaping the other.
One partial escape is to have the government undertake the socially beneficent functions. Government agencies collect and publish data on prices, costs, inventories, and sales; determine and prescribe quality specifications; prohibit fraud and unfair methods of competition; and provide technical and managerial assistance to small business. But government regulations too (e.g., product standards or rules of fair competition) may discourage competition and innovation. Moreover, it is inconceivable that in a pluralistic society government services could entirely supplant voluntary business collaboration. There is no escape, therefore, from the necessity of developing economic criteria and legal procedures for predicting, assessing, and sifting out the complex consequences of these various activities.
There are wide differences in the public policies adopted to this end; and there is in fact no wholly satisfactory solution, for several reasons.
(1) As we have already seen, the economic consequences of these activities will vary, depending in each instance not only on the nature of the collaboration but also on all relevant circumstances of the market in which it takes place; and these circumstances themselves constantly change over time. It is therefore extremely difficult to formulate general rules applicable to each individual instance.
(2) In economic terms, the ideal policy might be one that involves a comprehensive scrutiny of each individual situation, after the fact, to determine whether the collaboration was in practice doing more good than harm, on balance, and to institute whatever modifications seem to be required. But the law necessarily places heavy reliance on rules that are clear and readily enforceable: a case-by-case approach, ex post facto, would offer businessmen less guidance in advance about unacceptable courses of conduct; and regulatory processes would inevitably lag behind the dynamic forces they were seeking to control. The opposite extreme is the promulgation of per se prohibitions pertaining to specified interfirm collaborations; these fall afoul of the first objection but could be defended, on balance, as doing more good than harm. A familiar, intermediate course is to condemn only those arrangements whose impairment of competition as an effective force in the market place is direct and substantial. Such a rule requires an examination in some situations only of the nature of the collaboration and restraint; in others it requires a more comprehensive appraisal of its impact. Yet neither this nor any other solution can be economically perfect; in some situations direct and substantial concerted limitations on competition may prevent truly destructive rivalry.
(3) Finally, there is the difficulty that public economic policy is necessarily shaped by largely noneconomic considerations, and appropriately so. These include the attitude that society has toward the presence and exercise of private economic power and the respective weights it wishes to give to the goals of efficiency, equity, security, and progressiveness, all of which are affected by antimonopoly policy. There is no perfect resolution of these many, often conflicting, considerations.
Alfred E. Kahn
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