A cartel is a formal (explicit) agreement among firms. Cartels usually occur in an oligopolistic industry, where there is a small number of sellers and usually involve homogeneous products. Cartel members may agree on such matters as price fixing, total industry output, market shares, allocation of customers, allocation of territories, bid rigging, establishment of common sales agencies, and the division of profits or combination of these. The aim of such collusion is to increase individual member's profits by reducing competition. Competition laws forbid cartels. Identifying and breaking up cartels is an important part of the competition policy in most countries, although proving the existence of a cartel is rarely easy, as firms are usually not so careless as to put agreements to collude on paper.
Several economic studies and legal decisions of antitrust authorities have found that the median price increase achieved by cartels in the last 200 years is around 25%. Private international cartels (those with participants from two or more nations) had an average price increase of 28%, whereas domestic cartels averaged 18%. Less than 10% of all cartels in the sample failed to raise market prices.
In contrast, private cartels entail an agreement on terms and conditions from which the members derive mutual advantage but which are not known or likely to be detected by outside parties. Private cartels in most jurisdictions are viewed as being illegal and in violation of antitrust laws.
Two suspects, A and B, are arrested by the police. The police have insufficient evidence for a conviction, and, having separated both prisoners, visit each of them to offer the same deal: if one testifies for the prosecution against the other and the other remains silent, the betrayer goes free and the silent accomplice receives the full 10-year sentence. If both stay silent, both prisoners are sentenced to only six months in jail for a minor charge. If each betrays the other, each receives a five-year sentence. Each prisoner must make the choice of whether to betray the other or to remain silent. However, neither prisoner knows for sure what choice the other prisoner will make. So this dilemma poses the question: How should the prisoners act?
The dilemma can be summarized thus:
|Prisoner B Stays Silent||Prisoner B Betrays|
|Prisoner A Stays Silent||Each serves six months||Prisoner A serves ten years
Prisoner B goes free
|Prisoner A Betrays||Prisoner A goes free
Prisoner B serves ten years
|Each serves five years|
As can be seen, by staying silent (cooperating) both prisoners are better off than in the case where both decide to betray (deviate from the agreement, that is, competing). Nevertheless, if only one of the two prisoners betray while the other stays silent, the former would be free, which is still more desirable for him than having to stay in prison for six months.
Exactly the same occurs in a cartel: while their members are better-off being part to the agreement than competing, deviating (for example by reducing one's price) could imply capturing a big amount of the market demand and making big profits. In other words, the members of a cartel always have an incentive to deviate from their agreement which explains why cartels are generally difficult to sustain in the long run. Empirical studies of 20th century cartels have determined that the mean duration of discovered cartels is from 5 to 8 years. However, once a cartel is broken, the incentives to form the cartel return and the cartel may be re-formed.
Whether the members of a cartel will choose to cheat on the agreement will depend on whether the short term returns to cheating outweigh the medium and long term losses which result from the possible breakdown of the cartel (this is why, also in the Prisoner's dilemma game, the equilibrium varies if the game is played once or if it is, instead, a repeated game). The relative size of these two factors depend in part on how difficult it is for firms to monitor whether the agreement is being adhered to and on the importance of short-run gains relative to the long-run gain. The longer the time firms in the cartel can cheat without detection, the greater the gains from doing so. Therefore, if monitoring is difficult, the higher the probability that some part to the agreement will cheat and the more unsustainable the cartel will be.
There are several factors that will affect the firms' ability to monitor a cartel:
The larger the number of firms the more probable one of those firms being a maverick firm, that is, a firm known for pursuing aggressive and independent pricing strategy. Even in the case of a concentrated market, with few firms, the existence of such a firm may undermine the collusive behaviour of the cartel.
1. The following shall be prohibited as incompatible with the common market: all agreements between undertakings, decisions by associations of undertakings and concerted practices which may affect trade between Member States and which have as their object or effect the prevention, restriction or distortion of competition within the common market, and in particular those which:
- (a) directly or indirectly fix purchase or selling prices or any other trading conditions;
- (b) limit or control production, markets, technical development, or investment;
- (c) share markets or sources of supply;
- (d) apply dissimilar conditions to equivalent transactions with other trading parties, thereby placing them at a competitive disadvantage;
2. Any agreements or decisions prohibited pursuant to this article shall be automatically void. 3. The provisions of paragraph 1 may, however, be declared inapplicable in the case of:
- (e) make the conclusion of contracts subject to acceptance by the other parties of supplementary obligations which, by their nature or according to commercial usage, have no connection with the subject of such contracts.
- - any agreement or category of agreements between undertakings,
- - any decision or category of decisions by associations of undertakings,
which contributes to improving the production or distribution of goods or to promoting technical or economic progress, while allowing consumers a fair share of the resulting benefit, and which does not:
- - any concerted practice or category of concerted practices,
- (a) impose on the undertakings concerned restrictions which are not indispensable to the attainment of these objectives;
- (b) afford such undertakings the possibility of eliminating competition in respect of a substantial part of the products in question.
Article 81 explicitly forbids price fixing and limitation/control of production, the two more frequent cartel-types of collusion. The EU competition law also has regulations on the amount of fines for each type of cartel and a leniency policy by which if a firm in a cartel is the first to denounce the collusion agreement it is free of any responsibility. This mechanism has helped a lot in detecting cartel agreements in the EU.