The OECD background paper on this topic was written by Professor Simon J. Evenett in 2011, and can be found here.

illustration-of-concept-of-crisis-roundabout-D66F85

The purpose of this paper is to consider whether changes in policies towards cartel formation are merited during economic crises and associated recoveries. The paper is structured as follows:

Sections two defines crisis cartels.

The term crisis cartel is used to refer to a cartel that was formed during a severe sectoral, national, or global economic downturn. Such cartels can occur without state permission or legal sanction, which may trigger enforcement; or they may be permitted, even fostered, by a government, which may trigger advocacy.

The impact of a crisis on the incentive of firms to cartelise will depend on the nature of the crisis, be it sectoral, national, or international. In thinking through the impact of each type of crisis on the behaviour of cartel members, one must identify the ways in which the crisis affects the business environment and, more importantly, the incentive to cartelise and to remain a cartel member. There are two policy-relevant points to take away from most of the literature. First, economic crises alter the incentives faced by firms to engage in cartelisation, in particular by creating additional incentives for cartelisation. Second, as crises differ in their depth and scope, and the incentives generated by each crisis may differ, generalisation across sectors and time may be hazardous. Furthermore, crises may also change policy priorities in way that lead states to promote cartels.

Much contemporary antitrust enforcement appears to be influenced by the neoclassical analysis of the impact of cartels on otherwise well-functioning markets. This analysis is to be contrasted with that of some development economists who take as their starting point imperfectly functioning markets, a cause of which could be over-capacity of the type observed during sectoral, national, and global economic crises. Reflecting this, a number of development economists have argued that the harm done by the price-increasing effects of cartels pales when compared to the benefits of cartels in certain circumstances, such as when there is a need to achieve a volume of supply that triggers significant economies of scale (or preserve economies of scale as demands falls, as may occurs in a crisis).  In addition, manifold reasons are adduced in the literature in favour of promoting crisis cartels. These include: limiting or avoiding employment losses; facilitating rationalisation of a sector with excess capacity; promoting innovation by facilitating co-operation between otherwise rival firms; promoting productivity improvements by facilitating co-operation with the workforce; stabilising prices and promoting consumer welfare; avoiding “ruinous” competition that denies firms the necessary profits for reinvestment; preserving a proportion of the total market for favoured firms, including domestic firms; and avoiding a widespread backlash against cartel law, competition law, and their enforcement.

As is readily apparent, the reasons to set up a state-sponsored crisis cartel can be both economic and non-economic. It follows that the criteria to assess whether a cartel is justified cannot be limited to whether it increases consumer welfare – even though, if the objective is economic, the relevant assessment should be whether the cartel maximises consumer welfare by comparison to any available alternative. For non-economic goals, however, the assessment should focus on  whether a crisis cartel attains the chosen non-economic objective at a lower cost than any alternative policy considered, including all relevant trade-offs. Of course, these evaluations may vary depending on context (e.g. are effects purely domestic or can they affect other countries) and the policy preferences of specific governments.

The third section summarises evidence about crisis cartels created after general economic downturns. This section, with its focus on economy-wide crises, highlights system-wide choices taken with respect to crisis cartels.

A first example comes from Germany in the late 19th century, where cartels were an important instrument of government policy. The concern at the time was that one large producer would monopolize an industry in a given market, not that horizontal cooperation would foster a monopolistic outcome. Cartels were tolerated given the belief, common at the time, that collusion among producers would serve to restrain monopolistic tendencies.

Another example comes from the US after the Great Depression, when industry self-government was favoured over antitrust enforcement. The principal tool was the so-called trade practice conferences, 60 of which were held at the FTC. Outwardly designed to suppress “unfair” or “unscrupulous” forms of business behaviour, the conferences in practice acted to curb legitimate means of competition. Intervention gathered apace during the New Deal, during which the National Recovery Administration (NRA) was set up, which negotiated many accords or “codes” for individual sectors or industries that specified product market outcomes (such as prices and output levels), labour market outcomes (wages and associated conditions), investment plans, and other corporate practices. These mechanisms stayed in place until the Supreme Court judged it unconstitutional in 1935.

Crisis cartels have also been quite common in Asia. In Japan after World War II, the government often allowed crisis and recession cartels. This was justified on a number of grounds. First, to allow Japanese firms to invest more, since they could take more risk knowing that they would be allowed to form cartels during downturns. Second, the imposition of some control over excessive competition through temporary anti-recession cartels was deemed necessary to ensure that healthy competition would be sustained in the long-run. A last ground for promoting such cartels was to shift the burden of financing the adjustment of declining industries, labour-related­­ and otherwise, off the state budget. A second example in Asia comes from Korea, where several rationalisation or depression cartels – e.g. 250 trade associations – were set up under the permission or patronage of the government. Yet other examples can be found in the aftermath of the East Asian financial crisis of 1997.

The fourth section focuses on crisis cartels implemented in specific sectors.

Sharp falls in prices, perhaps triggered by falls in aggregate demand, are a frequent trigger for crisis cartels, although disruption from other sources (such as a prior war) played a role in some cases. The desire to avoid “ruinous” competition in sectors with high investment outlays and low incremental costs, so as to generate stable rates of return that encourages the progressive investment in a sector, has traditionally also been a motivating factor.

However, government intervention was rarely confined to encouraging the formation of crisis-era cartels and exempting such arrangements from relevant competition laws. Once the state got involved, it often sought (or was persuaded to seek) to influence the terms of the cartel agreement and its stability. Enforcement of the resulting cartels was often a public-private affair. Moreover, whenever competition from foreign firms was an important source of rivalry, crisis cartels included provisions to shut out imports, adding an international dimension to the consequences of this form of state intervention. Lastly, while a sectoral cartel may have been formed in response to an economic crisis or crisis conditions within a sector, the cartels subsequent trajectory may owe little to its crisis-related origins.

The paper provides numerous examples of such cartels, two of which come from the US. A first example is the “pro-cartel policy regime” concerning US railroads from 1872 to 1896, during which “every American railroad of any size joined a cartel”. Reasons for adopting such a policy included stabilising prices and protecting public capital, and avoiding a consolidation that could lead to monopolisation. Pro-cartel policies mitigated price competition among incumbents and thus boosted rail-line foundings, while the introduction of antitrust policy in 1898 enlivened competition, leading to expansion through the growth of incumbents rather than through the establishment of new railroads. Another US example concerns the agricultural sector after the Great Depression. The regulation introduced via the so-called Sugar Acts of 1934 lasted until 1974, and included restrictions on production, sales, imports, market entry and negotiating terms – while also providing subsidies.

A number of crisis cartels all over the world concerned commodities. The oldest are arguably the German potash agreements of 1876 and 1883. After four years of falling prices, the producers set up a cartel that kept up prices and investment in new mines. Another cartel following a fall in prices was set up in the US in 1885, as regards bromine. An arguably more interesting example (and more topical, given what is currently going on in this market) concerns the international steel cartel formed in 1926 by Belgium, France, Germany, and Luxembourg – which, at the time, accounted for 65% of world steel exports and 30% of the world steel production. This cartel, beset with instability created by disagreements among the cartel members about appropriate quota sizes and the punishments for infringing these quotas, collapsed with the Great Depression.

Section five reviews the evidence available at the time of the global financial crisis.

At the time of writing (i.e. three years from the onset of the crisis), there was exiguous evidence of crisis cartels in reaction to the global financial crisis. Rather than resort to crisis cartels, during this global economic downturn many governments offered bailouts and subsidies to domestic manufacturers, farmers, and service providers. These bailouts and subsidies serve to remind policymakers that there are alternative options to creating crisis cartels.

Section six summarises the options available to policymakers.

A major lesson from the recent sharp global economic downturn is that policy towards crisis cartels ought to take into account the availability and potential desirability of alternative state measures. Crisis cartels alter both production and consumption decisions. Worse, cartelisation may only indirectly affect outcomes that governments care about, such as employment, when a more direct intervention would be preferable. Historical evidence suggests that state intervention begets further intervention and that one-off interventions rarely satisfy whatever motives governments have or pressures they face. Establishing or permitting a crisis cartel can, therefore, become the start of sustained and far-reaching government intervention into a sector.

Even though the available empirical evidence makes it hard to sustain an argument in favour of crisis cartels, governments still face the practical challenge of responding to requests for the creation of cartels during times of extreme sectoral, national, or global economic dislocation. Competition authorities can play an important role here, using evidence-based and transparent procedures for determining whether crisis cartels should be adopted and under what conditions. One criterion for the adoption of a cartel is that the industry in question should demonstrate that its woes can only be rectified by the creation of a cartel and not by some other private sector action. In this regard, one must bear in mind that firms have alternatives to cartelisation including mergers, joint ventures, and engaging in other forms of legal co-operation. Should a competition agency or other government body decide to allow the creation of a crisis cartel, it is recommended that the cartel be allowed to operate for a specified limited period and should be subject to periodic review. However, even the temporary granting of a cartel exemption could have longer-term consequences as firms got used to co-operation.

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