Cartels

A cartel is defined as a formal agreement among competing firms selling homogenous products in regards to any sort of anti competitive behavior such as price fixing or bid rigging. Many people probably automatically associate the word “cartel” with drug trafficking organizations, and rightly so. Drug trafficking organizations provide a great practical example of the sort of anti competitive business conduct that is prohibited by the Sherman Antitrust Act. For example, you’ve probably heard of turf wars, which result when one gang is selling drugs on another gang’s “turf,” or territory. Usually the reason for the violence is that an agreement previously reached between the rival gangs has been breached. That agreement, whether express or implied, is most likely to the effect that one gang will not sell their drugs on the other’s “turf” and vice versa. This is exactly the sort of market allocation scheme forbidden by the federal antitrust legislation. By colluding with a competitor to divide up the market by geographical territory, the gangs reduce competition in the drug trade for their slice of the market, enabling them to charge higher prices for their drugs.

Cartels arise in many other contexts aside from the drug trade, however. You’ve probably heard of OPEC, which is basically a cartel of oil companies. De Beers is for all practical purposes a cartel in the diamond trade, although the company has successfully circumvented antitrust prosecutions while paying out large settlements in civil suits. Cartels are formed with the same goal in mind as any scheme or anti competitive conduct: Increase profits by reducing competition. Cartels are formal agreements between competitors to manipulate:

  • Product prices
  • Total industry output
  • Market shares
  • Customer/territorial allocation
  • Division of profits

There are both public and private cartels. Often the only difference is that the former has the blessing of the federal government and is therefore immune to prosecution under the antitrust laws. For instance, the federal reserve is largely viewed as a public cartel of private banks. The federal reserve controls the federal funds rate, which in turn controls the effective interest rate paid by consumers on loans. Think of the interest rate as the price a customer pays for a loan, and it becomes clear that this is price fixing at its highest level! By controlling the interest rate, the federal reserve effectively fixes a uniform price for loans of all types around the country. Given the existence of this uniform price, banks are less incentivized to compete to provide cheaper loans (i.e. lower interest rates). Banks make money off of interest paid on loans; they will not charge less interest if they think they can charge the higher rate without being undercut by another competitor. Thus, the federal reserve effectively works a reduction of competition in the banking industry by setting a uniform price for loans, depriving the banking customer of the benefits of market competition (i.e. lower interest rates).

In theory, public cartels pass along benefits to the public at large that would otherwise stay on the competitors’ books as profit. Other examples of public cartels include the independent sector regulators for railways, electricity, gas, water, and media, who try to pass regulations and industry standards with social welfare goals in mind. However, it is seriously contended that in practice public cartels actually do more damage than illicit private cartels, since they are backed by the government and thus immune to criminal antitrust prosecution.  Free from the restraint of keeping any agreements among competitors secret, public cartels are free to manipulate the markets as they see fit.

By contrast, private cartels are almost entirely illegal. The formation of any cartel to control prices or market shares is expressly forbidden by the Sherman Act, and will more than likely be prosecuted by the Antitrust Division of the Department of Justice. For instance, if a group of coffee producers held a meeting to determine who could sell their coffee in which geographic territory, this would constitute the formation of a cartel and be prosecuted as a market allocation scheme under the Sherman Act.