Is economics helpful when it comes to cartels?

Economics implies that cartels are inherently unstable and so should be short-lived because they price above the Nash equilibrium. However, the evidence is cartels are often long-lived.

When players interact for an infinite number of times, as do firms in real markets, they can escape the short-run Nash equilibrium of the Prisoner Dilemma. In the context of infinite interaction, a collaborative behaviour becomes sustainable depending on the benefits of cheating, the credibility of the punishment’s threat and the discount factor.
“Punishment” refers to the reaction of non-cheating firms to an infringement of the collusive agreement: non-cheaters will move away from the cartel equilibrium towards a more competitive equilibrium, so that the cheater’s profit is reduced. Stability of the cartel is ensured by a punishment mechanism that makes the benefits derived from deviation smaller than the benefits of keeping colluding. An effective punishment mechanism should be strong enough to deter cheating, but also credible. It is in every cartel member’s interest to set the punishment mechanism as high as possible, but credibility follows from each non-cheating firm’s interest to implement it if a breach actually occurs. The punishment mechanism should hurt the cheating firm more than the non-cheating ones; hence, it must correspond to the latter’s profit-maximising behaviour.

Economics’s contribution to anti-cartel enforcement

Ex ante, economics can be used to prevent the formation of cartels by prohibiting mergers that would ease collusion. As tacit and explicit collusion rest on the same economic principles, the criteria used to identify tacit collusion in merger review processes can provide guidance also for the detection of explicit collusion.

Ex post, competition law enforcement can benefit from economic analysis because the latter can provide evidence:

  1. on the plausibility that an industry is/was cartelised, i.e. it can
    a) suggest where to look for a cartel, and
    b) reveal whether, given the characteristics of the market, the cartel
    allegation is credible; and
  2. on the impact that a cartel has had in the market.

Unfortunately economics is unable to establish with certainty whether a market is cartelised: economic models can be employed as screening devices, but further investigation will always be necessary.

Likelihood of collusive behaviours

Economics can help identify markets that are prone to cartelisation and establish whether the cartel allegation is credible given the market’s characteristics. However, economists tend to reject the idea of prosecuting cartels on economic grounds only because patterns of prices under collusion and competition are often similar; moreover, economics cannot distinguish between no collusion and unsuccessful collusion, and it cannot distinguish between tacit and overt collusion.

Structural and behavioural markers represent – complementary – screening tools; they identify suspicious behaviours, but cannot provide hard evidence of collusion. Indeed, they could produce false positives, or negatives, because they cannot distinguish between tacit and express collusion or because market players can evade them. Moreover, not all noncompetitive behaviours infringe competition law.

Estimation of the cartel’s effect on the market

Economics is useful to assess the cartel’s effects on the market. The actual cartel’s impact is of relevance for damages actions, but it can also have a bearing on the size of the fine imposed.

The harm suffered by the direct purchaser of a cartelised product has three elements: (i) the direct effect – the quantity of product purchased multiplied by the increase in price as a result of the cartel; (ii) the output effect – the increase in the purchaser’s selling price that is a likely consequence of its input prices increasing, leads to a reduction in the demand for its products; and (iii) the passing-on effect, which occurs when the direct purchaser raises its selling price in response to the increase in output costs, therefore reducing the harm it suffers

The consequence of a cartel on the market can be estimated by understanding what would have happened absent the wrongful conduct: the claimant’s position during the cartel is compared to the position that he would have been in “but for” the anti competitive behaviour. The difference between the claimant’s profits in the counterfactual world to the one in the cartelised scenario is the amount of compensatory damages due to the claimant. To estimate the counterfactual profit we need to know, or estimate, the following:

  1. the amount of the overcharge;
  2. how much lower would have been the selling price at the lower input costs; and
  3. the level of sales occurred at this lower price.

Direct evidence can be useful to quantify the damage; however, economists have developed different helpful tools to carry out the calculation. Comparator-based methods assume that the counterfactual scenario is representative of the likely non-infringement scenario and that the difference between the infringement data and the data chosen as a comparator is due to the infringement. Cost-based methods estimate the non-infringement price by using some measure of production costs per unit and adding a mark-up for a profit that would have been reasonable in a competitive market. Financial methods compare the counterfactual profitability and the actual profitability of the claimant or the defendant. These approaches can estimate the likely non-infringement scenario but cannot delineate it with certainty and precision.

 

In conclusion, even though economic cannot provide hard core evidence of collusion, it is a useful tool to detect cartels and understand their effects in the market. However, the quality of the answers economics can provide is only as good as the data available and as appropriate as the approach chosen.

***

Ayers, I., How cartels punish: a structural theory of self-enforcing collusion, in Columbia Law Review, 1987, pp. 295-325.

Bishop, S. and Walker, M., The economics of EC competition law: concepts, application and measurement, University Edition, Sweet and Maxwell, 2010.

Friedman, J.W, A non-cooperative equilibrium for supergames, in Review of economic studies, 1971, pp. 1-12.

Harrington, J.E. Jr., Behavioral screening and the detection of cartels, EUI-RSCAS/EU Competition 2006 – Proceedings, 2006

Advertisements