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Saturday, 7 December 2013

Limiting the practices of Cartels


Cartels are agreements made between competitors with the aim of stifling or eliminating competition. This is mainly done with the aim of maximising profits for the members of such cartels. Cartels have been known to adversely affect the resource allocation in the economies leading to gross underperformance of the economies affected. This has led to an international consensus on the need to limit the practices of cartels through appropriate legislations at both the national and the international levels. This paper seeks to provide an overview of the laws and regulatory measures taken to limit the activities of cartels. It also creates understanding of cartels, their characteristics and their effects on markets. This paper also highlights some of the challenges faced by regulators in limiting cartel practices and seeks to make recommendations on how these limitations can be overcome.

A cartel can be described as an explicit agreement between competing businesses in a market to engage in practices that limit competition between them in order to maximise gains accruing to themselves at the expense of other market players (Gray, 2008). These agreements mostly pertain to fixation of prices above the market equilibrium levels, limit production to levels below the market equilibrium levels and other practices such as marketing and market segmentation. Other practices may include the allocation of territories, bid rigging, allocation of customers, use of common sales agencies, and profit sharing (Richard, Campbell and Elles, 1966). Cartels mostly occur in industries with a relatively small number of producers or sellers and almost always relates to a situation where these producers manufacture homogenous products (Connor, 2008). The homogeneity of products implies that competition can only be done based on pricing. This means that the members can easily detect a violation whenever a member of the cartel lowers their prices and gain on the market share of the others. The cost structure of the cartel members also bear great significance as any differences in the production cost structures may prompt the firms to pursue a different profit maximisation strategy (Dick, 1996).

The stability of demand also affects the operation and stability of cartels. Markets facing frequent demand fluctuations present the opportunistic members of the cartels with the opportunity to violate the cartel agreements and go undetected as the cartels may not be able to attribute the fluctuating revenues to a violation by a member (Dick, 1996). The main aim of cartel agreements is to increase the profitability of the members by limiting the competition between them. Cartels can either be private or public. Public cartels are protected by governments and may not be held legally liable for their action as the government is involved in enforcing the cartel agreements. Governments may establish cartels based on their assessment on the need to stabilise prices and control the level of production. For instance, in Japan, in the aluminium smelting, steel, and ship building industries (Symeonidis, 2002). In the USA, public cartels were permitted in oil production and coal mining during the Great Depression (Symeonidis, 2002). The same was done in Germany in the sugar, tin, and coffee industries during the same period (Symeonidis, 2002). On the other hand, private cartels are prohibited in most countries with various legislations being enacted to limit their cartel practices around the world.

The enactment of antitrust laws in most nations proves a growing commitment internationally to curtail cartel practices that may have an adverse effect in the economies in question. The identification and limitation of the cartel practices is also a subject of competition laws in many countries (Gray, 2008). However, the identification and proof of the existence of cartels is often difficult due to the reluctance of such market players to make use of formal agreements when engaging in illegal collusions (Harding, 2003). Cartels originated in Germany in the 1880s as the alliances of enterprises and spread to the UK and the USA in the 1930s (Symeonidis, 2002). The adverse effects of these cartels prompted the creation of the American led anti-cartel movement in the 1940s that aimed at banning the practice on a global level (Konkurrensverket, 2001). The acknowledgement of the need to limit cartel practices has dominated international thinking with most countries enacting competition laws whose role include the identification and limiting cartel behaviour in their economies.

Due to the fact that cartels can operate internationally, most countries have factored the need to cooperate with other countries in limiting cartel practices in their legislations. In the USA, the Sherman Antitrust Act of 1890 outlawed all agreements deemed to restrain interstate and foreign trade (Konkurrensverket, 2001). The violations of the Act are punishable as federal crimes. In the European Union, the outlawing of cartel behaviour is contained in the article 81 of the treaty of Rome which was later replaced by the 101 TFEU (Konkurrensverket, 2001). In the UK, the Enterprise Act of 2002 and the Competition Act of 1998 legislate and provide for identification and limiting of cartel practices within the UK (Gray, 2008). Where the violating firms operate across the national borders within the EU, the EU legislations are applied.

An extensive survey conducted on the activities of cartels indicates that in the last century, cartel activities have often led to a 25% increase in the prices of the products affected (Connor and Lande, 2005). Cartels operating across national borders had a price increase effect of about 28% with the domestic ones pushing prices upwards by about 18% (Connor and Lande, 2005). Of all the cartels studies, over 90% often led to significant changes in the prices of the subject products (Connor and Lande, 2005). A popular example of international cartels is the OPEC which controls the production and prices of oil among the oil producing countries (Connor and Lande, 2005). This cartel has been responsible for some of the worst price fluctuations in the energy industry in recent times. Another cartel which operated between 1992 and 1997 among the producers of graphite electrode involved the players agreeing to fix prices and allocate themselves markets around the world (Konkurrensverket, 2001). The price increase of this product in the United States alone was 60% over the duration of the collusion (Konkurrensverket, 2001). Similar adverse effects were observed in the case of lysine producers’ cartel which was in operation between 1992 and 1995 (Konkurrensverket, 2001). A recent study by OECD (Economic Co-operation and Development) between 1996 and 2000 estimated the effective commerce affected by 16 cartels amounted to $55 billion worldwide with an average overcharging rate of about 10% and an overall 20% harm to the economy (Gray, 2008). In their report, OECD termed cartel behaviour as a criminal behaviour with no benefits to the economy as a whole (Gray, 2008).
Markets performing at the optimum are those where the allocation of resources is efficiently done through the forces of competition in the market (Symeonidis, 2002). Where competition applies, producers strive independently to attract buyers to buy their products through price variations, product differentiation or other strategies as they may deem fit. This is of course done with the aim of maximising profits. On the hand, the buyers only buy products that provide them with the benefits they seek for where one of the key determinants of the choice of products to buy is the price of such a product. The equilibrium price is set as follows: while the buyers prefer to buy at the prices that they feel optimises their benefits, the sellers prefer to provide products at the highest price possible in order to maximise their profits (Symeonidis, 2002). Since the buyers can only spend what they view as the price optimising their benefits, they can only buy at a given price. On their part, the sellers are forced to reduce their prices to the price the consumers demand and would consequently lower the amount of goods to be supplied at such a price. If demand increases and the prices go up, the producers are at ease to supply more goods and where such goods exceed the demand, the prices are pushed back to the equilibrium levels.

The existence of competition in markets ensures that consumers can access a wide range of products at the best prices achievable. The producers get the incentive to be innovative in order to meet the quality and price expectations of the consumers. This leads to economic development in the subject markets due to the resultant innovation of products and business processes as the producers seek to outdo each other in providing affordable value to the consumers (Symeonidis, 2002). The forces of competition therefore become the most effective factors of resource allocation in the market and leads to higher market efficiency. Any practices that tend to limit the level of competition that can exist in the market tend to result in an underperforming market (Sutton, 1991). An underperforming market can be characterised by exorbitant prices that are higher than the consumers would willingly spend for products under normal circumstances. It can also be characterised by shortage of products where despite the existence of sufficient demand, the producers tend to produce less products for one reason or another (Symeonidis, 2002).

Underperforming markets also contain various artificial barriers to entry that prevent new entrants into the markets hence slowing down the rate at which such markets can grow (Morton, 1997). Even though cartels have proven difficult to prove, their presence can be imputed based on the characteristics of a given market. Markets that are perpetually hit by shortage of goods may provide a likely indication that the dominant market players are in a cartel. Similarity of prices (which are in most cases inflated) among the market players who are expected to be competing on price may also suggest the existence of a cartel. The absence of growth in a market through the lack of entry of new market players may also suggest the existence of cartel behaviour that has been designed to restrict the entry of potential competitors into the market (Leventein and Suslow, 2006). Efficient markets yield untold benefits to countries (through their contribution to the GDP, employment, and economic growth and development) and it is the duty of governments to facilitate such efficiency and limit the existence of players that may want to engage in behaviour that may limit such efficiency (Symeonidis, 2002).   

Cartels are not easy to prove due to the shrewdness of the players involved who desist from making formal and traceable agreements when engaging in such collusions. The principle of fair treatment requires that evidence of cartel behaviour be proven beyond reasonable doubt before the offending firms can be subject to any penalties under the law (Gray, 2008). This may be illustrated in the case of Wood Pulp 1993 versus the Commission of the European Communities (hereafter referred to as ‘the Commission’) (Competition law of the EC and UK, 2011).

Bleached sulphate pulp also referred to as wood pulp is a wood-based product which is used in manufacturing paper (Competition law of the EC and UK, 2011). It was produced by about 800 firms scattered across 30 countries but mainly in United States, Canada, and Northern Europe (Competition law of the EC and UK, 2011). About 50 of them supplied products into the European Community. The prices for the products would be announced in advanced and would be fixed per quarter and this announcement would be done by the various producers either in writing or orally. Some of these producers were members of an export cartel in the USA whose existence had been permitted provided their actions only affected the exports as provided for by the Webb-Pomerene Act of 1918. The end result of the pricing model adopted by these producers was the uniform increase of prices. This went against the expectation of the trial and error mode of pricing as the forces of demand and supply interact to set the equilibrium prices. This is illustrated below:
Source: http://www.oup.com/uk/orc/bin/9780199237920/resources/maps_cases/case9_3.pdf

The commission therefore sought to impose penalties to the producers affected upon which the Wood Pulp producers launched an appeal which assumed a two-fold approach. Firstly, it challenged the jurisdiction of the European Commission in view of the fact that most of the producers were located outside the European Community. Secondly, it disputed the basis for the penalties and denied any collusion between the wood pulp producers in setting their prices. On the question of jurisdiction, it was ruled that since the action took place within the boundaries of the European Community, the Commission had the authority to undertake necessary actions if evidence of cartel behaviour would be proven. Regarding the price fixation charges, the court found that parallel movement of prices was not sufficient evidence of collusion. The experts commissioned by the court to undertake studies into the market structure of the industry found that it was oligopolistic in nature and therefore players could easily monitor the actions of the competitors with ease and take actions appropriately (Competition law of the EC and UK, 2011).

According to them, market transparency made competitors to refrain from being the first ones to raise their prices because if they did, their competitors would simply refrain from doing the same and thereby attract more customers. However, in the even that cost pressures mounted to a level that the prices had to be raised and one supplier raised their prices; their competitors would quickly follow soot leading to the kind of price patterns observed by the European Commission. The court held that where evidence of collusion was absent, no criminal liability could be apportioned to the perceived offenders; especially where there was a plausible explanation for the actions taken by such producers. This was unlike other litigations where the Commission’s sanctions were upheld as in the case of ICI versus the Commission (Konkurrensverket, 2001).

The decision arrived at in the Wood Pulp underscored the maxim of fair treatment of alleged offenders. The implication of the ruling is that it required any prosecuting parties to engage in the strenuous exercise of finding hard evidence to prove collusion. This may be seen as an impediment to the restriction of cartel behaviour due to the perceived difficulty in obtaining hard evidence of collusion to the fact that organisations would normally avoid engaging in written agreements where the subject of such agreements is criminal in nature (Konkurrensverket, 2001). This difficulty may have been the reason for the commission’s insistence that parallel price movements should have been used as sufficient proof for collusion. Had their bid succeeded, through the principle of jurisprudence, it would have been easy to prove the existence of cartels by simply observing market movements. Although this may have ensured that the fight against cartels would be more effective, it would have constituted a grave injustice on those perceived to engage in such practices (Konkurrensverket, 2001). For instance, tow competitors who choose to dominate different sections of a market geographically may be accused unnecessarily in engaging in cartel practices. The court faulted the insistence of the Commission on price announcements and cautioned that their approach was likely to amount to punishing such announcements. The difficulty faced by regulatory bodies in restricting cartel behaviour may be similar to those faced by the commission in the case above. The need to protected suspected parties till proven guilty lays the burden of proof on the prosecuting party. This requirement has seen many offenders go free for lack of hard evidence, and in most cases, the regulatory agencies do not even initiate disciplinary action (Brown-Kruse, Cronshaw and Schenk, 1993). The perceived ineffectiveness of this approach has been the basis for the generation of other approaches such as the structuring of the markets in a manner that makes detection of cartel behaviour much easier as discussed below.  

Cartels can be inhibited through law and regulation with a significant measure of success. Most countries have enacted laws to guarantee healthy competition among market player in their economies and to identify and penalise any proven cartel behaviour by the producers in such economies (Simon and Walker, 1999). For instance, in Australia, cartels are limited through the provisions of the Trade Practices Amendment Bill of 2008 (Gray, 2008). In the UK, the same is regulated through the Enterprise Act of 2002 and the Competition Act of 1998 (Gray, 2008). It is also subject of the European Union’s regulations on anti-competitive behaviour in cases that extent beyond their borders as outlined in the European Community Act of 1972 (Harstad, Martin and Norman, 1998). In the USA, Cartel behaviour is criminalised under the Sherman Antitrust Act of 1890 with subsequent amendments (Konkurrensverket, 2001). The anti-cartel legislation in the European Union is contained in Article 81 of the Rome (Han, 2006). In section 1 of the article, the law prohibits agreements or treaties between businesses and associations that may inhibit trade between the member states with the aim of restricting or distorting competition within such markets (Konkurrensverket, 2001). The act singles out price fixing and market sharing and declares that any such agreements would be void. The act however exempts collusions in technology and distribution networks provided that they are not designed to restrict or eliminate competition (Gray, 2008). In Australia, it is a criminal offense to enter into a contract which has cartel elements in it with the aim of dishonestly acquiring certain benefits. The Australian legislation points out two key elements that must be satisfied for an agreement to be termed as a cartel: firstly, there must be a purpose to give effect to price fixation, output restriction, bid rigging, or customer allocation; and secondly, the competition element must exist where the parties to the agreement would have under normal circumstances been competitors (Gray, 2008). Individual liability in such collusions is a penalty of $ 220,000 or five years imprisonment, or both (Gray, 2008). At the corporate level, cartel behaviour is punished with a fine of $ 10 million; $ 30 million where it can be proven that the corporation accrued some benefits as a result of the offense; or 10% of the corporation’s annual turnover (Gray, 2008). In the United States, such penalties extend to $ 1 million for individuals with an improvement proviso of ten years; and a penalty of up to $ 100 million for corporations (Konkurrensverket, 2001).

The authority of the regulatory bodies in meting out penalties is also critical when it comes to discouraging the thriving of cartels (Stocking and Watkins, 1949). This can be observed in the United States where the regulatory body can impose heavy sanctions on the offending parties and accord criminal responsibility to perpetuators without further reference to other authorities (Konkurrensverket, 2001). The European Commission on the other hand has limited powers in this regard (Konkurrensverket, 2001). This Commission has no jurisdiction over individuals and can only fine offending corporations. The fines must also be substantial to ensure that companies suffer losses as a result of engaging in cartels. Where the fines are light, the companies would prefer to continue with the practice in full knowledge that the gains from the malpractice would definitely outweigh any penalties to be imposed once apprehended. The determination of fines is done in a transparent manner and is largely dependent on the gravity and the duration of the offense. For instance, where the offense has lasted for about 10 years, the fines would start from 20 million Euros upwards (Konkurrensverket, 2001). With the revision of the fining policy of the European Union in 1997, the Commission has done some heavy finings to cartel offenders as follows: in 1998, Volkswagen was fined 102 million Euros; in 1998, signatories to the TACA (Trans-Atlantic Conference Agreement) were fined 273 million Euros; and in 1999, 99 million Euros was fined on a group of steel producers; and in 2000, producers of lysine were fined 110 million Euros (Konkurrensverket, 2001). These penalties are certainly heavy enough to restrict engagement in anti- cartel behaviour.

Regulatory bodies need to share information across national borders in order to ensure early detection of cartel behaviour by market players (Office of Fair Trading, 2011). These information must however be handled with due care to ensure confidentiality and integrity of the information. As such, caution must be taken to ensure that whenever information is transmitted across the competition regulation agencies in cooperating countries, the information can only be used for the purpose for which it was obtained. Such a system is likely to work best in situations where different countries have independent competition regulatory agencies while still accountable to the regional authority as is the case in the European Union (Schwalbe, 2010). The European Commission could cooperate with member states’ agencies in ensuring that any suspicious patterns in the economies are detected promptly. The nature of practices by colluding companies is such that the information that could give evidence of cartel behaviour would never be stored in the offices where the regulatory bodies could easily access them in an inspection (Konkurrensverket, 2001). To combat cartels more effectively, more powers need to be granted to the regulatory agencies to search for documents more comprehensively and even inspect private residences of the key players in the companies in order to fish out such evidence. This power is currently lacking in the vast majority of countries fighting cartels in the guise of protecting their citizens’ privacy. This element of inability to cover private residences is a serious challenge to the fighting of cartels. Some regions such as the European Union also have rules that impair the work of the regulatory bodies. For instance, the Commission can only question suspected offenders on the basis of uncovered documents and not on any other goings on in the companies (Konkurrensverket, 2001). This is highly restrictive and the Commission should be allowed to generally ask questions on the matter at hand.

The engagement of highly specialised units in tracking down the cases of cartel behaviour can also add value to the fight against these cartels. For instance, the setting up of the specialised cartel unit by the European Commission in 1998 served to focus on efficient investigations of cartels drawing from the extensive expertise of the members of the unit in case handling (Konkurrensverket, 2001). This concentration also enables such teams to link related happenings in the market with relative ease and follow up cases that seem to warrant some measure of attention. The very existence of such close attention to market movements may be in itself a deterrent to cartel behaviour. When companies are aware that chances of them being detected are high, they tend to avoid such practices in order to avoid incurring unnecessary costs in terms of penalties and possible imprisonment of their top executives (Konkurrensverket, 2001).

Legislation also plays a role in curbing cartel behaviour based on its approach to responsibility levels in the crimes committed (James and Yao, 1995). For instance, corporations do not engage in collusion; it is the executives within those corporations that do. When penalties for cartel practices are apportioned as a group responsibility where only the corporations are made accountable, it may not be enough to stop such executives to engage in such practices (James and Yao, 1995). It is the fear of being held personally liable that most effectively deters executives from leading their corporations down the path of cartel practices. This forms the main difference between the United States and the European Union. While the European Commission has no jurisdiction over individuals and can therefore not apportion criminal liability, their US counterparts have been known to fine executives on a personal level and even imprison some of the serious offenders (Konkurrensverket, 2001). Cultivation of a vigilant environment by the regulatory agencies can be a major deterrent to such practices.

Another role that could be played by the regulatory agencies in uncovering and limiting the practices of cartels is using leniency programs (Konkurrensverket, 2001). The leniency program was embraced by the European Commission in 1997. The Commission is therefore less experienced than their US counterparts who have been running their version of the same, the Corporate Amnesty program since 1978 (Konkurrensverket, 2001). These programs were developed in recognition of the fact that it was quite challenging to prove the existence of cartels in the manner prescribed by the courts which in the execution of their mandates sought to protect suspected culprits from arbitrary punishments. Where the Commission starts an investigation, a company that is part of the cartel under investigation can discontinue its engagement with its colleagues and surrender all evidence in its possession in exchange for a reprieve in the fines that would accrue to it. This reduction would normally be between 50%-75% (Konkurrensverket, 2001). Moreover, in the event that the Commission is yet to initiate investigations or where they may not even be aware of the existence of a cartel, such a cooperating company could get between 75%-100% of the penalties that would normally accrue to them (Konkurrensverket, 2001). For this leniency to be applied, the companies must show meaningful cooperation and should be able to submit written statements and documents on such collusion. This approach has been quite fruitful in uncovering cartels since it was started in 1996. Such waivers and reductions are done on the premise that the public interest to be realised by uncovering cartels is much greater than the amount of fines being sacrificed to realise this greater good. The companies whose infringement was penalised in deducted form under this program include British Sugar and Greek Ferries in 1998 and the Seamless Steel Tubes in 1999 (Konkurrensverket, 2001).

In the United States, a similar program is referred to as the Corporate Amnesty program which has been in effect since 1978 (Konkurrensverket, 2001). Under this program, volunteers of information would be immune from criminal prosecution. This program was later reviewed in 1993 in a bid to improve its effectiveness (Konkurrensverket, 2001). In the revised program, immunity was made automatic where no prior investigation was in place. Secondly, corporations were also entitled to amnesty if they volunteered crucial information even after investigations have already began. Thirdly, executives were entitled to amnesty at any stage if they volunteered information that led to the solving of the cases (Konkurrensverket, 2001). The end result was the detection of cartels that led to accumulation of $ 1 billion in form of fines between 1999 and 2000 (Konkurrensverket, 2001).

The limiting of cartel practices has been a major preoccupation of many government agencies around the world. This is due to the increasing acknowledgement of the adverse effects that these cartels can have on the market economies. As has been cited in many cases, the existence of cartels interferes with the efficient allocation of resources in the market and therefore become a major stumbling block to economic growth and development in the affected economies. Many countries have enacted laws that are aimed at curbing harmful cartel practices in their economies. These include the Competition Act in the UK, and article 81 of the European Union. The fight against cartels is however not without challenges. One of the main challenges relate to the requirement that the agencies produce hard evidence of the existence of cartels before punishing the suspect companies. This proves difficult due to the fact that business executives who are already aware of the criminal nature of their endeavours may in most cases avoid written agreements, and where such agreements are made, they would normally be kept discreetly out of sight. This has prompted governments to come up with alternative ways of ensuring detection and disbandment of such cartels. These alternative approaches relate to use of amnesty programs and increase vigilance that make potential offenders afraid of prompt detection in the event that they initiate agreements of a cartel nature.

For more theory and case studies on: http://expertresearchers.blogspot.com/

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