Being unpredictable helps guard against collusion: a lesson from the 2016 Colin Clark Lecture

Professor Leslie Marx of Duke University delivered the 2016 Colin Clark Lecture last Tuesday morning at Customs House in Brisbane on how to defend against potential collusion by suppliers. In industries with a small number of players who can readily form cartels, collusion by companies to fix prices occurs from time-to-time, unfortunately. As Adam Smith famously noted in the Wealth of Nations:

“People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”

Professor Marx gave examples of companies that have suffered price fixing on many of their inputs, particularly Coca-Cola and HP. And she mentioned some of the famous cartels we have seen in Australia, including the pre-mixed concrete cartel in South-East Queensland and the cardboard box cartel (see the ACCC’s website for these and other examples).

But, as Professor Marx explained, cartels tend to be unstable. Members have the incentive to cheat against the cartel, to increase outputs and cut prices to increase their own revenues and market shares. The classic example is OPEC. Despite agreements to restrict output and hence raise the oil price, over its history, production levels by OPEC members tended to exceed target levels. (More recently OPEC members have been flooding the market to try to wipe out US shale oil producers.)

The incentive to cheat means that cartels require monitoring and enforcement mechanisms (see the figure below, which Professor Marx attributed to George Stigler, showing the structures necessary to limit “secret deviations” or cheating). As Professor Marx noted, due to the complicated structures required to fix prices, enforce cartel agreements, and reallocate any profits (e.g. where a company accidentally wins a contract it should not have under the agreement), there tends to be a lot of evidence (e.g. contracts, recorded phone calls) that can eventually be used against cartel members in courts of law. In some cases, accounting firms have even been used to verify that cartel members have been maintaining agreed market shares!

Triangle

Professor Marx gave several excellent pieces of advice regarding how companies can guard against collusion. The two I found most memorable were:

  • Be unpredictable in your procurement (e.g. change purchase times, contract terms, etc), and
  • Closely monitor and analyse the market data and look for deviations from previously established trends.

Being unpredictable can undermine cartels because, as noted above, they require rather complicated agreements among members, and these agreements are based on the status quo. So, changing your behaviour can mean cartels need to reach new agreements, which they may not be able to do.

Monitoring and analysing the market data is clearly important. For instance, if you are in an industry which has seen stable or declining prices, and suddenly prices increase sharply, and there is no reason to suspect underlying supply conditions have worsened (or demand has suddenly surged), you should consider the possibility of a cartel. In fact, according to Professor Marx, evidence from economic modelling regarding unjustifiable price increases has been used to prosecute companies for collusion in the US. Economic students should think about that the next time they are reluctantly attending an econometrics lecture!

Finally, well done to the UQ Economics School for arranging a most excellent Colin Clark Lecture for 2016, and, of course, many thanks to Professor Marx for her fascinating and illuminating presentation.

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