Capitalism's Clubby Side, From Adam Smith to Libor

Inside The OAO Uralkali Potash Mining Operations As Belarus Escalates The Potash War

Cartels sound unsavory, suggesting drug kingpins or despotic rulers of oil kingdoms. They are, in fact, illegal within the U.S. and most developed economies. But agreements among members of a given industry to shape markets to their mutual advantage are as natural a feature of capitalism as competition. Cartels exist openly in many places and covertly almost everywhere. The line between a cartel and a more legitimate joint trading or marketing venture can be a fine one, and cartels take many forms: production quotas, price fixing, import/export quotas. Even mechanisms as benign-sounding as product standards  or “best price” agreements can be used to keep out new rivals. Some cartels operate inside a single nation; others span international markets. DeBeers controlled the diamond market for decades, and saw its hold loosened only by outside forces, including new competitors and determined prosecutors. More recently, charges or disputes about cartels have involved everything from potash mines in Belarus to currency traders’ chatrooms in cyberspace, minor league baseball contracts and foreign car dealerships in China. And then there’s OPEC, the 800-pound gorilla of the cartel world.

The Situation

Saudi Arabia and other key members of the Organization of Petroleum Exporting States showed three things in 2014: how far a determined cartel can swing a market, that cartels sometimes want to drive prices down as well as up and that even within cartels there are losers as well as winners. Determined to recapture market share being lost to new sources, including oil from shale, Saudi Arabia and other Arab producers opened the taps, sending oil prices down 46 percent by the end of the year. Among those hurt were OPEC members Iran and Venezuela. In London and Washington, prosecutors are pushing for fines and possible criminal charges after revelations that traders manipulated prices in the $5.3-trillion-a-day foreign-exchange market using instant message groups whose names included “The Cartel.” Six banks had already been fined 1.7 billion euros ($2.3 billion) by the European Union over collusion over the Libor benchmarks used to set interest rates. In China, foreign businesses were dismayed by cartel cases they saw as a covert way of punishing outsiders. And the 2014 Nobel Prize in Economic Sciences was awarded to Jean Tirole, a French economist who showed how rules that work well to promote competition in one field can be counterproductive in another.

Source: European Commission
Source: European Commission

The Background

The idea is age-old, but formal cartels first emerged in Germany in the 1870s, then spread to other European nations and Japan. The historian Jeffrey Fear has noted that domestic cartels typically emerged in industries with high fixed costs and a record of ruinous competition: steel, coal, salt, paper, fertilizer, aluminum and potash. In the U.S., the years after the Civil War saw a flowering of pools, trusts and other forms of cartels  before  antitrust laws reined them in. Elsewhere, they were backed by governments as a bulwark against business failures and suffocating monopolies. The predictability of cartel arrangements was also thought to encourage more consistent investments in research and development. International cartels prospered in the 1920s and 1930s in industries ranging from copper to petroleum to rubber. On the eve of World War II, cartels controlled 40 percent of global trade. That conflict destroyed many of the arrangements, as did liberalizing reforms afterward. Cartels continued to flourish in a handful of places, especially Japan, but otherwise began a slow decline. Commodity cartels in emerging economies enjoyed a renaissance in the 1970s. As a consortium of sovereign nations, OPEC stood outside antitrust laws, but its aggressive campaign to control oil prices destroyed the good reputation these cooperative arrangements once had. Recent prosecutions over price-fixing, ranging from cathode-ray tubes ($1.9 billion in fines levied in 2012) and in the international auto parts trade ($1.6 billion in fines through 2013 and more to come), show the continued lure of collaboration.

"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." Adam Smith

The Argument

The idea that cartels operate to the detriment of consumers dates back to Adam Smith, who described them as conspiratorial combines that have “an interest to deceive and even to oppress the public.” And even defenders of cartels have little good to say about the kind of geopolitical jousting that landed one Russian potash CEO in jail in Belarus. But for much of the modern history of business, this has been a minority point of view. While cartels face more legal hurdles today, their ubiquity throughout the history of capitalism suggests that attempts to eradicate them entirely will fail. Still, there’s a threat to them that will never go away — cheating on the cartel’s rules by members who can’t entirely suppress their competitive side. EU officials have found that every-man-for-himself spirit useful: UBS and Barclay’s avoided $4.3 billion in fines by being the first to come clean about interest-rate manipulation.

The Reference Shelf

  • Business historian Jeffrey Fear provides an overview of cartels over the past century and a half.
  • Luis Cabral of NYU’s Stern School describes the history of the De Beers diamond cartel.
  • Mark LeClair’s historical study of cartels and antitrust laws in the U.S. and Europe.
  • A volume of essays edited by economist Peter Grossman covers cartels past and present.
  • Tony Freyer’s study shows how anti-cartel laws in the U.S. paradoxically limited competition.
  • Stephen Mihm discusses a century of international potash intrigue.

First Published Jan. 3, 2014