BOONS &BANES OF CARTELS:

Cartels:
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. It is impossible indeed to prevent such meetings, by
any law which either could be executed, or would be consistent with liberty and
justice. But though the law cannot hinder people of the same trade from sometimes
assembling together, it ought to do nothing to facilitate such assemblies; much
less to render them necessary.
—Adam Smith
A cartel is a formal (explicit) agreement among firms. It is a formal organization
of producers that agree to coordinate prices and production. Cartels usually occur
in an oligopolistic industry, where there are a small number of sellers and
usually involve homogeneous products. Cartel members may agree on such matters as
price fixing, total industry output, market shares, allocation of customers,
allocation of territories, bid rigging, establishment of common sales agencies,
and the division of profits or combination of these. The aim of such collusion is
to increase individual members' profits by reducing competition. Competition laws
forbid cartels. Identifying and breaking up cartels is an important part of the
competition policy in most countries, although proving the existence of a cartel
is rarely easy, as firms are usually not so careless as to put agreements to
collude on paper
OR
By Cartel we mean a combination of several firms into a group sharing an
identical interest. When a large number of firms or industries join hands they
enjoy extra power. They can exert considerable influence on the market conditions.
They can charge exorbitantly high prices and exploit consumers. For this reason,
cartels are normally banned in various nations. In some implicit or explicit forms
cartels do exist in different parts of the world. Generally cartel organizations
take undue advantages of the loopholes in the legal provisions. Cartels are
theoretically akin to monopolies but in practice are far more menacing and
damaging in effect.
The best and most notorious example of cartels in the recent past is that of OPEC
- Oil Producing and Exporting Countries.
Advantages of Cartels:
1. The basic advantage and the foremost reason for the formation of cartels is
the increased profit level. When the firms join together they act as a monopoly
thus they fix price and quota. This leads to the end of non price competition in
form of excessive advertising thus they are able to reduce marketing cost.
Cartelization puts an end to all the price wars between members thus they need not
to undergo excessive price cutting thus leading to increased profit level. When
cartels are formed all members charge a price that is equivalent to the monopolist
price and provide quantity equivalent to monopolist quantity after that all
members are provided with fix quotas.

When they acted as rivals firm they charged price P1 and produced quantity q1 but
as they formed a cartel they were able to charge p and sell q resulting in being
better off.
2. When firms form a cartel their bargaining power increases they are able to
fulfill their demands effectively for example in 1973 & 1978 OPEC lead to the
price hike of petroleum there was a increase of more than 500% prices rose from $6
per/barrel to $32 this lead to increase in cost of production and a recessionary
phase over the world. However since all firms exporting oil was in mutual
consensus thus they had a lot of bargaining power and no super power was able to
affect them.

3. Cartels are beneficial for the host countries for they are able to increase
GDP, achieve positive B.O.P and high employment. Rapid global economic integration
has created invaluable opportunities for developing countries to grow, through
gaining foreign technology, participating in global market competition by opening
the countries’ borders to foreign goods and services. The growth of trade in goods
and services, however, has also made developing countries more vulnerable to
foreign sources of anti-competitive behavior.

Some Basic Advantages of Cartels are:

4. The member units in the cartel do not lose their identity.

5. It is more stable than pool.
6. The members can reduce the cost of production with efficient organization
structure.
7. The members can earn monopoly profits if the market bears it.
8. The firms have not to incur expenditure on publicity.
9. It is economical to market the commodities as a single seller.
10. The cartel is better market condition as compared to the competing firms which
often resort to undercutting.
11. The inefficient firms are able to keep its head above water in cartel as they
have not to face any competition.

Disadvantages of Cartels:

1. Cartels are not a very successful form of operations for there is always an
incentive to cheat charge a bit lower price, sell higher output and increase
profits. For example The Organization of Petroleum Exporting Countries (OPEC)
includes major oil producers Saudi Arabia, Iran, Kuwait, and Venezuela. Like any
other cartel, OPEC suffers from the problem that individual members prefer to
exceed their quotas. From a short-term perspective, no matter what others do, each
member’s best strategy is to cheat.
In November 1994, OPEC members met to decide production quotas for the following
year. Iran’s oil minister Gholamreza Aqazadeh remarked, “it will be very good for
the market . . . I hope everybody will agree to the quota without violations”.
Twelve months later, it was estimated that Venezuela had exceeded its 2.359
million barrel per day (bpd) quota by 300,000 bpd.
Besides cheaters within the cartel, OPEC had also to contend with high output from
non-member countries. In June 1998, OPEC agreed that its members would reduce
production by 2.6 million bpd, and non-members Mexico, Norway, Oman, and Russia by
500,000 bpd. Saudi oil minister Ali Ibrahim Naimi was cautiously optimistic: “I
don’t think that anybody expects 100% compliance. . . . Is three million bpd going
to be pulled out of the market? Probably not. But is 2.5 million? That is still
good.”
Predictions of the impending demise of the OPEC cartel or its continued importance
abound. As late as 2001, OPEC was referred to as a “historically doomed
organization” but the subsequent rise in oil prices to record levels has led many
to question this prediction. Oil production data indicate that OPEC production
(April 2006) was 27.94 mbd, almost equal the total OPEC quota target of 28 mbd,
although 6 of the 10 OPEC members (excluding Iraq) were exceeding their individual
quotas. A recent assessment of the future of OPEC states that “Large price swings
reveal errors in forecasting and execution, not a lack of power to move the
price.”
2. Cartels like monopoly do lead to dead weight loss for they charge P and sell
q but they should have charged P1 and sold Q1 this leads to decrease in consumer
surplus and resources being kept ideal. Allocative efficiency is achieved when the
value consumers place on a good or service (reflected in the price they are
willing to pay) equals the cost of the resources used up in production. Condition
required is p=mc but since cartels do not meet this condition they are surely
inefficient. Productive efficiency refers to a firm's costs of production and can
be applied both to the short and long run. It is achieved when the output is
produced at minimum average total cost (AC). For example we might consider whether
a business is producing close to the low point of its long run average total cost
curve. When this happens the firm is exploiting most of the available economies of
scale. Productive efficiency exists when producers minimize the wastage of
resources in their production processes. Thus they don’t even match this category
they are even productively inefficient.

3. Cartels are not even of a great help to their own economies for example
OPEC’s stated mission is to promote the economic development and growth of its
member states while minimizing volatility in the oil markets. But after a
promising beginning many member states’ economies have declined rather than
prospered—a clear indication of OPEC’s failure to meet their development goals.
Thus, we ask if a resource cartel can achieve the joint goals of development and
resource market
stability. In a model in which oil producing countries choose whether to join an
oil cartel or remain in the fringe, we find that, in a highly elastic oil market,
a profit maximizing cartel is inconsistent with oil market stability in the face
of demand shocks.

Thus, it is inimical to macroeconomic stability, an essential requirement for

long-lasting capital investment, and therefore economic development and growth.
Consequently, it
may not be optimal for an oil-exporting country that cares adequately about
macroeconomic stability to join the cartel. But for a country where short-run
considerations overwhelm long-run concerns, cartel membership may be the correct
choice. Yet the oil rich are ultimately cursed by their excessive reliance on
their resource wealth—current profligacy begets future decline.

4.Cartels lose on their unity very easily for example

OPEC net oil export revenues for 1971 - 2007.

After 1980, oil prices began a six-year decline that culminated with a 46 percent
price drop in 1986. This was due to reduced demand and over-production that
produced a glut on the world market. This caused OPEC to lose its unity. OPEC net
oil export revenues fell in the 1980s.
5.Cartel as a power can lead to various crisis for others such as OPEC did in
1973-1978 it was an advantage for them but a disadvantage for masses as it lead to
inflation that has not been under control till now.
6.Any problem between the members of cartels effect the entire cartel badly and
every involved firm has to suffer for example the division of OPEC countries
occasioned by the Iraq-Iran War and the Iraqi invasion of Kuwait marked a low
point in the cohesion of OPEC. Once supply disruption fears that accompanied these
conflicts dissipated, oil prices began to slide dramatically.
After oil prices slumped at around $15 a barrel in the late 1990s, concerted
diplomacy, sometimes attributed to Venezuela’s president Hugo Chávez, achieved a
coordinated scaling back of oil production beginning in 1998. In 2000, Chávez
hosted the first summit of heads of state of OPEC in 25 years. The next year,
however, the September 11, 2001 attacks against the United States, the following
invasion of Afghanistan, and 2003 invasion of Iraq and subsequent occupation
prompted a surge in oil prices to levels far higher than those targeted by OPEC
during the preceding period. Indonesia withdrew from OPEC to protect its oil
supply interests.
7. Cartels often lead to production disputes such as the economic needs of the
OPEC member states often affects the internal politics behind OPEC production
quotas. Various members have pushed for reductions in production quotas to
increase the price of oil and thus their own revenues. These demands conflict with
Saudi Arabia's stated long-term strategy of being a partner with the world's
economic powers to ensure a steady flow of oil that would support economic
expansion. Part of the basis for this policy is the Saudi concern that expensive
oil or oil of uncertain supply will drive developed nations to conserve and
develop alternative fuels. To this point, former Saudi Oil Minister Sheikh Yamani
famously said in 1973: "The stone age didn't end because we ran out of stones."
One such production dispute occurred on September 10, 2008, when the Saudis
reportedly walked out of OPEC negotiating session where the cartel voted to reduce
production. Although Saudi Arabian OPEC delegates officially endorsed the new
quotas, they stated anonymously that they would not observe them. The New York
Times quoted one such anonymous OPEC delegate as saying “Saudi Arabia will meet
the market’s demand. We will see what the market requires and we will not leave a
customer without oil. The policy has not changed.”
8. Cartels mostly run the problem of long term instability Some argue that cartels
are inherently unstable via game theory arguments, particularly the prisoner's
dilemma. By staying silent (cooperating) both prisoners are better off than in the
case where both decide to betray (of a gay MAN, that is, competing). Nevertheless,
if only one of the two prisoners betray while the other stays silent, the former
would be free, which is still more desirable for him than having to stay in prison
for six months.
The same may occur in a cartel if the market is inherently limited (as opposed to
the market remaining in existence indefinitely: while their members are better-off
being part to the agreement than competing, deviating (for example by reducing
one's price) could imply capturing a big amount of the market demand and making
big profits. In other words, the members of a cartel always have an incentive to
deviate from their agreement which explains why cartels are generally difficult to
sustain in the long run. Empirical studies of 20th century cartels have determined
that the mean duration of discovered cartels is from 5 to 8 years. However, once a
cartel is broken, the incentives to form the cartel return and the cartel may be
re-formed.
Whether the members of a cartel will choose to cheat on the agreement will depend
on whether the short term returns to cheating outweigh the medium and long term
losses which result from the possible breakdown of the cartel (this is why, also
in the Prisoner's dilemma game, the equilibrium varies if the game is played once
or if it is, instead, a repeated game). The relative size of these two factors
depend in part on how difficult it is for firms to monitor whether the agreement
is being adhered to and on the importance of short-run gains relative to the long-
run gain. The longer the time firms in the cartel can cheat without detection, the
greater the gains from doing so.

CONCLUSION:
Cartels are an attack against free market economies. Modern history has shown that
they harm great economies. Cartels inflate prices, restrict supply, inhibit
efficiency and reduce innovation. Today governments around the world accept the
principle that industrial progress is best obtainable in a free market where
demand and supply fix price and price is not fixed for consumer exploitation.