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Abstract
One might ask how the production of cement in a small country such
as Norway became so much larger than the domestic consumption2
Gartmann (1990, p. 247).
1. Introduction
0014-2921/99/$ - see front matter 1999 Elsevier Science B.V. All rights reserved.
PII: S 0 0 1 4 - 2 9 2 1 ( 9 8 ) 0 0 0 5 1 - 8
1776 F. Steen, L. S+ rgard / European Economic Review 43 (1999) 1775}1796
this conclusion. They argue that collusion on prices triggers more aggressive
competition along other dimensions. Such behaviour, referred to as semicollu-
sion, may yield lower overall pro"ts than if no collusion at all. The purpose of
this paper is to extend the capacity model presented in Fershtman and Gandal
(1994) and test it on the Norwegian cement market.
There are several empirical studies focusing on non-price competition.
Roberts and Samuelson (1988) investigate advertising competition in the Ameri-
can cigarette industry. In contrast to our work, they do not test for the
relationship between the "rms' pricing policy and the nature of non-price
competition. Rosenbaum (1989) tests this relationship for the U.S. aluminium
industry. He "nds that excess capacity has a positive impact on price}cost
margins. Our focus, though, is on the opposite mechanism: how price collusion
a!ects capacity investments. As far as we know, there are no empirical studies of
the investment e!ects of price collusion. However, anecdotal evidence suggests
that price collusion do have a pro-competitive e!ect along other dimensions.
This is what we have set out to test.
In 1923 cement producers in Norway established a common sales o$ce. The
sales o$ce determined the domestic sale, and it set quotas according to each
"rm's capacity. The residual production was exported to the world market. The
domestic demand grew substantially after World War II. The increase in total
capacity was even larger, and led to an increase in exports. In the late 1960s 40%
of the domestic production was exported. The cartel agreement lasted until
1968, when the three "rms merged and established the "rm Norcem. During the
1970s Norcem gradually closed down capacity, and in the early 1980s the
domestic capacity was equal to domestic demand.
To tailor the model to the characteristics of the Norwegian cement market, we
extend the capacity model in Fershtman and Gandal (1994). We allow the "rms
to sell at an export market. They are price takers at the export market, and price
setters in the domestic market. Non-cooperative capacity setting is followed by
All the studies of semicollusion assume collusion in the product market (either on prices or
quantity) and competition along other dimensions. Competition on capacity is analysed in Fersht-
man and Muller (1986), Osborne and Pitchik (1987), Davidson and Deneckere (1990), Matsui (1989)
and Fershtman and Gandal (1994); competition on R&D is analysed in Katz (1986), D'Aspremont
and Jacquemin (1987), Kamien et al. (1992) and Fershtman and Gandal (1994); competition on
location is analysed in Friedman and Thisse (1993). For a survey of the literature, see Fershtman and
Gandal (1994) or Phlips (1995, chapters 9 and 10).
For a survey, see Bresnahan (1989) or Slade (1996).
According to Scherer (1980), in the 1920s and 1930s price collusion led to intense rivalry on
advertising in the American cigarette industry while it led to the installing of excess capacity in the
German cement industry. The existence of cartels in the domestic Japanese market, where quotas
were allocated according to relative capacity, led to excess capacity in many Japanese industries
during the 1950s and 1960s (see Matsui, 1989).
F. Steen, L. S+ rgard / European Economic Review 43 (1999) 1775}1796 1777
2. The model
P"A!Q. (1)
Our setting is identical to the model with cooperative price setting in Fershtman
and Gandal (1994), except that we (i) assume three rather than two "rms,
(ii) assume constant rather than increasing marginal cost, and (iii) allow the
"rms to export to a world market.
At stage three, the "rms set export quantities. Since ='C and K is
1
exogenous at stage three, it is unpro"table to have idle capacity. It produces
a quantity equal to K , and exports the quantity that is not delivered on the
G
domestic market. Hence, E "K !Q .
G G G
At stage two, the "rms set the prices in the domestic market cooperatively.
The maximization problem for the cartel is then the following:
n "max (P!C )Q#(=!C )E!K ) C , (2)
G 1 1 *
G .
where E, E . If K((A!=)/2, the marginal revenue in the domestic
G G
market exceeds the export price =. Hence, the cartel sets the domestic price so
that the entire production is o!ered at the domestic market. Then P"A!K in
the domestic market.
It can easily be shown that for K5(A!=)/2, it is optimal at
stage 2 to set P"(A#=)/2. The "rms will then sell Q"(A!=)/2 in the
domestic market. If K'(A!=)/2, it remains to determine the sharing rule in
the domestic market } each "rm's quota in the domestic market. In that case we
assume that
K
Q)" G D(P). (3)
G K
Each "rm's domestic market share is thus identical to its share of total capacity.
F. Steen, L. S+ rgard / European Economic Review 43 (1999) 1775}1796 1779
At stage 1, the "rms set capacity non-cooperatively. Firm i has the following
maximization problem:
We have to be careful with the interpretation of *E/*A, because a shift in A changes the demand
and domestic monopoly price. An increase in exports due to an increase in A could therefore be the
result of a higher domestic price and thus a reshu%ing of sales from the domestic to the export
market. To rule out this possibility, we have also undertaken comparative statics with the demand
function Q"a(A!P). A change in a can be interpreted as a pure shift in demand, since the
domestic monopoly price is una!ected. It can be shown that *E/*a'0 if A'3C!2=. Hence, the
results derived in Proposition 2 are not sensitive to such an alternative speci"cation of the demand
shift.
Unless otherwise stated, all cement "gures refers to the dataset collected by the authors. Precise
variable de"nitions and data sources are presented in Appendix B.
F. Steen, L. S+ rgard / European Economic Review 43 (1999) 1775}1796 1781
There has been imports to Norway, for example from Germany in the last century. However,
in 1895 Norwegian, Swedish an well as German producers agreed not to sell in each others
home markets, which eliminated any competition from foreign "rms in the Norwegian market (see
Gartmann, 1990, p. 91). In addition, they coordinated their exports in order to eliminate the
temptation to sell in each others home markets. As late as in the 1990s, there were market sharing
agreements in the European cement market (see EU, 1994).
In the 1964 annual report for CPC we can read the following: CPC1s deliveries to its ordinary,
domestic market increased from 464.000 tonnes in 1963 to 484.000 tonnes in 1964. In addition, it
delivered 54.000 tonnes to DPC1s customers, which implied that DPC1s export increased with an
identical amount. For this indirect export, CPC compensated DPC according to the ordinary export
prices' (p. 13).
1782 F. Steen, L. S+ rgard / European Economic Review 43 (1999) 1775}1796
Fig. 1. The development in Norwegian export and concumption the period 1927}1989 (in
1000 tonnes).
We have data for each "rm's annual production in the period 1913}1982. It shows a very
parallell development in production for all three "rms in the cartel period. In particular, all three
"rms expand production substantially from 1955 on. This is consistent with a hypothesis where all
three "rms had incentives to expand capacity to have a large quota in the domestic market
(see below).
F. Steen, L. S+ rgard / European Economic Review 43 (1999) 1775}1796 1783
Table 1
Industry hypotheses
Early Late
*E
# # #
*=
*E
0 (!) ! 0 (!)
*C
*E
(i) ! ! !
*A
(ii) ! # !
(iii) # # !
long run, however, the cartel could close down (not renew) capacity. As we
approach the late cartel phase, we expect the ordinary relationship between
costs and export to dominate: the higher the costs are, the lower is the exported
quantity. In the monopoly phase } after the merger in 1968 } the capacity was
very high, and export was not pro"table (Gartmann, 1990, p. 246). It is thus
reasonable to assume that the capacity was above the equilibrium level for the
monopoly, and that costs had no e!ect on the exported quantity. Hence, the
zero with the minus in the parenthesis.
To pin down the relationship between exports and domestic demand, we
distinguish between three time periods (phases). In the monopoly phase, an
increase in domestic demand is expected to reduce the exported quantity. Thus,
the last minus sign in all three outcome paths. In the cartel period, the situation
is more complicated. We know from Proposition 2 that the semicollusion e!ect
is triggered if the domestic demand is su$ciently large, the costs su$ciently low,
or the world market price su$ciently high, i.e., if A'3C!2=. Except for
World War II, and the year 1953, there are no dramatic changes in the measure
3C!2=. By inspection of a drawing (of the size of 3C!2=) we observe that
if there is any trend, then it is a negative time trend. We know from Fig. 1 that
the domestic consumption increased substantially in the cartel period, especially
after World War II. Technically speaking, we therefore expect A to cross
2C!3= from below (if any crossing at all). Hence, our hypothesis is that it is
more likely that each "rm overinvests in capacity in the late than in the early
cartel. Then there are three possible empirical results which all are consistent
with our model. They are all shown in Table 1.
In 1953, the export price was very high. It could be due to the fact the exported quantity was
quite low that particular year, and special cement was exported at a high price.
1784 F. Steen, L. S+ rgard / European Economic Review 43 (1999) 1775}1796
The next problem is to determine what is early and late in the cartel period.
After World War II the cement industry was regulated. The "rms had to ask for
permission to undertake capacity investments, and this regulation lasted until
the mid 1950s. The 1953 annual report for CPC, the largest domestic cement
producer, states (p. 14): &2the negotiations about increased production capacity
have still not succeeded2'. However, the 1956 annual report states: &As is well
known, the Norwegian producers have maintained an agreement on market sharing,
but two of the producers have in the post-war period not been able to exploit their
quotas. hese circumstances have now changed2' Hence, we conclude that the
early cartel phase lasts until 1956, and that the later phase runs from 1956
onwards.
In this section we specify the empirical model, describe the data, and present
and discuss our empirical results.
This suggests that even if the semicollusion e!ect was triggered in the post-war period, the "rms'
export opportunities were constrained. Later on we test for this by including a post-war regulation
dummy.
We have also used statistical tests to uncover the break (see Harvey, 1990). CUSUM and
CUSUMQ endogenous structural break tests we have undertaken indicate a break between 1955
and 1956.
We have also tested a model with lags, but the model performed worse than the one we report.
The reason could be that the producers have rational expectations, i.e., anticipate how large the
demand will be t years from now and then start installing capacity in due time.
Note that = is exogenously given at the world market.
F. Steen, L. S+ rgard / European Economic Review 43 (1999) 1775}1796 1785
the yearly Norwegian gross national product (GNP). The data set allows us to
calculate a very precise short run marginal cost "gure. However, to make our
conclusions robust with regard to the measuring problem, we also estimate
a model where C( ) ) enters as a composite of input prices. Hence, we formulate
two models, one in which C( ) ) enters as a calculated "gure based on the yearly
expenses of labour (excluded permanent clerical sta!), materials, fuel and elec-
tricity per ton produced cement, and one in which C( ) ) enters as a composite of
input prices on labour, materials and fuel/electricity. All values are in real terms.
The Norwegian consumer price index is used as de#ator.
To test the hypotheses concerning the e!ect of costs on exports, we include
two C variables. One cost variable runs for the entire data period, and one is
multiplied by a dummy that takes the value one in the period from 1956 to 1967,
and zero otherwise. To test the semicollusion hypothesis we include three
A variables, all multiplied by dummy variables that correspond to one of the
phases. Hence, we obtain individual parameter estimates on A for each phase.
Furthermore, we include a dummy variable to account for the e!ect of World
War II. The econometric models can be written as:
Model A: C( ) ) enters as a calculated ,gure
ln E "a#b ln = #b ln C #b } D } ln C
R 5 R ! R ! R R
#b } D } ln A #b } D } ln A
R R R R
#b } D } ln A #jDU?P } #e ; (8)
R R R R
See Sutton (1991) for a discussion of de"nitions of market size variables in empirical IO studies.
See Schmalensee (1989) and Martin (1993, Chapter 17) for a survey on the problems using
accounting data to measure marginal cost.
In an earlier version of the paper, we included a trend parameter to capture technical change.
However, it turned out that the model performed better without the trend parameter.
1786 F. Steen, L. S+ rgard / European Economic Review 43 (1999) 1775}1796
Table 2
Predictions and parameter restrictions } models A and B
through the DU?P } dummy. The error terms, e and g, have by assumption the
R
standard properties. In Table 2 the model predictions and the implied para-
meter restrictions (null hypotheses) are summarised. When it is su$cient to
investigate the sign and the signi"cance of a single parameter an ordinary t-test
is applied, and when joint restrictions are imposed, an F-test is used.
The results and model statistics are presented in Table 3. The statistical
properties of both model A and B are good. The overall explanatory power are
0.89 for both models. In models A, seven out of eight parameters are signi"cant
at a 0.05 level or higher, while in model B it is eight out of 12. The autocorrela-
tion statistics, Durbin}Watson and Ljung}Box Q-statistics (Ljung and Box,
1979) show no "rst-order, or higher-order autocorrelation.
F. Steen, L. S+ rgard / European Economic Review 43 (1999) 1775}1796 1787
Table 3
Empirical results } models A and B
Model A Model B
There are some issues that should be addressed regarding our results. First,
one could argue that the Norwegian GNP is exposed to the same business cycle
movements as their neighbouring countries. If this is the case, our market-size
parameters might pick up something more than only the domestic market size.
However, when investigating the export destinations during this period, from
1927 and every 10 years onwards until 1977, only between 5% and 6% of the
Norwegian export was sold in Europe. The rest was sold to the US (26%) and
the &rest of the world' (68%), which in this case mainly were South-America and
Africa.
Second, one could argue that GNP is a too aggregate measure of the market
size of cement. To check the robustness of our results to the market size variable,
we have estimated models A and B using a Norwegian construction and
building index to represent the market size. This index will not be exposed to the
same problems as the GNP measure. On the other hand, it might be too
disaggregated to capture the total Norwegian cement demand. Even though the
predictions from model B change in the sense of suggesting a non-signi"cant
parameter for b } and fewer signi"cant parameters in general, the main
predictions hold. In particular, all predictions from model A are the same using
the construction index. Hence, the aggregation level on the market-size variable
seems not to be critical to our main results. See Appendix C, where the results
are reported.
Third, due to the post-war regulations in Norway, one might argue that also
in 1945}1955 the industry was exposed to restrictions that reduced their produc-
tion possibilities. Models A and B have been reformulated to include a post-war
regulation dummy. As expected, the post-war regulation has a negative impact
on exports. All our principal results remain unchanged. We still conclude with
statistical di!erences between the periods regarding costs and the importance of
the domestic market size, and the semicollusion e!ect is still triggered in the late
cartel phase. However, the results are less clear than in the models presented;
fewer signi"cant parameters and not as good statistical properties on auto-
correlation.
Fourth, changes in costs could a!ect the domestic cartel price and thereby
a!ect exports. To take into account such an e!ect we should have tested
a structural model, where we explicitly modelled domestic demand and supply.
However, we observe from the data that real-costs are quite stable until World
War II and steadily decreasing after World War II. A decline in real costs results
in a lower monopoly price which, in turn, leads to a higher domestic consump-
tion. All else equal, it dampens the growth in exports in the late cartel phase.
This e!ect } which we have not captured in our empirical test } cannot explain
the observed growth in exports in the late cartel phase. Hence, this e!ect is not
an alternative to the semicollusion e!ect as an explanation of the observed
export pattern.
Finally, the capacity expansion could have been undertaken for other reasons
than the one we have focused on. Firms could have built excess capacity (1) in
anticipation of future domestic demand, (2) to preempt its rivals from building
capacity or (3) to facilitate price collusion in the domestic market. The observed
export pattern in the late cartel seems to be inconsistent with the "rst argument.
In the late 1960s, 40% of the production was exported. It seems unlikely that the
"rms overestimated the future demand to such a degree. Moreover, the incentive
to preempt its rival and to facilitate collusion was present in other countries
than Norway. An investigation done by the European Commission suggests
Fig. 2. The development in export in Norway and Europe the period 1927}1989 (in 1000 tonnes).
that there has been a secret cement cartel in Europe for many decades (see EU,
1994). Accordingly, there are no a priori reasons to expect an excess capacity
pattern in the Norwegian cement industry that is di!erent from other European
cement industries. However, we observe from Fig. 2 that the excess capacity in
Norway in 1955}1967, measured through the development in exports, is dis-
tinctly di!erent from the pattern in other European countries.
The purpose of this paper has been to analyse theoretically and test empiric-
ally the e!ect of the price cartel in the Norwegian cement market, a price cartel
We see that the growth in European exports accelerated in the early 1970s. A plausible
explanation is the oil crisis. It dampened the economic growth in Europe, and the cement producers'
continued growth in capacity forced them to expand their exports.
F. Steen, L. S+ rgard / European Economic Review 43 (1999) 1775}1796 1791
which lasted for 45 years. We "nd that what we have labelled the semicollusion
e!ect became signi"cant in the Norwegian cement industry in the late cartel
phase: each member of the price cartel increased its investment in capacity to
capture a larger share of a growing domestic market. The driving force was the
market sharing rule. Each "rm was given a quota in the domestic market
according to its share of total domestic capacity. Fershtman and Gandal (1994)
show that collusion on prices and competition on capacity can be unpro"table
for the "rms, because the costs associated with capacity expansion more than
o!sets the gains from price collusion. This suggests that a capacity expansion
that according to traditional theory of collusion could have been a virtue } for
example, an instrument to facilitate collusion } might instead become a problem
in this particular industry.
Did the "rms actually regard the capacity expansion as a problem? The
apparent success of the price cartel for many years } according to our empirical
study it was successful for more than 30 years } may explain why they under-
estimated or simply neglected the potential problem which the growth in the
domestic market triggered in the mid 1950s. Moreover, for a given capacity the
"rms are always better o! colluding than not colluding. So any decision not to
collude is not credible (see Fershtman and Gandal, 1994, p. 142). In the 1960s
} a decade too late } they "nally though of an alternative solution to the
problem, as the following description from cartel negotiations in the 1960s
indicates: &During the opening round of negotiations for a new cartel agreement
there appeared to be much dissatisfaction with the apparent lack of industry
coordination when it came to capacity expansion2. It consequently did not take
the parties long to see large potential bene,ts from a full merger1 (Lorange, 1973,
p. 33). In 1968, the three "rms "nally merged.
The welfare implications of such a merger is straightforward. Domestic prices
are not a!ected, while the foreign consumers will no longer purchase cement
produced in Norway at a price below long-run marginal costs. The elimination
of the excess investments in capacity has therefore been bene"cial for domestic
welfare. So in this particular case a monopoly is more bene"cial for the
Norwegian society than a price cartel.
As shown in Kreps and Scheinkman (1983), the game they have speci"ed with non-cooperative
rather than cooperative price setting at stage 2 can yield a Cournot outcome. By comparing the price
cartel outcome with the Cournot outcome, Fershtman and Gandal reach the conclusion referred to
in the text. However, other assumptions may give the opposite result. For example, Davidson and
Deneckere (1986) show that random rather that e$cient rationing results in a more competitive
outcome than the Cournot outcome, which may be enough to reverse the conclusion. Moreover, as
far as we know, there are no studies showing that the Kreps and Scheinkman (1983) result is valid in
industries with more than two "rms. We should therefore be careful in concluding that the price
cartel is always unpro"table in the setting we are investigating.
1792 F. Steen, L. S+ rgard / European Economic Review 43 (1999) 1775}1796
Acknowledgements
With the usual disclaimer, we thank Tore Ellingsen, Joe Harrington Jr., Jan
Tore Klovland, Kjell Gunnar Salvanes, two anonymous referees and seminar
participants at our home institution, the University of Oslo, the Stockholm
School of Economics, Warwick Summer Research Workshop 1996 on model-
ling "rm behaviour, 11th Annual Congress of the European Economic Associ-
ation 1996 in Istanbul and the 23rd Annual Congress of the European
Association for Research in Industrial Economics 1996 in Vienna for helpful
discussions and suggestions. Our research has been partly "nanced by the
Research Council of Norway through SNF.
Proof of Proposition 1. (A!=)/6 is each "rm's domestic sales quota when the
domestic price cartel is in force, while (A!=)/[18(C!=)] is the equilibrium
capacity for each "rm when capacity exceeds its domestic sale [condition (ii) in
Eq. (4)]. Then we have that if
(A!=) A!=
( , (A.1)
18(C!=) 6
the installed capacity at stage 1 is so low that no export takes place after the
cartel price is set at stage 2. Rearranging Eq. (A.1), we have that the members of
the price cartel will not export if A43C!2=. A su$cient condition for
K 'Q and E '0 is then that A'3C!2=.
G G G
Proof of Proposition 2. From Eq. (5) we have that
*E A!= 1
G" ! . (A.2)
*A 9(C!=) 6
*E (A!=)
G"! (0. (A.4)
*C 324(=!C)
From Eq. (6) it can easily be veri"ed that *E/*A"!, *E/*="# and
G G
*E/*C"0.
G
The data is collected from four main sources; the Norwegian industry statis-
tics (NIS), the norwegian trade statistics (NTS), the norwegian historical statis-
tics (NHS), and the national accounts statistics (NAS), all published annually by
the Central Bureau of Statistics Norway (SSB). The bureau started its publica-
tions of the Norwegian Industry Statistics in 1927, as is the "rst year of
observation utilised in this study.
The Norwegian export "gures are from NTS, containing the commodity
numbers: 35.22, 25.23 and 2523.1000. Export (E) is measured in tonnes and the
export price (=) is the unit price measured as NOK per ton. The latter is
calculated as the yearly export value divided by the yearly export quantity. The
European export "gures (Fig. 2) are from CEMBUREAU's production, trade
and consumption statistics; &World Cement Market in Figures. 1913}1981',
=orld Statistical Review No. 4, and yearly CEMBUREAU publications from
1982 to 1989.
The cost observations are from NIS; ISIC code 3340 prior to 1970 and ISIC
code 3692 from 1970 onwards. The calculated "gure C( ) ) is yearly expenses of
the three input factors, labour (excluded permanent clerical sta! ), materials, and
fuel and electricity divided by the yearly production. Hence, the calculated cost
"gure C( ) ) is a NOK per ton measure. Yearly production is also found in NIS,
but is checked against production "gures provided by Norcem, and production
"gures from CEMBUREAU. The labour price (c*) is labour expenses (excluded
permanent clerical sta! ) per hour, the material price (c+) is calculated as
material expenses per ton produced, and the electricity and fuel price (c#$) is also
a per ton price.
The export price, and the four cost measures are all de#ated using the
Norwegian consumer price index (CPI), which is found in NAS and NHS.
To construct the gross national product (GNP) series, several sources were
used. SSB does not publish o$cial "gures for GNP during the World War II;
the years from 1940 to 1945. However, SSB published "gures for GNP for the
years from 1940 to 1943, in the publication &e revenu national en Norve% ge
1935}1943, Capital e+ectif en 1939 et la re& duction du capital pendant la guerre.
1794 F. Steen, L. S+ rgard / European Economic Review 43 (1999) 1775}1796
Table 4
Summary statistics main variables (the period from 1927}1982)
CoL utus de l1occupation'. Figures also for 1944 and the "rst four months of 1945
were estimated by Aukrust and Bjerve (1945) in their book; &=hat the costs of the
war were to Norway', (Table 12, p. 45). Using these sources, we were able to
construct an unbroken series of GNP "gures from 1927 to 1982. (The 1945 GNP
"gure from Aukrust and Bjerve was multiplied by 3 to obtain a proxy for the
whole year.)
The construction index we use as a measure of market size is a volume index
of gross domestic product in the construction industry. It is derived from NOS
National Accounts Statistics [National Accounts 1865}1960 (Table 45), Histori-
cal Statistics 1968 and 1984]. Estimates for 1927}1929 and 1940}1945 is based
on hours worked in construction, from NOS Manufacturing Statistics (see
Table 4). Data for the various time periods are spliced by the simple ratio method
to form a consistent time series. The index is collected and constructed by Jan
Tore Klovland, Norwegian School of Economics and Business Administration.
Appendix C. Empirical results for models A and B when market size is measured
by a construction index
Model A Model B
Appendix C. Continued
Model A Model B
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