About 10 years ago, when any mention of oil prices in three digits USD would have brought allegations of psychotropic substance abuse, someone offered me a simple measure of competition in any market. What share of thought do rivals occupy? Is it obsessively high? Abysmally low? Is it just the top leadership? Or all-pervasive?
The cola market is known for the intensity of its rivalries, and even a casual observer can tell the obvious influence that brands of fizzy refreshments have on one another. Pepsi?s ad message of spontaneous youth ingenuity, for example, finds an instant response in Coca-Cola?s celebration of blurred synchrony. Each is conscious of the other?s appeal and keen to win the game of glugs this summer. Tellingly, cola prices adjusted for inflation have stayed more or less the same over the last 10 years or so.
The international oil market, on the other hand, is famous for its lack of competition. The market is in the grip of an 11-member cartel of oil exporters called Opec that exerts collective dominance over the scenario. And with oil prices twitching at every Opec utterance, these exporters do not have to pay much attention to non-Opec sellers of oil. This is why no analyst calls this week?s $106-a-barrel crude price record a ?spike?. Prices could go higher still, for all you know. Nobody can say what?s on Opec?s mind. This is also why it is time to give cartelisation as an economic phenomenon a rethink.
Since cartelisation is mostly seen as an antithesis to the free market, it is simply considered a bad thing, a phenomenon to be discouraged. That too, through all means possible, be it persuasion, legislation, or even harder tools of deterrence. This strikes curiosity. Cartels had a far more angelic image before World War II, when artificial monopolies found several justifications. Some of these even echoed current arguments in favour of patent-protected monopolies for pharma products and the like, namely that the assurance of a free run of profits acts as an incentive for innovation. Also, some cartels continue to be cuddly. De Beers evokes admiration for putting the sparkle in so many romances.
But the big reason to examine cartelisation closely is that it makes hardy state interventionists out of staunch laissez faire advocates. In most rich jurisdictions, outright cartels are outlawed. Penalties for collusion with other market players are stiff. How is it that cartels attract sterner attention than other market muddle-ups? Is there no market mechanism, or even incentive structure, that could moderate the influence of cartels over variables like output and prices?
Cartels were once thought to be self-limiting, given the incentive for players to ?cheat?. Cartels typically keep prices way above costs by limiting overall output, and so anyone sneaking extra stuff to the market makes enormous money, at least briefly, since prices slide after a point. Price control success requires an honour amongst conspirants (as Adam Smith termed them) that has been likened to the ?prisoner?s dilemma? from game theory. Two spies held in separate thick-walled prison cells are asked to spill the beans. If both keep shut, they stay in chains for a while. If one squeals on the other, he goes free and the other is thrown in the dungeon for life; and if both betray each other, they both get half-life terms. It makes sense to cooperate, but there is a lone temptation not to.
Some economists argue that attacking the conditions that make cartels viable is more realistic than waiting for cartels to collapse. Cartels thrive on low-cost commodities that have inelastic demand, transparent pricing, high barriers to market entry, and common cost structures. Take inelasticity of demand. Alternative energy could see high oil prices resulting in switchovers, which would make demand for this commodity vary more as its prices rise and fall. Likewise, quality discrimination (the jailer ploy) deployed by customers could instigate ?quality? producers to abandon the cartel for higher price realisations.
So far, such counter-cartel strategies have not proven very effective. Maybe it?s time to adopt the perspective of information economics. Some of the early thoughts on this are attributed to George Stigler, an economist who was puzzled by collusion because of the informational costs incurred by it.
Aha. While it is not true that collusion invariably makes colluders complacent on threats and lazy on costs, it is clear that fixing prices means forgoing information they would otherwise contain under free market conditions. Under profit maximisation theory, for example, output figures at given prices speak of others? marginal cost curves ? by which a player can gauge how competitive it really is and what its own weaknesses are. Information offers incentives.
Economic success depends to no small extent on the accuracy of information that determines the allocation of resources. The Soviet Union caved in. The cola market survives. But information yields alone would be insufficient by way of market incentives for cartel moderation so long as a supply sort-out is not matched by a softening of demand rigidities. The reference is not to price inelasticities, but to artificial tools that distort information by assigning it a role subordinate to other objectives. Energy is a case in point. Even free market prices could fail to yield information that tends to accuracy because of such distortions. This weakens the incentives.