Discovered Cartels – Are Antitrust Officials Using A Flawed Framework by [email protected]

Joseph Harrington on Discovering Cartels

Collusion among companies in the form of cartels is generally viewed as detrimental to the marketplace. The Antitrust Division of the U.S. Justice Department has uncovered some cartels, but it is believed that many more go undiscovered. Authorities typically examine the cartels they’ve uncovered to learn about cartels yet to be discovered. But is their approach flawed?

A research paper by Wharton business economics and public policy professor Joseph Harrington titled, “What Can the Duration of Discovered Cartels Tell Us About the Duration of All Cartels?” examines discovered cartels to see whether they accurately describe the actual latent population and duration of all cartels. [email protected] recently spoke with him to talk about his findings.

An edited transcript of the conversation follows.

[email protected]: Tell us about your paper.

Harrington: Well, it starts with the issue of collusion. And probably [a description of its harmful effects] was best stated by the recently-deceased [Supreme Court] Justice Antonin Scalia, who referred to collusion as “the supreme evil of antitrust.” Collusion is all about the fact that firms — which we count upon to compete for the business of customers, and doing so results in lower prices, better products and the like — in some industries, decide that [competition] leads to profits that are too low. So they engage in unlawful coordination of their behavior. Instead of driving prices down in order to get customers’ business, they decide, “Well, how about we all set artificially high prices, share the market, and we’ll all earn high profits.”

And so collusion is a real challenge [to a properly functioning marketplace]. And it’s become particularly so in the last several decades. I would say 30 years ago, if you asked an official of the Antitrust Division of the Department of Justice whether there are any global cartels, other than types like OPEC, they would have said no. But the fact is, we have observed many global cartels, as well as many domestic cartels, in the last couple of decades.

“If cartels tend to largely vary in terms of the likelihood of collapse, what we find is that the measured duration of discovered cartels is an overestimate of the true duration.”

But a challenge in terms of understanding cartels [is this]: How many unlawful cartels are there? How bad are they? How much do they raise prices? How long do they last? We face a challenge common to criminal behavior, which is, these criminals want to hide themselves. So what we observe are just those cartels that are unfortunate enough to be discovered and convicted.

So the challenge [becomes]: “Well, we know how many discovered cartels are out there. We know how long they last. We know how high a price they set. But is that representative of the actual latent population of all cartels?”

Where this specifically manifests itself in terms of a policy challenge is, suppose the Antitrust Division puts in place a new program and they want to know, “Is it proving to be beneficial? Is it actually helping to reduce the presence of collusion?” Well, all we can observe is what’s happening to the population of discovered cartels. So if, for example, we observe more discovered cartels, is that because the program is working to make discovery more likely, and that’s good? Or maybe it’s counterproductive. Maybe what it’s doing is actually creating more cartels, and that’s why there’s more discovered cartels.

That’s the starting point to this research, which is trying to determine what it is we can learn about the underlying latent universe of cartels from those that we actually discover. More specifically, what the research is concerned with is the issue of the duration of cartels. There have been many studies that have measured how long discovered cartels last. In these studies, the average duration ranges from five to eight years, depending on the study. And the issue is, “Well, is that a good proxy for the duration of all cartels?” What this research is trying to provide is a method for measuring how much bias there might be from looking at discovered cartels, with regard to the universe of cartels.

[email protected]: What are some key takeaways of the paper?

Harrington: To answer that question, let me say that the paper makes two contributions. First, it puts forth a theoretical framework to think through these issues and understand, “Well, when will bias occur? In what direction?” And the way it does this is to construct a model of the birth, death, and discovery of cartels.

If you read many papers in the literature, some economists will say that, “Well, the measured duration of discovered cartels is an overestimate of the actual true duration.” And some will say it’s an underestimate. And so what we want to do is put forth a theoretical framework where we can say precisely, when is it an over- or underestimate? What drives that?

… Let us think about cartels as differing in two key characteristics: what’s the likelihood of collapsing, let’s say, within a year; and what’s the likelihood of being discovered in a year? If cartels tend to largely vary in terms of the likelihood of collapse, what we find is that the measured duration of discovered cartels is an overestimate of the true duration. And the reason is that, if you have a cartel that’s really very stable, with a low chance of collapse, it just hangs around for a long time and has plenty of opportunities to be discovered. Cartels that are short-lived will tend to die and avoid discovery.

So the bias in that case will work toward saying that, “Well, if we measure, for example, the average duration of discovered cartels to be, let’s say, six years,” that probably is an overestimate. Now, there are other assumptions you can make, whereby you’d get bias going the other direction.

So one contribution and takeaway is to be able to frame these issues, so we understand, “OK, what drives bias?” The other contribution, and more where I think the key takeaway is, is to then use this framework to get a measure of the extent of this bias. How big is it?

“The other contribution … is to then use this framework to get a measure of the extent of this bias. How big is it?”

We take this framework, and we use data on convicted cartels by the Antitrust Division, from cartels that were born from 1961 to 1984. First of all, you could just measure the average duration of these convicted cartels, and it’s 5.8 years. But we could use this framework to then get a sense of how big is the bias with regard to the duration of all the cartels. Also those that are undiscovered.

And what we find — and I think one of the surprising results – is that the bias, actually, is not that large. We find a high likelihood [that] the average duration of all cartels probably ranges from about 5.2 years to 6.8 years.

[email protected]: What are some practical implications of your research?

Harrington: Probably the most substantive one is with regard to evaluating policy. Now, I think there’s been

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