A cartel, according to Webster, can be either ‘a written agreement between belligerent nations’ such as a prisoner exchange arrangement, or ‘a voluntary, often international combination of independent private enterprises supplying like commodities or services’ (Webster’s 1967). The second concept is our concern here. The majority of cartels have dealt with national or smaller markets, but many of the best known have been international in coverage. Economists often distinguish private cartels and public cartels. In the latter, the government theoretically makes the rules, typically under strong influence from the affected industry and enforces them. Private cartels involve private agreements. They may or may not be publicly enforced depending on the nation, the period and the agreement. Some international cartels are private, but the best known have resulted from agreements among national governments.

Cartels may involve price fixing, output controls, bid-rigging, allocation of customers, allocation of sales by product or territory, establishment of trade practices, common sales agencies or combinations of these. Many medieval cities and mercantilist nations were tightly bound by such restraints of trade, but the cartel movement is usually pictured as arising with the large private firm in the late nineteenth century. Cartels were carried farthest in Germany in the half-century ending with World War II, but they were also important in Austria, Switzerland, Italy, France, Scandinavia and Japan in the same period. They reached their peak during the great depression of the 1930s. Cartelization was slower to develop in Britain and other nations with a common law tradition such as the United States. A prohibition of contracts in restraint of trade (largely a refusal of the courts to enforce) goes back at least to the early fifteenth century in English common law. The prohibition was written into the American Sherman Anti-Trust Act when it was passed in 1890. Even in the United States, however, the National Industrial Recovery Act, passed at the bottom of the great depression in 1933, permitted industries to formulate enforceable ‘codes of fair competition’. The Act was ruled unconstitutional by the Supreme Court in 1935, but the United States continued public cartels in such fields as coal-mining, oil production, interstate transportation, and agriculture for many years.

In the years since World War II most private and public industrial cartels have weakened. America’s prohibition of private cartels was strengthened and many of its public cartels ended. The Western occupation forces in Japan and Germany imposed cartel prohibitions there. The subsequent national governments revised these rules to permit certain cartels, but they are far removed from the prewar, pro-cartel policies of the same countries. Most other industrial non-communist countries have adopted anti-cartel laws since the war, but few have gone as far as the United States. On the other hand, some international commodity agreements established extremely high prices in the 1970s. In a number of cases such as bauxite and copper the agreements failed within a few years. But the Organization of Petroleum Exporting Countries (OPEC) was able to keep world oil prices far above their costs for more than a decade. This was possible because Saudi Arabia, with more than a quarter of world capacity, was willing to reduce output greatly as smaller producers inside and outside OPEC expanded.

A ‘perfect cartel’ is one that maximizes the sum of the profits of its members. This requires that output be allocated among participants so that cost is minimized. That, in turn, implies that different producers operate their capacities at different rates. In the long run, some participants’ plants would be closed. The traditional solution for private cartels is side payments from the expanding to the contracting producers. In fact, although such payments have been made, perfect cartels have generally been beyond the reach of private cartels short of merger. A perfect cartel would be difficult to distinguish from a well-run firm. The classic example was the prewar German chemical firm, I.G. Farben (Interessen Gemeinschaft Farbenindustrie meaning ‘Community of Interests in the Dye Industry’). It did begin as an eight-firm cartel, but by 1925 they had all merged (Michels 1928).

Enforcement is a crucial aspect of cartels. This requires (a) detection of violations and (b) sanctions on violators. Detection is easy in oral auctions. Violations are immediately obvious when they occur. In the more common cases where firms must bid for customers in sealed-bid auctions or through salesmen, detection is much more difficult, unless winning bids are publicly announced. Cumulative changes in market shares seem to be the most credible evidence of whether ‘cheating’ is going on or not, but the usefulness of such evidence rapidly declines as the numbers of competing firms increase (Stigler 1964). The implication is that purely private cartels with many members are weak. If they have serious social cost it is most likely to work via changes in institutions such as the establishment of a basing point system or political pressure for oral auctions. Public enforcement seems essential for cartels to raise price for any length of time on unconcentrated markets.

Private enforcement also requires privately imposed sanctions. Oral auctions help here also. Only one conspirator per bid need incur any risk in punishing a violator, and even he need not always ‘win’. Punishment in these cases is not severe. Since the violator is usually free to withdraw from the bidding, he need not pay a price that involves a loss. He can be deprived of the gain from collusion and, perhaps, access to the objects being bid for. With sealed bids or where the rivals solicit customers through salesmen, punishment is apt to mean general price wars – the temporary suspension of the cartel. As the numbers in a cartel grow, the gain from violating it generally increases faster than the loss from such punishment when detected (Lambson 1984). Here is another reason to expect purely private cartels to be weak unless the market is concentrated.

In private cartels prices are unlikely to be set at joint maximizing levels. The bargaining power of major participants is apt to reflect their potential profitability without the cartel. Usually the low-cost firms have the best prospects without the cartel. If they determine cartel price, it is likely to be lower than that of a monopolist with the same plants. Small firms may also have a special influence on cartel price. A firm that is too small to be worth disciplining will probably sell at a discount from cartel price. Such a small firm as a cartel member is apt to favour high cartel prices from which it then discounts. If the numbers of such small firms become large, the majors may try to discipline the fringe as a whole to limit their discounts. In fact, however, the growth of a large fringe commonly leads to the collapse of the cartel.

Public cartels are also unlikely to be perfect cartels, but they often differ from private cartels. Many American public cartels (such as those in agriculture, oil prorationing, import quotas for oil refiners, and airlines under the Civil Aeronautics Board) allocated output, access to cheap imports of oil or to profitable markets in favour of small and high-cost firms, just the opposite of what would have occurred under successful private cartels.

Effective cartels are likely to result in excess capacity for several reasons. High-profit prospects attract entrants – as in American oil prorationing in the 1940s, 1950s and early 1960s or the famous oil glut that grew up in the 1980s after the huge price increases imposed by OPEC in the 1970s. High prices permit continued excess capacity that would be driven from the field in a competitive market – as in much of American agriculture. Existing firms will often build excess capacity if it increases sales because with prices far above marginal cost, additional sales are worth the additional cost to the firm (Posner 1975) – as occurred on competitive airline routes in 1945–1977 even though entry was prohibited (Douglas and Miller 1974). An equilibrium at high cartel prices is reached when excess capacity has forced cost up to the point where profits are reduced to normal levels and entry and expansion is no longer attractive. Excess capacity can be avoided if members’ output does not depend on current capacity. For instance, American flue-cured tobacco production depends on acreage allotments set in the late 1930s. As a result, the government was able over many years to prevent the development of excess capacity which presented such problems in other crop programmes.

Excess capacity may arise in private cartels also. In addition to entry and expansion attracted by high prices, excess capacity may be intentionally built or maintained so that the threat of retaliation against violators of the cartel can be credible (Brock and Scheinkman 1985).

Many nations have permitted and enforced cartels of certain sorts which were seen to be in the public interest. Most of the industrial non-communist countries of the world including the United States permit export cartels. From a narrow national point of view this makes some sense at least for large countries. Their national incomes are enhanced by exploitation of any powerful positions they occupy abroad. With all major countries following such strategies, however, the overall effect must be some net loss for most of them. Another reason for export cartels arises when a major importing country negotiates a restriction on exports from foreign sources. The Americans negotiated many such quotas with major foreign exporters to the United States in the 1960s and 1970s.

Import quotas almost always involve public cartels in form. Import licences are distributed among importers by the government and are kept valuable by the trade restriction itself. In the 1930s Germany used import restrictions along with complex foreign-exchange policies to exploit its special position with respect to many of its trading partners. The main purposes of import quotas today are protectionism and/or the allocation of scarce foreign exchange. Exploitative import cartels seem to be few. The large countries employ import quotas very little today, and small nations have little monopsony power. Because of international specialization, small countries can often be large in their main export markets, but specialization in consumption and imports is rare.

A number of countries use cartels to aid temporarily depressed industries. The Japanese ‘depression cartels’ are an example (Hadley 1970). Depressed industries can form cartels for 1 year or less if approved by a specified government agency. The state of the industry need not derive from a general depression, but the case for such cartels seems strongest in such a setting. No long-term adjustment by the industry is called for, and a temporary cartel may be one of the less costly ways of assisting industries seriously hurt by general economic decline. In normal times occasional bankruptcies may serve to weed out badly managed firms, and economic pressure on a declining industry serves to transfer resources to more productive uses, but widespread financial disasters during a depression seem of little social value. The crucial thing is that the depression cartel be truly temporary and that the problems that made the industry ‘depressed’ do not call for long-term adjustments.

Japanese cartel law also provides for ‘rationalization cartels’ (Hadley 1970), which are not so limited in duration as the depression cartels. They require the approval of the appropriate public agency, once more. A number of European nations also provide for rationalization cartels. Rationalization refers to long-term adjustments by an industry such as the replacement of suboptimal or obsolete capacity or the elimination of excess capacity. It is conceivable that joint action by the firms in an industry could offer a better solution to excess capacity than a fight to the finish on the open market might yield. At least the transition would be less painful if a joint decision were made about which plants should be closed and the survivors bought out the firms which were to go out of business. In practice, rationalization cartels have done little of this. Rather, they set price and/or output that reduced the pressure on their members to adjust. They accomplished little or no rationalization as a result.

Where rationalization means replacing suboptimal or obsolete capacity, the cartel approach seems even less promising. It would call upon efficient producers to help their high-cost rivals to become more competitive. A theoretically appealing exception is the specialization cartel. The firms in such a cartel agree to assign products to particular members, thus permitting optimal-scale capacity for each subproduct. Governments that permit such cartels often try to reduce their competitive effects by limiting the combined shares of the market of the cartel. For instance, in the European Coal and Steel Community such cartels may not have more than 15% of industry sales. However, four such groups permitted in Germany, each with a common sales agency, accounted for most of German steel and half of ECSC steel in the 1960s. Most of the specialization involved output quotas which permitted economies of long production runs. Little specialization of plant and equipment was accomplished, so few economies of scale were realized (Stegemann 1979).

In general, most rationalization cartels have turned out in fact to be oriented primarily toward short-term restraint of trade.

See Also