Friday, July 03, 2009

Cartel criminalisation

In a worrying trend I again find myself in agreement on the conclusions of a CIS publication, this time Jason Soon on criminalisation of cartels.

I will disagree with Jason on whether cartels do or do not have detrimental effects on consumer welfare. I'm actually open to the idea that sometimes they won't. What I will agree on is that criminalisation is poor policy.

Firstly it is unlikely to work effectively as an upfront deterrent. Anyone in business knows that someone already prepared to enter into a cartel under existing law is either foolish (they don't know the law), deluded (they think they are cleverer than regulators) or arrogant (they think the law doesn't apply to them). Increasing the penalty is unlikely to change behaviour before the fact. However, after the fact higher penalties make defectio from the cartel more risky.

As game theorists will tell you, cartels can't exist because the incentive to defect is higher than the incentive to stay. But if defection carries prosecution risks (those you defected on turn whistleblower) then the law against cartels becomes the mechanism to deter defection.

The other issue is that if a cartel has caused consumer detriment, no criminalisation action is effective in recovering the lost welfare.

If business is complaining about these laws they only have themselves to blame. Over the last ten or more years the main business response to concerns about merger activity has been to note that it is not industry concentration that matters, only the collusion between the concentrated players (ignoring completely how tacit collusion occurs more easily in concentrated industries). The claim has in efect been let more mergers through, just focus on collusion.

And that is exactly what we've got. Virtual inactivity in deterring mergeres and criminalisation of cartels.

It is entirely the wrong approach. Industry structure is what counts most. And yes, it is better that the small struggling firm goes broke than gets merged with the bigger firm. Letting mergers happen like this might seem good for shareholders, but it works against the idea of "creative destruction" promoted by the big end of town.

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