THE BLOG
07/05/2010 09:29 am ET Updated May 25, 2011

Gentlemen's Agreements -- When Collusion Undermines Capitalism

My first exposure to collusion occurred when I was in high school, working in a local pharmacy. Nearby were two other competing pharmacies. The three pharmacies got into a price war over cigarettes, with prices falling every week as they tried luring customers into their store and away from the competition. Cigarette sales soared as profits declined. This example of free market capitalism was put to an abrupt end with two phone calls, inviting both competitors to agree to one price rather than sell at a loss. Who won after this gentleman's agreement was put in place? The beneficiaries of the price fixing were the three businesses that no longer needed to compete and the losers were the customers who had benefited from the competition.

What about collusion on a larger scale? It occurs so often we barely take notice of it. Sometimes it is obvious while other times collusion is more subtle. Not too many years ago, the vitamin industry received massive fines from the European Union for participating in a cartel which fixed prices for a broad set of vitamins. This cartel consisted of some of the largest vitamin makers in the world. The collapse of the cartel was ushered in not only by investigations and fines, but also by the introduction of new competitors into the marketplace including Chinese vitamin makers.

Major league baseball represents another excellent example of collusion. The different baseball teams are supposed to act as competing companies yet routinely the owners have been found colluding to try keeping down player salaries and restricting free agency. The collective bargaining agreement first signed in 1968 was supposed to prevent this behavior but numerous times over the years the owners have been found guilty and forced to pay fines.

OPEC is an example of collusion where a cartel of sovereign countries has agreed to regulate the production of oil. The laws that regulate companies are not the same as those that regulate nations (hence we don't call OPEC illegal). Nonetheless, OPEC is an example of collusion which has greatly impacted the prices of oil and its members still account for two-thirds of the world's oil reserves.

Collusion allows companies to benefit from anti-competitive behavior such as price fixing while the consumer suffers. In the past, some have accused diverse industries such as the investment banks, cable companies and the US automotive industry of collusion. Unfortunately, "gentlemen's agreements" are often difficult to prove as they rarely produce documents stating their intentions to cooperate illegally and are usually less obvious than monopoly situations.