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09 January 2019

In Praise of Cartels

This article was written by Bill Prast. All views and opinions expressed are strictly his own.

“People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”

So said Adam Smith in “Wealth of Nations” (arguably the second-most influential document published in 1776).  But, unlike Thomas Jefferson and the framers of the Declaration of Independence in Philadelphia, I daresay the eminent Scottish economist may have reached a questionable conclusion.  Is a “contrivance to raise prices” really a “conspiracy against the public”?  Indeed, cannot it not be demonstrably in the public interest to raise prices under appropriate conditions?

I think a case can be made for the benefits of collaboration between producers, or indeed amongst consumers too, in order to achieve and sustain higher and stable prices.  I am happy to try to do so, without getting into the niceties of whether an oligopsony of buyers or an oligopoly of suppliers exists or should exist for a particular item, whether it be a fungible and relatively homogeneous raw material (read, metals and mineral fuels) or an item of high technology and complexity (read, passenger planes).

Published studies by academics on the apparently higher costs arising from market-controlling efforts by collaborating suppliers suggest the price impact is of the order of ten percent, sometimes more or less, depending on individual circumstances; usually, the duration of the specific collaboration is limited to a few years at most.  It is mostly against the law, after all.

Now, considering the metals trade – or indeed the trade in many kinds of raw materials - one could support the merits of the case for price administration.

Here are two premises: “The cost of metals is a minor component of the cost of finished products,” and “The revenues derived from the sale of minerals and ores is a major source of income for many countries that would otherwise be even more impoverished.”  These premises are not incorrect, and are broadly true although there are examples that one can cite to the contrary.

Hence one might conclude by inductive reasoning that a higher price for a metal would not be indigestible to the global economy, and at the same time would benefit some countries which are the source of the metal in question.  This might be a good thing.

Setting aside the kleptocratic tendencies of the ruling elite in more than a few countries around the world to siphon off any foreign exchange that reaches their shores, it may be simpler for the economically-developed nations – and I would go so far as to include China - to pay more for their imports of ores, concentrates and semis.  If they did, it would help to reduce poverty, improve public health, provide for schools, reduce environmental damage and all the other social programmes which are part and parcel of annual foreign aid budgets.

To a degree, this state of affairs already exists for some commodities.  The usual example given by critics is of course OPEC.  Since the members produce only about 40% of global oil demand, it is not correct to call the 15 members of OPEC a cartel.  It has the character of an oligopoly with Saudi Arabia as the price setter.  OPEC is the reason why the USA has seen a rapid rise in its shale oil output and is now producing more oil than anyone else; that could never have happened if crude oil prices remained as they were a few years ago, significantly below current market conditions.  Here we have a timely example of how the doctrine of unintended consequences works.

Although oil from the Middle East seems to dominate energy policy thinking in Washington DC and other capitals (and I use the word “thinking” loosely), the leading oil and gas producers include countries that do not border the Gulf with large populations and an immediate need for revenues arising from these exports.  Nigeria, Venezuela, Indonesia, Mexico come to mind.

I think all of this boils down to how and when the industrialised world intends to pay for its  purchases.  Paying more for raw materials now can be looked on as a sort of tax to benefit the planet as a whole, perhaps at a later date.  Yes, I fully appreciate that the intended ultimate beneficiaries may not get to see much in the short run, but how to prevent the wholesale diversion of government revenues by questionable regimes into European real estate portfolios is another matter.

In a recent conversation in London with a friend who is a very experienced international civil servant and currently working in sub-Saharan Africa under exceptionally difficult conditions, she raised the question of the “Dutch disease.”  I am no friend of that economic theory and  sought to decouple the negative impacts of a surge in foreign direct investment and foreign exchange earnings that arise from developing a natural resource from the positive impacts of a new discovery.  I hope I was successful.

For those folks who do not follow economic theory too closely, the “Dutch disease” was thought up in 1977 to explain why the manufacturing sector of the Netherlands fell into relative decline after a major natural gas discovery was made there.  I think it is a red herring and simplistic, but it has since been applied in discussions of third-world countries which experienced commodity booms but did not develop their economies.

Closing with some final thoughts from the a half-century ago: when Henry Kissinger was Nixon’s Secretary of State, he suggested in 1975 that it would be a good idea to guarantee a floor on the price of oil.  A figure of $7 or $8 per barrel was reported in ‘The New York Times'.  The idea was dismissed as impractical by industry observers who thought it was a bit too low.  Add a zero to that price and you get close to where we are now.  It still may be an idea worth considering.

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