Lack of clarity is the one thing that emerges from recent government responses to rising inflation. Most important is the absence of appropriate systems to throw light on the question of cartelization. We refer, of course, to the case of the missing Competition Commission of India (CCI) that’s been in limbo for years, even after the related law was passed last year by Parliament. That is the correct forum for consuming and producing industries to have their pricing conflicts addressed.
The need for CCI becomes even more glaring given the complex structure of the steel industry—some players have an edge over the rest as they have captive mines for ore and/or fuel (coal). It is thus important to see why Tata Steel and SAIL did not need to go with the latest in a series of hikes by other, top private players. Is it because the two have captive sources of inputs and face less pressure on margins? The latest hike may be on hold with the steel minister assuring the firms of excise relief, but given the market conditions, the prices will be volatile. So, can the market rely on MRTPC, the defunct, weightless agency that failed to check cement cartelization for decades, which has been asked to look at steel? This controversy is unlikely to die soon. And only points to wrong signalling by a government reeling under poll pressures, as well as to the cost of not having a functioning CCI.
Posted: Sun, Apr 20 2008. 11:21 PM IST
Commentary
A cartel is a collusive agreement between firms to restrict output in order to increase profits. In a cartel firms act as a monopoly and have non-price competition. Cartels usually occur in an oligopolistic industry, where there are small number of sellers and firms produce homogenous products. Cartel members may generally agree on price fixing, total industry output, market share, allocation of customers, allocation of territories, big rigging, and establishments of common sales agency.
The aim of such collusion is to increase profits by reducing competion. Competition law generally forbids cartels, although cartels do happen but it is not very easy to identify them as companies are amrt enough for not putting the agreement on paper.
Cartels are of two types private and public. Export cartels and shipping conferences are examples of public cartel. On the contrary, private cartel is an agreement on terms and conditions where members arrive mutual understanding and is unlikely to be detected by outside parties. This is because private cartels are generally illegal and firms hide it from the outside parties. The below example is based on a private cartel.
In this case the head of a real estate industry council accused steel and cement and industry of cartelization. In this article people are suspecting chances of there being a cartel agreement between Tata Steel & SAIL.
Cartels are not considered healthy for economies as consumers have to pay higher prices and it also reduces efficiency. The finance minister of India P. Chidambaram said that the government would not encourage cartels as it leads to increase in inflation and would take strict action against cartels. The advantage of cartels to manufacturers is that they can earn supernormal profits. Firms can maximize their profits by reducing the quantity supplied and would lead to an increase in prices. This can be illustrated using a diagram.
The diagram above shows that the firms have restricted output and raise their prices. The are of supernormal profit is the area shaded in grey.
In this case there is not are different views of different people. Some people feel that there is a cartel between the two giant firms but some people deny it. As the government does not support cartels especially when it comes to the steel and cement industry. If actually there is a cartel between Tata steel and SAIL as they couldn’t be accused of cartelization because of different opinions of people.
Tata and Sail are two of the biggest firms in steel industry and have the capability to achieve economies of scale so could also reduce their prices and increase their supply to increase their revenue. This would create barriers of entry and increase their market share. This can be shown using a diagram.
The diagram shows that there is a increase in supply from q1 to q2 and there is a reduction in prices from p1 to p2. This will help a firm to maximize its revenue, although they lose out on an opportunity to earn supernormal profits because they have reduced their prices and could only afford to earn normal profits as shown above. But by doing this they can create barriers to entry and reduce the competition.
If there is a cartel agreement between the two firms the government can impose a huge fine on the firms for not obeying the government. The government cannot shut the two firms as it would be a huge loss for the nation economically but can force them to either reduce their prices or break the agreement. The government would not encourage formation of cartels as it discourages competition which leads to inefficiency.
A government would like to have more competition in a market as it leads to increase in efficiency and lesser prices for consumers. This may also help the government to keep control over the inflation levels.
