Let hard core cartels off the hook? Nah

The reactions to the news that cartel behaviour will not, after all, be criminalised, have been all over the place.

I covered the initial reactions from the law firms most involved in competition law here as well as my own reaction, where I was disappointed that "hard core" cartels were not going to be criminalised (I only chose the law firms, by the way, because they were first to react, not because I was climbing into them); John Small has written 'Criminalising cartels' which doubted the rationale for the non-criminalisation decision; Bernard Hickey has criticised the decision (this version has more comments but this version has prettier graphs); Paul Walker has written 'Do we need competition policy?' and 'Competition policy, again (updated)', broadly questioning the case for criminalisation and taking a critical approach to interventionist competition policy in general; and Jim Rose has written a thoughtful piece, 'Does competition law in high-tech markets help consumers?' which is less about the criminalisation issues but more (like Paul) thinking about the scope of competition law particularly in modern more tech-based economies. No offence to anyone I've missed.

Over at the New Zealand Dr Oliver Hartwich also came out with a piece, "Three cheers for competition (and for Paul Goldsmith)", which welcomed the non-criminalisation news. But I have real difficulties with some of his arguments.

Here's one of them:

The problem lies in the nature of competition law. It is an area of law which is prone to arbitrariness. Practically everything is a matter of interpretation...In short, the nature of competition law is such that you would never want to make it the basis of criminal sanctions. Criminal law requires a great degree of predictability. If you commit a crime, you should know what penalty to expect if caught. With competition law, you often do not even know you have done something wrong until a judge tells you so

Now, I've some sympathy for this argument in some contexts, and have said so in the context of 'abuse of market power': where s36 of our Commerce Act might or might not apply, and megabuck fines might or might not be in play, it's a fair point.

But as I said then, "there will be instances where there are guys in black hats who know they are wearing them", and "hard core" cartels are the classic example. The people engaged in them know there are no 'efficiency' or 'collaborative activity' benefits. They know full well that the sole purpose is to rip off unsuspecting buyers of their products. And if you think those old style, smoke-filled-room cartels belong back in the days of Teddy Roosevelt's trust-busting US of A, and things like that don't happen anymore, then you haven't been following the international case law*.

A second argument Dr Hartwich makes is in the same general area of fuzziness of the law:

Then there is the difficulty in finding proper definitions. To quote the late economist Murray Rothbard, “there is nothing anticompetitive per se about a cartel, for there is conceptually no difference between a cartel, a merger, and the formation of a corporation: all consist of the voluntary pooling of assets in one firm to serve the consumers efficiently.” Indeed. Yet somehow the formation of a corporation is fine whereas a merger or a cartel might be illegal.

Rothbard's argument is surreal. They're self-evidently not the same, and self-evidently do not have the same effects. The formation of a corporation very likely involves the creation of no market power; a merger of two businesses might or might not create market power; a cartel almost certainly does.

And to say that they all different routes to the same objective, "to serve the consumers efficiently", is false in the case of most cartels, and absolutely, blatantly, spit-in-your-eye false in the case of the "hard core" cartels I'm most concerned about. They are by definition inefficient from an allocative efficiency point of view - consumers don't get to buy the quantity they would have liked to, at the price they'd be happy with, in the way they would have in a workably competitive market - and very likely inefficient from a dynamic efficiency point of view. For example, I can't see cartelists putting much effort into innovation that might undermine the product they've got a stranglehold on.

But pulling back from some of the detailed arguments, let's take an overview.

A lot of the comment has been along the lines that free-market people who are generally in favour of letting businesses get on with their business without too much interference - and I don't have a problem with that as a general approach - ought to be glad that a potential piece of heavy-handed business legislation has been rolled back.

Let me give you three reasons why I think that, as a general approach, is wrong in this instance.

The first is that cartels interfere with the proper operation of markets. You can't be a believer in letting markets rip and in standing idly by when cartels swing into action. Market prices are supposed to be signalling consumers' demands and producers' opportunities. They're not, when the prices are getting stuffed up by cartels. That's why proponents of markets (like me, and competition authorities everywhere) get so hot under the collar about them.

The second point is - for folks who genuinely worry that criminalising cartels, or even prosecuting them under our present civil law arrangements, risks penalising possibly welfare-enhancing collaboration and 'chilling' things consumers would have gained from - is that (a) we already have a route for companies to justify 'good' cartel arrangements (John Small's post was very good on this) (b) the proposed Commerce Act changes are introducing another one, and (c) the criminalisation proposal (as was) had an 'out' for making an honest mistake.

Let me explain. You form a cartel (I'm using 'cartel' to cover all the cartel-like behaviours, not just price-fixing). If that's all you do, you're toast. You're bang to rights under s30 of the Commerce Act. It's deemed, out of hand, to be a malign substantial lessening of competition.

But you can, under the Act as it stands, apply under s58 to have your arrangements 'authorised'. This means going through a process where you show that what you're doing may have some competition downside, but it's outweighed by the benefits. You'll see a good example here: the Commission authorised the Infant Nutrition Council's Code of Practice "which restricts advertising and marketing of infant formula for children under six months of age", "restrictions on advertising and marketing may lessen competition", but "the public benefits arising from higher breastfeeding rates outweigh any lessening of competition from the arrangement".

The proposed changes to the Commerce Act introduce another, 'clearance', channel. 'Clearance' is where you get the Commerce Commission to agree that there's no competitive detriment in the first place, so you don't even have to go through the balancing of detriment and benefit exercise. This clearance route, incidentally, is the standard way many proposed mergers get the nod.

But wait, there's more. As the Commerce Committee said (on p9 of the proposed changes), "criminal sanctions should be reserved for conduct that is truly culpable. A person should have intended to engage in the conduct in question, or at the very least have been reckless as to its consequences, to attract such sanctions". Quite so, which is why (see p6) people could have used an "Honest belief" defence, namely "they honestly believed that the cartel provision of the contract was reasonably necessary for the purpose of the collaborative activity...The term “reasonably necessary” requires the exercise of judgment in which a person could make an honest mistake".

This looks to me like quite an extensive suite of opportunities for people to argue their case for a pro-competitive cartel and, in extremis, escape having their collar felt if they've accidentally and honestly strayed over the line. And it still leaves the worst of the worst liable to have the book thrown at them, which is as it should be.

The third point for pro-business people to ponder is that, very often, it is other businesses that bear the brunt of hard-core cartelists' ripoffs. While there is no 'typical' cartel, a very common example is a cartel for some industrial input. You may see comments floating around at the moment about cardboard packaging, which is a reference to one of our closer to home cartels, the Amcor/Visy rort which stitched up the market for cardboard cartons, a mainstay component for many manufacturing and distribution businesses. As the ACCC pointed out, "The Federal Court ordered Visy and Amcor to pay $95 million in damages to a customer class action involving more than 4500 businesses".

Incidentally, I highly recommend the ACCC's 'Cartels case studies & legal cases' resource (which is where the quote came from). If nothing else, it's going to shake any unthinking assumption you may be holding about the harmlessness of cartels.

And with that I'm almost done. I'll just add that I'm somewhat taken aback. I was expecting more reactions along the lines, "Some cartels are beyond the pale. They are disgusting, exploitative conspiracies. I condemn them. I strongly advise everyone not to go there. But there's a whole bunch of activities that are more difficult to categorise..."

I'm still waiting.

*You might want to read Robert Marshall & Leslie Marx's book, 'The Economics of Collusion: Cartels and Bidding Rings'. It's excellent: as my long suffering colleagues in the economics trade will vouch, I've been wishing it on everyone. It's also readable by non-economists, as the authors have deliberately structured it for the intelligent lay person. The details of the lengths cartelists have been prepared to go to defend their conspiracies are an eye-opener.

"Hard core" cartelists are criminals

Earlier this week the government said that it is flagging away criminalising cartels. The rationale was "the significant risk that cartel criminalisation would have a chilling effect on pro-competitive behaviour between companies": in other words, businesses could be put off from engaging in worthwhile cooperation for fear of straying into heavily penalised criminal territory.

Most of the reaction to the news was either positive or matter of fact.

Buddle Findlay said they had always opposed criminalisation, for the very reason the government has now recognised. They also felt that there had been a side benefit from the whole exercise: "While the need for prison jumpsuits for cartel conduct no longer exists, the threat of criminalisation has been a significant factor in renewed compliance training and focus for New Zealand businesses.  In our view, the threat of criminalisation by itself has been critical to deterring anticompetitive behaviour".

Simpson Grierson reported the news without taking any positions, though they picked up on something else that also might have gone off the government's radar - the proposal to bring the shipping lines under the Commerce Act. There is, of course, no good reason for shipping line cartels to be exempt from the competition law of the land, any more than there was any good reason for IATA, pre 1980, to run a global airline cartel.

Minter Ellison Rudd Watts said the change in tack would be "welcome news for businesses which have expressed strong concern about the potential chilling effect that criminalisation could have on legitimate pro-competitive activity". They also, correctly, said that "Criminalisation is a controversial issue, not least because of the difficulty in evaluating its deterrent effect", pointing out that for various reasons actual criminal prosecutions in Australia and the UK have been thin on the ground (I'd also spotted the Aussie development).

And Chapman Tripp's consultant Grant David said in the NBR that dropping criminalisation was a good idea, but there was a better reason for it, which was "the question should be whether it is appropriate to subject executives to serious risk of imprisonment for conduct that is uncertain in nature and can be deterred in other ways" (here's a link but it may be paywalled if you haven't signed up).

My own take is somewhat different. I've been left with distinctly mixed emotions.

There's the bleeding-heart liberal part of me that welcomed it. The western world - particularly the US, but more generally - is getting overfond of redneck policy, long on retribution and short on rehabilitation and prevention.  In that light, one less criminal sanction on the books isn't a bad idea.

And there's the economist part (and the barrack-room lawyer part) of me that can see the government's point about potential chilling effects on cooperation, particularly as other proposed changes to the Commerce Act were simultaneously making collaborative activity easier to organise. Easing up on cooperation on the one hand, and (arguably) making it more uncertain on the other, didn't make for a completely coherent policy package.

But.

But on the other hand I have a deep, visceral dislike of "hard core" cartels, as they're often called in the competition enforcement business. These are the premeditated, concealed, hijackings of the competitive process: the ones with the coded messages, the throwaway mobile phones, the maps with the cartel members' territories, the furtive meetings in hotel rooms on the fringes of trade meetings in Osaka or Düsseldorf or Buenos Aires. These go beyond the concerns economists or lawyers might have about the affront to competitive markets: they are concerns every citizen ought to have about the proper operation of their society. "Hard core" cartels are in the same general territory as fraud and embezzlement, and ought to attract the same penalties.

Self-evidently, these sorts of rorts would never have been confused in the conspirators' minds with licit collaboration.

So I regret that the proposal, along with grey area "is it cooperation or is it collusion" activity, will also let the "hard core" cartels escape criminalisation. It can't have been beyond the wit of statutory draftmanship to have carved out a description of "hard core" cartel behaviour, and criminalised it, just as there are gradations of other bad behaviour (murder/manslaughter, reckless/dangerous/careless driving).

Let's get serious here. Piddling offences not worth the courts' time are prosecuted every day. But "hard core" cartels,  about as obnoxious and harmful as it gets when it comes to white collar crime, escape the dock. It's not right.

The dance of the seven veils (economist version)

..and what I mean is, I'm going to show you a series of graphs, but I'm going to take my time baring all.

Here's the first bit.

This shows our actual official cash rate (the OCR, the bold black line) over the last couple of years, compared with the Reserve Bank's projections of where it thought the cash rate would need to go (the various coloured lines, which are forecasts the Bank made at different times). You'll see that recently the OCR has gone down, though the Bank had thought it would need to go up. In our 'gotcha' culture, there have been plenty of people to say the Bank made a 'mistake', but as I've said before, that's probably not the best interpretation. People make the best decisions they can under considerable uncertainty, and every now and then they get blindsided.

Right. here's the next bit.

This is the entire history of the Bank's interest rate projections, since we started on the inflation targetting caper, compared with what actually happened.

I could look at this graph for hours. No, really, I could. It's fascinating.

If you were a blame-seeking muckraker, you could go to town on this. "For over twenty years the Bank has been saying that the OCR will need to go here, or there, and the OCR has gone somewhere else. Heads must roll!" But since we are reasonable people who understand nuance, reality, complexity and uncertainty, let's try some different responses.

My first thought was that it said something about forecasting. Very often, in the financial markets, the default forecast is that something that is going up, will go up a little more, and then drop back (or, if it's going down, will drop a little more, and then rise). You see it all the time in, for example, forecasts of exchange rates. The default tends to be some kind of "reversion to the mean" - people tend to think the current trend could run on a bit more, but will eventually drop back to something more "normal". So my initial reaction was that this looked like a not very sophisticated forecasting scheme.

But in talking to some folks at the Reserve Bank's modelling workshop today, I came to the view that there's something else happening. These aren't really "forecasts" in the normal sense of "what will happen to something": rather, they're actually the RBNZ's view of what OCR will be needed to keep inflation inside the RBNZ's target range. Seen in that light, what the graph arguably shows is that the RBNZ has tended to think that monetary policy is more powerful than it actually is.

For example, over that period from 2004 to 2007, the Bank thought that modest increases in the OCR would have enough oomph to keep things under control: in fact, the OCR had to rise a lot more than that to do the job. Similarly, in the weaker post-GFC period, the Bank thought a brief period of stimulus would be enough to fire things up. In the event, it took a much longer time, and much lower rates than the Bank had expected to wield, to try and work inflation up again. And it hasn't succeeded yet: it thinks it's on track, and that today's low interest rates will be enough to get inflation back to near 2%. But on this showing it's just as likely that monetary policy still isn't as high-powered as you might imagine, and that even lower rates for even longer might be required.

You might think, why has our central bank held this overoptimistic view of the influence of monetary policy? I don't have a good answer to that, but - and here comes the next bit of the striptease - we're in good company. Here are the equivalent forecasts made by the Norwegian and Swedish central banks, in both cases dating from when they also embarked on the great inflation targetting adventure.

Interestingly, they have both tended to err in the same systematic way - they have persistently thought that interest rates would need to be higher than actually proved necessary. Part of it is happenstance: the post-GFC global economy has been a strange place, where central banks might have reasonably expected inflation to have picked up as the global economy has recovered, but it hasn't, for reasons that aren't clear yet. And part of it, in my view, is that when a central bank first sets out to be an inflation targetter, it's absolutely got to establish its credibility early in the piece. And above all, that means not letting inflation go above target. So there's an inevitable tendency to want to set rates at a conservatively high level that takes an inflation-above-target outcome out of play. You can see something much the same playing out in the early days of our own experience.

All of this, by the way, came from an excellent paper albeit with the rather opaque title, "Monetary policy forecast and global indicators", presented by Hilde Bjørnland (BI Business School and Norges Bank) at today's workshop. It's not up on the RBNZ's website yet, but it'll be well worth your while to have a read when it is. I'd also recommend "International inflation dynamics and the New Keynesian Phillips Curve: The role of the global output gap", by the Bank of Thailand's Pym Manopimoke, where she shows that global influences are playing a larger role in individual countries' inflation outcomes, and the rather inscrutably named "Foreign shocks" by Norges Bank's Drago Bergholt, where (if DSGE is your thing) he improves your workhorse DSGE model to allow for a greater influence for international linkages.

Poorer management, lower productivity. Makes sense

On Tuesday we had the Productivity Commission's excellent symposium on innovation  and productivity, where one of the main talking points was the growing importance of investment in 'intangibles' like research and knowhow. We're not especially good at it, as the three right hand bars in the graph below show (taken from this recent Productivity Commission working paper, 'Measuring the innovative activity of New Zealand firms' - symposium attendees will recognise it from the brochure).

By coincidence the Peterson Institute for International Economics in Washington had a conference last month on 'Making Sense of the Productivity Slowdown' which covered some of the same landscape. One of the presentations in particular was quite suggestive about one of the intangible knowhows we could do with a bit more of - and that's managerial skill.

The LSE's John Van Reenen was talking about 'Productivity Issues: Past, Present & Future'. He's been working with a sophisticated index of management expertise: you can find out more about it at the World Management Survey website, but in essence it grades companies, on a 1 to 5 scale, on how well they do 18 different management things. Van Reenen (and others) have then gone on and looked at the links between management expertise, as measured, and various financial and economic outcomes. They are generally sizeable: here, for example, is the global link between a firm's Total Factor Productivity (TFP) and the quality of its management.

TFP, by the way, for folks not versed in the black arts, is the bit of a firm's performance left over after you've accounted for the contributions of its workforce, its employees' skills, and its capital spending. At one level it means "anything we can't get a handle on", but it's also often used as a shorthand for important intangibles like management quality, social skills and "the way we do things round here", and smart processes.

In this latest outing, he's had a go at explaining differences in countries' TFP: if you make a plausible assumption about management's importance in overall TFP, and you have measures of TFP and management expertise, you can estimate how much of countries' TFP differences is down to differences in management. Often, in these kinds of surveys, New Zealand tends to be among those absent, but for once we're in the numbers, and here are the results. Differences in TFP are measured as a percentage of the US level. I've circled NZ in red.

Now, I think we can all agree that this is somewhere down the more heroic end of estimation, and also that there are the usual issues of correlation and causation. But we can also agree that rough and ready estimates, that are approximately in the right sort of area, are also useful things to have. 

And I think there is something to this one. The overall pattern looks realistic: poorer countries at lower levels of development - the ones on the left with, say, less than 20% of America's TFP - tend to have bigger issues to confront than the relative quality of their management, and sure enough the contribution of management to the development gap tends to be low. But at higher levels of development, where you've got higher levels of resources available, how you manage them becomes more important. 

On these estimates, 43.5% of the productivity gap between us and the States is down to our relatively weak management capabilities (and it's interesting that Australia, with a somewhat similar business environment to ours, comes out with a similar number, at 45%).  These numbers also sit comfortably with other evidence that our management capabilities aren't that flash: for example, the Productivity Commission's services inquiry found some data that suggested that low ICT uptake appeared to be linked with a "couldn't be arsed" approach by business owners (as I posted at the time).

Even if the proportion is uncertain - let's just say it might be somewhere between a quarter and a half - it makes for a significant line of attack if we're thinking about better management's potential contribution to narrowing the productivity gap with overseas. There were some neat ideas at this week's productivity symposium - but they're not going to get the traction they should if our business managers are slower to run with them, or worse at execution, than their overseas competitors.