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Archive for June 6th, 2012

The Economist Corner (4) – Are Cartel Fines too Low?

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Given today’s announcement, I suspect Alfonso has better to do than posting on this blog. Run, Alfonso (on the banks), run!

With this, it is thus my duty, and honour, to introduce the 4th edition of the Economist Corner. For this edition, Benoît Durand (RBB Economics) has sent us a good piece on a money-related issue, i.e. fines for cartel infringements. Enjoy!

In the last decade the European Commission has imposed higher fines on cartels, in particular under the helm of Neelie Kroes.  The stated purpose for this increase was that fine levels were not sufficiently high to deter the formation of cartels.

In general, the deterrence property of sanctions is a key aspect of law enforcement.  Becker (1968), who was the first to apply economic principles to crime and punishment, explains that the level of sanctions should be set so as to deter crime.  A high level of sanction in turn contributes to minimise the costs of enforcing the law.[1]

Firms consider the expected benefits and costs of participating in a cartel.  Under this logic, if the expected sanctions are higher than the collusive gains, then firms will not take the chance.  Because there is always a significant probability that cartels slip through the net, the penalties should be several times larger than the gains such that no firm would dare try fixing prices.  By way of example, consider that a cartel member expects to pocket 50 million euros extra every year for about 6 years, whilst the probability of being caught is 1 out of 5.  In this setting, it would take a massive fine of slightly more than 1.5 billion euros to convince a firm not to collude.[2]

As cartels continue to exist, it must be the case that the current level of sanctions is ineffective.  This is the conclusion that Combe and Monnier (2011) draw after reviewing the fines for 64 EC cartel decisions between 1979 and 2009.  They show that in virtually all cases fines were set below the optimal deterrence level; i.e. in spite of the sanctions, the cartels were profitable.[3]

Is it therefore necessary to raise corporate fines above the current levels to deter the formation of cartels?  It is hard to say, but to achieve full deterrence, competition authorities need not increase fines at stratospheric levels as suggested by the logic described above.  First, they could adjust sanctions to give cartel members the incentive to undercut each other, which would trigger the collapse of cartels.  Second, in complement to corporate fines, competition authorities could consider applying measures targeted at company officers who have brokered the cartel agreement.

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Written by Nicolas Petit

6 June 2012 at 9:58 am