Unprofitable Cartels: Evidence from a Natural Experiment in the UK

Abstract

I analyse the effect of collusion on profitability with the use of evidence from a natural experiment of policy reform: the introduction of anti-cartel legislation in the UK in the late 1950s. This caused an intensification of price competition in previously collusive industries but did not affect industries that had not been collusive. Three main results are established: First, a comparison of the two groups of industries shows that the breakdown of collusion had no significant overall effect on profitability in the long run—although it had a strong negative effect on firm numbers. Second, the larger was the decrease in firm numbers, the smaller was the decline of profitability in previously collusive industries; however, no such correlation exists in industries that were not affected by the cartel law. Third, most cartels did not restrict entry; but in industries where entry had been restricted, profitability rather than firm numbers decreased when collusion broke down. These results are consistent with theories that emphasise the role of entry conditions for profitability: Cartels are often unprofitable because of entry even when collusion is effective.