Browsing old threads by Borodog, one of the most thought-provoking posters over at the 2+2 forums, I came across this interesting essay that touches on a subject much misunderstood by the average joe:

Price Fixing and Cartels in the Free Market?

Not a problem.

First, the moral argument, which is trivial and completely unassailable. If I do not wish to sell my goods and services for less than a certain price, how is it morally justifiable to compel me to do so? If I own a gas station and want to sell my gasoline for no less than $4 per gallon, how is it morally justified for you to use the police power of the state to force me to sell it for only $3 per gallon?

Furthermore, if I and my competitors voluntarily agree to each sell our product at the same fixed price (i.e. price fixing), how is it morally justified to use force to compel us to do otherwise, or to use force to compel us not to talk amongst ourselves? So if I and the other 3 gas station owners on our corner decide to sell our gasoline for $4 per gallon and not a penny less, who are you to demand otherwise, except a thief or the errand boy of thieves?

Second, the economic argument. Yes, “cartels” certainly form in the free market. However, they don’t actually pose any problem for consumers.

First, it is incontrovertible that the higher the cartel attempts to fix the price, the more incentive there exists for each cartel member to break with the cartel by lowering its price to capture market share. This incentive operates on all of the cartel members, and it is powerful. A cartel is actually a very unstable entity, and the worse it tries to “gouge” consumers, the more unstable it becomes. This acts as a natural governor on price fixing by the cartel.

Furthermore, aside from internal incentives that hurt the cartel, there are external ones as well. The more the cartel attempts to jack up prices (and hence profits), the more it A) incentivizes competition to enter and occupy its markets, and B) incentivizes consumers to choose alternatives to its products and services (A & B here are of course two side of the same coin). These external incentives are every bit as powerful as the internal ones.

Note the substantial difference between a free market cartel and a government established cartel regarding these internal and external incentives. First, in the free market each member has an incentive to break the cartel (which is in the consumers’ favor), but in a government created cartel, the state creates harsh coercive penalties for members that break with the cartel. Second, the government created cartel exists specifically because the state has reserved the market for them and made new competition illegal. Thus the natural governors on cartels are destroyed in a state cartel.

Lastly, let us presume that while yes, all of the above is true, still there must be some effect, right? As long as the cartel doesn’t try to jack up the price too high they can still jack up the price a little, right?

I would argue that yes, this is absolutely true. However, this does not change the trend of enormous benefit to the consumer over time because of free market competition. So while it might be the case that at any one time the consumers might benefit by a small amount if companies were violently prevented from communicating with each other and charging what they wanted to for their own products, the benefits that accrue to the consumer over time on the free market are compounded and enormous. To destroy the efficiency of the free market in the name of a short term decrease in price is foolhardy, because you will act to destroy the enormous benefits that accrue over time.

As an afterthough, let us take the examples of the two most famous cartels I keep hearing about, the oil cartel and the diamond cartel. What exactly are the “negative” effects on the consumer of these cartels (we shall entirely neglect the fact that both of these cartels are government created)?

I can buy a gallon of gasoline right now for about $2.10. If I wanted to produce this gallon of gas mysef, without the aid of the evil oil companies and perhaps the evil oil cartel itself, I would undoubtably have to spend many thousands, if not tens of thousands, hundreds of thousands, or millions of dollars. I would have to fly halfway across the country or around the world, purchase the land and machinery to pump crude oil out of the ground, and perchase the machinery to refine it into gasoline. With the evil oil cartel in place, I save at least 99.99% of that cost, and probably an amount significantly closer to 100% than even that.

What about diamonds? I hope you can see the same effect. I would have to fly somewhere, buy some diamond bearing deposits, buy the machinery to dig in the ground, fly to Amsterdan and hire some Hacidic diamond cutters to cut and polish my stone. I would have to spend many, many, many times what I spend going into an (overpriced) jewelery store in the mall and just buying one that came through the evil diamond cartel.

Read the thread in its original context here.

Excellent short lecture by Stephan Kinsella:

Part 2
Part 3
Part 4