By Raveen Ekanayake and Kaushalya Attygalle
In 2013, it was found that brand-name drug manufacturers in the United States were paying their competitors - generic drug manufacturers, to keep their products off the market shelves. In a case that was presented before the Supreme Court, Solvay Pharmaceuticals had paid a generic drug manufacturing company named Actavis close to US $ 30 million each year to delay making a drug that could compete with Solvay’s product, and thus, allowed the brand name company to sell their product at significantly higher prices. This “pay-for-delay” agreement deprived consumers of their right to choose and their right to fair pricing of the product. In a country that is trying to make healthcare more accessible to disadvantaged communities, such anti-competitive business practices have become a huge impediment to reducing healthcare costs.
This incident is an ideal case in point to highlight the existence of ‘cartels’ and their adverse impact on the poor. Cartels occur when companies stray away from operating within the usual competitive market system and opt to work together instead. These agreements often take place behind closed doors. They serve no legitimate purposes, rather they only serve to rob consumers of the tangible blessings of competition and are viewed as a side-on attack on free market fundamentals. History has elucidated us to the fact that great economic harm and large-scale competitive disadvantages suffered by modern economies are a result of cartel mentality. Cartels inflate prices, restrict supply, inhibit efficiency, and reduce the scope for innovation (Pate 2003).
Types of cartels
Anti-competitive business practice can occur in various forms that affect both buyers and sellers. Price fixing is the most common form of cartel conduct where a group of companies that are considered to be competitors agree on the pricing of their goods or services. Another form of cartel occurs when competitors agree to share the same customer base, suppliers and even divide certain geographic areas among themselves.
Such cartels even go to the extent of agreeing not to produce the other’s goods and services or expanding to produce the competitor’s goods and services. Bid rigging, or collusive tendering, is another form of anti-competitive cartel behavior that ensures that bids received for a tender notification are submitted in a manner agreed upon by the members of the cartel. Cartels also tend to have restrictions on output which the member companies enter into agreements that limit supply. It is also important to note that cartels can occur both from the seller’s side as well the buyer’s side.
Impact on the poor
While the above mentioned anti-competitive practices can have adverse impacts on consumers in general, the impact of cartels is more severe on the poor. Cartels can impact the poor as both a consumer and a small business owner.
Cartels can affect the poor consumer when price fixing, bid rigging, output restrictions, and shared information occur in industries producing essential goods and services such as basic food, medicine, fuel, transport, and water. For example, as a result of price fixing, a poor consumer will no longer be able to enjoy the benefits of prices that are based on competitive markets but instead, be forced to reduce their consumption as the good or service may no longer be affordable to them.
Similarly, small and medium enterprises are affected by cartels as these small firms face major difficulties in entering or even surviving in a market that has a few strong firms operating within a cartel. In a cartelized market, small business owners face many difficulties in selling their goods and services at competitive prices as the cartelized firms will be able to dominate market prices. In addition to this, small firms will also have to succumb to higher production costs and lower revenue as they may also have to purchase inputs at higher prices.
While seller cartels are often in the forefront of the discussion on cartels and anti-competitiveness business practices, buyer cartels could also negatively impact the poor. If a small firm is a supplier to a cartelized market, this will have adverse impacts as the supplier will be forced to sell their products at the price set by the cartel. For example, commodities such as coffee, cotton, tea, tobacco and milk, which are often supplied by small farmers, are known to have buyer cartels that do not allow these farmers to receive the best possible price for their goods.
Thus, effective implementation of competition laws that severely penalize such practices is undoubtedly essential to ensure that markets operate in a fair and just environment but above all, these laws are essential to protect poor communities from being further disadvantaged.
With cartelization on the rise, governments across the world are scrambling to regulate markets in the bid to safeguard the interests of consumers, especially the poor. Antitrust legislations in this lightare viewed as the ‘most effective brake against the cartelization of industry’ (Arnold 1951).
Almost all countries in the world now have some form of antitrust legislation and have established dedicated agencies armed to enforce them. The United States (U.S) is at the forefront of the battle against cartelization; both at home and internationally. It is said to have the toughest and most advanced set of antitrust regulations in the world, hence drawing lessons from the U.S would come a long way in assisting emerging economies such as Sri Lanka draw up similar frameworks. At the very core of the contemporary U.S antitrust legislation framework is the landmark federal statute the ‘Sherman Antitrust Act of 1890’. The Sherman Act prohibits certain business activities that federal government regulators deem to be anticompetitive, and requires the federal government to investigate and pursue trusts, companies, and organizations suspected of being in violation. The Antitrust Division (ATD) of the United States Department of Justice is at the frontlines of antitrust enforcement.
Deterrence and detection
The fundamental objective of any antitrust legislation is deterrence and detection of cartel formation. In pursuit of this objective, an array of tools and sanctions are at the disposal. In the U.S, participation in a cartel is viewed as a property crime, akin to burglary or larceny and thus is dealt with accordingly as a criminal offence. In the words of widely respected American jurist, legal theorist and economist, Richard A Posner‘ criminal sanctions are not prices designed to ration the activity; the purpose so far as possible is to extirpate it’.
Thus in addition to civil action for damages (up to treble damages and attorneys’ fees) and class actions, the Antitrust Division, through the criminal justice system are able to prosecute culpable individuals, who are subject to imprisonment. Under legislation in effect since 2004, corporations could be fined up to a maximum of US$ 100 million under the Sherman Act. Fines could be further extended under a provision of federal law allowing, in the alternative to the statutory fines, a fine equal to either twice the gain from the illegal activity or twice the loss to victims. Individuals convicted of Sherman Act violations can also be imprisoned for up to ten years.
Compared to other crimes, cartel activity is easily concealable, and cartel participants have a strong interest in concealing their unlawful activity, hence, deterrence alone would not suffice, detection plays a pivotal role. Detecting cartels requires enforcement agencies be armed with powerful tools. As such the U.S antitrust division is vested with the power to carry out grand jury investigations of cartel activity. The division is endowed with powers to obtain search warrants and seize relevant documents. With court order, the Division can record conversations without consent. The division’s criminal investigations are supported by other government agencies, such as the FBI and various offices of inspectors general. Agents from these agencies assist in locating and interviewing persons of interest, executing search warrants, or conducting surveillance.
Detection of cartels through leniency programmes is also a powerful tool in the arsenal of most antitrust enforcement agencies. Leniency programmes affect deterrence in a number of ways; firstly they directly increase the expected probability of being detected. Secondly, leniency programmes have a destabilizing effect on potential cartels because the first participant to apply for leniency can escape sanctions that are then imposed on the other cartel participants. Thirdly, through participating corporations provides access to evidence that otherwise might be unavailable (e.g., documents and witnesses located outside the United States).
Whilst leniency programmes across the globe have been instrumental in assisting enforcement agencies detect cartels, they have inherent limitations owing to their narrow focus on those at the very heart of cartels. They fail to incentivize people who are aware of but not complicated by cartel operations, they provide no protection for those whistleblowers that are at the periphery of a cartel hence much activity goes unreported. In response to these limitations, the past decade has witnessed four jurisdictions namely, South Korea, the United Kingdom, Hungary and Pakistan expanding their leniency programmes to incorporate antitrust informant or whistleblower reward programmes which incentive whistle blowing through monetary rewards and protect whistleblower’s identity from disclosure. The reward program administered by the UK office of Fair Trading offers monetary rewards up to US$ 157,000 depending on the value of information, harm to the economy and consumers and the effort and risk involve in providing the information.
In Sri Lanka, antitrust legislation is provided through provisions under clauses 34 and 35 of the Consumer Affairs Authority Act, No.9 of 2003. The Consumer Affairs Authority (CAA) is the sole agency tasked with enforcing these regulations.
Antitrust legislation and enforcement is still at its infancy. A collaborative study carried out by the Institute of Policy Studies of Sri Lanka (IPS), the Law and Society Trust and the Consumer Unity and Trust Society back in 2003, shed light on the possibility of cartel mentality prevalent in the cement and shipping industries in Sri Lanka. A decade-on since the publishing of findings, the question still remains, as to whether regulatory authorities have been able to detect such operations and have taken necessary measures to deal with them.
The CAA has been alleged of not being proactive enough, placing too much emphasis on investigation matters relating to pricing and the protection of consumers as opposed to carrying out investigations into the more pertinent area of anti-competitive practices, thereby allowing cartel operations to largely operate unfettered. In this light, a good first step would be to enhance detection measures by way of arming the CAA with corporate leniency programmes and whistleblower rewards schemes details earlier, whilst at the same time strengthening deterrence by way of criminalizing cartel operations. In drawing up such framework Sri Lanka should draw upon lessons/experiences of other nations such as the US, EU, Australia and Canada which are at the frontlines of the battle against cartels.
(The Authors are Research Assistants at the IPS. The more detailed version with endnotes and references is available in the IPS Blog ‘Talking Economics’: www.ips.lk/talkingeconomics )