D. The Instability of the Cartel

Analysis demonstrates that a cartel is an inherently unstable form of operation. If the joint pooling of assets in a common cause proves in the long run to be profitable for each of the individual members of the cartel, then they will act formally to merge into one large firm. The cartel then disappears in the merger. On the other hand, if the joint action proves unprofitable for one or more members, the dissatisfied firm or firms will break away from the cartel, and, as we shall see, any such independent action almost always destroys the cartel. The cartel form, therefore, is bound to be highly evanescent and unstable.

If joint action is the most efficient and profitable course for each member, a merger will soon take place. The very fact that each member firm retains its potential independence in the cartel means that a breakup could take place at any time. The cartel will have to assign production totals and quotas to each of the member firms. This is likely to lead first to a good deal of bickering among the firms over the assignment of quotas, with each member attempting to gain a larger share of the assignment. Whatever basis quotas are assigned on will necessarily be arbitrary and will always be subject to challenge by one or more members.13 In a merger, or in the formation of one corporation, the stockholders, by majority vote, form a decision-making organization. In the case of a cartel, however, disputes arise among independent owning entities.

Particularly likely to be restive under the imposed joint action will be the more efficient producers, who will be eager to expand their business rather than be fettered by shackles and quotas to provide shelter for their less efficient competitors. Clearly, the more efficient firms will be the ones to break up the cartel. This will be increasingly true as time goes on and conditions change from the time the cartel was first formed. The quotas, the jealously made agreements that formerly seemed plausible to all, now become intolerable restrictions for the more efficient firms, and the cartel soon breaks up; for once one firm breaks away, expands output and cuts prices, the others must follow.

If the cartel does not break up from within, it is even more likely to do so from without. To the extent that it has earned unusual monopoly profits, outside firms and outside producers will enter the same field of production. Outsiders, in short, rush in to take advantage of the higher profits. But once one strong competitor arises to challenge it, the cartel is doomed. For as the firms in the cartel are bound by production quotas, they must watch new competitors expand and take away sales from them at an accelerating rate. As a result, the cartel must break up under the pressure of the newcomers’ competition.14

• 13As Professor Benham states:
  Firms which have produced a relatively large share of output in the past will demand the same share in the future. Firms which are expanding—owing, for example, to an unusually efficient management—will demand a larger share than they obtained in the past. Firms with a greater “capacity” for producing, as measured by the size of their ... plant will demand a correspondingly greater share.” (Benham, Economics, p. 232)On the difficulties faced by cartels, see also Bjarke Fog, “How Are Cartel Prices Determined?” Journal of Industrial Economics, November, 1956, pp. 16–23; Donald Dewey, Monopoly in Economics and Law (Chicago: Rand McNally, 1959), pp. 14–24; and Wieser, Social Economics, p. 225.
• 14For illustrations of this instability in the history of cartels, see Fairchild, Furniss, and Buck, Elementary Economics, II, 54–55; Charles Norman Fay, Too Much Government, Too Much Taxation (New York: Doubleday, Page, 1923), p. 41, and Big Business and Government (New York: Double-day, Page, 1912); A.D.H. Kaplan, Big Enterprise in a Competitive System (Washington, D.C.: Brookings Institute, 1954), pp. 11–12.