O Cartel!

The author is research associate of the Philippine Institute for Development Studies PIDS (on-leave).

For over a decade from the 1970s to the 1980s, the Philippine cement
industry thrived under a powerful, government-sanctioned cartel that
captured Filipino consumers and industry users including the
government. In the absence of information, the government, through the
Philippine Cement Industry Authority (PCIA), had to coordinate closely
with the industry association, the Philippine Cement Corp.
(Philcemcor). This led to the collusion of firms through informal
agreements to set production quotas and geographic markets. By
regulating prices and outputs, prices were no longer the product of
competition among rival producers but more of the outcome of
negotiations between the government and a small number of producers.

During the 1990s, the PCIA was abolished, restrictions on cement
imports were removed, prices were deregulated, and tariffs were
gradually reduced from 50% in 1979 to the current level of 5%. But
despite these liberalization and deregulation episodes, no effective
competition has emerged. Implicit coordination in the industry has
continued because of the firms’ market power. Their collusive behavior
has become more glaring as prices rose substantially and continuously
in a simultaneous manner since 1999, a time characterized by excess
supply, overcapacity, and weak demand. Ironically, this parallel
behavior also coincided with tariff reduction and entry of imports and
new foreign players in the industry.

Price-cost margins, indicators used to measure market power, were high
at 42%, higher than the average margin for the whole manufacturing
industry. A firm with market power is able to charge price
significantly above cost while a firm without market power would charge
a price closer to cost. The industry’s market power is attributed to
the following factors: high and stable market shares and high
concentration levels in the last 13 years, difficulty of entry owing to
the large capital requirements of cement manufacturing, limited import
competition due to the natural characteristics of cement – high
transportation and handling costs and short shelf-life, inelastic
demand which provides power to firms to control prices, and absence of
competition policy in the country.

Cement average ex-plant prices indicate that there is not much price
variation in the industry. In February 2000, the average price in
Northern Luzon was P101/bag, 99.17/bag in NCR, and P100/bag in
Mindanao. The standard deviation, a measure of price variability, was
also low. It was 1.15 in Northern Luzon, 1.04 in NCR, and 1.1 in
Mindanao.

Under a competitive environment, this low variation in price would
imply that firms would have more or less similar cost structure.
Otherwise, the only logical explanation for the low price variation
would be the presence of price coordination among firms. Cement
financial data indicate that their production costs vary extensively.
In 1999, average production cost per bag (in pesos) were as follows:
Bacnotan 87.50, Northern 58.50, Solid and FR 76, Titan 127, Rizal 194,
Fortune 75, Davao Union 79, Apo Cement 98.60, and Grand 63.70.

With these different cost structures and assuming competitive
conditions, the firms should be quoting different prices. If
competition is effective, inefficient firms are weeded out allowing the
market shares of efficient firms to increase. Obviously, their cost
structure cannot explain the low variation in prices that we observe.
Low-cost firms share the market with high-cost firms. What is
preventing efficient firms from undercutting their inefficient rivals
in the market? Cement is a homogeneous good and since government
policies that may distort market prices are already abolished, the only
logical explanation is the presence of price coordination and the
threat of a price war which sustains cartel activities.

Aside from price uniformity, another characteristic of cartel prices is
stability for long periods of time and occasional episodes of
volatility for short periods which indicates cheating. Between 1993 to
1996, price movements showed a fairly stable movement, prices rose
during the dry season and fell during the rainy months. When the 1997
Asian crisis struck, big drops in prices were registered starting in
mid-1997 which eventually led to a price war. Note that competitive
firms react to a negative demand shock by reducing output, in contrast,
a cartel reacts by expanding output or engaging in a price war. After
hitting a price of P45/bag in December 1998, the lowest level hit
during the price war period, prices began to increase in a simultaneous
fashion beginning in January 1999. In May 2000, price/bag was already
P110; in mid-2001, it was around 140-145 per bag.

The outcome of cartel behavior is against public interest and is highly
distortive of economic efficiency. Cartels limit competition and allow
firms to manipulate prices to the detriment of consumers, other
industry users including the government. The recent Department of Trade
and Industry ruling of protecting the industry through increased
tariffs tends to show that the government remains captured by the
industry it is supposed to regulate. It is no wonder that cartel
behavior persists in the country; the government allows it through its
use of regulatory measures, through its failure to legislate the
correct laws against anti-competitive behavior; and simply ignoring
that such behavior exists.

Given our weak institutions, firms can successfully organize to
influence government policy. Rather than compete, firms will always
lobby for government protection and hide from the challenges of market
competition by invoking antidumping and safeguard measures or engaging
in cartel activities. The cement case illustrates that our previous
experience of regulation, promotion, and protection encouraged greater
concentration, limited the potential for competition, and prevented the
development of a culture of competition in the country.
The Tariff Commission must exercise caution in imposing safeguard
measures to the industry given the firms’ market power and tendency to
collude. These measures could easily become protectionist tools, hence,
the Commission must carefully weigh the welfare gains and losses of
increasing tariffs to the industry. It is only with competition that
consumers will obtain the best possible goods at the lowest possible
prices. Cartels are not the key to the survival of domestic industries,
effective competition is.

(This article is based on a study by the author entitled “The State of Competition in the Philippine Manufacturing Industry.”)

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