Economics
The situation in the European air cargo industry bears many hallmarks of a cartel, and this was the finding of the European Commission. The OECD (2002) defines a cartel as “a formal agreement among firms in an oligopolistic industry…on matters such as price, total industry output, market shares, allocation of customers, allocation of territories, bid-rigging, division of profits or the establishment of common sales agencies.” The main difference between this definition and the behavior of the airlines in question is that the industry is not oligopolistic in the true sense of the word. In an oligopoly, there are only handful of industry players, so any such collusion as indicated in the definition of a cartel would serve to disrupt market forces to the benefit of the companies within the oligopoly. In air freight, however, the prevailing market condition was that of monopolistic competition. This makes is harder to prove a case of cartel behavior — effectively the members of the cartel would need a collective market share so high that their behavior dominated the market. Thus, the main assumptions of a cartel are that it will control the terms of trade in the market, and that this will serve to benefit the members of the cartel.
The European air freight industry is interesting in that for the most part any individual route will only be served by one or two airlines, thereby created oligopolistic conditions. For the continent as a whole, no such conditions exist but for most point-to-point matches such conditions do exist. However, there are other competitors including discount airlines, courier services such as DHL, FedEx and UPS, domestic postal services and other forms of transportation. The issue, however, is that some of the courier and postal services may use air freight space on commercial airlines in order to ship the goods, meaning that on some route combinations there is little alternative to break the oligopoly. It is also worth considering that while land-based options are available on short-distance routes, there are many longer-distance routes that can only be served by the air freight industry for rapid movement of goods, for example Athens-Stockholm or Warsaw-Madrid or other such longer-distance low-volume route.
The European Commission was able to prove a case of cartel behavior to its satisfaction in this situation. There were a total of thirteen European airlines cited in the case, among them British Airways, Air France, KLM and SAS (Chee, 2010). Total fines for the entire cartel were expected to be within the $1 billion range (Shore, 2010). In total, 11 carriers were fined, although more were investigated. The total fine reached €799 (Europa, 2010). The airlines fined spanned the globe and included in addition to the ones named above Air Canada, Martinair, Cargolux, Cathay Pacific, Japan Airlines, LAN Chile, Qantas, Singapore Airlines and Lufthansa. It is worth noting that many of these airlines are located in the world’s least corrupt countries — Hong Kong, Singapore, Canada, Australia and Sweden, which makes the charges even more surprising.
The points of claim with respect to cartel behavior were as follows. The European Commission noted that the airlines in question coordinated their charges for fuel and security surcharges over a period of six years. The airlines in question never offered discounts for these surcharges, meaning that their pricing behavior was tightly coordinated. The airlines in question contacted each other in order to “ensure that worldwide air freight carriers imposed a flat rate surcharge per kilo on all shipments. The second step of the cartel behavior was with respect to the security surcharge, and this was fixed in the same manner as the fuel surcharge. The third step in the cartel behavior was with respect to the refusal by all airlines to pay a commission on surcharges to their clients, those being the freight forwarders who use the airlines’ flights to move goods (Europa, 2010).
The Commission charges that the agreements on fuel and security surcharges constituted price fixing. The agreement not to pay commission to the freight forwarders for collecting the surcharges served to prevent the freight forwarders from using price as a means of introducing competition to the market. No single freight forwarder would have a price advantage over the others, meaning that there is a reasonable expectation that prices to customers would vary little. The Commission notes that it had also investigated 11 other airlines and a consulting firm, but been unable to find sufficient evidence of cartel behavior. The airlines that were found guilty had also been investigated for the same behavior on two other surcharges, but insufficient evidence was found to bring about anti-trust action (Europa, 2010).
There are a few factors that make some sectors more susceptible to this form of collusion. The first is information asymmetry. The companies that commit the collusion must have an information advantage over the companies that are victims of the collusion. The greater the level of information asymmetry in the industry, the easier it will be for companies to engage in cartel behavior. Another factor is the tightness of the margins in the industry, as well as the structure of its fixed costs. If all firms in an industry are likely to have difficulty making profits, but all are faced with high exit costs, then the firms are more likely to band together to ensure profitability. The airlines in question are almost all national carriers, unlikely to exit the business but subject to slim margins and for most frequent losses as well. There is significant motivation to preserve profits, and such airlines may see competition as creating negative industry conditions for all firms, as none are likely to exit the industry even if it is unprofitable, as national airlines tend to be supported by national governments no matter how much they struggle.
2. There are two major factors that contributed to the downturn in Q4 GDP in the United Kingdom for 2010. The headline factor, as cited by many, was the weather (ONS, 2011). The weather was cited to have knocked 0.5% from the GDP growth, which would otherwise have been flat. The weather impacted retail sales during the busy Christmas season, and it impacted construction as well. The combined effect of slumps in both of these sectors due to the weather was that the economy contracted. Other sectors saw only minor improvements during the quarter, not nearly enough to counteract the negative momentum caused by Mother Nature (Ibid).
Critics of the government also argue that fiscal policy contributed to the contraction. In particular, government cuts to the public sector will result in rising unemployment and will help to stall recovery (BBC, 2011). The government’s claim in that by stabilizing borrowing costs — which were never really at risk of rising far anyway — the stage is set for economic growth. The connection, however, between sovereign borrowing costs and the ability of the country to generate internal growth and/or attract an influx of FDI is tenuous at best, and even then the impacts are long-term. Thus, the short-run impacts of an austerity strategy will be negative; a sacrifice in the hopes that the long-run impact will be positive. Thus, fiscal policy was inevitably going to have a negative impact on the Q4 GDP growth rate. The only real issue is the government not being up front about that, which resulted in the GDP decline being viewed with shock.
The prospects for a stable recovery in 2011 are not good. Government sources continually revise estimates of economic growth downwards, and the unemployment rate is expected to rise in 2011 (BBC, 2011). Short-term growth is not going to be predicated on government spending, so it must come from either growth in exports or growth in the domestic economy, which will have to come as the result of an increase in demand from consumers. With unemployment expected to rise, the latter is not expected to occur. Even consumers with jobs are not likely going to be heartened so much about the country’s economic prospects to dramatically increase spend — a few tenths of a percent on sovereign bond rates is not a noted driver of domestic demand. Coupled with rising inflation there is almost no likelihood of a spike in domestic demand in 2011. This leaves the current account as the most likely source of growth for the coming year. This may occur. The pound is losing ground as expectations for a rate hike are lessening in the wake of the Q4 GDP news (Reuters, 2011). This should promote UK exports. However, there are still policy hawks who believe that interest rates should rise to head off inflation. If that happens, not only will it choke off the domestic economy, but the pound will not fall as much, removing traction for exporters. That there is still a likelihood of a rate hike leads one to forgo optimism about the prospects for anything other than a slow, inconsistent economic recovery in the UK in 2011.
3. The theory of comparative advantage highlights the benefits of trade. The theory rests on the idea that specialization will allow nations to be more efficient in their production. The sum total of global production will increase if nations undertake some specialization and trade with one another. The simple examples are two country, two product models. Country A in a year can produce 100 bags of potatoes and 50 chickens. Country B. can produce 60 bags of potatoes and 40 chickens. The concept of opportunity cost is then introduced to the model. Country A can outproduce Country B. On both products — it has competitive advantage in each. But if Country A focuses on potatoes, it can then produce 200 bags of potatoes. Country B. produces 80 chickens when it specializes in chickens. If they each produced their own, they would have a combined 160 bags of potatoes and 90 chickens. By specializing, they have 200 bags of potatoes and 80 chickens, which is a superior level of aggregate output.
The basic comparative advantage example assumes that there are no trade barriers between the two countries. In the real world, there are usually trade barriers, often in the form of tariffs or duties. These costs represent the introduce of inefficiency into the model. The opportunity cost of specialization is increased by the trade barriers. This reduces the benefits of specialization. If the barriers are relatively low, trade may still produce a net benefit, but if the barriers are high then the trade may not produce a net benefit.
Comparative advantage works across all industries, but in the case of many products even nations committed to free trade choose to retain tariffs and other trade barriers. These nations do so less for economic reasons than for political reasons. The economic case is clearly in favor of specialization and trade under the theory of comparative advantage. Both parties benefit from lowering barriers and initiating trade, as total output will be higher. However, because specialization implies that nations forgo production of certain goods, governments undertake actions to eliminate comparative advantage from these certain markets. The trade barriers imposed are designed to create opportunity costs of trade so high than specialization and trade in the good in question will be discouraged. In that regard, governments are well aware of the negative impact that the policies will have on the economic conditions of the specific good.
However, there are political considerations that drive trade barriers, especially with respect to food. Food security is one of those issues that compels governments to enact trade barriers. Remember that comparative advantage only works when there is free trade. There are two conditions under which free trade is going to be impossible. The first is in times of war. Britons understand this — naval blockades meant that they needed to be able to feed themselves during World War Two. There is no guarantee that such a scenario will never occur again, and in some parts of the world a return to warfare is all but guaranteed sooner or later.
The second condition under which free trade simply will not occur is when resources are constrained. There is little if any arable land on this plant that is not being used for food production. . While production continues to increase due to efficiency it is not hard to envision a point in time when we have basically maximized our global food production capability. Very few politicians are crazy enough to send their food output to another country at the expense of starving their own populations — Pol Pot might have been the only one to try this in recent memory. So faced with a zero sum game in food (or any other commodity), nations are going to look after their own interests. Nations that previously traded agricultural goods when there was a global surplus will cease to do so in conditions of global shortfall. Any nation dependent on this trade will be faced with starvation. Given this, it is fully understandable that nations use trade barriers to ensure the survival of domestic agricultural industries. The economics might suggest that there are short-term losses in terms of overall global production as a result of these policies, but in the long-run the strategy will deliver a highly-valuable political result in the form of food security.
Overall, comparative advantage works, and free trade policies that encourage such specialization should be encouraged. Total global output will rise for the benefit of all. However, in certain products nations are highly motivated to retain their production capabilities. For such products — food, military hardware, fuel — there are likely going to be trade barriers that discourage trade for strategic, rather than economic, reasons.
Works Cited:
BBC. (2011). Osborne’s budget ‘to fuel growth’. British Broadcasting Corporation. Retrieved May 9, 2011 from http://www.bbc.co.uk/news/business-12830224
Chee, F. (2010). BA could face cartel fine up to €80 million. Reuters. Retrieved May 9, 2011 from http://uk.reuters.com/article/2010/10/26/uk-eu-ba-idUKTRE69P1X620101026
Europa. (2010). Antitrust: Commission fines 11 air cargo carriers €799 million in price fixing cartel. Europa.eu. Retrieved May 9, 2011 from http://europa.eu/rapid/pressReleasesAction.do?reference=IP/10/1487&format=HTML&aged=0&language=EN&guiLanguage=en
OECD. (2002). Cartel. OECD. Retrieved May 9, 2011 from http://stats.oecd.org/glossary/detail.asp?ID=3157
ONS. (2011). GDP growth. Office for National Statistics. Retrieved May 9, 2011 from http://www.statistics.gov.uk/cci/nugget.asp?id=192
Reuters. (2011). Sterling stung after UK Q4 GDP revised down. Reuters. Retrieved May 9, 2011 from http://uk.reuters.com/article/2011/02/25/markets-sterling-idUKLDE71O10S20110225
Shore, B. (2010). EU to fine airlines over cargo cartel. BBC News. Retrieved May 9, 2011 from http://www.bbc.co.uk/news/business-11717805
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