In Germany in the post industrialization era modern industrial enterprise was clustered into three sets of industries: Heavy industrial machinery
(electrical and non-electrical), chemicals and metals. In these industries, Germany was amongst global 1st movers and recovered the quickest after WW 1. The form of collusion most practice in Germany throughout this period was cartels, these varied dramatically in both size and organization.
Collusion can be defined as; a form of non-price competition involves two or more firms deliberately contracting in order to protect the price of their good or goods. The major benefit of collusion is that because the firms do not attract customers through price competition abnormal profits can be made.
One of the major events that shaped the formation of cartels (a form of explicit collusion) in Germany was the 1887 ruling by the Reichsgericht that contractual agreements made between colluding firms were enforceable by law. These agreements the German high court explained “were not only in the interests of those who signed them but were also in the public interest.”1 The reasoning behind this by the court was that a naturally competitive market would result in price sink to an inoperable level which would not be beneficial to the manufacturer, consumers or the economy.
The cartels which resulted from this ranged from complex formal contracts to gentlemen’s agreements. However these cartels were not necessarily monopolistic or stable, and forms of competitions did still exist in some areas.
Although no exact figures are available for the number of cartels in this period the economic historian Jurgen Kocka estimates that “there were 4 cartels in 1875; 106 in 1890; 205 in 1896; 385 in 1905.”2 This unquestionably shows a rapid growth in cartels in the late 19th and early twentieth centuries, but it is unlikely that the clarified legal position alone did this. Hence there must be other factors encouraging a growth in cartels in this early period.
Cartels had multiple positive functions for the German businesses which competition did not have, which encouraged them to collude rather than use free market competition. They help protect against harmful competition which would harm businesses profits and in so doing investors investments. During the businesses cycles they managed to control supply and demand through quotas and represented the industries interest on mass.
Moreover, in export markets, cartels could assist those firms who were not large enough by global standards in competing more effectively in the international marketplace by sharing market information, pooling risk associated with initial penetration in contestable markets, etc. On the pro-efficiency side, firms can achieve gains from economies of scale in their production processes while remaining separate entities. Therefore, cartels were numerous in industries where scale economies are important, for example automobile production. When capital markets are imperfect, joint ventures can enable small firms to participate in projects that are otherwise beyond their means. These arrangements can also enable small firms to diversify and share risks.
After the1887 ruling, the idea of collusion was welcomed by the new breed of industrialists as the onset of the 1873 depression had caused prices for industrial goods to fall for a twenty year period. In addition to this it was becoming harder and harder for these firms to compete as new firms entered the market place. It was in this period that the practice of cartels grew most rapidly. By the political unification of Germany in 1871, the country already had an extensive rail network. This spurred both related businesses, such as iron, coal and steel which were used in the production and running of the rail network as well as businesses that benefited from improved transport links, for example banking. Alongside Germany’s strong craft tradition, and her comprehensive educational system with both academic and technical schools, lead to a very rapid period of industrialization.
With the onset of the depression in the early 1870’s, German firms were experiencing slower and slower growth. Firms began to change their aims from expansion to simply protection of their existing markets. This lead to the option of aggressive competing seeming more and more risky, as to drive competitors out of the markets was not only expensive but time consuming. More appealing in these turbulent years was the idea of collusion, which would allow firms to keep their existing markets as well as maintain a stable price for their goods. Hence small scale firms began to band together in cartels rather than compete in order to stay in business.
Throughout the inter-war period, there was a great lack of capital. To combat this, enormous domestic cartels were formed as well as numerous substantial mergers, in order to rationalise and achieve economies of scale. German multinationals now sought security: long-term licensing agreements & long-term contracts with suppliers became important to ensure this. Thus German paper companies invested in Finnish timber; the German iron & steel cartel had long-term agreements for the supply of Swedish iron – with an agreement to use chlorine from I.G. Farben; & German power companies invested in hydro-electric plants in Norway. Joint ventures were also formed with American & other companies.
The German iron & steel cartels were the largest buyers of Swedish iron ore but they could not buy the mines as Scandinavian parliaments had set limits on foreign ownership since 1907. So the cartels entered into long-term contracts to purchase a large share or the entire output of the mines. The terms: a minimum amount plus an option to buy a larger amount, around twice the minimum. This allowed short-term adjustments according to demand. Larger amounts were purchased at lower prices, of course. In Norway, foreign ownership had to be less than 50%; the German cartels combined this with long-term contracts.
In Germany, however, by the outset of World War II, nearly all industry was controlled by cartels closely supervised by the government. Opponents of cartels have alleged that they have driven competing firms out of existence, reduced volume of trade, raised prices to consumers, and protected inefficient members from competition. Cartels were blamed for having benefited German aggression by furnishing markets, profits, and technical data to Germany before World War II. Supporters of cartels claim that they protect the weaker participating firms, do away to an extent with limitations on trade resulting from high tariffs, distribute risks and profits equitably, stabilize markets, reduce costs, and hence protect consumers.
To say collusion in the form of cartels were a substitute for competition would be incorrect, within these cartels competition still existed. Each firm within a cartel would be forced to negotiate for their market share and the prices that would be charged. How well each firm did in these negotiations would most likely signify the profits that would be made for the rest of the year, so each firm would competing to be allocated a large market share. In addition to this, new innovations and research still occurred as each firm sought to gain more productive efficiency in order to cut their margins and gain extra profit.