December 5, 1988
"Competing, Not Conspiring"
San Jose Mercury News
By Timothy Taylor
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JUST because you're paranoid doesn't mean they're not out to get you. But if you tend to see economic conspiracies everywhere, it's wise to consider the possibility that you are failing to understand how a market economy works.

The news and business pages have been full of economic conspiracy theories lately, some explicit and some only hinted at.

For example, a recent front-of-the-business-section story argued that "close observers of the industry" believe that the increases in airline fares before Thanksgiving were "the first truly visible signs of a cartel at work." The evidence appears to be that many airlines raised fares at roughly the same time.

Another example: Attorney General John Van de Kamp is claiming that auto insurance companies may have been "conspiring to boycott, coerce, or intimidate" the state. His evidence of a conspiracy is that in the days immediately after the passage of Proposition 103, about two-thirds of the companies either withdrew from the market or threatened to do so.

A third example: The OPEC oil ministers met in Vienna, in an explicit attempt to hold down the supply of oil and push oil prices past $15 a barrel.

In most other examples, the economic conspiracy is hinted at rather than spelled out. One front-page story began, "Major U.S. banks raised their prime lending rates..." All the banks decided on the same day to increase interest rates by half a percent? It's common to read about how the price of, say, gasoline is increasing everywhere, or how all the Japanese computer companies changed their prices at about the same time. Don't these stories hint at some sort of implicit conspiracy between the banks, the oil companies, or the Japanese?

What all these cases have in common is a confusion over how to discern when there is evidence of an economic conspiracy. It may seem obvious that if all the companies in an industry change their prices together, they must be colluding. But the seemingly obvious implication is wrong.

Here's why: In a market economy, all companies selling the same product have to charge close to the same price. If a company charges too much, it will lose customers. If a company charges less, and manages not to go broke, other companies will be forced to match the lower price. The result is what economists sometimes call "the law of one price"; in a free market, a single price tends to prevail.

So when the price of airline tickets or insurance or gasoline or a mortgage increases, there are always two possible explanations. The companies have formed a cartel to push up the price, or supply or demand have changed in such a way that a higher market price is now appropriate. The fact that all the companies in an industry changed their prices at nearly the same time is of absolutely no use in distinguishing between these two explanations!

For most price changes, including those named above, the market explanation is a considerably more convincing reason for increased prices than the conspiracy explanation.

The greed of businessmen, you see, is a constant thing. As Adam Smith wrote back in 1776: "People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices."

But if greed and the desire for conspiracy is constant, both before prices change and after they change, greed and conspiracy cannot explain why the change in prices occurred. Instead, there must be some reason why greed managed to increase prices on that particular day. The only way to prove a conspiracy is to show some evidence of how that conspiracy was agreed upon and enforced.

In the airline industry, the most logical explanation for the price increase is that airlines recognized that demand for travel is higher over the holidays, because people are willing to pay more to visit family and friends. Two days after the "cartel" story appeared, Continental and Eastern announced discount fares to Florida and other vacation spots.

In the insurance industry, it should be obvious even to a political official that when a law passes to cut insurance rates by at least 20 percent, no conspiracy was needed for companies to realize they're about to have some financial trouble.

And in the case of OPEC, while it's clear that the organization is trying to control the oil market, it's also been clear for a few years now that this conspiracy cannot enforce its price and output decisions on its own members, much less on the rest of the market.

Perhaps the real giveaway about these ill-considered accusations of economic conspiracy, though, is how the imagined conspiracy comes and goes. When prices go up, the reason always seems to be that companies are conspiring. But when prices fall, no one gives the conspiracy any credit.

When is the last time you heard someone say, "Oh, those nice oil companies just lowered the price of gasoline again." Companies don't act out of charity when they lower their prices, and they generally aren't conspiring together when their prices increase.

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