PRICE WARS AND THE STABILITY OF COLLUSION

PRICEWARSANDTHESTABILITYOFCOLLUSION:ASTUDYOFTHEPRE-WORLDWARIBROMINEINDUSTRY*MargaretC.LevensteinBetween1885and1914USbromineproducerscolludedtoraisepricesandpro¢ts.Thiscollusionwasdisruptedbypricewars.BrominepricewarsarecomparedwiththeGreen/PorterandAbreu/Pearce/Stacchettimodels.Somepricewarsresultedfromtheimperfectmonitoringproblemswhichmotivatethesemodels.SeveralempiricalimplicationsoftheAPSmodelareborneout,butthebromineindustry'spricewarsweregenerallymilderthancontemplatedbyAPS.Moreseverepricewarswerepartofabargainingprocess,inwhich¢rmstriedtoforcerenegotiationtoanewcollusiveequilibriumwithadi¡erentdistributionofrents.i.introductionEconomistshavelongdebatedthecausesandconsequencesofpricewars.Stigler[1964]arguedthatcartelpro¢tsinducecheatingorentry.Apricewarinevitablyfollows,andcollusiondisintegrates.Earlierstudentsofindustrialorganizationbelieved,tothecontrary,thatthepossibilityofpricewarsstabilizedcollusion(Burns[1936],pp.27^30).Whenpricewarsarose,theywereascribedtoexogenousforcesdisruptingotherwisestablecartels(StockingandWatson[1951],p.505).Hearkeningbacktotheolderliterature,gametheoristshavearguedthatpricewarsmaybenecessaryforcartelstability,andthattheyoccurinresponsetoexogenousshocks(GreenandPorter[1984],Abreu,Pearce,andStacchetti[1986],hereafterAPS).Firmsengageinpricewarstodetercheating,which,inaworldofimperfectinformation,theycannotdistinguishfromstochastic£uctuations.These``equilibriumpricewars''donotre£ectthecollapseofcollusion,butareinsteadacrucialelementinitsstability.Thesegame-theoreticmodelshavenotbeenwidelytested,partlybecausetheydependonvariables,likebeliefsandstrategies,thatareßBlackwellPublishersLtd.1997,108CowleyRoad,OxfordOX41JF,UK,and350MainStreet,Malden,MA02148,USA.117THEJOURNALOFINDUSTRIALECONOMICS0022-1821VolumeXLVJune1997No.2*Theauthoracknowledgeshelpfulcommentsfromtwoanonymousreferees,DavidArsen,SeverinBorenstein,Je¡Borland,InsongGil,ThomasIosso,FrancineLafontaine,KevinLang,RichardLevin,NancyLutz,PaulMilgrom,DavidPearce,MatthewShapiro,DavidWeiman,LawrenceWhite,andparticipantsinseminarsattheUniversityofChicago,StanfordUniversity,UCLA,andtheCliometricsSocietySummerConference.ShealsoappreciatesthevaluableassistanceshehasreceivedfromE.N.Brandt,BarbaraBrennan,DeloresGoulet,MargaretLyon,andKathleenThomas,allofthePostStreetArchives,andfromthearchivistsattheBakerandNewEnglandDepositoryLibraries.Allerrors,ofcourse,remainherown.notobservable.InthispaperIanalyzeinternaldocumentsfromaturnofthecenturycartelöcontracts,correspondence,minutesofnegotiationsfoundinthearchivesoftheDowChemicalCompanyöthatexplicitlydiscusswhatindustryparticipantsdidanddidnotbelieve,whichstrategiestheypursuedandwhichtheyrejected.Iusethesesources,aswellasindustryandgovernmentpublications,toevaluatetheroleofpricewarsinstabilizing,anddestabilizing,thebrominecartel.1ThebrominecartelintheUSdidusethethreatofpricewarstoprovideindividual¢rmswithanincentivetoparticipateinthecartel,assuggestedbyFriedman[1971].Anexaminationofthehistoricalincidentsleadinguptoeachofthesixbrominepricewarssuggeststhatimperfectmonitoringproblemsötheinabilitytodistinguishbetweenrandomshocksandrealcheatingödidcontributetotheoccurrenceofsomepricewars.AcomparisonofthequalitativecharacteristicsofpricewarswiththeoptimalpunishmentdescribedbyAPS¢ndsthatinfourcasestheinitialpricecutandthedurationofthepricewarweresimilar,aspredicted.However,thosepricewarswererelativelymild,anddidnotapproachtheCournotreversionlevelsproposedinGreenandPorterandFriedman,letalonethemoreseverepunishmentscontemplatedinAPS.Twootherpricewarsbeganrightafterpubliclyannouncedviolationsofthecollusiveagreement.Thesepricewarsweretheresultofdisagreementsamongparticipant¢rmsregardingthedistributionofrentsgeneratedbycollusion.Thesepricewarslastedlonger,andpricesfellmuchfurther.Thesetwopricewarsarebetterunderstoodasbreakdownsincollusionthanasequilibriumpunishments.ii.thebrominepoolsFollowingtheUSCivilWarbattle¢elddiscoverythatpotassiumbromidehadsedativeproperties,itquicklybecameapopularpatentmedicine,usedasaheadacheremedyandstomachsettler.WhileelementalliquidbrominehadbeenproducedcommerciallyintheUnitedStatessince1845,demandhadbeenlimitedtouseindaguerreotypephotography.Inresponsetothenewpharmaceuticaldemand,sodiumchloridesaltproducerswhoseundergroundbrinecontainedbrominebeganextractingittomakeelementalliquidbromine.These¢rmspumpedandheatedthebrine,extractingsodiumchlorideandthenbromine.Virtuallyallofthiselementalliquidbrominewasthensoldtooneofseverallargepharmaceutical1DetailedcitationsfromthesedocumentscanbefoundinLevenstein[1993].118margaretc.levensteinßBlackwellPublishersLtd.1997.distributorswhoconvertedthebromineintopotassiumbromidesalts.Thesepharmaceuticaldistributorshadnationalsalesnetworksthroughwhichtheydistributedpotassiumbromidesaltstopatentmedicineproducers,pharmaceutical``jobbers,''andpharmaciesaroundthecountry.In1880thereweretwelveliquidbromineproducers,locatedalongtheOhioandKanawhaRivers.(These¢rmswillbereferredto,collectively,asthe``OhioRiverbromineproducers.'')From1885to1902,compe