Cartels, rational behaviour and punishment strategies

Well, it turns out that a group of firms in an oligopolistic industry have been working together to maximise profits and rig the market.

http://www.theguardian.com/business/2015/may/20/banks-hit-by-record-57bn-fine-for-rigging-forex-markets

To paraphrase Capt Renault in the film Casablanca, “I am shocked, shocked, to find that collusion is going on in this oligopolistic market.”  Now the banks involved find themselves facing fines as a result of their activities.  The real question is, what will be the effect of these fines?  Consider some basic statistics.  According to reliable sources in 2013 $5.3 trillion per day was traded on the forex markets.  Presumably their collusion over a period between 2007 and 2013, six years, increased the bank’s profits on each day’s billions of dollars worth of trade.  Those additional profits across the six year period probably added up to a very significant amount, although we will never be sure how much.  The fines, which seem to total around $6.3 billion, start to look pretty insignificant when compared with the rewards that the banks netted across the six years thanks to their collusion.  Stock market investors agree with this analysis as the share prices of a number of the banks involved rose on the announcement of the fine.  Food for thought indeed.

As economists we tend to assume that people are rational and respond to incentives.  From this perspective you can argue that this bit of market rigging looks like a one way bet.  If you get caught the fines involved are smaller than the extra profits you make, so it is sensible to form a cartel, and if you don’t get caught then you get to keep all of the extra profit.  You can’t lose.  Perhaps we should be vigilant for more of this kind of behaviour in the future.

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