¹ Robert Herrick, To the Virgins, to Make Much of Time.

² Robert Frost, Nothing Gold Can Stay.

³ For an illustration of this method, see: U.S. Department of Justice and Federal Trade Commission 1992 Horizontal Merger Guidelines, reprinted in 4 Trade Reg. Rep. (CCH) ¶ 13,104.

⁴ We will refer to firms that possess market power in a relevant market as “dominant firms.” Firms not possessing market power in the relevant market will be referred to as “non-dominant firms.”

⁵ We will refer to such collusion as the dominant firm's disciplining the market. Effective discipline does not require agreement between the firms, nor any other form of communication between them. In some instances, a non-dominant firm's understanding of the dominant firm's wishes, coupled with an assessment of the dominant firm's power to punish other firms and its willingness to do so – may result in an independent decision of the non-dominant firm to follow what it perceives as the dominant firm's wishes. The dominant firm may, in many cases, fine-tune such behavior with the slightest of signals.

It is noteworthy that not all inter-firm interaction requires enforcement by some party. Some agreements are self-enforcing, as it is in the mutual interest of the parties to abide by the agreement. See Klein, Benjamin, “Why Hold-Ups Occur: The Self Enforcing Range of Contractual Relationships,” (1996) 34 Econ. Inquiry 444CrossRefGoogle Scholar; Klein, Benjamin & Leffler, Keith B., “The Role of Market Forces in Assuring Contractual Performance,” (1981) 89 J. Pol. Econ. 615CrossRefGoogle Scholar. However, self-enforcing agreements may be less stable than ones enforced by a dominant party or a third party (e.g., a court), since changes in circumstances may modify incentives so that the agreement is no longer in the interest of the other party. Alternatively, parties may engage in strategic behavior in negotiating the agreement, and may renege on an agreement even if it is profitable for them, in order to force the other party to surrender a greater share of the surplus created by the agreement. Finally, some agreements are inherently not self-enforcing, even if mutual adherence would lead to maximizing the joint utility. For example, if a member in a price-fixing cartel thinks its partners to the cartel will abide by the agreement and fix high prices, it would be better off lowering its own prices just below theirs (to capture some of their sales). If the same member expects the other members not to abide by the price-fixing agreement, he would certainly not abide by it himself – to do so would mean losing sales to the other firms! Therefore, regardless of what the cartel member expects, he has a strong incentive to renege on the cartel agreement. Enforcement by a third party (e.g., a court, if such agreements were legal, or a dominant firm that can detect and punish offenders, if such exists) may sustain such non-self-enforcing agreements. Thus, cartels with an effective enforcer, including one that is a dominant participant in the industry, are more stable than those that are self-enforcing.

⁶ The probability of market discipline surviving a slump in market power of the dominant firm depends on many factors, including the estimated length of the slump in market power, the gains a maverick firm expects to reap from non-disciplined behavior, the maverick firm's estimate of the severity of punishment to be imposed by the dominant firm when it regains market power. Assessment of the probability of such behavior is beyond the scope of this paper.

⁷ The dominant firm might find such measures necessary to preserve their power to discipline the market.

⁸ A non-dominant firm cannot usually effectively police a downstream cartel. See Granitz, Elizabeth & Klein, Benjamin, “Monopolization by ‘Eaising Rivals’ Costs': The Standard Oil Case,” (1996) 39 J. Law & Econ. 1CrossRefGoogle Scholar. Anon-dominant firm may pay downstream firms in other ways in return for exclusivity, but cartel policing is better currency for the upstream firm to pay with, as the value to the downstream members is usually greater than the damage to the upstream firm caused by reduced sales of inputs (much of the harm is externalized on consumers, however).

⁹ In a nutshell, and as we will explain in detail infra, in Section III.2, the reason for the cyclicality of the market power possessed by the dominant firm in this case study seems to lie in the economic incentives foreign PVC producers have to ship their product to Israel. When the market is in a glut (i.e., prices are low), the foreign producers attempt to elevate prices in their home markets by shipping their product to markets that are isolated from their home market (e.g., to Israel). This undermines the Israeli producer's market power. However, when the market experiences excess demand (or at least, does not suffer from excess supply), foreign PVC producers do not have an incentive to rid their markets of supply (or at least of as much supply), and the dissipation of imports results in the accumulation of market power in the hands of the local producer.

¹⁰ While the price of PVC is correlated around the world, some PVC producers possess a degree of market power in certain geographic areas. Therefore, for example, the Israeli PVC market is a properly defined geographic market. But compare F.T.C. v. Occidental Petroleum Corp., 1986–1 Trade Cas. (CCH) ¶ 67,071 (D.D.C., 1986); Baker, D.I. & Balto, D.A., “Foreign Competition and the Market Power Inquiry,” (1991) 60 Antitrust L. J. 945, 960Google Scholar (Viewing the PVC market as an international market).

¹¹ This description is, of course, highly simplified, but is sufficient for the purposes of this paper.

¹² Decision of the General Director of the Israel Antitrust Authority, of 11 August 1999, regarding Objecting to the Merger Between EIL Plastic Industries Ltd. and Volfman Plast Ltd., Marsh Plast Ltd., and Pipeplast (Israel) Ltd., Section 4.2(a) (at p.7) (Hereinafter: “The IAA Decision”).

¹³ In re The B.F. Goodrich Company, 110 F.T.C. 207; 1985 FTC LEXIS 30, at para. 78.

¹⁴ The term ‘plant’ refers to each single unit of manufacturing machinery, not the entire factory. Each factory usually employs several plants.

¹⁵ In re Goodrich, supra n. 13, at para. 64–65.

¹⁶ Holding a large inventory may also smooth fluctuations in demand. However, PVC is bulky, and therefore costly to store, and the cost of holding an inventory sufficient to bridge the entire length of time required to construct a new PVC production plant is prohibitive. Also, large inventories may depress the price of PVC. See Johnsen, D. B., “Property Rights to Cartel Rents: The Socony-Vacuum Story,” (1991) 34 J. L. & Econ. 177, at 178CrossRefGoogle Scholar. Finally, in warm climates (such as Israel), PVC and PVC products suffer significant attrition if stored for long periods. See, The IAA Decision, supra n. 12, at 13.

¹⁷ In re Goodrich, supra n. 13, at para. 60.

¹⁸ A firm producing below minimum efficient scale may have higher production costs, which may offset the transportation costs of PVC imported from foreign producers with larger scales of production. However, fluctuations in relative operational costs (like fluctuations in exporting costs) are not expected to be substantially correlated to the price of PVC, and so cannot be an explanation for the correlation between price and the market share of imports (a correlation we shall describe below).

¹⁹ On contestable markets see, e.g., See Baumol, W.J., Panzar, J.C. & Willig, R.D., Contestable Markets and the Theory of Industry Structure (New York, HBJ College & School Division, 1982)Google Scholar.

²⁰ See In re Goodrich, supra n. 14, at para.85–90.

²¹ For an assessment of the availability of information as to competitors' prices, see In re Goodrich, supra n. 13, at para. 204–215.

²² We shall refer to all these costs as “exporting costs.”

²³ The IAA Decision, supra n. 12, Section 4.2(a), at 8.

²⁴ If the costs of exporting from Israel were low, the actual demand facing an Israeli PVC manufacturer would not be the local demand, but the global one. While exporting PVC from Israel could sometimes be economically feasible, importing costs are significant enough (as we shall see) to partially isolate the Israeli market, making the existence of a second Israeli PVC manufacturer unfeasible.

²⁵ Hereinafter: “IEL.” As noted above, most PVC producers are upstream integrated. IEL is not. The VCM market is similar in structure to the PVC market, with a single local producer, unaffiliated with IEL, dominating the market.

²⁶ The IAA Decision, supra n. 12, Section 4.2(a), at 8. At the time of issuing the IAA Decision, there were proposals to reinstate a tariff on imports of plastics, including PVC, at a rate of 4%. See The IAA Decision, supra n. 12, Section 4.3(a), at 10.

²⁷ The IAA Ddecision, supra n. 12, Section 4.3(a), at 10.

²⁸ Ibid., at 11.

²⁹ Ibid., at 8.

³⁰ This data was given by the Israel Antitrust Authority.

³¹ This data was given by the Israel Antitrust Authority.

³² The IAA Decision, supra n. 12, 4.2(a), at. 8–9 and footnote 15. The author of this paper does not have data regarding previous cycles, so the assumption that the pattern evidenced between 1995 and the first quarter of 1999 repeats itself (and thus is cyclical) relies on the IAA Decision.

³³ See Hovenkamp, H., Federal Antitrust Policy (St. Paul, MN, West Publishing Co., 1994), ¶ 3.1b, 3.2c, 81–82, ¶ 3.7d, 120–122, ¶6.2b, pp. 245–246Google Scholar.

³⁴ See Hovenkamp, Ibid., at ¶ 1.4b, 33–36; Baumol, Panzar & Willig, supra n. 19.

³⁵ See supra nn. 17, 23, in Section II.

³⁶ An F.T.C. Administrative Law Judge estimated the cost of building an efficient plant at $100 million, and estimated that 75–80% of that investment would be a sunk cost, unrecoverable if not used for PVC manufacture. In re Goodrich, supra n. 13, at para. 63.

³⁷ See supra n. 28, in Section II.

³⁸ This risk could have been mitigated by purchasing derivatives, but an exchange for PVC derivatives, or for PVC, does not exist.

³⁹ The IAA Decision, supra n. 12, Section 4.2(a), at 9.

⁴⁰ IEL itself asserted, in a prospectus from Feb. 1992, that despite the elimination of tariffs on imports, transportation costs and the reliability and immediate availability of PVC give it significant advantages over foreign competitors. See the IAA Decision, supra n. 12, at footnotes 23, 24.

⁴¹ All data below has been provided by the Israel Antitrust Authority. However, due to the confidentiality of much of the data, the information provided was not the raw data, but rather the aggregates. Note that while the aggregate data is useful, it is based on a small number of observations. The aggregate data was derived from five observations (annual information, 1995–1999). The very small number of observations has a strong negative implication on the reliability of the aggregate result. No information was given by the IAA regarding the specific model used in the regression.

⁴² The coefficient of the market share (in the Israeli market) of PVC imported to Israel from the U.S., in a regression where the independent variable was the price of PVC imported to Israel from the U.S., was found to be −0.2404. The t-Stat for the regression was – 3.504271.

⁴³ The coefficient of the market share of PVC imported from the EU was – 0.014461. The t-Stat was – 1.429939, making the significance of the coefficient questionable.

⁴⁴ Again it is prudent to caution against reliance on these statistics, due to the small number of observations employed to derive this aggregate, and since it is unclear how the regression model was structured. Proper vindication of the results will require a larger number of observations, which were not available to the author of this paper.

⁴⁵ As mentioned above, in Section II, tariffs on PVC imports from the U.S. and EU were removed in 1989; those on imports from other countries were gradually reduced beginning in 1991, until finally eliminating them in mid – 1997. The data at hand, therefore, regards imports subject to tariffs at rates that differ from year to year.

⁴⁶ Were there no exporting costs, the demand facing any Israeli PVC producer would be the world demand, which is a great many times larger than the minimum efficient scale for PVC production. In that case, there would be room for far more than one Israeli producer.

⁴⁷ Naturally, the market price of PVC is low when there is a glut in the market.

⁴⁸ In “home markets” we mean the geographical market or markets, in which the foreign producer makes substantial sales. Any other market would be an “outside market,” or a “target market.”

⁴⁹ We will examine, infra in Section III.C.3. an alternative explanation which views the fluctuations in import market shares as caused merely by relative price differences between the markets (that is – the price of PVC in the target market is higher than that in the home market). We find the empirical evidence does not support this explanation.

⁵⁰ If firms in the outside market re-export the output to the home market, the firm in the home market will not gain from exporting the surplus. Therefore, it will not export in the first place if it suspects a substantial amount will be re-exported back into its market. We will discuss this when considering condition 3, infra.

⁵¹ For cyclical market power to occur, the exporting into a target country should be profitable only due to the increase in profits in the home market that results from reducing the supply by exporting to a target country. The cyclical market power phenomena will not occur if conditions are such that it is profitable for the foreign producer to export significant amounts to the target country even without the added incentive of raising price in its home market. For example, if prices at the target country were higher than the price at the home market plus the exporting costs, the foreign producer would export in both high and low markets, and the local producer would never possess market power.

⁵² It will also export, even if MR_H ≥ mc, if P_T−EC_T > P_H. We find, infra in Section III.3.c, that the empirical evidence does not support this as an explanation to the phenomenon of the cyclical market power in the Israeli PVC industry.

⁵³ Instead of throwing away, it might give the marginal unit to someone who would not be willing to pay the market price for the product (to give it to someone who would be willing to pay will cannibalize the firm's sales). However, a firm would destroy, rather than give away the product if there is a substantial possibility for reselling the product (again, cannibalizing its sales).

⁵⁴ The third condition, infra, differentiates between cases where the product will be exported and those where it will be thrown away.

⁵⁵ The supply curve would be downward inflexible in our example if current production level were 100 widgets, and upward inflexible if current production was 0 (though, by definition, producing zero units is downwards inflexible as well). Often, when at a given output the supply curve is downward inflexible, it would be upward inflexible as well. However, since we deal here with a reaction to reduction in demand, which normally dictates reduction in supply, it is sufficient that the supply curve be downward inflexible.

⁵⁶ If demand were absolutely stable, surpluses or shortages would be rare even if the supply curve were relatively rigid. However, demand in the PVC industry, as in most markets, is not stable.

⁵⁷ Condition two – that the foreign firm possesses some market power in the relevant market – is essential to reach this result. Were the foreign producer lacking any market power, diverting its output to an outside market would not raise prices, because other firms could expand their sales in the home market to replace the output that was removed from the market.

⁵⁸ The foreign firm might still decide to export the surplus, if the increase in profits from the restricted output in the home market surpasses the sum of the exporting costs and the loss of revenue in the market in which the surplus affects the foreign firm's sales. Of course, even in this case the foreign firm would prefer to export to a market that is more isolated from the markets in which it sells.

⁵⁹ This assumes that the surplus that is exported to the outside market has an effect on prices in that market. Since the foreign firm exports a quantity that affects prices in the home market, and since home markets of such firms tend to be substantially larger than outside markets that satisfy condition three, the above assumption would usually prove true.

⁶⁰ Infra, in Section III.C.3.

⁶¹ Supra, Section II.

⁶² See supra, Section II, nn. 14–17 and main text regarding them.

⁶³ See Johnsen, supra n. 16.

⁶⁴ As we said supra, in Section II (text regarding n. 29), between 1991 and 1997, exports accounted for no more than approximately 17%.

⁶⁵ Supra, Section III.A, main text regarding nn. 33–40.

⁶⁶ This varies, of course, from producer to producer. The more demand for PVC exists close to the plant's location, and the lower the political and economic boundaries between the plant and the centers of demand, the less market power a producer would enjoy. Therefore, we may expect the Israeli producer, facing no demand nor any competition from firms located in bordering countries, to enjoy greater market power than an American firm, which finds much demand for its products, and several competitors, in other geographically proximate states of the United States. Still, it seems that even U.S. firms enjoy some degree of market power over the markets in the vicinity of their plants.

⁶⁷ These Israeli firms need not be PVC producers. If PVC is dumped in Israel, presumably at a certain point the depressed prices in the Israeli market will make arbitrage profitable for anyone willing to pursue this line of business.

⁶⁸ Supra, Section II, in main text regarding n. 28.

⁶⁹ Supra, Section III.B, in main text regarding n. 60.

⁷⁰ Supra, in Section II, main text regarding n. 28.

⁷¹ The coefficient was – 0.138948. In other words, for every $7.20 decline in the price difference between Israel and the U.S., American exporters gained another 1% on market share. The t-Stat for this correlation was −1.497643. R square was 0.528628. As we mentioned above, this regression was done by the IAA, based on very few observations, a fact that limited the effectiveness of the regression calculations (data was examined for the years 1995–1998). The IAA did not provide information regarding the specific model used in the regression.

⁷² The coefficient was – 0.021443, translating into a 1% increase in market share for every $46.64 rise in the price of PVC in Europe relative to that exported to Israel. The t-stat for this correlation was −0.899007. R square was 0.287804. Again, the utility of these results is severely limited by the small number of observations on which they are based.

⁷³ The IAA Decision, supra n. 12, Sections 5.2, 5.3, and 6, at 14–20).

⁷⁴ The Israeli Antitrust Authority (IAA) blocked a merger of a subsidiary of the local PVC producer with several producers of PVC piping. In its decision, the IAA found the merger would facilitate the cartel policing in the PVC piping market as well as the exclusion of foreign competitors in the PVC market. Naturally, the IAA decision focused on the merger's facilitating effects. This paper shifts the focus to the mechanism that the merger facilitated.

⁷⁵ The existence of long-term contracts between the local PVC producer and local PVC consumers has not been sufficient to prevent the formation of a temporary spot market at certain times (typically, when PVC prices were low). Much of the supply in this spot market comes from imported PVC. The spot market undermines the local producer's market power. Apparently, though PVC consumers prefer the certainty of long-term contracts, they find acquisition of PVC in the spot market to be a viable alternative, when it is available. See the IAA Decision, supra n. 12, Section 4.2(a), at 9.

⁷⁶ A possible exception would occur if the entrant's capacity is very low and therefore lost profits from the price reduction offset lost profits from sales the incumbent loses to the entrant. But such limited entry is not likely to destabilize a cartel.

⁷⁷ See, e.g., Dick, Andrew R., “When Are Cartels Stable Contracts?” (1996) 39 J. L. & Econ. 241, at 266CrossRefGoogle Scholar. “Wider industry coverage expands the cartel's ability to pool information within its membership and thus should improve the accuracy and cost effectiveness of monitoring. The net value of cartel services also should tend to increase with the agreement's industry coverage and should decline with cartel membership to reflect higher coordination costs… Cartels' market share also had a large economic effect on their stability. Cartels whose industry market share was above 50 percent on average survived nearly twice as long as cartels that marketed less than half of their industry's exports.”

⁷⁸ The IAA Decision, supra n. 12, Section 4.3(b), at 12.

⁷⁹ The IAA Decision, id. Note that these long term contracts lead to a need for long term PVC supply contracts. As we mentioned above, none of the foreign PVC producers consent to such contracts.

⁸⁰ There are seven piping producers of any meaningful market share. Two of them jointly distribute their products, and another two were denied the IAA's permission to merge with each other and with IEL, and are now appealing the decision. The IAA Decision, supra n. 12, Section 4.2(b), at 10. The IAA estimates that if the merger would be allowed, three firms (the merged firm, the joint distribution firm and a third piping producer) would have together 83.1% of the market's production capacity. The IAA Decision, supra n. 12, Section 6, at 19.

⁸¹ Id. The largest importer has a market share of approximately 4%, and no other importers have a significant market share.

⁸² The IAA Decision, supra n. 12, Section 4.2(b), at 9–10.

⁸³ Normally, the cost of PVC composes 60% of the overall cost of the piping. The IAA Decision, supra n. 12, Section 4.2(b), at 10.

⁸⁴ An outright refusal to sell or overt discriminatory conditions as to price or quantity are likely to be detectable antitrust violations. However, the costs of the litigation might make refusal or discrimination an effective weapon. Also, the PVC producer may employ other, less detectable or provable methods, such as delaying the supply or conditioning it on encumbering, but less obviously objectionable, terms.

⁸⁵ See Bork, R., The Antitrust Paradox (New York, Free Press, 1993) 231Google Scholar; Hovenkamp, supra n. 33, ¶ 7.9; Kaplaw, L., “Extension of Monopoly Power through Leverage,” (1985) 85 Colum. L. Rev., 515, at 516Google Scholar.

⁸⁶ Viscusi, W.K., Vernon, J.M. & Harrington, J.E., Economics of Regulation and Antitrust (Cambridge, Mass., MIT Press, 2^nd ed., 1995), at 235–236Google Scholar.

⁸⁷ See Bork, supra n. 85, at 292–293.

⁸⁸ Bork, Ibid.

⁸⁹ The existence of a spillover effect depends on the residual demand for the type of PVC used for piping, and on the minimum efficient scale for importing such PVC. If the residual demand for this type of PVC, by Israeli industries other than the piping industry, is lower than the minimum efficient scale, the cost of importing PVC will be high (and increase the larger the difference between MES and residual demand), so the amount imported will diminish. As said above, an empirical examination of this issue is beyond the scope of this paper.

⁹⁰ Bork, supra n. 85, at 292.

⁹¹ See Bork, ibid., at 299–309; Hovenkamp, supra n. 33, ¶ 10.8a.

⁹² Hovenkamp, ibid., at 384.

⁹³ Hovenkamp, Ibid.

⁹⁴ Bork, supra n. 85, at 304.

⁹⁵ See Kaplaw, supra n. 85; Riordan, M.H. & Salop, S.C., “Evaluating Vertical Mergers: A Post-Chicago Approach,” (1995) 63 Antitrust L. J. 513Google Scholar; Rasmusen, E.B., Ramseyer, J.M., and Wiley, J.S., “Naked Exclusion,” (1991) 81 Am. Econ. Rev. 1137Google Scholar; Stefanadis, C., “Selective Contracts, Foreclosure and the Chicago School View,” (1998) 41 J. of L. & Econ. 429CrossRefGoogle Scholar.

⁹⁶ Rasmusen, Ramseyer & Wiley, ibid.

⁹⁷ Normally, an upstream firm has little incentive to police a cartel, as the cartel will restrict output in the downstream market, which in turn will reduce demand for the upstream firm's products. However, under certain conditions such an arrangement might prove profitable to the upstream firm. See JTC Petroleum Company v. Piasa Motor Fuels, Inc., 190 F.3d 775 (7^th Cir, 1999); Granitz & Klein, supra n. 8. The relationship between the Israeli PVC and PVC piping industries may present such a case.

⁹⁸ Claims have been made that by taking actions to prevent the entry of exported PVC into Israel, IEL is privately enforcing anti-dumping measures. For a somewhat related discussion see: Alford, R.P., “Why a Private Right of Action Against Dumping Would Violate GATT,” (1991) 66 N.Y.U. L. Rev. 696Google Scholar. The merits of this claim in our case seem feeble. Even disregarding GATT or other formal limitations, IEL is a heavily biased enforcer; it does not utilize a right of action but rather self-enforcement (the latter lacking the scrutiny of an unbiased court), and the specific action discussed affects – in fact, eliminates competition – not only in the market in which the alleged dumping occurs, but in a downstream market as well.

⁹⁹ On stacked monopolies, see Hovenkamp, supra n. 33, ¶9.2c, at 335–336.

¹⁰⁰ JTC Petroleum Company, supra n. 97, at 778–779.

¹⁰¹ The empirical evidence, while generally pointing to the correlation above, suffered from consisting of a small number of observations, which lowered the reliability of the empirical analysis.

¹⁰² Again, limitations of the data available reduced the reliability of the empirical analysis, though the results did support the proposed explanation.