THE RISE AND FALL OF THE OPEC CARTEL

At various points in the 1970s and 1980s, oil-producing nations restricted output and thereby increased the price of oil. More recently, over a 14-month period that lasted into March, the Organization of Petroleum Exporting Countries and non-OPEC nations acted in concert to restrict output, and again the outcome was higher and higher oil prices.

However, OPEC is not omnipotent, and at best its power is likely to be ephemeral.Historically, cartels have not been successful at perpetuating themselves. Consider the attempts to form cartels in coffee and copper. The oil cartel is likely to fare no better than any other.

Yes, OPEC seemed invincible in the 1970s and early '80s. But the condition that allowed it to prevail then does not exist now.

The power of OPEC stemmed in part from U.S. government policy. The government did not intentionally aid OPEC, but it did do so inadvertently. Washington had established price controls on domestic petroleum, and these vitiated the function of prices and caused the oil shortage.

Prices give signals. As the price of a product goes up, it signals consumers that the product has become more scarce and that they ought to consume less of it. Additionally, as a product price increases, it signals producers that consumers want more of it. And the higher price provides an incentive to produce more of it.

Since oil prices were not allowed to change freely, the signals were distorted. Prices ceased to ration oil, and a shortage ensued. In fact, it was not until after President Reagan removed the price controls in January 1981 and allowed the market to function that oil prices steadily dropped.

Oil prices convey information, and when they are not allowed to freely fluctuate they do not convey the news that circumstances have changed. Though increasing oil prices encourage consumers to conserve on oil, slowing the increase in prices delays conservation.

Had prices not been controlled, conservation would have proceeded more quickly, new entry would have proceeded more swiftly, and OPEC's power would have waned more rapidly.

In addition, U.S. government policy further aided OPEC through a windfall profit tax. This levy was placed on oil producers at precisely the time we needed to encourage oil production. As with any tax, it discouraged production.

What has this to do with the current state of affairs?

Cartels are fragile. They are neither like competitive companies nor like monopolies. Competitive firms try to maximize their own profits, not industry profits. Monopolies try to maximize industry profits, but by definition a monopoly is the industry.

The members of a cartel try to maximize industry profits as a group, but in doing so an individual company may not maximize its own profits. Thus, there is the ubiquitous problem that cooperation may break down, and individual members may leave the cartel or cheat by producing more than their share.

Under the best of circumstances, it is unlikely that a cartel will endure indefinitely.

On previous occasions, OPEC fared as well as it did because of U.S. government policy.

At this time, however, it appears that Washington is not on the side of OPEC. It appears unlikely that the government will resort to price controls and windfall profit taxes. If the government really wants to help, it need merely step aside and let the market function.

It worked before.

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