Anarcho-capitalism is a libertarian project of a stateless order in which private companies would be responsible for providing security, law, and dispute resolution. In previous articles, I briefly described the most important doubts about the feasibility of such an order and analyzed the most widespread concern, which is that agencies will not cooperate with each other. We now move on to another objection to anarcho-capitalism, which suggests that private security agencies (PDAs), instead of competing with each other, would form a cartel. The effects of cartelization can be twofold: first, colluding agencies may inflate prices and lower the quality of security; second, the cartel could, in the long run, transform into a state. This argument was most fully expounded by economist Tyler Cowen in a series of articles (some of which were co-authored by Daniel Sutter) debating the feasibility of anarcho-capitalism.
Why do cartels not emerge in typical markets?
The formation of a cartel is unlikely in the context of typical economic goods. Companies wishing to form a cartel face four fundamental problems. First, the goods in question cannot have close substitutes; otherwise, consumers would turn to them. Second, transaction costs are a problem—organizing and maintaining a cartel is not straightforward. Third, price gouging and reduced quality by the cartel create a strong economic incentive for new players to enter the market and attract the cartel’s customers by selling goods at lower prices. Finally, cartels are threatened not only from the outside by new market entrants, but also from within by cartel members who may violate agreements in an attempt to take over other companies’ customers (this is known as “chiseling”). All of this means that cartels are rare in typical markets and are destined to collapse.
The Security Production Market Is Not Typical
The security production market is not your typical market. First, security produced by agencies has no close substitutes.
Second, in terms of transaction costs, the security production market appears to be “pre-primed for cartelization”: to produce security effectively and resolve disputes between customers, security agencies must cooperate. This cooperation could form the basis of a cartel. Cowen refers to this as the “paradox of cooperation”: cooperation between PDAs is a prerequisite for the stability of anarcho-capitalism, but it also creates ideal conditions for the formation of a cartel.
Third, colluding companies will be able to hinder or even block the entry of new companies that could threaten the cartel’s existence. In contrast, producers of typical goods cannot prevent new players from entering the market, since the success of a new car manufacturer does not depend on cooperation with existing manufacturers. However, the success of a security agency entering the market depends not only on the prices it offers, but also on whether other agencies will peacefully resolve conflicts between themselves and their clients.
If existing agencies refuse to cooperate with a new agency, it will be unable to protect its clients effectively and thus threaten the cartel. Worse still, this process will work in its potential, with capital owners being reluctant to invest in this area because they fear such a turn of events.
The fourth issue is the possibility of breaking up the cartel from within. According to cartel theory, companies that form a cartel have a strong economic incentive to break the agreed rules. While a company that breaks the rules may be caught in the market for typical goods, this does not entail serious punishment. Although such chiseling may lead to the dissolution of the cartel, we can expect each company to engage in it, hoping that its actions will be insignificant enough not to undermine the cartel and expecting others to cheat. Does the fact that the security market differs from other markets change the way this anti-cartel factor works? The fundamental difference is that, when one agency is caught undercutting prices, the others can punish it by threatening to stop cooperating with it. Therefore, a cartel in the security sector has better methods of disciplining companies that break the rules.
Establishing and Maintaining a Cartel Is Costly
Of the four reasons mentioned above for why cartels are seldom formed, it seems that the first and third do not apply to security production. Security produced by agencies has no close substitutes. Furthermore, if agencies were to successfully establish a cartel, they would have powerful tools at their disposal with which to hinder new entrants. Fortunately for supporters of anarcho-capitalism the other two issues—the problem of coordination and the problem of internal cartel stability—suggest that cartelization would not be so easily achieved.
Let’s start with the issue of coordination. While cooperation between agencies is indeed a prerequisite for anarcho-capitalism to function, cooperation does not automatically lead to cartelization. Creating a cartel in such a complex market would be challenging. Whether they would succeed would depend on many factors. The likelihood of collusion would decrease if:
The number of agencies in a given area was very large.Different agencies operated in areas with some overlap, but not complete overlap.The agencies differed in size, which made it difficult to establish common operating rules and control agencies that broke them. It also made it difficult for companies seeking to form a cartel to assess its profitability.Agencies would offer their clients different types of products. The more diverse the products, the more difficult it would be to establish and enforce rules of collusion.Agencies would be run/financed by people belonging to significantly different social groups. For example, Christian agencies might be reluctant to collude with agencies gathering followers of other religions.
If we envisage the security production market as a geographically separate market consisting of a small number of companies offering homogeneous products to similar customers, collusion seems much more likely than if the market consisted of a large number of companies of various sizes offering different products to different customers and operating in different territories that only partially overlap. As proponents of anarcho-capitalism point out—citing research on concentration in security production markets or highlighting its radically heterogeneous nature—we have reason to believe that, in most cases, the balance would tip in favor of anarcho-capitalism.
David Friedman also argues that the fact that PDAs will have to cooperate with each other does not mean that this cooperation will consist of joint action by all PDAs. He points out that it will instead take the form of a series of bilateral relationships between agencies. While it is possible to argue that anarcho-capitalism requires cooperation between a single security provider and all other providers in a given market area, it is quite another to claim that it requires all security providers to establish binding rules of operation jointly.
The Internal Stability of the Cartel
Given this, establishing and managing a cartel would not be easy. On top of this, it is doubtful whether it would remain stable. As with any cartel, all agencies would certainly try to flout the rules. Assuming that the cartel would not seek to block customer migration between agencies (such an agreement would not be profitable for those involved in the collusion), the agencies would have numerous methods at their disposal to try to attract customers from other companies.
The essence of a cartel is setting inflated prices at which goods are sold on the cartelized market. While it would be easy to control whether one of the cartelized apple producers was undercutting prices, this would be more difficult in the case of security agencies, which, as mentioned, offer a very heterogeneous product. Although the cartel may try to impose uniform prices, the agencies would have considerable freedom in deciding what goods to sell at that price. Therefore, even with a formal agreement on certain terms, each company would fight fiercely to attract customers. In fact, they will all have to do so because they will expect the other companies in the cartel to act in this way and they will all be forced to bend the cartel rules.
Not only may cartel members attempt to violate the cartel’s agreements, they may also, at some point, either alone or in concert with other companies, attempt to break completely with its rules in order to gain a lasting advantage over other companies. For example, let us imagine that the PDAA has 10 percent of the market. Believing that it has a good chance of gaining an even larger share, the PDAA decides to break the cartel and offer its customers lower prices and products tailored to their needs. In theory, such an agency could face the threat of other companies refusing to settle disputes amicably with it. However, its situation would be fundamentally different from that of a new agency entering the market and threatening to disrupt the cartel. This agency would already have its own customers, and could also count on the fact that not all cartel members would want to fight it. In fact, the free rider effect should encourage other companies to cheat and secretly cooperate with PDAA.
The PDAB might find it more advantageous to declare that it has no intention of fighting the PDAA. If it did so, the other agencies would be less willing to exclude PDAA. Some customers may then decide to switch to PDAB because it does not exclude PDAA, meaning the cartelized agencies would have to exclude both PDAB and PDAA, making the whole venture costly. This could be so costly that it would be more advantageous to dissolve the cartel. Therefore, if one company were to break away from the cartel, it could lead to its disintegration like a series of dominoes falling one after another.
The likelihood of this scenario seems to depend on the number of companies involved. However, there is an interesting relation here: if there were a large number of companies, collusion would be difficult for technical reasons; if there were only a few companies, collusion would be more difficult because the chance that one of the companies would break the collusion would increase (the larger the company, the greater the chance that such a breach would go unpunished).
Creating a Cartel Poses Risks to Individual PDAs
So far, we have assumed that the security production market differs from other markets, which is disadvantageous for anarcho-capitalists. However, it could be argued that the fact that it is a very different market works against cartelization. The risks associated with forming a cartel in a typical market seem small; at worst, the cartel will be broken up (either externally or internally), returning everything to the previous state. However, creating a cartel in the security production sector introduces a new dynamic that could threaten specific PDAs. The point is that, unlike a cartel of car manufacturers, a cartel in the security market ceases to be a collection of companies and becomes a quasi-political organization.
Clearly, cartel members will seek to obtain the strongest possible position within it. They will form alliances, collude to eliminate weaker companies (fewer companies means greater profits), fabricate evidence of other companies’ wrongdoing, and preemptively “attack” companies they fear may try to dominate them. In short, they will engage in all the activities typical of political struggle. This means that a company joining the cartel risks being eliminated as a result of these political actions. Furthermore, since the managers of the targeted agency will try to defend themselves, the cartel may resort to more drastic methods to achieve its goals, such as accusing the managers of abuse and punishing them with violence. Therefore, the creation of a cartel in the security production sector will involve a high risk for security producers.
The question they will have to ask themselves is: is it better to be the CEO/board member of an agency operating in a free market for security production, or the CEO/board member of an agency operating in a cartelized market? This argument seems even stronger if we assume that the potential final stage of cartelization would be the renewal of the state.
The transformation of the cartel into a state would mean a risk of a radical deterioration of the situation for many PDA leaders (especially the smaller ones): certainly, those who would be at the head of the new state would not want to share power. And that means they might be reluctant to form a cartel in the first place.
Anti-Cartelization Measures
Finally, it must be emphasized that an anarcho-capitalist society does not have to watch the process of cartelization idly. The scope and strength of such collective action would be weakened by the existence of the free rider effect. Nevertheless, if a sufficient number of individuals were determined enough, they would be able to delay or stop the process of cartelization.
It is conceivable that some agencies would take up the cause of combating cartelization, and consumers who are immune to the free rider effect would be willing to pay these agencies slightly higher premiums in exchange for hindering cartelization. Such agencies could inform consumers about the dangers of cartelization in their advertising campaigns and point out that they themselves do not engage in it. At the same time, the initiative could also come from the public, e.g., organizations that would make consumers aware of the dangers of cartelization and encourage them to choose security agencies that are involved in anti-cartelization activities. Consumers could boycott companies suspected of cartelization tendencies. Individuals may seem too weak to resist cartelization. But this is where large companies would come into play, as they would have greater capacity to act and more to lose. They could jointly decide to support agencies that would guarantee in various ways that no cartel would be formed. Finally, it is conceivable that agencies would have some kind of identity (religious, national, community-based) that would make cartelization difficult. Such PDAs would be supported by people who identify with certain principles and who would require their agency to engage in anti-cartelization activities.
Among the various arguments against the possibility of anarcho-capitalism, the argument about likely cartelization is one of the strongest. Critics have presented good arguments as to why typical arguments against cartelization do not seem to strike as hard in the security production market. Nevertheless, cartelization is by no means certain.
