In February 2007, Brazil’s antitrust division announced dramatic raids on eight major cement manufacturers for alleged collusion in setting prices, carving up markets, and pushing out competitors. Alberto Salvo, an assistant professor of management and strategy at the Kellogg School of Management, does not mince words on the subject. “The allegations that cement producers had been dividing regional markets did not surprise me one bit,” he says.
The reason behind that certainty is that by 2007, Brazilian-born Salvo already had been studying that country’s cement industry for six years, and his analysis of the data, he says, indicated loud and clear what the antitrust authorities were just discovering: there was something rotten in the state of Alagoas—and the state of Sergipe—and the states of São Paulo and Minas Gerais—in fact, in all 27 of Brazil’s political divisions.
“Recent evidence indicates that cartels are an important phenomenon in the contemporary global economy,” Salvo, an assistant professor of management and strategy, wrote in 2010 in the Canadian Journal of Economics. His work on Brazil’s tacit/explicit cement cartel has earned him the Canadian Journal of Economics 2010 Robert Mundell Prize, presented to the young economist whose article is adjudged best for the year of its publication.
A Weighty Industry
Certainly Salvo’s article topic, cement, hardly seems sexy at first glance. But what makes it so is its urgent importance to a developing economy like Brazil’s, where cement industry sales jumped from 45 million tons in 2007 to 59 million tons in 2010. Another factor is the upcoming surge in cement demand, in part because Brazil will host both the 2014 World Cup and the 2016 Olympics, with their accompanying needs for new infrastructure. A third consideration: Brazil, according to the U.S. Geological Survey, is the world’s fifth fastest-growing cement market in the world, behind China, India, the United States, and Turkey.
Cement is high-profile and compelling in Brazil. Yet when Salvo initially examined the industry’s spatial supply arrangement, meaning its geographic segmentation of markets, he found “a bit of a puzzle,” he says, both in segmentation and in the expected flow of cement traded between and among Brazil’s 27 states. The expected, recurring patterns—what economists call “gravity”— were not at all what was expected at prevailing prices, Salvo explains.
Normally, elements that affect trade flows include distance, “border effects,” and home bias. The distance effect is obvious: the farther removed the seller is from the buyer, the lower the level of transactions, or “trade flows”; the presence or absence of waterways also plays a big role. “What we’re finding in the modern economy,” Salvo says, “is that the effect of distance remains very large, even in digital goods traded over the Internet—information and cultural proximity.” Even for products without a physical component, he says, “Distance has a big, big effect.”
International borders are the second issue. If borders separate the buyer and seller, that too may reduce trade flows, as may the presence of border officials with their hands out, demanding bribes to ensure the movement of goods to their intended destination. Finally, “home bias” affects trade flows, as in the case of, say, a preference for the yogurt made only by local farmers or the ability of producers to understand and respond to local tastes.
Brazilian cement was different, Salvo found. Some of these trade flow obstacles were not operating there. What he found instead were scenarios like the one in two small and adjacent northeast states, Alagoas and Sergipe, each of which hosted one cement plant, owned by a different cement producer. Brennand Cimentos in Alagoas held an 83 percent market share of its home state and did not even sell in neighboring Sergipe but did sell in other states. That seemed strange: “Given cement prices and costs, both manufacturing and transport costs, it would actually be quite profitable in the short run to sell to Sergipe,” Salvo says he realized. “What’s stopping it from crossing that state border?” he wondered. The sole producer in Sergipe, Votorantim Cimentos, meanwhile, had an 89 percent share in its home state but only 7 percent in neighboring Alagoas.
“This pattern of trade is very odd,” Salvo knew, after analyzing data he wheedled out of the cement industry association over time. “There are moments in time when Brennand’s Alagoas-based plant is actually shipping to farther-away states than Sergipe.” But, “If you take prices in Sergipe in a given year—the price of cement is 9.44 reais per 50-kilo bag—and calculate the cost of selling to the state they don’t sell to, from their plant in Alagoas, the cost of doing business would be 5.68 reais. So we’re not talking about peanuts: their cost is 5.68 and their price is 9.41, so we’re talking about almost a 4-reais margin, almost 40 percent.”
His conclusion as an economist? “There’s something that’s stopping them from selling to Sergipe.” And that something was neither distance nor a border effect, because Brazil is a federation of states, much like the United States, where traveling back and forth is seamless.
Further, the same kind of pattern was repeated elsewhere, Salvo found. Brazil’s largest markets are the adjacent states of São Paulo and Minas Gerais, respectively the number one and number two markets in terms of percent of national GDP. Between them, the three largest cement producers are Votorantim again, the Swiss company Holcim, and the French company Lafarge. All three companies have plants in both states.
Yet despite this fertile ground for competition, Salvo found practically none. Votorantim had a disproportionate share of the market—50 percent—in São Paulo, and only a small share, 8 percent, in Minas. Holcim had a large share, 24 percent, in Minas Gerais and only 9 percent in São Paulo. Lafarge was large in Minas Gerais, with 25 percent, and very small, 5 percent, in São Paulo. In addition, there were a small number of producers, which increases the potential for collusion. Brazil had 19 cement companies when Salvo began studying them in 1991 and only 12 when he finished in 1999.
What Salvo was looking at, he knew, was a very controlled setting: a simple product, with little differentiation or home bias, and a single country with the same tax and legal system, language, and currency. Further, unlike other developing countries such as India, where in-state trade flows tend to receive more favorable tax treatment, Brazil’s government has actually instituted tax laws to encourage trade between states.
Looking at the data, Salvo realized it could not be explained by high trade costs. “You should allow for other things to explain such a pattern of shipments, for example the fact that producers are behaving strategically and agreeing to stay out of each other’s territories,” he says. “That’s the idea of the paper: we economists have to do a better job of modeling what we call oligopolistic interaction.”
The story does not end there, with economic concepts; indeed at times it has the feel of a crime thriller. “On any given day in 2007 there was an antitrust raid on the cement industry—at just about every producer and trade association in the country,” Salvo says. “It was the federal police…they simultaneously raided the offices of all these different producers. Trustbusters claimed at the time that they had hard evidence there was an explicit cartel. They claimed to have testimony by whistleblowers.” Newspaper accounts describe a former Votorantim employee who alleged that the eight company directors met regularly to establish prices and agree upon regional divisions.
“One of the high-ranking officials among Brazil’s antitrust bodies,” Salvo continues, “splashed all over the newspaper, ‘We’re going after these guys, and these guys have been running a cartel; we’ve got the ‘smoking gun.’ ” Indeed, Mariana Tavares de Araujo, head of the Secretariat for Economic Law (SDE, of the Ministry of Justice), spoke of “direct evidence” of a cartel impacting the building and construction sector. Tavares described meetings among the executives at hotels, agreements on carving up territories. “By starting the investigation, we will put the jigsaw puzzle together,” Tavares told the press. “If we conclude that a cartel existed, the harm [to society] will have been huge.”
Clearly, the cement makers were unhappy. They faced potential fines of between 1 percent and 30 percent of their 2005 revenues, which would have been a hefty punch. But not much happened. A local judge gave the producers what they wanted: impoundment of the seized evidence—which the producers claimed was “commercially sensitive”—under court seal, where it has remained ever since. Salvo was, and is, disappointed but not surprised. It is widely accepted that Brazil’s antitrust authorities do not have much bite.
At times he has stepped out of his academic role to get involved. He has presented his work on cement at various institutions and antitrust authorities in Brazil and tells of the time, in 2005, in Rio’s Fundação Getulio Vargas, when into his seminar room walked a somewhat intimidating crew of three cement executives, one of whom he had interviewed four years earlier. “After the talk, the cement executive and other people with him approached me and asked if I wanted to go back to the trade association’s Rio-based offices and talk about my work,” Salvo says. “We regularly hire consultants and we pay very, very well,” he says the exec told him.
But Salvo had an “out”: an immediate flight to catch back home to London, where he was living at the time, which he jokingly describes as “fortunate”. “I never consulted on cement,” he says. Even still, both the industry and Brazil’s antitrust authorities at different times “have tried to hire me…it seemed they wanted to be more serious on their casework.”
The economist demurs when asked if he is a whistleblower: “The fact is that everything I say could be explained by tacit, non-explicit collusion,” he says. “I have not had a role examining case evidence—that’s something I have considered doing after these raids, but it quickly became apparent that everything they had seized was going to be confidential, which is a shame.”
Whatever the outcome in Brazil, there are lessons to be learned. Cement producers have figured into similar cartel accusations elsewhere: the United Kingdom, India, and South Africa, among others; and evidence points to cartels in other industries, especially in the European Union, whose inter-country trade has remained suspiciously fragmented over the years. Salvo has contemplated suing to make those seized materials public. Society has much to gain from learning how cartels operate in emerging markets such as these, he says. “In 2010 I asked a former head of another antitrust body, CADE, whether they thought there was any chance that all the material seized three years earlier from the cement trade association’s headquarters and the many firms’ offices—and immediately impounded—would ever come to light,” Salvo recalls.
He says CADE’s head replied—off the record—that the authorities were actually signing bilateral agreements with individual producers. Salvo speculates that those documents forgave the collusive behavior with no admission of guilt in return for a slap-on-the-wrist fine, rather than make the whole seedy mess public. The official believed that the information seized on the inner workings of the cartel would never come to light.
But Salvo says he is talking to colleagues in Brazil, including economists and lawyers, about that nation’s equivalent of a Freedom of Information Act. He refuses to let the cement industry’s collusive practices simply fade away.
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