Diamonds are Forever - Cartel and Monopoly
I'm posting a 14-part series of mini-essays on diamonds (but really about the economic point of view). Here's part 7.
Cartel and Monopoly
Besides the Diamond-Water Paradox, diamonds probably come up most frequently in economics courses to illustrate issues pertaining to cartels and monopoly.
For a good chunk of the 20th century, the De Beers Group (1888-present), a cartel, held the leasing rights for most of the world’s known diamond mines. Along with the Alcoa bauxite mines, the De Beers case is one of the only examples of (essentially) one seller controlling the global supply of a natural resource. As most mines were in South Africa, keeping track of the world’s supply of diamonds was initially a manageable task.
De Beers also convinced most of the rest of the world’s diamond miners to sell through its Central Selling Organization (CSO). The CSO inspected and sold these diamonds to downstream dealers—see more on this unusual process below.
To my mind, the De Beers’ cartel raises three important issues. It would be tough to squeeze them all into a single week, but I suppose more opportunities to remind students of scarcity are better than fewer.
First, Econ 101 teaches us that cartels are highly unstable arrangements. Cartel members face incentives to cheat, to “chisel,” on the cartel arrangement; external pressure derives from producers who never joined the cartel or who eventually break away.
The persistence of the De Beers cartel is therefore somewhat of a puzzle.
Unlocking this mystery lies in realizing that in the heyday of De Beers’ cartelization, there was no free diamond market at all. The South African government nationalized the diamond mines. De Beers would lease the mines from the government, which laid first claim to any new deposits in the country. From there, De Beers made their own production and pricing decisions, albeit in the context of a highly interventionist system.
When new mines were discovered in the former U.S.S.R., that government cut a deal with De Beers, and the cartel went international. The South African government even patrolled the coast to prevent diamond smuggling. See Murray Rothbard’s discussion for more details. The lesson: persistent cartels require enforcement mechanisms, and government is the most common and effective enforcer.
Secondly, many infer that De Beers’ dominance allowed it to enjoy “monopoly profits.”
My view is that the cartel did not bestow monopoly profits, but that it did result in higher diamond prices.
De Beers, which would rent land from the government, would have paid the fully capitalized value of the land (assuming the government charged a price comparable to what a private owner would, of which there is no guarantee). Presumably, this fully capitalized price reflected the value to De Beers of having a government-backed cartel. This price is higher precisely because having a government-backed cartel allowed De Beers to sell diamonds for higher prices.
In short, windfall gains would have gone, in one way or another, to government officials, but not to De Beers’ owners.
The third issue concerns the prices that De Beers’ cartel status allowed them to charge. Even during the heyday of DeBeer’s dominance, its ability to charge elevated, monopoly prices for diamonds was still highly constrained by several factors. This idea also relates to my second point above in that these constraints would have influenced how much De Beers would be willing to pay to lease a mine.
Importantly, there are myriad close substitutes for diamonds. For example, alongside diamonds, the Bible mentions over twenty stones prized for their beauty. These stones were known thousands of years ago, and all existed in the relatively small geographic region (Palestine) where the Bible’s authors lived. Like the diamond, these stones were and are all used in jewelry and architecture. Today, the Gemstone Encyclopedia lists over 300 beautiful stones. Substitutes for diamonds abound.
What’s more, diamonds’ permanence severely curtails the higher price that might arise from one entity controlling all known sources of a commodity. This idea, known as the Coase Conjecture, suggests that once the durable cat is out of the bag, it becomes another source of competition. As soon as De Beers makes a sale, it creates a secondary diamond market. New diamond owners become competitors with De Beers. A single global seller of diamonds is thus analytically distinct from a single global seller of bread, a highly perishable item.
Lastly, you might have noticed the important caveat word “known” in the preceding sentences. Potential competition for De Beers stems from the fact that anyone on earth, at any moment, could discover an as-of-yet unknown diamond deposit. This happens, time-to-time, with diamonds.
Throughout the 20th century, people discovered new diamond deposits across several continents.