For more than a decade, a longstanding conspiracy lurked beneath the hood of the German auto industry: collusion on regulatory noncompliance.
Three of Germany’s largest car manufacturers — BMW, Daimler, and Volkswagen — were fined nearly $1 billion by the European Commission in July 2021 for conspiring to limit the effectiveness of clean emissions technology between 2007 and 2018. Such coordination to limit technical development is illegal under EU antitrust legislation.
What were the implications of this collusion? MIT Sloan assistant professor who specializes in energy economics, joined with colleagues from the State University of New York at Albany, Bar-Ilan University in Israel and the University of Toulouse in France to find out. They co-authored “Colluding Against Environmental Regulation,” a working paper quantifying the empirical incentives and environmental impacts of the scheme.
Usually business collusion cases have implications for customers, such as higher prices. Li was attracted to this case because it had public environmental implications as well.
“As an antitrust case, it was unique, because we were dealing with a setting where the damages weren’t entirely on the buyers of a product. Usually, with price-fixing or market-sharing cases, it’s the people in the market for the products who would be harmed by alleged collusive activity.
“In this case, firms were accused of coordinating to limit the effectiveness of emissions control technology, which creates externalities. People harmed by the alleged behavior are not just people who purchase the diesel vehicle but everyone around them who breathed the pollution,” Li said.
The case focused on nitrogen oxide (NOx)-control technologies in the companies’ diesel engine vehicles from 2007 until 2018 and the use of Selective Catalytic Reduction (SCR), which requires a large quantity of Diesel Exhaust Fluid (DEF) to neutralize NOx emissions to comply with EU standards. The companies allegedly plotted to shrink the size of DEF tanks, making cars less effective in reducing harmful nitrogen oxides.
The automakers harbored a strong financial incentive to conspire: Larger DEF tanks reduce profits because they take up trunk space and increase production costs. By using smaller tanks, automakers padded their profits by between €0.68 and €2.83 billion total.
And by acting together instead of unilaterally, the team’s models determined that manufacturers reduced their expected noncompliance penalties by €571 million.
“The expected noncompliance penalty is comprised of a probability of getting caught multiplied by the penalty if they are caught,” Li said.
By acting jointly, firms could reduce the probability of their noncompliance being detected, as well as reduce the penalties they would each face if more firms were caught together, she explained.
In an unusual twist, buyers benefitted from the particular plot thanks to larger trunk space in their cars and a lower purchase price. But buyers — and other citizens — were harmed by the air pollution from noncompliance, whether they were aware of it or not.
Ultimately, the €875 million EU fines were in line with the social welfare damages computed by Li’s team. They determined that combined antitrust and environmental penalties would have to reach between €1.46 billion and €7.37 billion to remedy the damages of the collusion.
In quantifying the environmental implications of collusion — not just the impact on cost for buyers — Li believes that her research could help policymakers and lawmakers understand why coordinated behavior to undermine environmental or other types of regulation imposes additional damages on society.
“Our findings suggest that some regulatory environments create strong incentives for firms to coordinate their noncompliance behavior. By doing so, firms can reduce their expected penalties by reducing the chance of detection as well as the penalties if they are caught,” Li said.
Policymakers can counter these incentives with higher fines when they find firms have coordinated noncompliance. Depending on the legal and regulatory framework in a region, these group fines may be imposed by the antitrust authority, as the European Commission did, or by the environmental regulator when designing penalty schedules, Li said.