In the late 1990s it was rumoured that an international investment based in London met with clients and competitors to make deals and set prices for a number of financial assets in one of the private rooms of a famous lap dancing club. Rumours also abound of trans-national corporations in certain sectors meeting once a year in possibly exotic locations to agree prices in their markets.
The boundary between co-operation and collusion among competitors can be a fluid one. Collusion between firms is illegal but the establishment of joint ventures can sometimes make the division between co-operation and collusion more permeable in some sectors and markets. It is the duty of regulators to attempt to define less porous boundaries.
A lap dance club in Rome
You might say what have lap dancing clubs got to do with the business relationships between competitors? Well apart from their metaphorical utility, they point up some of the paradoxes about regulation.
Lap dancing clubs are seen as part of the sex industry but had been regulated under the Public Entertainment Licence (PEL) which covers venues which sell alcohol.
At present there are proposals to regulate them under the sex licensing legislation, which is more restrictive. The moral and social issues about these type of establishments, notwithstanding, it does point to the problematic nature of business regulation.
Like difficult customers, businesses frequently complain about regulation, and point to apparently nonsensical examples. Yet one of the paradoxes is that not only does regulation often sustain the competitive environment, but also allows businesses to follow their own self-interest.
The notion of self-interest is most frequently associated with Adam Smith's The Wealth of Nations, perhaps one of the most misinterpreted books in history. In his previous work The Theory of Moral Sentiments, he pointed out that if individuals do not have a 'moral sentiment' with counterparts in economic exchange then their self-interest will not be realised and just prices will not ensue. Regulation frequently substitutes for moral sentiment in market economies.
By the same token, differences in regulation of time, place or market can present new opportunities. These come under the heading of regulatory arbitrage. Arbitrage is the process of taking advantage of differences in prices in two or more markets.
An example of the regulatory version is the establishment of the Euro-dollar market in London in the early 1960s. Regulation in the United States, at the time, limited foreign access to dollar deposits. To circumvent these regulations a new offshore ('Euro') market developed to cater for this suppressed external demand.
There is an equivalent in our lap dancing example, by being licensed as a PEL rather than being regulated as sex establishment, these clubs had lower regulatory costs.
Systemic Risk and regulatory risk
The related issue is risk, of which two types are relevant here: systemic risk and regulatory risk. The former is that posed to the economy and financial system as a whole, whilst the former occurs when changes in laws and regulations impact on business activities.
The risk management strategies of minimising the impact of this regulatory type may perversely lever up systemic risk. This applies more strongly to firms with dominant or monopolistic market power. By exploiting their ability to extract economic rents from their commanding market heights, in order to limit regulatory risk, these firms may reduce economic welfare in the economy. This consists of lower output, income and employment - the consequence of which is to lever up systemic risk.
The thought of scantily-clad or naked businessmen (and aficionados of this type of establishment tend mainly, though not exclusively, to be men) gyrating around a regulatory pole and responding to bids to set prices from a closed audience is not a pretty one.
The bottom line is that if you regulate these collusive activities as the equivalent of PELs and not something more visceral, based on co-operative relationships, we all be will be dancing our way to some kind of oblivion.