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The Origins of Big Business

September 7, 2011 Leave a comment

Have you ever wondered why we have companies that are too big to fail? Have you wondered why big businesses are racking up record profits and sitting on trillions of dollars of idle capital during the current recession while small businesses are fighting for survival across the nation?

Some people would tell you that we need a big, strong federal government to keep the giant corporations in check. Otherwise, those greedy, soulless corporations will swallow up small businesses, ship jobs oversees, destroy our environment, exploit workers, implement monopoly pricing and squeeze innovation out of the economy. Only by government regulation can these evil, profit-producing monstrosities be held accountable and made to serve “the common good.”

There is no doubt that large corporations have a lot of power. The real question is how and why did they get to be so big and powerful? I would argue that the same government regulatory schemes that seek to control these massive corporations are the reason why those large corporations exist in the first place.

Many would have you believe that most large corporations come about because small and medium-sized, greedy corporations prey on other small businesses and consumers to become large greedy corporations. While there are probably a few examples of that happening, that is not usually the way it works.

If you look at the industries with the greatest consolidation, you will find that they are all heavily regulated. Let’s look at some examples.

–       The Auto Industry

–       Big Oil

–       Wall Street

–       Telecommunications

–       Health Insurance

–       Supermarkets

–       Cable Television

–       Airlines

–       Railroads

The chicken or the egg?

 

In trying to understand why all of these heavily regulated industries have consolidated down to a handful of very powerful companies, there are, essentially, four possibilities:

1.                  Regulation was a reaction to excessive consolidation,

2.                  Consolidation was a response to the effects of regulation,

3.                  Some other factor triggered both consolidation and regulation, or

4.                  A cycle of increased regulation and increased consolidation fed upon itself to bring about a small number of highly regulated corporations.

I would argue that the fourth option is the true explanation for why so many of our industries are dominated by a small number of large corporations. Here’s my reasoning.

Early on in the life-cycle of an industry, success is driven largely by innovation. Small companies spring up based on their ability to produce and implement new ideas and technologies. Sometimes, one company in a new industry grows quickly to dominate that industry, but often its success is short-lived, as new competitors appear on the scene driving further innovation and toppling the early winners.

As the industry grows, it becomes a target of government regulation. Over time, more consumers come to depend on the services or goods produced by the industry. The government itself might become a large customer of the industry. The bigger an industry becomes, the more “the common good” depends on it. Under pressure from consumers, or in order to simplify and standardize its own relationship with the industry, government begins to intervene. Health, safety, environmental and consumer protection regulations are established. Large government contracts impose constraints on how companies deal with their labor force. Industry standards are handed down by national and international governmental and quasi-governmental organizations.

So, what is the effect of this new regulatory blanket on the industry? Suddenly, success and failure in the industry begins to depend less on innovation and more on successfully meeting the demands of the regulators. New, small companies that would like to innovate can not gain a foothold because their limited time and capital are consumed by trying to comply with regulations. Other innovators find it more practical and profitable to sell their innovations to existing, large companies that already have the infrastructure to comply with regulations. It is just too risky and expensive to grow a small company from scratch while battling the regulatory bureaucracy—why not just cash in by selling to the “big boys”.

As the government sees consolidation taking place in this once fragmented industry, its natural reaction is to increase regulation to protect consumers and workers from the growing power of these fewer, ever-expanding corporations. Of course, the additional regulation only makes it more difficult for new competitors to enter the industry and increases the likelihood that there will be additional consolidation among the survivors.

And so, you end up with just a handful of highly regulated companies that are slow to innovate and can successfully stifle competition. They do not innovate because the regulators won’t let them. They do not innovate because they do not have to. They do not innovate because they have too much of a stake in the status quo.

Of course, the regulators don’t really mind this scenario either. They would rather work with a small handful of corporations than deal with a messy industry with hundreds or thousands of competitors. Over time, a cozy, you-scratch-my-back-and-I’ll-scratch-yours relationship develops between the small number of industry players and their regulators. Legislation and further regulations are developed to provide protection and guaranteed profits for the big companies as a result of their lobbying efforts and cozy relationship with their regulators. Often, the relationships between the regulators and the regulated corporations are corrupted with bribes, campaign contributions, personal favors and so forth.

If you want an example of how government regulation favors big corporations over small businesses, you need look no further than the banking industry. While the big “Wall Street” banks were taking in hundreds of billions of dollars in federal government bailout money, industry regulators were tightening the screws on thousands of community banks around the country. Lending standards for small banks have been elevated to unattainable levels that have choked off the flow of cash to small businesses. Small banks are not being allowed to loan, and a small bank that does not loan can not survive. Without loans from community banks, small businesses that rely on them for funding can not survive. Without successful small businesses in their communities, workers can not find jobs.

Why would regulators strangle small, community banks while handing out billions to the big, money center banks? Quite simply, it would be a lot easier for the government to control the financial system in this country if there were fewer banks. Consolidation is good for politicians and bureaucrats, but bad for small businesses and consumers.

Government regulation begets industry consolidation. Industry consolidation begets government regulation. Who wins? Big business and Big government. Who loses? Entrepreneurs, consumers and workers who can’t find jobs working for small businesses in their communities because their would-be employers have been put out of business by collusion between big government and big business.

The next time you hear someone tell you that government regulation is necessary to curb the excesses of big business, ask yourself how these businesses got to be so big in the first place. If Big Business is the disease, then Big Government is the cause, not the cure.