Is "Bigger" Really "Better?" Libertarian Ruminations on the Economy of Scale

Unless you've been living under a rock, it should be obvious that human social organization in the Western world is increasingly being dominated by large-scale organizational structures. Examples are obvious and bountiful. Why is the financial world today controlled by a handful and large Wall Street banks that have grown to the point where they are "too big to fail," and why are small local banks struggling to stay in business? Why are a few large scale retailers like Amazon, Walmart, Home Depot, and Target, thriving while small local "mom and pop" stores are out of business? Why are individual schools getting larger and often bundled and "administrated" into large school districts or corporate entities? Why are small family-owned farms being usurped by large "factory farms" owned by huge corporations? And finally, why are Federal and State governments growing by leaps and bounds, while small local governments are struggling to remain solvent?

Orthodox economic theory says that the natural evolution of markets inevitably leads to dominance by a few large scale competitors and that the rise of oligopolies is a sign of economic maturity or progress. In other words, "Big is Good!" But what if orthodoxy is wrong? What if our current state of social organization is actually a malaise? What if the "bigger is better" thesis is actually a well-disguised ideology that has created large scale social structures that are really "too big to survive?" In short: What if "smaller is better?"

For the sake of argument, let's assume that most of what Adam Smith identified as the basics of free market competition is more-or-less accurate. Namely, that economic activity involves competition between buyers, between sellers, and between buyers and sellers. And that all competition takes place on two axis: quality and price. The quality of a good or service is determined by the free choices made by the buyers and sellers in the form of a contract. The price refers to what the buyer is willing to pay for it, and what the seller is willing to accept. The "Holy Grail" of economic competition is to provide high quality goods or services at the lowest price. The defenders of the "bigger is better" thesis say that larger organizations naturally benefit from "economy of scale" because larger organizations are more innovative and efficient than small organizations, and therefore can produce higher quality products and services at a lower price. Thus, it seems as though the "free market" leads inevitably to dominance by a few large scale organizations, or oligarchy. The problem with all this is that "bigger is better" contradicts almost everyone's "real world" experience with large-scale, centralized, bureaucratic social structures.

I currently teach at a small liberal arts college, but I have also taught at a major state university. Most small private liberal arts colleges are now "out of business" while the larger ones are thriving. Orthodoxy says that large universities benefit from "economy of scale" and therefore are more innovative, efficient, and therefore less costly. Of course anyone that ever attended or taught at a major university will readily question all three of those statements. How can a major university provide a superior education if most of the courses are taught by graduate students and adjuncts? If large universities are indeed "better" then why are the retention rates of large universities so dismal in comparison to small colleges? Admittedly, the issue is much more complex than this, but the question remains: "Is bigger really better?"

Libertarians like myself argue that the rise of large scale corporations are often the product of "crony capitalism" and not "free market capitalism." Thus, governments drive small organizations into extinction by: subsidizing the costs of large organizations, issuing expensive regulations that small organizations cannot afford, and via tax policy. In my next blog, I'll explore the coevolution of "big government" and "big corporations" and the difference between "crony capitalism" and "free market capitalism." I will argue that, contrary to what orthodoxy says, with few exceptions, in the absence of large scale government intervention, "smaller is almost always better."            

A Libertarian Perspective on "Too Big to Fail"

As the government continues to “bailout” failing corporations such as General Motors, Chrysler, American Investment Group (AIG), and a host of other financial institutions, the “too big to fail principle” has been cited as the primary justification for these rescue packages. This is a utilitarian principle that implies that the costs of “allowing” these corporations to fail outweigh the benefits; that is, if they fail others will fail and unemployment will rise. Although most economists seem to accept this utilitarian justification, no one has offered any explanation of how these corporations got “too big to fail.” Let’s explore two alternative explanations. The free market explanation is that corporations get “big” because they offer higher quality products and/or services at a lower cost than their rivals. These natural monopolies get “big” because they defeat their competition. In the absence of competition these monopolies raise prices and earn windfall profits. But natural monopolies are usually short-lived because other corporations can see their success, copy their strategies and/or improve upon those strategies. This process of weeding out the “unfit” (inefficient) competitors and inspiring competitors that are more “fit” (efficient) is called “creative destruction.” Unfortunately, there are other ways for corporations to “destroy” their competition. The second way to “get big” is to raise the cost of competing in a market by artificially raising the cost of others entering the competition. The easiest way for “big” corporations to stifle competition from smaller, more innovative companies is by lobbying government officials to raise the cost of competing by imposing costly regulations. These artificial monopolies can maintain their stature, regardless of their actual “fitness.” In fact, most artificial monopolies are downright inept: U.S. Postal Service, Public Schools, Public Utilities, etc. Now, how did AIG (American International Group) get “too big to fail?” Did it “take-over” its competitors because it was more “fit” or because it was more adept at lobbying government? The basic problem with the “too big to fail principle," is that if a corporation is “too big to fail” in the eyes of the government, it can take risks that other smaller, risk-sensitive corporations cannot. This leads to the proliferation of large, inefficient corporations that are protected from failure. Then, these maladapted corporations proceed to takeover over smaller, more efficient corporations. In short, the “too big to fail principle” tends to undermine “creative destruction.” Libertarians argue that when governments artificially prop up obviously inefficient corporations that take irrational risks, and reward incompetent executives with bonus pay, they also drive good corporations out of business. Would you rather invest in, work for, or buy from an inefficient corporation that is “too big to fail;” or invest in, work for, or buy from an efficient corporation that will probably be driven out of business by an inefficient corporation that is “too big to fail?” If you owned a smaller, more innovative, and more efficient competitor would you rather continue to compete with a corporation that is “too big to fail,” or agree to a lucrative takeover offer? The libertarian view on the “too big to fail principle” is that it undermines “creative destruction,” and leads to endless cycles of future government bailouts. But more than that it gives rise to an enormously destructive corollary the “too small to succeed principle.”