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.”

Corporate Bailouts

What can a libertarian philosopher contribute to the ongoing debate over the government’s response our current economic malaise? In positive terms…not much! But here are a few questions that might lead us to a more enlightened conversation. First of all, why do we Americans continue to embrace deficit spending as a way of life? Why do we discount the value of a distant future on behalf of the immediate present? Why do all levels of government, all corporations, and almost all Americans live in debt? Why do we demand that our politicians nurture an economic environment marked by easy credit so we can borrow money from the future so we can live in spacious homes, drive new cars, and attend college now rather than later? Why do we max out our credit cards today, knowing full well that we’ll pay more for those goods over the long run, and perhaps even face foreclosure and/or bankruptcy next year? Why do so many of us risk our hard earned income on lotteries, and casino and online gambling? Pay day loans? Underfunded pension funds? In short, why do we believe that the only way for us to maintain our current standard of living is to perpetuate access to easy money, deficit spending, and to live our lives in debt? That’s a lot to digest in one blog! Simply put, here’s my short answer: We Americans have become excessively bound by tradition. We’ve become so dependent recycling old solutions to old problems that we’ve lost the ability to come up with new solutions to new problems. Why? Because centralized governmental structures have undermined our capacity for ground-level innovation via: legislative barriers, tax incentives, and corporate subsidies. The examples are legion: the persistence of transportation technology based on 19th century fossil fuels, employment-based health insurance, Medicare, Medicaid, Social Security, public schools, etc. Libertarians argue that government has a perverse tendency to support the status quo at the expense of innovation. Economic legislation tends to pursue equilibrium rather than change. Legislation such as professional licensure, institutional accreditation, and building codes tend to protect the status quo from external competition by erecting artificial barriers to innovators. How else can we explain the otherwise inexplicable fact that most of the high-level discussion on economic recover centers on bailing out old, large, tradition-bound corporations like AIG, General Motors, and Ford? The arguments in favor of these wholesale bailouts usually hinge on a collectivist, utilitarian premise, “too large to fail.” But why do we continue to believe that old, big, inefficient, and inflexible institutions are better than young, small, efficient, and flexible ones? So if the “Big Three” fail, what happens to all those workers? Well, they’ll probably have to wait for Honda, Toyota, and other younger, more innovative corporations to build newer, smaller, more efficient, and more flexible factories. But those workers will probably have to relocate to other states and go back to school and become more efficient. In a nutshell, when upholding tradition and the status quo no longer works, we must be willing to change. But first, we’ll have to overcome our government’s institutionalized preference for everything that is old, big, inefficient, and inflexible.