The Paradox of Economies of Scale and Government Bounties to Big Business

One of the key arguments that economists and historians have traditionally made in favor of big business, and one that the public has generally accepted, is that it is necessary because of economies of scale. This image was exemplified by the Ford production plants of the 1920s, which could produce thousands of cars per week. The reason that economists and the general public have traditionally believed that economies of scale are important is that the fixed costs of production, costs that will be there whether one or a million units are produced such as advertising, rent, and administrative staff costs, when spread over a large number of units of output become lower per unit. The argument for scale amounted to an argument for centrally planned economies. In his book "Managerial Revolution", written in the 1930s before the murderous nature of Nazism had been fully revealed, James Burnham argued that a new managerial class was independent of owners and he cheered the advent of national socialism in Germany because government control and guidance of large industry reflected the realities of the new managerial power. Thirty years later, in the early 1960s, John Kenneth Galbraith described the economy of big business as based on planning by a "technocratic" elite in his book New Industrial State.

But while the public has accepted the argument that big business is necessary for consumerism because only large firms can produce large numbers of outputs, big business has tactically demanded and likely required government subsidies in order to survive. And there is a paradox. For if big business is most efficient, then why does it need subsidies? In his 1977 book Politics and Markets Charles Lindblom argued that business occupies a "privileged position". More fundamentally, ever since the days of Hamilton, and with the exception of some business interests in the late nineteenth century, much of American business has asked for two crucial kinds of subsidies: protectionist tariffs and monetary expansion. When Jackson abolished the Second Bank in the early 1830s he limited the degree of monetary expansion. That period, from the 1830s to 1900, was the period of greatest innovation in technology and strongest gains in real hourly wages of workers of any in American history. It was also a period of uncertainty, volatility and conflict between labor and management. However, even in the nineteenth century monetary expansion associated with the Civil War facilitated expansion of credit and therefore enhanced the size of business. By the late nineteenth century the Mugwumps, traditional, mostly Protestant (there were some Catholics and Jews as well in their ranks) Yankee elites in Boston and New York protested the support to speculators like Jay Gould that the monetary expansion had provided, coupled with erosion of their annuities and bank accounts.

The expansion of the railroads contributed mightily to the expansion of US markets into a single whole, and were the crucial step in making big business economically viable and efficient. But the railroads were largely the product of subsidy, and the canals that preceded them were government public works projects, not private enterprise. Neither the railroads or canals were entirely responses to market demand. Rather, they were made possible by land grants and rights of way granted by often corrupt state and local governments. An example is New York, where Jay Gould was so indebted to Boss Tweed that he paid Tweed's bail when Tweed was arrested for corruption. Thus, the Civil War inflation and government subsidies to railroads made expansion of the railroads possible. In turn, the railroads coupled with high tariffs made expansion of business possible. In turn, business enjoying both these supports and economies of scale, consolidated in the nineteenth century.

Late nineteenth century big business was poorly managed. It is likely that the labor conflicts and inefficiencies of the large firms were due to their too-rapid expansion. In management, experience is the foundation on which expansion depends. In a laissez-faire market, a firm becomes large as its managers gain expertise in one market and then duplicate the success in subsequent markets. An example is McDonald's. The founders of McDonald's, Dick and Mac MacDonald owned a single store in San Beranardino, California. Ray Kroc, a multi-mixer distributor, read about their success and visited the store. Kroc's vision of a national chain of stores led to his agreement with the McDonald brothers. But it took Kroc many years to make McDonald's a success. He had to learn the importance of standardization through multiple false starts in California. He had to learn the importance of professionalization of the franchisee relationship through mismanagement of franchises by his friends from his country club who did not focus on managing the stores. He had to learn how to use real estate investment to help finance store expansion and contribute to profit margins from Harry J. Sonneborn. He had to learn how to standardize equipment and the size of French Fries. Kroc did not conceptualize almost any of the food offerings, most of which were the result of suggestions from franchisees. He did not create the clown, which was the result of a local advertising campaign by one of his large Washington, DC franchisees.

Would any of the steps that McDonald's took have been made had there been a massive tariff on hamburgers or if state governments, in return for bribes, had offered exclusive distributorships to Ray Kroc, or if credit expansion through the Federal Reserve Bank had benefited McDonald's as it does Wall Street today? Would any of the innovation in McDonald's have occurred?

In the early 1960s Ronald Coase wrote about the reason that organizations reach a given scale or size. He argued that, like much else in economics, it is due to an equilibration of costs and benefits. The costs of scale include ability to manage, incentives to top management, conflicts between labor and management, difficulties in obtaining information about operations, inflexibility in changing direction when markets change and office politics. The advantages of scale include economies of scale and economies of scope, i.e., the ability to share information learned in one business to a different business, much as Time Warner's AOL unit was able to share information with Roadrunner (that's a joke; the Time Warner and AOL units were in constant conflict after their ill-advised and incompetently executed merger).

The subsidies to big business have increased, not diminished, over time. The Democrats have inadvertently or not, been big business's best friend by demanding regulation, supposedly in support of big labor, that squelches smaller firms by further increasing the advantages of scale economies. They have also established the Federal Reserve Bank, which once the Republicans realized was actually the most important of all the subsidies to big business went on a binge and nearly doubled the rate at which the money supply grew after 1971. The Democrats have never complained, and have follwed the same course since. Thus, both parties have seen subsidization of Wall Street and big business at public expense as the cornerstone of their economic policies. The Democrats came up with the idea and the Republicans enhanced it. I became a Republican because the Democrats are better at initiating big government programs that subsidize big business. They do it by telling everyone that they support the poor and that the regulation supports the poor. But there were no segregated inner cities before the Democrats began to "support" the poor.

Which will outbalance the other--office politics or economies of scale and scope? Clearly, if government is providing support to big business, the amount of support needs to be subtracted from the gains from economies of scale.

Moreover, time has revealed that scale is not the most important factor in management. The Japanese were able to defeat big American business not because of scale but because of skill. Wal-Mart was able to defeat K-Mart not because of scale (it was a smaller firm until the 1990s) but because of skill. In particular, management of information, incentives, labor relations, inventory, factory management, total quality management, technology, product design and marketing, and similar factors can generate competitive advantages. Large firms like Nike have found it necessary to emulate small firms. They outsource their manufacturing and reserve the product design and marketing for themselves. In effect, they are consultants who control the business. These ideas have been circulating for many years. Yet, they bring into question whether scale provides much of an advantage. Coca Cola has found that local manufacturers can out-think them with respect to understanding local tastes, and has had to scramble to decentralize in order to compete globally. Its original vision of a one-world market drinking trillions of gallons of Coca-Cola was illusory.

Thus, the American idea, rooted in the expansion into the frontier, that scale and the expansion of markets is necessary results in a paradox. If scale is the source of economic gains, then why are such extensive subsidies to big business necessary? And if scale is crucial, why has there been so much volatility in world business?

William Graham Sumner on 19th Century Corporate Fraud and Government Subsidies to Business

The Progressive movement that developed in the 1890s into one of the most important political movements of the twentieth century was in large part a reaction to the development of big business and the trusts of the late nineteenth century. Theodore Roosevelt, a Republican as were the vast majority of Progressives, ultimately believed that nationalization or at least federal licensure of big business firms was necessary to ensure that trusts remained good and reasonable.

But did the very existence of trusts depend at least in part on government subsidies in the first place? This is what William Graham Sumner wrote in 1883 about corporate fraud and government subsidies to business:

"I have said something disparagingly in a previous chapter about the popular rage against combined capital, corporations, corners, selling futures, etc., etc. The popular rage is not without reason, but it is sadly misdirected and the real things which deserve attack are thriving all the time. The greatest social evil with which we have to contend is jobbery. Whatever there is in legislative charters, watering stocks, etc., etc., which is objectionable, comes under the head of jobbery. Jobbery is any scheme which aims to gain, not by the legitimate fruits of industry and enterprise, but by extorting from somebody a part of his product under guise of some pretended industrial undertaking. Of course, it is only a modification when the undertaking in question has some legitimate character, but the occasion is used to graft upon it devices for obtaining what has not been earned. Jobbery is the vice of plutocracy, and it is the especial form under which plutocracy corrupts a democratic and republican form of government. The United States is deeply afflicted with it, and the problem of civil liberty here is to conquer it. It affects everything which we really need to have done to such an extent that we have to do without public objects which we need through fear of jobbery. Our public buildings are jobs--not always, but often. They are not needed, or are costly beyond all necessity or even decent luxury. Internal improvements are jobs. They are not made because they are needed to meet needs which have been experienced. They are made to serve private ends, often incidentally the political interests of the persons who vote the appropriations. Pensions have become jobs...The California gold-miners have washed out gold, and have washed the dirt down into the rivers and on the farms below. They want the Federal Government to now clean out the rivers and restore the farms. The silver-miners found their product declining in value, and they got the Federal Government to go into the market and buy what the public did not want in order to sustain (as they hoped) the price of silver. The Federal Government is called upon to buy or hire unsalable ships, to build canals which will not pay, to furnish capital for all sorts of experiments, and to provide capital for enterprises of which private individuals will win profits. All this is called 'developing our resources' but it is, in truth, the great plan of all living on each other.

"The greatest job of all is a protective tariff. It includes the biggest log-rolling and the widest corruption of economic and political ideas...The farmers have long paid tribute to the manufacturers; now the manufacturing and other laborers are to pay tribute to the farmers. The system is made more comprehensive and complete, and we all are living on each other more and more...

"...Attention is all absorbed by the clamorous interests, the importunate petitioners, the plausible schemers, the pitiless bores. Now who is the victim? He is the Forgotten Man...."

The Left As Teen-Age Rebellion

The programs that the left advocates have done little to help and instead have harmed the poor. American inner cities deteriorated in response to urban renewal and welfare programs. The socialist revolution in Russia resulted in the starvation of millions of peasants and a wide range of ethnic hatreds. The Chinese socialists have oppressed and murdered Tibetans and the religious as well as millions of politically incorrect businessmen and bourgeoisie. More people have been slaughtered by the left and by socialism than by the advocates of any other creed or belief system. There has not been a socialist economy that has produced economic progress, and the general result of socialism as in Cuba and North Korea have been violent suppression and impoverishment of the poor. Yet, sociopathically, the academic left continues to justify, rationalize and lie about the effects of its programs.

In America, the left advocates a Kafkaesque program of large institutions, big government and centralized control. Its program includes not only the bureaucratization of medicine but also of investment, self-defense, business and political speech. The failure of its programs do not deter its commitment to rigid, large scale enterprises. For instance, the left remains obsessively attached to social security and the Federal Reserve Bank despite dismal benefit/contribution ratios from the former and inflation and corruption from the latter.

The left's recidivist advocacy of failed ideas can be explained in three ways. One, the left might be depicted as religiously obsessed with its ideas, and riddled with power needs, and so habituated to its love of government and centralized power despite seventy years of repeated failure. Two, the left is cognitively limited. Although many on the left are not smart, many are smart enough to grasp the pragmatic implications of its program. So this is at best a partial explanation. Three, the left is economically motivated.

There is a recurrent theme that goes something like, "Oh, isn't it amazing that George Soros or this or that businessman is a billionaire and yet he favors our (left-wing) positions". Conversely, many Libertarians and conservatives conceive of businessmen as supportive of the free market position, and then are astounded when businessmen do not support that view. In reality, the left's views coincide fairly neatly with the views of big business. Big business believes in big government because without it it would not be so big. The political scientist Charles Lindblom in his book on market economies remarks on the "privileged" position of big business, and indeed, since the days of Hamilton big business has relied on centralized government. There is no evidence that government support of big business helps the public in any way. Rather, subsidization makes firms less efficient and less customer oriented. For instance, cable television, telephone, public utilities, health care, banking and insurance firms are subsidized and they are among the least customer-responsive firms. The reason is that government regulation reduces competition.

Chief among government subsidies to big business is first the Fed, which provides interest rate and loan subsidies to business, and second, higher education, which provides training to large firms, to a degree at public expense. Thus, professors' livelihoods are linked to the welfare of big business and they themselves enjoy subsidies just like the ones big business enjoys. Without big business demand for graduates, there would be no demand for universities. So why are academics so often critical of big business?

In fact, university professors are NOT critical of big business where it counts, and their criticisms are not adverse to big business's interests. Big business is not adverse to enhanced central control, socialism, regulation and the mixed economy because such control eliminates competition. Universities have, as well, been the chief advocate of central banking through economics and business programs. Big business would not be so big without the Fed, and without the regulation that historians and sociologists advocate. There are few economists who question central banking, and of all the issues this is the one that big business cares about most.

University professors depend on big business much as teen-agers depend on their parents. Without big business demand for graduates, there would be no demand for universities. Thus, like teen-agers, university professors rebel by criticizing big business's hypocrisy, its lack of "social responsibility", and its selfishness, even as the professors themselves are equally hypocritical, equally irresponsible socially and even more selfish than business executives. But, like teen-agers, the university professors return home to be fed at the end of the day, and find the possibility that they will be thrown out and sent to work unthinkable. Moreover, the upshot of their criticisms, like teen-agers', is a psychological replica of the institutions and habits that they criticize. In other words, they claim to criticize big business even as they advocate systems that are necessary to it. In the end, the university professors are the chief proponents of big business capitalism, helping it by diverting attention to shrill issues like diversity and global warming.

Community, Progressivism and the States

Woodrow Wilson advocated states' rights as part of his progressive philosphy. In his book Constitutional Government in the United States, first published in 1908 and still considered a classic in the political science field, Wilson argues for the importance of the states. The model of centralized federal authority was a product of the two Roosevelts, not of Wilson, despite his inadvertent contribution by creating both the income tax and the Federal Reserve Bank. Theodore Roosevelt, the most statist of all of our presidents, argued for integration of government and business. Franklin Roosevelt extended state power in numerous areas, most importantly by abolishing the gold standard.

Despite the twentieth century's centralization of power, Wilson understood the importance of local government to community. Excessive centralizaton overlooks the importance of community and so is anti-democratic. Since the primary thrust of the New Deal was such centralization, it was at odds with the progressive era's emphasis on democracy, or at least Wilson's version of it.

Wilson writes (pp. 50-1):

"Not only are the separate and independent powers of the states based upon real economic and social differences between section and section of an enormous country, differences which necessitate adaptations of law and of administrative policy such as only local authorities acting in real independence can intelligently effect; but the states are our great and permanent contrbiution to constitutional development. I call them a great contribution because they have given to the understandings upon which constitutional government is based an intimacy and detail, an adjustment to local circumstances, a national diversity, an immediate adaptation to the variety of the people themselves, such as a little country may perhaps dispense with but a great continent cannot...They have furnished us with an ideal means of integrating a vast and various population, adapting law to changing and temporary conditions, modulating development and permanently securing each item of progress. They have been an incomparable means of sensitive adjustment between popular thought and governmental method, and may yet afford the world itself the model of federation and liberty it may in God's providence come to seek...Constitutional government can exist only where there is actual community of interest and of purpose, and cannot, if it be also self-government, express the life of any body of people that does not consitute a veritable community. Are the United States a community? In some things yes, in most things no. How impossible it is to generalize about the United States."

Big business has likely pressed for centralization, and it is likely in the interest of big business to have consistent regulation and policy across the states. But big business has exited the nation. Manufacturing has moved to Asia and Mexico. The remaining large firms often do not pay high wages. Do the American people owe a favor to the firms that have not been interested in supporting them? Moreover, the problems that confronted big business in decades past have been modified, reduced and eliminated by technology. The coordination of separate regulatory, accounting and legal systems today is far from the problem that it was in the 1930s and 1940s. Integrated computer systems make compliance across diverse regulatory systems simple. Thus, large firms will suffer little from decentralization. Moreover, given the globalization of business and the eagerness with which firms have entered foreign countries with diverse regulatory systems, it is difficult to understand why adding more diversity will pose much of a problem to them, or given the eagerness with which firms have adjusted to diverse regulatory systems they can properly claim that they are an impediment here in the United States.