[This is the second article in the left-leaning LBRT101 section of the Guided Study at Liberty HQ]

One of the main concerns curious people have about libertarianism is that it is pro-business and pro-Big Business. If it ain’t multinational, it ain’t capitalism! But is being pro-market inherently the same as being pro-business? Do libertarians really love large corporations? These are questions that are often ignored, but are central to the discussion of economics.

So what do the questions mean? Isn’t being pro-market the same as being pro-business? In fact, the answer is a surprising “no.” To understand why this is the case, we need to understand the concept of corporatism as opposed to that of free markets. Free markets and libertarianism are about property rights and the freedom of choice that arises from those property rights. Corporatism, as we shall see, is the negation of both of these principles.

Corporatism

A lot of politicians talk about welfare these days, but few people talk about the largest and most widespread type of welfare in the US − corporate welfare. In fact, it’s almost never discussed outside of libertarian circles. Corporate welfare, corporatism, or political capitalism (none of which are actually free markets) describe a situation where government intervenes in the market to distort it in ways which specifically benefit the largest businesses. Many regulations passed under the pretense of helping individuals in need are in fact used to prop up the power of companies and corporations.

What this means is that due to government help, many corporations are artificially large. Not only this, but some large businesses are allowed to continue to exist while they would actually go out of business on the free market. This corporatism is pervasive in our economic system and fosters the existence of inefficient large corporations. Unfortunately, even many supposedly pro-market people confuse corporatism with free markets. Let’s look at how government intervention props up businesses that should not exist.

Obvious Examples

Military Industrial Complex

Corporatism is an interesting beast. Sometimes it’s very obvious, while at other times it’s very subtle. The easiest example of corporatist policy is seen in the Military-Industrial Complex, which is illustrated visually below:

Take Congress as the starting point. Congress gives extra tax dollars to the DoD. The DoD then uses them to give taxpayer-funded contracts to the large military contractors, which in turn fund the campaigns of Congressmen. This promotes boundless military spending far beyond the level necessary for a robust national defense. In fact, the US spends more for military purposes than then next 13 biggest spenders [1]. That number includes large countries like Russia and China, which are considered the US’s biggest rivals in military power. It also includes the main countries that were on either side during World War Two. Again, US military spending is greater than all of these countries put together. This is exacerbated by the Military-Industrial Complex, which creates enormous government-funded corporations that siphon wealth from the economy into overinflated military spending.

That the Republicans support the military-industrial complex unconditionally is very curious, because war is very much contrary to all the principles conservatives are supposed to have. First off, war violates the sovereignty of a country and it aggresses against the lives of millions of individuals. Army structure is highly collectivistic and totalitarian − following orders without question. Not only this, but it’s publicly funded and adds substantially to the debt. If there were one policy conservatives should oppose, it’s the perpetual warfare in which the US has been embroiled for centuries. Even James Madison warned us long ago:

Of all the enemies to public liberty war is, perhaps, the most to be dreaded because it comprises and develops the germ of every other. War is the parent of armies; from these proceed debts and taxes … known instruments for bringing the many under the domination of the few…. No nation could preserve its freedom in the midst of continual warfare.

The “domination of the few,” of which James Madison warned us so correctly, can be labeled aptly with what we know of as the military industrial complex.

Banks

If libertarians are supposed to love big businesses, then they should love the big banks on Wall Street, right? Quite wrong. It would be a true challenge to find a real libertarian who is a proponent of the big financial institutions like J.P.Morgan Chase, Goldman Sachs, and Bank of America. Why? Because these large banks were not creations of the free market. The reason why the banks have gotten as large as they have is due to the government intervention that has propped them up. Economist Arnold Kling discusses banks, noting that

far from being engines of free enterprise, they are conducive to what might be called “crony capitalism,” “corporatism,” or, in Jonah Goldberg’s provocative phrase, “liberal fascism.” […] our big banks are the product, not of economics, but of politics. [2]

One of the ways in which banks are helped by intervention is when their risks are backed by the government. The banks know both from history and from present promises that they will be bailed out if they make bad investments. This creates what is known as moral hazard. This means that the banks know that they are not playing with their own money, but with other people’s money. If they happen to make correct, profitable investments, they will keep the profits. If they make bad investments, then their losses will be socialized across all of society through taxpayer funding. This is not free markets at work. This is corporatism.

Another way in which the government benefits large banks will be explained a little later in the article, where we discuss the Federal Reserve.

Government subsidization and cartelization

Another obvious example of corporatism is when businesses are subsidized by government. This is money that the businesses would not have received under free market conditions. The effect of these subsidies is that business that are less profitable will be made to look more successful than they actual are. While businesses on the free market make money because of a superior or cheaper product, businesses that are subsidized make money thanks to political connections.

One such example is the ample agriculture subsidies the US government hands out to agribusiness corporations. Congress leads the public to believe that the farmers it’s helping are the small farmers of the (long-gone) American past and in this way manages to manipulate the public while coordinating a transfer of wealth from the middle and lower classes to the upper class − through government intervention. These subsidies are not at all necessary to keep food prices low, yet misguided public fear keeps the money flowing upwards. For example, in 2008, Congress passed a bill to give $284 billion of subsidies to agribusiness through 2012.

Besides subsidization, government can outright cartelize certain industries. What this means is that it can prevent new businesses from entering a market and competing with already-existing businesses. This results in stagnation in the industry, as well as an increase in prices due to a lack of competition. Unfortunately, the free market is often blamed for this situation, when the real culprit is the intervention which restricted the market and the entrepreneurs. AT&T is a prime example of this. Many people remember the government breaking up the AT&T monopoly and consider that a case where the free market failed and the government had to step in. While this explanation is appealing and straightforward (who wouldn’t like to be able to solve problems by easy government action?), it was not the case. Adam Thierer explains what happened in his article “Unnatural Monopoly: Critical Moments in the Development of the Bell System Monopoly”:

Most legislators, academics, and many others believe the telephone industry is a natural monopoly that was privately monopolized by the aggressive actions of the American Telegraph and Telephone Company(AT&T). That was hardly the case. Although AT&T undoubtedly encouraged the monopolization of the industry, it was the actions of regulators and federal and state legislators that eventually led to the creation of a nationwide telephone monopoly. […] [T]he reason competition did not arise within the industry earlier this century is because it was not allowed to [by government regulation] [3]

To summarize his argument, AT&T was a monopoly because it was explicitly made one by government. This isn’t some cranky historical revisionism − it’s a public secret that is not really denied by anyone. Before the middle of the 20th century, the government decided that competition against AT&T was “unnecessary duplication” and gave AT&T a monopoly. The problem with their decision was that only the market process can decide the correct level of capital investment in an industry. When the government creates barriers to entry, it creates monopoly and inefficiency.

AT&T is not the only example. Economist Thomas DiLorenzo gives further support:

The railroad and trucking industries were cartelized by the federal Interstate Commerce Commission (ICC) for many decades, for example. The ICC set monopolistic prices in these industries and prohibited genuine competition. The Civil Aeronautics Board (CAB) cartelized the airline industry by prohibiting price competition [4]

When a person approaches the problem from the correct framework of analysis, it becomes apparent that corporatism is all around us in very evident forms.

Less obvious examples

The Impact of Regulations

In the discussion of the impact of regulations, I will ignore the ways in which regulations can be innovation busters by preventing novel ideas from ever becoming products. Instead, I will focus on a much more pervasive problem that arises from government regulations.

Everyone knows that government regulations have costs. The government cannot simply say “change your business practices in such and such way and jump through hoops X, Y, and Z” and have the change come about for free. There are often large costs to the regulations. Most people realize this. The logical conclusion of most people, then, is that businesses must inherently be anti-regulation. After all, why should a business want to impose extra costs on itself?

In fact, there is a very good reason for some businesses − not all! − to want to have government enact regulations on a market. This is because regulations impose what is known as a fixed cost of compliance on businesses. However, remember that not all businesses are the same! Large businesses are able to absorb the costs much more easily than smaller businesses. As a result, regulations not only make smaller businesses struggle and hence lose market share to larger businesses, but they often prevent new businesses from entering the market at all! If a young new entrepreneur has a fixed amount of money to invest in the creation of a new start-up business, regulations add on to that burden and often make it literally impossible for her businesses to come off the ground. Not only do businesses incur additional production-related costs when government mandates changes to the production process, but they also develop the need to invest extensively in lawyers to be able to keep up with the new regulations and accompanying paperwork. Taken together, all these burdens severely restrict the entry of new businesses into a market and allow existing large businesses to stop innovating and to stop cutting prices. [5]

The eerie thing about this process of suppressing smaller businesses by using government is that it is very often started by larger businesses themselves. Take the story of sugar, for example [6]:

Back in the day (like in all stories), soda used to be made with sugar. Nowadays, it’s made with high-fructose corn syrup (HFCS), which is relatively less pleasant to the taste and is considered by some scientists to be less healthy than sugar. Why the switch? Was it the case of free markets being greedy and using a cheaper ingredient to make an inferior product? Actually, it’s the exact opposite.

The tendency of the free market was to use world sugar in the production of soda. This was a problem for domestic sugar producers, because they could not compete with the foreign sugar. But instead of deciding to compete with foreign producers for the money of the millions of consumers that make up the free market, they decided to turn to the power of government and to impose a tariff on foreign sugar.

The other character in this story is a company called Archer Daniels Midland (ADM), a corn producer. Why would a corn producer want to increase the price of sugar? We know from economics that when the price of a good increases, people buy less of it and look for substitutes. High-fructose corn syrup, made from cornstarch which ADM produces, is such a substitute. The problem for ADM, however, was that HFCS was too expensive to make to compete with sugar. The price of sugar had to be artificially increased using the government. ADM allied itself with sugar producers (who were pushing for a sugar tariff to eliminate competition) and managed to increase sugar prices way above the costs of HFCS (the world price of sugar is 22 cents per lb, while the US price is a whopping 44 cents per lb [7] − double the price). Thanks to government intervention, for every $1 that ADM makes, consumers pay a hidden $10 due to the protectionism.

This story would be scary on its own right even if it ended there. However, there is a bonus section, all just for you! Enter the close friend of corporatism: unintended consequences. The effects of the intervention did not end with sugar prices increasing artificially and the rise of HFCS. It turns out that the same machines that produce HFCS are suited for the production of ethanol. Therefore, companies started to make ethanol from corn. Ethanol production from corn resulted in increased food prices, because corn was now being employed in more production processes. In fact, the increased use of ethanol is responsible for a 10 to 15% rise in the price of food. Combine this with an additional 45-cent per-gallon subsidy for domestically produced ethanol (which encouraged evenmore production) and a 54-cent tariff placed on foreign ethanol (which artificially restricted much-needed competition), and ADM quickly cornered the market and drove up food prices by using government intervention.

The Federal Reserve

It was discussed previously how large banks are government-created creatures. We pointed out that moral hazard allowed banks to circumvent the free market and make money off the tax payers. However, we left out a more sophisticated analysis of banks which is more subtle − the Cantillon effects of the Federal Reserve.

The Federal Reserve (Fed) is the central bank of the US created by the federal government, whose head, the Chairman, is selected by the President of the US. The Federal Reserve can control the money supply of the economy − increasing or decreasing it at will.

Classical economists believed in what is known as the quantity theory of money. This theory states that if the money supply were doubled by the government, the result would be a doubling of the price level in the economy. That is, if something cost $5 before, it would cost $10 afterwards. The reasoning for this is that a doubled amount of money chases a fixed amount of goods, which leads to an increase in prices. The belief in this theory means a belief in what is known as monetary neutrality. That means that injections of money into the economy do not matter, because they simply increase all prices across the board (both goods and wages).

Economists have moved away from this theory because they realized that it’s not quite true that money is neutral. In fact, there is a thing called Cantillon effects. Essentially, it takes time for the price level (all the prices in the economy) to increase when money is injected into the economy. The people who get access to the money first are able to use it before the prices of goods increase. Consider a small town with around 300 people. If one of them is suddenly given an extra $2000 to spend, prices will not increase immediately. They will increase as the money starts making its way through the economy. The lucky man who got them first, however, will likely get to use much of the money before the prices of goods “catch up” to the increased money supply. This means he will be able to draw resources away from society for free.

Who, then, benefits from Cantillon effects? The people who get the money first. And who gets it first? The largest banks. That is where the Fed-created money is injected first, which results in the banks being able to use the money before it loses its value − therefore gaining an unfair advantage that they would not have on a free market. This effect is very subtle, and even many economics majors in college are not taught about the redistributive effects of money printing. (The analysis could be extended even more, in fact. Not all prices in the economy adjust equally quickly. That is, while food prices could increase quickly due to money printing, wages are usually locked in by contract for a much longer time. This means that the price of goods increases while people’s income doesn’t. This is especially harmful to the lower and middle class − and beneficial, again, to large banks.)

Much, much more!

There are many more ways in which corporatism destroys free markets – all the while having them take the blame for its own failures! Keep an eye out for more ways in which government violates property rights to favor large businesses as you read through the guide to libertarianism.

What does this mean?

So far, we’ve analyzed corporatism. What is the conclusion from all of this, and how does it relate back to the original question? Roderick Long explains that

Corporations tend to fear competition, because competition exerts downward pressure on prices and upward pressure on salaries; moreover, success on the market comes with no guarantee of permanency, depending as it does on outdoing other firms at correctly figuring out how best to satisfy forever-changing consumer preferences, and that kind of vulnerability to loss is no picnic. It is no surprise, then, that throughout U.S. history corporations have been overwhelmingly hostile to the free market. Indeed, most of the existing regulatory apparatus − including those regulations widely misperceived as restraints on corporate power − were vigorously supported, lobbied for, and in some cases even drafted by the corporate elite. [8]

Nobel Prize winning economist George Stigler concludes that

as a rule, regulation is acquired by the industry and is designed and operated primarily for its benefit [9] [Emphasis mine]

Economist DiLorenzo concurs:

[L]arge corporations often support and lobby for onerous [government regulations] because they understand that the regulations will be so costly to enforce that they will likely bankrupt their smaller competitors while deterring others from entering the market in the first place. Businesses long ago discovered that the only way to have a long-lasting cartel is to have the cartel agreement enforced by the government. [4]

We see the emergent pattern: businesses (especially large businesses) favor government distortion of markets in their favor. There are many economic theories that explain this. One is that of regulatory capture, promoted by Stigler, who argues that industries are able to use the government agencies regulating them to benefit them by destroying the market. Another is that of the “Bootleggers and Baptists,” where big businesses are able to ride on some popular sentiment and use it to pass laws that secretly benefit them [10].

Are libertarians, then, pro-business? The answer is a resounding no. The interests of businesses can be, and oh-so-often are contrary to the very idea of the free market. Being pro-business means being in favor of whatever measure is needed to secure the profits of a business. However, this means accepting all the government intervention which favors big businesses all the time.

Being pro-business and being pro-market are two diametrically-opposed stances. Being pro-business means agreeing with the anti-market interests of many businesses, which foster inefficiency, lack of innovation, protectionism, and increased prices. Being pro-market, on the other hand, allows one to see that the large-corporation world that exists today is not a product of a respect for property rights and free choice, but instead a product of special interests in bed with government. The history of big business is the history of big government.

Conclusion

Libertarians are not pro-business. Neither should they support all the big businesses that exist today right off the bat. They shouldn’t defend businesses that have grown unnaturally large thanks to government, rather than the market. I must take the opportunity to chastise Ayn Rand, who calls large businessmen a “persecuted minority.” She gets so caught up in defending markets that she forgets that we do not in fact have free markets, and that she is often defending the products of government intervention. This is not to say that all businesses today are fake and should be denounced. Yet in a large number of cases, businesses grow thanks to government. In the coming articles we will explore how free markets, as opposed to corporatism, work to generate wealth.

Here is a good video that sums up this article, and makes the case why it is in fact supporters of government intervention who can be better characterized as “pro-business”:

P.S. The Solution

One of the questions that the reader may have is “how do we solve the problem?” In the coming articles we will see why moving toward a free market is likely the better solution − one which decentralizes power and which rewards companies which truly create, and not destroy, value.

Some people might be tempted to conclude that if government created artificially large firms, it should go on to regulate them. I would like to point out that this has been the solution that has been tried so far. Not only this, but this continues to allow inefficient firms to remain in business − it in fact entrenches them and reinforces their power and legitimacy.

Others might think that the firms should be broken up by government. Even some libertarians have argued for this solution, in fact. The problem with this, however, is that government does not, andcannot know what the “right” size of a firm is. This can only be discovered by the market.

The solution, then, would be to remove the government intervention that makes businesses artificially large − and allow market forces to tear the firms down and move the capital and resources into useful lines of production. Be warned, however − this process is tricky, and often what may appear to be freeing up the market will actually be granting of special non-market privileges. We will explore this process after giving a better explanation of how markets work.

-Wheylous

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Tagged: agribusiness, AT&T, Bank of America, banks, big business, big corporations, big government, bootleggers and baptists, Cantillon effects, Capitalism, cartel, cartelization, corporate welfare, corporatism, crony capitalism, cronyism, evil libertarians, Federal Reserve, fixed costs, Goldman Sachs, HFCS, High fructose corn syrup, J.P.Morgan Chase, military industrial complex, monopoly, political capitalism, regulations, regulatory capture, subsidies, sugar