A Free Market Look at "Too Big to Fail"

Consider a company that has several divisions. One of them is losing money. What does the company do? It slows or shuts down operations in that losing business and devotes those freed up resources to the parts of its business that are making money. What makes sense for one business makes sense for the economy as a whole. Consider the typewriter.

Thirty years ago, typewriters were an integral part of daily life and a necessity for almost every institution. Today the typewriter has gone the way of the dodo bird, replaced by printers for personal computers. In the interim the world hasn’t stopped. People haven’t gone running hysterically through the streets day after day. Life went on and hardly anyone noticed. That is the beauty of the free market. Absent from government interference companies adapt to new market conditions. Those that do not adapt fail and are replaced with new companies. The resources from the failed companies are sold or liquidated through bankruptcy proceedings and they are freed up to be used by the more efficient entrepreneurs.

Imagine a company in 1980 that manufactured only typewriters and computer printers. No doubt the typewriter division at the time was the nuts and bolts of the business. It was the source of most of the profits, employed the most people, and commanded the most resources. It certainly could have been the opinion of management that if the typewriter business slowed dramtically they would have to fire most of their work force and even still might not survice.

As the years went on, management in the typewriter/printer company saw a shift in demand. More printers were being sold and fewer typewriters. They had to shutter old machinery and replace them with new printer specific lines of production. Workers had to be retrained. Perhaps there was some resistance to the change from veteran typewriter workers. Upon realization that the shift was critical for the company to not go bankrupt and eliminate all their jobs they had a change of heart. It’s makes sense. If the printer division is making more money, then resources should be shifted away from typewriters into printers. This would literally mean that he same warehouses that housed finished typewriters would now be used to house the printers. The same workers get retrained for new specific tasks and so on down the line.

None of this is particularly earth shattering. Companies that adjust to changes in market demand do well and others that do not adjust properly fail.

Now consider the “Too Big to Fail” argument. Suppose that thirty years ago there was a company or an industry for that matter that employed a high percentage of the area’s workforce. In hard times, you can imagine the howl for the government to do something to save the workers. Imagine a typewriter manufacturer that sold nothing but typewriters. Maybe the company was responsible for employing either directly or indirectly most of an area’s population. Now say the company did a poor job of forecasting the shift to printers and started losing money.

Suppose that when they were on the brink of bankruptcy they began crying out for government intervention to save them. What will happen to all our workers they will say? Our products are sold at typewriter stores. What of their employees? And what about the raw material suppliers and the eating establishments that our employees frequent? The word will go out that it would be madness to allow such an important company to disappear. The state’s senators and congressmen, if they are influential enough perhaps can arrange a bailout. If the industry is large, the cries to do so will be deafening.

Now consider what this means for the country as a whole. Just as it would not have made sense for the company that made both typewriters and printers to maintain its production in typewriters, it makes no sense for us as a country to take money from the public to give to a specific group of money losers. To the economy as a whole it doesn’t matter if it is the typewriter/printer company that now makes the printers or if the solely typewriter company disappears and is replace by a new company making printers. The key is that the market must be allowed to adjust to the public's desires and those are the items that need to be made with our limited resources.

Look at it from a foreign country’s perspective, say China for example. If we subsidized typewriter manufacturers in 1990 and did not let them fail we would have been wasting not only our valuable money and resources, but also our competitive edge. China would happily step in and supply the world’s growing appetite for computer printers. The market for printers will be filled with or without us.

Free market capitalism is what made the United States such a powerhouse of industry after World War II. We spent the next few decades satisfying market needs and in the process inventing and improving at an astounding rate. Everyone’s standard of living increased as a result. The polar opposite occurred in the centrally planned socialist economies behind the Iron Curtain. They had constant shortages of all consumer items. Hunger and misery were a fact of life.

If we as a country do not stop this foolish idea that some firms or industries are too big to fail we will only be subsidizing losers at the expense of the winners. Too big to fail is not free market economics and it doesn’t work. It will be doing a disservice to all of us to allow a few bad decision makers with powerful political allies to punish the rest of us.

Below are some of my previous weekly posts:

Another deflation scare as excuse to print money

Will fractional reserve banking create hyperinflation?

Governments cannot create jobs

Business cycles are caused by the Federal Reserve

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