Would the Big Guys Still Buy Out All the Little Guys in a Free Market?

I frequently discuss free market economics with my friends. A few of them are free market advocates like I am, but we still ask each other tough, critical questions from time to time. Sometimes we are just playing devil's advocate, but other times we honestly don't know the answer. In one recent discussion I had, one of my friends (a supporter of free markets) asked a good question to which he did not have an answer. I'll paraphrase what he said:

"I understand how government intervention is often used to concentrate wealth in the hands of the politically well-connected. But I still have lingering doubts that a totally free market would prevent wealth from becoming ever more concentrated in the hands of the wealthiest and most powerful people. For example, look what happens to most successful start-up companies. A big competitor inevitably comes along and offers to buy out their business for such an attractive sum that it would be crazy to refuse. So the big guys can just buy out all of the little guys to eliminate the competition and maintain their monopolies, can't they?"

I started to respond but stopped in mid-sentence when I realized I didn't have an answer to the question. My friend had stumped me. A small seed of doubt regarding totally free markets had been planted in the back of my mind.

A few weeks went by. I continued to read books and articles by Austrian economists and libertarian scholars, keeping an eye out for something -- anything -- that might address the hard question my friend had asked. Finally, today as I was reading Thomas Woods's new book Meltdown, a passage on page 48 jumped out at me:

In the wake of the Enron scandal and the dot-com boom and bust, Congress passed Sarbanes-Oxley, a regulatory act that well-established firms came to welcome since they knew it would give them a competitive advantage against newcomers. They had no idea how much. The most recent estimated annual cost to implement it in a public corporation is $3.5 million.

So how does this $3.5 million cost of implementing the Sarbanes-Oxley regulations apply to small businesses choosing to sell out to their much larger competitors? Woods quotes Michael S. Malone from a 2006 Wall Street Journal article:

"The closer you look at Sarbanes-Oxley," writes [Malone], "the more you realize it is almost perfectly designed to crush new business creation.... [$3.5 million is] pocket change for a Fortune 500 company, [but] the entire annual profit of a newly public firm. Is it really any wonder that smart entrepreneurs look for a corporate sugar daddy instead of an IPO?" Add to that Regulation FD ("Fair Disclosure") and the new rules on stock option valuation, and the result is that "fewer new companies are going public; economic power is being concentrated in the hands of fewer companies; competition is reduced; new wealth is less widely distributed; the rich are getting richer; fewer talented people want to join entrepreneurial ventures; and corporate boards are getting stupider and more paranoid." That could be why the biggest, most established firms typically seem to favor additional regulatory burdens. Expect to hear them joining the chorus today, solemnly informing us how sadly necessary additional regulation is.

In other words, one of the main reasons so many entrepreneurial ventures sell out to the big guys rather than "go public" and compete with them is because government regulations have made "going public" prohibitively expensive.

This is a perverse effect of the government on the economy that few people understand. The mountains of government regulations burdening our economy disproportionately harm the small businesses, not the big ones, because the costs of complying with them are typically fixed rather than proportional to a business' size. And in addition to that regulatory strangulation, small businesses must also prepare themselves to do legal battle at any time with large corporations and their teams of highly paid lawyers over "intellectual property" and other anti-competitive schemes -- not an inexpensive undertaking for a small business, to be sure.

The little guys sell out to the big guys not because our economic system is inherently rigged against them, but because our government has made it so through incessant regulation and interference.