The Economy by Peter R. Crabb: Economic climate favors the big, who grow bigger

PETER R. CRABB, professor of finance and economics at Northwest Nazarene University in NampaSeptember 17, 2013 

Peter Crabb

With slow economic growth and above normal unemployment, things are stacked against the little guy. This economic environment favors only the largest of corporations.

Since the recession ended in 2009, the U.S. economy has grown at an average annual rate of just above 2 percent as measured by real gross domestic product. But prior to 2008, the economy grew at more than 3 percent. This 1 percent difference may not seem like much, but over a decade it translates into trillions of dollars in lost output and income.

Meanwhile, unemployment is stuck above 7 percent nationally and 6.6 percent in Idaho. The number of employees at nonfarm business in Idaho is still about 20,000 below the peak in 2007.

What’s a business to do in such a weak economy? Grow through acquisition.

A number of large U.S. multinational corporations are acquiring other companies since internal or “organic” growth has become so difficult.

Microsoft recently announced it will buy cellular phone maker Nokia. Koch Industries, one of the largest private companies in the world, announced it will buy Illinois-based Molex Inc. for more than $7 billion. Just this August, Idaho-based Micron Technologies completed its $2 billion purchase of Elpida, a Japanese manufacturer of memory chips.

Economic theory shows us why these firms are trying to grow bigger. Firms that achieve economies of scale can better compete in their industry through lower costs and better pricing. This becomes increasingly important when you can’t grow top line revenue.

Economies of scale occur when the average total cost for producing a product (total cost divided by the quantity of output) falls as the firm increases its production capability and quantity of output. In general, companies achieve economies of scale by spreading administrative costs over a higher production level and expanding into new geographic markets.

A similar and related property is economies of scope. This theory shows how a firm can lower the average total cost of production by increasing production of different, but related, goods.

In today’s markets, firms are after more scale and scope. Recent merger and acquisition activity, like Microsoft’s foray into cellphones, suggests large, multinational corporations are pursuing strategies designed to increase both their global scale and their product mix.

Economic conditions are favoring large companies that do both. Since 2009, U.S. corporate profits have grown at an average annual rate of 13 percent. Meanwhile, proprietors’ income at nonfarm businesses, a proxy for the small business owner, has grown at only 8 percent.

This trend doesn’t bode well for the labor market. Compared to small businesses, large multinational firms are less likely to hire here at home, and as a result the U.S. unemployment rate is likely to stay elevated.

In a slow growth economy, the big guys will continue to take over smaller rivals. Politicians often say they will “look out for the little guy.” If they mean what they say, they will pursue policies that open more markets to competition and level the business playing field.

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prcrabb@nnu.edu

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