First it was banks. Now it’s tech.
The “too big to fail” question is now directed at the darlings of the tech industry, those innovative companies that brought us more connectivity and social platforms.
This past year executives of companies such as Facebook and Google have spent more time in Washington, D.C. Both the president and members of Congress have increased their inquiries into what tech companies do with the vast amount of data they collect.
Economic theory and history suggest that such inquiries will lead these business leaders to adopt a very specific business strategy: Grow really big at all costs.
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To understand this, let’s first go back 10 years. The events of, and the government response to, the 2008 global financial crisis led regulators to start marking certain banks as “systematically important” and thereby in need of government guarantees. The dramatic recession that followed the financial crisis led to a similar determination on the part of the government that the auto industry was also critically important.
What was somewhat surprising about all this attention from regulators was how easily it was accepted by the banking and automobile company leaders. But it makes more sense if you consider that the increase in regulations makes it harder for new companies to enter the same industry and increase competition.
Economists call such regulations barriers to entry. The more difficult it is to enter a market, the less competition there will be.
As regulations increase, business executives have an incentive to enlarge and diversify their firms. For example, the Sarbanes Oxley legislation of the early 2000s discouraged smaller firms from growing. Large firms can bear the reporting and compliance requirements of this regulation more easily. As a result, there are fewer publicly traded corporations today.
Unfortunately, a “get big” strategy serves neither the firm nor consumers as industries become oligopolistic. An oligopoly is a market structure in which only a few sellers offer similar or identical products because there are large barriers to entry.
Oligopolistic firms maximize profits by forming cartels and acting like monopolists. You may say that cartels are illegal and this cannot happen. But firms, particularly large businesses, can implicitly act as cartels by not undercutting each other’s businesses, thereby protecting their turf from further competition.
The takeaway is that if we decide to increase regulation of the technology giants and social media companies, we can expect fewer choices and higher costs for these products and services. Only large firms that can handle the many compliance issues will be able to compete, and these same firms will control pricing and be beholden to government regulators.
Your phone and the apps on it may soon be too-big-to-fail businesses.
Peter Crabb is a professor of finance and economics at Northwest Nazarene University. firstname.lastname@example.org.