Too big to fail, whose problem is that really?

A couple of days ago I heard that not only banks, but also insurers can be ‘too big to fail’. It lead me to wonder which other markets might have players that are too big to fail.

Up until now I’ve only heard of financial companies that are considered too big to fail, but I think that non-financial companies can also become too big to fail if their ties to the government are too strong or if there are no alternatives present in the market. In this regard it is important to notice is that most often, the companies that are considered too big to fail offer services, not products. And this makes sense in a way, as products that fail leave open obvious holes for competitors to step in and fill with products of their own and will lead to decreased sales for the producers of the failed goods, whereas with many services, you pay for a future performance, and a default of such a company will leave a gap that can be hard to fill because you depended on that service. However, too big to fail relates more to the role of government in our societies. Too big to fail implies that a company will be saved no matter what, because the loss of a failing company is irrecoverable for the community it is headquartered in.

The question that rises immediately to my mind is that of why something can become too big to fail in the first place.

I think that it can be split up in a couple of smaller questions:

  1. How can a government allow a company to become too big to fail in the first place?
  2. Why do consumers use the services of companies that are too big to fail?
  3. How does the behaviour of individual companies shape the markets they operate in, and how does this shape the risk to the societies that are connected to those markets?

In response to the first question, I think that it matters that politicians are not neutral. They are influenced by businesses to sway their way. In addition, in our society, we see that many companies are operated with government backing, leading to schemes that actually make becoming too big to fail very likely. Governments create regulations that favour big companies, and leave it to the companies to make it work.

As to the second question, I think there are two factors that allow companies to become too big to fail:

  1. Consumers can be (and I suspect often are) at a disadvantage when it comes to the available information when it comes to the the risks of buying into services that are necessary for day to day life are not made clear. What makes things worse is that companies are not required to be transparent when it comes to supplying information that can help consumers make this risk assessment.
  2. Higher economies of scale can lead to better pricing, but at the same time they can lead to companies that reach such a market dominance that they are becoming irreplaceable, or that their replacement would become too expensive.

Governments have erected telecom watchdogs, but these seem to be more occupied with regulating telemarketers and services with shady business practices that operate on the networks and seem less occupied with making sure that we can make a fair choice when we want to switch telecom providers.

People are limited in their choices because of government actions narrowing their freedom of choice or the freedom of the market to offer choice to the consumer. A good example of the failure of governments due to overregulation is the market for telecommunications products. This market is an oligarchy in almost every country. The reasons for this are twofold:

  1. Historically telecom companies have enjoyed a state backed monopoly, and if that monopoly has been released for the market they operate in, they also inherited the infrastructure that enables their services. This has enabled those companies to remain in controlling positions in those markets.
  2. regulations limit the number of players that can be active in the market. A good example is the limit on the radio frequencies that may be used by telecom companies to offer mobile services. The government has overregulated the use of RF spectrum in ways that eliminate the possibility of new players entering the market without paying them huge fees for entry, which favours he current players in the market.

Governments should not be managers of markets themselves, but should be the managers of the fairness of the markets. More often than not, government intervention through regulation seems to lead to selection pressure that makes markets less fair for everyone involved. I’d rather spend billions of tax money on the execution of anti-trust regulations than on saving banks.

As for the third question, I think I’ve already partially answered it in the answer to the first and second questions in that it is clear that companies are prone to grow towards monopolists, and that they are allowed to do so by our governments. Both Governments and companies are not transparent enough to enable the individual to to make for effective choices that will increase their freedom. To me, it seems that many big companies do business in ways that aim to limit the hindrances to their operations without regard to their civic duties or moral obligations. It makes sense to eliminate competitors and to limit entrance of newcomers to the markets they operate on as it increases profit and makes it easier to do business, but it poses a problem.

Of course, failure of this kind in the marketplace is undesirable, but is it really up to the government to cover such enterprises? Isn’t it the consumer that has the obligation to manage his own risk, as long as there’s no issue with abuse?

The individuals that make up our societies need to become owners of this problem before they can solve it, as without an active participation in the process, it is impossible to influence it. In this sense it is important that they do not only control their wallets, but also make sure that the markets remain fair though voicing their opinions effectively in the political arena. Unfortunately, politics seem to be dominated by elites with their ‘own’ agenda’s, and voters seem to be under the impression that there’s no way to change this for the better. (I put quotes around won because it is always the question on how much of the agenda of politicians is influenced by special interest groups) Thus political reform that would enable such choice seems unlikely, and the split between politics and the people continues to widen.

One of the causes that I’ve hinted on but not covered in much detail, is that services and infrastructure are often in the hands of the same players. To me that is wrong, as it hands the player the means to make markets less fair. Consumers should be held responsible just as much as governments and companies. Both governments and companies are essentially service providers, and should be completely transparent so that individuals can make informed choices. Informed choices can only be made when you have the right information.Consumers should be entitled to gather this information unobstructed, either as individuals or grouped together into collectives that provide this service to the consumer for them.

Buying a service is part of managing your life. In that sense, all life is politics. All purchases are politics just as much as voting is. Both pertain to managing your life.

 

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