How the State Destroys Small Businesses

On the Ron Paul Forum, someone asked:

I would love for you to explain in detail (since you seem to know such things) what the Fed has done to decimate mom and pop businesses in the nearly 100 years since its founding.

This question deserves its own separate post.

First, I'll expand your question. The correct question is: "How do the State and the red market destroy small businesses." The Federal Reserve is just one arm of the ruling class' war on the average US citizen.

There are two ways the red market destroys small businesses. The first method is the Federal Reserve and a corrupt monetary system, which is the most powerful method. The second method is government regulations. The burden of regulations falls heavier on small businesses and individuals than on large corporations. A large corporation can, as a % of sales, spend less on a team of lawyers to ensure compliance with the crushing regulations. A small business or individual can't afford the hassle of regulation compliance, and is driven out of business, or must grow and become another large corporation.

It's completely pointless to discuss economics when the basic unit of value, money, is completely and totally corrupt. It's like doing Mathematics where there's a huge division by zero error everywhere.

I'll start with a quote from Thomas Jefferson. This is frequently citied on anti-Federal Reserve websites.

If the American people ever allow private banks to control the issue of their money, first by inflation and then by deflation, the banks and corporations that will grow up around them, will deprive the people of their property until their children will wake up homeless on the continent their fathers conquered.

This is, of course, exactly what has happened. All US citizens are, technically, homeless slaves. Nobody owns their land. Due to property taxes, they merely have a perpetual transferable lease from the government. The income tax converts everyone into slaves.

Business cycles are 100% created by the Federal Reserve. Some other factor always gets the blame in the media. The Federal Reserve and The Compound Interest Paradox are 100% responsible for boom/bust cycles.

The Federal Reserve Destroys Small Businesses

Let's consider a hypothetical industry. Let's call it widget manufacturing. Widgets can be manufactured just as efficiently on a small local scale as in a large factory. If you seriously analyzed most consumer goods, you would actually find that small local business are more efficient than large centralized factories. Massive government subsidies are required to make large corporations profitable, in the form of government regulations and Federal Reserve sponsored negative interest rates. Large corporations exist because they're more efficient at extracting favors from the government, in the form of cheap loans or regulations. Even though I refer to "widgets" in this article, you could substitute any consumer good.

Suppose that widget manufacturing is dominated by small businesses. Let's illustrate how the Federal Reserve destroys the "mom and pop" widget industry.

Suppose that each small widget manufacturer can make 100 widgets per day, and the average person can afford to buy 1 widget per year.

Consider the effect of a boom/bust cycle.

The Federal Reserve expands the money supply by cutting interest rates to 1%. Suppose the money supply doubles. With more money in circulation, and prices haven't risen to compensate yet, the average person can now afford 2 widgets per year. The widget manufacturers all borrow to increase their manufacturing capacity. The widget manufacturers who don't borrow to expand can't meet their rising payroll costs and other expenses. Besides, interest rates are cheap! The banks charge a 1% fee on the loans and offer to loan to the widget industry at 2%. Who wouldn't borrow at 2%? Free money! Who would refuse? The widget industry was thriving, so all this widget debt is rated AAA investment grade.

In other words, due to the expansion of the money supply, the small businesses are forced to borrow to expand to keep up with boom cycle.

Now, the Federal Reserve says "we are concerned about inflation". They jack up interest rates to 10%, and the money supply crashes to half of what it was before. Now, the average person doesn't buy 2 widgets per year; the average person can only afford 0.5 widgets per year. However, the widget manufacturers have geared up their production expecting to sell 2 widgets per person per year. All the widget manufacturers doubled their productive capacity; they now can make 200 widgets per day. The price of a widget crashes.

The widget manufacturers who doubled their productive capacity by borrowing weren't stupid or greedy. They had to do it to stay competitive with the other widget manufacturers during the boom cycle. Of course, the media loudly decries all the widget manufacturers who were foolish and greedy. They now deserve to lose their businesses.

The price of a widget has to crash to compensate for the reduction in the money supply. But the widget manufacturers have all this outstanding debt! They can't cut prices, because then they won't be able to repay their loans. They can't leave prices where they are, because then their competitors (who are just as desperate) will offer lower prices and take their customers. The aggregate productive capacity is far greater than the aggregate demand.

Almost all the widget manufacturers will be forced into bankruptcy. All the widget debt is slashed from AAA to junk quality. The banking industry forecloses on all the small widget manufacturers. The banking industry takes possession of the means of production.

Now, the banking industry has a problem. It is in foreclosure of the widget industry. However, the bank is stuck with all this junk quality debt and junk assets. Who wants to invest in widget manufacturing? That's a dead industry! Fortunately, the banks don't have to mark their debt and confiscated assets to market; otherwise, they would also be insolvent. Besides, there is no market in the subprime widget industry debt. The banks don't need to sell the loans, when they can still carry them on their books at face amount. Maybe they'll write down 5% or 10%, just so they can look good publicly. Perhaps some small banks will go bankrupt. The large banks know the Federal Reserve is going to help them soon; after all, they control the Federal Reserve! Also, the large banks have diversified assets so the widget debt is a small percentage of their total assets. Other industries are also struggling during the economic bust, but they aren't in as bad shape as the widget industry.

The Federal Reserve says "We are concerned about the credit crunch and rising unemployment. It is time to cut interest rates." Interest rates are slashed to 1% again. The money supply grows to even more than it was before. The banks are still in foreclosure on the widget industry, but due to the money supply expansion, the confiscated widget manufacturers' assets rise in value. The banks have been "saved" by the Federal Reserve. The banks sell off the widget industry in pieces to a handful of megacorporations. The loans can be priced at 4%; the banks know they will get repaid because the widget industry is now a handful of oligopolies. Even in the next recession, the widget industry won't cut prices that much, because the widget corporation cartel will keep prices at a comfortable level. The large corporations can afford to stockpile inventory during the next recession, perhaps also having layoffs and slowing production.

If some individual says to a bank "Can I borrow to buy my widget factory back?", the bank will charge 8% interest. The bank will say that small widget manufacturers are unworthy creditors. After all, their business model has been discredited in the "free market"! They have to be charged 8% when the megacorporation only was charged 4%, because a large diversified corporation is always going to repay its debts.

In case this scenario sounds like a fantasy, this is EXACTLY what happened to small farmers during the Great Depression. It happens to a different segment of the economy in each business cycle. Currently, it's the subprime mortgage debtors who are getting the shaft.

Regulations Hurt Small Businesses

Government regulations also hurt small businesses.

Suppose a few small widget manufactures manage to survive the boom/bust cycle. The large corporations have a problem, because the small manufacturers are going to be more efficient. The large corporation can sell widgets for $5 each, and the small manufacturer can profitably sell widgets for $4 each. The solution is that the management of large corporations lobby for regulation of the widget industry. All widget designs must be approved by the FWA (Federal Widget Administration). This regulation is really complicated and it costs $5M/year to stay in compliance. Large corporations gladly comply with this regulation. They make 100M widgets per year, and they can raise the price of a widget by $0.05 to cover the cost of compliance. What about the small widget manufacturer? He also has to pay $5M/year to ensure compliance regulation, but he only sells 1M widgets per year. He has to raise the price of a widget by $5 to cover the cost of compliance. Now, the large corporation can sell widgets for $5.05 each and the small manufacturer is forced to sell for $9 each. Suppose the government provides "regulation relief" to small businesses and the small business only has to pay $2M in regulation compliance costs. His total cost is still $6 per widget, which is more expensive than the large corporation.

Patent regulations also squeeze out the small manufacturers. As the widget industry progresses, most of the advancements will wind up patented by large corporations. The few large corporations in the widget cartel will sign mutual patent licensing agreements with each other; otherwise, they couldn't manufacture anything without fearing a lawsuit from a competitor! However, the small business owner isn't going to be able to sign a mutual licensing agreement. He can't manufacture anything without running afoul of the patents! Even if the things covered by the patents are really common sense ideas (such as software patents), the small business owner has no recourse. He can't afford to pay the legal fees for a patent lawsuit. Even if he goes to trial, there's no guarantee he'll get a judge or jury that understand the intricacies of widget manufacturing. In fact, judges are selected by the owners of large corporations, and the jury selection rules will make sure that someone smart enough to understand widget manufacturing doesn't make it onto the jury! The small widget manufacturer can't successfully argue that the techniques covered by the patent are obvious to an expert widget manufacturer.

Even if some small businessman is lucky enough to get a useful patent, the other corporations in the cartel have patented the rest of the aspects of the widget industry. In that case, the small businessman will probably sell his patent to a large corporation, or to a patent holding company. For an example of what happens when a small inventor sells a patent to a patent holding company, consider Research in Motion's famous patent lawsuit. Patent holding companies buy up many such patents, and try to enforce them even though they themselves have no product. That is pure state-sponsored extortion.

Also, customers are trained to buy based on flashy TV and newspaper ads. A small manufacturer cannot afford TV ads, but the large corporation can easily afford to spend a few cents per widget advertising. After all, advertising is cheaper than making widgets more efficiently or with higher quality! Even if the small manufacturer really is making widgets that are cheaper and better, he has no way to convey this to potential customers. He has to rely on word-of-mouth. There are no effective word-of-mouth consumer networks, partially because people don't have the spare time and partially because people trust the TV advertising to be fair. After all, if the government was unfairly regulating the widget industry, surely some newspaper would report on the story! Unfortunately, the newspapers and TV stations are owned by the same handful of people who control the widget manufacturing corporations.

Also, the retail industry is also dominated by a few large retailers. Large corporations want to buy from other large corporations. They don't want to deal with a small manufacturer, who can only supply a fraction of their sales. All the "mom and pop" retailers have been driven out of business by the process described above, so there's no place for the small widget manufacturer to sell his product. The only widgets offered for sale in Widget-Mart are those manufactured by the large corporations in the widget cartel.

A New Competitor is Blocked from the Widget Industry

Now, the widget industry is dominated by a few incredibly inefficient megacorporations.

Suppose someone says "Hey! These widget manufacturers are totally clueless! I can manufacture and sell widgets for half their price or less!" He opens a business.

He will be unable to get his product on the shelves of retailers, for the reasons described above.

He will run afoul of patent lawsuits.

The FWA (Federal Widget Administration) might shut him down for selling widgets that aren't regulation compliant.

The IRS might investigate him for not reporting all his income; the IRS is notorious for cracking down on small businesses for tax evasion. Even if he is ultimately found not guilty, he will have spent a lot of time and money fighting the IRS.

Maybe our entrepreneur is incredibly industrious and smart and hardworking and lucky and overcomes all these obstacles. This happens occasionally, even in mature industries. Ben and Jerry's is such an example, but don't hold them as an example of the economic system being fair; that's faulty reasoning. Our entrepreneur still has these huge fixed costs. In order to maximize his profit, he has to keep growing his business. As he grows, his profit also grows, because his fixed costs are a lesser percentage of his price. At some point, he will raise money from venture capitalists. The VCs will advise him to structure his business like a large corporation; this is correct advice, given the corrupt nature of the economic system. At this point, the growing business is having the same inefficiencies as a large corporation, but he's gaining the same benefits a large corporation typically gets. Eventually, he goes public with an IPO, sells his shares in his business, and retires. The ultimate effect is that the widget cartel has gained a new large corporation, but nothing has changed.

For each entrepreneur that succeeds, there are thousands or more that fail. The media triumphs the successful entrepreneur as evidence that the economic system is, in fact, fair. Of course, the economic system is unfair. A spectacularly successful business is the exception, rather than the rule. The media, as usual, uses this reverse Strawman Fallacy to falsely praise the current economic system.

For example, suppose someone desires to only be a small business owner, and not grow to be a megacorporation. They will be doomed to a career of just scraping by, or they will be forced out of business.

Agorism to the Resuce

Suppose our entrepreneur decides to be an agorist. He is going to manufacture widgets off-the-books. He is going to sell them privately to trusted trading partners. He's going to completely avoid taxes and he's going to completely avoid government regulations.

The agorist widget manufacturer can totally avoid patents. Even if he's unknowingly infringing a patent, it's not a problem.

The agorist doesn't have to worry about the FWA (Federal Widget Administration). He isn't reporting his work to the red market. He isn't formally registering himself as a business owner.

The agorist can save all the expense of income taxes. The agorist isn't paying income taxes, so he isn't supporting the Federal Reserve's subsidy of the widget manufacturer's cartel.

The agorist truly is more efficient than the large corporation. The on-the-books small widget manufacturer could produce widgets at $4 each. By completely avoiding income taxes and regulations, the agorist widget manufacturer may be able to profitably sell widgets for $3 or $2 each. His agorist customers will appreciate the lower price. If someone wants a custom widget with special features, the agorist will gladly comply. The agorist will repair his widgets for $0.50 or even for free; people who buy widgets from a large corporation will be forced to buy a new one when it breaks. The agorist can even afford to make higher quality widgets that don't break as often, provided his customers appreciate the quality. Large corporations sometime intentionally make products that break, to generate repeat sales, i.e. "planned obsolescence".

Suppose the agorist hires some employees. Later, they want to start manufacturing widgets themselves. There won't be any intellectual property laws preventing them from doing so. That's acceptable, if there's the demand; maybe the former employees will move to another city. Perhaps the market is big enough for several agorist widget manufacturers. Perhaps there will be an agorist widget association, where they mutually certify each others' quality.

Given the defective rules of the economic system, the agorist solution is the only hope that small businesses have. If you want to be a small business owner, you practically HAVE to work off the books or break laws in order to be profitable.

Summary

There are many tools the red market has to crush small businesses. Most of these laws and regulations were themselves written by the people who control most large corporations.

The most effective tool for squeezing out small businesses is boom/bust cycles. During boom cycles, the small business owner is forced to borrow and expand. A small business that does not borrow during the boom cycle will lose ground to competitors. During the bust cycle, the small business owner is unable to repay his debts and is foreclosed by a bank. The bank holds the confiscated assets until the next boom cycle, when it can sell them at a reasonable price.

In addition to the Federal Reserve, government regulations help squeeze out small businesses. Patents are an effective tool to squeeze small businesses out of the market. The cartelization of the retail industry means that small businesses can't get their product on the shelves of large retailers. The elimination of small retailers facilitates the elimination of small manufacturers. Customers expect slick TV ads; they'll be reluctant to buy from a manufacturer who doesn't have slick TV ads. Government regulation of product quality squeezes out small businesses, because large corporations pay less per unit in compliance costs. Large corporations love complicated IRS regulations, for the exact same reason.

In the above example, I use the hypothetical case of widget manufacturing. You could substitute pretty much any industry and the analysis would be the same.

Joining an agorist community is the only way out for the would-be entrepreneur. By avoiding taxes and regulations, you can have higher profits and lower prices. If you don't want to be forced to scale your business to a megacorporation to survive, then working agorist-style is your best option. The rules of the economic game are biased against the average person, so the only fair response is for people to completely ignore them.