Why Modi (and all policymakers) should stay away from Big Business

modi-industry

Many Indians seem to believe that a key problem with India today is crony capitalism where large companies have bought politicians and bureaucrats in return for all types of favors.  AAP believes that BJPs PM candidate Modi is corrupt because of his association with big business; while BJP believes that closeness may make it easier  for reforms and sustainable growth.

Though AAP may be wrong, but the BJP definitely is.  Big business, is never good for the markets.  If Modi is as smart as he is being portrayed to be, he should should stay away from them while deciding policy matters (as he probably will after May).

Most of the criticism of big business in India has to do with crony capitalism.  Actually the problem with big business runs much much deeper.  Let me give a shot at describing the problem.

Economics theory says large companies exist because they can do something better than the market.  So large firms (typically with many tiered hierarchies, many divisions, many products and services, etc.) subsume buying and selling, and replace them with command and control of the hierarchy.  In other words, large companies are entities that exist by subsuming free market principles internally within the organization. This much is well known and Nobel prize recipients Coase, Williamson, et. al. have done some magnificent work on the Theory of the Firm.

I would like to take this a step further.  As an organization becomes larger (which essentially means that the command and control hierarchy becomes larger)  it becomes more and more inimical to the market.  (Though many large business owners would be horrified at being classified as market haters!)

Markets work best when a large number of buyers and sellers can chose what they want to buy and sell.  Since the number is large, the degree of choice is high, and this choice also gives each of them the freedom to accept or reject offers from the other party.  This is the core principal of a free market, which is the gold standard for efficiency, freedom and I will later argue – fairness.

But when an economy is populated predominantly by large companies, it by definition implies reduced choice for the seller of inputs, and reduced choice for the buyer of the companies output.  Distributors and retailers will tell you how salesmen push unwanted products down their throat, ancillary industry owners will tell us about how they need to hold large amount of inventory, and there are many many examples of unfair and unethical practices that large firms (ab)use on small buyers and sellers.

But this is not all.  One, large companies want us to believe that choice is limited – they spend large amounts on creating ‘Brand loyalty’, which is nothing but convincing potential buyers that they have limited choice.  Two, MNCs have already started this great farce of IPR – which essentially prevents many companies from competing with similar products at similar prices.  In many sectors Industry incumbents will call for creating bodies for ‘regulating quality’ – effectively preventing more competition.

But large companies do have some advantages, they are not bad in some dimensions, you may argue.  You would be absolutely correct. There are great advantages to economies of scale that only large companies can manage.  They are also great advantages in quickly being able to service a need that comes up quickly.  The rapid spread of telecom also shows how large companies can rapidly and at a low cost roll out a new technology.

In other words, large companies may have many advantages, but they will necessarily work against the functioning of free markets.  And so someone (Who? Don’t know yet!) needs to control large companies to protect the free functioning of markets.  Regulation has never done the job, government controls will be as bad, we really need to think of better tools to control big business.

But at the very least, their advice should not be taken too seriously – Modi  should laugh with them, hug them, stand and shake hands with them, all of that is good civilized behavior.  But he should not follow the advice they will give.

Note that I have not even brought up the problem of crony capitalism!   That is just another  mechanism of preventing market forces from functioning.

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