Today we will look at how debt based funding is anti-competitive. First of all we will discuss large disincentives to competition then small scale disincentives to competition.
Following the credit crisis in 2008 it was recognized that competition had contracted in the finance sector. This has been seen as a source of potential future problems by the UK’s Conservative government and they have setup the Independent Commission on Banking, charging them with the task of finding structural improvements to improve stability and competition in the banking industry.
The most obvious disincentive to competition in this area has been the tax payer funded government insurance scheme. This scheme has enabled the largest of these financial institutions to survive their own foolish lending. They have been given an exemption from the riggers of the free market because of their size. Smaller institutions which made the same mistakes however either dissolved or were sold by their share holders for cheap, often to the larger institutions. Whether or not you think government insurance of deposit, bond and share holders is healthy it is obviously a disincentive to competition.
It’s not only the finance sector which has lost competition through bailouts either. In 2009 the UK approved bailouts for the largest remaining players in the car industry and the insurance industry. Large players in these areas have been allowed to survive their economic problems, due to their size and stature.
Also to be considered on a large scale is how the instability of the credit cycle destroys competition. During a contraction in the credit cycle some businesses which were solvent until the crash will become insolvent or bankrupt, due simply to the downturn. This does not have to be because of foolish investment, as any business which has taken on a lot of debt can struggle to service it during an unanticipated down turn. Larger businesses in any sector have an advantage during a credit contraction simply because they have further to fall. A larger business which has not been badly caught out by the crisis might be able to shrink where a smaller competitor will fall into bankruptcy.
As everybody who studies economics is well aware the free market stops doing its job of enforcing competition when there are fewer competitors. In general this leads to higher prices and financial inefficiency in sectors of the economy with limited competition.
Now we should look at the beginning of a business. In general it is assumed that people from all kinds of economic backgrounds are capable of starting a business venture. It would be both totally incorrect and slightly unsavoury to imply that people in the upper income brackets are more suited to enterprise. However many kinds of enterprise can not be started without an initial investment of capital. This may be to support the owner and their family with some initial income until they are getting some income from their venture. In other cases the business venture requires capital for the purchase of inventory, premises or equipment.
Now if you consider Steve, a fictitious individual at a turning point of his life, currently in his early thirties. Steve has some work experience; and a formal education. Being at this stage in his life he has a roughly 70% mortgage on his own home. In this circumstance when considering a new business venture Steve must make a difficult choice. If he leaves his job and start out with a business he might well lose his home, even without taking a start-up loan for business funding. The risk involved having an unpaid debt provides a clear disincentive to him in taking any risk in the first place.
Next we consider Jane another fictitious individual in a similar situation. Jane however does not own a property or have any existing debt. The retail business she is considering starting however will require her to take on a loan so she can purchase inventory. Since she is not on a high income she does not have a lot of savings to capitalise here business with. Now as was explored in an earlier article on debts and prices in order to start up her enterprise Jane will need to service this start-up loan with increased prices. This makes her business less competitive than a better capitalised enterprise would be and so more likely to run into problems.
As was discussed in my earlier article the improved price structures in a full reserve banking backed economy put more capital into the majority of people’s pockets. This will mean that more people like Steve will own their homes outright and more people like Jane have personal savings to use as start-up capital.
You will see in turn more entrepreneurs setting up their own enterprises and increasing competition in all sectors where somebody can find a niche.
Well if debt is such a market distorting disincentive to competition would it be a good idea to base your entire monetary system on debt? The answer we have to find to this is a resounding no! But progressively with the expansion of the financial system into every other part of the economy now almost the entire monetary system is based on high levels of personal, business and government debt.
If you want the economy to be more competitive, if you like the positive incentives of free market capitalism, join the campaign for a positive monetary system.