As the 2016 presidential race slogs on, candidates from both parties continue to try to outdo one another with ever-bolder claims and expansive policy visions. But the platforms of the leading Democratic candidates embrace a fundamental contradiction, one that has so far gone unnoticed.
Both Hillary ClintonHillary Rodham ClintonClinton targets Trump in speech, urging supporters to 'resist, insist, persist, enlist' Clinton defends April Ryan, Rep. Maxine Waters in speech Lobbying world MORE and Sen. Bernie SandersBernie SandersIn California race, social justice wing of Democrats finally comes of age Sanders to headline progressive 'People's Summit' The Hill's 12:30 Report MORE (I-Vt.) vow to break up concentrated markets (areas of industry dominated by a few large corporations), particularly in the financial-services sector. Both candidates also advocate for greater government regulation of private markets.
Yet, at the same time, both candidates urge more regulation of various markets. Clinton, the New York Times reports, “favors more intensive regulation of Wall Street than what is in place now.” She also plans to extend federal regulation to cover the “shadow banking” industry. Sanders responds with similar instincts, supporting “tougher bank regulation.” In the candidates’ first head-to-head debate, the two sparred fiercely over whose regulatory proposals were tougher on businesses.
These two policy prescriptions—deconcentrated markets and increased regulation—are in serious tension. Though seldom discussed, there is a link between government regulation and what economists call “economies of scale,” one of the primary drivers of market concentration.
Economies of scale arise where a company’s average costs decrease as its size increases. If it costs $1 million to build a factory, but only $1 for each unit that rolls off the assembly line, it is much cheaper to produce one thousand units than one hundred. Increasing size lets a company capture these economies of scale.
As the example suggests, scale economies are more pronounced where fixed costs (like building a factory) are high. The higher the fixed costs, the greater the economies of scale. If the effect becomes strong enough, smaller businesses will exit the market, leaving only large corporations in a concentrated market—the evil denounced by Clinton and Sanders.
But regulation tends to increase the fixed costs of running a business. Regulatory compliance requires expenditures that often do not vary along with the size of a company. Every impacted firm—regardless of size—must devote resources to researching the evolving regulatory landscape. Many licensing fees are uniform, as are many compliance software license fees. The same mandated government reporting will often cost a small firm nearly as much as a large corporation.
But imposing a set regulatory cost across-the-board can have very different impacts on different-sized firms. After the Dodd-Frank Act was passed, a 2013 study by the Consumer Financial Protection Bureau revealed a disparate effect on small banks. As a percentage of retail deposits, smaller banks spent more than double what larger banks spent on regulatory compliance.
And there’s the rub. Trying to deconcentrate markets while also increasing regulatory overlay is self-contradictory. To a billion-dollar company, annual regulatory-compliance costs of $1 million may not be insurmountable. But the very same $1 million burden may destroy a small competitor. Even if large corporations are broken up, high costs imposed by regulation will inevitably lead to their resurgence.
Though this dynamic deserves greater attention, what studies do exist confirm its dangers. A 2012 article in the journal Econometrica, for example, demonstrates that increasing environmental regulations can lead to markets with fewer competitors. And, the author concludes, surviving firms enjoy greater power over the market—again, the very evil condemned by Clinton and Sanders. Late last year, the New City Initiative (a think tank representing independent fund managers) reported a similar outcome: the number of small investment-fund operations in the United Kingdom fell after stricter regulations were passed in the wake of the financial crisis.
For competition to flourish, what is needed are not necessarily more, but smarter, regulations, ones tailored to avoid the pernicious effect of burdening all competitors while also disadvantaging a subset of them. At the very least, policymakers—particularly those with presidential aspirations—should be aware that they are chasing paradoxical goals. The unintended consequences of heavier regulatory burdens will be less market competition, leaving more power in the hands of the few and harming the pocketbooks of the many.
Newman is a professor of antitrust and contract law at the University of Memphis School of Law and a former trial attorney with the Antitrust Division of the U.S. Department of Justice.