Investing Blog

Big businesses love economic recession. Recessions allow big business to borrow cheaper, price out smaller businesses, and use the power of government through regulations to squash upcoming competitors.

Credit and Recession

If you haven’t noticed already, borrowing money to fund or start a small business is incredibly difficult. Thanks to tighter lending standards and scared bankers, small business owners are beginning to rely more on personal credit and less on corporate, or business credit offered by traditional lenders. The biggest difference between the two is risk, with personal credit lines small business owners are on the hook personally for every single dime they borrow, even if their business goes under.

On the flipside, big businesses have never found it easier to borrow huge sums of cash and do so inexpensively. Since many investors are sitting out of equities and squatting in triple A corporate debt, the biggest and most established firms are sucking in every bit of excess credit at low prices, allowing them to shuffle it through their operations and squeeze every dime out of their ROE until it reaches equilibrium with their borrowing costs.

Pricing

During periods of economic recession prices drop quickly as the market adjusts for a slump in consumption and investment as well as demand for any product from top to bottom. To counteract the sales slump, businesses employing economies of scale (larger firms) are able to get even lower per unit prices than their smaller competition. Even lower prices allow large firms to take to the street in pricing out their competition, and many small firms already trying to deal with a slack in demand are so undercapitalized that they can’t see the recession through the end.

Regulation

Big business may not use regulation, or at least, may not enact regulations itself, but all new regulations and taxes certainly help squash their competition.

Let’s consider two companies, both make the same kind of scissors, and both are equal in every regard. Quality, color, etc.

Company A produces 500 pairs of scissors per year for $1 each, selling them for $2.

Company B produces 5000 pairs of scissors per year for $1.5 each, selling them for $2.

Which company should be able to price out the other? Company A, obviously. Well, we forgot to tell you something…a new regulation was passed whereby anyone producing scissors had to have at least $1 million in liability insurance just in case a consumer harmed themselves with the product.

$1 million in liability insurance costs $1,000 per year. For company A, that amounts to $2 per pair of scissors. For Company B, that amounts to $.20 per pair of scissors. Company A may have the most streamlined processes and get the best deals on labor and other inputs, but thanks to the new law it will produce scissors at a cost of $3 each where Company B will produce them for just $2.20 each. Who wins now?

Economy