It is generally thought that in most developed markets it is the small and mid-sized businesses that provide the backbone of a prosperous economy. They are usually more flexible and more innovative than their larger counterparts. Additionally, they do not have significant market power and as a result, competition is fierce. On the other side, large businesses profit more from economies of scale and scope. However, as an industry gets increasingly dominated by a smaller number of larger firms, market power increases and with that the risk of a reduction in competitivity for example via on average higher prices or less investment in R&D. Large firms tend to engage increasingly into rent-seeking behaviour. Overall, an economy dominated by a relatively small group of big businesses will deviate increasingly from the ideal of perfect atomistic competition, resulting in lower trend growth amid an increasingly sclerotic economy and a society where economic and political power is concentrated in the hands of a few. The only beneficiaries of such a process will be the owners of these increasingly large companies.
Unfortunately, there are strong signs that the US has been taking a step in this direction (this is not to say that they are close, just that they are moving closer). I have already previously written about the state of small businesses in the US (Small business job creation, personal income & consumption: weak dated Oct 7). Small firms (defined as having less than 50 employees) were responsible for approx. a third of all jobs created in the period of Q392-Q42000 and Q303-Q307 and only accounted for 9% of the job losses in between Q101-Q203. However, in between Q407-Q408 they accounted for 45% of all job losses! The reason for this shift in job creation can be found in the dependency on the domestic economy and the restrictive financing environment. Small firms tend to be more domestically focused than large companies. If the data here are anything to go by, then small businesses - this time defined as those with less than 500 employees - were responsible for half of nonfarm private GDP but only roughly for a quarter of exports. Given the subdued outlook for the domestic economy, their creditworthiness has deteriorated substantially. Furthermore, while large businesses can access the capital markets directly and were able to profit from the bond issuance boom of this year, small firms are depending on the banking sector to get access to credit. Important sources for the smallest US businesses have been home equity loans and credit card loans. But home equity values have been declining sharply while the lines for credit cards have been cut back significantly and lending standards tightened as banks remain unwilling and unable to lend.
In turn, this combination of a poor outlook for the domestic economy (amid an overindebted and undersaving consumer in an economy overly dependent on consumption) and a lack of financing creates an extremely challenging environment for small businesses and job creation does not promise to stage a rebound soon.
A result is that the trend growth rate of the US economy (or any economy with a similar dynamic) should decline - in line with my multi-year view - as in aggregate small businesses lose market share in favour of large businesses. Large businesses in turn should fare relatively better than their smaller counterparts, be it in terms of market share as well as in terms of profitability. I think that the banking sector provides a case in point given that the largest banks have been showing significant profits again for the past quarter whereas below the surface, the bankruptcy of smaller and medium-sized banks is continuing. The chart below shows the number of bank failures per week as reported by the FDIC. Last week marked a new record in the current crisis with 9 bank failures (that is excluding CIT), bringing the total to 115 this year.Finally, if this is indeed the case then the numbers being reported by the quoted company sector do paint too rosy a picture with respect to the state of the (US) economy.