What would happen to smaller businesses in a free market economy? Would they survive, or would large corporations put them all out of business?

Small businesses not only survive, but also thrive in a free-market environment. How do you think large corporations become large? They certainly do not begin with an office in every country and $13 billion in annual sales. They usually begin with an idea, one or two risk takers, and a small amount of start-up capital. Large corporations only become large by consistently pleasing their customers.

In a free market economy, large chain stores place smaller stores in the position of having to remain competitive. True, not all small businesses can survive this competition. But while it can be heart breaking to personally see small, family-owned businesses get "crowded out" by the big boys, a proper economic analysis must consider productivity increases in net terms. To this end, it is important to remember that the success of megastores like K-Mart or Staples is based on the voluntary association of consumers and the creative, risk-taking entrepreneurs who put their personal wealth and reputation on the line in order to please them.

One-stop shopping centers use their enormous purchasing power to provide the best products at the lowest prices, which allows consumers to save money. These consumers in turn have that much more to spend on other things that they consider to be of great value. Remember, the most basic proposition of the science of economics is that resources are scarce. When a consumer’s precious resources are freed up by low-cost megastores, he can improve his life by spending or investing the savings in some other valuable way, such as for better health care. It should come as no surprise that the world's wealthiest nations are also the world's healthiest nations.

Choice is another positive benefit of these large chain stores. Local "mom and pop" operations simply do not have the resources to provide their customers with the greatest array of product choices.

But the question is will small businesses survive in a free market economy? The answer is yes, but not all of them. For instance, should we lament the loss of the buggy whip industry because the advent of the automobile made its product obsolete? Absolutely not. The nature of job creation is job destruction: consider that at the same time the buggy whip industry was declining, the automobile industry was booming.

The same rule of thumb applies to small operators who cannot compete in a world of scarce resources and unlimited wants.

Fortunately, entrepreneurs of all economic powers adapt to change. Everyone can probably think of at least one local example of a small business that does well despite a large chain competitor, even if it is simply a Mexican family restaurant vs. Taco Bell. Even the largest, most generic of stores cannot drive out niche-specific commerce, simply because that niche knows the importance of putting a premium on quality, personal service, hard-to-find services, or in this case, good, authentic food.

My point is that dynamic market economies are always changing. It is their nature to seek the most effective means for solving consumer dilemmas. Some people may be inconvenienced; however, in net terms, society is always improved by embracing the type of voluntary association that may lead people away from one transaction toward a more appealing one.

It should be added, however, that in a mixed economy such as ours, there is another way for companies to grow large: by becoming political entrepreneurs.

Political entrepreneurs use government as an ally in keeping competitors at bay (through tariffs for instance) or by lobbying for protective regulations that directly harm their competitors.

Archer-Daniels-Midland (ADM) is a good example of a political entrepreneur. The Cato Institute (Cato) estimates that at least 43% of ADM's profits would not exist without government-provided tariffs and subsidies. In addition, Cato found that for every dollar of profits earned by ADM's ethanol program, taxpayers shelled out $30 to cover its costs.

The type of cozy relationship that ADM shares with government "crowds out" the small family farmer and agribusinessman. It can be seen from this that the single biggest threat to the small business is actually government interference, whether by tax, regulation (which is essentially another tax), or nationalization (which happened to many entrepreneurs when the communists seized their property).

The above, however, is no reason to fear a large business. What is important is whether or not it gets large through its market success and not its political success. It is also important to remember that politicians and government employees can be political entrepreneurs, too. Many of them actively lobby corporations to provide them with favors (campaign donations, for instance) in exchange for some quid-pro-quo (tariffs or a change in the tax code). Economists call this the "capture" theory of regulation, but that's another story for another day.

Once businesses get to a certain size, they can afford to hire the highly trained tax lawyers, accountants, and regulatory specialists needed to safely comply with the onerous government mandates. Sadly, the young upstarts and "moms and pops" are rarely in such a position. But despite the many disadvantages of being new and small, many still do extremely well.

If you would like to learn more about political vs. market entrepreneurs, I would recommend one or both of these books: The Myth of the Robber Barons and Empire Builders: How Michigan Entrepreneurs Helped Make America Great by Dr. Burton Folsom.