What makes capitalism work is competition among firms. Firms that can deliver value replace firms that can’t, resulting in increases in worker productivity, which is the basis for increases in our standard of living. But when governments bail out poorly managed firms, productivity stagnates, with Japan being a leading example. Knowing that when push comes to shove, governments will be unable to avoid the political pressure to save large firms, we must take steps to ensure that in the future, no firm is too big to fail!

While regulations which keep firms from growing after they have reached a certain size may seem like socialist actions, they are actually firmly grounded in capitalism. Monopolies and oligopolies are the least competitive market forms, leading to inefficiencies and below-average productivity levels. Furthermore, if a monopoly goes bust, it has to be bailed out or every company/individual relying on its product will be affected. If several firms are in competition, the industry can better adjust to the loss of the most badly managed firms.
Don’t take my word for it though: the break-up of institutions deemed “too big to fail” was advocated by some of the top economists in the world last week, for the simple reason that bailouts pervert the incentive system that has made capitalism so successful.
Of course, even if we get to the point where there is no one company deemed too big to fail, political pressure during recessions may still persuade governments to bail out entire industries. For example, subsidies that encourage home sales along with bailouts of certain players in the auto industry (despite no shortage of excellent auto manufacturers headquartered outside North America) could occur on a larger scale. Unfortunately, that appears to be a risk we have to take, as, debt-wise, we cannot afford a repeat of the firm bailouts we have seen next time the business cycle bottoms.