How do you know this is cause and not effect? The adaptation of the system to not having government monopolies may have been to go to a name-based reputation system.
It certainly seems to me this would work for software, probably even better than it does for fashion. Arguably it already does.
" What incentive is there for a couple guys to build a time machine in their garage when, as soon as they try to mass produce their invention, any number of larger companies better equipped to manufacture things at scale will just make their invention and sell it for less?"
Yes, this is the standard argument. Do you have any evidence that it actually works that way? I don't see a lot of small companies making it big on a patented product where they get a lot of protection that works; I do see a lot of companies of all sizes being stomped on.
Goals aren't results. You've stated the goals of the system, but really, who cares what the goals are? What matters are the effects. The effects in reality do not seem to be a net positive for the "little guys", who can't afford the patent process in the first place, especially now that turnaround time is measured in years. In fact the horrible outcome you describe in a world without patents seems rather similar to what actually happens in this one.... the little guys won't be able to afford the lawyers, and everybody in the system knows it.