Private Equity and Creative Destruction

Want to see what America would look like without private equity? Move to Detroit and contemplate the ruins of a city ruined by the placid conformity of auto industry executives. The  economic impact of the corporate takeover business can’t be measured by the outcome of takeovers as such. Private equity transformed the way American business thought about the world. If managers did a lousy job, outside investors could raise money (a lot of it from trade union pension funds as well as university endowments) and kick them out.

Newt Gingrich and Rick Perry should be ashamed of themselves for bean-counting Bain Capital’s record on job creation. Any investment firm operating over decades of rapid employment growth will be able to show that the companies it bought added jobs over time. That’s what the academic studies on private equity show in any event, as Jordan Weissmann reports at The Atlantic. More relevant is the alternative. We’ve been there, done that, and don’t want to do it again. Corporate America in the 1950s and 1960s coasted on the postwar monopoly enjoyed by American companies after the destruction of European and Japanese industries. Detroit in the late 1960s had African-American neighborhoods stretching for miles with well-kept single-family homes and manicured lawns; by the end of the 1970s it had turned into a moonscape. The rust belt still hasn’t recovered from the laziness of American capital a generation ago.

Private equity takes money from institutional investors who otherwise would passively invest in public securities, and gives them the chance to exercise direct ownership of companies whose management fails to exploit their potential. It creates competition where no competition existed before. As in every business, there are ten wannabees for every visionary. A lot of the success of private equity derives from the fact that equity values rose steadily from1983 through 2000, and anyone who had a chance to own equity with borrowed money did exceptionally well. One can argue that many of the players who got rich during the boom years simply rode the big wave. (Bain Capital, though, was one of the first in, and throughout one of the smartest, and one of the least reckless about using excess leverage.)

But all that is beside the point. The private equity business as a whole, and the associated capital market innovations that supported it (high-yield bonds, for example), forced American businesses to think competitively. One of the results is that large American businesses are leaner and more efficient than ever before — with the result that big companies actually are creating most of the jobs out there.

The table below is taken from Standard and Poor’s website. It calculates employment growth among the S&P 500 companies, showing that overall employment in the country’s biggest companies grew by more than 10% during 2010, while overall employment stagnated. The nimbleness of corporate America — the fact that the collapse of the housing market and the household balance sheet did not push the U.S. into a new Great Depression — is the result of the Reagan Revolution and the unfettered capitalism it let loose on the world.

From the standpoint of individual employees whose lives may be disrupted by corporate reorganizations, none of this is pleasant. And it doesn’t seem fair that a Harvard type in suspenders and a pink shirt should make millions by spurring managers to think smarter and employees to work harder. Of course it isn’t fair: it’s capitalism. Entrepreneurs aren’t made in the image of Mother Teresa. More often than not they are obsessive about succeeding to compensate for other insecurities. I’ve known a lot of great entrepreneurs, and not one of them was what you would call a balanced personality. Mitt Romney seems like much too nice a fellow for this line of work.

There are plenty of things about which I disagree with Mitt Romney; I entirely agree with Governor Huntsman’s warning that Romney’s rhetorical blasts against China would lead to a trade war, and I also agree with Newt Gingrich’s sensible views on immigration against Romney’s hard line. In both cases, it seems to me that Romney is pandering to prejudice. But there is no question that his record at Bain Capital qualifies him to make better economic policy. Obama’s economic advisers, by contrast, think in terms of such abstractions as “aggregate demand,” and blundered into a stimulus program that failed to stimulate. Romney understands that the American economy runs from the bottom up — that risk-taking and innovation and the stubborn desire to win are what make companies succeed.

One wonders at the pettiness of Romney’s opponents. One of the problems that Republicans have in the primary is that the Reagan consensus — cut taxes and roll back regulation — holds sway over all the contenders, except, of course, for Ron Paul, who is a throwback to an ugly era of American isolationism — Charles Lindbergh without the airplane. In 1980, the differences between Reagan and the establishment candidates were enormous — “voodoo economics” against conservative Keynesianism. Now that supply-side has become the mainstream Republican doctrine, the practical differences between Romney and a Gingrich or Perry are small in economic policy. Perhaps the reliance on personal attacks stems from lack of substantive differences. If that is true, there is hope that once Gingrich and Perry come to understand that they are not going to be the Republican candidate, then the party will unite behind its candidate and this whole miserable discussion will be forgotten.

S&P 500 Companies–Annual Total Employees By Sector
Industry classifications 2006 2007 2008 2009 2010  Change-2009-2010 (%)
Consumer discretionary 4,277,445 4,396,384 4,254,578 3,531,991 4,257,873    20.6
Co  nsumer staples 3,718,842 3,964,979 3,941,564 3,769,682 3,926,440 4.2
Industrials 2,859,535 2,970,289 3,046,972 2,765,496 2,885,477 4.3
Financials 2,132,149 1,999,980 2,324,999 2,165,622 2,533,598 17
Information technology 1,082,432 1,165,602 1,366,864 1,336,111 1,595,804 19.4
Health care 1,118,690 1,095,649 1,128,667 1,190,583 1,218,258 2.3
Energy 660,386 619,464 661,226 562,214 696,727 23.9
Materials 609,635 654,227 655,641 601,832 614,069 2
Telecommunications 632,274 627,742 606,478 581,905 551,505 -5.2
Utilities 386,195 385,417 393,190 373,455 386,373 3.5
Total 17,477,583 17,879,733 18,380,179 16,878,891 18,666,124 10.6
Source: Capital IQ.