By R. Tamara de Silva
In Defense of Private Capital and Capitalism
January 14, 2012
Is Mitt Romney guilty of capitalism? His opponents in the race for presidential nominee of the Republican Party have converged in their rhetoric and ideology with the Democratic Party and President Obama to decry that Romney's actions at Bain Capital and the private equity model in particular, are wrong, so extremely wrong that they make him wholly unworthy of consideration of President of the United States. Whether or not the latter conclusion is true or false, their argument is not evidence of either conclusion. I have read that a majority of Americans tune out politicians unless they stand to benefit from a specific government program or benefit-this would be a rational instance of when to tune them out.[1 ] The Democrats and accusing Republicans are in error about private equity and capitalism. What is worse they are placing populism above this country's core principles.
By R. Tamara de Silva
"If someone who is very wealthy comes in and takes over your company and takes out all the cash and leaves behind the unemployment? I don't think any conservative wants to get caught defending that kind of model." This quotation, which could have been from David Axelrod or President Obama, was actually from Newt Gingrich. In other words, conservatives cannot defend capitalism if it means that people will lose jobs.
Some history is helpful. Job creation and job retention are not the primary motivations for innovation and industry in the United States, they have never been. Job creation gained traction in the public discourse when it used as a justification for the government spending TARP funds-the rationale being that the government's spending would create a soft landing for the economy, lessen the economic impact of the recession and Credit Crisis and create (albeit often temporary and expensive) jobs. Yet it is not job creation that has motivated this country's most celebrated capitalists but profit motive or sometimes the pursuit of excellence expressed as an idea. Henry Ford did not start building his own self-propelled vehicles that ran on gasoline in order to create jobs any more than Steve Jobs began building personal computers to create jobs.
We may not be in an economic crisis but a period of economic change. Capitalism has hard edges, especially in periods of extremely rapid economic change. Failure and obsolescence are the sina qua non of capitalism. What Mr. Gingrich's statement is missing is the possibility that America and the rest of the developed world are in the midst of period of rapid flux.
Almost without exception, most neo-classical economic theory holds that crises do not persist indefinitely, because economic systems revert to some equilibrium or balance. Perhaps, America and Western Europe as seen by the possible collapse of the European monetary union, may by in as much a period of economic change as it is in crisis. The distinction is important because if we are in a period of rapid economic change, things may not get better exactly as we expect them to-they will change.[ 2 ]
We may be in the midst of another economic revolution akin to that of the Industrial Revolution. Alternatively, we may be seeing disruptive technologies change the world and create economic upheaval (the hard edges) in the form of extreme wealth and extreme poverty as we saw in the close aftermath of the steam engine, the internal combustion engine, the railway and the utilization of electricity.
The world has never been, not at any time since mastery of the seas meant dominance in trade-not even during the silk trade--as interconnected as it is now. Technologies like the Internet and information technology have been both disruptive and creative at once, and at a breathtaking pace. The face of manufacturing, as we have recognized it for most of the twentieth century has itself changed, so has its importance as a percentage and engine of economic growth. It has been replaced by other sectors including and perhaps infamously, the financial services sector described by the term financialization. Just as what happened one hundred years ago, politicians lobbied for groups that were nearing obsolescence, but were unable to stop change itself. We see changes in the countless examples of relatively lower skilled, high paying jobs that have been erased and may never return. In periods of rapid economic change, settled patterns of work are upended. Another factor is the creation of disparate wealth between wealthy superclasses (robber barons) and everyone else, including the newly displaced.
Bain Capital, Private Equity and Venture Capital
It is easiest to extol the virtues of free markets and capitalism when able to toss in Steve Jobs, Bill Gates, Thomas Edison or Henry Ford as stunning examples of its success- but to be fair, these people are eight sigma events. Most capitalists are hardly this glamorous, they never make magazine covers, and their stories and personages are decidedly more bland if not just boring-fitting very well into the fat middle of a normal bell curve. Mitt Romney has been roundly accused of being unpardonably bland but this is not an economic transgression. Attacks on his career at Bain Capital are misplaced because both the private and venture capital business models provide extremely important social and economic functions.
Romney and Bain Capital are charged with making too much money, having businesses fail and alternatively, causing some of the most sympathetic people in North America to lose their jobs. The fallacy of these arguments are legion.
Bain Capital is primarily a private equity firm that also has a venture capital arm. Private equity firms invest by buying ownership of companies where they see the potential for a return for themselves, a return they capture by later selling the company at a profit to another party or parties either in the private or public markets (they sometimes retain acquired companies). Private equity investors can be more sophisticated than other corporate governors and in theory be better managers- thereby using their unique vantage point and experience to create wealth for investors.
Venture capitalists take a lot of risk, often investing their own money in start-ups and the new companies of entrepreneurs in the hopes of finding the next Google, or Apple. Both private equity and venture capitalists are rewarded for being able to recognize the best entrepreneurs, the best ideas, and helping to bring them to market by financing them, so that the world profits from the next iPhone, the next life-saving technology or Google.
No one in either industry risks their own or their investors' money expecting to fail. They would not stay in business if they did.
Sometimes, as the bi-partisan critics point out, people in companies acquired by private equity lose their jobs. One of the reasons for this is that private equity turns companies around by making them more efficient. This is often accomplished by getting rid of excess layers of management, unnecessary employees and generally, "bloat." It is important to remember that what is considered "excessive" in layers of management or how "bloated" a company may look-is largely subjective. Profit motive is the engine of capitalism, not job retention.[3 ]
When we introduce terms like "looting" which is a loaded term it is important to keep in mind that this is also a subjective term. Romney's critics are looking at Bain in hindsight...with some not insubstantial measure of bias. Also consider, that the world may be changing at a rapid place and some degree of job displacement may be the norm.
Investing in companies and trying to turn them around is not as easy it is sounds. It also involves an appetite for risk that most people do not have. A majority of businesses fail within two years of sooner after their inception (even if they are not distressed to start before being acquired by a Bain Capital).
Taking risk is nonetheless commendable. Taking huge risks can lead to catastrophic failure or success. I read somewhere that Thomas Edison failed well over 1,000 times before successfully creating the lightbulb. But he made in well in excess of 1,000 attempts and had the stomach to endure that much defeat-this is not common. Facebook, and Google were not guaranteed to successes. There is only one Mark Zuckerberg and only one Steve Jobs. If a high failure rate did not come with taking significant risks, there would be a 100,000 Bill Gates as opposed to just one. Looking at Bain's record, I am reminded of the Pareto Principle or 80/20 rule--that 80 percent of the effects are the result of 20 percent of the causes.
Overall, venture capitalists do well and their importance to the economy cannot be disputed. Venture capital is responsible for 12.1 million private sector jobs or about 11% of total private sector jobs that collectively generate $2.9 trillion in revenue.[4 ] Private and venture capital firms are responsible for most jobs in the software, telecom and semiconductor industries.[ 5]
Slavery and Principles in Opposition
The Founders has a very odd notion for their time, the idea that people were born with natural rights-not granted by a monarch or a government but actually born with rights, rights inherent to all individuals. This was a radical idea!
While there is no pure form or capitalism, capitalism is more conducive to individual freedom and human rights than any other system.[6 ] It simply trumps all alternatives. Capitalism promotes the opposite of slavery and is conducive a core principle deeply held by the Founding Fathers - that human beings have human rights. Self-ownership, the opposite of slavery is one of them.
This also comes with the harsh reality that some people will not succeed and must fail in a capitalist system. Because in a larger sense, it really makes no difference whether capitalism works perfectly or not-it is the legally instituted economic system most opposite of slavery.
Candidates for the Presidency, including the incumbent, like all politicians crave power so much that they must feed populist tendencies which, are based on emotion regardless of whether they cannibalize this country's core principles. All of the arguments against Bain Capital are populist ones designed to enrage, and excite anger and envy. They seek to alter the capitalist system by selectively identifying what parts of a free market are acceptable at a moment in time and what are not--and to suggest improper conduct where there is no evidence of any illegality (other than profit) by imposing the same arbitrary values-envy not being a great value by the way.
Some principles have to be above populist tendencies or we will have no principles standing. Steve Jobs and Henry Ford are good examples against these populist arguments-their motivations were never job creation or job retention but their economic enrichment-in pursuing these narrow goals they changed the world. Insisting that job creation or retention trump the motive of wealth creation, is something entirely other than capitalism.
Adam Smith's first great work before The Wealth of Nations was The Theory of Moral Sentiments, which made the case for sympathy as a foundation for human relationships in a civil society. Politics plays a large role in human relationships especially when it is used as lever to ignite class warfare and to institutionalize envy. Populism must never be used as a political campaign, however convenient or effective, because it ultimately enrages and divides a nation at its core, and sometimes these divisions cannot be healed.
Instead of attacking Bain Capital, all the candidates from both parties ought to address what harms capitalism (other than themselves obviously). If it were just Adam Smith's animal spirits competing and the fiercest winning, we would not have government subsidies, tax breaks and bailouts--all selectively doled out for a few-not all. Not even a Fed giving free money to some (a preferred very few)-not all. Or maybe we would because many of those that succeeded the most would always use their resources to create cartels, monopolies and buy political influence. Bribery and policy for vote getting- have no place in a purely capitalist system and their presence has...at least this is my guess-given capitalism a bad name.@
R. Tamara de Silva
January 14, 2012
R. Tamara de Silva is an independent trader and securities lawyer
1. Class War? What Americans Really Think About Economic Inequality, Lawrence Jacobs.
2. Of course economists that guess correctly and point out a plausible causal variable will appear brilliant but there again, only in hindsight. We cannot really know if we are in a crisis or in a period of dramatic change but it cannot hurt to be aware of the possibility of the latter.
3. The profit motive cannot be selectively excised from capitalism in favor of job retention, as many of Romney's critics suggest. It was not that long ago that the USSR boasted of full-employment but could never match the sheer volume of innovation produced by its arch rival.
6. There is no purely capitalist system and may have never been-in the sense of a laissez-faire system because the State is always and in some manner involved.