The Obama administration does not understand market economies, or they have no trouble lying about it for political purposes. Private equity firms play an essential role in a robust economy, even as they are maligned by people who do not understand the big picture or whose own ox has been gored by reality.
The essential truth is: A firm does not come to the attention of private equity entrepreneurs unless it is in deep trouble. The trouble may be due to mismanagement or the fact it is in a declining industry. The industry may be declining because technology makes its products/services obsolete or because global competition is driving it out of business. The problem may also be a combination of mismanagement, obsolescence and global competition. Generally, each case is different. In the end, some firms can be saved by restructuring and others cannot.
This process is continuous and is what one famous economist (Schumpeter) called “creative destruction.” Economic growth inevitably means some industries boom while others wither: Automobiles destroyed the buggy industry.
The question for society at large is how do we get the workers and the capital employed in the declining industries moved to higher end uses? In the case of labor, the reallocation is achieved by the growing employment and higher wages paid in the expanding industries. Workers migrate to the higher wages. Note: If the government stops the “destruction” of declining industries, it chokes the life out of expanding industries, and we are left with no growth and industries whose obsolescence grows every day — if you want to know what that looks like, just recall the former Soviet Union.
The market for labor insures workers are directed where they are needed. So, how do we get capital moved to where it is needed? That is where private equity firms come in. There essential public service is to sort through each troubled firm to determine if it can be saved and how to save it. This takes a huge amount of work and risk capital. If the problem is mismanagement, the answer is to get better management. Think how important that is: It prevents entrenched management from serving its own interests at the expense of both the shareholders and the workers.
The problem also is simple if it is technical obsolescence — the firm has to be liquidated and the proceeds invested elsewhere; no one could have saved the buggy industry. It is more complex if the problem is global competition. In this case, a significant restructuring may make the firm competitive; but, this involves considerable risk for whoever finances the restructuring.
The one example around which the Obama administration makes its case against Bain Capital and Mitt Romney is GS Technologies, an old steel firm that went bankrupt in 2001, eight years after it was bought by Bain Capital. The U.S. steel industry faced increasing global competition since the 1960s, as Europe and Japan rebuilt after World War II, and developing economies around the world invested in the steel industries. Due to low steel prices during the period when GS Technologies went bankrupt, scores of other steel firms also went bankrupt. It was a period of consolidation in the U.S. steel industry as global market share declined.
By contrast, Bain Capital invested in Steel Dynamics in the late 1990s and that company now employs more than six times the number of workers who lost their jobs at GS Technologies.
Facing intense foreign competition, all steel firms are not going to survive.
The ones that do must have the best management and the best steel technology: Steel Dynamics does, GS Technologies did not.
The Obama administration also makes a big deal about Bain Capital making money on GS Technologies. Bain owned GS Technologies for eight years. Is it not entitled to any profit for eight years of effort? Is this just more of Obama’s anti-capitalism?
Bain may have made money operating GS Technologies, but it would have made a lot more money if it had succeeded. There is no doubt that Bain would prefer to succeed. Only a moron would suggest Bain wanted to fail for some vague antipathy toward workers.
This is most assuredly not “vampire capitalism.” The life’s blood is not being sucked out of anyone. Indeed, it is more like medical triage, where those who can be saved are saved and those whose time has run out expire. The gross distortion at play here is consistent with the president’s persistent class warfare agenda. He ran as a “transcending figure” that was above base politics; he governs, when he gets around to it, as the worst form of demagogue.
Bob Martin is emeritus Boles Professor of Economics at Centre College.