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The private equity debate: That '70s show

by Robert Teitelman | Published May 24, 2012 at 1:09 PM

More on the continuing rumble over private equity. Noah Smith defends private equity by arguing that without it, we'd resemble the Japanese, with their entrenched corporations and oppressive, male-dominated salary men corporate lifestyles. Paul Krugman, brandishing charts, insists that private equity increased inequality. Matthew Yglesias tries to thread the needle, arguing that many of the apparent differences, particularly on the liberal side, can be reconciled. Yglesias responds to a tweet from The Nation's Chris Hayes echoing President Obama that this is an important national debate, as opposed to the usual campaign personality attacks. "From where I sit," mutters Yglesias, "what we've actually been having is an extremely confused and confusing debate that has almost no content beyond affect."

Amen. Why such a mess? Well, at the risk of providing more confusion, let's try to get some perspective on all this. I begin with Smith's decision to view Japan as a commentary on the U.S. Clearly, Smith is not talking just about private equity. Rather, he's discussing a broader debate about the merits or demerits of the transactional life, notably about the importance of entrepreneurs, mobility and change of control. There are, of course, cultural and political reasons for Japanese resistance to M&A that go beyond the defense of large corporations. (It's not really, as Andrew Sullivan writes in a headline, a matter of just "corporate raiders." Private equity almost never engaged in hostile raids -- and indeed the age of the corporate raiders really came and went in the '80s.) Similarly, the American move toward a more open change-of-control regime was enabled by the rediscovery of an American archetype, the entrepreneur. The historical roots of both capitalistic systems (though the free market crowd will insist that the American way is "more" capitalistic than Japan and that if America didn't invent capitalism, it perfected it) are tangled and complex. Japan had made the leap into modernity with the Meiji Restoration, then suffered a devastating defeat in World War II. The U.S. had recovered from the Great Depression and then powered forward after the smashing victory in World War II. That said, Japan's big business-centric system, with all the caveats included, superficially resembles the American big corporate, lifetime-employment, male-dominated model that lasted up into the '80s. Both of these models featured stakeholder governance, barriers to attack and relatively powerless capital markets. (There are big differences: The U.S. lacked zaibatsu and control by the big banks. You'd have to go back to J.P. Morgan to get some semblance of Japan's big-bank hegemony in the U.S.)

Smith may be right that Japanese workers are mostly unhappy (or he may be wrong: he admits it's not exactly an empirical fact). The more relevant question is whether Japan's post-bubble malaise stems from its failure to unleash change through its corporate sector with private equity and M&A. The answer to that is unclear.

In the U.S., the attack on private equity is just another episode in a long critique about the '70s and the broad changes that have taken place since Gordon Gekko's "Greed is Good" and "Barbarians at the Gate." The defense of this post-'70s regime was laid out in the usual cartoon way by David Brooks on Tuesday (I posted on the column here) when he depicted U.S. corporations as near collapse in that decade of oil crises and stagflation, only to be saved by these apostles of change. (This faith in "change" is odd in a conservative.) Krugman seems to be aiming at Brooks in his post on inequality, which ironically uses the "Greed is Good" headline. All of these theories, pro and con, exaggerate the role private equity played. Private equity, then known as leveraged buyouts, was a manifestation of larger changes, not a prime mover. Its economic effects certainly increased throughout the '80s, but they were still relatively minor. Far more important were the explosion of M&A and the rise of institutionally dominated equity markets, which made the case for shareholder value and control (there is an entire subtheme here on the role of debt, particularly after Paul Volcker wrung out inflation in 1981, and which featured Michael Milken and the use of junk bonds as takeover currency). At the same time, belief in the value of corporate life was fading. Women were leaving the home to go to work. Unions were shrinking as manufacturing slipped. Loyalties fell on both sides: Companies felt pressed to restructure regularly, and the post-'60s generations resisted remaining in one job for a career. Somewhere around this time, income inequality began to widen and the finance sector grew.

How do we sort all that out? The fallacy of both attackers and defenders of private equity is the belief that we somehow live in static times. Those who claim private equity is essential to prosperity and innovation, like Brooks and presumably Mitt Romney, ignore the fact that growth was historically high in the '50s and '60s. But, they'll argue, the world changed and so did we. Indeed, it did. And it's now been a half-century since those changes occurred. Did they provide the ultimate answer? Perhaps times have changed again in fundamental ways we can't discern. Perhaps stability, prudence and a little less recklessness are now on the Zeitgeistian agenda. On the other side, those who view untrammeled change and ruthless restructurings leading to job loss, bubbles and widening inequalities must wrestle with untangling all the themes that were so tightly wound with the '70s transformation: job mobility, high consumption, gender equality, shareholder democracy. You don't just get to pick and choose; more often, history chooses for you. Private equity may not have been the prime mover, and at times it spawned uncertainty and job losses (or worse); but it also opened opportunities, not just for buyout mavens like Romney, but for owners and managers and, in some cases, workers of middle-market companies. How do you separate out good and bad?

A final thought here: Europe. In terms of private equity, Europe is a kind of halfway house between the U.S. and Japan. The cultural and social background is very different. Europe too has an advanced capitalist economy, but with a different corporate mix certainly than Japan, and a different view of governance, the capital markets and banks than America. Forget for a moment the woes of the euro zone, which really have little to do with corporate versus transactional models. Simplistically put, Europe appeared to be slowly making a '70s shift toward what's known as the Anglo-Saxon model: more restructuring, a greater influence of equity markets over banks, greater labor mobility. Europe, mostly Germany, had several famous outbursts over private equity, which is interesting because Germany had engaged in intense restructuring and reform after reunification and had the best-known sector of middle-market companies, the mittelstand, seemingly perfect for buyout investing.

Now, who knows where Europe is heading? The point here is that while it's fascinating to look at these transnational differences, it really leads into a dense thicket, not only of cultural and historical differences, but of complex themes and subthemes. It's a debate that can't be simplified into sound bytes and slogans -- though it already has been. And it's a debate that's full of experts declaring linkages and connections they have no way of proving, like Krugman's attempt to correlate private equity with income inequality or Smith's declaration that Japanese salary men are miserable. Cartoon will battle cartoon, just like in the movies. But hey, it's politics. It's the way we do things here. - Robert Teitelman

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