Wednesday, May 23, 2012

In defense of private equity: Japan.


Taking a short break from my blogging break here, to wade into the controversy over private equity.

In general, I am a supporter of private equity, so first a disclaimer. There appears to be a real and genuine problem with the private equity industry in the U.S.: our tax code encourages private equity companies to load their acquisitions up with too much debt. That is a relatively recent problem, and one that seems fixable.

Anyway, I generally support private equity. Why? Because of Japan.

Fact 1: In Japan, there is no big private equity industry, because it is very difficult to do a leveraged buyout of a company. The Japanese government allows companies to defend themselves from takeovers in ways that are illegal in America. Also, Japanese companies often hold each other's shares, a practice known as "cross-shareholding", which tends to prevent hostile takeovers. Cross-shareholding creates huge financial risks; however, many of the Japanese companies that engage in cross-shareholding are big banks that are backed by the government (much as ours are here in the U.S., but more explicitly), so this risk is assumed by the Japanese taxpayer. For a comprehensive primer on Japanese corporate governance, see here.

Upshot: In Japan, private-equity firms cannot buy companies and force them to restructure.

Fact 2: Japan has a productivity problem. We think of Japan as being super-productive, and in fact some industries (and most export-oriented factories) are. But overall, Japanese productivity kind of stinks. Since at least the 90s, Japan's Total Factor Productivity has lagged far behind that of the U.S. Nor is this due (as Ed Prescott has tried to claim) to a slowdown in technology; it appears to be a function of how resources are allocated within and between Japanese companies.

Although it's hard to measure white-collar productivity, anecdotally, it is horrendous in Japan. Employees sit idly in front of their computers waiting for the boss to leave so they can go home, or make busy-work for themselves, copying electronic records onto paper (yes, this is real!). Unproductive workers are kept on the payrolls because of lifetime employment, with high salaries guaranteed by the system of seniority pay. To this, add endless meetings, each of which must be exhaustively prepared for in advance. Layer upon layer of bureaucracy with poorly defined accountability. Pay based entirely on tenure rather than merit.

I have seen a little of this with my own eyes, but if I had to work full-time for a Japanese company for any extended period of time, I would probably quit and join the yakuza. It is baaad. Like, Brazil-the-movie-bad.

Would private equity shake up this insane little world? I think it would. In the U.S., Steven Davis, Josh Lerner, and their co-authors found that private equity firms have a positive impact on the productivity of the companies they buy out. Here is a survey of other research on the topic; basically it all agrees that productivity gets a boost when a firm gets acquired.

It is my opinion that Japan desperately needs this sort of productivity boost.

Now, the knock against private equity (besides the debt problem I mentioned at the beginning of this post) is that it screws over the workers of the companies it buys. In fact, it does seem to be the case that private equity firms achieve most of their productivity gains by firing people. The stereotypes are true. So private equity's detractors say: Workers may not be shareholders, but they are stakeholders. When workers sign on to work for a company, and thus sacrifice their mobility and outside options, they enter into an implicit contract with a company, that says, essentially, "This company will try to live as long as possible." When private equity companies chop up and sell a company, this implicit contract is violated, and the worker-stakeholders lose out. (Note: Just to pat myself on the back, I thought of the "implicit contract" thing before reading this Larry Summers paper! But it says basically the same thing.)

And I agree with that. And I think it is a real cost of letting private equity do its thing. But I don't think it's as big a cost as people make it out to be. Again, the reason is Japan. In Japan, the implicit contract between worker and firm is far more important than in the U.S.; companies there view workers as very, very important stakeholders. This is, in fact, why the government makes it so hard to take over companies; Japan is a Bain-basher's dream land.

But - and here I venture into the realm of anecdotes and intuition - I do not think that Japanese workers are happier than American workers. First of all, the low-productivity office environment I described takes its toll. Long wasted overtime hours separate men from their families. Squelched individual initiative creates feelings of frustration and stasis. The impossibility of switching companies, the lack of merit pay, and the pre-determined nature of promotions leave few career goals to strive for. And, most importantly, the binding of employees to their employers creates a pervasive feeling of powerlessness (無力感) and fear; if bad decisions or market shifts force a company to lay off workers, those workers have basically no hope of finding a similar job elsewhere. No wonder the suicide rate in Japan is so astronomically high. The bulk of those suicides are men of working age.

And I didn't even mention women. Anyone who knows Japan knows how poorly Japanese women are utilized (and how poorly they are treated) at many Japanese companies. It is disgusting, and it is harming Japan's economy big-time. One reason is the impossibility of winning discrimination lawsuits in Japan's hidebound legal system. But I think a bigger reason is related to corporate governance; since there is no pressure on these zombie companies to boost productivity, there is no reason for them to hire more women or make better use of the women they already have. Private equity would change that, I think. What private equity does is force companies to cut labor costs; one big way of cutting costs is to replace your existing workers with workers who are of similar quality but are paid less. In a country with a big gender pay gap, those alternative workers are known as women.

So I say: Japan should let the corporate raiders raid. Sic the pirates on the zombies.

And although American critics of private equity have valid points, I think they should look to Japan before they denounce the role that Bain Capital and company have played in our economic and social development. By all means, change the tax code to discourage private equity companies from over-leveraging their acquisitions. Close the carried interest loophole. Create re-employment services to help the workers laid off in restructuring. But for pete's sake, don't wish that our corporate culture was like Japan's. You wouldn't like it.


Update: Paul Krugman chimes in, with a claim that the rise of buyout firms increased inequality. Sorry, maybe it's true, but I don't see the proof here. Correlation does not equal causation, and a lot of other stuff was going on at the time, in particular globalization, the death of unions, and changes in technology.

Update 2: Some people have been asking "Well, maybe private equity boosts productivity in the short term, but doesn't it reduce investment in the long term?" I was curious so I did a little Googling. Here is a paper by Jarrad Harford and Adam Kolasinski purporting to show that private equity firms generally create more long-term value than they destroy. Here is a private study showing that firms bought by private equity tend to increase, not decrease, their investment rates in the medium-term. Here is a paper by Josh Lerner and others showing that companies bought by private equity maintain about the same rate of research and development. But on the other hand, Josh Kosman's new book purports to show that companies bought by private equity tend to go bankrupt. And the overleveraging thing appears to have become a lot more common recently; this may mean that private equity has been more destructive recently than in the 80s, but the long-term data isn't in yet. My tentative conclusion: If done right, private equity creates value and improves productivity, but we need to close the interest tax deduction loophole that encourages overleveraging.

Update 3: Here's a recent news story about just the kind of low white-collar productivity that I'm talking about...

74 comments:

  1. Anonymous3:09 AM

    1) Could this not be summarized as "I wish for capitalism at its best, which includes free markets and productivity gains via unemployment but also a powerful regulatory state to prevent rent seeking"
    2) American workers have become extremely productive, yet an average workers real has remained flat or declined so...who are these productivity gains for? However miserable Japanese workers are...at least they are employed [well, those who are in the traditional system, the Japanese youth seem to be on their way to having the Western European experience of never finding permanent work]. Productivity gains in the United States means...what, 14% unemployment? I am sure most of those people would be happy to shuffle paper around and be inefficient.

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  2. American workers have become extremely productive, yet an average workers real has remained flat or declined so...who are these productivity gains for?

    Japanese wages have declined a lot more than ours.

    Productivity gains in the United States means...what, 14% unemployment?

    Actually, our employment-to-population ratio is higher than Japan's. They have a large population of unemployed people who don't say they are looking for jobs (and so are "not in the labor force") but would actually like to work. They're called "women".

    I am sure most of those people would be happy to shuffle paper around and be inefficient.

    For the rest of their lives? And stay at the office til 11 PM? If you say so... @_@

    ReplyDelete
  3. So what is your solution to the problem of implicit contract if you let the corporate raiders raid? "Create re-employment services to help the workers laid off in restructuring"? Can you provide an example of where that was done successfully?

    I like growth and productivity as much as the next guy, but you are proposing that a very large number of little people bear personally huge costs. "Create re-employment services to help the workers laid off in restructuring" does not help unless the number of jobs increases. Otherwise you're just playing musical chairs.

    ReplyDelete
    Replies
    1. "Create re-employment services to help the workers laid off in restructuring"? Can you provide an example of where that was done successfully?

      Sweden, right?

      I like growth and productivity as much as the next guy, but you are proposing that a very large number of little people bear personally huge costs.

      I don't know about huge costs. Being laid off sucks, it is true. But I think that if the macroeconomy is managed well, those people are going to be unemployed for months, not years. And the alternative - of letting people stay in unproductive jobs - seems like a worse outcome if you do it more than a little bit. I mean, a balance needs to be struck.

      Delete
    2. I'd love a link to restructuring of Sweden.

      When I consider the restructuring of Russia after the Soviet Union, I have very little faith in the management of the macroeconomy. When I look at the management of the macroeconomy in the US over my lifetime, somehow it seems as if the burden has always been born by unemployed middle class, who find their life prospects seriously diminished. It's not simply temporary: it is a lifelong reduction in income and reduction of savings for that cohort.

      I don't like sounding snarky to you, but I am reminded of "first, assume a can opener."

      Delete
    3. I like the Danish idea of flexicurity. With universal healthcare, a strong safety net, extremely affordable higher education and vocational training (I'd like to see universal free bachelors degree or vocational degree, as well as universal free pre-school), etc., then we don't need to create a lot of inefficiency to try to prevent layoffs. Of course, Romney and his party are vehemently against anything like this.

      Delete
  4. Anonymous8:37 AM

    Employees sit idly in front of their computers waiting

    Noah, this is not a lack of productivity on the part of the employee. It is a lack of productivity on the part of management, which has failed to mind meaningful work for the employee to perform.

    Private equity does not perform this function in America, either. Look at Romey. He never created meaningful work for the employees of any company with which he was associated.

    ReplyDelete
    Replies
    1. Anonymous2:07 PM

      So the tens of thousands of people working for Staples aren't doing any "meaningful work"?

      It seems like you're resorting to hyperbole.

      Delete
    2. Whoa, Anonymous is arguing with himself!

      Delete
  5. Anonymous8:41 AM

    I had the possibly erroneous impression that in Japan, many women are actually, you know, housewives and mothers. And most of those who aren't wish they were. Of course the productivity of a housewife/mother is zero, she counts as not-employed and contributes nothing to the GDP, so lots of important people want to do away with the horribly reactionary institution of, you know, family. Since Plato, the progressive idea has been for women and children to be held in common (by the state).

    ReplyDelete
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    1. Anonymous10:56 AM

      Japan has one of the lowest birthrates in the world.

      Delete
    2. Anonymous11:55 AM

      1.39, rather more than one and many women never marry or have children. The rate actually increased 5% in as many years. Lots of Japanese cannot afford to have children, and being a somewhat responsible-minded bunch they don't want to just pop 'em out for government to raise, as some groups do over here. Anyway, the fact you mention is largely irrelevant to what I've said above.

      Delete
    3. Of course the productivity of a housewife/mother is zero, she counts as not-employed and contributes nothing to the GDP, so lots of important people want to do away with the horribly reactionary institution of, you know, family.

      This is an excellent point, and the policy implications are obvious: We should implement Japan-style sex discrimination in American workplaces, but on men instead. Obviously, since Japanese housewives and mothers are so much more productive and happy than they would be if they had equal opportunity, American men would be happier and more productive working as househusbands and fathers, rescued from the tyranny of public-sector employment by our far-sighted, benevolent policy of discrimination...

      Delete
    4. Anonymous5:48 PM

      Too fat, but then it's your own blog. Have a nice day!

      Delete
  6. Noah
    this is an excellent blog entry. I always had this sneaking feeling that something about the Japanese productivity story stinks. You have laid it out quite well.

    Please do carry out your thoughts further, regarding Japanese fiscal policy and its relative ineffectiveness over the past decades (btw, please also comment on Raghuram Rajan in FT today)

    Som D.

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    1. What is the evidence that Japan has such terrible productivity?
      In spite of all these people who you claim are doing nothing, their society is magically still generating a whole lot of income for them.
      Yes, if we look at GDP/capita the US comes out ahead --- $50,000 vs $40,000

      But we all know the US is immensely skewed, so let's look at medians. The US median income is $33,000. I can't find the comparable figure for Japan, but their Gini is .249 (second lowest in the world, top 20% get 36% of income, lowest 20% get 11%); the US has a Gini of .408 (94 lowest in the world, top 20% get 46% of income, lowest 20% get 5%). And those are income numbers, wealth numbers are even worse.

      So what I see is that Japan is plenty productive enough to build a decent society, whereas the US is using its excess productivity to enrich the plutocracy. I fail to see why this is a preferable state of affairs.

      More generally, reading this article I see a huge amount of "Japan sucks because they choose to do things differently from us", very little "Japan sucks because of these objective reasons".

      Delete
    2. What is the evidence that Japan has such terrible productivity?

      Well, a good place to start would be the links I posted in the original post. Did you check those out?

      Yes, if we look at GDP/capita the US comes out ahead --- $50,000 vs $40,000

      In PPP terms it's 48k to $34k. That means our per capita GDP is 40% higher than theirs.

      I can't find the comparable figure for Japan, but their Gini is .249

      CIA puts their Gini at 37.6.

      Source: http://en.wikipedia.org/wiki/List_of_countries_by_income_equality

      For more info on Japan's substantial income inequality, check out this:
      http://mitpress.mit.edu/catalog/item/default.asp?ttype=2&tid=11983

      and read this article:
      http://www.usatoday.com/money/world/2006-07-23-japan-usat_x.htm


      More generally, reading this article I see a huge amount of "Japan sucks because they choose to do things differently from us", very little "Japan sucks because of these objective reasons".

      Actually I don't think Japan sucks. It has its ups and downs. It has fewer problems than we do with violent crime, drug addiction, and massive incarceration. Despite the fact that its inequality has skyrocketed since 1990, it still has fewer poor people than we do. Japan is much more environmentally conscious than the U.S. And there are many aspects of its culture I find enviable, such as giving respect to people who perform low-skilled occupations and service jobs.

      However, corporate culture is, in my opinion, not one of Japan's strong suits.

      And Japan's productivity problems are difficult to deny. Japanese economists agree on this point.

      Delete
  7. Anonymous10:06 AM

    Interesting…but it seems your argument can be summed up as:

    Japanese corporate culture sucks and Japan doesn’t have private equity thus Japanese corporate culture sucks because Japan doesn’t do private equity.

    I don’t think it is all that obvious.

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  8. If the title hadn’t mentioned Japan, I would have thought the above statement was about the US.

    Based on stories from friends, the above office depiction is not too dissimilar from various public sector jobs in the US. Some people may view the ease of this employment as ideal but on a large scale it certainly won’t lead to the productivity or technological advancement that is critical for improving our standard of living.

    http://bubblesandbusts.blogspot.com/2012/05/noah-smith-in-defense-of-private-equity.html

    ReplyDelete
  9. Phil Koop11:35 AM

    I think Krugman has got your number here. Sure, we wouldn't want to change places with Japan, and we wouldn't want to trade places with Somalia either. But your casual assumption that private equity is the factor that has made the difference is absurdly heroic - it melts on the first contact with the facts.

    Meanwhile, you have provided more grist for the Cowan shill-mill.

    ReplyDelete
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    1. I think Krugman has got your number here.

      I don't think so. You're talking about this post, right?

      http://krugman.blogs.nytimes.com/2012/05/23/was-greed-good/

      At the risk of saying "Krugman is wrong", what he's doing is presenting correlation as if it were causation. It's not. The fact that U.S. productivity growth in 1980-2000 was not faster than in 1950-1970 does NOT show that private equity failed to have a beneficial effect on productivity. Same thing for the trade deficit (which I would never try to link to PE in the first place). And, as I wrote in the update to my post, there were lots of other things causing a runup in inequality in the last 30 years; it's impossible to blame inequality on private equity without digging deeper.

      But your casual assumption that private equity is the factor that has made the difference is absurdly heroic - it melts on the first contact with the facts.

      That's a cute line, but I never made such an assumption. I concluded, after looking at the available research (you did click on those links in my post, right?) that private equity probably did have a beneficial effect on productivity in the U.S. And regarding the difference between the U.S. and Japan...well, Krugman did not say anything about Japan in his post. So where are these "facts" that are melting my thesis?

      Delete
    2. Anonymous2:38 PM

      Re-read the PK piece. The piece only presents correlation. There is no claim made about causation.

      PK only claims that the people at the top of the economic ladder have done very well, so that all the other changes are viewed by their apologists as "good for the country" in spite of evidence to the contrary or lack of evidence. The apologists simply say, "What is good for the 1 percent is good for the country" as an absolute truth wether or not the evidence supports their contention.

      PK simply points out that the overall rate of growth of the US economy does not support the hypothesis that unleashing the LBOs unleashed pent up growth from its restraints. He doesn't say that LBOs caused lower growth. He only said that after the LBOs were unleashed growth was slower than the previous periods. Where is the evidence that LBOs unleashed growth? PK is simply saying that no one has produced evidence that they do.

      -jonny bakho

      Delete
    3. I agree completely with Jonny Bakho... you're horribly guilty of putting words in Krugman's mouth. He's simply refuting the wingnuts' claims that the rise of PE was great for the economy. That's far different than saying the rise of PE CAUSED inequality. You need to be MUCH more careful Noah.

      Delete
    4. you're horribly guilty of putting words in Krugman's mouth. He's simply refuting the wingnuts' claims that the rise of PE was great for the economy. That's far different than saying the rise of PE CAUSED inequality.

      No wingnut (to my knowledge) has claimed "PE reduced inequality". Therefore, Krugman's observation about the correlation between PE and inequality cannot be considered a refutation of a wingnut claim. I thus interpret it as an original claim, implication, or suggestion. I'd say that's fair.

      Delete
    5. Anonymous2:17 AM

      The above two posters are precisely correct. You read into Krugman's piece what you wanted it to say.

      This is a common tactic of hacks , one I'd think you'd strive to avoid. You should issue a retraction.

      Delete
    6. Johanes2:22 AM

      Noah, welcome back
      Nice piece but I disagree with you on Krugman. I agree with the Jonny Bakho & Sprizouse. Krugman was annoyed and I think he was simply saying "Hey, how can you claim that PE increased productivity. If you want, I can also make the same claim that it increased inequality".
      However, I wonder which statements Krugman actually referred to that made he think that the right made such a claim in the first place

      Delete
    7. Anonymous2:27 AM

      This is how Krugman prefaced his three charts :

      "...Before the Gekkos came along, they assert, American business was sluggish, unproductive, and uncompetitive. Then came the LBOs and all that, and our economic energy was unleashed.

      As I said, everyone on the right knows that this happened. Needless to say, none of it is at all true."

      The data then speaks for itself. He makes no claims about causality except to show that the PE cheerleaders don't have much of a case as evidenced by aggregate economic data.

      Lots of bad things have happened to our economy over the last thirty years or so. Sorting out which things were worst is no easy trick , but outfits like Bain rank among them , IMO.

      Delete
    8. here are plenty of studies showing that companies' productivity increases when they are bought out by PE. That demonstrates causation at the firm level. True, firm-level productivity increases might not aggregate up to economy-wide productivity increases. BUT, simply showing a chart of productivity over time does not prove or disprove the causal effect of PE on economy-wide productivity.

      Delete
  10. Austin12:06 PM

    I do not believe Noah is arguing, "If Japan had private equity, all would be solved." His point is simply that private equity has a role to play in an economy, particularly under the right conditions. An atmosphere of lagging productivity, such as Japan, is an example of said conditions, and so it is a good subject to illustrate that point.

    Unless Noah's next post is titled "Prime Minister Noda: Hire Bain, Fix All Your Economic Woes." In which case I'll gladly eat my words.

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  11. Tom Moore12:40 PM

    The definition of “Private Equity” is an issue here. The LBO operations which Bain receives jeers for are much different than constructive buyouts, acquisitions a la Buffett, VC/mezzanine financing….. Constructive destruction is largely overplayed. Capitalism with risk, competition, etc. is often good for society, but if unchecked it may have devastating consequences as if puts more value on the short-term than the long. Despite the Romney line, the other side is not against capitalism, private enterprise, or even private equity, just Romney style PE.

    Noah, what changed in the Japanese system that caused their downturn and stagnation? Or was it all external?

    ReplyDelete
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    1. Noah, what changed in the Japanese system that caused their downturn and stagnation? Or was it all external?

      The main external shocks, which all happened in the 80s, were that A) catch-up growth ended, B) working-age population peaked, and C) Globalization began, for which Japan was poorly prepared. Some people think Japan was also ill-prepared for the IT revolution.

      So what then happened was a huge bubble, financial crisis, liquidity trap, and stagnation...basically what's happening to us right now. That led to deflation, which is very hard to get out of (and the Bank of Japan's hard-money bias didn't help...again, just like us now!). It also led to insolvent banks being kept on life support by the government (again, pretty much like us today). Japan's capital markets don't work too well, so between risk-averse "zombie" banks with balance sheets loaded down with "zombie" companies, and poorly-functioning capital markets, new businesses have had difficulty getting financing. That exacerbates the deflation problem.

      Also, Japan's labor markets are dysfunctional. The Baby Boomers got lifetime employment guarantees, which companies are still reluctant to break, especially because Baby Boomers tend to kill themselves when they get laid of. So there are a ton of extremely unproductive old Baby Boomers working for Japanese companies, given huge salaries because of seniority pay, and as a result wages for younger workers are held down. That doesn't help the deflation situation either.

      Most Japan experts think that what Japan needs is: 1) Looser monetary policy, 2) Lots of corporate restructuring (hence this post), 3) More free trade agreements (they are being lapped by Korea in this regard), and 4) more immigration (not sure if I agree with this one). And, of course, they need to get women into the workforce in larger numbers.

      Delete
    2. Thanks, Noah, I always find out blog post interesting and understand as someone without a PhD in Econ. I’m not sure how Romney style PE would help with you’re a,B, C of what happened in Japan.
      A) Catch-up growth will inevitably end once it’s caught up. I suppose if Japan falls behind, it will be able to have the benefit of catch-up growth again. This is more an external factor than a cultural factor. As long as there was catching-up to do, Japan and the Japanese seemed to be expert at it.
      B) Would sending all the older, less productive workers off on pension solve this problem? Then new, younger, hungrier workers would be able to drive the economy hopefully without tragic suicides? Does leveraging a company while paying one’s self a management fee with the barrowed funds (as was the case in the Bain deals that Newt, Perry, Obama highlight) constructively solve this problem, or does it add to it by destroying HR and organizational infrastructure in scorched earth manner rather than in a productive hedge trimming sort of way?
      C) The corporate and employment structures of Japan that you note may well be ill suited to compete in a global economy. I think Paul Krugman’s post (second chart) shows that the U.S. has not been particularly good in this regard either. I think in some ways this goes back to your point “A” – as other economies have the advantage of catch-up growth. Is PE especially suited to add value in an increasingly global market?
      You show a reasonable correlation to Japan’s lack of PE and its economic state, but I would love to see you expand on how PE is best, or even well, suited to solve Japan’s ills – other than they can shake things up by laying off older workers and drive down wages. PE does not encourage looser monetary policy. It does not create free trade (other than to drive down wage costs). It does not advance immigration concerns or gender equality. It does do a lot of corporate restructuring, but not always to the benefit of the company and its employees.
      I think you may have fallen into the Republican trap – “the controversy over private equity.” Private equity is not the issue Obama et al have with Romney and Bain, it is the negative, corporate raiding, LBO styled PE that they practice(d), and how this is not good experience for heading a nation.

      I miss your posts. Don’t’ stay on hiatus too long.

      Delete
    3. OK gotta get back to work but one more reply!

      Catch-up growth will inevitably end once it’s caught up.

      Sure, you have to switch to intensive growth...productivity growth. That can come from from technology, from better organization, and/or from better policy. Japan is doing fine on the technology front.

      Does leveraging a company while paying one’s self a management fee with the barrowed funds (as was the case in the Bain deals that Newt, Perry, Obama highlight) constructively solve this problem, or does it add to it by destroying HR and organizational infrastructure in scorched earth manner rather than in a productive hedge trimming sort of way?

      It seems like the leverage/dividend thing does not help anyone. But it also seems like this is not essential to the other thing PE does, which is fire people to improve productivity. So we should just change the tax code to discourage the overleveraging/dividend trick.

      The other, separate question, is whether firing a bunch of people hurts productivity in the long run. I don't know the answer to that; it is an empirical question. We must not simply assume an answer to this question because of our emotional or political instincts; we must look at the evidence. So go Google for some papers! And check out the ones I linked to in my post, also.

      I think Paul Krugman’s post (second chart) shows that the U.S. has not been particularly good in this regard either.

      The trade deficit thing? I don't think trade balance and productivity are very empirically correlated. Seems to have more to do with savings/investment, monetary policy, and exchange rate policy. "Competitiveness" is a tricky concept.

      It does not advance immigration concerns or gender equality.

      Not so fast. PE forces companies to cut labor costs. In Japan, "cheap labor" = women, immigrants, and young workers.

      In the US you see a historical correlation between buyouts/restructuring/downsizing and women's employment. That doesn't prove causation, but the intuition is there.

      I think you may have fallen into the Republican trap

      Nope. I am way too smart for that. ;)

      Delete
    4. Anonymous8:43 AM

      Noah

      Your description of Japan is mostly a micro description of Keynes on the paradox of thrift.

      Delete
    5. @Tom "Then new, younger, hungrier workers would be able to drive the economy hopefully without tragic suicides? "

      Claiming that suicide rates tell us ANYTHING about either the social or the economic conditions of a society reveals extreme ignorance. Look at a table of suicide rates:
      http://en.wikipedia.org/wiki/List_of_countries_by_suicide_rate
      Japan and China basically the same --- yet vastly different in wealth.
      Switzerland extremely high. Male rates much higher than female (so much for how bad women have it...) Haiti at the bottom of the list.

      They tell us something about culture, yes, but anyone reading economic lessons into them is a hack.

      Delete
  12. But even the billionaire Bruce Wayne hates Bane!

    ReplyDelete
  13. Without the tax code which forces (joke) PE to load up the debt, would there be PE?

    No. Why bother.

    True, we'd have to find jobs for all those professional managers waiting in some building somewhere to get in and fix all those broken companies.

    Not your finest hour, Dr Smith.

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  14. o. nate1:47 PM

    You've shown a correlation between lack of private equity and low productivity in Japan, but it seems rather than the first causing the second, it's more likely that there is a confounding variable which explains both - i.e. poor corporate governance and lack of shareholder accountability. Couldn't the same results be obtained without LBOs if companies were managed more to the bottom line and less to maintaining the ossified status quo?

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    1. Couldn't the same results be obtained without LBOs if companies were managed more to the bottom line and less to maintaining the ossified status quo?

      I believe so, yes.

      Delete
  15. JohnR2:58 PM

    I like the result of the post, which is to make us take a second look at a picture which may have become faded to the point of near-invisibility. That being said, I'm not completely convinced by your reasoning. It may well be correct, but I pick up more than a hint of my own "Well, there's nothing wrong with the death penalty that a bit of tweaking wouldn't cure" thinking of some years back. The more I found out about the death penalty, its use and application, the more I realized that (given human nature and human proclivity to push a process far beyond any acceptable benefit) it was simply not worth it (at present, anyway). Perhaps Bain-style LBOs and private equity 'addition-by-subtraction' operations are ultimately more beneficial than not to the US economy. Perhaps not. Using Japan as a counterexample, however, may not be your strongest argument. There would seem to me to be an awful lot of social and cultural variables there; do they really line up that neatly into a nicely controlled array? This looks like a job for some fun and time-consuming modeling...

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  16. I think it's rather a stretch to say that having private equity firms in Japan would improve the situation of women there. I think it would be most instructive to look at improvements for women here and see how many of those can be laid at the feet of private equity as opposed to, say, the women's movement.

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    1. I agree. But the women's movement in the U.S. was strong in the 60s and 70s, and women didn't really make huge gains in the workplace until the 80s and (really) the 90s. And Germany has had a strong women's movement for a long time but lags severely on workplace equality. And Taiwan and the Philippines have good female labor participation with essentially no women's movement.

      I agree that a strong women's movement is a great thing, but it seems neither necessary nor sufficient to get women into the workplace.

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    2. Anonymous4:49 PM

      Data I’ve seen indicate little if any of the progress women have made in the U.S. is attributable to private equity. The public sector has a much higher female employment rate than does the private sector. If the goal is simply to lower nominal wages (and I don’t think that’s a good goal, nor something that will fight deflation), then we should see more women and minorities in the private sector.
      Women have surpassed men in education.
      A recent poll (sorry I don’t have a link) indicated women were more ambitious than men.
      I think PE is low on the list of reasons women are a larger portion of the workforce today than pre-1980.

      Moreover, simple employment participation does not mean advancement. Women are more commonly part-time workers, and, as you point out, have lower wages including benefits. Would you advocate eliminating the min wage, eight hour work days, workplace safety standards, etc. in order to lower wage costs? That’s a race to the bottom that is not only empirically bad for economies in the long-run, but also ethically abhorrent.

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    3. Larry Headlund2:28 PM

      But the women's movement in the U.S. was strong in the 60s and 70s, and women didn't really make huge gains in the workplace until the 80s and (really) the 90s.

      There is an interesting pattern in male and female average pay by decade and the gender gap From here


      year,male,female,female/male ,change,male change,female change
      1960,38907,23606,60.67%,,,
      1970,50875,29924,58.82%,1.85%,30.76%,26.76%
      1981,47816,28324,59.24%,-0.42%,-6.01%,-5.35%
      1992,46175,32685,70.79%,-11.55%,-3.43%,15.40%
      2002,47020,36018,76.60%,-5.82%,1.83%,10.20%
      2009,47127,36278,76.98%,-0.38%,0.23%,0.72%
      , , , ,-16.31%,-7.37%*,21.23%*

      * change from peak year 1970

      Women made by far the biggest absolute gains in the workplace during the 1960s but men did even better so the gap widened. They closed the gap during the 80s and 90s but over half of that was a result of men losing ground.

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    4. Larry Headlund2:41 PM

      The last sentence should be: They closed the gap during the 80s and 90s but men lost over the period over half as much as women gained.

      Delete
    5. Larry: The same is true of employment levels:
      http://3.bp.blogspot.com/_otfwl2zc6Qc/TCANv-2RWjI/AAAAAAAANxY/lux19E4YhME/s1600/jobs.jpg

      You can see how the gap was closing slowly in the 50s, 60s, and 70s, but really closed a lot in the 80s and 90s. There wasn't as much net hiring going on, but women made up a greater percentage. Companies had been hiring both men and women; in the 80s and 90s they slowed their hiring of men and kept up their hiring of women.

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  17. Do you know anything about Private Equity in the UK? I don't know the specifics there, except I have a general sense that doing a tender offer for a buyout is more difficult than in the U.S. If that's right, can you make the same case about the UK?

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  18. Larry Headlund4:07 PM

    Coincidentally Paul Krugman in his blog considers the economic value of private equity firms like Bain. He doesn't contrast with Japan but he reaches an opposite conclusion to you.

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  19. 2slugbaits4:47 PM

    Noah,

    As Larry Summers pointed out a long time ago, there are negative externalities associated with some kinds of buyouts. Specifically, the trust issue is one that bleeds over to other workers in other companies that may not (yet) be under a hostile takeover threat. Eventually workers will have to be compensated for the added risk that they take on whenever they accept a job. Second, private equity firms tend to dump pension costs onto the taxpayer. They also dump unemployment costs onto the taxpayer and other workers as unemployment insurance premiums go up. Measured productivity for the targeted firm might go up, but that does not mean total workforce productivity goes up. Private equity firms are probably a good thing on balance if the economy is already operating at full employment and the goal is to push out the AS curve, but it's not at all clear that private equity firms are helpful if there is a large output gap...and that's especially true if you're in a ZIRP world with a locally upward sloping AD curve ala Krugman and Eggertson.

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    1. (rant on)
      gimme a break. I've been through and survived several buyouts by small and large firms. Know what Warren Buffet's firms do when they buy firms? Sell underperforming assets and fire people. Warren Buffet might seem nice but he is the king of "private equity," before it was called that. I don't really lose sleep over it. Very often the people who get fired are incompetent managers and some of the plebes frankly cheer.

      I am not saying its a picnic, but knowledgable workers have a lot more leverage over their situation. Sometimes there is just no good way to say "you suck at your job you picked the wrong career." The buyout just provides the convenient excuse. It's a lot easier to say "well, sorry not much i can do." I have seen incompetent analysts shuffled from department to department because no one wanted give direct feedback (and there are HR rules about this too).

      Also (rant off):
      -firms pay UI (unemployment insurance premium) and its spread out over all firms (you might argue whether the premium is "fair").

      -i agree with you on the pension thing, but its not smart for the government to insure underfunded pensions and create the moral hazard in the first place. if you are insuring an underfunded pension maybe the govt should get a first lien on all assets up to the magnitude of the underfunding (a lien that survives bankruptcy too).

      - in a merger or buyout the "headline" job losses are often misleading and designed for equity analysts. A company at any given time has many open positions. First thing to be cut are open positions from the budget (which count as "job cuts" but no one really gets fired). Then there is natural attrition. layoffs are often much lower than the headline number. and sometimes those synergies dont appear either.

      - i am not sure why being at full employment matters. buyouts on the whole are often better than the alternative (liquidation in bankruptcy, where all jobs are lost).

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    2. In my opinion, the most important impact of leveraged buyout destruction of a company is the dissolution of its pension. This is the lives of defenseless working class Americans, not the same kind of thing at all as investors taking a risk. This is breach of contract, pure and simple. If we're going to accept corporate bankruptcy, in any fashion, pension guarantees should be built into the system, and not at $0.40 on the dollar. We need to strengthen the federalization of the pension system (and 401K, etc. - I know of firms that are siphoning off their employee contributions. I'd report, but then family would be out of work...). This federal oversite would ensure compliance with contribution requirements, and offer the guarantees to workers that they were promised as part of their labor contract.

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    3. Just a little more, in response to dwb. I don't want the feds to underwrite pension guarantees, I want them to ensure compliance with the business's contribution requirements each and every quarter that they are in business (enforcement), under their prevailing contracts. Federalizing this requirement, and ensuring the contributions were made to an appropriate "safe from bankruptcy" depository is what I'm seeking.

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    4. they already do: the Pension Benefit Guarantee Corp often takes over (rescues) pensions. ERISA covers contribution requirements.

      http://www.dol.gov/ebsa/faqs/faq_compliance_pension.html
      http://www.dol.gov/ebsa/Newsroom/fsbankruptcy.html

      the issue really is that the "contribution requirements" are not adequate {to be fair, this is much more art that science, how do you know what pension assets will return in the future and how long people will live?}

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    5. 2slugbaits4:54 PM

      dwb,

      First, if you're an accountant, then firms pay unemployment insurance. If you're an economist, then the insurance premia come from the wage bill and come out of wages.

      Second, private equity (PE) firms target precisely those companies with juicy and well funded pension plans because that's where the money is.

      Third, when a PE firm takes over, the business plan is really a matter of breaking trust with either the workers or existing management (or both). They do so by breaking unwritten and informal understandings. When those understandings are breached, this creates transaction costs on other firms. PE takeovers have the effect of increasing costs for other firms.

      Fourth, when looking at total welfare you have to compare the welfare gain to shareholders from greater efficiency to the welfare losses of displaced workers. Unless the economy is operating near full employment the efficiency gains are, as Larry Summers points out, "second order" effects.

      Fifth, PE firms do not ordinarily target companies that are candidates for liquidation; they target relatively healthy companies that are merely underperforming. For example, even thought the US govt practically begged Bain Capital to take over GM and Chrysler, Bain refused because both were considered liquidation candidates absent a govt guaranteed loan.

      Sixth, one way to tell if a PE takeover increases efficiency or simply steals assets and screws shareholders as well as labor & management is to check he magnitude of the profits. In the real world no company operates with gross inefficiencies, so the opportunity for increased profits through greater efficiencies is limited. If you see outsized returns to a PE firm, then chances are that the firm is extracting rents rather than increasing profits.

      Seventh, the macro case for not doing PE takeovers during a ZIRP recession is that if the AD curve is locally upward sloping because of the Fisher effect, then as Tobin & Krugman have both argued, any increased efficiencies actually reduce total output.

      Finally and FWIW, one of the reasons Romney had to distance himself from Bain Capital is that even by the standards of Wall St sharks, Romney was considered an audacious liar and double-crosser. Bain was having a hard time finding any investment banking partners if Romney was part of the team, so he had to be eased out.

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    6. i am flattered. This is not a Romney thing, he a zombie as far I am concerned. tie the london whale around his neck and throw him overboard.

      Most of this paper sounds to me like transparent anti-Romney electioneering rhetoric, just wrapped it up in some clever math. One cannot be "anti-PE" and "anti-wall street sharks" pro Warren Buffet, Buffet does the same thing (but with equity, not debt). I bet Buffets companies collectively have displaced 10x as many workers as Bain.

      If you said lets give tax credits for job retraining or education for displaced workers, i'd agree. Yep to tighter pension laws (you cant raid them they are protected by law i think you mean freeze benefits). But PE, i mean Berkshire Hathaway, performs a useful function.

      also: my experience, the low to the ground employees who know how the spreadsheets work and how the systems work are not the ones fired. It's the 50% target bonus middle managers. boo-hoo for them, but they land on their feet.

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    7. 2slugbaits9:09 PM

      dwb,

      Again, PE firms can and do perform a useful purpose, just as investment banking performs a useful purpose. Just as speculation and arbitrage serve useful purposes. And just as hedge funds and derivatives can add economic value. But those are all things that you worry about when the central economic problem of the day is pushing out the AS curve. PE guided restructuring is a great thing if the world looks like 1979, but not so great in 2012.

      Pension funds are vulnerable if the PE firm goes the chapter 11 bankruptcy route...ask former TWA employees about that one.

      Seriously, you should read the rather famous Larry Summers paper on this. It's about 20 years old, but still gets the basic economics right.

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    8. The real reasons I am concerned about PE: 1)creation of oligopolies with pricing power; 2) tax avoidance (take labor income at lower dividends and cap gains rates); 3) unfunded pension liabilities being shifted to taxpayers.

      based on experience though, I just don't buy the rest especially the notion that where you are in the business cycle matters. In a recession restructuring happens. PE is cyclical to begin with. Not every part of the economy moves at the same speed (oil and gas is booming, and you see a lot of PE deals in that sector along with healthcare and IT; not a lot of activity in housing and construction). The size of private equity is what - a couple hundred billion in 2011? peanuts.

      Buffet is planning his next acquisition. If I see Summers criticizing the buyout due to displacing workers during a recession, i'll start taking these arguments more seriously.

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    9. Larry Headlund9:17 AM

      Private equity firms presently own companies employing one of every 10 non-govermental U.S. workers, or 10 million people

      Private equity funds under management totalled $2.4 trillion at the end of 2010.

      Delete
    10. total us stock market val (wilshire) is about 17 Tn. the corporate bond market is about 35 Tn. so sounds like PE is about 4% by market cap.

      most job losses are during the early years of a buyout, so the new flow matters more and the marginal impact on a labor force of 130 milion is small.

      Delete
    11. Larry Headlund11:09 AM

      Private Equity Funds = PEF = $2.4Tn
      total us stock market val =SMV= $17Tn
      corporate bond market = CBM = $35Tn

      You say PEF/(SMV+CBM)*100 = 4% is PE share. This assumes that none of corporate bond market is for private equity firms or that what private equity firms borrow, their leverage, doesn't count in their impact on the economy., indeed, the more they borrow the less their impact.

      Delete
  20. Noah, thank you for being crystal clear about what evidence supports what, which claims are your opinion, how backed-up that opinion is, and for thoroughly linking to relevant sources.

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  21. yeah sorry i am kind of confused here:
    1. a while back you did a post about venture capital not beating the market. is that a contradiction to this? {i happen to think that its misleading to compare returns because a lot of venture capitalists take "labor income" as capital gains etc. - they put a lot of management time into shepherding businesses}.

    2. ok on PK: "Sorry, maybe it's true, but I don't see the proof here." hmm, you are dangerously close to not being "No"-ahponion anymore. might have to change your blog title after you defend. I advise you to tread cautiously, only Scott Sumner takes on PK and lives.

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    1. a while back you did a post about venture capital not beating the market. is that a contradiction to this?

      That same paper found that PE does beat the market. That might just be because of tax advantages though.

      Delete
  22. Anonymous7:46 AM

    I am afraid that you are confusing correlation with causation. Remember, your arguments are purely anecdotal. Most of all, what you say about family and women is not in any way causally related to private equity. This is purely cultural. For instance, in Japan (and other Asian countries) often the men go off to dinner after work together, instead of having dinner with their family. So the fact that they don't spend as much time with their family has much more to do with culture than with inefficiently long work hours. So correlation, but no causation. Same with women, this is obviously purely cultural. So quite frankly, I fail to see any arguments about causal relations between PE and differences between Japan and the US in this piece. I'm not saying you're wrong, I just don't see the evidence.

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    1. Well, you know how skeptical I am when people start to talk about "culture"...

      http://noahpinionblog.blogspot.com/2012/04/in-which-i-shoot-down-culture-fairy.html

      I mean, in Japan's case, yes, it's culture. Corporate culture. But is it Japan's national or ethnic culture (and hence, unchangeable and permanent)? I don't think so. This office culture didn't exist before WW2. I think economics interacts with culture and I think institutions interact with culture, and I believe this particular culture can be changed. And I think that changes in corporate governance are one thing with the potential to change it.

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  23. Anonymous7:48 AM

    The Japanese Have A Word for It, De Mente:
    "The author presents the reader with about 150 Japanese words and phrases that have special meaning for the Japanese. For example, he translates the word "kamatoto" into English as "The Dumb Blonde" i.e the Japanese propensity to feign innocence in order to gain the upper hand in a relationship or business deal."
    http://www.amazon.com/review/REDN29O7BMGZV/ref=cm_cr_pr_viewpnt#REDN29O7BMGZV
    http://books.google.com/books?id=D5oFAAAACAAJ&sitesec=reviews

    You must have fallen for the kamatoto routine. You obviously don't understand Japan...maybe reading the book will get you off to a better start next time.

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  24. Anonymous12:49 PM

    If this hasn't been said before, it seems to me that you are trying to describe a very complex system with an insufficient number of variables and the unintended consequences of these changes would likely prove disastrous. What would happen to demand with a large number of unemployed dropped onto the market? How many companies would then die off as a result (to then be picked apart by the vultures).

    I see this as a roughly equivalent to a natural system (although I do not believe that it is self balancing), there may be a small unfilled niche for a predator or a scavenger but if you introduce a large number of non-native predators into an island environment you are likely to have mass extinctions. It would be better to design your incentives to have the predators only pick off the sickest and least healthy of the heard while the rest learn how to run again.

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  25. Employees sit idly in front of their computers waiting for the boss to leave so they can go home, or make busy-work for themselves, copying electronic records onto paper (yes, this is real!).

    That statement shows you know absolutely nothing about the work ethic in Japan.

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    1. the idler of march10:58 PM

      I actually read this article as my colleague behind me here in Marunouchi hand-copied Australian sovereign yield numbers from Bloomberg into his journal, a process he repeats without fail daily. He doesn't actually understand what duration is, and nor does he realize that this additional knowledge exists which would allow him to make better use of those numbers. He probably does believe he is working but he definitely isn't, if we define work to mean some productive activity rather than something that fills time and makes you feel good about yourself. I actually work for a foreign company and from my experience the situation is significantly worse amongst Japanese ones.

      Work ethic means making a considered and thorough attempt to add value to your company, not just doing stuff.

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  26. Anonymous2:13 AM

    I have worked in Japan, at a Japanese Company for ten years. I am a female Manager, because I was not Japanese I was taken a little more seriously than OL's (office ladies) who are just there to snag a husband. I can confirm what is written in this article about productivity, or lack of it. It is very much a culture of being seen to be doing something rather than actually getting stuff done. It is a lot to do with the society and organisation and their culture, which I might add is very strictly adhered to. Seniority is showing respect for age and wisdom, whereas western culture value youth and gung-ho attitudes more. We could learn a lot from Japan, and yes, they could learn from us. Things will change over time, as the youth who have been trained in the west return to Japan and take over the reigns of those retiring. I would not write Japan off just yet. I left Japan due to the realisation that I could not make as much of an impact in my business as I would like as I had two handicaps, one being female and one being non-Japanese, despite speaking the language well I would never fit in. I still respect and admire my Japanese co-workers who give their all for the company. That is because they know they will be looked after and their loyalty rewarded. Unlike here in Australia, I have been made redundant twice in the ten years since leaving Japan, my loyalties are very much focused on myself these days, and I wont go the extra mile unless it serves to benefit me, unlike Japan days when I would do it for the Company or my Customer just because I could. Different values and attitudes are hard to compare. I realise though that in japan the concept of GIRI (obligation) cements many relationships in business and I feel here things are more real and genuine and I am working for a positive outcome for my Company and myself and my customer, not just because some unwritten rule says I should. It is an interesting dilemma and has no quick fix answers.

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  27. Citing from http://web.mit.edu/krugman/www/japtrap.html

    Everyone agrees that Japan needs structural reform: it needs to clean up its banks, deregulate its service sector, reform its corporate accounting, and so on. But while such measures will increase the economy's microeconomic efficiency, will they help it recover? ... Measures that raise Japan's supply capacity but leave demand where it is will not help the situation; indeed, if unemployment rises as a result of increased efficiency the country might actually be worse off.

    To be helpful in the current situation, structural reform must somehow induce people to spend more. It is possible to imagine several ways in which this might happen. A reformed financial sector might be able to lend to people and firms that are now credit-constrained. Deregulation might create new investment opportunities, raising investment demand. And conceivably reform might raise expectations of future income, encouraging higher spending now.

    The striking thing about discussion of structural reform, however, is that when one poses the question "How will this increase demand?" - as opposed to supply - the answers are actually quite vague. I at least am far from sure that the kinds of structural reform being urged on Japan will increase demand at all, and see no reason to believe that even radical reform would be enough to jolt the economy out of its current trap.

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  28. RT @MattYglesias: Why we need a safety net RT @TPM: McCain defends Romney's Bain record: 'The free enterprise system can be cruel'

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  29. Krugman was not asserting what you say he was asserting: he does not say that the rise of private equity caused increased inequality. He says that if private equity was supposed to have produced improved productivity or made trade more competitive, it doesn't show up in the data; now maybe there were other effects that completely offset what would otherwise have been productivity gains or trade competitiveness, and it would've been even worse without private equity, but that's not the story that gets told, and not the story Krugman was responding to.

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