Op-Ed: Build and destroy

As governor of Massachusetts, Mitt Romney didn’t preside over particularly robust job growth. Texas Gov. Rick Perry, now the front-runner for the Republican presidential nomination, has hit him hard for that, and we’ll hear more about it. Romney claims that Massachusetts was in a tough spot due to a weak national economy and a thicket of regulations that had built up long before he took office, yet that he made things much better than they otherwise might have been. That may or may not be true. But the really interesting part of Romney’s CV isn’t his time as governor. Rather, it’s the 15 years he spent at Bain Capital, a private equity firm that specialized in buying large numbers of companies and whipping them into shape.

Romney’s experience at Bain Capital has his left-wing critics salivating. They see it as a ripe opportunity to paint him as a wanton destroyer of jobs, who larded up perfectly healthy companies with debt to make a fast buck. Even his Republican rivals have taken shots at him for his years in private equity. Back in 2008, Mike Huckabee, who at the time was running for the Republican presidential nomination, took a not-so-subtle shot at Romney, saying, “I want to be a president who reminds you of the guy you work with, not the guy who laid you off.”

Like many private equity firms, Bain Capital invests in start-ups and in established firms. Start-ups tend not to be controversial — after all, no existing jobs are at risk — but Bain Capital actually specialized in leveraged buyouts of established firms, which have proven very controversial indeed.

To understand leveraged buyouts, it helps to understand two different approaches to increasing productivity, which I’ll borrow from the writer and entrepreneur Jim Manzi. Increases in “operational efficiency” can be thought of as finding new and better ways to play a particular game. Increases in “allocative efficiency” can be achieved by choosing the games you happen to be best at playing. When I was a kid, Deion “Prime Time” Sanders was famous for playing professional football and professional baseball. Most professional athletes, including many truly great athletes, never go that route. They figure they’re better off choosing their best sport (allocative efficiency) and then devoting all of their time and energy to excelling at it (operational efficiency).

In the business world, investors are putting capital to work. At places like Bain Capital, brainy women and men crunch numbers to determine where they’ll get the best return for their money. In the 1980s, a few rocket scientists decided that a large number of American companies were flabby, uncompetitive and needed a kick in the ass. Manufacturers based in Asia and Europe were tearing U.S. firms to shreds. The plan was to turn these companies around by buying them, booting out old management, and doing a combination of things — getting out of some business lines and into new ones, firing the weakest or the most expensive employees, and much else — to turn them around. They generally paid for this by issuing huge amounts of debt, which had a side effect: Companies either had to make their debt payments or go under, which had a funny way of persuading management to concentrate on improving operational efficiency.

Call it heartless. Call it inhumane. But it worked. Not every time, to be sure, but more often than not. Recently, Steven J. Davis of the University of Chicago’s Booth School of Business, John Haltiwanger of the University of Maryland, and several colleagues released a fascinating paper on “Private Equity and Employment.” The authors used Census data to offer an apples-to-apples comparison of establishments (particularly factories and stores) and firms (the businesses that own them) targeted by private equity investors for buyouts and a control group. They found that while private equity deals led to greater job losses at existing establishments, they led to big increases at new establishments owned by the same firms. The net result is that job losses were less than 1 percent of initial employment.

Private equity accelerates “creative destruction,” moving firms out of obsolescence and into the cutting edge. Jobs are destroyed in the process. But jobs are also created. When target firms can’t increase operational efficiency, well, everything that can be sold off is and the money flows to some other business idea that will yield higher returns. That is one reason why, as the economists Nicholas Bloom and John Van Reenen recently observed, some countries are much more productive than others: they’re good at getting efficient firms to grow larger (and, as a corollary, letting less efficient firms die off). Creative destruction can be extremely hard on workers and families. Yet crippling this process leaves an economy riddled with weak, inefficient companies that sure as heck won’t create new jobs.

If nothing else, Mitt Romney’s private equity experience taught him the importance of creative destruction. And that should count for a lot.