Enough with the Bad Economics — Understanding Private Equity Firms

Democrats have made it a key strategy in the upcoming election to denounce Mitt Romney’s career as the former head of the private equity firm Bain Capital (see the two campaign ads above to an example of what I mean). Over and over again he is slammed for “destroying” jobs, often by outsourcing them overseas. Apparently, if only these practices could be stopped, Americans would be far better off.

Putting aside Mitt Romney’s qualifications for the presidency — for I’m not writing this to endorse or oppose any candidates; this is about the issues — it is abundantly clear that Obama’s ad managers do not understand the fundamentals of economics, much less how private equity firms work.
Henry Hazlitt once said, “the bad economist sees only what immediately strikes the eye, the good economist also looks beyond. “ Our friends on the left always seem to make the unfortunate mistake of only focusing on the effects of a single group of people while overlooking all other groups and consequences. It is often easy for the casual observer with no training in economics to see the benefits of ordinary consumer goods, but when it comes to more complex services, the positive effects are often much harder to recognize. So, perhaps Mr. Obama should be asking himself:  What do private equity firms actually do and what are the benefits?

Private equity firms, like Bain Capital, serve the purpose of restructuring and investing in companies to make them more efficient. Often this includes outsourcing jobs to other businesses or even foreign workers. What is most noticeable is that certain employees lose their jobs or they are replaced by non-Americans. This leads many people to believe that government should work to protect jobs, and that certain private sector functions are bad for people. The problem with this thinking is that it does not capture the whole picture.

By increasing the productivity of businesses and shipping jobs overseas where they can be performed for less, private equity firms provide people with all the services of those restructured businesses, and free up people to create new products and services as well. Therefore, a private equity firm never destroys jobs in net balance; it only helps to reallocate workers to new and more productive purposes.

Democrats have also made the common mistake of believing that the prime directive of an economic system is to provide work for all citizens. In fact, full employment should never be held up as the goal of a strong economy because there is always and everywhere an infinite amount of work to be done. The proper goal then of an economic system is to get those goods and services most easily, because after all, who wants to spend all their time working? What we must ask ourselves is what should we produce, and how should we do it.

Some workers may become temporarily unemployed, but the new productive capabilities not only employ those who had no previous jobs, but also create more wealth in society as a whole allowing businesses to reabsorb workers into new and more productive ventures. And what of the profits made by increasing the efficiency and wealth of society? The money is not simply thrown into a fire, but is spent or saved, creating revenue and investment by firms, which benefits society at large and creates jobs along the way.

Furthermore, it must be recognized that it makes no economic difference if the jobs are outsourced overseas or to a business down the street. The core principle to be adhered to is that the most productive and wealthy economic system divides work to the people who can produce goods and services most efficiently. To illustrate this point, even in your own home, you have foregone thousands of jobs that could have been had by your children by outsourcing your production of food, clothing, televisions, and everything else you spend your money on. But by dividing the labor between everyone and specializing in what we do best, all people can enjoy the benefits of the free market.

The campaign ads’ assumptions are clear: that putting a profit before people is wrong. To the contrary however, a profit in the private sector is not something doled out to people for being popular; it is a signal to the entrepreneur that he or she has done something valuable for their fellow man. The true irony is that there really is a large difference between running a country and running a private equity firm. Being successful in the business world (barring government subsidies and market interventions, of course) means adding to the productivity and wealth of society; being successful as a politician means standing out of the way of rapid economic progress and change, a truly challenging feat for any egotistical bureaucrat.

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