6:00pm January 23, 2012

Mitt Romney’s Fatal Private Equity Mindset

Mitt Romney

Former Massachusetts governor Willard Romney’s private equity approach for winning back America didn’t sell in Iowa or South Carolina. You would think that South Carolina, with an unemployment rate hanging dangerously close to ten percent, would have bought into Mr. Romney’s main selling point: that he’s a business man who understands how to create jobs.

An argument for job creation usually begins with a discussion of what we econo-geeks call derived demand. A business will hire people after determining that the increase in consumer demand for its product exists and justifies the marginal increase in costs that new hire will generate. In other words, there are enough requests for Arby’s roast beef sandwiches to justify hiring a new sandwich maker and fry person.

Problem is that Mr. Romney doesn’t even address consumer demand when touting his “businessman” credentials. Probably has something to do with the line of business Romney touts as a basis for his understanding of the economy: private equity.

David Rubenstein, appearing last weekend on Fareed Zakaria: GPS didn’t make mention of spurring consumer demand either when asked to describe how private equity works. Mr. Rubenstein, who leads the world’s largest private equity firm, The Carlyle Group, argued that a private equity firm’s goal is not to fire people.

On the contrary, said Mr. Rubenstein. According to statistics, the more people you hire, the greater your revenues and profits. Private equity firms are trying to hire more people so that they can make more products. “We are incented to do well”, says Mr. Rubenstein. This incentive is created by aligning the P.E. firm’s interests with those of its investors, the workers of the bought-out company, and the banks.

A fee equal to 20% of the bought-out company’s profits is pretty good incentive.

During the mid to late 1980s when Mr. Romney took over Bain Capital, the statistics did show that leveraged buyout activity (the phrase used to describe private equity during the go-go eighties). For example, in a 1988 paper by Andrei Shleifer and Lawrence Summers, the study found that in a sample of 42 companies, approximately 50% of the sample experienced increases in employment.

Shleifer and Summers determined that employment grew on average for these companies by .9% and that employment growth in these companies was 12% less than employment in companies in the same industry that were not buyout targets. When the professors looked at the subset of bought-out companies that did not sell significant portions of themselves, almost 62% of these bought-out companies increased employment.

Had Romney placed within his decision matrix for running for higher office the need to grow employment in Massachusetts or the U.S., he would have stayed at Bain given the shabby statistics displayed above. But if Mr. Romney is to become president and embarks on turning around the economy of the United States, what approach would we expect him to take?

I would not expect him to act like the fictional Gordon Gekko and break America up because it’s breakable. After railing against President Obama about borrowing us into a double-A credit rating, Mr. Romney would not have the luxury of saddling his new takeover target, the United States of America, with debt.

I would expect him to focus on generating consumer demand for goods, services, and credit, but with interest rates at historical lows, and unemployment at 8.5%, I don’t see much ammunition in Mr. Romney’s fiscal policy arsenal to increase aggregate demand.

Instead I expect Mr. Romney to focus on reorganization of the executive branch of government for two reasons. First, he will want to fabricate comfortable surroundings in the Executive Office of the President. The federal government is not corporate America. Romney will want to replicate the corporate setting in order to reflect accountability to the CEO, and efficiency of operations.

Building on revamping the White House, Romney will next seek to reorganize the federal government itself. A leveraged buyout is just as much about reorganizing a company as it is about financing the buyout of a company. This will be the most demonstrable display of the Governor’s “business man” skills.

As he learns the ropes of Washington, from dealing with Congress to learning where J. Edgar Hoover left the files, Mr. Romney will stay in his comfort zone, focusing on commerce while promoting a hands-off approach to business.

He’ll more than likely push for and receive additional tax cuts for small businesses, and with the Democrats likely to remain in control of the Senate, will likely acquiesce to extending tax cuts for the middle class through 2014. This will be his mantra for stimulating consumer demand.

All this is contingent on how Mr. Romney does throughout the spring and early summer in the primaries. The once and future frontrunner has had a dose of reality over the past week. Iowans and South Carolinians rejected him. His only primary win to date is New Hampshire. He finds himself behind in the delegate count to Dr. Gingrich. Dr. Paul and Mr. Santorum pose no real threat to him in Florida, but in the home of Disney World expectations of a runaway win are as fantasy filled as a trip to the Magic Kingdom.

In short, discount any expectations from a Romney presidency. As much as he rails against the current president, there is a good chance he won’t even get past the historian from Georgia.


About the Author

Alton Drew
Alton Drew provides advocacy, legal and legislative analysis, and legislative monitoring services for not-for-profit associations and foundations with a particular emphasis on broadband adoption, spectrum, and local community development. Using various social media platforms, Mr. Drew amplifies messages for not-for-profit associations and foundations as part of their online media campaigns. Follow him on Twitter @altondrew; Facebook at http://www.facebook.com/alton.drew.5; or visit him at www.lawandpoliticsofbroadband.com or www.lawandpoliticsofcapital.com.



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One Comment

  1. You hit the nail on the head. Romney offers nothing different from the typical Republican mantra regarding cutting taxes and deregulation.

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