Brief Thoughts on Private Equity and the Myriad Sources of the Decline in Trust

by Reihan Salam

Josh Barro and Matt Yglesias have interesting posts on private equity. Matt’s point regarding loss of trust are particularly well taken, though of course it is worth pointing out that there are a number of factor driving a decrease in trust and social cohesion in the United States, including increasing diversity, as Robert Putnam has (despite his political instincts) suggested.

Considering the range of forces that contribute to decreasing trust and social cohesion, it’s not obvious to me that the rise of private equity deserves pride of place. One way of managing the decline in trust and social cohesion has been the outsourcing of non-core functions. As Erik Brynjolfsson and Adam Saunders observe in Wired for Innovation, highly productive “digital organizations” exclusively employ high human capital workers. One driver of this phenomenon could be that this human capital homogeneity fosters within-organization trust and cohesion, and it also lowers the stakes of job churn. In the rare event a Google manager fires a software engineer, she can be fairly confident that the employee in question will land on her feet. This isn’t necessarily true of old-line industrial firms, which often involve more cultural friction between managers, who are generally drawn from the orderly world of the college-educated middle- and upper-middle-class, and mid-skilled and less-skilled workers, who tend to be drawn from the less orderly world of the working class, and for whom the loss of a job can be a grievous blow. Indeed, this dynamic might play into compensation levels: while the kind of people who gravitate towards managerial jobs might be inclined to work in technology firms situated in high-amenity regions, they might require outsized financial incentives to take on jobs in (relatively) low-amenity regions in which some degree of cultural friction and hierarchy (which is often a response to the fact that not all workers flourish with a high degree of autonomy) are part of the job.  

On a separate note, let’s link two sections of Matt’s post. The first is this:

I think critiques of private equity that rely too heavily on the charge that they exploit the tax deductibility of corporate debt are fairly weak. The tax code is full of ill-advised loopholes and deductions. But just because I think the mortgage interest tax deduction should be done away with doesn’t mean I think people are doing something wrong when they take advantage of it. I take advantage of it myself.

And the second is this:

At a minimum, it [i.e., shrinking firm size, which Matt posits flows from a decline in trust] strongly suggests that insofar as the availability of the carried interest loophole tends to channel smart greedy hardworking people into private equity rather than conventional corporate management we’re needlessly exacerbating an underlying weakness in our social fabric.

Much the same can be said about the corporate debt bias in the tax code that proposals like the Buffett Rule would tend to exacerbate, as Barro argued in a Forbes post that may or may not have vanished into the maw of Forbes’ archives.