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‘In Defense of Private Equity: Japan’


As the battle over Mitt Romney’s work at Bain Capital and the merits of private equity rages, a variety of theoretical explanations of what PE brings to an economy have been offered — for instance, we can thank Newt Gingrich for prompting Reihan Salam’s superb NR piece way back in January.

But it’s worth looking at a counterfactual example: What would a wealthy industrialized economy look like without the dynamism encouraged by private equity? Noah Smith (“Noahpinion”), a popular economics blogger with an econ Ph.D. from Michigan, has a fascinating blog item about what that looks like in Japan, and it’s not pretty. He writes:

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 Presott 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.

He goes on to explain why the results of a more secure and sclerotic capitalist system (greater job security, lower productivity) aren’t necessarily good for workers at all. He notes, in fact, that private equity and its effects on corporate governance might even be a good thing for women. To think, Bain waging a war for women!

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.


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