The Obama campaign’s strategy is starting to crystallize. Many of us have noted that the president and his allies have been careful not to condemn the private equity industry as such, and indeed that they are very happy to raise substantial sums of money from leading private equity investors. The recent attacks on Mitt Romney’s years at Bain Capital are being defended on the grounds that it is Romney who has claimed that his private equity experience will make him a better public sector leader, and so it is essential that the American public understand the “lessons and values” he learned from this experience.
This is a very nuanced position, yet it parallels the basic argument advanced by the strategists behind the Swift Boat Veterans from Truth during the 2004 presidential campaign. Sen. John Kerry managed to overcome Vermont Gov. Howard Dean’s spirited bid for the Democratic presidential nomination in large part by emphasizing his decision as a young man to volunteer serve in Vietnam. Rather than build a case around his years in the U.S. Senate, during which Kerry had primarily distinguished himself as a critic of the national security establishment and as a reliable representative of left-of-center Massachusetts voters, he made the case, explicitly and implicitly, that his military service would insulate him against Republican attacks in the post-9/11 era. Kerry’s military service demonstrated that unlike President Bush, who had served in the Texas Air National Guard and not in combat operations, he understood the costs and the rigors of war, or so the argument went. So when the Swift Vets entered the fray, they undermined a central aspect of Kerry’s narrative. They sowed doubt about a crucial biographical fact that separated Kerry from a number of other left-liberal candidates, including Howard Dean.
In a similar vein, Team Obama seems to have concluded that in light of the economic climate, Mitt Romney’s decision to represent himself as a post-ideological economic Mr. Fix-It really does represent a potent threat. It is thus crucial that the Obama campaign, organized labor, and other actors turn Romney’s business experience into a liability. Notably, the president and his allies has evinced little interest in offering a substantive defense of these attacks. Everyone from Stephanie Cutter to President Obama himself has essentially said that profit maximization is a legitimate part of a free enterprise economy, that private equity investors have every right to run their businesses as they see fit, etc. They aren’t offering a policy critique of the private equity industry. Rather, they are suggesting that working in private equity dramatically raises the likelihood that one is a terrible person. Moreover, they are making the case that private equity experience is not relevant to public sector experience, as the public sector cannot be rationalized in the same basic ways, public sector leaders need to focus on the short term rather than the long term, and, as one of my interlocutors colorfully put it yesterday, we can’t simply sell Michigan if it has become an underperforming asset.
These are all clever formulations, but they demonstrate a certain lack of conviction. One obvious reason why President Obama is wise not to make a policy critique of the private equity industry is that his central problem with it seems to be the use of leverage. As James Surowiecki, a staunch champion of the president’s policies, observed back in 2009, the use of leverage is pervasive among U.S. business enterprises for a fairly straightforward reason:
The government doesn’t make people go into debt, of course. It just nudges them in that direction. Individuals are able to write off all their mortgage interest, up to a million dollars, and companies can write off all the interest on their debt, but not things like dividend payments. This gives the system what economists call a “debt bias.” It encourages people to make smaller down payments and to borrow more money than they otherwise would, and to tie up more of their wealth in housing than in other investments. Likewise, the system skews the decisions that companies make about how to fund themselves. Companies can raise money by reinvesting profits, raising equity (selling shares), or borrowing. But only when they borrow do they get the benefit of a “tax shield.” Jason Furman, of the National Economic Council, has estimated that tax breaks make corporate debt as much as forty-two per cent cheaper than corporate equity. So it’s not surprising that many companies prefer to pile on the leverage.
More recently, Surowiecki has written a more politically congenial critique of the private equity industry that invokes Mitt Romney that is also worth a look. After offering a condemnation of the industry, he concludes on the following note:
If we capped the deductibility of corporate debt, and closed the carried-interest loophole, it would not prevent private-equity firms from buying companies or improving corporate performance. But it would reduce the incentives for financial gimmickry and save taxpayers billions every year. Private-equity firms are excellent at gaming the rules. Time to change them.
This may well be a defensible approach. There is a small problem, however, as Josh Barro has pointed out. Under the president’s proposed Buffett Rule, the debt bias will actually become more extreme rather than less.
But this isn’t really the interesting issue. The really interesting issue concerns the core differences between the public sector and the private sector. One emerging argument, which strikes me as entirely correct, is that private equity investors like Mitt Romney should be particularly mindful of the importance of the public sector, and in particular the importance of a well-designed safety net designed to smooth economic transitions and to help Americans build the human capital they need to adapt to a changing labor market. Josh has put this very well:
The question he should be asked, then, is what policy implications arise from the economic shifts of the last few decades, driven (in small part) by private equity. Does rising income inequality mean that fiscal policy should be more redistributive? Does a reduction in job security call for a stronger safety net? Do new workforce needs mean we need a shift in education and training policies?
It’s worth noting that, as Governor of Massachusetts, Romney’s signature policy achievement was a universal health care program—that is, a safety net program that reduces the cost of job loss or income loss.
Romney is fond of saying that we need a president who has business experience and understands how the economy works. But understanding how a private firm should interact with the economy is different from understanding how the government should interact with the economy. Bain provides a useful case study to ask Romney to discuss the difference—if the candidates can take a break from cheap point-scoring.
For obvious reasons, Romney has been reluctant to discuss the impetus behind his state-based universal coverage program. He has made gestures in the direction of significant entitlement reform, e.g., he offered an innovative premium support proposal for Medicare during the Republican primaries. And he has defended the federal Department of Education on the grounds that it can be deployed to check the power of teachers’ unions at the state and local level. Though his tax reform proposal has a number of flaws, it embraces the crucially important idea of curbing tax expenditures. Indeed, it might be both shrewd and substantively valuable for Romney to consider addressing the problem of the debt bias embedded in the tax system.
But this has to be an essential part of the case Mitt Romney makes to the country over the next five and a half months. He needs to explain that the problems plaguing the public sector flow from its resistance to the kind of trial-and-error experimentation that has fueled technological leaps in the private sector. Recently, Jim Manzi wrote a brief distillation of the sources of organizational innovation by drawing on his personal experience as an entrepreneur:
When some friends and I started a software company in 1999, we used current software development languages and tools that were designed to allow access via the Internet. This was entirely incidental to us, since we assumed that we would ultimately install our software in the traditional manner. When we delivered a prototype to an early customer, they didn’t have IT people to install it, so we allowed our customer temporary access to our software via the Internet — that is, they could simply access it much as they would access any web site.
As they used it, two things became increasingly clear. First, this software made their company a lot of money. Second, despite this, the IT group had its own priorities, and it would be very difficult to get sufficient attention to install our software any time soon. Our customer eventually floated the idea to us of continuing to use our software via the Internet, while paying us “rent” for it. We realized that we could continue this rental arrangement indefinitely, but this would mean less up-front revenue than if we sold the software. We were running low on money, and had few options.
Our backs to the wall, we theorized that eliminating the need for installation could radically reduce costs, if we designed our company around this business model in ways that would be different than how traditional software companies were organized. Our engineering, customer support costs and so on could be much lower because we wouldn’t have to support software that operated in many environments, just one. Sales and marketing could be done in a radically different, lower-cost way when selling a lower-commitment rental arrangement. We experimented with this approach with our first several customers. Eventually, we made it work, and we committed to this approach. But this decision was highly contingent: the product of chance, necessity and experimentation.
Note the idea of having “our backs to the wall.” These are the moments during which business enterprises are forced to leave their comfort zones and embrace innovative business practices. Innovation is difficult and disruptive. It is extremely painful to lose a job, yet it is also true that employers are often reluctant to fire people with whom they have longstanding relationships or whom they brought into the organization. This is part of why a certain unsentimental personality type tends to predominant in the management of firms in competitive sectors.
One of the challenges in the public sector is that for a variety of reasons, including the sensitivities surrounding the functions being performed, there is a great reluctance to embrace trial-and-error. Instead, there is a desire to get things right in a very consistent, reliable way. Now, this might strike those of you who have had any encounters with the public sector as a set of goals honored mostly in the breach, but that is because bureaucracies that aren’t subject to the competition are vulnerable to the progressive decay of organizational capital and human capital. An ideal public sector bureaucracy is full of public-spirited individuals who care deeply about their work and who suffer more from the “guardian syndrome” than the “commercial syndrome,” as Jane Jacobs put it some years ago. Seth Roberts recently offered a brief description:
Should police officers be paid per arrest? Most people think this is a bad idea, I imagine, but the larger point (what can we learn from this?) isn’t clear. In Systems of Survival, Jacobs tried to spell out the larger point. She wrote about two sets of moral rules. One set (“guardian syndrome”) applied to warriors, government officials, and religious leaders. It prizes loyalty and obedience, for example. The other set (“commercial syndrome”) applied to merchants. It prizes honesty, avoidance of force, and industriousness, for example. The two syndromes correspond to two ways of making a living: taking and trading. The syndromes reached the form they have today because they worked — different jobs need different rules. When people in one sort of work (e.g., guardian) follow the rules of the other, things turn out badly. Ayn Rand glorified the commercial syndrome. When Alan Greenspan, one of her acolytes, became a governor, he did a poor job.
This could be at the heart of a coherent critique of Mitt Romney. He suffers from the commercial syndrome, which is inappropriate for a guardian. Another view, however, is that large swathes of our public sector are caught in a different space entirely. The public sector is already plagued by the commercial syndrome, which is why rigid bureaucratic hierarchies are no longer working very well. Workers and managers have devised structures that benefit providers more than consumers, in large part because the consumers in question — public school students, beneficiaries of social services, etc. — are powerless and thus in no position to resist. Moreover, the providers of public services are far more politically powerful than the beneficiaries, who tend to be disproportionately drawn from constituencies with limited political voice. The providers naturally present themselves as proxies and as champions of consumers, but it is easy to see why this situation might not work terribly well.
Another way of looking at this set of issues is through the sets of managerial tools that are deployed in the private and public sectors, e.g., systematic performance monitoring, setting appropriate targets, and providing incentives for good performance, to draw on the categories identified by Nicholas Bloom and John Van Reenen. Public sector organizations tend to place heavy emphasis on performance monitoring and setting appropriate targets. Yet they tend to have a far more difficult time with providing incentives for good performance in a granular way, e.g., they tend to rely on rigid salary schedules that aren’t well-aligned with productivity. Moreover, the quality of systematic performance monitoring and target-setting is not uniformly high in the public sector for the straightforward reason that a lack of competition dulls the need to apply these tools in a rigorous, ever-improving way. As we’ve suggested, this doesn’t mean that efficient and effective public bureaucracies don’t exist. There are a number of solid examples of bureaucracies — just as there are many private firms — that are extremely good at performance monitoring and target-setting. It happens that in the United States, these bureaucracies are the exception and not the rule. One suspects that this flows from the high level of heterogeneity in the United States. Because the population of consumers of public services is so diverse in the U.S., it is all the more important to have a public sector that can adapt to different cultural contexts, shifts in family structure, etc.
This is why I suspect a certain kind of private sector experience is actually very valuable for reforming the U.S. public sector. As Rick Hess often argues, U.S. public schools actually do draw on best practices from the private sector. The trouble is that they draw on best practices established during the first half of the twentieth century, and a series of blocking coalitions have resisted organizational innovation in the decades since. To the extent that private experience teaches one how to think rigorously about the structure of service-delivery organizations, and how they can be made to work better, it might be far more valuable than, say, experience as a legislator.
It isn’t necessarily true, however, that Mitt Romney has drawn the right lessons from his years in private equity and his efforts to reform organizations in a competitive environment. He needs to make the explicit case that he has done so.
And the best place for the Romney campaign to start — actually, the best place for anyone who cares about public sector reform and the direction of the country to start — is Yuval Levin’s outstanding new essay in the Weekly Standard on “Our Age of Anxiety:”
[A]s he pursues pro-growth reforms like these, Romney should also lay out a new vision of the American safety net, understood as a way to make the benefits of a thriving economy available to all—of making the poor less dependent, not making everyone else more so. Productivity and efficiency need not come at the expense of financial security and social cohesion; indeed, they have often gone hand in hand throughout our history. Only in a stagnant economy, in which redistribution is the only means of bettering the condition of the needy, is the good of employers and producers fundamentally at odds with that of workers and consumers, or with that of the poor.
Economic growth driven by competition and innovation has been easily the most effective means of lifting people out of poverty, particularly when coupled not with an empty promise of material equality but with a fervent commitment to upward mobility. And for those unable to rise, the safety net should work in line with the broader economy, using market mechanisms to offer options and encourage choice, and never coming at the expense of the family, religion, or civil society—as our welfare state too often has. The welfare reforms of the mid-1990s offer a model for such a broader transformation of our often counterproductive antipoverty programs. They should be adapted for the various related aims of our safety net.
None of these reforms would dramatically disrupt the lives of most Americans. They could all take the form of modest, gradual reorientations of our governing institutions and policies directed to better preparing America for the new economic order we confront. And none of them would require a dramatic rethinking of Romney’s agenda, either. He has already proposed a number of these ideas, and could easily find his way to others. What he has lacked is a unifying thread—an understanding of America’s particular predicament that could begin where anxious voters are and end with a platform for renewal.
What ties these various elements together is the need to modernize our economy to compete and grow. That is the essence of a conservative reform agenda to get us out from under the rubble of the liberal welfare state and help America come to terms with both its considerable strengths and its very real weaknesses in the emerging world economy.
This needs to be the other half of the Bain Capital story — something to the effect of we rolled up our sleeves and tried to save American businesses in the toughest, most globally competitive sectors. We did it despite the facts that the tax code encouraged us to load up on debt, our health system drove countless American businesses in the ground, and our schools didn’t give our workers a fair shake. That is why we’re here to see to it that government becomes an ally of American families and firms, not a force that saps them of their strength and vitality. That means more competition and more innovation. It means looking out for consumers, not providers.