Paul Krugman on Private Equity Transactions

A close friend kindly pointed me to an eye-catching juxtaposition in Paul Krugman’s latest New York Times column, titled “All the G.O.P.’s Gekkos,” a reference to Gordon Gekko, the villain featured in the 1987 film Wall Street. Before I get to the juxtaposition, some preliminaries:

Krugman begins by offering a highly tendentious and misleading survey of the evidence on private equity’s impact on unemployment:

The popular image — shaped in part by Oliver Stone — is that buyouts were followed by ruthless cost-cutting, largely at the expense of workers who either lost their jobs or found their wages and benefits cut. And while reality is more complex than this image — some companies have expanded and added workers after a leveraged buyout — it contains more than a grain of truth. One recent analysis of “private equity transactions” — the kind of buyouts and takeovers Bain specialized in — noted that business in general is always both creating and destroying jobs, and that this is also true of companies that were buyout or takeover targets. However, job creation at the target firms is no greater than in similar firms that aren’t targets, while “gross job destruction is substantially higher.” [Emphasis added]

Incredibly, I drew on what appears to be the same study (“Private Equity and Employment“) in a column I wrote some months ago. Note Krugman’s use of “gross job destruction.” The authors of the paper — Steven J. Davis, John Haltiwanger, Ron Jarmin, Josh Lerner, and Javier Miranda — compare target firms and control firms, i.e., firms that were the subject of private equity transactions and comparable firms that were not.

The authors offer the following summary of their findings:

(1) Employment shrinks more rapidly in target establishments than in control establishments in the wake of private equity transactions. The average cumulative two-year employment difference is about 7% in favour of control.

This seems consistent with the story Krugman tells.

(2) However, employment also grows more slowly at target establishments in the year of the private equity transaction and in the two preceding years. The average cumulative employment difference in the two years before the transaction is about 4% in favour of controls. In short, employment growth at controls outstrips employment growth at targets before and after the private equity transaction.

But wait. Employment grows more slowly at target establishments in the two years preceding private equity transactions. This seems worthy of note — a complication for the story Krugman tells. To underline this, it suggests that the firms were declining before the private equity transaction, i.e., that they might have gone out of business.

(3) Gross job creation (i.e. new employment positions) in the wake of private equity transactions is similar in target establishments and controls, but gross job destruction is substantially greater at targets. In other words, the posttransaction differences in employment growth mainly reflect greater job destruction at targets.

Again, this seems consistent with the story Krugman tells.

(4) In the manufacturing sector, which accounts for about a quarter of all private equity transactions since 1980, there are virtually no employment growth differences between target and control establishments after private equity transactions. In contrast, employment falls rapidly in target establishments compared with controls in Retail Trade, Services and Finance, Insurance and Real Estate (FIRE).

This is interesting. So private equity transactions did not lead to employment declines in manufacturing. Rather, they led to employment declines for financial sector professionals, retailers, and other service workers. 

So far, it seems that Krugman is only offering a somewhat misleading picture of the authors’ findings. But then the authors offer a number of other insights:

The foregoing results describe outcomes relative to controls for establishments operated by target firms as at the private equity transaction year. They do not capture greenfield job creation at new establishments opened by target firms. To address this issue, we examine employment changes at the target firms that we can track for at least two years following the private equity transaction. This restriction reduces the set of targets we can analyse relative to the establishment-level analysis. Using this limited set of targets, we find the following: [Emphasis added]

“Greenfield job creation” is presumably relevant to the larger employment picture.

(5) Greefield job creation in the first two years post-transaction is 15% of employment for target firms and 9% for control firms. That is, firms backed by private equity engage in 6% more greenfield job creation than the controls.

This result says that bigger job losses at target establishments in the wake of private equity transactions (Result 1 above) are at least partly offset by bigger job gains in the form of greenfield job creation by target firms. However, we have not yet performed an apples-to-apples comparison of these job losses and gains. As mentioned above, our firm-level analysis – including the part focused on greenfield job creation – relies on a restricted sample.

This is definitely not consistent with the story Krugman tells. There is a caveat, that we need further research, yet this seems worthy of note.

Our firm-level analysis also uncovers another interesting result:

(6) Private equity targets engage in more acquisitions and more divestitures than controls. In the two-year period after the private equity transaction, the employment-weighted acquisition rate is 7.3% for target firms and 4.7% for controls. The employment-weighted divestiture rate is 5.7% for target firms and 2.9% for controls.

This final result, like the result for greenfield job creation, reflects outcomes in the restricted sample of target firms that we can match to the LBD and follow for at least two years post-transaction. The selection characteristics of the restricted sample may lead us to understate the employment performance of target firms, an issue that we are currently exploring.

It would have been helpful for Krugman to note these concerns and considerations, yet doing so might have undermined his larger narrative purpose. The authors of the paper offer tentative thoughts on their findings:

Especially when taken together, our results suggest that private equity groups act as catalysts for creative destruction. Result 1 says that employment falls more rapidly at targets posttransaction, in line with the view that private equity groups shrink inefficient, lower value segments of underperforming target firms. We also find higher employment-weighted establishment exit rates at targets than at controls in both the full and restricted samples. At the same time, however, Result 5 says that private equity targets engage in more greenfield job creation than controls. This result suggests that private equity groups accelerate the expansion of target firm activity in new, higher value directions. Result 6 says that private equity also accelerates the pace of acquisitions and divestitures. These results fit the view that private equity groups act as catalysts for creative destruction activity in the economy, but more research is needed to fully address this issue.

All I’ve done is literally copy and paste the summary findings of the authors of the paper Krugman cites. And in doing so, I think it’s pretty clear that Krugman is not presenting the full picture.

I was wondering why I highlighted different findings in my column — and then I realized that the authors have released a newer version of the paper, from September of 2011. It turns out that Krugman was working from a 2008 version of the paper. That the paper has been revised is understandable, particularly in light of the large number of unanswered questions in the 2008 version. The title is the same and the authors are the same, yet the more recent paper has findings that might be of interest to Krugman’s readers. Granted, it is still a working paper, but please read the abstract:

Private equity critics claim that leveraged buyouts bring huge job losses. To investigate this claim, we construct and analyze a new dataset that covers U.S. private equity transactions from 1980 to 2005. We track 3,200 target firms and their 150,000 establishments before and after acquisition, comparing outcomes to controls similar in terms of industry, size, age, and prior growth. Relative to controls, employment at target establishments declines 3 percent over two years post buyout and 6 percent over five years. The job losses are concentrated among public-to-private buyouts, and transactions involving firms in the service and retail sectors. But target firms also create more new jobs at new establishments, and they acquire and divest establishments more rapidly. When we consider these additional adjustment margins, net relative job losses at target firms are less than 1 percent of initial employment. In contrast, the sum of gross job creation and destruction at target firms exceeds that of controls by 13 percent of employment over two years. In short, private equity buyouts catalyze the creative destruction process in the labor market, with only a modest net impact on employment. The creative destruction response mainly involves a more rapid reallocation of jobs across establishments within target firms. [Emphasis added]

So it seems that while that private equity transactions lead to more “churn,” the labor market impact is extremely modest and it is focused on the service and retail sectors.

A question: has private equity had a bigger impact on the service and retail sectors that, say, the advent of online commerce firms like and the the growing success of Walmart and consolidated providers of retail financial services? 

Th authors’ findings in their 2011 version of the paper is extraordinary given Paul Krugman’s characterization of the 2008 version of the paper:

So Mr. Romney made his fortune in a business that is, on balance, about job destruction rather than job creation. And because job destruction hurts workers even as it increases profits and the incomes of top executives, leveraged buyout firms have contributed to the combination of stagnant wages and soaring incomes at the top that has characterized America since 1980.

Is this consistent with the more recent findings of Davis, Haltiwanger, Jarmin, Lerner, and Miranda? Let’s repeat:

In short, private equity buyouts catalyze the creative destruction process in the labor market, with only a modest net impact on employment.

It’s not clear to me that it is consistent with the more recent findings. More to the point, what are the alternatives Krugman has in mind, given that a presumably large share of the target firms were failing firms? One wonders if Krugman would endorse state intervention to keep failing firms in business. That is one obvious conclusion, though of course it is a somewhat problematic strategy given the potential expense and its larger impact on the marketplace. 

Now for the juxtaposition. Having made the claim that Mr Romney made his fortune in a busines that is, on balance, about job destruction rather job creation in a column that reference Gordon Gekko, widely recognized as the villain of the 1987 film Wall Street, Krugman writes,

So what do we learn from this story? Not that Mitt Romney the businessman was a villain. Contrary to conservative claims, liberals aren’t out to demonize or punish the rich. But they do object to the attempts of the right to do the opposite, to canonize the wealthy and exempt them from the sacrifices everyone else is expected to make because of the wonderful things they supposedly do for the rest of us.

It could be that “liberals aren’t out to demonize or punish the rich.” But could it be that Krugman, by apparently misrepresenting (I could be missing something) the findings of a scholarly paper and associating a Republican presidential candidate with Gordon Gekko, is indeed trying to demonize or punish at least one rich individual? I can’t speak to whether or not this is a systematic pattern with Krugman, though others will draw their own conclusions.

To underline the point, I don’t think that all liberals should be associated with Paul Krugman’s views and intellectual tactics. What concerns me, however, is that very few of Krugman’s readers will follow the link the 2008 paper, and then do a Google search for the 2011 version of the same paper.

P.S. I asked a friend, an adept researcher, to offer his thoughts:

Target/control firms were matched on size, age, etc. — so it’s not as if lower employment growth in the years prior to takeovers was determined only because they were “mature” industries. Private Equity seems to have targeted firms that were doing worse than comparable firms. Your point that these firms may have done badly in absence of private equity isn’t just a speculation. It just seems to be the case that the poorer performance of equity firms makes it genuinely difficult to determine the causal impact of LBOs on employment.

Also, The “apples-to-apples” comparison point was just applied to the restricted sample the authors used. It doesn’t mean that those estimates were off. This seems to be exactly what was analyzed further in the followup study. It’s not as if the original paper was one study, and this is another — the original data offered a partial picture of the aggregate impact on employment; this is an updated study that offers a more complete picture (using the same data) that does not support Krugman’s points.

My friend also adds, however, that “the statistical analysis here isn’t ideal by my taste, but the results seem reasonable.”

I assume that there will be more follow-ups on this subject, which is a good thing.

Reihan Salam — Reihan Salam is executive editor of National Review and a National Review Institute policy fellow.

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