The Agenda

Private Equity and the Smithian Division of Labor

I have a pet theory that complaints about private equity are rooted in discomfort with the Smithian division of labor. As a general rule, we seem to be comfortable, or rather we seem to have grown comfortable, with firms that reduce and rebalance their workforce to survive or to thrive. GM, for example, has embraced offshoring and it has let go of a not inconsiderable number of U.S. employees since the federal government took a large equity stake in its operations. This has been part and parcel of the firm’s bid to arrest its decline. 

But what happens when managers who are good at leading turnarounds of this kind set up small shops of their own that promise to engineer turnarounds of this kind at a wide range of firms by first taking an equity stake, and taking advantage of the extreme corporate debt bias in the tax code to do so? In that case, many thoughtful people think that something sinister has happened. By moving from craftwork to an industrialized process, we’ve gone from something that is an acceptable part of doing business to something that is really awful. 

Matt Yglesias recently touched on this logic. In a recent post, he references the anti-Romney arguments rooted in the former Massachusetts governor’s Bain Capital experience. The second argument, that Romney’s tenure at Bain Capital speaks to something unsettling about his character, struck me as particularly interesting, and it draws on a somewhat older post that responded to Gingich’s Bain Capital attack ads:

[W]hile I’m happy to defend the layoff business as a legitimate and even useful element of a dynamic modern economy, I’m sure glad it’s not my job. Normal people, if put in a position where layoffs are necessary, find them to be emotionally arduous in the extreme. I wouldn’t want to be the guy who takes over companies and shuts down operations for a living, and I don’t think I’d want to be friends with that guy. It seems like a job only an emotionally unbalanced jerk would want, hence Up in the Air. A major innovator such as Apple does end up causing layoffs at rival firms. But no one at Apple ever has to feel responsible for those layoffs. To walk into a dying factory or doomed corporate office and actually fire people, you need to be pretty callous. [Emphasis added]

This passage struck me as particularly interesting in light of the history of Apple. Though Americans mostly remember Steve Jobs as the brains behind the iPod and the iPhone, the devices that helped Apple go from an also-ran in the PC wars to the world’s dominant consumer electronics brand, he was also a job destroyer. Shortly after returning to Apple as CEO in 1997, he fired 3,000 workers and he shut down all of Apple’s manufacturing facilities, shifting production to contractors in East Asia. Before this brutal round of layoffs, Apple was just over a billion dollars in the red. After it, the then-struggling company made a $309 million profit. In the years that followed, Apple’s employment levels soared as the company more than replaced manufacturing workers with engineers, support staff, and, perhaps most surprisingly of all, a growing army of retail employees. Had Jobs not fired large numbers of workers, it’s not clear that Apple would have survived.

If we tried to craft at attack ad featuring the workers Steve Jobs fired in 1997, I imagine we wouldn’t find a large number of people who’d be willing to cooperate. One reason is that many of these workers presumably found work elsewhere in technology industry, which flourished in the late 1990s and has continued to do so. But it is worth noting that Steve Jobs, who went so far as to offer to help craft political ads for Barack Obama’s reelection campaign before he died, could quite plausibly be described as an “outsourcer-in-chief.” The critical difference, it seems, is that Apple PEed itself. It just happens that Jobs decided not go along with his friend Larry Ellison’s plan to raise $3 billion in financing to make a hostile takeover bid. 

(I should stress that Matt is well aware of this dynamic. It’s not clear, however, that many people who find the anti-PE narrative compelling get what’s going on here.)