Creative Destruction - Grounding Their Ideas in the Essence of the Story (image: riabaeck, flickr)

Creative Destruction - Grounding Their Ideas in the Essence of the Story (image: riabaeck, flickr)

No one reads Washington Post editorials for their astute economic analysis. The paper did not surprise readers with its balanced discussion of private equity today.

While the paper is right to point out that whether private equity firms directly increase or decrease employment is not a good measure of whether they are beneficial to the economy, it totally overlooked the main issues surrounding private equity and its impact on the economy. The question is whether the high profits earned by the partners are primarily due to increasing economic efficiency or to rents earned by dumping costs on others.

As noted here, it is standard practice for private equity to load firms with debt. This means that taxable profits are turned into tax-deductible interest payments. The difference can be a gain to Bain and other private equity firms, but it is coming at the expense of taxpayers.

In the same vein, private equity companies often engage in complex asset shifting. This can leave a heavily indebted firm with few valuable assets. If it eventually goes bankrupt, the creditors collect little money because the private equity company has transferred the assets with value into an independent company. This can also mean big profits for Bain and other private equity companies, but this is not a gain to the economy.

Another frequent game of private equity companies is to dump pension obligations on the Pension Benefit Guarantee Corporation. The reduction in liabilities can mean big profits for Bain and other private equity companies, but does not provide any benefit to the economy.

These are the sorts of issues that appear in serious discussions of the benefits of private equity.

The Post piece also included the bizarre assertion that:

“Probably it [private equity] is one feature of U.S. capitalism that makes our system more flexible and capable of ‘creative destruction’ than Europe’s.”

This is bizarre because the U.S. economy is not obviously more flexible and capable of “creative destruction” than Europe’s economy, as people familiar with the productivity data know.

 

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Source: OECD.