Krugman on private equity

Larry Ribstein —  10 December 2011

Paul Krugman, writing in Thursday’s NYT, sees Romney as a real life version of Oliver Stone’s Gordon Gekko in the film Wall Street.  He characterizes Romney and his private equity ilk as job-destroyers, and argues that they should be taxed (and presumably also regulated) accordingly. He contrasts this with the supposed position of the GOP “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.”

I earlier wrote on the NYT’s previous attempt to make political hay out of Romney’s business career.  The story focused a lot of unfavorable rhetoric on one of Bain’s deals.  I pointed out that, clearing away the rhetoric, although there was some short-term job and salary loss, the restructured company ultimately

became an industry leader, just as Bain Capital had intended. With its overseas acquisition, the company’s labor force swelled to 7,400 workers. The business invested in and refined products, like a test that rapidly detects whether a heart attack has occurred, that became widely used. From 1995 to 1998, Dade’s annual sales rose to $1.3 billion from $614 million. Its assets grew to $1.5 billion from $551 million. But another number was climbing just as fast — Dade’s long-term liabilities, which surged to $816 million from $298 million.

There was a bankruptcy after Romney was no longer associated with Bain, but

In 2007 it was sold to Siemens for $7 billion — 15.5 times the price paid in 1994 for an “ailing” orphaned division of a big corporation. The article concludes with the suggestion that the “painful” layoffs “ultimately worked.”

In short, the story’s details don’t support its slant. Romney’s “brand of capitalism” seems to have worked in this instance, even if its success was colored by events that occurred after he left Bain. Although I’m not suggesting that Romney should or would run the country the way he ran Bain and Dade, I’m also not troubled by his history as a deeply invested owner and manager of Bain. True, he and the other “elites” at his firm made a lot of money. But if every deal was like Dade, it’s not clear society as a whole, including the working class, came out worse.

Now along comes Krugman with his own take on Romney-the-job-destroyer. Krugman seeks to support his point by comparing Romney to a fictional character. 

Now, I’ve spent more than a little time deconstructing Hollywood’s anti-capitalist bent in general and Oliver Stone’s fanciful Gekko invention in particular.  One would think that a Nobel laureate could do a little better than to draw support for his criticism of an industry from a cartoonish portrayal of it, even if the laureate in question has traded academic journals for the editorial pages. 

In fact, Krugman does do a little better by citing a “recent analysis of “private equity transactions” as concluding that, while they both create and destroy jobs, “gross job destruction is substantially higher.” Based on this evidence Krugman concludes:

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. * * *

The truth is that what’s good for the 1 percent, or even better the 0.1 percent, isn’t necessarily good for the rest of America — and Mr. Romney’s career illustrates that point perfectly. There’s no need, and no reason, to hate Mr. Romney and others like him. We do, however, need to get such people paying more in taxes — and we shouldn’t let myths about “job creators” get in the way.

There are a number of holes in this “analysis.”  Let’s start with the evidence Krugman relies on.  Curiously, he omits one of the main findings of the paper.  In the paragraph immediately following the quote about gross job destruction the authors observe:

While noteworthy, these results make up only part of a richer and more interesting story about the employment effects of private equity. Using our ability to track each firm’s constituent establishments, we estimate how employment responds to private equity buyouts on several adjustment margins, including job creation at greenfield establishments opened post buyout. This aspect of our analysis reveals that target firms create new jobs in greenfield establishments at a faster pace than control firms. Accounting for greenfield job creation erases about one-third of the net employment growth differential in favor of controls. Accounting for the purchase and sale of establishments as well, the employment growth differential is less than 1 percent of initial employment over two years.

In other words, private equity doesn’t destroy jobs, but reallocates them from less productive uses to more productive uses in new, or “greenfield,” businesses.  This point is emphasized in the abstract of a much more recent version of the paper Krugman chose to ignore, released last summer (emphasis added):

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.

Krugman’s analysis has other holes in addition to its evidence deficit.  First, it is fair to say that private equity’s objective isn’t to create jobs but to make money.  One hopes that the two will go hand in hand, but there are many reasons why they may not, including government policy.  In other words, there’s a problem when employing people costs firms money, but private equity is only the messenger. The point of my earlier blog post on this is that Romney’s experience restructuring firms gives him a lot better idea than many politicians, including the current president, of what government needs to do to fix the underlying problems.

Second, Krugman seeks to leverage his analysis of private equity into criticism of the 1%, concluding that “we do. . . need to get such people paying more in taxes.” Even if you are willing to conclude that private equity destroys jobs and shouldn’t get any breaks, this is far from killing the argument that business as a whole would thrive if less burdened. This could include some of the businesses that Bain profited by restructuring.

The bottom line is that one shouldn’t read Krugman without a grain, or perhaps a whole tub, of salt.

Larry Ribstein


Professor of Law, University of Illinois College of Law

8 responses to Krugman on private equity

    save_the_rustbelt 17 December 2011 at 6:48 am

    Resistance to change has killed many businesses. And jobs.

    Are private equity firms the proper change agents? Sometimes yes, sometimes no.

    The truth lies somewhere between worshiping the financiers and reviling them.

    However, if we look at the “age of finance,” say the past three decades, the net results are not so hot. Except for the financiers.


    I’ve worked in private equity the past six years. My gut says that Romney (like most law professors or lawyers) was never in the trenches and has no clue how to really achieve “savings” (sorry, I meant “synergies”). He simply told people who were in the trenches to deliver the an IRR at or higher than the model. Obviously you can easily dismiss my opinion as being ignorant or uninformed.


    The quotes you use do not seem to support your argument. The newer version presents a strawman (“Private equity critics claim that leveraged buyouts bring huge job losses.”) when the Krugman quote does no such thing.

    Do you have more, on point, evidence of Krugman’s intellectual dishonesty? The newer version of the paper indicates a modest net impact, which impact appears to be negative.


      If you aren’t persuaded by my blog post or my response to the last comment then you aren’t going to be persuaded. I’m not going to play blog comment whack-a-mole with you


        That’s fair. I was just pointing out that your evidence does not support your conclusion. If you had more of substance, it would bolster your argument.



    My point was that krugman omitted the greenfield point, which immediately followed the quote that he used and was emphasized in the more recent version of the paper. In my view this was a deliberate distortion. Moreover, it directly contradicts his point that private equity destroys without producing. The authors emphasize that greenfield developments are a kind of creative destruction. Krugman could take issue with the paper if he wants but it isn’t honest to use the paper to support his point.


    In both the abstract and in the paper itself, unless I am reading something wrong, it says the “net impact” is modest, but is it negative or positive?

    This DealBook write up of the 2008 paper says the net loss is one percent. Here’s the link to that paper:

    Here’s a link to the full paper:

    I read through it a few days ago when Marginal Revolution linked to NRO discussing it, but it’s not working right now. Does it say the net impact is positive or negative?

    Krugman says “on balance” to describe the tilting between job creation and job destruction and alludes to the complex nature of private equity in general, so I don’t think it’s fair to imply he brushes over this or blames private equity for huge job losses, especially if the net impact is in fact negative, however small. Nor is it right to imply he’s saying they should be taxed because of the field they are in–which can result in job destruction as well as in job creation and productivity gains–as opposed to their incomes and overall level of wealth.

    His broader point was that these guys aren’t inventors or anything like that, despite the (valuable) purpose they serve in finance.