Via Professor Bainbridge, I read today about the nonsense surrounding Mitt Romney enjoying firing people. I’m late to the this one, but here is the quote in context for anybody who missed it:
“I want individuals to have their own insurance,” he said. “That means the insurance company will have an incentive to keep you healthy. It also means if you don’t like what they do, you can fire them. I like being able to fire people who provide services to me.
“You know, if someone doesn’t give me a good service that I need, I want to say I’m going to go get someone else to provide that service to me.”
Bainbridge explains why, even if one was to take this quote and extend it to Romney’s days at Bain Capital, the ability to fire people who are are failing to provide a needed service is a feature of a well-functioning market for corporate control, not a bug:
In many cases, restoring a business to efficiency and profitability thus requires the kind of shakeup occasioned by a corporate takeover, such as the sort of LBOs in which Romney specialized, which brings in new managers who are willing to fire people. LBO specialists who like to fire people thus played — and still play — a critical role in ensuring that US corporations are sufficiently lean to compete effectively in a pitiless global economy.
The economic point goes well beyond the market for corporate control. The ability to impose sanctions on an economic partner is fundamental to modern contracting. In nearly every treatment of the economics of contracting, one begins with the notion that the transacting parties potentially have at their disposal both reputational capital — that is, self-enforcement — and written enforcement as means for assuring contractual performance. Klein & Leffler (1981) is the model that comes to mind. The key insight is that parties do not have to rely upon imperfect court enforcement, but can create self-enforcement mechanisms were performance is assured not by litigation, but by threat of termination of the economic relationship. The costs imposed on the non-performing party are not damages, but the loss of the expected premium stream from the economic relationship. In the economic literature, self-enforcement has been used not just to explain economic relationships in which court enforcement is entirely unavailable, but the complementary nature of written terms and reputational enforcement in a wide array of complex contractual arrangements including franchising arrangements, tying, resale price maintenance and exclusive dealing. I discuss the distinction between standard economic approaches to contract that ignore these complementarities and the Klein (and also Oliver Williamson) approach to self-enforcement here.
The role of termination in facilitating well functioning economic relationships is critical in not just the market for corporate control, but it all kinds of product and service markets. It is hard to take these arguments against Romney seriously — even harder than the arguments disparaging his role at Bain. In context, what Romney actually said is unremarkable. How many of us don’t want to be able to terminate our economic relationship with the restaurant that feeds us low quality food or the service person who we find out shirked and provided shoddy quality work after the fact? Our ability to do so constrains economic opportunism. Perhaps the real objection is not that Romney talked about termination, but that he expressed a preference for terminating shirkers with whom he has economic relationships. Not only does he fire people, but he likes it! Perhaps the appropriate response then, from an economic perspective, is not to pillory him for it a la Huntsman, but to thank him for allowing us to free-ride on his efforts.