Wednesday, January 11, 2012

Conservatives and the Free Market

When Newt Gingrich fired off an attack on Mitt Romney's record at Bain Capital the response from the rightwing punditry was as thoughtless as it was predictable. Newt accused Romney of looting companies and undermining capitalism. In reflexive reaction, various “conservatives” have decried Newt's comments as an attack on free market capitalism using the language of the left. It is no more valid to claim that Gingrich's criticisms are an attack on capitalism than to suggest that condemning pornography is an attack on capitalism.

There is a wide gap between free market capitalism as conservatives intuitively understand it and what is practiced by Wall Street financiers today. Free market capitalism and Wall Street are not one and the same. Criticism of the one is not criticism of the other.

I think it is safe to say that they ordinary conservative thinks of a capitalist system as one of risk and reward. You save your money and invest it in a business venture hoping to earn a profit. No conservative has any problem with how much money a business makes by doing this. People like Steve Jobs and Michael Dell invested their time and money and built enormous fortunes by creating, competing and producing value. No conservative has any problem that the creation of new businesses often results in the destruction of old businesses. The fortunes built in the automotive industry came at the expense of the destruction of the horse drawn carriage business. Businesses producing mini-computers and typewriters were destroyed by the rise of the personal computer. However, in this creative destruction there was the creation of wealth and the betterment of the larger society. This view of capitalism has little in common with the capitalism of Wall Street that Newt Gingrich criticized.

The capitalism of Wall Street has very little to do with the creation of wealth and the betterment of the larger society. It has very much to do with the concentration of wealth and the betterment of a few who are given special privileges and opportunities by the government. Bain Capital is no exception. A brief look at history and one of Bain's biggest successes, Staples, will prove the point.

The 1980's saw an explosion of private equity investments of all kinds. There were more deals and larger deals than ever before. Many of the dealmakers earned hundreds and even billions of dollars. Often they reaped these fabulous rewards by putting little of their own capital at risk. This explosion was no accident. The fuse was lit in the mid 1970's and early 1980's when IRA and 401(k) accounts were created. These government favored accounts allowed a person to put money away for retirement without income tax first. But you couldn't just save your money or pay down your mortgage early. You couldn't freely decide how to prepare for your retirement. You had to put this money in an approved account managed by Wall Street. The laws creating these accounts were sold as a benefit to the middle class. The real benefit went to Wall Street firms as they skimmed off millions in fees. The fees were chump change. The real treasure was in the accumulating trillions of dollars in these retirement accounts that were now available for Wall Street firms to use for “investment.”

With these funds available Wall Street firms were able to embark on a campaign of leveraged buy outs and industry “roll ups” that were extremely profitable. Where there was a poorly managed company, Wall Street firms with access to the vast new pool of retirement funds could outbid any competitor to buy the company, restructure it by disposing of underperforming divisions, and reap billions with a subsequent public offering. The process created no new wealth but did concentrate it in the hands of those with access to the new capital pool.

Bain Capital's success with the office supply chain Staples is an example of the roll ups that became possible with the new pool of IRA and 401(k) funds. Staples was founded in 1986. Prior to 1986 there were many office supply stores in every city and town. For the most part these were locally owned and operated businesses competing to provide the mix of price, service, and selection that the local customers wanted. None of these companies had access to a vast pool of capital and so their growth had to be slow and organic. Staples, with Bain Capital's backing, was able to embark on a campaign of accelerated growth that provided advantages in buying power and selection that no local operator could compete with.

The success of Staples, as with many other roll ups in other industries such as sporting goods, pet supplies, and electronics, brought about a remarkable transformation. Thousands of local businesses were wiped out. The middle class owners of these businesses either found something else to do or, perhaps became managers for Staples. The income they earned left the local community and ended up with the Wall Street backers of Staples. The employees of these business lost their jobs. These job losses aren't counted by Romney in claiming credit for job creation. Some of the employees went to work for Staples where Romney counts them as a job created. To be fair the success of Staples did have some benefits. The cost of office supplies went down. So did service, and, arguably selection.

It is debatable whether the success of Staples is a net positive. Lower costs for office supplies are of some value. Do they offset the value to the communities of retaining wealth locally? Did the new jobs at Staples offset the lost jobs at thousands of local office supply stores? What isn't debatable is that the story of Staples is the story of a concentration of wealth in the hands of a few at the expense of the many. What isn't debatable is that the story of Staples is the story of a privileged few accumulating wealth because of government intervention and favoritism. Whatever else the story of Staples is it is not a story of free market capitalism.

Staples is the foundation of Mitt Romney's claim to be a job creator and supporter of capitalism. It is right, fair, and consistent with conservative principles to criticize Mitt Romney's performance at Bain Capital. His performance is a result of the privilege that both the Tea Party and the Occupy crowd are incensed by. Newt Gingrich has done the conservative establishment a favor if they have the sense to listen.

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