The PE Man vs. the Statist
Monday, June 18, 2012 at 7:25PM
John Prothro

President Obama is trying to demonize private equity as an ugly cabal of fund managers (like Romney) who devour family businesses and ship jobs overseas.  Contrasting his own experience with Romney’s, Obama touts government “investments” that supposedly keep jobs at home while supporting the future of innovation. 

Obama wants America to believe his interventionism is a kinder and gentler alternative to the profit driven ruthlessness of Romney’s past.  But the choice here is really between Obama’s state capitalism—the misnomer that encourages public intervention into private industry—and true capitalism from which private equity was conceived. 

Obama’s argument could work.  On the surface, statism appears nobler than capitalism.  After all, the statist has the luxury to make decisions based on subjective feelings like social justice and fairness.  The capitalist, on the other hand, is a slave to economics and sometimes makes tough decisions to improve the bottom line. On an emotional level, the statist looks virtuous, but in reality the capitalist is the one most responsible for the greater good.

Unlike Obama’s state capitalism, private equity survives on the efficient and prudent use of capital and thus must focus investment into areas most likely to benefit humankind.  In a free economy, a company only profits when customers voluntarily choose to use its product or service, presumably because that product or service benefits them in some way.  A company’s balance sheets and financial statements, then, are objective markers that measure how effectively a company makes life better for people.  For this reason, value-driven private equity investment cannot be divorced from the greater good.

The state, however, has a very different model.  Rather than relying on the market to satisfy consumer preferences, the state allocates capital based on the whims of political actors.  Sometimes these whims are well intentioned, but often they are not.  State capitalism is extremely vulnerable to cronyism, prejudice, fraud and many other breeds of corruption that arise when power players have access to taxpayer dollars.  Witness the underhanded corruption of the banana republics, China, Russia, and the Middle East—places where state capitalism is celebrated—and one can easily see the harmful results of state power inserted into the market.

Perhaps the greatest distinction between private equity and state capitalism is the assumption of risk.  Private equity managers not only risk their careers when they invest; they often put their own money into deals, making them doubly motivated to make sound investments.  Government patronage is an entirely different matter.  Under Obama’s system, the unsuspecting taxpayer underwrites the financial play-acting of the politician.  And if the taxpayer is fortunate enough to realize he has been cheated, his only recourse is the ballot box.  Unfortunately, his vote is not worth what it was before the politician used the voter’s money to buy the support of special interests.

Despite these differences, however, there is one interesting and exciting correlation between private equity and American politics.  Many startup private equity funds fail after their first attempt.  Untested fund managers may be given an opportunity to prove themselves, but their investors have little patience for failure.  If a new fund fails to produce a strong rate of return, its principals are left to search for another job. Given the dismal performance of Obama’s investments—i.e. Solyndra, the Volt, Green Jobs, Abound Solar, the Stimulus, Cash for Clunkers—one can only hope Obama enjoys a similar fate. 

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