Garett Jones  

Bain Capital and the Decline of Galbraithianism

My Visit to NASA... A Bunch of Arguments in Favor ...
Today most serious economic observers take it for granted that creative destruction is the norm.  The rise of internet firms, the overnight demise of Enron and Arthur Andersen a decade ago, and especially the rapid turnover of the Fortune 500 are all examples.  [A useful critique of the Fortune 500 turnover stats is offered by the Kauffman Foundation here.]  

But the Serious People didn't always take Schumpeter's big idea for granted.  There was a time--the 60's--when John Kenneth Galbraith bestrode the business media like a colossus, all six feet eight inches of him.  And his view, spelled out in The New Industrial State, was that corporate managers had successfully slowed down the process of creative destruction, had put those pesky profit-maximizing shareholders in their place, had turned the focus toward corporate empire-building and workmanlike R&D departments and managed change.

The corporate chieftains of the 60's could have used this slogan: 

"Capitalism: Now with 55% less risk!"

GMU Law's Henry Manne (then at a competitor) told a different story in the 60's: In this quick, prophetic, influential read, he noted a big downside to a world where shareholders were treated with contempt: It meant lazy, inefficient firms could soak up otherwise useful resources.  The article focuses on one way to get the company to act "as if" it were working for shareholders: Allow more intra-industry mergers.  Manne predicted that efficient firms would tend to take over less efficient competitors, overhaul management at the target firm, and boost productivity.  Quite close to a free lunch, something you should always order.  

Manne's argument was presumably designed to shock (What, now you're going to go around creating monopolies for the sake of efficiency?); with 2700 citations, I'm certain it changed minds.  

But notice: On a key issue, both Manne and Galbraith are in agreement: Both saw themselves living amid a capitalism where shareholders weren't even close to fully controlling their firms.  

That ended in 1982.  The first private equity boom (and the merger boom it accompanied) helped create a world where creative destruction became the norm. Don't give the corporate raiders complete credit for making Schumpeter true, but they deserve a decent share.  

And Bain Capital was part of that: Founded in 1984, their approach was, according to published reports, the private equity version of Manne's model: Bringing best practices to poorly-run corporations.  

You can imagine a business school professor asking herself, 

What if a prominent consulting firm pooled together some cash and started taking over firms instead of just writing reports that nobody reads? I wonder how that would turn out....

It'd be a good way to see if these consultants can actually add value rather than just borrowing your watch to tell you what time it is.

Bain Capital, a spinoff of the consulting firm Bain & Company, ran the experiment. They're just one example of the private equity boom that put shareholder interests higher on the to-do list, but they're on everyone's mind because of the election, so I might as well do what I can to pull in page views.  

That means that the rise of Bain and the other raiders caused the decline of John Kenneth Galbraith's relevance.  Galbraith described a world that no longer exists.  A good prose stylist, we might read him for the same reasons we read Austen novels--some eternal truths, yes, but mostly because we like to hear about this long vanished world where firms cared about more than mere profit and visitors brought letters of introduction.  

As I put it on Twitter:

Bain Capital: Making John Kenneth Galbraith wrong since 1984

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CATEGORIES: Economic History , Finance

COMMENTS (4 to date)
Frank Howland writes:

Michael Jensen (see in the corporate finance literature wrote later than Henry Manne, but he's been a passionate advocate of an active market for corporate control and of private equity.

I am surprised by your reference to Enron and Arthur Andersen as examples of creative destruction. Wikipedia's article on creative destruction quotes David Harvey as writing: "Both Karl Marx and Joseph Schumpeter wrote at length on the 'creative-destructive' tendencies inherent in capitalism. While Marx clearly admired capitalism's creativity he [...] strongly emphasised its self-destructiveness. The Schumpeterians have all along gloried in capitalism's endless creativity while treating the destructiveness as mostly a matter of the normal costs of doing business". It sounds like you are closer to Marx than Schumpeter.

david writes:

Note that JKG advanced the argument because he thought that organized labour would not allow states to tolerate the instability associated with industrial-scale competition.

Like the rest of the old Keynesians more generally - "oh, of course money is endogenous, the Fed would never dare risk the high unemployment from refusing to print" - their generation overestimated the unity of the labour establishment.

Mike Rulle writes:

I agree we should have Private Equity. At the very least it can help put a floor on the stock market value. But PE is often just financial "risk arbitrage" which just manipulates the seniority of cash flows.

Being someone who leans toward thinking the EMH is a close approximation of reality, I question the amount of value PE actually creates in reducing the natural tension between management and shareholders. In fact, I have come to view the term "shareholder" as one which is designed to favor management. I strongly prefer the term "owner". Its meaning is clear and direct.

I too agree with goals you seem to imply. I just don't think Private Equity per se is that good at it. If I had my way, I strongly prefer that companies be organized like MLPs or REITS.

Maximum cash should be returned to shareholders. Management will be forced to come to capital markets more frequently when making sizeable investment decisons.

This is not perfect either (what is?). But at least owners and potential owners will have more direct say.

Ritwik writes:

Creative destruction! The post 1980 world has creative destruction! Now why would you dilute your well deserved reputation with such weak sauce?!

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