The truth about job creation

(MoneyWatch) 

COMMENTARY Depending on who you listen to, Bain Capital, the private equity firm that Mitt Romney ran for 15 years, is either a corporate raider that made gobs of money gutting companies or a virtuous venture capital-like firm that invests in companies to create jobs.

Not surprisingly, neither is true. In fact, there's so much political spin, self-serving rhetoric, and misinformation on the subjects of job creation, private equity and the economy that I thought I'd take a stab at explaining, in plain English, how it all works.

Job creation 101

Companies don't exist to create jobs, and private equity firms are no exception. Rather than get into an age-old debate, I'll just say that companies exist to win and keep customers, grow their business, make profits, and make money for shareholders.

Well-run companies that manage to do all that efficiently and grow over time tend to create more and more jobs. That, in a nutshell, is how it works. Of course, innovation creates markets and expands existing ones, and companies compete for share of those markets. But jobs fundamentally come from growing, profitable businesses. Period.

These days it's popular to challenge that basic construct with Utopian nonsense. Some people say that companies shouldn't exist to win business, grow sales, increase profits, and grow shareholder value. They should have more "virtuous" metrics.

Well, it's a good thing that American executives and business leaders don't listen to any of that nonsense because, if they did, there'd be no new jobs. Unemployment would rise with population growth and we'd lose more and more jobs to China and other nations over time. It's not a pretty picture.

Private equity for dummies

Just like any other company, private equity firms don't exist to create jobs. But they're not in the business of destroying jobs, either. They generally acquire significant equity positions in distressed companies with a goal of turning them around. They do that the same way any company should on its own, by making the company more efficient, more profitable, and ultimately, more competitive and capable of growing.

So you see, while restructuring a company typically does involve cutting some jobs, the truth is that private equity firms are highly incentivized to get companies healthy, profitable, and ultimately growing again. And as I explained above, that means more jobs. Generally speaking, the more successful the turnaround, the more money private equity firms and their investors make.

If that sounds as if the goals of all the key stakeholders in a private equity transaction are aligned, that's because in general, they are. According to Steve Judge, interim president and chief executive of the Private Equity Growth Capital Council, "Private equity is unique because the interests of the firm, the investors, and the portfolio company are all aligned. Because of that, the lion's share of a firm's compensation is directly tied to the returns they deliver for their investors."

Now, it's true that private equity firms and the way they structure deals have evolved over time. For example, the era of super-leveraged buyouts went out with the 80s and portfolio companies don't get saddled with as much debt as before. Which is why James Coulter, co-founder of TPG Holdings, the industry's largest company, says, "It's a new era. Fixing a company, improving operations and driving growth are more important than financial engineering."

It's not rocket science

Companies use profits to hire people and fuel revenue growth. The cycle continues as long as growth is profitable. Sure, you can also fund growth with debt, but too much leverage, as private equity firms and everyone else has come to realize, can be a bad thing.

If you're starting to see a parallel with our economy, then you're starting to get the picture. America has too much debt and our cost of doing business is too high, so our growth is limited. And yes, it really is that simple. That said, there's no silver bullet or quick fix for the economy. There's a lot of work to do to turn America around.

Through years of fiscal mismanagement and legislative stupidity, we've managed to create an unhealthy fiscal environment in America. As a nation, we're not competitive on a global scale. Just like a company, America needs to be restructured.

We need to dramatically cut our spending and national debt. We need to simplify the tax code, get rid of all the loopholes, and lower the tax rates for companies big and small. We need to incentivize companies to repatriate their profits and manufacture on-shore. And we need to repeal legislation that hinders our ability to grow the economy and therefore create jobs.

Interestingly, if we do all that it'll also reduce the dysfunctional lobbying, regulatory conflicts of interest and crony capitalism. How about that.

Look, job creation isn't rocket science, it isn't a miracle, and it's not something a politician can just conjure up like a magician. It's the result of competitive, profitable, growing companies and a healthy, growing economy that isn't laden with debt. That's all there is to it.

[jp3smiles]

The vast majority of job creation results from the activities of companies. However, it is clear that there are jobs created outside the for-profit corporate sector. As the for-profit sector continues to utilize human resources more effectively, the need for human employment will continue to decrease in relation to revenue. The status quo of job creation dominated by for-profit entities appears to be unsustainable in the long run and a simplified view that excludes other sources of job creation appears to be unduly limited in scope and likely unable to provide longstanding solutions.

[carpe_postremo]

@SteveTobak, my impression is that developing technology makes it easier & cheaper every day to expand business revenue by investing in technology, without necessarily increasing employment. The cost of compliance with employment laws from all levels of government combined with historical expectations of job benefits outside of wage (e.g., health/disability insurance, retirement offerings) only further pressure businesses to avoid hiring. If technology continues to displace the need for mass employment and our education/sociocultural system fails to create/inspire people who are productive in ways not reproducible by our non-human hardware & software, the destruction of mass employment & mass consumption (i.e., demand destruction) will only continue. If a new way of preserving mass consumption and mass employment (of people's time) is not devised & implemented, I'm not sure if capitalism & democracy are sustainable.

[stobak2]

I think the first time I heard that argument was over 20 years ago, and yet, unemployment was below 5% just prior to this latest financial crisis. If you look at historical data, employment more or less follows the economy's cyclical ups and downs. That said, your point is a good argument for why we need to incentivize companies to manufacture on shore instead of outsourcing, as I said in the post.

There are lots of ways to create a better environment for companies to create jobs; what's preventing that is poor leadership and gridlock in Washington. I don't mean that in a partisan way; it's been the case for several administrations, right and left.

ST

[jp3smiles]

Excellent point carpe!! The secular change in our economy due to the tremendous efficiencies in the work place provided by the IT revolution of the late 1990's continues in an accelerated fashion. In my view, the notion that we are merely in a cycle that will result in 5% unemployment during some near-term period of sustained growth does not comport with the current and future reality.

[rayward73446]

Your take on the "truth" leaves out a very critical point. Companies have been given tax credits for sending jobs overseas for many years. Always looking for more profit, companies have taken jobs from Americans and shipped them abroad. American manufacturing is a good example of how the move to off shore workers have decimated an industry. Wages for existing jobs have been flat since 1992, the jobs/wages that exist today have not kept up with the growth in business profits.
Companies have lost sight of the fact that a thriving middleclass is great for them as well as everyone else. Their nearsightedness, and sometimes unethical practices have caused the middleclass to move much more towards the poverty level, more than anytime in history. This trend continues as millions of unemployed struugle to find a new job, they are finding that companies are now paying even less in wages. We need jobs, and we need good paying jobs even more!

[stobak2]

Nice try; I covered that in paragraph 14 (third paragraph from the end).

ST

[Epi13]

@stobak2 -That would work well if this was not a global economy, but it is. You cannot ignore where we receive capital (not just where things are manufactured).

Incentives to produce in America are already available and do not include hiring -they are efficiency based incentives -the use of technology.

Though I do like your suggestion of simplifying the tax system; one thing I do see helping, not in creating jobs necessarily but at least making the option to do so easier -and removing the ability of companies to increase profit through taxes will at least help the treasury.

But it's hard to go backwards when you've already moved forward.

[Epi13]

An efficient growing company does not mean 'more jobs' as you imply (that was the old business model). When dealing with false capital (money, material, stocks, etc) an efficiency of thought is all that is needed to expand a business. The advancements of technology, outsourcing, perceived market value, centralization, etc have made this possible. While the idealization that a growing company needs more employees sounds all good and well, the reality (especially when dealing with investment firms) rarely actually happens.

When I hire an employee it is because I have over extended myself with the service I provide. Sadly though that employee is expendable (I try not to think like that when hiring) because as the market changes my need for employees changes and rarely is that because of a lose of market share (hopefully it is because of increased efficiency). Efficiency is (should be?) intrinsic to adaptation, and adaptation is rarely an over extension of services.

If you wrote this article 30 years ago I would say it is dead on the point, but it's 2012 and the degree of separation is steadily and exponentially growing smaller every year that goes by.

[Epi13]

Actually I take that back, even 30 years ago a business growth model was logarithmic not linear as you suggest.

[JustSayin123]

Wow, I had to do a double-take to make sure I was looking at a CBS webpage! How'd you manage that?

Well said. Couldn't agree more.

[bmallen3]

Somebody should make a point of explaining this to Democrats and especially that idiot Obama. In a nutshell, what is described is profit money that trickles down to people in the form of salaries . This is how it has always worked and those who think a government run economy works should go to Greece.