Joe Klein, Kevin Kline, and Qualifications for the Oval Office

Many journalists, pundits and politicians have offered opinions about whether Mitt Romney’s experience at Bain Capital is an asset in his bid to become the next President of the United States.  Joe Klein, who writes for Time magazine, may have the most misguided analysis of all.  This weekend he was a guest on the Chris Matthews show and offered this assessment of private equity and profit maximization:

You know, it’s true that it’s kind of cheesy to go after Romney because some of these companies that he tried to change, you know, failed and jobs were lost. The real argument against Romney and that form of capitalism is that it was all about short-term. It was all about maximizing shareholder value.  And what the president’s argument could be and should be is, `I’m not about short-term. I’m about long-term, and it’s going to take us a while to get out of this mess.’

Maximizing shareholder value is about the short-term?  Does Mr. Klein understand that the market value of a company’s equity depends on the expectation of future earnings?  Has he paid any attention to the debate about the price of Facebook shares in the wake of its IPO?  If the shareholder value of a company only depends on the short-term, why is there so much disagreement and uncertainty about the appropriate stock price for Facebook?  The uncertainty arises because the future profitability of the company is unknown.  Future profits depend on how well Facebook will be able to sell advertising to its hundreds of millions of users, and how that may change as more Facebook users access the site through their smart phones.

Joe Klein knows little about the way private companies or the economy works.  Increasing the shareholder value of a company requires changing expectations about the future stream of profits from a company.  It is all about the long term.

Klein’s ideal Presidential candidate, other than Barack Obama, may well be the Kevin Kline character from the movie Dave.  Dave was the manager of a temporary help agency before filling in for the President in the 1993 movie.  Helping people find jobs sounds like the ideal experience for the Oval Office for movie-goers and voters who believe that Presidents create jobs.  Dave’s last act as President was to initiate “a program to try to find a decent job for every American who wants one“ because “if you’ve ever seen the look on someone’s face the day they get a job — I’ve had some personal experience with this – – they look like they could fly.”  Hollywood wouldn’t support a President that said “I’ve seen the look on investors’ faces the day they realized they had turned around a company and created a lot of wealth.”  But, as Brit Hume of Fox News said over the weekend “the business of making a profit has jobs as a by-product.  It’s not as if there’s some favorite industry out there called Jobs R Us, which is in business for the purpose of creating jobs.”

The President and the Congress establish and enforce the laws, taxes and regulations that impact the creation of wealth and consequently the creation of jobs.  Running a business is not the same as governing, but private sector experience helps one understand the costs and benefits of government intervention in markets.  President Obama believes that the Presidency is different than running a private company because maximizing profits is “not always going to be good for communities or businesses or workers.”  The President also said: “When you’re president, as opposed to the head of a private equity firm … then your job is not simply to maximize profits. Your job is to figure out how everybody in the country has a fair shot.”

Voters should consider how each candidate proposes to change taxes and regulations to encourage more wealth and job creation and provide equal opportunity and a fair shot for everyone.  Mischaracterizing the economic role of private equity firms and trying to count the number of jobs that were created or lost as Bain invested in start-ups or troubled companies is largely a waste of time.  The Romney campaign believed that promoting Bain as a job creator would ameliorate the view that their candidate is an out-of-touch rich guy.  The Obama campaign continues to push this unimportant issue and their best explanation seems to be that Romney was the first to mention job creation at Bain.  Let’s hope that both campaigns get off this topic and turn to the important economic policy issues facing our country.

Real Estate and Small Business

Start-ups and new businesses are extremely important for job creation and employment growth.  The strength of the economic recovery depends on the rate of new business formation and the employment gains from these start-ups.   Real estate is the primary asset for many small businesses and the collapse of residential and commercial property values devastated their balance sheets.  Declining real estate values have also reduced the net worth of entrepreneurs and likely slowed the rate of small business creation.

The latest Federal Reserve’s Flow of Funds Report, which was released last week, indicates that real estate is a substantial component of the assets of non-corporate non-financial businesses.  In 2007, prior to the collapse of real estate property values, the market value of real estate accounted for

• 69% of the assets of non-corporate businesses
• 33% of the assets of corporate businesses

Moreover, residential real estate accounted for the majority of the real estate holdings by non-corporate businesses and 41% of all assets of these businesses.

The sharp decline in residential and commercial real estate values during the Great Recession had an enormous impact on the balance sheets of non-corporate businesses.  The plunge in real estate prices accounted for 99.9% of the decline in the value of their assets between 2007 and 2009.  The value of real estate owned by non-corporate businesses has increased since 2009, but for each $8 decline in property values there has been only $3 in gains between 2009 and the end of 2011.  The recession has taken its toll on small businesses; the asset value of all non-corporate businesses is 10% below the pre-recession level, while corporate businesses are worth more than in 2007.

The decline in real estate property values devastated the balance sheets of small businesses and probably reduced the rate of new business formation and job creation.  The latest Federal Reserve data indicates that corporate businesses are worth more than they were prior to the downturn, while non-corporate businesses have declined in value.  Real estate is the primary asset for most small and new businesses, which account for much of new job creation.  Depressed real estate values remain a drag on small businesses.  Small and new businesses will not be an engine of growth until residential and commercial real estate values recover.

Jobs, Autos and Krugman

Paul Krugman wrote a thought-provoking opinion piece in last week’s New York Times calling the auto industry bailout “the single most successful policy initiative of recent years.”  Krugman, an expert in the area of economic geography, wrote that “companies that make a large contribution to a nation’s economy — don’t exist in isolation. Prosperity depends on the synergy between companies, on the cluster, not the individual entrepreneur.”  He pointed out that successful manufacturing companies in China and Germany locate near specialized suppliers and specialized labor.  Krugman used this clustering argument to justify Federal help for Michigan automakers: “If G.M. and Chrysler had been allowed to go under, they would probably have taken much of the supply chain with them.”  In effect, he stood the infant-industry argument on its head and argued that large and previously successful companies should be bailed out even if they squandered the advantages provided by their economic cluster.

Foreign Automakers Have Avoided Michigan Despite the Synergies from Economic Clusters 

Over the past two decades foreign automakers located production facilities in Alabama, South Carolina, Mississippi and Tennessee even though these states lacked the clusters and synergies that should have made Michigan an ideal destination.  Michigan failed to attract new investment in auto manufacturing despite their experienced labor force and convenient supply chain.  According to the BLS, employment in motor vehicle manufacturing in Michigan fell by 68% between 1973 and 2011 but increased in the rest of the United States.  Economic clusters are important, but they aren’t enough to offset high marginal tax rates and labor laws that businesses view as unfriendly.

Large Companies Generally Grow More Slowly and Create Fewer Jobs

Krugman’s opinion piece was also meant to be a rejection of Governor Mitch Daniel’s claim that Steve Jobs was a big job creator.  Once a company becomes large and successful its rate of job creation generally slows.  Fortune’s list of the 50 largest companies in 1996 (based on 1995 revenue) includes a number of companies deemed “too big to fail”, including General Motors (1^st), Chrysler (9^th), Citicorp (19^th), AIG (25^th), Fannie Mae (32^nd), Merrill Lynch (33^rd) and Bank of America (37^th).  Apart from Walmart, which tripled the size of its workforce in the past 15 years, the rest of the Fortune 50 employed fewer workers worldwide in 2010 than they did in 1995.  Apple (which ranked 114 on Fortune’s 1996 list) also tripled the size of its workforce between 1995 and 2010.

Jobs are Created in Start-Ups and Young Businesses

The research of John Haltiwanger and co-authors has shown that jobs are created by young businesses and start-ups.  Many of these start-ups will fail, but the successful ones will create new products using new technologies and account for a substantial proportion of net job creation.  Entrepreneurs, innovators and risk-takers are important for job and productivity growth.   High marginal tax rates, that discourage investment in human and physical capital, will lower the rate of job creation by young businesses that are not yet “too big to fail.”