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Did Romney and Bain Capital Profit at the Expense of Bain's Employees?

Gary North
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Jan. 14, 2012

An anti-Romney attack advertisement has run on television in South Carolina. It's long: 28 minutes. It identifies Bain Capital as a firm that made enormous profits by buying struggling firms and firing people wholesale. Two comments are in order. First, it's inaccurate. Second, Gingrich has recommended that it be pulled, re-edited to correct errors, or else abandoned.

Nevertheless, Gingrich and at least two other candidates criticized Romney and Bain before the video was run. The critics charge that Bain's policy was to buy firms and fire people who worked for the companies it bought.

This was posted yesterday on one of this site's forums.

I'm in agreement that sometimes companies need to shut down to stop the bleeding, that the stockholders need to be happy with their investment, or other companies purchased the parts of a bankrupt company, saving some jobs rather than allowing them all to go away. And I also realize that companies really don't owe their employees anything. (all you can hope for are moral people running your company).

But it sounds like Romney and Bain gamed the system at the expense of employees. Am I wrong about this?

Free market economists have struggled with this phrase for 200+ years: "at the expense of." It rests on the single most common mistake in all of economic theory, what Ludwig von Mises called the Montagne dogma. The accusation: profits in capitalism come at the expenses of others. Mises wrote in 1949:

Hence, people concluded, the gain of one man is the damage of another; no man profits but by the loss of others. This dogma was already advanced by some ancient authors. Among modern writers Montaigne was the first to restate it; we may fairly call it the Montaigne dogma. It was the quintessence of the doctrines of Mercantilism, old and new. It is at the bottom of all modern doctrines teaching that there prevails, within the frame of the market economy, an irreconcilable conflict among the interests of various social classes within a nation and furthermore between the interests of any nation and those of all other nations.

Modern economists refer to this as the zero-sum fallacy. The model is gambling. The accusation is true in gambling. It is worth noting that the gambling industry refers to itself as gaming, which is not pejorative. The word gambling is pejorative in some circles. In gambling, winners do profit at the expense of losers. In such a game, to use the questioner's phrase, the system is gamed. It is gamed to favor the house, which runs the game.

The Austrian School of economics has been adamant: the rules of the game in business are not the rules of the game in a game. Murray Rothbard explained why in Man, Economy, and State (1962).

It is not accurate to apply terms like "gambling" or "betting" to situations either of risk or of uncertainty. These terms have unfavorable emotional implications, and for this reason: they refer to situations where new risks or uncertainties are created for the enjoyment of the uncertainties themselves. Gambling on the throw of the dice and betting on horse races are examples of the deliberate creation by the bettor or gambler of new uncertainties which otherwise would not have existed. The entrepreneur, on the other hand, is not creating uncertainties for the fun of it. On the contrary, he tries to reduce them as much as possible. The uncertainties he confronts are already inherent in the market situation, indeed in the nature of human action; someone must deal with them, and he is the most skilled or willing candidate. In the same way, an operator of a gambling establishment or of a race track is not creating new risks; he is an entrepreneur trying to judge the situation on the market, and neither a gambler nor a bettor.

I wrote an article on this last month: I wrote this:

Gambling is always a statistically rigged zero-sum game. It is rigged, because the house wins statistically. It is zero sum, because the winners profit at the expense of the losers. Finally, it is a game: played for its own sake. It adds losses where none had existed.

The free market is not rigged to favor the house. There is no "house." It is not zero-sum. It is not a game. It is an arrangement in which people get together to benefit themselves as individuals. But the benefits are not matched by losses except when fraud is involved, which the is illegal. Both parties expect to benefit from a transaction. The potential gains are open-ended. The losses can be limited by contract by a limited liability clause if the parties agree. The arrangement is inherently win-win.

This term is the heart of the matter: win-win. This idea goes back to Adam Smith's Wealth of Nations (1776). He used it against mercantilist economics, which rests on this assumption: win-lose.

Consider Bain Capital. As with any profit-seeking firm, to make profits long-term, it has to act on the behalf of customers. There is no other source of gain in a free market economy.

Customers want good products at low prices. The free market delivers this. How? By forcing producers to compete with each other. The system is based on two-fold competition: sellers vs. sellers, buyers vs. buyers.

To cut prices, businesses much cut costs. The main cost in most businesses is labor. So, to increase output per unit of labor, a business must either cut labor costs or increase output from the existing group of employees. Both forms of cost-cutting are legal. Both forms are moral. Both can exist in a company.

Let me describe the free market's arrangement.

Apart from a contract, no seller has a legal claim on the customer's future money. The customer has legal sovereignty over his money. So, to persuade a customer to spend his money, a seller must offer a win-win deal.

Apart from a contract, no employer has a legal claim on an employees future time. The employees has legal sovereignty over his time. So, to persuade an employee to sell his time, an employer must offer a win-win deal.

Apart from a contract, no employee has a legal claim on an employers future money. The employer has legal sovereignty over his money. So, to persuade an employer to spend his money, an employee must offer a win-win deal.

Bain Capital no more profited at the expense of employees than employees profited at the expense of Bain Capital. Some employees got fired after take-overs. This is normal procedure in take-overs that are based on the buyer's perception of a profit opportunity. Most take-overs are based on cost cutting. A few may be based on market expansion. Economists call this opportunity an "unexploited" opportunity. The term "exploitation" has no moral content in the economist's vocabulary. In Marxism, it does. Marx spoke of workers as being exploited. In theory, Marx was a mercantilist. He saw capitalism as win-lose.

If a company stops ordering a high-cost piece of equipment because it finds a cheaper piece of equipment, does it thereby exploit the seller of the expensive piece of equipment? No. The use of "exploit" here is misleading. It has moral connotations. We may say that the company has taken advantage of an opportunity. But we are not saying that the company has taken advantage of the seller of the high-cost piece of equipment.

There are two ways to use the low-cost piece of equipment: (1) as a way to cut costs with the same number of sales; (2) as a way to cut costs by increasing revenues by greater output. But the results are the same from the point of view of the seller of the high-cost equipment: forfeited sales.

A firm that adopts plan #1 has a problem. It is deliberately restricting output. A competitor can buy the same piece of equipment, adopt strategy #2, lower its selling prices, and sell more goods to customers. Some customers will switch from company #1 to company #2. Does company #2 exploit company #1 by taking away some of company #1's previous customers? No.

We are back to Larry the Liquidator in Other People's Money. I have written about this here:

The public is hostile to people like Larry the Liquidator. Yet the Larrys of the world perform a crucial service. They reduce waste. This is a form of conservation. Maybe we should call them conservators. They conserve economic value, as determined by customers and shareholders. If they guess right, they increase value.

The techniques used by cost-cutters in a free market are different from those conducted by civil government. Civil government is a monopoly. It is not governed by profit and loss in a competitive environment. It is not based on voluntary exchange. Elections are a zero-sum game: winners take all. At best, government is win-lose. A successful businessman can be a failure in government when he attempts to apply the same policies. The skills of making a profit are not the skills of running a government. No one can run a government like a business. The systems are different.

So, Romney should not talk as though his skills as a businessman will make him a better President. His critics should not accuse him of being a bad politician because Bain Capital fired people.

When it comes to the federal government, we need cost-cutting -- massive cost-cutting. This would be win-win. This is Ron Paul's approach. The trouble is, "Ronnie the Liquidator" sounds bad. But so does an annual $1.3 trillion deficit.

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