Do leveraged buyouts destroy the economy? Krugman thinks so

It is interesting to watch the millionaire Paul Krugman turn into a populist, as the more he goes off on "taxing the rich," the more he demonstrates his own economic ignorance. In a recent column, he attacks Mitt Romney for being a "job destroyer" because Romney's firm, Bain Capital, engaged in leveraged buyouts, likening him to the villain of Oliver Stone's move, "Wall Street."

Not having seen "Wall Street" or its sequel, I'm not particularly interested in Oliver Stone's view of the world, especially since Stone worships dictators such as Fidel Castro and Hugo Chavez, both of whom have reduced their respective countries, Cuba and Venezuela, into economic basket cases. Nonetheless, the theme that Krugman wants to portray is that leveraged buyouts usually are bad and that they "destroy jobs."

The problem is that Krugman (once again) does not understand the simple Law of Opportunity Cost, which is pretty common among Keynesians. He writes:

So Mr. Romney made his fortune in a business that is, on balance, about job destruction rather than job creation. And because job destruction hurts workers even as it increases profits and the incomes of top executives, leveraged buyout firms have contributed to the combination of stagnant wages and soaring incomes at the top that has characterized America since 1980.

It is hard to know where to begin, but I will start by saying that the official rate of unemployment by itself is no measure of prosperity or even the health of the economy. I recall watching two economists debate each other on television about 30 years ago, with one of the economists having come back from a trip to Romania and talking about the poverty that he witnessed there.

"But there's NO unemployment there," the other economist shot back. (The second economist is a Marxist and teaches at a university where I used to live.) To the Marxist, "unemployment" was the trump card: "Aha! You claim Romania is a bad place to live, BUT EVERYONE THERE HAS A JOB! SO THERE!!"

Indeed, after the communist regime fell there, the curtain was lifted and people found out just how poor Romania was and how even the government's official "we have no unemployment" line was fraudulent. Nonetheless, people on the left still hold that unemployment really is the only variable that matters, economically speaking.

When it comes to issues of leveraged buyouts, Krugman's logic goes south, especially on the employment situation. First, we have to remember that a viable firm is one in which the value of the whole is greater than the sum of its parts. This is important, because Krugman wants us to believe that firms like Bain buy healthy and viable companies, destroy them from within, and then pocket the money and throw people out of work. Furthermore, it is the creation of unemployment, according to Krugman, that creates the "wealth" for people like Romney.

Now, we have to understand that the ONLY way for Bain or any other firm in this situation to make money is for the standard "buy low, sell high" and the only way that such a thing can happen with a leveraged buyout is for the sum of the parts of the firm be greater than the value of the firm as a whole. In other words, the firm has to be in trouble, whether it be mismanagement or something else that has made the company decline in value.

For example, Bain could NOT have purchased Apple for a leveraged buyout, since the value of Apple as a firm would be greater than all of the individual assets that Apple possesses. Yet, if one reads Krugman's column, he wants to paint a picture of Bain purchasing a company that is doing great, and it just destroys it so that some rich guy can walk off with money in his pocket.

Logically speaking, that is not possible. One cannot purchase a viable, healthy firm, sell off its assets, lay off its workforce, and make money. For that matter, the kind of cost-slashing measures that might occur if a corporate raider actually tries to save the firm are not arbitrary; they are done because the value of the sum of the parts is greater than the value of the whole.

Employees who go through such buyouts generally don't have happy stories to tell about it, but one should remember that if a firm is in a situation in which it finds the value of the sum of its parts to be greater than the value of the whole, the hard truth is that those employees most likely are going to lose their jobs, anyway. Why? A firm in that condition is not likely to last long, as it has an illness that either can be fixed only with new management or entrepreneurial ideas, or is going out of business (where its assets will be sold at a bankruptcy auction).

An analogy is the junkyard for cars. Many of the cars that are brought to junkyards still can be operated, and many of them could be fixed to the point where they might work. Junkyards, however, don't make money from fixing the cars on the lot. Instead, they make money by selling the parts taken off the junked cars to mechanics and dealers or selling the components as scrap to be recycled.

That is the hard reality of the world of leveraged buyouts. A firm is not a candidate for such a fate unless buyers perceive either that the company is going out of business or is so mismanaged or has unnecessarily-high costs of production. As everyone knows, leveraged buyouts are risky in that the raiders sometimes don't get what they anticipated, and when people lose their jobs, there are hard feelings.

However, Krugman would have us believe that leveraged buyouts are the CAUSE of unemployment, as opposed to the fact that job losses in such situations come about because the firm no longer was as viable as it once was. True, I realize that Keynesians probably are incapable of thinking of something in terms of opportunity cost, and they certainly can find no value in someone breaking up a firm and selling off the assets when the conditions allow them to do so.

In Wonderland, economies grow because of the nebulous thing called "aggregate demand," which is created by governments creating money. There is no such thing as opportunity cost in that world, and the entrepreneurial processes of creating more goods while using fewer resources does not spell growth to them, but rather unemployment.

Krugman wants us to believe that people get rich in a market economy by causing large-scale unemployment. In a market economy, people become wealthy by providing something that others want and are willing to give up something scarce that has value to others in order to obtain that new good or service. In the process of doing so, entrepreneurs create employment opportunities that enable more and more people to be able to obtain things that they previously could not.

Unfortunately, Krugman has chosen another path of explanation and the end result of governments following his advice is more poverty, inflation, and, in the end, more unemployment.