IN THE EARLY 1980s, soon after the publication of Wealth & Poverty, I received a phone call from a man with a mellow mid-Southern accent, honed from roots in rural Tennessee and long years talking down to top executives of American enterprise. William Bain was the name, “but everyone calls me Bill,” he said. I had never heard of him, or his eponymous company, a consulting firm in Boston with ambitions in venture capital, but I was soon on board calling him “Bill” and listening closely to what he had to say.
He invited me to speak to his team of Bain & Company partners, and also, if he might…no Offense…he wanted to impart some ideas of his own, some points I might have missed on supply-side economics.“We’ve done some research,” he said, “that shows the theory is much more general and powerful than even you believe.”
As one unused to charges of underestimating the power of supply-side theory, I was intrigued. I went on to give many hundreds of speeches and do scores of debates with such figures as Robert Reich, the Harvard professor who became secretary of labor under President Bill Clinton; Lester Thurow, the eminent MIT professor and bestselling author;And the legendary six-foot-eight-inch tribune of tall taxes, John Kenneth Galbraith of Harvard and Gstaad, Switzerland. I received astonishing fees of up to six figures (a level I breached for an event in Cambridge, UK, for a German bank). At the time, supply-side was that hot. But every speech and book that I produced from then on bore the imprint of my conversations with people at Bain. I learned more from them than from any other audience or, if truth be told, from my four years of Harvard, which included little economics beyond disgruntled attendance at a lecture by Galbraith reading out loud word-for-word from his bestselling book.
What I gathered from Bain was the key role of learning and information in economics. Later I immersed myself in the works of Claude Shannon, MIT’s legendary inventor of mathematical information theory and conceiver of the information “bit” as a unit of surprise. But even before I received these theoretical underpinnings, the practical lesson in information economics that I gained 30 years ago with Bain was transformative. It replaced the stimulus and response incentive structure of original supply- side theory with the sound microeconomic underpinnings of learning, information, and entrepreneurial surprise.
Across from the oldest cemetery in Boston under chandeliers at the Parker House, the Bain meeting brought together, as I recall, perhaps 100 men in suits. Notable in the group were Bain himself, a spruce young man with blond hair brushed straight back, and an Israeli woman, Orit Gadiesh, who within 10 years would rise to the top of the organization.But Bain seemed more eager to introduce me to one Mitt Romney.
I recall the introduction vividly, and not just because of a dismal year I had spent working for his father, George, then the governor of Michigan, in 1966 and 1967, ghosting an unpublished presidential campaign tract called The Mission and the Dream. I had been a speechwriter for Nelson Rockefeller, a dyslexic who treated his writers as royalty. Romney treated my emergent tome with all the gravity he might have devoted to the owner’s manual for the Nash Rambler.I ultimately learned from my time in Lansing that the worst periods of your life can be redemptive (I would later learn, as a dot-com-era businessman, that the euphoric times can be catastrophic).
Worked out during dark months in a motel in Lansing with only occasional interaction with the supposed author—who was guarded by a coterie of careful protectors from any haunting by ghosts from east of Grosse Pointe—the research and themes of The Mission and the Dream foreshadowed and enabled Wealth & Poverty. My lack of a paycheck as his campaign collapsed impeded my futile efforts to date the damsels of Michigan State and left me subsisting on ever more dubious items from deep in my motel refrigerator. My ordeal was not improved by my residual link to the Rockefellers, embodied in a borrowed white Plymouth, whose parking tickets from extended stays on the street in front of the Romney office—ignored by me—went to 5600 Rockefeller Plaza in New York, followed in the course of time by two solemn state policemen from Michigan, who traveled all the way to Rockefeller Center to collect the money. This pilgrimage marked a low point in my relations with both the Eastern Establishment and the Romney campaign.
Romney’s failure to pay me, however, did allow me to keep the research and writing from The Mission and the Dream. With a rapidity that would have been impossible starting from scratch, a decade or so later I could turn it into the book that popularized supply-side economics and made me Ronald Reagan’s most quoted living author.
I REMEMBERED MITT at the Parker House because of his striking looks, confidence, and charisma, which I remarked at the time were even more impressive than his father’s. Winner of joint degrees from Harvard Business and Law Schools, he had been one of the leading candidates in the country for the super-competitive realms of the Boston consultancies. More significantly, I believe, he conveyed the gravitas of a graduate of the Mormon school of hard knocks and hair shirts as a missionary for two years selling his religion’s bread-and-water regime in Bordeaux, France. He had also been a narrow survivor of a fatal head-on collision with the careening car of a local Catholic priest, which took the life of the wife of Romney’s mission president.
Consultants with a modus operandi, unique to Bain, of attaching themselves to companies only at the CEO level, none of these young corporate quarterbacks showed any propensity for attentive service on the benches of life. These were young men, alone in America, with the leverage and audacity to advise famously imperious chief executive officers on lifeand- death matters in their companies. But at the Parker House meeting in 1981, among all these luminaries, Mitt was already clearly ascendant.
He seemed only mildly interested in my association with his father, and he gave me the impression That I had lived in Lansing longer than he had. Out in Lansing, I had come to admire George as a man who got up every morning at five and played a round of golf with three golf balls in parallel, while running from shot to shot. He was a magnificent creature, an inspirational entrepreneurial leader at American Motors, and an exemplary father for Mitt. But I eventually found him gullible to the point of brainwashing about liberal ideas.
The elder Romney was abashed by Ivied expertise, the great peril of establishment Republicans from the time of both Bushes through the presidential candidacy of John McCain. All cherish the illusion that leading Yale, Harvard, and Princeton economists possess some useful wisdom about the economy. They generally don’t. Their preoccupation with static macroeconomic data blinds them to the actual life and dynamics of entrepreneurship. Their preoccupation with liabilities and debt blinds them to the impact of their policies on the value of economic assets. Their GDP model, which measures everything as kinds of spending, pushes them to manipulative policies and redistributions inimical to business equity value and growth, innovation, and creativity. Believing that a weaker dollar is just the thing to spur a sluggish economy, by hyping the spending category of “net exports,” they miss the consequent devaluation of all the assets of the country.
George Romney capitulated to these forces. His great achievement as a big-spending governor of Michigan was the enactment of a state income tax.As Nixon’s secretary of housing and urban development, he followed the liberal temptation into a series of ineffectual big-government programs. Tangentially ensnared by a scandal surrounding FHA and Ginnie Mae mortgage-based securities that he pioneered, he even could be described as an early source of the feel-good finance of confectionary home ownership that ultimately brought the economy down at the end of the Bush years.
I was hopeful that the son would surpass the father as a man with a mind of his own, resistant to the wiles of wishy-washy “compassionate conservatism,” the Republican form of Obama’s hopeychange.Thus I looked on with nothing short of horror at his can-you-top-this effort to win a Massachusetts Senate race by sloughing off every principle of his upbringing to thread his way down the slim sidelines to the left of Ted Kennedy.
He even repudiated Reagan, who had actually won Massachusetts twice.
ON THE SURFACE, Romney was an improbable conservative champion. But beyond all his round-heeled political compromises in Massachusetts, I knew he combined huge abilities as a leader with a fundamental grasp of supply-side theory excelling all other Republicans. When he spun out of Bain & Co. to form Bain Capital in 1984, he launched an Olympian record in private equity that was not effectively impeached despite many efforts during the political campaigns that followed. He capped it with a bold and utterly ruthless rescue of the parent firm when Bain & Co. ran off the rails as the founders attempted to cash out in the early 1990s. Romney cut the founders’ share by half, slashed compensation, fired half the people, shook or faced down the creditors, notably including Goldman Sachs, and saved the day for his future entry into politics. He doesn’t boast about it, but this flawless performance in the clutch expressed Romney’s extraordinary gift for crisis management, demonstrated again and again in his career and personal life.
Back in the 1980s, Bain Capital under Romney was a spearhead of a massive national movement of corporate restructuring. The high tax rates of the inflationary 1970s had forced a deadening siege of conglomeration and corporate bloat and resulted in a catastrophic 60 percent decline in the real value of corporate equity. This was the era of palatial new Corporate headquarters, jet fleets, and lavish entertainment budgets all serving incoherent jumbles of unrelated companies that had equity worth less than the sum of their parts. Corporations often had either to splurge or merge to avoid a suffocating confiscation of profits through the interplay of inflation with exalted tax gouges, which could rise to effective rates above 100 percent of real returns.
Conglomerates artfully combined companies nursing losses with companies harvesting profits, thereby muting the impact of the deadly tax regime.But Ronald Reagan’s counter-inflationary supply-side tax policies, coupled with Paul Volcker’s monetary contraction, made these morbid combines dysfunctional.They had to be dismantled and reorganized for a low-tax, low-inflation regime, kicking and screaming all the way, and Romney was a key leader on the case. Brought to a level of highest sophistication by Michael Milken, who was wrongly charged as a Ponzi predator by the old corpocracy and its legal accessories, this restructuring campaign radically increased the value of the assets of U.S. business.
This history is deeply relevant today. For the first time since the Carter years, the U.S. once again leads the world in corporate tax rates, promiscuous conglomeration, and importunate lobbying for government succor, while undergoing a foundering of independent business and a net flight of capital and skilled manpower abroad. It is the resulting collapse of America’s assets that makes its liabilities increasingly unsupportable.
Despite the nation’s need for renewed restructuring— again at both the governmental and business levels—our memory of the original episode is deeply clouded. If Milken’s contribution is recalled as felonious, it’s no surprise that Bain Capital’s is seen as predatory. If Milken is seen chiefly as an exponent of junk bonds rather than the vessel of a trillion-dollar appreciation of the equity in his companies, Bain too faces criticism for loading down its companies with debt. To determine whether Bain caused job losses or gains, critics in the media doggedly misrepresent the record of restructuring by focusing on the anecdotes of particular company turnarounds. These single-company narratives, which even Romney’s defenders use, are nearly irrelevant to the economic effects of a general restructuring that releases capital for better uses, more jobs, and higher valuations all across the economy. One of the key beneficiaries of the hundreds of billions of released and recycled money was venture capital,Which funded new technology startups such as Cisco and Google that today collectively account for some 21 percent of GDP and more than half the value of the nation’s equities.
CONTRARY TO CLAIMS OF JOB LOSSES from restructuring were closely studied and refuted by Harvard Business School eminence Michael Jensen and his team in the mid-1990s. Between 1976 and 1993, which covers Romney’s Bain Capital years, Jensen calculates that U.S. corporations conducted 42,621 merger and acquisition deals worth a total of $3.1 trillion. Selling firms won premiums of 41 percent, generating $899 billion in constant dollar gains for shareholders (well over a trillion in today’s dollars). Buying firms also gained on average, by increments that increased over the years. Since Bain under Romney was an out-performer, its results were better proportionally.
Harvard economist (later Treasury secretary) Larry Summers speculated that these gains disguised wealth transfers from bondholders, workers, suppliers, and communities. Jensen disproved this charge, showing—in the aftermath of the transactions— sharp increases in capital expenditures, R&D, employment, and share value. During this period, encompassing the Reagan years, the nation massively led the world in job creation with between 50 and 55 million new jobs, at steadily rising pay, compared to some 10 to 15 million jobs lost. With the U.S. generating jobs far faster than overseas rivals, this restructuring could hardly have caused job losses to foreign countries. We continued to lead the world in job creation, launched the computer revolution, and maintained our manufacturing employment level until the crash of 2000.
What was the reason for the huge impact of private equity investments and buyouts? Jensen stresses the importance of realigning the management with the stockholders and overcoming the “agency problem.” Ownership fosters good management because owners are their own agents. All other arrangements foster subtle or even open conflict between the managers—some prone to enrich their own worth, hire cronies, and build empires—and the shareholders, who in general single-mindedly want to maximize the worth of the enterprise.
The underlying reason for the efficacy of private equity transactions, however—as I learned from my meetings with Bain and later tutelage under Milken— is the better alignment of knowledge and power. Romney could build value for his investors because he combined the financial power of Bain with an intimate knowledge of all the companies in his portfolio and a dynamic understanding of the always-changing economic landscape. Like Warren Buffett and John Doerr and other successful investors who deal in entire companies, he exploited the legality of insider knowledge by owners and aspiring owners.
By contrast, government “fair disclosure” securities laws routinize and stultify information release by debouching it through law and PR departments, thus denying public company shareholders any similar access to their companies. The effect is to enforce ignorance on most public stock market investors, reducing them to a level short of real ownership. When a company goes public, ironically, its information immediately goes private, vetted and netted by lawyers and PR counsel until it contains no substance at all beyond quarterly disclosures of enigmatic numbers.
Conglomerates such as Berkshire Hathaway or General Electric, venture capitalists such as Doerr’s Kleiner Perkins, and private equity players such as Romney’s Bain Capital all escape this trap. They can intimately understand the investments they make.They legally join the knowledge of ownership with the power of profits. They are entrepreneurs, commanding the most powerful money in any economy: fully informed finance.
If Romney had been listening more attentively when I gave my speech back in 1982, he might have been more cogent in responding to the charges of “vulture” capitalism in later years. I showed that consumer spending is nowhere near 70 percent of the real economy (GDP leaves out all intermediate transactions in the supply chain) and is nearly irrelevant to economic growth (“supply creates its own demand”). I spoke on the centrality of venture capital and the power of entrepreneurs responding to tax rate reductions: “High tax rates don’t stop rich people from being rich; they stop everyone else from getting rich,” I said. “Progressive tax rates don’t redistribute incomes, they redistribute taxpayers…from factories and offices and onto foreign beaches and early retirements,” among other old favorites that still ring true looking across to Europe in 2012. And I made my case that capitalists thrive only by serving others. But at the time, in the early 1980s, I still did not really grasp the deeper sources of the power of venture capitalists and private equity players.
After my speech, I began an educational gauntlet at Bain, which set my course for years to come.
MY CHIEF INSTRUCTORS were Bill Bain himself and another of his leading consultants with a political background and commanding personal presence, T. Coleman Andrews. The hornrimmed black-locked namesake of his grandfather, who had run for president on the Dixiecrat ticket, Andrews smacked less of his Virginia heritage than of his years at Dartmouth, then leading the world in computer education under president John Kemeny.The young Virginian was Romney’s chief cohort on the road, raising funds for Bain.
Bain and Andrews explained to me that tax rate reductions were just a special case of the strategy of aggressive price cutting on which Bain had based much of its consulting practice. Bain itself would often do its first project for free. “We have discovered,” Bain said, “that aggressive price cuts can trigger a cascade of strategic benefits, not just expanding market share, building asset values, and increasing revenues and profits, but also gaining more knowledge of the strategic environment and provoking overreactions and blunders by rivals.”
“Companies in trouble that raise their prices, on the other hand,” Bain explained, “all too often begin a spiral of decline.” The market darkens before them as they retreat from it into highly paid niches. Their technological progress slows as their volumes decline and rivals rush ahead into the future. Bain saw the U. S. under President Carter as a company in trouble that was raising its prices in response, with all the predictable bad effects, such as competitive reverses to Japan and Germany, lower real revenues for the government, collapsing equity values, and the famous “national malaise.” Mutatis mutandis, we see the same situation today under President Obama.
At the heart of Bain’s analysis was a proposition that originated in studies by research teams in the U. S. Navy during World War II—the famous “learning curve.” Bruce Henderson, another Tennessean with a Vanderbilt degree, led the Boston Consulting Group after the war in further developing and extending this pioneering insight. In the 1960s, Henderson hired Bain and later Romney and his friend the future prime minister of Israel, Bibi Netanyahu. All three gained their original grasp of capitalist dynamics at BCG, founding a theory of business economics on the intricacies of learning and innovation.
Generalized as the “experience curve,” it held that—largely because of on-the-job learning, broadly considered—the costs incurred in producing any good or service decline by between 20 percent and 30 percent with every doubling of units sold. Growing apace with output and sales was entrepreneurial knowledge springing from improvements in every facet of the company, every manufacturing process, every detail of design, marketing, and management.Crucially, the curve even extended to customers, who learned how to use the product and multiplied applications for it as it dropped in price.
Experience in these terms is the root of company value, which is a product of the knowledge in the company, the learning of the customers, the balance sheet of assets and liabilities, and not least, the policy environment.Private equity investment firms, such as Bain Capital under Romney, work on all these levels to achieve capital gains.
The experience curve describes efficiency increasing with experience and scale in the provision of any product, from pins to cookies, insurance policies to phone calls, pork bellies to chicken broilers, steel ingots to airplanes. On the other hand, by raising prices—or taxes—you slow down all this learning and experience, increasing average costs across a business and an economy, depleting asset values, exacerbating liabilities, and lowering both private profits and public revenues.
Michael Rothschild, another business consultant and author of Bionomics, soon generalized the learning curve to all biology. Rothschild showed that Henderson’s roughly 25 percent increase in efficiency with every doubling of accumulated output applies to everything from hunting and gathering by hominids on an African savannah to the collection of nutrients by rain forest slime molds. (Today slime molds are being tried as a material for biocomputing.) Bionomics presciently opined that in the crucial test of relevant intelligence, public sector unions learn more slowly than tapeworms (parasites that only rarely devour their hosts).
A decade later, in The Singularity Is Near, inventor-prophet Ray Kurzweil found exponential advances across the technoscape that dwarf the incremental advance of GDP cherished by economic histories.
In his book Knowledge and the Wealth of Nations, David Warsh presents a dramatic story of compounded learning curve gains over the course of millennia in a 1993 paper by Yale economist William Nordhaus. For something like a half a million years, from cave fires to candles illuminating the entire palace of Versailles, the cost in labor hours of a lumen hour of light dropped by a total of perhaps 75 Percent. Then between 1711 and 1750, the British government taxed candles and windows, causing a “little dark age,” with a 30 percent increase in the cost of illumination.
Accelerating through the 19th century, though, came free market and transport advances that opened Britain to innovation and trade. The labor cost of light began a precipitous plunge, with gaslight costing one-tenth as much as candlelight and kerosene light one-tenth as much as gaslight, and electricity bringing a further thousand-fold drop.
Yet most economists remained in the dark, grousing about the rise of the British national debt, which reached 250 percent of GDP in 1820, and decrying the immiseration of workers in “dark satanic mills.” By focusing on money prices rather than real costs, liabilities rather than assets, they almost completely missed the fabulous real gains in living conditions and asset values epitomized by the sinking labor cost of light. Over the course of the 19th century, as Nordhaus showed, the cost of light plummeted to merely a tenth of 1 percent of its level at the century’s beginning. Warsh exclaims, “The traditional story was off by three orders of magnitude, or a factor of a thousandfold!” Demand-side GDP data tend to miss all most important technological revolutions and thus foster zero-sum thinking focused on government benefactions and redistributions.
Rothschild and Kurzweil had the gist of the story. Nordhaus offered a historic panorama. But Henderson and Bain were the first to explore in depth the sources of the curve in the economics of information and learning.
ONE OF BILL BAIN’S first assignments at the Boston Consulting Group came in the mid-1960s at Texas Instruments in Dallas, where naval veteran Patrick Haggerty was a leading exponent of the learning curve for the production of electronic components. With Haggerty’s support, Bain’s team formulated the strategy that led TI to leadership in the industry, and microchips became the single product best epitomizing the power of the curve and its impact on the world economy.
At the same time, in 1965, Gordon Moore, then the young director of R&D for a subsidiary of Fairchild Camera and Instrument, made an explosive prediction in an article in an industry journal. Using research from his young associate from Caltech, Carver Mead, Moore prophesied an annual doubling of the number of transistors that could be put on a Single silicon device. Adapted because of a later slowdown to a doubling every 18 months, this projection came to be known far and wide as Moore’s Law, as Mead named it. But it could just as well have been dubbed Henderson’s Law or Bain’s Bonanza.
What differentiates Moore’s Law from the Bain- Henderson theory is only that chip functions rode a faster learning curve than any other product. By contrast, beginning in 1915, it took automobile production volume not 18 months but five years to double, and another five years to double again.
The magic of miniaturization and learning drive an ever-growing expansion of the market. Take the case of the 1211 transistor. It was one of the first successful products introduced by Moore and Robert Noyce. In those days, with each TV containing essentially one transistor, the number of potential TV transistor sales was limited more or less to the number of households on the globe. The 1211 could run Down the learning curve in cost to the price of its package, about a dime, but no further.
With the integrated circuit, however, you could put ever-expanding numbers of transistors together on a single silicon sliver. Today just one large-screen television set contains trillions of transistors, more than all the Tvs in the world a few decades ago, and so does every smartphone, and each transistor now costs a thousandth of a penny or less. The bold adventure down the curve promoted by Henderson and Bain has climaxed in trillions of dollars of new asset value in an information economy.
Bain’s analysis means that tax rate reductions, deregulation, and stable monetary policy can move an entire economy toward a hugely higher level of learning, informational efficiency, and equity value.Every company can move further down its curve.Every entrepreneur and worker can enhance his performance by increasing his units of experience.Lower rates yield more revenues not because workers make greater efforts or investors pursue higher monetary returns, but because workers and investors alike gain more knowledge, experience expands at every level, and every company and capital asset increases in value.
ROMNEY’S BUSINESS CAREER expresses all these redemptive realities of capitalism. He comprehends them better than any other American presidential candidate in history. But as a politician he has occasionally fallen victim to the temptations of static data.
Romney is famously “data driven.” That is mostly good. His universal health care bill in Massachusetts worked perfectly on paper for the existing pattern of patients and facilities when it was passed. Things changed as the program went into effect. As Bain would have predicted, people learned, politicians took over, and the state’s medical costs ended up doubling.
A decisive rule of social science long taught at Bain is that people learn how to exploit any good they experience as free. If it is paid for by taxes, it is tantamount to free for the user. To the demand-side analyst, for example, universal health insurance is a solution; to a supply-side analyst it will be the problem because it thwarts learning and technological progress. Regardless of what politicians promise to gullible voters, government services cannot ultimately escape the constraints of supply and demand.A price of “free” evokes unbounded demand while choking off supply.
These same dynamics from Bain also apply to most other government policies. In monetary policy, for example, free money in the form of a zero interest rate regime diverts the wealth of savers to favored governments and corporations while creating shortages for everyone else. As leading supply-side economist David Malpass writes, “When something of value is free, it runs out fast and only the well connected get any.” A politicized monetary system stifles the spread of information throughout the economy at a cost hugely higher than the nominal gains of supposedly spurring growth or preventing losses.
Today, American politics is widely obsessed with the formidable data of debt and deficits that overshadow our future and sow despair. America’s liabilities indeed loom massively on the horizon. But the first edition of Wealth & Poverty, published in 1980, sprang from a period of essentially balanced budgets and trade surpluses under Jimmy Carter and helped launch a siege of deficits and trade gaps under Ronald Reagan. During the Carter years, the government was mostly in the black while everyone else was in the red. Under Reagan, though, the trillion-dollar rise in government liabilities was dwarfed by a $17 trillion expansion of private-sector assets released by companies such as Bain Capital under Mitt Romney. Over the decades following the Reagan revolution, government liabilities continued to expand, but once again private-sector asset values increased more—60 trillion dollars more.
Today we need leadership attuned to the revitalization of U.S. companies and opportunities. In order for businesses to move down their learning curves, gathering information, fostering creativity, lowering costs, and enhancing service, the government has to provide a predictable regime of low and simple tax rates, stable money, and prudent regulation. We need a turnaround in policy that can reopen the horizons of the American economy and engender a revaluation of Americas assets like that achieved during the Reagan era.
This is the essence of the Bain way, enhancing the equity assets of the economy. Combining his demonstrable gifts as a manager of crisis with his profound ideas on the effects of learning, Romney can become the first president with a full mastery of the dynamics of capitalism and the management skills to forge a new era of American leadership.