Former Bain partner Edward Conard has published a controversial book “Unintended Consequences”1 in which he provides a positive case for income and wealth inequality and for market solutions to societal problems. His story is an unabashed defense of market capitalism (and private equity). A NYT reviewer has labeled the book “The Most Hated Book in America.”
Conard argues that economic progress arises due to investment, innovation and the efforts of talented entrepreneurs to push forward new ideas. Entrepreneurs compete aggressively to come up with new and better products at lower prices. Most of the benefits of this progress accrue to workers, not to the entrepreneurs themselves. He points out that 70% of GDP is wages and 10% is profits. Sure, successful entrepreneurs enjoy large individual financial rewards, but this is a small fraction of the total financial benefits from their activities.
Conard argues that necessary conditions for investment include strong prospective returns to capital, available equity capital and talented people willing and able to pursue new ventures. Historical equity risk premiums of 7.5% indicate that there is a plethora of lucrative investment projects available to be pursued. Returns to equity are higher in the US than Japan or Europe because the regulatory burdens and costs of labor redeployment are lower.
The second ingredient is equity capital. Conard argues that equity capital derives from high savings rates and successful prior ventures. The effect of high tax rates on capital is to reduce the supply of equity capital available to fund new ventures, and will therefore slow the rate of economic growth. He further notes that savings rates for wealthy people are very high; successful risk takers supply capital for additional risk taking.
The third ingredient is leadership. There are many talented people around, but there is a shortage of potential entrepreneurs because building and running a start-up is extremely hard work and carries huge personal risk. It is much easier and safer to be a salaried employee or professional (an “art history major” in Conard’s somewhat derisive lexicon). Entrepreneurs work incredible hours and spend little time with families or in leisure activities. But as he puts it: “God didn’t put talented people on Earth to be happy. He put them here to take responsibility, lead, innovate, and take prudent risks.”
But the moral obligation may not be enough. In order to induce more people to take on the risky and arduous life of the builder there must be out-sized rewards. Conard believes that inequality is a good thing. It is both a driver and result of successful ventures.
This line of thinking leads Conard to support a range of policies that may enrage the political left, including reducing obstacles to hiring and firing workers, reducing the power of unions, off-shoring or out-sourcing repetitive tasks, and lowering tax rates on capital. He also favors opening up legal immigration in an effort to augment the supply of willing entrepreneurs.
I agree with Conard on the importance of investment and innovation, and that the results of this are shared by all. Economic growth is a positive sum game, not a zero sum game. I also agree that the life of an entrepreneur or senior executive is stressful. But I disagree with the notion that one failure puts you out of the game. Perhaps it is the policy at Bain Capital that only people with unblemished records are considered for CEO or other leadership positions, but if so it is not a wise policy. There are many examples of successful start ups where the founder(s) had failed in prior efforts. Only a small fraction of new ventures is successful. We should be looking for policies that encourage an entrepreneurial culture, and part of that is tolerance of failure.
1Edward Conard, “Unintended Consequences – Why Everything You’ve Been Told About the Economy is Wrong,” 2012.