The economy was not that great in the 1960s
Why do we want it back? And lies about private equity.
Photo by Manny Becerra on Unsplash
Hello,
Welcome to Known Unknowns, a newsletter that believes flexibility is the best hedge against uncertainty, and that if someone tells you leverage decreases risk, they are selling you something (usually with high fees).
Unions are back! For now.
2023 may be remembered as the American union’s last stand or its resurgence of glory. Right now, it seems it will be the latter. The UPS near-strike achieved high pay—well above median earnings. The SAG-AFTRA and WGA strikes have deprived us of the entertainment we have come to love and rely on (or they will at some point). And now autoworkers, who have not seen a big real wage gain in years and have been working many hours while their employers earned big profits, are fighting for their share.
But asking for a well-deserved raise and asking for a pay increase of more than 100% (which UAW is when you account for all the benefits and a 32-hour work week) are two different things. A short-term win that your less-competitive employer gives can mean more serious long-term pain—or that you lose your job altogether. Now, there is no shame in asking for a lot when you negotiate. The number one lesson I learned in the brothel about negotiating is, “If you don’t hear ‘no,’ you did not ask for enough.” But you can ask for way too much and poison negotiations; and if the people for whom you are negotiating form unrealistic expectations, this is not a good outcome either.
More generally, even if this all works out in the short term, I suspect this will be more of a last stand for unions than a resurgence—unless unions change their model. The economy has changed a lot since the 1960s, yet we still have the same union model. And I see three big changes posing a challenge for the future of unions:
1. Superstar effect. High productivity workers get paid way more than everyone else, and it is much easier for employers to observe who is productive at their jobs—this is due to many factors, including work being less routine, the role of technology, and the greater number of service jobs.
2. Work is less idiosyncratic to employers. Mechanization means that GM makes cars in a similar way to Ford, every office uses the same word processing software, etc. This reduces the returns on firm-specific capital and, coupled with the superstar economy, increases the returns on individual capital and the gains from changing jobs (which people aren’t doing—but that’s another story).
3. The economy is in the midst of a big transition to tech that will change work and profitability in unpredictable ways.
The union model does not accommodate any of these trends, let alone a world where firms need to compete globally. And demanding safety and certainty and stability in this environment is much more expensive. The union model works by compressing wages among workers, discouraging mobility (this is even a feature of UAW’s demands), and limiting flexibility (for employers and employees). I do think unions can play a helpful role in the modern economy, but their model needs to change to suit the economy we live in now. And the best way to deal with a changing economy is to provide insurance and flexibility.
As I wrote in Bloomberg, unions should function more like guilds, somewhat similar to what makes SAG work. This model sets a wage floor and some working conditions, but individuals can negotiate on their own and still get flexibility. It also provides health and retirement benefits, which can encourage mobility and provide stability. In the future there could also be wage/retraining insurance, and perhaps profit sharing with employers, so risk better shared.
But instead, we get policies and demands that aim to restore the 1960s economy—I can only assume that means 1960s living standards too. Or in the case of California, something even stranger and less productive.
Private equity does not reduce risk.
Lately, when I talk to asset managers, I hear a strange argument: that private equity belongs in any balanced portfolio because it provides diversification. Now, diversification is a risk-reduction strategy, so if that’s true, private equity would reduce risk. I suppose it can do that, if you only own about five stocks, but if you already have a well-diversified portfolio of publicly traded assets, what does private equity add? Just because it is private doesn’t mean the equity is all that different. Really, all you get is leverage, and no one would say more leverage decreases risk (unless they are selling you something).
Of course, it depends on the type of private equity; maybe infrastructure of some VC funds adds something to the diversification party. But usually, people are talking about buy-out funds, which are just more equity, leverage, illiquidity, and high fees.
I am not against private equity as an asset class. If you want to add some beta to your portfolio and want to avoid mark-to-market accounting, and don’t mind paying high fees for that—you do you—no judgement (unless it is tax-payer dollars). But don’t tell me this is a risk-reduction strategy just because you call it an alternative asset.
Until next time, Pension Geeks!
Allison
I have been baffled by the whole private equity as portfolio savior thing.
Since the mid-90s, I have worked in companies that were partially or wholly owned by an ESOP for much of the time. One of them has gone public while still having the ESOP. To my mind, ESOP is a form of private equity when the company with the ESOP is still privately held.
The main difference I have seen when between the ESOPs when the companies are privately held or publicly traded is that the privately held company uses a fairly complex valuation process by a third party (ESOPs are subject to ERISA, so probably less financial fun and games than true PE) where public market valuations are only part of the input. So the share price tends to fluctuate less and is also set once a year, so people who retire that year know the share price. Publicly traded companies have the ESOP share price set by the public market, so it fluctuates hourly and is subject to all the market emotions, good and bad.
Beyond those differences, I haven't seen any significant change in how the companies were managed, although the public company has more Sarbanes-Oxley focus on reporting financials. I have never understand why private equity would be a magic elixir for creating lots more profit out of a company. That is generally just management quality which can be good or bad in both private and publicly held companies.
ESOPs don't have much in the way of fees either than some administrative costs, although they can blow up if used as tax dodges related to Subchapter C and S companies (e.g. Sam Zell and Chicago Tribune). Private equity seems designed to provide lots of fees to the private equity managers. It is hard for me to see how paying lots of additional private equity management fees somehow creates more profits from the company itself. So I think this is somewhat like the comparison of low cost index vs active management mutual funds - less than 10% of fund managers regularly beat their indices, not necessarily because they are bad managers but because they simply can't overcome the headwind of additional costs.
It’s the unpredictable part that many in government seem to ignore since it’s hard to wrap an existing narrative around it.