Capital Markets

February 26, 2019

Capitalism is under attack. What does this mean for Private Equity?


By Justine Crestois, Junior Account Executive, Financial Services

Many economists and commentators point to the election of President Trump, Brexit, the yellow-vest protests in France, and the rise of anti-immigrant populists in countries like Italy and Brazil as evidence that capitalism is in crisis.

Importantly, however, the global elite – the symbolism of what is wrong with capitalism in the eyes of its critics – are also starting to pay greater attention to the impact of a growing wealth gap with this issue, for example, a repeated and hot topic at this year’s World Economic Forum.

It’s all about the…tax

As a result, and specifically in relation to the alternative investment sector, the focus has once again turned to taxation with various politicians and trade unions largely leading the fight.

However, it has not all been politicians and trade unions talking up taxation and alternatives. In an op-ed published last week on Crain’s New York Business, Morris Pearl, a former managing director at BlackRock and chairman of the Patriotic Millionaires, denounced a long-standing carried interest loophole in the US which allows private equity and hedge fund managers to pay the capital-gains tax rate, that is 20 percent, on the fees they charge investors, rather than the higher income-tax rate. Pearl was clear to point out that it was “a lower tax rate than teachers and truck drivers”.

On the same topic of taxation, albeit with a differing view, Stephen Schwartzman, CEO and co-founder of Blackstone, drew criticism when commenting at Davos on Representative Alexandria Ocasio-Cortez’s proposed tax hike of 70 percent on earnings above $10m. Schwartzman is reported to have sarcastically said that he was “wildly enthusiastic” about it. For the detractors of capitalism, this would have added fuel to their fire.

Greed is good?

Against this backdrop, the supporters of capitalism need to make their arguments more clearly and to show that capitalism does not mean greed is good. As Seth Klarman, CEO and portfolio manager of the Baupost Group, notes: “people will say the words ‘Wall Street’ with a derogatory tone. They’re talking about an immoral place, where there’s just disgusting amounts of greed and nothing good happens – which isn’t fair and isn’t true.” Indeed, many economists will also tell you that capitalism has been the driving force behind the most remarkable decline in global poverty ever witnessed in human history – more should be made of this.

But aren’t today’s businesses simply, yet ruthlessly, searching for endless growth and ever increasing profits for the benefit of their shareholders? And isn’t this the cause of today’s disenfranchisement and disillusionment with capitalism? As Paul Collier, Professor of Economics and Public Policy at the University of Oxford recently said in a rather blunt fashion, “Whoever got up in the morning to maximise shareholder value?”

The challenge for corporates and the alternative investment sector in particular, is to prove these assertions wrong and to bring more balance to the debate.

Private Equity in the spotlight

Historically, too much emphasis has been put on promoting funds’ financial returns within the financial community, or extolling successful fund managers. Yet, if the industry is to better shield itself from external criticism and the risk of this manifesting meaningfully into unfavourable policies and regulation, then much more attention needs to be paid to portfolio companies and the positive impact these businesses have on people and communities.

If not higher wages or more employee benefits, businesses should adopt a more tangible approach in regards to their communication. Giving to charities to educate girls in Darfur or funding a new arts centre at Yale will not work this time, as these are too far away from the local worker trying to make ends meet.

Funds’ communications should rather focus on how they improved the business, not only from a financial engineering point of view, but also putting an emphasis on how many jobs have been created, the new improved services provided to customers, the environmental benefits of consolidation for example, and so on and so forth – sharing stories the average person can relate to.

This could not only appease social unrest amongst the less financially literate but also give them a different angle on, and a better understanding of capitalism itself.

Capitalism needs to fight back. Whilst there is no silver bullet, better communicating its successes is a good first step.