Nearly 20 years ago, I was teaching American business law to professors in a summer program in Genoa, Italy. Being highbrow Europeans, many of my students looked down on the material. However, one aspect of American capitalism was a well of deep envy—private equity. These academics pointed to private equity as one of the key differences that make the American economy the most innovative and productive in the world.
After all, European workers are just as capable, just as smart and just as creative as Americans, but American companies are universally acknowledged as the world's best. This isn't patriotic pride talking. In a famous study, Nicholas Bloom and John van Reenan, two British-born academics, demonstrated that U.S. firms are the best-run in the world, on average. Better management matters because it generates more wealth from the same stock of inputs. The average American firm generates more social surplus—the sum of producer and consumer surplus—out of every dollar, every hour, every idea and every molecule invested. That is more wealth for all of us, which can be used not only to purchase more goods and services, but also by government (through taxes) to create public goods. Efficiency drives progress.
Where does better management come from? Bloom and van Reenan show cross-country differences are explained largely by the lack of poorly run companies in the U.S. There are extremely well-managed companies in every economy, but the U.S. has few laggards compared with every other country—even high-performing ones, like Germany and Japan.
This is where private equity comes in—it is a key mechanism for bringing up the bottom. Here is how this works.
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