What does it mean when Romney says, 'I understand the economy'?

This whole dust up over candidate Mitt Romney’s tenure at the private equity firm Bain Capital has been surreal.  Obviously—I think it’s obvious—his R competitors who are attacking him, like Perry and Gingrich, are faux OWS’ers—it’s awfully hard to imagine they really have a problem with Bain and others like them.

But other than the fact that politicians can be hypocrites, is there anything voters can learn from this episode (and I suspect most of us already knew about the hypocrite thing)?

I think there is, and it has to do with how Gov. Romney thinks about economics.  He keeps stressing how he understands the economy, while President Obama does not.  But I submit to you that few people know what a person means when they claim to “understand the economy.”   I know I don’t.  Do you understand the economy like Arthur Laffer understands it or like Paul Krugman understands it?

For example, here’s an interchange that conveys a certain understanding—a not uncommon one, but a profoundly incomplete one.

A woman at a campaign stop complained that because her company moved out of state, she now faces a five-hour commute to work.   What, she asked, would Gov Romney do to keep good jobs in Iowa?

According to this account: “Sometimes it’s counterintuitive,” replied Romney, a former businessman, explaining that businesses often invent new, more efficient ways to compete.

“The term is called productivity. Output per person,” he said. “Our productivity equals our income.”

I’m not playing “gottcha” here—his response wasn’t a gaffe.  There are many in business, and many in economics, who believe this or something close to it—productivity is really output (or aggregated national income) divided by hours worked.   And more output per hour provide the potential for higher living standards.

But here’s the rub: for decades, for most American workers, that potential has not been realized.  Our productivity has anything but “equaled our income.”

In the decade of the 2000s, productivity grew 28% while real median household income fell 7%.  Since 1979, productivity is up 84% and real median compensation, including fringe benefits,* rose 12%.

To me, and not just based on this snippet, of course, it sounds like Romney probably really does understand the part of the economy he’s come to know in his business career.  It’s an economy whose metrics are return on investment, rates of profit, and particularly in the PE world, leverage, or debt financing, since a) profit margins for the PE guys are significantly amplified if they can borrow their investment capital, and b) there’s a huge tax advantage since they can deduct interest payments as a business expense.

You will note that the word “jobs” isn’t on that list.  And the reason for that is very simple: the metric of job creation is not how PE firms measure their success.   Grading PE firms on job creation is like grading chess masters on their ability to dunk the basketball.  It’s a non-sequitur.   Here’s one of Mitt’s former colleagues, quoted recently in the LA Times:

Bain managers said their mission was clear. “I never thought of what I do for a living as job creation,” said Marc B. Walpow, a former managing partner at Bain who worked closely with Romney for nine years before forming his own firm. “The primary goal of private equity is to create wealth for your investors.”

The economy that Gov Romney understands is the economy of Wall St., not Main St., and it’s by no means the only economy you want your president to understand.  In today’s America, the president needs to understand the economy measured by middle-class incomes, paychecks, the quantity and quality of jobs, rates of poverty, income gaps.

And sure, the president must also understand that part of the economy measured by productivity and profits.  But if he thinks understanding the latter is “understanding the economy,” he is dangerously wrong.

*It’s important to add benefits to this type of calculation so you’re not leaving off an important and growing part of the wage bill.  To construct median compensation for this calculation, I multiplied the median wage by the ratio of aggregate compensation to aggregate wages.  This essentially assigns the average benefit package to the median worker, which is too generous.  And you still get the large gap stressed in the text.