The fuss about private equity, which has recently been jostling for space on the business pages with genuine news about interest rates, stock markets, the rise of Asia and climate change, is the quintessential storm in a teacup. Why has this obscure technical issue suddenly caught the public imagination, even invading dinner party conversations in which discussions of finance are normally confined to boasts or complaints about the rise in house prices?

The answers, which began to emerge yesterday in the hearings of the House of Commons Treasury Select Committee, are much more interesting – and more important for Britain’s economic future – than any of the questions over how private equity is regulated or taxed.

To understand the true reasons for the campaign against private equity we have to recall the history of this controversy. The fuss began a few months ago when several prominent European trade unionists, led by IG Metall in Germany and the GMB in Britain, started complaining that private equity firms were behaving like “asset strippers” or even “locusts”.

The crimes that the firms were accused of entailed their entire modus operandi: buying businesses that were considered relatively unattractive by their original owners – including such British brands as Boots, Birds Eye and the Automobile Association – and then restructuring them to generate bigger profits, often by sacking workers, spinning off subsidiaries, selling property and taking on more debt. The trade unions’ objection to such activities was understandable enough, since in many cases the restructured companies did not only dismiss existing staff, but also broke up longstanding collective bargaining arrangements and hired more non-union employees.

There were, however, two big weaknesses with this line of attack. The first was that detailed evidence on private equity companies did not, in general, support the claims made by the unions. Instead of destroying jobs and stripping businesses down to their bare essentials, private equity deals, at least in Britain, turned out to be quite beneficial not only for investors but also for employees. The largest study of British private equity deals, published late last year by the Centre for Management BuyOut Research at Nottingham University Business School, showed that employment had risen by 21 per cent on average after four years, although it did dip typically by 5 per cent in the first year after a buyout. It also showed that productivity almost doubled in this period and that product innovation and investment increased.

Embarrassingly for the trade union campaigners, the Nottingham study “found higher levels of employment, employee empowerment and wages” after these deals. To put it another way, private equity deals have turned out, on the whole, to be not very different from many other restructurings performed on sleepy British businesses since Margaret Thatcher launched her privatisation programme. All these restructurings, going right back to British Telecom in 1985, were opposed by the unions and initially by most employees, but in the end many of them produced not only more profitable companies, but also in many cases better working conditions and higher wages for the employees who remained.

The marked similarities between the present wave of business restructurings and the privatisations of the 1980s points to the second problem with the frontal assault on the private equity business. The actions that unions found so objectionable – slimming down employment, focusing operations on core businesses, selling off underperforming assets, refinancing balance sheets to improve tax efficiency – were really no different from the corporate strategies undertaken by most successful businesses, whether they were owned by private equity, a single family or investor or the stock market at large.

The only distinction that really matters for business management these days is between operations that are highly profitable and those that are not. The initial attacks on the private equity industry, when stripped down to their essence, amounted to a rejection of profit as the main yardstick for business success. And while a thinly disguised attack on the profit motive may have been acceptable, indeed popular, with the trade union movement, the traditional Labour Party and even the British public – it turned out to be totally unacceptable to new Labour ideology as redefined by Tony Blair and Gordon Brown.

Having recognised this a few months ago, opponents of private equity moved to a new line of attack. Instead of denouncing the impact of corporate restructurings, they turned to a line of criticism that seemed certain to win the support of a Chancellor desperate for new revenue sources, by exposing the alleged tax privileges enjoyed by private equity. However, the attack on the alleged subsidies afforded to highly leveraged takeovers by Britain’s tax regime misfired again. It turned out, on closer inspection, that the unions’ criticisms of private equity companies as taxpayers applied to all private companies in Britain. What the unions were really calling for was a fundamental reform of the entire British corporate tax system – and one that would move directly against the pro-investment tax reforms adopted by successive Chancellors since the early 1980s and particularly by Mr Brown, who deliberately made debt financing more attractive to all private companies in his very first Budget ten years ago.

After suffering this setback, the opponents of private equity have been left with only one genuine argument – the tax privileges enjoyed by the employees of private equity firms as individuals. Here the critics have hit on a more promising issue, since a 10 per cent marginal tax rate does seem overly generous for multimillionaires. But again they run into the problem that the private equity partners’ advantages are just a specific case of a general tax relief that Mr Brown deliberately created for all investors in all private companies, to widespread and justified acclaim.

The upshot is likely to be a marginal revision of the tax code, forcing the British partners in private equity firms to treat a larger portion of their earnings as ordinary income, subject to 40 per cent income tax, rather than capital gains. But the impact of such any such change will be marginal – partly because an estimated 160 out of the top 200 earners in the UK-based private equity industry are not domiciled in Britain and partly because there is plenty of flexibility to restructure their transactions so as to continue minimising tax.

Minor tax reforms will have very little impact on either the private equity business or the City of London. Still less will they satisfy the private equity industry’s critics who are really railing against capitalism and private profit.

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