Announcer: Welcome once again as MIT professor, Paul
Samuelson, discusses the current economic scene.
This series is produced by Instructional
Dynamics Incorporated.
This recording was made April 23rd.
Paul Samuels: Two days ago we received the preliminary
estimates of what happened in the first quarter of the year.
The results, I think, can only be described as shocking.
Real output, that is money GNP corrected for the change in
general prices, actually declined.
That's no surprise, but the annual rate at which it
declined was a surprise.
It was no less than 5.8%.
The best forecasters that I know, the ones who are most
up-to-date on the ball, generally speaking estimated 4.5%
real decline as their best outside guess.
Anyone who made such an estimate, for example, Data
Resources Incorporated, I think, deserves a medal for
being in the right direction, but you can't give anyone
a cigar for having guessed how bad the rate of growth
would actually be.
Even the Director of the Office of Management and Budget,
Roy Ash, who had a peek at the data and who released
a glimpse as to what they were gonna show, spoke only
of a 5% rate of annual increase.
Well it's much near to 6%.
As if that weren't enough, however, we then proceeded
to get the bad news with respect to what was happening
to general prices.
Again, the very best forecasters, let's say Albert Summers
of the conference board, let's again say Otto Eckstein
of Data Resources Incorporated, again Alan Greenspan
of Townsend-Greenspan.
They had braced us, prepared us, for some very bad news,
and some of them had forecast that prices would be rising
by as much as 9.5%.
Almost the 10% and two-digit inflation.
Well in the event it turned out that the rate of actual
price increase was 10.8%.
Call it 11%.
In comparison with not the best forecasters of recent time,
but good forecasters, you can say we had a 2% blow of worse
news with respect to the rate of real output decline,
and a 2% blow with respect to worse news on the
inflation front.
Of those two blows both hurt, but I think the decline
output hurt the most if only because 2% on 5.8% is
relatively much more significant than 2% on 11%.
Now, was there any good news in the numbers?
Yes, I think there were some crumbs of comfort.
For example, inventory accumulation behaved better in
the first quarter.
You may recall that in the fourth quarter of the year
the rate of growth was kept positive only by the fact that
a lot of inventory piled up on an involuntary basis.
Most of that was in the automobile industry.
As I recall, we had almost 19 billion dollars of inventory
in the fourth quarter, which represented, that's annual
rate, which represented more than a doubling of the rate
of inventory accumulation, and we were told that much
of that, perhaps even most of it, came in the automobile
industry where they were piling up on dealers' floors and
in the pipeline, large autos.
Well we expected that that piling up of auto inventory
would be followed by slashes in the production line
and employment.
If you've been reading the newspapers, you've read
periodically of some new hundreds and even thousands
of General Motors workers or Chrysler workers or Ford
workers who were being furloughed or were being laid off
because the kinds of cars which the factories they worked in
could produce were not the kinds of cars which Americans
wanted now to buy.
Of course, many of those factories are being converted
over towards compacts and subcompacts.
One large California factory, for example, I believe is
being converted to Vegas, and the transition itself
of conversion, which is necessarily slow itself does
create a certain amount of layoffs.
So it was interesting to see that the extreme weakness
in the real economy in the first quarter was not the
result of any continuing piling up of inventory.
Indeed, as I remember it, inventory accumulation fell
from a revised number of 18 billion down to something
like 8 billion dollars annual rate.
Now, there's always a way to fish in the data and find
some cheerful bits.
One of the things that you can do is to compute something
called Final GNP in real terms, or in money terms.
Now what is Final GNP?
It simply consists of the regular GNP numbers, but with
all the inventory change, inventory accumulation or
de-accumulation figures, removed from them, and when you
do that you find, of course, that this fourth quarter
was already weak because you don't have the support of
that extraordinary amount of temporary inventory
accumulation, but by the same token you find that the
drop in inventory accumulation in the first quarter
shows up as an improvement in final demand, and actually,
final demand in the first quarter this year was better
than it was in the last quarter of last year.
However, in neither quarter, was anything like what
had been the case just a year ago, say in the first
quarter of 1973, when the economy was still zooming upward.
Indeed, zooming upward at too rapid a rate.
What has been the reaction to this particular news?
Nothing very much actually.
The stock market hardly dropped as the news came over
the wire.
In fact, the stock market chose to react more positively
to a different bit of news.
The First National City Bank, Citibank, had issued a press
release saying that the prime rate, the rate charged by
banks to their best customers, would by the end of the
summer be down to 6%.
This was greeted with amazement by people in the money
market, and since the Citibank has a pretty good track
record, it led to a great deal of temporary cheerfulness
and one could perhaps offer as an explanation of why the
market went up for three days running.
This particular bit of news from the Citibank.
I must say the news itself is amazing.
So amazing that I would not be prepared to bet my chips
on the truth of it because the end of the summer, as I
work it out, would be say September 15th.
We're talking now towards the end of April if we count
May, June, July, August, September, that's four and a half
months from now.
It's not even possible that the prime rate, which as I
speak has gone up to 10.4%, one of the highest rates
on record, it's not even possible that it could drop
to 6% in such a time, but I don't think it could drop
to 6% in such a time without falsifying the recovery
from the first quarter recession, which is explicit
in most of the models, and for all I know, in the model
of the Citibank itself.
What happened I believe was that the Citibank press office
must have been caught in a delay, and at some earlier
time some analyst in the Citibank who was feeling optimistic
and who hadn't yet seen the extent of the current upswing
in loan demand with the accompanying increase in interest
rates across the board, that such an analyst banking on
some improvement in the rate of price inflation later
in the year, had made such a statement.
Well it got embalmed in the pipeline and finally was
issued just in time when, I imagine, the man who had
formed that opinion has, at the least, been modifying
it a bit.
The head of the Economics Department of the Citibank made
some clarifying explanations.
I believe that he spoke of six to seven percent as a
possibility later this year, and so that if the prime rate
went down to 7.5%, you'd be at least in gunshot of
that prediction.
Well I don't think that all the experts in the money
market or even very many would agree with the extent
of this drop in interest rates.
I think that Henry Kaufman, Salomon Brothers, has as
larger and larger a following in which it is felt that,
until we get a handle on inflation, the interest rates
will stay high, and that's doubtful that you'll get
a tremendous swing in the rate of inflation or in interest
rates in the face of an economic recovery that can take
place in a very short period of time.
Well, although the concern by and large still is with
respect to the rate of inflation, and in particular,
double digit inflation, there must be some reinforcement
of the minority camp who think that it's an illusion
to believe that the first quarter is the only quarter
of drop or that the drop in the second quarter will
be nominal at best, and will be followed by fairly
normal economic expansion.
In other words, there are still some people who think
we're in for a full fledged recession of one kind or
another, and people of that view must have, then,
strengthened their conviction by what's happened in the
first quarter numbers.
Of course, we're getting some more data across the board.
There was a drop, not surprising perhaps, in the saving rate
When you're paying all that much more for your fuel items
and the cost of living, and when all industrial prices
are still rising, and when for the the first time a typical
worker is, very definitely now beyond any statistical
argument or dispute, showing a reduction in his real
take-home pay after taxes, then it's natural that if you
maintain your level of consumption to any degree that
you would have to dip into the rate at which you're
doing saving.
If not, dip into actual savings themselves, and I believe
that we saw a drop in the saving rate from something
over 7% to somewhere around 6.5%.
That's a number which is to be watched.
Housing starts in March as, I guess, most experts really
had expected.
It did not show the continued strength of the
February increase.
In fact, they dropped again, and it now looks that the
March figure is the more solid figure, the more believable
figure because housing permits agree with it, and the
February figure looks more and more like a fluke due
to perhaps the good weather, and never confirmed by
what was happening to housing permits.
Well let's turn from the passing short-run situation
to consider some more fundamental problems.
What I want to do is to discuss with you some widely
held fears, some economic apprehensions.
Let me just rattle off a list.
I've written down a number of fears and, without committing
myself as to the validity of them, whether they represent
paranoid apprehensions or whether they represent prudent
reasonable concern, we can try to discuss after we've laid
on the table what some of these particular fears are.
Well first question that's being discussed a lot these
days is inflation concealing an ominous drop in real
profits and in real profitability.
Are fictitious inventory profits and nonrecurring profits on
markups of the worth of durable equipment?
This markup in terms of their bygone historical cost?
Are these blinding us to the fact that once the inflation
stabilizes, stabilizes perhaps at the 5% rate that so
many of the forecasters professed to see in their crystal
balls for the fourth quarter and into 1975, or shall we
then be waking up to the fact that the profitability
of corporate enterprise is seen to be seriously eroded?
Well now, if the answer to these questions is yes,
does that perhaps carry the implications that the stock
market is now dangerously high despite the apparent
low price earning multiples?
Thus, if we recalculate profits on a proper, maintainable,
real base, will we find that profits are much less
than is now reported with the result that the correct price
earning multiples are now really very high rather than
very low?
And if there is serious erosion of profits, doesn't that
bode ominously for the future of our needed
capital formation?
You see I'm playing the part of the devil's advocate.
I'm trying to put on the table for discussion what I
sensed to be the fears in the minds of very many people.
Isn't it the case that we find ourselves now with a
surprisingly tight under-capacity position in many
basic industries?
Not only in oil and coal, but in oil refining, in railroads,
in paper, in chemicals, in cement, in plastics, well you
name it.
And if we were to make good, these shortages, to say
nothing of our taking care of the demands for pollution
control that are inevitably put on industry today,
won't be necessary for us to have an unprecedented
rate of effective saving.
Saving that will go into effective capital formation.
And will that really be possible under our present
punitive taxing of corporate profits and our present
progressively punitive personal tax structures, with the
loopholes in that structures being more and more closed down
There is a view, you know, that capitalism breathes
through those loopholes, and if you close down those
loopholes, then it will cease to be breathing well.
It'll be capitalism with emphysema.
You see we have here the paradoxical twin specters
of too little capacity along with low profit margins,
if not negative profit margins.
Those two are supposed to, usually, not go together,
and wouldn't something like this seem to signal the
decline and fall of the Roman Empire?
I mean the American production system as we've known it.
Moreover, with the unions sharpening their knives of
collective bargaining, the situation looks to be even worse.
Particularly now, so it might be argued, that productivity
is ceasing to show its' previous rate of advance, and now
that we seem to be moving into a new era of scarcity in
which farmers and raw material producers all over the world
can hold up us urban and manufacturing consumers for ever
impoverishing terms of trade.
In short, is it the case that we have been living in
the years since World War II in a honeymoon, which like
all honeymoons, must alas, come to a close?
Just as the weather is getting colder, at least so it
is argued by a school of climatologists out of the
University of Wisconsin and elsewhere, I believe Professor
Bryson and some others, they claim that there is some
evidence that the good monsoons are deserting India so
that the crop failures, which used to come one in five
years, were delightfully coming only once in 18 years
in the miraculous 19th and 1960 phase of the weather
cycle, but that weather cycle is now coming to an end.
Similarly, the Sahara is supposed to be drying up.
You know if you read Biblical and pre-Biblical remnants
you find that the Sahara was once a green, luxurious place.
Well the Lord giveth and Lord taketh away with respect
to the weather.
It is supposed to be the case that Greenland was once green,
but now the oceans are cooling off.
You know, there's always two schools of cataclysmics.
There are the boilers and the freezers, and just recently,
I've been having to worry about the world boiling.
What was it that Robert Frost say?
Will the world end in fire or in ice?
Or Robert Heilbroner has written a very gloomy book
just recently in which one of his concerns is that
the exponential increase of energy use necessarily
is causing the atmosphere to heat up.
Now it's very small up to now, but don't forget what
compound interest is like as you extrapolate it into
the future.
It's a little hard for me to worry about to opposite
things at once.
Namely that the oceans are gonna get too warm that
the birch trees are gonna die all through New England
and into Canada, and that the fish are gonna move further
north at the same time that the ocean is getting cold
and the glaciers are gonna be moving down, but it is
possible to worry about one or the other of those things
as is happening.
Well it's quite obvious that these are very tall questions,
and I would like to talk about them.
I think, just in case you are impatient for the answers,
that if we study these fears one by one, I think, that
many of them can be reasoned away.
If they are susceptible to reason or at least can be
put into a better quantitative perspective.
Well I obviously don't have the time to handle the
weather, the tax system, the future of saving and investment
and pollution control, and all the things that the
intelligent person should be concerned with today.
Let me begin though by trying to discuss what has been
happening to the profitability of corporate enterprise.
What has been happening to the distribution of income
as between labor and as between property?
I'm referring, in front of me, to a manuscript by
Professor William Nordhaus of Yale University.
You will be able to read the finished, revised version of
this in a forthcoming publications by the Brookings
Institution, their current papers, I would think in about
three months a time.
I've mentioned those current papers before as having
great deal of material by modern economists that would
be of interest to anyone trying to follow the passing
American and international economic scene.
Well this is one of the more interesting of such studies.
The first thing that has to be done, according to Professor
Nordhaus, is to see what the bare facts are.
Is it the case that the share of profits is going down?
Well now there are different ways of measuring the
share of profits.
You can measure the share of profits relative to the
total GNP, and as I look at the chart which plots what's
been happening since 1948, this would be through 1973,
there is a distinct long-term downward trend.
Now there are some ups and downs within that trend.
For example, since the trough of 1970 of the last recession,
there has been a gentle increase in the share of profits,
but it hasn't brought the level of profits back to
where it was in the middle of 1960s at the height of
the long Kennedy-Johnson prosperity, nor has it brought
it back to anything like the pre-Korean war period.
So what you can say is that since 1948, the share of
profits in the GNP, corporate profits, has been a
declining one.
Now that's not the only way to measure profits as a share
because if the government is taking an increasing share,
then you can have a declining share of wages in the GNP
as well as of profits.
That would simply mean that the government was spending
more of our resources.
More for national defense, more for conservation, more for
bad causes if you think that most of government expenditure
is a waste.
So there is a second way of measuring the fall of profits.
Unfortunately, this second way does not give a more
reassuring picture.
It gives, if anything, a more rapid decline in the
rate of profits.
Let's take the share of profits in gross corporate product.
Just put a ring around General Motors and all the
corporations in the country, and you find a flow of value
added in them.
Value added that goes to profits, goes to wage bill,
and so forth, and that also shows a decline.
Well the facts, of course, are not quite so simple
as that, as Professor Nordhaus makes clear because
if you were to mention this to a person of liberal
persuasion, he would say, "Ah yes, but don't forget
that the corporations in recent years have been getting
a very favorable shake with respect to their depreciation
deductions, and so reported profits are down, but that's
just because they've been allowed to take bigger deductions.
They've been allowed to take faster depreciations under
the tax law.
As a result, you need to make a correction to the
depreciation numbers."
And Professor Nordhaus has attempted to do this in a table.
He's looked to see how much of a change in depreciation
came about through the tax laws, but he decides that
that isn't the only adjustment that needs to be made.
You also need to make an adjustment for the rate of
inflation where we're back to our concern as to whether
the inflation is creating transient fictitious paper
profits, which are papering over the true situation,
and so he says, "Let's suppose that we try to reckon
real earnings, and for that purpose, we have to assume
that the corporations last year used up, in value,
not the value of the machines reckoned at their bygone
historical low cost, but at their genuine reproduction
cost at the new higher price level," and he finds that
that correction is even greater than the correction
that has to be made for tax laws.
For example, profits are understated by 10 billion dollars
in 1973 in comparison with 1948 because of the tax law,
but they're overstated by 12.5 billion dollars because
of inadequate allowance for the price level.
Well, he then calculates what's happening in terms of true
economic depreciation and makes both of those adjustments.
Well now, after you've then taken out true economic
depreciation and allowed for interest, then you can take
a new look about what's happening to the genuine income
on capital, and here he comes out with some rather
interesting results that there seems to be no doubt that
there is a decline in the rate of yield on capital.
First, he regards it as surprising.
I'm not sure whether I regard it as surprising or not
that the corporate enterprise as a whole doesn't make a
rate of profit much more than the interest they have
to pay on the part of their capital which they borrow.
To the degree that corporations now smooth out risks
there is no reason why there should be any great
discrepancy, and he finds there to be only a percent or two.
Well what's happening actually to the rate of return
on capital?
The numbers are as follows, and here we must distinguish
between real rates and nominal, or money, rates.
By and large, there's been a drop from about almost 10%
on after-tax return in real terms that was achievable
just before the Korean War in 1950 or just before the
Vietnam War in 1965.
We're down now to about 5.5% real return after taxes.
In nominal terms, you used to get almost 20% in nominal
return in 1948.
Well that went way down through the Eisenhower period
so that in '58, '59, '60, your only nominal terms are
getting about six or seven percent.
It went up in the Kennedy-Johnson period, and surprisingly,
that still hovers around 10 or 11 percent.
Well what are we to conclude from this?
I conclude one thing, namely that in comparison with
alternatives, which is the only meaningful thing to the
investor, it looks to me as if it is not the case that,
taking into account what sort of an inflation hedge common
stocks are, it is not the case that corporations in fact
have been giving you much less protection than the eight
or nine percent which you can lock away in long-term bonds.
In a certain sense, that's a reassuring affect for that
large part of the public which holds stocks, but that is
still consistent with the fact that the real yield on
both bonds and stocks is going down through time.
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