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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