Tape 152 - Longtime erosion of profits

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Announcer	Welcome once again as MIT professor, Paul	0:02
	Samuelson, discusses the current economic scene.	0:04
	This series is produced by Instructional	0:07
	Dynamics Incorporated.	0:09
	This recording was made April 23rd.	0:11
Paul Samuels	Two days ago we received the preliminary	0:17
	estimates of what happened in the first quarter of the year.	0:19
	The results, I think, can only be described as shocking.	0:23
	Real output, that is money GNP corrected for the change in	0:28
	general prices, actually declined.	0:35
	That's no surprise, but the annual rate at which it	0:38
	declined was a surprise.	0:42
	It was no less than 5.8%.	0:44
	The best forecasters that I know, the ones who are most	0:49
	up-to-date on the ball, generally speaking estimated 4.5%	0:53
	real decline as their best outside guess.	1:01
	Anyone who made such an estimate, for example, Data	1:07
	Resources Incorporated, I think, deserves a medal for	1:10
	being in the right direction, but you can't give anyone	1:15
	a cigar for having guessed how bad the rate of growth	1:19
	would actually be.	1:25
	Even the Director of the Office of Management and Budget,	1:27
	Roy Ash, who had a peek at the data and who released	1:32
	a glimpse as to what they were gonna show, spoke only	1:38
	of a 5% rate of annual increase.	1:42
	Well it's much near to 6%.	1:46
	As if that weren't enough, however, we then proceeded	1:49
	to get the bad news with respect to what was happening	1:53
	to general prices.	1:56
	Again, the very best forecasters, let's say Albert Summers	1:58
	of the conference board, let's again say Otto Eckstein	2:04
	of Data Resources Incorporated, again Alan Greenspan	2:07
	of Townsend-Greenspan.	2:13
	They had braced us, prepared us, for some very bad news,	2:14
	and some of them had forecast that prices would be rising	2:20
	by as much as 9.5%.	2:23
	Almost the 10% and two-digit inflation.	2:26
	Well in the event it turned out that the rate of actual	2:29
	price increase was 10.8%.	2:33
	Call it 11%.	2:37
	In comparison with not the best forecasters of recent time,	2:40
	but good forecasters, you can say we had a 2% blow of worse	2:44
	news with respect to the rate of real output decline,	2:52
	and a 2% blow with respect to worse news on the	2:56
	inflation front.	2:59
	Of those two blows both hurt, but I think the decline	3:01
	output hurt the most if only because 2% on 5.8% is	3:04
	relatively much more significant than 2% on 11%.	3:14
	Now, was there any good news in the numbers?	3:22
	Yes, I think there were some crumbs of comfort.	3:26
	For example, inventory accumulation behaved better in	3:32
	the first quarter.	3:37
	You may recall that in the fourth quarter of the year	3:39
	the rate of growth was kept positive only by the fact that	3:42
	a lot of inventory piled up on an involuntary basis.	3:46
	Most of that was in the automobile industry.	3:51
	As I recall, we had almost 19 billion dollars of inventory	3:54
	in the fourth quarter, which represented, that's annual	3:58
	rate, which represented more than a doubling of the rate	4:01
	of inventory accumulation, and we were told that much	4:04
	of that, perhaps even most of it, came in the automobile	4:08
	industry where they were piling up on dealers' floors and	4:12
	in the pipeline, large autos.	4:16
	Well we expected that that piling up of auto inventory	4:20
	would be followed by slashes in the production line	4:24
	and employment.	4:27
	If you've been reading the newspapers, you've read	4:28
	periodically of some new hundreds and even thousands	4:30
	of General Motors workers or Chrysler workers or Ford	4:35
	workers who were being furloughed or were being laid off	4:38
	because the kinds of cars which the factories they worked in	4:43
	could produce were not the kinds of cars which Americans	4:47
	wanted now to buy.	4:52
	Of course, many of those factories are being converted	4:54
	over towards compacts and subcompacts.	4:57
	One large California factory, for example, I believe is	5:00
	being converted to Vegas, and the transition itself	5:03
	of conversion, which is necessarily slow itself does	5:07
	create a certain amount of layoffs.	5:14
	So it was interesting to see that the extreme weakness	5:18
	in the real economy in the first quarter was not the	5:23
	result of any continuing piling up of inventory.	5:28
	Indeed, as I remember it, inventory accumulation fell	5:32
	from a revised number of 18 billion down to something	5:35
	like 8 billion dollars annual rate.	5:40
	Now, there's always a way to fish in the data and find	5:44
	some cheerful bits.	5:51
	One of the things that you can do is to compute something	5:57
	called Final GNP in real terms, or in money terms.	6:00
	Now what is Final GNP?	6:05
	It simply consists of the regular GNP numbers, but with	6:07
	all the inventory change, inventory accumulation or	6:11
	de-accumulation figures, removed from them, and when you	6:14
	do that you find, of course, that this fourth quarter	6:19
	was already weak because you don't have the support of	6:22
	that extraordinary amount of temporary inventory	6:27
	accumulation, but by the same token you find that the	6:30
	drop in inventory accumulation in the first quarter	6:35
	shows up as an improvement in final demand, and actually,	6:38
	final demand in the first quarter this year was better	6:44
	than it was in the last quarter of last year.	6:49
	However, in neither quarter, was anything like what	6:54
	had been the case just a year ago, say in the first	6:59
	quarter of 1973, when the economy was still zooming upward.	7:03
	Indeed, zooming upward at too rapid a rate.	7:08
	What has been the reaction to this particular news?	7:14
	Nothing very much actually.	7:18
	The stock market hardly dropped as the news came over	7:21
	the wire.	7:27
	In fact, the stock market chose to react more positively	7:28
	to a different bit of news.	7:33
	The First National City Bank, Citibank, had issued a press	7:36
	release saying that the prime rate, the rate charged by	7:43
	banks to their best customers, would by the end of the	7:48
	summer be down to 6%.	7:50
	This was greeted with amazement by people in the money	7:53
	market, and since the Citibank has a pretty good track	7:57
	record, it led to a great deal of temporary cheerfulness	8:03
	and one could perhaps offer as an explanation of why the	8:07
	market went up for three days running.	8:12
	This particular bit of news from the Citibank.	8:14
	I must say the news itself is amazing.	8:17
	So amazing that I would not be prepared to bet my chips	8:20
	on the truth of it because the end of the summer, as I	8:24
	work it out, would be say September 15th.	8:29
	We're talking now towards the end of April if we count	8:33
	May, June, July, August, September, that's four and a half	8:37
	months from now.	8:41
	It's not even possible that the prime rate, which as I	8:42
	speak has gone up to 10.4%, one of the highest rates	8:46
	on record, it's not even possible that it could drop	8:52
	to 6% in such a time, but I don't think it could drop	8:55
	to 6% in such a time without falsifying the recovery	8:59
	from the first quarter recession, which is explicit	9:05
	in most of the models, and for all I know, in the model	9:11
	of the Citibank itself.	9:15
	What happened I believe was that the Citibank press office	9:18
	must have been caught in a delay, and at some earlier	9:23
	time some analyst in the Citibank who was feeling optimistic	9:28
	and who hadn't yet seen the extent of the current upswing	9:33
	in loan demand with the accompanying increase in interest	9:38
	rates across the board, that such an analyst banking on	9:43
	some improvement in the rate of price inflation later	9:48
	in the year, had made such a statement.	9:51
	Well it got embalmed in the pipeline and finally was	9:56
	issued just in time when, I imagine, the man who had	10:01
	formed that opinion has, at the least, been modifying	10:05
	it a bit.	10:10
	The head of the Economics Department of the Citibank made	10:13
	some clarifying explanations.	10:16
	I believe that he spoke of six to seven percent as a	10:19
	possibility later this year, and so that if the prime rate	10:25
	went down to 7.5%, you'd be at least in gunshot of	10:32
	that prediction.	10:36
	Well I don't think that all the experts in the money	10:39
	market or even very many would agree with the extent	10:44
	of this drop in interest rates.	10:48
	I think that Henry Kaufman, Salomon Brothers, has as	10:51
	larger and larger a following in which it is felt that,	10:54
	until we get a handle on inflation, the interest rates	10:59
	will stay high, and that's doubtful that you'll get	11:05
	a tremendous swing in the rate of inflation or in interest	11:08
	rates in the face of an economic recovery that can take	11:11
	place in a very short period of time.	11:16
	Well, although the concern by and large still is with	11:21
	respect to the rate of inflation, and in particular,	11:28
	double digit inflation, there must be some reinforcement	11:32
	of the minority camp who think that it's an illusion	11:37
	to believe that the first quarter is the only quarter	11:43
	of drop or that the drop in the second quarter will	11:46
	be nominal at best, and will be followed by fairly	11:50
	normal economic expansion.	11:56
	In other words, there are still some people who think	12:00
	we're in for a full fledged recession of one kind or	12:02
	another, and people of that view must have, then,	12:07
	strengthened their conviction by what's happened in the	12:12
	first quarter numbers.	12:16
	Of course, we're getting some more data across the board.	12:19
	There was a drop, not surprising perhaps, in the saving rate	12:22
	When you're paying all that much more for your fuel items	12:26
	and the cost of living, and when all industrial prices	12:31
	are still rising, and when for the the first time a typical	12:34
	worker is, very definitely now beyond any statistical	12:38
	argument or dispute, showing a reduction in his real	12:42
	take-home pay after taxes, then it's natural that if you	12:45
	maintain your level of consumption to any degree that	12:50
	you would have to dip into the rate at which you're	12:54
	doing saving.	12:57
	If not, dip into actual savings themselves, and I believe	12:58
	that we saw a drop in the saving rate from something	13:04
	over 7% to somewhere around 6.5%.	13:07
	That's a number which is to be watched.	13:13
	Housing starts in March as, I guess, most experts really	13:16
	had expected.	13:21
	It did not show the continued strength of the	13:23
	February increase.	13:27
	In fact, they dropped again, and it now looks that the	13:28
	March figure is the more solid figure, the more believable	13:32
	figure because housing permits agree with it, and the	13:35
	February figure looks more and more like a fluke due	13:40
	to perhaps the good weather, and never confirmed by	13:43
	what was happening to housing permits.	13:45
	Well let's turn from the passing short-run situation	13:51
	to consider some more fundamental problems.	14:00
	What I want to do is to discuss with you some widely	14:05
	held fears, some economic apprehensions.	14:11
	Let me just rattle off a list.	14:17
	I've written down a number of fears and, without committing	14:22
	myself as to the validity of them, whether they represent	14:30
	paranoid apprehensions or whether they represent prudent	14:36
	reasonable concern, we can try to discuss after we've laid	14:41
	on the table what some of these particular fears are.	14:47
	Well first question that's being discussed a lot these	14:52
	days is inflation concealing an ominous drop in real	14:56
	profits and in real profitability.	15:00
	Are fictitious inventory profits and nonrecurring profits on	15:03
	markups of the worth of durable equipment?	15:09
	This markup in terms of their bygone historical cost?	15:13
	Are these blinding us to the fact that once the inflation	15:16
	stabilizes, stabilizes perhaps at the 5% rate that so	15:21
	many of the forecasters professed to see in their crystal	15:28
	balls for the fourth quarter and into 1975, or shall we	15:31
	then be waking up to the fact that the profitability	15:35
	of corporate enterprise is seen to be seriously eroded?	15:39
	Well now, if the answer to these questions is yes,	15:44
	does that perhaps carry the implications that the stock	15:48
	market is now dangerously high despite the apparent	15:51
	low price earning multiples?	15:55
	Thus, if we recalculate profits on a proper, maintainable,	15:58
	real base, will we find that profits are much less	16:03
	than is now reported with the result that the correct price	16:07
	earning multiples are now really very high rather than	16:12
	very low?	16:17
	And if there is serious erosion of profits, doesn't that	16:19
	bode ominously for the future of our needed	16:24
	capital formation?	16:27
	You see I'm playing the part of the devil's advocate.	16:29
	I'm trying to put on the table for discussion what I	16:31
	sensed to be the fears in the minds of very many people.	16:38
	Isn't it the case that we find ourselves now with a	16:44
	surprisingly tight under-capacity position in many	16:50
	basic industries?	16:54
	Not only in oil and coal, but in oil refining, in railroads,	16:56
	in paper, in chemicals, in cement, in plastics, well you	17:02
	name it.	17:06
	And if we were to make good, these shortages, to say	17:07
	nothing of our taking care of the demands for pollution	17:11
	control that are inevitably put on industry today,	17:15
	won't be necessary for us to have an unprecedented	17:20
	rate of effective saving.	17:23
	Saving that will go into effective capital formation.	17:26
	And will that really be possible under our present	17:31
	punitive taxing of corporate profits and our present	17:35
	progressively punitive personal tax structures, with the	17:39
	loopholes in that structures being more and more closed down	17:44
	There is a view, you know, that capitalism breathes	17:49
	through those loopholes, and if you close down those	17:52
	loopholes, then it will cease to be breathing well.	17:54
	It'll be capitalism with emphysema.	18:00
	You see we have here the paradoxical twin specters	18:05
	of too little capacity along with low profit margins,	18:09
	if not negative profit margins.	18:14
	Those two are supposed to, usually, not go together,	18:17
	and wouldn't something like this seem to signal the	18:21
	decline and fall of the Roman Empire?	18:24
	I mean the American production system as we've known it.	18:28
	Moreover, with the unions sharpening their knives of	18:32
	collective bargaining, the situation looks to be even worse.	18:35
	Particularly now, so it might be argued, that productivity	18:39
	is ceasing to show its' previous rate of advance, and now	18:44
	that we seem to be moving into a new era of scarcity in	18:47
	which farmers and raw material producers all over the world	18:51
	can hold up us urban and manufacturing consumers for ever	18:55
	impoverishing terms of trade.	19:01
	In short, is it the case that we have been living in	19:06
	the years since World War II in a honeymoon, which like	19:09
	all honeymoons, must alas, come to a close?	19:13
	Just as the weather is getting colder, at least so it	19:17
	is argued by a school of climatologists out of the	19:23
	University of Wisconsin and elsewhere, I believe Professor	19:28
	Bryson and some others, they claim that there is some	19:31
	evidence that the good monsoons are deserting India so	19:35
	that the crop failures, which used to come one in five	19:40
	years, were delightfully coming only once in 18 years	19:46
	in the miraculous 19th and 1960 phase of the weather	19:51
	cycle, but that weather cycle is now coming to an end.	19:57
	Similarly, the Sahara is supposed to be drying up.	20:01
	You know if you read Biblical and pre-Biblical remnants	20:05
	you find that the Sahara was once a green, luxurious place.	20:10
	Well the Lord giveth and Lord taketh away with respect	20:16
	to the weather.	20:21
	It is supposed to be the case that Greenland was once green,	20:23
	but now the oceans are cooling off.	20:28
	You know, there's always two schools of cataclysmics.	20:31
	There are the boilers and the freezers, and just recently,	20:35
	I've been having to worry about the world boiling.	20:40
	What was it that Robert Frost say?	20:43
	Will the world end in fire or in ice?	20:44
	Or Robert Heilbroner has written a very gloomy book	20:51
	just recently in which one of his concerns is that	20:54
	the exponential increase of energy use necessarily	20:58
	is causing the atmosphere to heat up.	21:04
	Now it's very small up to now, but don't forget what	21:08
	compound interest is like as you extrapolate it into	21:10
	the future.	21:13
	It's a little hard for me to worry about to opposite	21:15
	things at once.	21:17
	Namely that the oceans are gonna get too warm that	21:18
	the birch trees are gonna die all through New England	21:22
	and into Canada, and that the fish are gonna move further	21:26
	north at the same time that the ocean is getting cold	21:32
	and the glaciers are gonna be moving down, but it is	21:35
	possible to worry about one or the other of those things	21:39
	as is happening.	21:44
	Well it's quite obvious that these are very tall questions,	21:47
	and I would like to talk about them.	21:51
	I think, just in case you are impatient for the answers,	21:55
	that if we study these fears one by one, I think, that	22:02
	many of them can be reasoned away.	22:08
	If they are susceptible to reason or at least can be	22:13
	put into a better quantitative perspective.	22:18
	Well I obviously don't have the time to handle the	22:23
	weather, the tax system, the future of saving and investment	22:29
	and pollution control, and all the things that the	22:36
	intelligent person should be concerned with today.	22:41
	Let me begin though by trying to discuss what has been	22:46
	happening to the profitability of corporate enterprise.	22:53
	What has been happening to the distribution of income	22:56
	as between labor and as between property?	23:00
	I'm referring, in front of me, to a manuscript by	23:05
	Professor William Nordhaus of Yale University.	23:12
	You will be able to read the finished, revised version of	23:16
	this in a forthcoming publications by the Brookings	23:22
	Institution, their current papers, I would think in about	23:27
	three months a time.	23:32
	I've mentioned those current papers before as having	23:34
	great deal of material by modern economists that would	23:37
	be of interest to anyone trying to follow the passing	23:43
	American and international economic scene.	23:47
	Well this is one of the more interesting of such studies.	23:50
	The first thing that has to be done, according to Professor	23:55
	Nordhaus, is to see what the bare facts are.	24:00
	Is it the case that the share of profits is going down?	24:06
	Well now there are different ways of measuring the	24:12
	share of profits.	24:13
	You can measure the share of profits relative to the	24:15
	total GNP, and as I look at the chart which plots what's	24:18
	been happening since 1948, this would be through 1973,	24:24
	there is a distinct long-term downward trend.	24:32
	Now there are some ups and downs within that trend.	24:39
	For example, since the trough of 1970 of the last recession,	24:41
	there has been a gentle increase in the share of profits,	24:48
	but it hasn't brought the level of profits back to	24:53
	where it was in the middle of 1960s at the height of	24:56
	the long Kennedy-Johnson prosperity, nor has it brought	25:01
	it back to anything like the pre-Korean war period.	25:06
	So what you can say is that since 1948, the share of	25:12
	profits in the GNP, corporate profits, has been a	25:17
	declining one.	25:21
	Now that's not the only way to measure profits as a share	25:22
	because if the government is taking an increasing share,	25:28
	then you can have a declining share of wages in the GNP	25:33
	as well as of profits.	25:37
	That would simply mean that the government was spending	25:39
	more of our resources.	25:43
	More for national defense, more for conservation, more for	25:46
	bad causes if you think that most of government expenditure	25:53
	is a waste.	25:58
	So there is a second way of measuring the fall of profits.	25:59
	Unfortunately, this second way does not give a more	26:05
	reassuring picture.	26:08
	It gives, if anything, a more rapid decline in the	26:09
	rate of profits.	26:14
	Let's take the share of profits in gross corporate product.	26:15
	Just put a ring around General Motors and all the	26:24
	corporations in the country, and you find a flow of value	26:29
	added in them.	26:33
	Value added that goes to profits, goes to wage bill,	26:36
	and so forth, and that also shows a decline.	26:42
	Well the facts, of course, are not quite so simple	26:50
	as that, as Professor Nordhaus makes clear because	26:53
	if you were to mention this to a person of liberal	26:57
	persuasion, he would say, "Ah yes, but don't forget	27:01
	that the corporations in recent years have been getting	27:05
	a very favorable shake with respect to their depreciation	27:09
	deductions, and so reported profits are down, but that's	27:16
	just because they've been allowed to take bigger deductions.	27:21
	They've been allowed to take faster depreciations under	27:25
	the tax law.	27:29
	As a result, you need to make a correction to the	27:31
	depreciation numbers."	27:37
	And Professor Nordhaus has attempted to do this in a table.	27:39
	He's looked to see how much of a change in depreciation	27:42
	came about through the tax laws, but he decides that	27:48
	that isn't the only adjustment that needs to be made.	27:52
	You also need to make an adjustment for the rate of	27:55
	inflation where we're back to our concern as to whether	27:58
	the inflation is creating transient fictitious paper	28:03
	profits, which are papering over the true situation,	28:07
	and so he says, "Let's suppose that we try to reckon	28:12
	real earnings, and for that purpose, we have to assume	28:17
	that the corporations last year used up, in value,	28:22
	not the value of the machines reckoned at their bygone	28:26
	historical low cost, but at their genuine reproduction	28:31
	cost at the new higher price level," and he finds that	28:36
	that correction is even greater than the correction	28:41
	that has to be made for tax laws.	28:46
	For example, profits are understated by 10 billion dollars	28:47
	in 1973 in comparison with 1948 because of the tax law,	28:53
	but they're overstated by 12.5 billion dollars because	28:58
	of inadequate allowance for the price level.	29:01
	Well, he then calculates what's happening in terms of true	29:05
	economic depreciation and makes both of those adjustments.	29:09
	Well now, after you've then taken out true economic	29:13
	depreciation and allowed for interest, then you can take	29:17
	a new look about what's happening to the genuine income	29:24
	on capital, and here he comes out with some rather	29:28
	interesting results that there seems to be no doubt that	29:34
	there is a decline in the rate of yield on capital.	29:38
	First, he regards it as surprising.	29:45
	I'm not sure whether I regard it as surprising or not	29:47
	that the corporate enterprise as a whole doesn't make a	29:49
	rate of profit much more than the interest they have	29:52
	to pay on the part of their capital which they borrow.	29:56
	To the degree that corporations now smooth out risks	30:00
	there is no reason why there should be any great	30:04
	discrepancy, and he finds there to be only a percent or two.	30:06
	Well what's happening actually to the rate of return	30:12
	on capital?	30:15
	The numbers are as follows, and here we must distinguish	30:18
	between real rates and nominal, or money, rates.	30:22
	By and large, there's been a drop from about almost 10%	30:28
	on after-tax return in real terms that was achievable	30:34
	just before the Korean War in 1950 or just before the	30:40
	Vietnam War in 1965.	30:46
	We're down now to about 5.5% real return after taxes.	30:49
	In nominal terms, you used to get almost 20% in nominal	30:55
	return in 1948.	31:04
	Well that went way down through the Eisenhower period	31:06
	so that in '58, '59, '60, your only nominal terms are	31:09
	getting about six or seven percent.	31:14
	It went up in the Kennedy-Johnson period, and surprisingly,	31:15
	that still hovers around 10 or 11 percent.	31:20
	Well what are we to conclude from this?	31:25
	I conclude one thing, namely that in comparison with	31:28
	alternatives, which is the only meaningful thing to the	31:35
	investor, it looks to me as if it is not the case that,	31:37
	taking into account what sort of an inflation hedge common	31:43
	stocks are, it is not the case that corporations in fact	31:48
	have been giving you much less protection than the eight	31:54
	or nine percent which you can lock away in long-term bonds.	31:59
	In a certain sense, that's a reassuring affect for that	32:03
	large part of the public which holds stocks, but that is	32:09
	still consistent with the fact that the real yield on	32:12
	both bonds and stocks is going down through time.	32:16
Announcer	If you have any comments or questions	32:21
	for Professor Samuelson, address them to Instructional	32:23
	Dynamics Incorporated.	32:26
	166 East Superior Street, Chicago, Illinois, 60611.	32:27

Item Info

Title:

Tape 152 - Longtime erosion of profits

Date:

1974

Contributor:

Samuelson, Paul A. (Paul Anthony), 1915-2009

Subject:

Format:

audiocassettes

Language:

English

Digital Collection:

Paul A. Samuelson papers, 1933-2010 and undated

Source Collection:

Paul A. Samuelson papers, 1933-2010

Series:

Economics Cassette Series: Paul Samuelson

Rights:

Limited Re-Use

CC BY-NC 4.0

Rights Note:

This material is made available for research, scholarship, and private study. Copyright in this material has not been transferred to Duke University. For reuses of this material beyond those permitted by fair use or otherwise allowed under the Copyright Act, please see our page on copyright and citations: https://library.duke.edu/rubenstein/research/citations-and-permissions.

Identifier:

RL10082-CS-0144
ref2427_qym
samuelsonpaul
duke:325167
pstau001144
ark:/87924/r4hq3sf5v
8861245e-8153-4002-8bf0-6aff2954e360

Permalink:

https://idn.duke.edu/ark:/87924/r4hq3sf5v

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Tape 152 - Longtime erosion of profits

Transcript

Item Info

Economists' Papers Archive

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