All Commentary
Monday, July 1, 1963

Profits–Their Consequences

From the 1962 Annual Report, United States Steel Corporation.

The year 1962 was one in which the nation’s total production, em­ployment, and money income were all greater than they were in any previous year. The record was marred, however, by the failure of expenditures for new plant and equipment to be significantly greater than those of five years ago, by the persistence of pro­nounced unemployment, by the de­velopment of a large fiscal deficit where balance had earlier been promised, by one of the sharpest stock price declines in security market history, and by a con­tinued adverse balance of pay­ments situation resulting in fur­ther decreases in our already shrunken gold reserves. There has been economic improvement but its extent has proved far from satisfactory.

Underlying the disappointing features of the situation and in substantial measure responsible for them is the continued failure of profits and profit prospects to provide the incentives on which peacetime expansion of employ­ment and production entirely de­pend. Corporate profits as a per­centage of sales were only about three-fifths what they were in earlier postwar years; the per­centage was scarcely better than it was in the depression year of 1954. The profit squeeze, and its origins, is thus of significant in­terest; it is of especial importance to the owners and employees of steel companies, because the steel industry is experiencing the profit squeeze and its consequences in more acute form than are many other industries.

For example, its profit margin on sales has, since 1958, been re­duced by approximately one-third despite the fact that it shipped approximately one-sixth more steel. The 1962 profit margin was smaller than that of any nonwar year since the depression year of 1938. Its product prices have not increased since 1958; its hourly employment costs have increased by approximately 20 per cent; and it has been squeezed out of some markets so that it and its em­ployees have lost to foreign pro­ducers some 6 to 10 per cent of the market they formerly supplied.

The critical importance to prog­ress of profits and profit prospects merits public attention. Such at­tention is especially relevant in view of proposals being advanced to “cure” the unemployment and other adverse features previously noted. Involved may be important national policies with respect to taxation, government expendi­tures, international trade, mone­tary matters, labor, subsidies, and prices. These policies constitute a significant segment of the insti­tutional framework within which the American economy functions and they may be at the present time of overriding importance.

It seems probable that present policies in these areas are at least partly responsible for what is re­garded as unsatisfactory economic growth or so-called “high level stagnation.” The prospect of their public and legislative review and revision thus holds the hope of al­terations in them that will release the growth and employment in­centives; it presents also the fear that, flinching from the sup­posedly unpopular, there will in­stead be dangerous resort to “easy-way-out” measures long since proven fallacious. Careful scrutiny is well warranted.

Profits and Employment

That the profit squeeze lies at the root of other unsatisfactory features of the situation is clearly evident in terms of ordinary ob­servation, accepted economic prin­ciple, and the statistical record. In the matter of employment, for ex­ample, it seems clear that there is no dependable reason why any person ever hires another except that he values the service thereby received more highly than its cost to him. In the case of corpora­tions which pay some three-quarters of all nongovernmental wages and salaries, this means that, within their financial capa­bilities, they will invest in tools of production and will, with alac­rity, hire people when a profit from so doing is foreseen—a profit which is significantly greater, of course, than can be obtained by relatively riskless investment of money in, say, tax-exempt bonds.

Conversely, it follows that when the cost of hiring people is too high in relation to the prices at which resulting products can be sold, then they are competitively compelled to reduce their employ­ment of people since loss is the only alternative. It is axiomatic that it is the prospect of profit, and it alone, that inspires the pro­ductive employment of people in the private economy; it is the dim­ming of that prospect that breeds unemployment and stops economic growth.

This principle has long been recognized by so-called conserva­tive and liberal economists alike. For example, the late Lord Keynes in analyzing the unsatisfactory economic condition of his own country in 1931 wrote, “We live in a society organised in such a way that the activity of produc­tion depends on the individual businessman hoping for a reason­able profit, or at least, to avoid an actual loss. The margin which he requires as his necessary incentive to produce may be a very small proportion of the total value of the product. But take this away from him and the whole process stops. This, unluckily, is just what has happened. The fall of prices relative to costs, together with the psychological effect of high taxa­tion, has destroyed the necessary incentive to production. This is at the root of our disorganisation. It may be unwise, therefore, to frighten the businessman or tor­ment him further.”

The principle is confirmed by the record. Shrinking profit mar­gins go hand-in-hand with rising unemployment percentages. From 1929 to 1932 corporate profits as a percentage of sales declined from about 5 per cent to less than nothing; and the percentage of those unemployed increased from about 3 to 24. By 1936-37 the profit percentage of sales had risen to about 31/2; and the unem­ployment percentage decreased from about 24 to about 15. In 1938 the profit percentage dropped to about 11/2 and the unemployment percentage rose to 19. In the non-war years since then, as shown in the accompanying chart, the ten­dency for unemployment to in­crease as profits decrease is also clearly observable on the record. It is not mere happenstance that the postwar downtrend in profit margins has been accompanied by an uptrend in unemployment that now threatens to become chronic.

Restatement of Principle

Once it is recognized that em­ployment rests wholly on the profit expectations of employers, that truth can be restated to serve as a validity check on policy formu­lation. For example, if labor lead­ers find themselves unable or un­willing to propose and pursue any policies that demonstrably im­prove employers’ profits or profit prospects, then by this default they contribute nothing to getting people back to work and instead tend to guarantee that unemploy­ment will continue or increase.

Similarly, if legislators are un­able to revise or devise tax or other laws that will demonstrably permit or promote improvement in the profit prospect, then they, too, contribute nothing to getting people productively re-employed. Similarly, if the administrators of law cannot conduct themselves in ways that avoid undermining confidence in the profit prospect, then they, too, contribute nothing to alleviate unemployment and permit economic growth.

Similarly, if professional econ­omists engage in establishing “guideposts” for wage setting, then they should admonish that no increase in the general wage level is warranted when there is pronounced unemployment; for they, better than any other group in the land, must know that the presence of pronounced unemploy­ment is in itself proof complete that the level of wages is already too high in relation to the level of prices at which the fruits of em­ploying people can be sold.

Finally, if the profit and loss makers themselves cannot propose policies to unleash the profit in­centive that will be considered on their merits, rather than rejected out of hand as self-serving pro­posals, then they, too, can con­tribute nothing.

The Root of the Trouble

Yet such policies must be evolved and established for, as earlier noted, the profit squeeze lies at the root of the unsatisfac­tory features of the economic situation. Thus, if profits are squeezed and unemployment there­by increased, the fiscal problem is aggravated; for the income tax bases are relatively diminished at the very time the welfare burden is enlarged. If large fiscal deficits should occur, then the unsettling question of their inflationary fi­nancing is raised; and should that question arise, then, in turn, the risk of undermining international confidence in the dollar’s stability is heightened.

If profits are squeezed, then not only is this source of job-creating expenditure for plant and equip­ment curtailed, but the ability and incentive to attract “outside” capi­tal is simultaneously impaired and this, in turn, reacts to maintain or worsen the unemployment situ­ation. If industries do not make modernization expenditures, then they must lag behind in interna­tional competitiveness; and this reacts to worsen our adverse bal­ance of payments situation.

As Keynes said of his own coun­try many years ago, the impair­ment of the necessary profit in­centive to production is the root of our problems. If this situation is adequately corrected, it thus ap­pears that little else is impera­tively required; if it is not, then other measures must prove com­paratively futile.

Origins of the Profit Squeeze

Some light on the appropriate­ness of corrective measures may come from noting the origins of the profit squeeze. They appear to be both economic and political. It is historical fact that great wars cause postponement of the produc­tion of numerous durable con­sumer, producer, and public goods not needed in the war effort. Such goods already in existence are made to last a little longer. The big backlog of demand created by World War II became the basis for a long reconstruction boom financed by “soft” money policies adopted during and inherited from that war. Following that war this country not only had its own back­logs to take care of but it under­took to aid reconstruction in other lands. Our government, through loans, gifts, or expenditures, has supplied some $120 billion of tax­payers’ money to foreign coun­tries and people.

Under cover of the boom a great inflation in hourly employment costs was engendered; and total taxes have risen to near three times their peak wartime levels. During the boom and while scarci­ties and “soft” money still existed, prices could increase to cover the employment and tax cost infla­tions without extinguishing the profit margin reason for employ­ing people.

Such booms end; and it now seems probable that basic world capacities and competitive capa­bilities were substantially restored or over-restored by 1957 or 1958 because, since then, basic com­modity prices have been drifting slightly downward, and the inter­national balance of payments has been seriously and regularly against us, as well manifested by shrinkage in our stock of mone­tary gold. Cost-covering price in­creases have met resistance from world-wide sufficiency of capacity. But the domestic wage inflation did not similarly halt. It has con­tinued, thus intensifying the cost-price squeeze on profits and em­ployment opportunities.

During the boom this country “geared” itself not only to satisfy normal living demands but to sup­ply the great—but transitory—backlog demands. With the “catch up” demands satisfied there is over­abundant ability, for a while, to meet normal living demands. Por­tions of manpower and industrial capacity are not now needed for the former purpose, and their competitive pressure on markets is part of the profit squeeze.

This need not be regarded with dismay. Instead, it represents op­portunity; for, having overcome the ravages of war, resources are thereby released to speed innova­tions that spell progress, if we but have the wisdom to establish the policies permitting and pro­moting it.

The “Spending” Cure

It is sometimes supposed that increased government spending can cure economic troubles—es­pecially unemployment. It is a se­ductive notion that must be re­garded with much skepticism. As background it may be noted that government in the United States (federal, state, and local) can in a general way be regarded as spend­ing three approximately equal chunks of money. Government is a direct employer of people—for ex­ample, schoolteachers and police­men—with payrolls of about $50 billion a year. It spends another somewhat similar amount to pur­chase privately produced goods and services, involving private em­ployment in their provision. The third chunk is used to cover in­terest on debt, subsidies, grants at home and abroad, social security, and other “welfare” disburse­ments for which it receives no concurrent equivalent in goods or services rendered.

Government expenditures are fi­nanced by taxation supplemented by borrowing. According to official government data, a little over half of the taxes are loaded directly or indirectly on business and inflate (by about one-quarter) the amounts that must be secured in the market place to cover the dis­bursements required for continued private production. The rest of the taxes are levied on individuals as a transfer of big parts of their buying power to government.

It is apparent that government has become a monstrous burden on the economy and that its costs constitute a big element squeezing profits. To suppose that by becom­ing a still bigger burden it would thereby improve profit prospects is, on its face, upside-down rea­soning; for the opposite is called for. Part of the spending cure theory rests on the fallacy that by resorting to “deficiteering”—spending more than is collected in taxes—the nation’s so-called pur­chasing power can be increased with happy results for everybody.

But government cannot give purchasing power or anything else (except promises) to anybody without first securing it in some fashion from the governed; to suppose otherwise is to engage in arithmetic nonsense. It need only be noted that if government covers its deficits by borrowing—how else?—it thereby usurps sayings or credit resources that might otherwise be invested or utilized in employment-providing production of marketable goods. What is given through deficiteer­ing is equivalently usurped through borrowing, and no new self-sustaining jobs come into ex­istence; such jobs are created only when savings are productively in­vested in the hope of profit. The burden of government is best measured by the larger of its taxes or its expenditures; reductions in both are now called for.

In the 1930′s the deficiteering cure was tried out on a monu­mental scale and failed miserably in its purpose. For the fiscal years, 1931 to 1939 inclusive, federal deficits averaged 4.6 per cent of national income. In today’s magni­tudes this would mean deficits averaging over $20 billion. It did not cure unemployment: in 1930, before the deficiteering, unem­ployment averaged 8.7 per cent; in 1939, following it, unemployment averaged 17.2 per cent. Only under the survival stimulus of war was unemployment reduced to less than 5 per cent in 1942.

Tax Policy

It is now so generally accepted that it need only be briefly men­tioned that our federal income tax structure could scarcely be better designed to extinguish the profitincentive, confiscate capital, and paralyze the growth processes. As the President of the United States recently noted, we have main­tained and even augmented the wartime tax structures when the purpose was maximum diversion of resources to the war effort with corresponding repression of non-war activities.

The war is ended; but the re­pression remains. The taxes are unfairly “loaded” against effi­ciency and profit-making. Income taxes on corporations are approxi­mately equal to their combined dividends and reinvested earnings. When earnings are transferred to owners as dividends, they are taxed again as individual income—and this despite the fact that dividends, which are all that the risk-taking stockholders get from their corporations, are less than 4 per cent of national income. In­efficient or nonearning corpora­tions pay little or no income tax and are thus, in effect, subsidized at the expense of the efficient. The steeply progressive individual in­come taxes, with rates running up to over 90 per cent, also could not be better designed to siphon off the savings margins of the more productive and efficient and to dis­courage the productive investment of what remains in profit-seeking ventures.

It follows that in the present situation, when profit incentive stimulation of innovation is sorely needed to stave off threatening stagnation, hardly anything can be considered more logical than reduction in the stifling burden of government taxation and expendi­ture and reform of the tax struc­ture. In this connotation “reform” does not mean so-called “loophole” closing or taxation in additional areas which offset the effect of reduced rates. It means, instead, a general determination to substi­tute for present incentive-destroy­ing taxation a more equitable sys­tem so that savings will be per­mitted and their confident invest­ment in profit-seeking innovation will not be discouraged.

Labor Policy

Since employment costs in the private productive economy are three times as great as the total taxes on business, it follows as a matter of arithmetic that changes in the wage level have three times the effect on profit margins as do changes of similar proportions in the tax level. It next follows that the leaders of labor with their ability to influence the wage level have it within their power to off­set or to augment tax changes affecting the profit margin, or in­dependently to establish a wage level in relation to prices that will speed re-employment of those now without work and provide oppor­tunity for new entrants to the labor force. They have a responsi­bility in the matter which is in­deed grave; it transcends partisan considerations.

Analysis of the situation enables one to assert with conviction that only as the prospect of earning profits improves will the man­power and resources of our land be fully utilized for economic growth. It further indicates that this can be achieved by stemming or reversing employment cost in­flation and the rise in government expenditures, and by altering the tax structure to reduce or elimi­nate its features that undermine the incentives to engage in profit-seeking, employment-providing enterprise.




Ideas on Liberty

Reason for Pride

Business should be publicly proud when it is most profit­able and efficient, publicly ashamed when it is least profit­able and inefficient. There should be praise for the com­panies that, in free and fair competition, are most efficient. most productive, most profitable.

HENRY FORD II. What America Expects of Industry