Business and Armament

1

THE quickening conflict with Russia is not only the most important political fact in the present situation of the United States, but also the most important economic fact. If the1 lighting in Korea is followed by an open conflict with the Chinese Communists, or through any satellite by a direct engagement with Russia, then we are heading for an all-out war economy. At this writing what we seem to be committed to is a more limited conflict with Russia of indefinite duration, and the necessity of raising the number of men under arms from about 1.4 million to 3 million. With the help of wise diplomacy the additional cost of the contest with Russia may be kept down to about 18 billion dollars a year in terms of the 1950 dollar, or about 7 per cent of the current output of the country. This cost includes 3 billion dollars or more of military aid to other countries, but it does not include all of the extra cost that will have to be met during a period of about one year while original equipment for the enlarged military force is being produced. Bad diplomacy would greatly add to the cost of defense and foreign aid. Hence the figure of 18 billion dollars should be regarded as a minimum one.

How can the goods and services needed for this conflict be provided? Can they be obtained in the main or entirely from increased production, must they be obtained by reducing the proportion of the national output now used to replace and increase industrial plant and equipment, or must they be gained by reducing the current standard of living.”How will the increased taxes to pay 1 he annual bill of 18 billion dollars affect the volume of savings and the incentive to produce? Finally, will not the huge increase in the demand for goods start a wage-price spiral, and if so, what should be done about it?

The conflict with Russia is not merely a competition in arms; it is fundamentally a contest in production — and a long-run contest. Consequently, it is of vital importance that the additional goods and services needed for defense and foreign aid come out of an accelerated increase in the output of the country. This would prevent the standard of living of the country from being reduced for longer than several years, and it would mean that American industry would be better prepared to meet a still greater demand for goods in case the conflict with Russia should become even more active than it is now. It is of special importance, moreover, that the outlays on defense and foreign aid shall not retard the replacement and increase of our industrial plant and equipment, as did the Second World War. During the four years of the war (1942 to 1945 inclusive), only 3.8 per cent of the output of the country was used to replace and expand private plant and equipment, in comparison with 8 per cent during the three years (1939, 1940, and 1945) preceding our entry into the war and more than 10 per cent during the four years since 194.5. To win the production contest with Russia, the United States should continue to use at least 10 per cent of its output to improve and enlarge its private industrial plant and equipment.

If the war does not spread, it ought to be possible to accelerate the growth of production so that within several years all or most of the goods needed for the conflict with Russia can be provided from increased output. Unfortunately, the government cannot be counted on to go very far in adopting policies designed to stimulate production. Politicians feel little demand from the public that production be encouraged. Consequently, the responsibility for accelerating the increase in output must fall pretty largely upon private enterprise. Industry should be able, however, to raise substantially the rate at which output expands. The pressure of the additional demand caused by the enlarged military services and foreign aid will encourage enterprises to expand capacity; and strange to say, some of the tax policies of the government will have the same effect. ’There are live principal ways in which industry may be expected to accelerate the growth of output:–

I. The size of the labor force will be increased. Experience during the Second World War shows that a strong demand for labor will produce a considerable expansion of the labor force. Indeed, it seems clear that the labor force can be expanded sufficiently to prevent the increase in the armed services to 3 million from causing a drop in the number of civilian workers. For example, a rise of only 2 per cent in the proportion of women of 14 years of age or over who are at work would raise the labor force by over a million. Such a rise would leave the proportion of women at work less than it was during the Second World War. Another important opportunity to increase the labor force is by raising the proportion of males over 65 years of age who are at work. This proportion gradually dropped from about 70 per cent in 1890 to about 45 percent in 1940. Most of this drop was involuntary — that is, men did not quit of their own accord but were retired by management while they were still capable of useful work. The strong demand for labor produced by the Second World War raised to nearly 50 percent the proportion of males over 65 years of age who were in the labor force.

The increased demand for labor produced by the conflict with Russia will cause many companies to raise the usual retirement age, will encourage unions to oppose premature retirements, and will open employment opportunities for men who have been retired. If the proportion of males above 65 years of age who are at work were raised to the level of 1890, the labor force would be increased by over 1.2 million. Such a large gain in the employment of older workers cannot be looked for within a short time, but the country within two years or less should have the benefit of the output of at least 500,000 more men 65 years of age and over than are now employed.

2. The rate of technological discovery will be accelerated. This will happen for several reasons. The shortages of goods created by the conflict with Russia will encourage enterprises to spend more money on developing substitutes for steel, copper, lead, lumber, and other scarce materials. The strong demand for labor will accelerate the increase in the wages of production workers, thus making it more advantageous for employers to spend money on research to keep down labor costs. The conflict with Russia will, of course, accelerate the expansion of research by the government, and many results of this research will be useful to industry. Finally, higher taxes will encourage outlays on research, because these expenditures reduce the tax liability of the spender. To be sure, there are dangers to be guarded against, especially that the urgency of the conflict will cause neglect of fundamental research.

3. More productive uses of labor will be encouraged. The conflict with Russia will pull labor out of parts of agriculture which are still overstaffed and where the productivity of labor is relatively low, and will increase employment in manufacturing, transportation, and mining, where the productivity of labor is relatively high. The output of labor in some Southern states, for example, is little more than half the national average, mainly because these workers are producing the wrong things and because the demand for labor in other occupations and other places has not been strong enough to pull more men out of the overstaffed parts of Southern agriculture.

4. The training of men in crafts, and possibly in professions as well, will be encouraged. As a result, the United States will have a better trained labor force with a higher proportion of professional men, technicians, and skilled workmen. The labor force of the country has never been as well trained as it should have been — though the ratio of craftsmen and professional workers to all workers has long been increasing. The defense program will create the need for thousands of skilled workers to make and maintain armaments. Many of these men will be trained in the armed services themselves and on leaving military service will be available for industry. But the strong demand for labor will encourage employers to train craftsmen, as it usually does. During the thirties, when the demand for labor was weak, the proportion of skilled workers in the labor force dropped, but the strong demand for men in the forties caused the proportion of skilled workers to rise from 11.7 per cent in 1940 to 13.5 per cent in 1949.

Although the need for professional workers as well as craftsmen will be increased, there is danger that universal military training will interfere with the training of professional and technical workers. Yet we must realize that the ability of the country to step up production depends in large measure upon expansion of technological research. In asserting that the contest with Russia would accelerate technological research, I assumed that ways would be found to give military training to the men needed and still not retard an increase in the number of professional workers.

5. The replacement of equipment will be accelerated. It is true that the rising cost of equipment and the difficulty of obtaining new equipment will tend to hold down the rate of replacement. On the other hand, higher corporate income taxes will encourage more rapid discarding of old equipment because scrapping old machinery usually reduces tax liability by increasing depreciation allowances. Rising labor costs will cause many companies to review their replacement policies, which, as W. J. Kelly of the Machinery and Allied Products Institute has well said, are often “the product of industrial folklore handed down from one generation to another.”

2

WILL these favorable influences upon production be offset in large measure, or even entirely, by the unfavorable effect of higher taxes upon the supply of investment-seeking funds? Part of the 18 billion dollars addition to the output can be obtained without an increase in plant and equipment - by speeding up the replacement of old equipment with new. These replacements are paid for, of course, out of depreciation allowances. But output cannot, be raised about 18 billion dollars a year above what it would otherwise be without making the country’s plant and stock of equipment larger than they would otherwise be. Part of this additional plant and equipment will be government owned and will be largely paid for out of taxes. But much of the increase will have to be financed by individual and corporate savings. Can the needed funds be obtained in the face of tax increases on individuals and corporations?

The personal income tax has been raised and may be increased further. The effects of advances in the already stiff income tax rates are a mixture of good and bad. Consumption is limited at a time when expenditures are outrunning the capacity of industry to produce, but, in addition, savings are limited too, and the incentive to invest is weakened. What is needed during the contest with Russia (or at least during the early stages of that contest) is a tax that will principally discourage spending, not saving and investing. A general sales tax on consumer goods would limit spending, but such a tax will not be enacted — though some new excises may be passed. But in spite of increases in the personal income tax, the volume of personal savings available for investment in industry will probably rise to a small extent. The tendency for taxes to reduce personal savings will be offset somewhat by the tendency for shortages of goods, especially durable consumer goods, to increase savings. Furthermore, in the last several years, a high proportion of personal savings has gone into residential budding rather than into industry. Shortages of building materials and labor will reduce the proportion of personal savings spent on housing and increase the proportion devoted to industry.

The corporate income tax has been raised from 38 per cent to 45 per cent. In 1948 and 1949, corporations had available about 11 billion dollars of undistributed profits to spend on increasing productive capacity, and in 1947 they had about 7 billion. Will not the increase in the corporate income tax prevent the much needed growth of industry by limiting the funds available for reinvestment ?

There is danger that this will happen. Fortunately, however, most of the increase in the corporate income tax will soon be passed on in the form of higher prices — as has happened during the last ten years. Since corporations even in 1943 and 1944 under price control were able to make a profit after taxes of 4.2 cents to 4.3 cents per dollar of sales, it is reasonable to expect that profits after taxes may equal 4.5 con Is per dollar of sales. With corporate sales of 400 billion dollars a year or more, total corporate profits would be 18 billion or more — enough to permit sufficient increases in dividends to offset the rise in the cost of living and to leave about 9 billion dollars of earnings for reinvestment. This is less than corporations have recently been reinvesting. Nevertheless, it is probably more than they would have continued to reinvest had the Korean war not occurred. They would undoubtedly have made substantial increases in dividends and cut the amount of profits that they reinvested.

Particularly harmful to the much needed expansion of industry would be a badly designed excess profits tax. As a general rule, the industries where profits are exceptionally large need to increase their capacity. Expansion of capacity in the industries where profits are largest would help to adjust supply to demand and to bring profits down. A poorly designed excess-profits tax, by taking most of the profits that might be used for expansion, would retard the increase of capacity at many points where expansion is badly needed. If an excess profits tax is enacted, its tendency to retard the growth of industry should be mitigated by a provision that only part of the regular rates apply to profits spent on new plant and equipment.

My conclusion is that the total volume of personal savings and corporate savings is likely to be somewhat smaller than it has been, but that the funds available for investment in industry will be larger than would have been available in the absence of the Korean war. The explanation of this seeming contradiction is that the drop in residential construction will make a larger proportion of personal savings available for industry, and that the quickening conflict with Russia, by discouraging increases in dividends, will cause cuts in corporate saving to be less than they otherwise would have been. This conclusion indicates, however, that the funds available for expanding industry will be only about as large as they recently have been — perhaps somewhat more from personal savings and less from corporate savings. This prospect indicates the need for public policies designed to encourage investment in industry.

3

ONE of the most certain consequences of conflict with Russia will be a rising price level. People are likely to spend such a large proportion of their incomes after taxes for consumer goods that the output will not meet the demand. The bargaining position of unions will be strong and they will get substantial wage increases which will reinforce the upward spiral.

The rise in prices is bound to be uneven and to create many serious injustices. Nevertheless, the people evidently regard a moderately rising price level (say nearly 10 per cent a year) as a lesser evil than the steps necessary to prevent it —such as slider indirect controls (strict controls on credit, substantial taxes on spending, a budget deficit financed by real savings rather than by bank credit) or direct controls (wage and price ceilings and rationing). At any rate, the politicians seem to feel no strong demand from the people that rising prices be prevented, and government policies (as distinguished from the talk of officials) are probably more inflationary than anti-inflationary.

if the country is going to have a moderately rising price level, with all the inequities that go with it, steps should be promptly taken to see that all parts of the community share as fairly as possible in the inflation. Especially must all unorganized workers — such as government employees, white-collar workers, clergymen, college professors, and others — have their compensation linked automatically to the cost of living. Rents, pensions, and such payments as tuitions in colleges and schools also will need to increase automatically as prices rise. Savers will need to avoid putting their money into savings banks or into bonds, where the purchasing power of their savings will drop. Adjusting wages, pensions, and rents to increases in prices would strengthen inflationary influences but would make inflation less unfair.

Even more important than how to reduce the inequities of inflation is the question of how rising prices will affect the volume of output and hence the ability of the United States to win the production contest with Russia. A very rapid rise in prices, more rapid than is likely, would cause much hasty, ill-considered, and wasteful spending on plant and equipment as well as on consumer goods, and thus would retard the rise in output. A moderate rise in prices, say about 10 per cent or a little less a year, would not cause much wasteful spending. But such a rise might eventually lead the people to change their minds about wage and price controls and rationing. This would be unfortunate because wage and price ceilings and rationing would be bad for the standard of living. They would prevent industry from producing goods in the proportions that consumers most desire, and therefore would reduce the return that consumers get for their dollars. Pricc ceilings would also cause a drop in the quality of goods. Consequently, it is important that the rise in prices be kept slow enough and that the inflation be kept fair enough so that the community will not reduce the productivity of industry by insisting on comprehensive direct controls.

Retarding the rise in prices is not easily accomplished when trade-unions are in an exceptionally strong bargaining position and are rapidly pushing up wages. Nevertheless, stiller indirect controls, by making it harder for employers to pass on wage increases, would probably cause them to do a better job of bargaining with unions. The main features of a program of stiffer indirect controls would be substantial reductions in government civilian spending, stricter control of bank credit, cuts in the prices at which farm products are supported, and a real attempt to induce people to save by offering them a government savings bond payable in a fixed amount of purchasing power rather than a fixed number of dollars.

This analysis indicates that the best way to limit the disrupting effect of the conflict with Russia upon the domestic economy is to accelerate the expansion of production. If the conflict with Russia were to cause production to increase at 4 per cent instead of 3 per cent a year and if the additional outlays on defense and foreign aid were about 18 billion dollars a year (in 1950 dollars), the gain in production, after about, six years, would entirely offset the increased military expenditures. As a matter of fact, since the expanded defense program is likely to produce an early and substantial increase in the labor force and a corresponding jump in production, the reduction in the standard of living by defense expenditures may last considerably less than six years.

Stepping up the expansion of production can be achieved. Success depends particularly upon avoiding two great dangers: the government must not handicap industry by unduly taxing away supplies of investment-seeking funds, and military policy must not prevent the increase in professional and technical workers badly needed for expanding technological research. If these two dangers can be avoided, the United States will win the production contest with Russia. Furthermore, if Russia causes the United States to step up the increase in output, the contest between the two countries will, within several years, give America a higher rather than a lower standard of living. If the rise in money incomes can be kept broad and not confined to a few groups, such as trade-union members and farmers, the advance in the standard of living will extend to most parts of the community.