The Great American Experiment
I
LET us think of the several million business enterprises of the country as parts of one vast productive establishment. Its plant and equipment have cost almost $200,000,000,000, and when operating at capacity it employs over 50,000,000 persons. It is capable of producing about $1600 worth of goods each year for every worker. This is not a large amount, but it is more than the industries of any other country are able to produce, and it is five times as much as our own industries could produce a century ago.
During the last ten years, as everyone knows, the industries of the United States have not been operating very satisfactorily. For nearly two years they produced at scarcely two-thirds capacity, and most of the time they have been operating at scarcely three-fourths. So unsatisfactory did the operation of our economy become that six years ago the people sent to Washington an administration dedicated to giving the country a ‘New Deal.’ No one knew very definitely what the New Deal would be. Even the New Dealers, though in substantial agreement concerning the nature of our ills, had not decided among themselves what to do about them. They did, however, have an unmistakable mandate from the country to ‘do something,’ and they proceeded to give us action in large quantities. Seldom, indeed, has a government in a democracy dared to experiment so boldly with the long-established customs of the people. So new and sweeping have been the efforts of the Administration to make the country prosperous that they may well be called the Great American Experiment. Certainly they will go down in history as among the most fascinating experiments in the annals of economics.
Unfortunately the results of the Great Experiment have not been commensurate with the boldness and the sweeping character of the policies. Even as early as 1935, Great Britain was able to raise her national income above 1929. Canada, Sweden, Japan, Chile, and Hungary have also succeeded in bettering their pre-depression records. The United States, however, along with France, Poland, and several other countries, has been unable to attain the national income of 1929. Plainly something is wrong — either the Great Experiment has been based upon a faulty diagnosis of our ills, or the policies for correcting these ills have not been well selected. What is the trouble?
II
The diagnosis upon which the Great Experiment is based is simple and can be stated in a single sentence: ‘The trouble with our economy is that business activity in good times depends too largely upon expansion of plant and too little upon buying for current consumption.’ The great collapse of prosperity in 1929 was due, it is said, to the fact that the plant of the country had grown faster than consumer incomes, with the result that business enterprises could not find enough attractive investment opportunities to continue the current volume of investment. As investment declined, consumer incomes declined also, because men lost their jobs in the capitalgoods industries. Thus a downward spiral was started, the decline in investment producing a decline in consumer incomes, and the drop in consumer incomes causing investment to fall still lower.
The collapse of 1929, however, according to the New Deal view, was not simply an isolated event. It was symptomatic of an important change in the condition of the country. America is no longer new. The frontier has disappeared; our natural resources are pretty well developed; population, though still increasing, is growing at a declining rate and will soon be almost stationary. In a mature country, such as we have now become, say the New Dealers, the attractive investment opportunities are likely to be insufficient to absorb the savings of the community. If savings are not invested, they pile up in the form of idle deposits, and the demand for goods drops. Consequently, conditions in twentieth-century America require a new distribution of income: an increase in small incomes at the expense of large. This would simultaneously diminish the volume of saving and, by raising the demand for consumer goods, help to offset the decline in attractive investment opportunities. Thus the New Dealers are attempting nothing less than the creation of a new basis for prosperity. It is precisely because their purpose is so ambitious that the Great Experiment is so fascinating and so important.
The New Dealers have acted vigorously on the basis of their diagnosis. They have endeavored to discourage saving by substantial increases in taxes on incomes. In good years over 50 per cent of savings come from incomes of $10,000 a year or more, and nearly one fourth from profits. The yield of the personal income tax has been substantially increased—partly by advances in surtax rates, but in the main by changes in the exemptions. For example, the exemption of income from dividends has been removed and the deduction of capital losses has been greatly restricted. The Administration has also endeavored to discourage investment by changes in the tax on corporate incomes which roughly double its burden, and by a tax on undistributed profits to discourage corporations from reinvesting a substantial part of their income. For example, corporations in 1936 paid federal income taxes of almost exactly the same amount as in 1929, though corporate incomes were only half the level of 1929. Fortunately most of the tax on undistributed profits and some of the changes in the capital-gains tax were repealed in a Congressional revolt in the spring of 1938.
The government has tried to raise consumer purchasing power by public expenditures on a scale exceeded only in wartime, and by encouraging increases in the price of labor. In the four years ending June 30, 1937, the government spent 13.8 billion dollars more than it collected. As a result of the NRA codes, the wage policy of the PWA and the WPA, the Wagner Act, and the Public Contracts Board, the hourly earnings of factory workers in 1937 were 21 per cent above 1929, and of other types of labor from 10 to 15 per cent above 1929. The prices of finished goods, however, were 12 per cent below 1929, and so also was the cost of living.
III
It is not certain that the New Deal has succeeded in substantially reducing the disposition of the community to save. True, profits have been drastically cut — in 1936 they were only 56 per cent of 1925, when industrial production was virtually the same. Even in 1929, however, only one fourth of the country’s savings represented the reinvestment of the profits of business enterprises. True, also, collections under the personal income tax have substantially increased. In 1936, when reported net incomes were nearly 23 per cent below 1929, income tax payments were 21 per cent above 1929. Some forms of saving (such as life insurance), however, seem to be increasing. About half of the saving by individuals comes from persons with incomes of less than $25,000 a year. Despite the great increases in the surtax paid by this group, the New Deal has probably not substantially reduced the proportion of incomes saved by persons in the middle brackets.
But whether or not the New Deal has succeeded in discouraging savings, it has been conspicuously successful in limiting the growth of investment — probably more so than it intended. Possibly the Administration was not aware of it, but its impediments on investment were imposed at a time when the physical plant of industry was wearing out and becoming obsolete far faster than it was being replaced. Indeed, in 1933, purchases of capital goods by industry were well over two billion dollars less than depreciation and obsolescence. It is not surprising that efforts to limit investment, imposed at a time when the disposition to invest was extraordinarily feeble, should be remarkably effective. Not until 1936 did business purchase more than enough capital goods to offset depreciation and obsolescence. At the peak of the recovery in 1937, the capital of industry increased somewhat more than two billions. This, however, was barely sufficient to provide each of the 500,000 new workers (net) who must be absorbed by industry each year with as much new equipment as the present employees, on the average, possess.
Far less successful than the efforts of the New Deal to limit investment have been its attempts to restore consumer purchasing power. Despite the huge expenditures of the government and despite an all-time high in the price of labor (or perhaps because of these), the payrolls of private business in 1937 were only 37.4 billion dollars against 45.8 billions in 1929. The cost of living was 12 per cent below 1929, but despite this the payrolls of business in 1937 would buy 8 per cent less than in 1929. To the payrolls of private industry, however, should be added the compensation of government employees, work-relief wages, the contributions of employers to social security, and other payments to labor, such as workmen’s compensation benefits. These brought labor income of all kinds in 1937 up to 46.7 billion dollars, compared with 51.5 billions in 1929. At the lower price level in 1937, labor as a whole (including government employees and relief workers) had about 2.5 per cent more purchasing power than in 1929.
The recovery of consumer purchasing power to approximately the level of 1929 was made possible, it will be observed, only by large government payments. Furthermore, the restoration of consumer purchasing power to the level of 1929 failed to generate a substantial volume of new investment, with the result that industrial production remained well below 1929, and the recovery was halted with 7,000,000 unemployed. The effort to create a new basis for prosperity seems to have failed.
IV
Evidently something is seriously wrong with the Great Experiment. What is the trouble? Several things, but principally three.
In the first place, the efforts of the New Dealers to prevent the recovery from being based in large measure upon the expansion of investment limited the increase in consumer purchasing power. The success of the government in discouraging investment may be roughly measured by comparing the purchases of capital goods in 1937 and in 1928, two years when the volume of industrial production was virtually the same. Had industry purchased the same quantity of capital goods in 1937 as in 1928, about 800,000 more men would have been employed in 1937 in the manufacture of capital goods and in commercial and industrial construction. A considerable amount of housing is built by speculative builders who intend to sell and by others who intend to rent. Consequently, the efforts of the government to limit the increase in investment discouraged residential building.
All in all, it is conservative to estimate that the government’s policy of discouraging investment meant the employment of 1,000,000 fewer men in the capitalgoods and construction industries in 1937. This meant smaller demand for consumers’ goods, and hence less employment in the consumer-goods industries. About one third of the unemployed in 1937 had some income from relief, but it is not extravagant to guess that 1,000,000 more jobs in the capital-goods and construction industries would have meant 500,000 more jobs in the consumer-goods industries. This would indicate that the government’s policy of discouraging investment was responsible for not less than 1,500,000 unemployed in 1937, and a loss of payrolls (and hence consumer purchasing power) of over two billion dollars.
In the second place, the government has attempted to increase consumer purchasing power by methods which have tended to prevent larger consumer incomes from generating an expansion in investment. The efforts to raise consumer incomes by increasing the price of labor have, of course, raised production costs and thus made it more difficult for managements to discover attractive opportunities for profitable plant expansion. This effect is vividly illustrated by the state of profits. Even as late as 1936, when business was fairly active, only 203,000 out of the 478,000 active corporations of the country made any money, and their profits were 20 per cent below 1924, a year of mild depression when industrial production was 10 per cent below 1936.
The enormous expenditures of the government in excess of its receipts had the immediate effect of raising consumer demand, but they have not had the secondary effect of inducing enterprises to embark upon long-range plans. Boards of directors have felt that the situation created was too artificial, too temporary, and too uncertain to provide a sound basis for large new commitments. They have wanted to know when and how the budget would be balanced, and whether balancing it would mean a new collapse of business. The President has said that the budget can be balanced by the growth of national income. Business managers have wondered whether a drastic tax increase will not be necessary, and they ask who will pay the new taxes and what the taxes will do to business. They have doubted whether the government could raise from 3 to 4 billions of additional tax revenues without seriously hampering recovery.
Pending an answer to these questions, managers do what any sensible person would do — they restrict commitments, and, as the money spent by the government reaches business enterprises and their owners, it piles up in the form of idle deposits. The huge borrowings of the government have raised deposits to the level of 1929, but the turnover of these deposits has been less than 60 per cent of 1929, and in 1936 and 1937 it was even less than in 1933. Even in 1937 the checks drawn against deposits were 10 per cent below 1931, a year of severe deflation.
Finally, and most important, the Great Experiment has suffered from a fundamental inconsistency in its plan. The New Dealers wish to limit the increase in investment because they believe that a recovery based very largely upon plant expansion is unsound. At the same time they expect the increase in consumer purchasing to stimulate an expansion in investment. They realize that only in this way can full recovery be achieved. Larger incomes mean larger savings, and, unless the savings are promptly invested, idle deposits will pile up and the demand for goods will drop. But the very measures which the government employs to prevent recovery from becoming too largely an expansion of investment naturally tend to prevent the growth in consumer incomes from stimulating more investment. Small wonder that the recovery of consumer purchasing power in 1937 to virtually the levels of 1929 evoked such a meagre expansion of plant!
The very core of the difficulty is found in the failure of the New Dealers to distinguish between discouraging saving and discouraging investment. If it is true, as the New Dealers assert, that attractive investment opportunities in twentieth-century America are exceedingly scarce, then saving should be discouraged, but at the same time every encouragement should be given to investment. For example, scarcity of investment opportunities might warrant increases in the taxes that fall mainly upon savings (income taxes in the middle and higher brackets), but it would require reductions in taxes on profits, such as the corporate income tax and taxes on capital gains. The New Dealers indiscriminately increased both kinds of taxes.
V
What are we to do? Only one course is possible if we wish a real recovery and do not wish to transform our economy into one in which the government operates a large part of industry. That is to reverse the policy of the Great Experiment and seek to base recovery fundamentally upon an expansion of business spending. Ours is the kind of economy that flourishes only when men are disposed to take risks and when the spirit of enterprise is lusty and vigorous. Furthermore, it is the business man who almost invariably takes the initiative in our economy, particularly in the upturns. Consumers spend what they get, but what they get consists almost entirely of what business enterprises have previously decided to spend. That is why there cannot be much of an increase in consumer incomes until business managers increase their budgets.
Whether business concerns decide to spend less than their incomes or more than their incomes depends, of course, upon the outlook for profits. Putting people back to work and increasing consumer incomes, therefore, require that business men be helped to take a favorable view of profit prospects. Any recovery program which is not based upon this fact is bound to fail. This does not mean that the recovery must begin with an enlargement of plants. The rise in business spending typically starts with replenishment of inventories and larger expenditures on deferred maintenance. Eventually, however, it must take the form of expansion of plants, because, as incomes and savings increase, industry must put those savings to work.
But what of the objections of the New Dealers that a recovery based largely upon investment is bound to be temporary and unsound and to bring about its own collapse? It is true, in theory at least, that an expansion of investment may prove temporary because the attractive investment opportunities are soon used up. Actually, however, the additions that can be made to the plant of the country in any one year are not large. Certainly overexpansion of plant had little to do with the depression of 1929. The severity of that collapse was due in the main to (1) an enormous expansion of short-term debt which first inflated demand and later undermined it, and (2) international economic conditions which destroyed confidence in currencies and produced a world-wide run on banks.
In the ten years ending in 1929, the net additions to the privately owned plants of the country over and above replacements and obsolescence were only about 27 billion dollars, or roughly one sixth of the total plant value. In 1929, net additions were little more than 4 billions, and the plant of the country was somewhere in the neighborhood of 170 to 200 billions. Such changes as these do not explain the sudden and violent reversals in the outlook for profits that characterize our economy. As a matter of fact, the conditions which may bring about changes in the outlook for profits and thus produce contraction of spending are virtually innumerable — the overdoing of speculation in inventories; the collapse of consumer demand temporarily inflated by installment credit; the narrowing of profit margins by increases in operating costs; the closing of important avenues of investment by rises in the prices of capital goods or construction costs; political and international developments.
But are not investment expenditures peculiarly unstable because they are easily postponed? Consequently, is not a recovery in which investment plays a large part bound to be an unstable one?
The answer is yes. All recoveries are unstable, because the possibility that some event will darken the prospect for profits and precipitate a contraction of business is always present. But many other forms of expenditure, such as the outlay of companies for inventories, the expenditures of consumers for durable goods (automobiles, for example), and the large and increasing expenditures of consumers for services, are also easily postponable and, therefore, unstable. Consequently, it is not clear that a recovery based in large measure upon investment is less stable than one based almost entirely upon purchases of consumers’ goods. In fact, the business collapse of 1937, one of the sharpest in our history, indicates that the very kind of recovery which the New Dealers are trying to create is highly unstable because it lacks a backlog of demand based on long-term plans to sustain employment and consumer purchasing power when a change occurs in the short-term outlook.
VI
Should the New Deal policy of discouraging savings be continued or perhaps extended and made more effective by substantial increases of the income tax in the middle brackets where large saving still occurs? Is it true that the American economy, now that the frontier has disappeared and the rate of population growth is declining, can no longer offer attractive investment outlets for the amount that the community is likely to save?
If the national income were to rise to 85 billions (in terms of present prices), all unemployment except seasonal unemployment would disappear. At this level of income the community would probably save about 12 billions a year. The federal and local governments have always borrowed a considerable part of the savings of the country for roads, schools, dams, sewers, and other public works. Let us assume that they continue to use about a billion of savings a year. This would leave 11 billions for private industry to put to work.
The net annual increase in the wage earners of the country is about 500,000. Each of these new entrants into industry needs the same amount of shelter and equipment as each of the present employees possesses. Otherwise the productivity of labor will drop. At present the amount of capital per worker is about $4000. Here is an outlet for 2 billions of savings a year, simply giving the new workers in industry the usual amount of tools and equipment.
A capital of $4000 per worker is obviously not very large and does not suggest that the country has too much plant. As a matter of fact, the country has far less plant than is needed to enable employees to earn the wages they would like to have and urgently need. During recent years the average earnings of employed workers have been slightly more than $1300 a year. Indeed, if figures on wages and profits are to be trusted, a large part of the working force of the United States does not produce as much as 50 cents per hour. The only way to raise the standard of living of labor is to increase its productivity so that employers can afford to pay it higher wages. This could be done partly by better management, but the workers also need more and better tools. In order to raise the productivity of labor sufficiently to make possible an average annual wage of $2000 (certainly not a large amount), industry would probably require twice as much capital per worker as it now possesses. If the capital available for each worker were increased only $100 each year, this would absorb approximately 5 billions of the savings of the community.
The number of families in the country increases by about 400,000 every year. This creates a large potential demand for additional housing. The movement of population, as a result of industrial and market shifts and the retirement of people to warmer climates, creates a much greater potential demand. For six years during the twenties, the United States spent more than 4 billions a year on housing. At that time the housing industry was getting nearly one out of every three dollars that consumers spent for durable goods. In 1937 it got only one out of every seven dollars. It is plain that if houses were more attractively priced the housing industry could easily absorb 4 billions of savings for many years to come. All in all, there seems to be an easily discoverable market for 11 billions or more of savings a year in addition to what the government might demand.
VII
The actual capacity of industry to absorb the savings of the community depends upon (1) reasonably favorable price relationships (excessive building costs, for example, might easily prevent any appreciable expenditures on housing); (2) the rate of technological discovery; and (3), most important of all, the temper of the business community — its willingness to make ventures and to take risks. The New Dealers are surely right in believing that attractive investment opportunities are more difficult to discover to-day than during the nineteenth century, when the vacant continents of North America, South America, Australia, Africa, and large parts of Asia were vigorously competing for the savings of Europe. The dominant fact about the present economic age is the world-wide revolt against the free market and the effort to substitute legislative and administrative decisions for the results produced by markets. The very process of substituting controlled economies for the old free economies of the nineteenth century discourages forward planning. Indeed, it is uncertain whether private investment can ever flourish in a world controlled largely by legislative and administrative decisions. If the private operation of industry is to be successfully combined with comprehensive public direction of industry, one of the policies of the government needs to be the definite and wholehearted encouragement of investment. Business can probably do much in the face of important administrative uncertainties provided it has faith that the government is fundamentally committed to encouraging enterprises to expand and to take risks.
Such a policy would involve (1) refusing to impose new costs on industry faster than technological change increases the ability of industry to bear them; (2) the encouragement of technological research; and (3) changes in the tax laws for the purpose of making risk-bearing more attractive.
In 1929, of course, industry could have borne a substantially larger burden, and technological progress since then has been considerable. Nevertheless, it has not been sufficient to offset the combined effect of a 10 to 21 per cent increase in the price of labor, a 16 per cent drop in the prices of finished goods, the doubling of the corporate income tax, and the new social-security taxes. Industry as a whole needs an opportunity to catch up before shouldering substantial new burdens.
The encouragement of technological change is largely a matter of making research facilities available to the 1,700,000 concerns too small to afford their own research organizations. America is still predominantly a land of small business, for about half the payrolls and 57 per cent of the employees subject to the old-age pension tax (which is nearly all of industry outside of railroads and agriculture) are in 1,700,000 concerns employing less than 400 men each. Perhaps the Federal Government and state universities can work out arrangements for giving these concerns research service on special problems at cost.
In some respects our tax laws seem designed to discourage rather than to encourage risk-taking. What other conclusion can one draw from the imposition of heavy taxes on income from industry and the exemption of income from municipal and state securities? The surtax on the higher brackets needs to be moderately reduced, income from dividends to be taxed at a lower rate than income from interest, and the corporate income tax modified to permit a reasonable loss-carryover provision. No such carryover is now permitted, but new enterprises are usually in the red for from two to five years.
Note that the encouragement of investment involves far more than economic issues. The spirit of enterprise is more than an economic force; it is the very basis for free democratic institutions.
Only so long as opportunity is abundant is social conflict mild, and only when social conflict is mild are men willing to settle their differences by voting, by negotiating, or by arbitrating rather than by fighting. The basis for opportunity is expansion. Upon the willingness and ability of democracies to encourage investment will depend their ability to keep opportunity abundant and, therefore, to preserve the free institutions which are the first casualties of severe social conflict.