Are Profits Too High?

by SUMNER H. SLICHTER

CORPORATE profits in 1947 reached an all-time high — 17.5 billion dollars after taxes (but before eliminating inventory gains) in comparison with 12.5 billion dollars in 1946. Many people believe that profits are too high. The CIO has called them “extortionate,” and demands “substantial” wage increases at the expense of profits.

The last year has seen a sort of race between industry and consumers, with industry struggling to increase output as fast as people spent their money. Industry added 1.6 million people to its payrolls (over twice the normal increase) between the end of 1946 and the end of 1947, and it increased physical output about 5 per cent. Nevertheless, industry has lost the race with consumers. The people of the United States increased their expenditures for consumer goods by over 20 billion dollars, or about 14 per cent. As a result, the cost of living at the end of the year was about 10 per cent higher than at the beginning. As prices went up, profits increased also.

Not all industries shared equally in the growing demand for goods. Aircraft manufacturing and air transport suffered huge losses in 1947, and department stores, the amusement industry, the electric light and power companies, telephone and telegraph companies, manufacturers of tires, woolen goods, hosiery, and dairy products made less money in 1947 than in 1946. On the other hand, manufacturers of building supplies, petroleum products, machinery, and household equipment made particularly large gains.

Although no generalizations about profits apply accurately to all industries, I believe that profits on the whole in 1947 were not excessive and I question whether wages can be generally increased under present conditions without a rise in prices instead of a reduction in profits.

At the outset a few comparisons between present and past profits are desirable. These comparisons will not answer the question, Were profits too high? But it is instructive to know how present profits compare with pre-war profits and how large they are in relation to production, sales, and investment.

Profits in 1947 were slightly more than twice as large as in 1929 and about 2.75 times as high as in 1940. Large as were profits in 1947, they were not large in relation to the size of the product of industry. In fact, profits in 1947 were a smaller part of the gross national product than in 1929 and 1940 — 7.4 per cent compared with 8.1 per cent in 1929 and 7.6 per cent in 1940. Americans must remember that the country is growing and that pre-war magnitudes often have little relevance in measuring the present performance of industry. Today the United States has 22 million more people than in 1929 and 12 million more than in 1940 — in other words, it has added the equivalent of about two Canadas to its population since 1929 and one Canada since 1940.

Profits per dollar of sales in 1947 were slightly less than in 1929 and slightly more than in 1940 — 5.8 cents in 1947 in comparison with 6.1 cents in 1929 and 4.8 cents in 1940. This means that the large profits of 1947 were in the main the result of a large volume of sales rather than of a wider spread between selling prices and costs. Incidentally, all forms of income from property (profits, interest, and rents) were only one sixth of the national income in 1947 in comparison with over one fourth in 1880 and about one fifth in 1929.

Profits are frequently computed as a rate of return on owners’ equity — that is, on the net investment of owners in the business less the debts of the business. The profits of 3100 leading corporations in 1947 were over 12 per cent of owners’ equity. This way of measuring profit, however, is unsatisfactory. One reason is that the losses and revaluations of assets which accompany depressions diminish the owners’ equity. Between 1930 and 1933, for example, losses and revaluations cut the owners’ equity in American corporations by 21.7 billion dollars. The more money a company lost during the depression, the higher, of course, would be the ratio of any given amount of profits today to owners’ equity. Hence, any given volume of profits would seem exorbitant provided only the company had lost enough during the depression!

Another reason why owners’ equity is a bad measure of profits is that it reflects the original cost of plant and equipment rather than the present cost of replacing the plant and equipment. In most cases original cost is only half or two thirds of present replacement cost. It is the return on the present cost of plant and equipment, however, not on the cost of fifteen or twenty years ago, which determines the ability of enterprises to attract capital. If the rate of profit were figured on the present cost of plant and equipment, it would be one-third to onehalf less than the rate of return on owners’ equity.

Industry needs more capital

What yardstick should one use in judging whether profits are too large or too small? Profits have the function of providing industry with capital — partly by giving people an incentive to invest their savings in industry and partly by directly providing industry with investment funds. Hence one’s judgment concerning the adequacy of profits depends upon how fast one wishes industry to grow.

At present American industry is in urgent need of huge amounts of additional capital. There are two principal reasons for this need. One is that the increase in capital since 1929 has been abnormally slow. During three years of the severe depression of the thirties and four years of the war, plant and equipment for civilian industries was not being produced as rapidly as it was wearing out or becoming obsolete, and in three other years the net increase in capital was negligible. In the fifty years preceding 1929 the country annually produced about $1.75 of capital for every dollar of plant and equipment which wore out or became obsolete, so that the plant and equipment of the country was growing rapidly. In the last nineteen years, however, the country has produced only about $1.14 of new capital per year for every dollar of plant and equipment which wore out, with the result that at the end of 1947 the industrial plant of the country represented less than 8 per cent more capital than at the beginning of 1929.

Again, industry needs large amounts of capital because of the great increase in the labor force. The labor force in private industry today is 10.1 million larger than in 1929 and about 4.5 million larger than in 1940 — partly a result of the growth in population but also a result of the growing popularity of work and of the increasing proportion of the population who seek work. With the abnormally small increase in capital during the last nineteen years and a rapid increase in the labor force, plant and equipment per worker was about 9 per cent less at the end of 1947 than at the beginning of 1929. It was even slightly less than nearly thirty years earlier in 1919. Until 1929, plant and equipment in industry had been increasing at between 10 per cent and 15 per cent a decade. New investment of about 60 billion dollars is needed to bring plant and equipment per worker up to the level that would be normal in view of the long-term tendency for capital per worker to increase.

New capital and the investor

Were profits in 1947 effective in attracting additional capital into industry — particularly purchases of equity securities by the public? The answer to this question is emphatically, No. Last year American corporations spent 26.7 billion dollars on plant and equipment, inventories, and extending credit to customers. Only 4.1 billion dollars of this money came from the sale of securities to the general public. Of this amount, over two thirds came from bond issues, and less than one third from the sale of stock. In other words, less than 5 per cent of the capital funds of American corporations last year came from the sale of stock. About 60 per cent came from inside the enterprises themselves — from depreciation allowances, the sale of government securities, and most of all, from the reinvestment of profits.

Let us look at the matter from the standpoint of the individual investor. Last year individuals increased their savings in the form of securities, bank deposits, insurance, and real estate by 14.4 billion dollars. It is a striking fact, however, that only 1.3 billion dollars of these savings were represented by net purchases of new corporate stock issues. In other words, equity issues of American corporations attracted less than one tenth of individual savings in the form of securities, bank accounts, insurance, and real estate. Individuals put less into equity securities than into any one of the other principal forms of saving — checking accounts, savings accounts, government securities, and real estate.

The failure of profits to attract substantial amounts of outside capital into industry does not, of course, prove that profits in 1947 were too low. The willingness of people to buy stock depends upon their estimates of the long-run outlook for earnings — not upon the earnings record of a single year. It is difficult, howover, to argue that profits which attract only a small amount of outside capital into industry are “exorbitant.”

Although profits failed to induce people to invest much equity money in industry, profits did supply industry with large capital funds — in fact, profits were by far the largest single source of capital funds for industry. Over three fifths of the 17.5 billion dollars of profits, before inventory adjustments, in 1947 were plowed back into the business, and less than two fifths distributed to stockholders as dividends. Out of 26.7 billion dollars of new capital expenditures by non-financial corporations in 1947, 10.1 billion dollars came from retained profits. All but 800 million dollars of the 5-billion-dollar increase in profits between 1946 and 1947 was plowed back into industry. In spite of the plowing back of large profits, enterprises still found it necessary to borrow heavily from banks. In fact, the increase in borrowing by industry was larger than in any previous year except 1919, 1920, and 1946.

One of the industries in greatest need of capital for expansion is iron and steel. The capacity of the industry has increased only 25 per cent since 1929, but industrial production is running about 75 per cent, above 1929. The industry, along with most other industries, is dependent in the main upon reinvested profits for capital. Yet even in 1947, the industry earned substantially less on investment than most other manufacturing industries and earned a little more than 6 cents a dollar on sales. Prices of most steel products are still too low to yield more than a return of 3 per cent to 4 per cent on new plant at present costs of construction.

The great dependence of industry upon profits for capital in 1947 may seem surprising, but it does not represent a new condition. As a matter of fact, purchases of equity securities by individuals in 1947, though representing only a small part of their savings, were far larger than normal. Rarely has industry had much success in selling stock to the general public. Consider, for example, the three most recent non-war years prior to 1947 — namely, 1940, 1941, and 1946. In these three years individuals saved no less than 44.3 billion dollars in the form of cash, bank accounts, securities, and real estate. They did not, however, increase their holdings of corporate stocks or bonds — in fact, these holdings dropped by a small amount. Evidently most savers are little attracted by the securities of American corporations. The two largest items of personal savings in those three years were currency and demand deposits, which increased by 19.7 billion dollars, and insurance, which increased by 14 billion. Real estate took 5.5 billion dollars of savings, and government securities 3.9 billion.

Records of earlier years are less complete, but it is clear that the sale of stock to the public has supplied American industry with far less than half of its capital. For example, during the period 18951939, the total public issues of bonds greatly exceeded the issues of common and preferred stock. During this period American industry issued (exclusive of refunding issues) 39.4 billion dollars in bonds and notes, and 27 billion dollars in common and preferred stock. Likewise, earnings plowed back greatly exceeded new stock issues. During the period 1910-1929, corporations plowed back 37.3 billion dollars of profits, compared with 19.5 billion dollars of stock offered for public subscription.

If wages are increased

Is it possible, under present conditions, to increase wages at the expense of profits? I believe not. Of course, an individual employer or an industry might grant wage advances without raising prices, but this would only increase the upward pressure on prices elsewhere. The level of prices and profits depends, as I have pointed out, upon the rate at which people spend money for goods, on the one hand, and the rate at which industry produces goods, on the other. When people spend money faster than industry is able to increase output, as they did last year, a rise in prices and profits is an arithmetical necessity.

Under present conditions general wage increases would reinforce the tendency for demand to outrun production. So large and urgent is the accumulated demand for goods that a general rise in wages would not reduce employment. Consequently, higher wages would mean larger payrolls. Part of the larger payrolls would be paid to the Federal government in higher taxes and a small part of them would be saved. In the main, however, larger payrolls would mean a greater demand for consumer goods. Last year, for example, payrolls increased by about 11.5 billion dollars. More than 9 billion dollars of this was attributable to higher wages and the rest to the increase in employment. At any rate, higher wages accounted for nearly half of the 20-billiondollar increase in expenditures on consumer goods in 1947.

The effect of higher wages upon the demand for goods under present conditions would not be confined to consumer goods. Higher wages also increase the demand for capital goods. This is a result of their effect upon the profits of the consumer goods industries. The demand for consumer goods is raised by wage advances in both the consumer goods and the capital goods industries. The cost of making consumer goods, however, is raised only by the increase in payrolls in the consumer goods industries. Hence, unless a substantial proportion of the wage increase is taken by taxation or is saved, the growth in the demand for consumer goods raises their prices by more than the increase in the cost of making them. The resulting advance in profits of the consumer goods industries increases the demand for capital goods and encourages business concerns to borrow from banks, if necessary, in order to buy capital goods. Hence, under present conditions higher wages do not encroach upon profits — on the contrary, they stimulate spending and thus help to raise prices and profits.

Of course, under other conditions, the effect of wage increases might be very different. For example, if wage earners were willing to save a large proportion of their wage increase, they might succeed in raising wages at the expense of profits. Furthermore, if there were not a huge backlog of demand for goods, businessmen might doubt their ability to pass on wage advances in the form of higher prices. Under such conditions, wage increases would lead businessmen to curtail rather than to expand their expenditures for capital goods.

If higher wages under present conditions mean higher prices, unions, employers, and the general public should reconsider carefully the whole matter of wage policy. A higher price level for nonagricultural products in the United States has much to be said in its favor, particularly if it comes gradually and is accompanied by higher wages. Among other things, a higher price level would help increase imports into the United States, thus assisting other countries to get on their feet and also giving Americans more to consume and raising the standard of living here. If unions expect to raise the standard of living of their members by encroaching upon profits, however, they will be disappointed — at least so long as a strong sellers’ market continues. Today the best chance for employees as a whole to gain a rise in their standard of living is through an increase in the total flow of goods. Unless more goods are obtained by imports, they must be gained in the main through the use of more and better plant and equipment. Hence employees and everyone else in the community have a keen interest in the expansion and improvement of the plant and equipment of industry.

Can industry attract more capital?

The extreme dependence of business concerns upon internal funds for expansion is disturbing. Surely it would be desirable if the reluctance of people to buy stock in American industry could be largely overcome. If savers were willing to put as much as one third of their savings into common or preferred stocks, industry would be far less dependent upon plowed-back earnings. As a result, enterprises would probably be able to secure ample funds for expansion while operating at somewhat lower rates of profit than have been customary.

How can the reluctance of savers to buy stock in American corporations be overcome? Many people believe that the secret of this reluctance is to be found in high taxes — tax rates which leave the individual investor a substantially smaller return than any given security seems to yield. Undoubtedly, high tax rates have diminished both the ability and the willingness of many persons to save. In addition, high taxes and the absence of adequate offsets for losses have particularly diminished the attractiveness of speculative investments, such as common stocks frequently are.

Nevertheless, high taxes do not seem to be the principal explanation for the small purchases of common stocks by the public. Even before taxes became high, corporate stocks attracted only a small fraction of individual savings. Furthermore, high taxes do not fully explain why savers put a larger fraction of their savings into government savings bonds or bank accounts or even into real estate than into the stock of corporations.

If tax rates remain very high, as is probably inevitable, some special incentive should probably be given to individuals to save. This could be done by permitting people to claim a substantial tax rebate on that part of their incomes which they save. Savings should be defined, however, so as to exclude hoarding. Another helpful change would be the elimination of the severe double taxation of dividends. A corporation is nothing but an association of stockholders. At present the profits of most corporations are taxed at the rate of 38 per cent, and the individual stockholder pays an additional tax on the dividends he receives. The double taxation of dividends may be eliminated by permitting the individual taxpayer to claim a rebate for that part of the corporate income tax which has already been paid on profits which he receives as dividends.

The essence of the matter, however, is that corporate securities, and especially common stocks, do not seem to satisfy the tastes of most individuals. This has been plainly demonstrated by the pronounced preference which individuals show for putting their savings into houses, insurance, savings deposits, and government securities. The type of investment which attracts most individual savings strongly suggests that individuals save for security rather than for capital gains. If industry is to attract capital from the outside, therefore, it probably must offer investors different sorts of securities from those which it has been offering. Perhaps the answer is to be found in some new form of preferred stock or debenture stock — a security which assures the individual a minimum return on his investment but which does not exclude all possibility of capital gain. At any rate, the problem of making industry less dependent upon internal funds must be solved in large measure by business concerns themselves — by their developing kinds of securities which meet the preference of the great majority of investors.

The problem of raising the standard of living

There has been some criticism of the large reinvestment of profits in industry. As a matter of fact, the country should be thankful that over four fifths of the increase in profits between 1946 and 1947 was plowed back into industry rather than distributed in the form of dividends. This meant that industry, instead of holding back production as it is sometimes accused of doing, was spending large amounts to increase output. To a limited extent and for a short period of time, plowing back profits may divert the output of industry from making consumer goods to making capital goods. This, of course, is inflationary. As new plant and equipment is put into operation, however, the output of goods relative to incomes is increased.

In the last eight years the United States has made considerable progress in raising its standard of living — consumption of consumer goods per capita (adjusted for changes in price) has increased about 31 per cent since 1940. The lowest income groups have fared particularly well. Between 1941 and 1946, the average real income of the lowest fifth of the families increased 68 per cent; that of the second lowest fifth, 59 per cent; and that of the highest fifth, 20 per cent.

In the next few years, increasing the standard of living is likely to be more difficult. During the next five years military expenditures will be at least 50 billion dollars and they are likely to be closer to 100 billion dollars. In addition, the United States will send substantial quantities of goods to Europe. These expenditures do not represent a high percentage of the prospective national income but they are large enough to limit substantially the quantity of goods available for consumers. Consequently, if American consumers are to have a rising standard of living while the country is spending huge amounts on armaments and European aid, the total output of industry must be greatly increased. This means more and better plant and equipment.

Attempts to raise the standard of living by wage increases under present conditions represent 2 superficial attack upon the problem. There is much to be said, of course, for wage increases to those who did not participate in even the first or the second round. Employees should not expect, however, that wages in general can be increased under present conditions at the expense of profits. Even if wages could be increased out of profits, as some union leaders believe, that would be a national misfortune. The need for enlarging and improving the plant of American industry is urgent, and the encroachment of wages on profits would deprive industry of its largest source of funds for expansion. Several years from now the country will look back with gratification at the large amounts of profits which business concerns used in 1947 and 1948 to buy more and better plant and equipment. It will then be plain that plowing back profits helped give Americans a rising standard of living in the face of huge expenditures on armaments and on aid to Europe.

Mr. Murray Replies

Two diverse points of view have been presented in the articles “Are Profits Too High?” — which gives industry’s point of view — and “The Gap Between Prices and Wages” — which tells labor’s story. The fundamental difference between the arguments is that I believe that the rights of people and their warm human needs take precedence over profits, even though we admit that profits are a necessary stimulus for our economy. There is no doubt in my mind as to which comes first, wages or profits. An economy can be healthy only if it is based on a healthy people — which in simple terms means enough of the right foods in our stomachs and the proper clothes on our backs.

The case against industrial wage increases and for the maintenance of current high profits brushes off the present level of profits by saying that the old ways of measuring profits are wrong, and that even if profits are high, they are needed to finance new factories and machinery. The business viewpoint also stresses that wage increases cannot be paid out of profits because at this time wage increases are inflationary; and, even if wage increases can be paid out of profits, new factories are preferable to higher standards of living.

The first question to be answered is: Are profits high or low? There are several ways of measuring profits, but businessmen among themselves almost always express profits as a per cent of invested capital. This method quickly shows how much they make for every dollar they have invested. Publicly, however, through such devices as the NAM advertisements, they describe profits as a per cent of sales, and further mislead the public by referring to the relatively low figures simply as “profit per cent.” Only by repudiating traditional profit-measures or by heroic and complicated “corrections” and “adjustments” can the present huge profits be made to appear normal.

Any reader of the Wall Street Journal becomes quickly convinced that this is a golden era. However, corporations are pleading that their profits are needed for new factories and new machinery. This is the heart of the argument: Should corporate profits provide for dividends plus new factories, or should the funds for new factories come from savings and loans?

If new factories are financed by stocks, bonds, individual savers, or lending institutions, these lenders receive returns on their investment. If, on the other hand, the new capital is taken out of profits, the corporations do not incur any obligations such as additional interest or dividend payments. Since profits are the difference between prices and costs, this “profit-capital” results from keeping prices high in relation to wages and other costs. Therefore, it is to industry’s advantage to keep prices high and wages low. In this situation consumers and workers are supplying capital for new factories and neither retaining ownership of the capital nor receiving interest and dividends.

But are there enough savings to supply the needed capital for new factories, or must wages be kept down to supply that capital? The fact is: we have so much savings stored up in the United States that they will supply enough capital to more than duplicate every factory and building. Total business holdings are estimated at about 200 billion dollars. Individuals alone have more than 155 billion dollars of savings stored in cash, checking accounts, or government bonds. Business has more than 65 billion dollars similarly stored. In addition we are saving over 21 billion dollars every year, which is seeking investment outlets. Over and above all this, according to the Federal Reserve Board, our banks have a potential lending power of hundreds of billions of dollars, far more than ever before.

It is true that investors with tremendous amounts of stored-up savings are not flocking to the stock market as in the twenties. This is not because they lack funds. The real reason is they fear another crash. I ask: In all fairness, should workers and consumers be forced to lower their standard of living to pay for factory expansion because investors don’t have faith in the long-run stability of our economy and prefer to hoard their money?

Actually the Wall Street capital shortage has greatly improved this year. Money has been loosening up, and the most recent stock issues were easily sold at good prices. Recent surveys by the Department of Commerce and the Federal Reserve Board show that business is not suffering from a capital shortage. Record high earnings are overcoming enough fears to supply adequately the demands for capital. Dividend earnings as a per cent of the cost of stocks are at record levels of about 6 per cent. This 6 per cent rate of dividend earnings on common stock is more than double the ½per cent interest available on U.S. government bonds.

However, the 6 per cent figure does not tell the real story, since less than half the total profits are being paid out as dividends. If total profits are used, the rate of return on stock, according to the Department of Commerce, rises to more than 12 per cent — surely an incentive for investors.

It is ironic that our present high-profit, lowconsumption economy is based on the fear of a future depression. It is ironic because our main hope for continued prosperity is the sustained buying power that goes with a low-profit, highconsumption economy.

It does no good, and causes great suffering, to speed up factory construction the way we did in the twenties, if we are to call a complete halt to expansion and allow existing factories to deteriorate as we did in the thirties. We must have growth and expansion. But at the same time we must maintain a stable economy, which means keeping the purchasing power of the millions at high levels.

It is particularly unfortunate that so much of our present record-high investment is going for commercial use, and so little to expand crucial bottleneck industrial areas such as basic steel. While it is true that money is being invested in steel, most of it is going into such fields as expansion of fabrication plants rather than into expansion of basic steel production.

Perhaps the most ominous and far-reaching effect of the doctrine that profits should provide for capital expansion is that it increases monopoly control. We all know that Boards of Directors decide how much of the profit will be distributed as dividends, and how much will be saved and plowed back into new factories and new machinery. With the present degree of interlocking directorates and close corporate control, this means that crucial savings decisions now are being made largely by a handful of men — the very same men who make the decisions about investment, wages, and research.

The argument that huge profits are needed for capital expansion is a far more complicated and dangerous doctrine than at first meets the eye. It involves justifying factory expansion at the expense of those least able to bear the expense — the lower income groups. It involves return, in an extreme form, to a profit-heavy, low-consumption economy which brings the eventual depression much closer and makes it much more severe and much more certain. Finally, it justifies a practice which draws even tighter the grip of monopoly on our economy.

The point is often made by corporations that the lower income groups are improving their position much faster than the higher income groups. But big business fails to explain that widely different bases are used to compute the percentages. Incomes of families in the lowest fifth increased by 68 per cent from 1941 to 1946, but this 68 per cent represented only $337. Families in the highest fifth increased only 20 per cent, but this 20 per cent represented $1503. The distribution of income is steadily becoming more unbalanced.

There is no reason why substantial wage increases cannot come out of corporation profits without any further price increases. We believe that regardless of how profits are made — whether as the result of increased demand and purchasing caused by increases in population, or for any other reason — profits are profits. We believe industry is entitled to fair profits. But we also believe that the men and women in our cities and towns deserve a standard of living that will enable them to maintain their self-respect. It is the obligation of the men who run our industries to recognize their responsibility and divide the profit dollar so that the men who turn the wheels will get a fair share.