Have We Conquered the Business Cycle?

by SUMNER H. SLICHTER

1

BETWEEN the peak quarter of the 1953 boom and the low quarter of the 1954 recession, business concerns cut their spending for plant, equipment, and inventories by $12.9 billion a year. In the same period the federal government reduced its purchases of goods and services by $14.3 billion a year. Ordinarily such big cuts in investment and government spending would have produced a severe recession. Indeed, it is an essential part of Keynesian doctrine that a change, upward or downward, in investment will be followed by a still larger rise or fall in consumption.

But consumption did not behave as Keynesian doctrine said it would. Instead of dropping as a result of the fall in investment, it increased. At the bottom of the recession, consumption was running $4 billion a year higher than at the peak of the boom. And the total output of the country, instead of decreasing as much as the drop in business investment and federal spending, fell only $14.4 billion a year—about half of the total drop in business investment and in the federal government’s buying of goods.

Why did the economy show such si rong resistance to influences which might have produced a disastrous depression? Why did consumption continue to rise in the face of falling production and employment? Does the mildness of the recession in 1954 mean that fundamental changes are occurring in the economy; that the economy is becoming less susceptible to ups and downs; that at long last the business cycle, the most important defect in capitalism, is being conquered?

There are many economists and businessmen who are not convinced that progress has been made in reducing the fluctuations in business. Some of them, indeed, seem to doubt that any great progress is possible. They refer to the impossibility of foretelling the future and to the inherent tendency of people to be carried away by the course of events so that they are usually either too optimistic or too pessimistic. Hence they conclude that, so long as men have economic freedom, there are bound to be more or less severe fluctuations in production and employment. The mildness of the recession in 1954 is attributed largely to good luck.

There is no doubt that luck had much to do with the mildness of the recent recession. In the first place, the recession here came at a time when Britain, France, Western Germany, Italy, the Netherlands, and other countries were having a boom. The boom abroad led to a small increase in our exports; but, more important, it sustained the prices of raw materials all over the world and thus helped keep business confidence strong and discouraged the forced liquidation of inventories. If the recession in the United States had coincided with contraction in Europe, our troubles would have been considerably greater.

In the second place, the recession here came at a time when state and local governments were rapidly expanding their purchases of goods and services. Their outlays for these purposes at the bottom of the recession were $3.3 billion a year greater than at the peak of the boom in 1953. Now it is true that the expenditures of state and local governments have a long-run tendency to grow as population increases and as the demand for roads, education, and other government services grows. Indeed, the purchases of goods and services by state and local governments in the badly depressed year of 1931 were considerably higher than in the boom year of 1929. Nevertheless, it was a matter of luck that the recession of 1954 came at a time when the need for roads, schools, hospitals, and other public works was unusually strong and when state and local governments were giving many of their employees overdue wage increases.

In the third place, it was a matter of luck that the recession of 1954 came in the upward phase of the construction cycle. The upward and downward swings of construction have been much longer than the upward and downward swings of business in general. During the expansive phase, the growth of construction is little affected by a general decline in business — just as the decline of construction during the contraction phase is little affected by a general expansion of business. Had the recession of 1954 occurred in the contraction phase of the construction cycle, the story might have been quite different. As it was, construction expanded throughout the recession, and construction expenditures were about $2.4 billion a year greater at the bottom of the recession than at the peak of the boom.

In the fourth place, the recession came at a time when manufacturing concerns (especially the makers of durable goods) had enormous unfilled orders. At the end of the second quarter of 1953, unfilled orders stood at $73.6 billion. Fifteen months later, when the upturn was beginning, unfilled orders were $48 billion. The large volume of unfilled orders was a powerful influence in sustaining business confidence, and the fact that during the recession business concerns were able to keep their plants and their men busy by producing $25.6 billion more goods than were ordered in that period helped tremendously to sustain the entire economy.

In the fifth place, the recession came at a time when the volume of short-term consumer credit had not been pushed so high that there were no longer plenty of good credit risks for new loans. At the peak of the boom, outstanding consumer credit was about $27.2 billion and repayments of installment credit (which make up about three fourths of all consumer credit) were running at the rate of about $2.2 billion a month. Some people in the personal loan business believe that, at present levels of income, consumer credit might “safely" be pushed up to $43 billion a year. Doubtless, good risks for such a volume of credit could be found, but repayments, which are deflationary unless offset by new lendings, would run at perhaps $3.4 billion a month. It would not be easy in a period of recession to find new borrowers for $3.4 billion a month. Hence it was fortunate that when the recent recession started, consumer credit was $27 billion rather than $43 billion. For six months after the beginning of the recession, consumer credit continued to expand, then it dropped for several months, and finally it began to grow again. At the bottom of the recession it was about $1.5 billion higher than at the peak of the boom.

Mixed with the good luck that moderated the severity of the recession was some bad luck that tended to make it worse. Under ordinary circumstances one would expect the federal government to mitigate any recession by raising its expenditures relative to its receipts, thus adding to private incomes by its spending more than it subtracted from private incomes by tax collections. But when the recession began, the finances of the federal government were in an unsatisfactory state. In spite of the fact that business was booming, the federal government’s cash receipts in the fiscal year that ended almost at the peak of the boom in the middle of 1953 were about $5 billion below its cash outlays.

Quite understandably, this coincidence of a big deficit with a boom was of great concern to government officials, and to many others as well. Hence the government, instead of mitigating the recession by increasing its spending, or at least by cutting taxes more than it cut spending, aggravated the recession by cutting spending more than it cut taxes. The deficit in the cash budget dropped from $5.3 billion in the fiscal year 1953 to $0.2 billion in the fiscal year 1954.

When the good luck and the bad luck are balanced against each other, one is forced to conclude that the good luck was greater than the bad luck. But the depressing effect of the cut in the federal deficit was almost as large as the combined stimulating effects of increases in state and local expenditures and of increases in construction. Hence the balance of good luck is pretty much represented by the fact that the principal countries of Europe were experiencing a boom, by the large volume of unfilled orders, and by the fact that consumer credit had not been pushed so high that the recession converted it into a deflationary influence. But these fortunate circumstances are hardly sufficient to explain the extraordinary resistance of the American economy to the large cuts in business investment and federal spending. The explanation must be found in large part within the economy itself — in economic policies, institutions, and practices that greatly increase the stability of the economy.

2

THE changes that are making the economy more stable fall into three principal groups: those connected with the operation of the banking and credit system; those connected with the planning policies of business; and those which explain the maintenance of spending for consumption.

1. Banking and credit practices. It has been usual in business recessions for banks to curtail their lending and for the quantity of money in the community to drop. In the recession of 1954 this did not happen. Commercial banks expanded their loans and investments by over $8 billion between the middle of 1953 and the middle of 1954, and there was an increase in the same period of more than $1 billion in demand deposits and about $5 billion in time deposits.

These favorable results are often attributed to the actions of the Federal Reserve System in making credit easy. Undoubtedly, the easier terms that business and other lenders were willing to grant had considerable influence on the volume of lending in a few fields — especially the real-estate field. More abundant reserves seem to have led the banks to hunt harder for good credit risks among small concerns, because a sample survey shows a 10 per cent increase in loans of $1000 to $10,000 between December, 1953, and September, 1954, in the face of a drop in loans of larger size. But the banks would not have been able to increase their lending had good credit risks not been available and had a demand for funds not been there.

Incidentally, only part of this demand for funds was directly met by the commercial banks. Much of it was met by insurance companies and savings banks, but the insurance companies and savings banks increased their lending partly by selling government securities which were purchased by the commercial banks. Thus, some of the expansion of investment by savings banks and insurance companies was financed by the commercial banks and led to an increase in the money supply.

The availability of good credit risks was due to a variety of influences. One of the most important was the unusual liquidity of both individuals and business enterprises — the result of the large quantity of government securities issued during the war. These securities furnish a larger and better basis for credit than the country has ever possessed. Their effect in stimulating the economy may be compared roughly to the stimulus which the nation received in its early years when Hamilton persuaded the newly formed federal government to assume the Revolutionary War debts of the states, thus converting these debts into a solid basis for credit.

Another influence making for good credit risks was the willingness of the federal government to insure or guarantee a large part of certain types of real-estate loans. Still another influence that is easily overlooked has been the improvement in the job security of a large part of the labor force. American industry is making growing use of managerial, technical, clerical, and skilled workers. The number of workers in these classes increased from 40 per cent of the labor force in 1940 to over 47 per cent in 1950. Although these classes of workers are not immune from layoff, their employment is usually steadier and more certain than the employment of many wage earners. Hence the growth in the proportion of professional, managerial, clerical, and skilled workers in the labor force increased the number of good credit risks in the community. This was particularly important in sustaining the demand for housing.

Even other classes of workers, thanks to the great spread of seniority rules, have gained greatly in security of employment. Many millions of highseniority workers now have the equivalent of an annual wage and, therefore, are good credit risks for loans to finance the purchase of homes and durable consumer goods.

2. The planning policies of business. Advances in the art of management and in the growth of technical research are introducing important changes in the planning of the investment programs of business concerns. The essence of these changes is the growing tendency to introduce new processes or new products and improvements in processes and products regardless of business conditions — that is, the growing emphasis upon basing investment expenditures on long-range plans.

The increasing rivalry in engineering development and research makes it hazardous for any enterprise to hold back an improvement or a new product or process simply because business is suffering a dip; such a delay might enable a rival to make the improvement or to introduce the new product first. Between the peak of the boom in 1953 and the bottom of the recession in 1954, the outlays of non-farm concerns for plant and equipment dropped only from $32.2 billion a year to $30.3 billion. Enterprises in 1954 required a smaller volume of outside funds than in 1953, but they still needed funds in considerable volume and helped provide the demand for funds that made possible the growth in the volume of credit and thus the volume of money. The growth in longrange investment planning is revealed by the McGraw-Hill survey of business plans for spending on plant and equipment. In 1954, 91 per cent of the companies participating in the survey were able to estimate their capital spending for the next four years, compared with 81 per cent in 1953 and 64 per cent in 1952.

3. Spending for consumption. The increase of $4 billion a year in spending for consumption between the peak of the boom and the bottom of the recession which was so important in limiting the recession is attributable to the maintenance of personal incomes in the face of a drop in employment, to the rise in personal incomes after taxes, and to the drop in the rate of personal savings.

The maintenance of personal incomes in spite of a drop in employment was mainly made possible by a rise in pension payments, unemployment compensation, and benefits to veterans. Between the peak of the boom and the bottom of the recession, personal incomes from these sources rose by $2.1 billion a year — enough to offset more than two thirds of the drop in the wage and salary payments and other forms of labor income.

With personal incomes before taxes almost as large at the bottom of the recession as they were at the top of the boom, modest cuts in the personal income tax resulted in an actual rise in personal incomes after taxes during the recession, so that personal incomes after taxes were $2.8 billion a year higher at the bottom of the recession than at the peak of the boom. The rate of personal saving at the peak of the boom was unusually high. The sense of security enjoyed by most managerial, technical, clerical, and high-seniority workers made them willing to cut their Saving moderately in order to raise their standard of current consumption. Thus, in spite of the rise in personal incomes after taxes, personal savings dropped by $1.2 billion a year between the peak of the boom and the bottom of the recession. The result of these several influences was, as I have pointed out, the extraordinary rise of $4 billion a year in personal consumption expenditures in the face of a drop in employment.

3

ARE the policies and conditions that helped keep the recession mild in 1954 simply temporary or are they a permanent part of the economy? There is no doubt, I think, that they are permanent.

Business enterprises have learned the desirability of being liquid, and as long as the federal government retains a large short-term debt, as it undoubtedly will, they will be able to remain liquid without too much loss of income. Among individuals good credit risks will continue to grow in number as per capita incomes rise and as technological changes continue to increase the proportion of professional, technical, and skilled workers in the labor force.

The demand for credit in future periods ol recession is bound to be sustained by the persistent expansion of engineering development and technological research and by their growing competitiveness. Hence, each enterprise will find it steadily more hazardous to postpone putting into effect engineering and technical changes simply because business is temporarily dropping. One is led to the conclusion that there should be good opportunity in future recessions to expand credit and the money supply, just as was done in the recession of 1954. But whether or not such an opportunity exists will depend upon whether moderation is observed in permitting credit to expand during boom periods.

Can consumption in future recessions be expected to show as strong a tendency to rise as it did during the recession of 1954? Consumers can probably not count on the well-timed tax cuts that they enjoyed at the beginning of 1954. On the other hand, cuts in spending by the federal government are not likely to tend to depress personal incomes as did these cuts late in 1953 and throughout 1954. Unemployment compensation and pensions are inadequate in coverage and in amount, and are bound to be liberalized. The average unemployment compensation payment in 1954 was around $25 a week — about 36 per cent of the average weekly earnings of factory workers. The average benefit payment could be increased by two thirds without seriously undermining men’s willingness to work. The coverage of unemployment compensation needs to be broadened, and in many states the duration of benefits needs to be extended. During the first 11 months of 1954, 1.61 million persons exhausted their benefit rights while still unemployed.

Liberalizing of unemployment compensation and pensions will come gradually, but it is bound to come; and as it does, workers will receive more adequate offsets to drops in wage and salary disbursements, and business will gain more stable markets. It is surprising that business does not take the lead in insisting that unemployment compensation and pension laws be substantially liberalized.

Impressive as is the progress already made, much remains to be done before the business cycle is conquered. In addition to broadening and liberalizing the social security system, three other important steps are needed; business concerns need to improve greatly their handling of inventories; firm public support needs to be created for flexible credit policies; and fiscal policy needs to be developed into an instrument for business stability.

Twice since the end of the war, in 1949 and 1954, a sudden shift from building up inventories to cutting inventories has been a major influence in bringing about the contraction of business. Although it is difficult in the extreme to judge the short-run trend of business, it ought to be possible for enterprises to avoid such a prolonged build-up of inventories as occurred in 1948 and in 1953.

Incidentally, the fact that inventories go up in times of boom and go down in times of contraction is a good reason for being optimistic about the possibility for reducing substantially the fluctuations of business. The changes in inventories mean that fluctuations in sales are less than fluctuations in production. It ought to be possible for business concerns to adjust their output more closely to changes in sales. If they succeed in doing this, they will reduce the fluctuations in the incomes of their employees and their suppliers, and thus they will reduce fluctuations in the demand for goods and make sales even steadier.

Firm public support for flexible credit policies remains to be established. This need is made clear by the strong criticism that was evoked among politicians, businessmen, and even some economists by the moderately restrictive policies of the early months of 1953. Restrictive credit policies during periods of high employment and expansion are bound to be unpopular with many enterprises and persons. Such policies prevent business concerns from fully exploiting attractive opportunities to make money and they prevent individuals from buying houses and durable consumer goods on exceedingly easy terms. And yet if credit is not limited in periods of boom, easy credit policies will not succeed in inducing continued expansion of credit in periods of recession or slow growth.

Most important of all is the development of fiscal policy into an instrument of economic stability. Here is an enormously powerful instrument for stability, if the country can only learn to use it. The state of the budget helped check the booms in 1947, 1948, and 1951 and it moderated the recession in 1949; but the state of the budget in 1947 and 1948, and to a large extent in 1949, was due more to luck than to wise planning. And in the boom of 1953 and the recession of 1954 the net influence of fiscal policy, as we have seen, was to aggravate both the boom and the recession.

The problem is to persuade the people of the country to insist on moderate budget surpluses in times of high employment and rapidly expanding output. The rising government revenues which prosperity produces sorely tempt legislators to increase expenditures or to cut taxes. And yet if the cash budget is barely balanced in time of boom, or perhaps is in the red, as it was in 1953, it will not be easy, when business contracts, to raise expenditures sufficiently above receipts to halt the contraction. Possibly the country will have to experience two or three recessions which are more severe than the drop in 1953-54 before it becomes willing to insist that fiscal policy be used to stabilize business.

Perhaps the business cycle will never be completely eliminated, but it would be tragic if men were to adopt a defeatist attitude toward conquering the cycle. That would simply discourage the vigorous and persistent efforts which are needed to reduce instability of production and employment. One can scarcely expect production always to increase by the same amount each year, because conditions at some times will be more favorable for expansion than at other times. It is, however, an attainable ideal that actual decreases in total production will come only at rare intervals and that they will be small and short. Unemployment would fluctuate in amount because in some years the increase in production would not suffice to absorb all of the growth in the labor force, and in other years it would more than suffice. But unemployment would not be large, and the changes in unemployment would also be small.

If the country clearly sees that some growth in total production almost every year is an attainable ideal, cannot the people be persuaded to insist that the policies required to transform this ideal into reality be carefully and faithfully followed?