Capital Conservation; E. Speer

142 tributed by the industrial realtor. It is sometimes said that every new business, and every expansion of an old business, begins with an idea and a prayer for success. But if that idea is to get off the g-round and have a prayer of a chance for success, somebody has to find the right ground in the first place the right site, in the right location for the right price. And, of course, this is where you people enter the picture. So I have deep respect for the members of the Society of Indus trial Realtors and the contribu tions you make to the ongoing success of American industry. I'm sure· that without those contribu tions, there would be a lot less capital generated within our capi tal system in this country. A great deal of attention is be ing centered these days on real and possible shortages of the natural resources we're going to need in the years ahead. You can 1974 CAPITAL CONSERVATION 143 pick up almost any issue of the news and trade magazines and read about the importance of con servation in our use of oil, gas and other resources, because of the widening gap between con sumption and domestic supply.

Even in real estate, there is a gap between demand and supply, cre ating a land fever across the coun try the likes of which we haven't seen since the days .of the Wild West. In fact, as you well know, the land boom is generating its own special brand of inflation with values and prices climbing quite a bit faster than the Consumer Price Index. The problem, as I understand it, centers about the rapid consump tion of what your profession calls "buildable land." Of course, many of the eighty thousand units of government that we have in this country are contributing to the problem, rather than its solution, by a rush to find legal ways of restricting the use of the land that remains. All of this comes on top of the turmoil being created in the name of a clean environment by many groups, most of them sincerely concerned, although not always fully informed. There are times when I suspect that the first of our natural resources to be ex hausted may turn out to be the American taxpayer. He must foot the bill for the army of inspectors and enforcers who staff all of the agencies and bureaus that are one of the fastest growing elements in our American society.

Capital, a Vital Resource There is one national resource, however, that we absolutely can not do without. This national re source is essential to the develop ment of land. It is more important than drilling rigs or mining tech nology in locating and extracting raw materials from the ground. It is the "magic" ingredient that converts all of the other ingredi ents of the business process into jobs and income, goods and ser vices, and all the real and intangi ble progress that our nation gains from each successful business venture. This vital national resource is capital. It is the money put to gether from a variety of sources and invested in what we always hope will be a "money-making" project - which means a project that will generate not only wages and salaries, but will also pay div idends and interest and increase the nation's supply of investment capital. It isn't 'necessary,. of course, to tell a group of industrial realtors about the role of capital in keeping the wheels of progr~ss turning.

I'm sure that you and the mem144 THE FREEMAN March bers of your Society spend a good portion of' your time explaining these economic facts of life to those who come to you for service and guidance. I mention the sub ject because, like other resources, the supply of capital is not inex haustable. We get a hint of this from time to time - as we have during much of 1973 - when money gets tight and the cost of borrowing capital gives every eco nomics professor a chance to show his students what happens when demand outruns supply. It's also true that there's a greater need for capital today than ever before - and we're going to need more of it in the future. But unless we begin to practice some capital conservation - exercising the same degree of concern toward this vital national resource that many Americans have toward our natural resources - all of the rhet oric about how far and how fast our economy grows in the future will have become little more than an academic discussion.

How much capital are we using, and how much will we need in the future? Well, capital expenditures by American ind ustry have been averaging around one hundred bil lion dollars a year. And I've seen estimates on future needs that place capital demand at well over a trillion dollars during the next twelve years - that is, between now and 1985. Now, I'll confess that I'm not used to thinking in trillion-dollar terms, even in this era of the trillion-dollar economy. But it isn't difficult to see how such a figure on capital needs could be correct, if you break out some of the individual require ments. Specific Needs For example, the' domestic oil industry believes that their capital needs alone could be a minimum of two hundred billion dollars over the next twelve. ye-ars. '. The power generating' utilities are talking of a need for seventy bill,ion dollars just in the next five years. In com munications, one company - Amer ican Telephone and Telegraph has projected its capital require ments at forty to fifty billion dollars during the next decade. In transportation, the railroads be lieve that capital spending in the neighborhood of thirty-six billion dollars will be necessary over the next decade to keep pace with ex pected demands on their transport facilities. And in the steel indus try, estimates of capital spending range upwards of thirty billion dollars between now and 1980 if we are to keep steel supply in bal ance with steel demand, and install the nonproductive equipment re quired by ever-changing pollution control standards.

1974 CAPITAL CONSERVATION 145 That's a. lot of billions to be in vested .over a rela tively short pe riod of time - yet it is only a partial listing. Additional capital in equally large amounts will be needed for private housing and other land development activities . . . to increase the stock of goods and services that American fami lies have come to expect and want ... to build recreation centers and the facilities to house a growing national interest in the arts. So there's an unprecedented need for capital to maintain as well as to improve our standards of living and to move forward in our efforts to upgrade American standards of life. You know, when naturalists talk about conservation of the land, they mean preserving the capacity of the land to renew itself. It is in this same sense that I speak of capital conservation, for the whole theory of our system is one of using, renewing and increasing the supply of capital. We invest dollars in productive efforts . . .

that create profits ... which are reinvested or paid out in dividends so that more dollars will flow into the mainstream of capital invest ment. And under ordinary circum stances, this system could be counted on to supply all of our capital needs. But today's circumstances are not as "ordinary" as they once may have been. For one thing, we haven't been investing as much of our Gross National Product in new assets as we once did. Back in 1950, almost eleven and a half per cent of our GNP was being returned to the economy to in crease our stock of fixed assets in this country. As recently as 1970, however, this percentage had dwindled to 6.2 per cent - about half what it was twenty years earlier. During those same twenty years, we dropped to last place in the rate of net domestic invest ment among the ten leading in dustrial na.tions of the Free World. And what about profits from the investments we have made? Well, I don't know how you people are making out in the real estate busi ness, but I can tell you that in steel and many other areas of in dustry, they're nothing to write home about.

Paper Profits Oh, I've been reading those arti cles in the papers about the big increases that are occurring in business profits. I saw one not long ago that said the after-tax earnings of U.S. corporations in the second quarter of 1973 climbed to an annual rate over seventy-two billion dollars - a 36 per cent jump over the same period of 1972. And from numbers like that, I'm sure many of the American 146 THE FREEMAN March people believe that business is roll ing in profit dollars these days. But the truth is that an inflated dollar is still an inflated dollar, whether it goes into a pay enve lope or is added to the profit col umn of a business ledger. Morgan Guaranty Trust Com pany pointed out several months ago that more than half of the in creased profits reported by non financial corporations during the past year have been so-called "in ventory profits." These are the gains made on the goods that a company sells out of inventory or put another way, the difference in the value of those goods between the time they were bought or pro duced and the time they were used or sold. And this value reflects the rate of inflation that occurs during that period.

So a business gains no lasting benefit from these inventory prof its. In fact, considering the Fed eral tax bite on the profits result ing from the increased value of inventories, and the higher cost of rebuilding those inventories, there actually could be a loss. On this basis~ then, the ongoing level of corporate profits didn't increase during the first two quarters of 1973. It went down - to a point where, as a share of Gross Nation al Product, they were some forty per cent below the average level of the 1960's. Would You Believe? In fact, during the past three years, the average return on sales for all manufacturing companies was only 4.8 per cent - not the 28 per cent that the general public believes companies make in profits - and below the average of six per cent earned in the 1950's and the 5.7 per cent earned in the decade of the sixties. We are particularly concerned about our own profit situation in the steel industry. As we look down the road, we can see the demand for steel growing right along with the rest of the economy. After all, steel is not only a very versatile material-but it is also an inex pensive material. Your average pound of steel costs in the neigh borhood of ten cents, and there isn't much you can buy these days for ten cents a pound. It's even less expensi ve than those pro verbial peanuts.

We've worked hard to keep the cost of steel down. Over the past dozen years, the steel industry has invested more than nineteen billion dollars to acquire the modern effi cient facilities we need to produce better steels - and to maintain and improve both the jobs and the earning potential of steel employ ees. Millions of additional dollars were spent to research and develop not only new steels that give the buyer more for his dollar, but new 1974 CAPITAL CONSERVATION 147 ways of using steel that reduce the costs of such things as housing and commercial buildings. I'm hap py to say that even in this era of intense competition among ma terials, these efforts have paid off with a continuing high demand for steel in this country. Just about every order book in the industry has been full during 1973, and some of them are beginning to fill up for the early months of 1974. This kind of business won't last forever, of course, but we do ex pect the demand for steel to grow at a pace that will require perhaps twenty to thirty million tons of additional raw steel production by 1980. And this is where that thirty billion dollars comes in that I men tioned a few moments ago. It's go ing to require that amount of capital to add this new capacity to replace our existing facilities as they wear out - and to meet the demands being placed upon the in dustry to help clean up the en vironment.

Generating Additional Capital Now, the thirty-billion-dollar question is this: Where is all that capital to come from? I can assure you that we don't have it squir reled away in an old ingot mold. During the five years prior to 1973, the industry's average return on sales was a lowly 3.7 per cent. Even during the first half of 1973, when sales were at an all-time high, the average profit on sales in the industry was a mere 4.5 per cent. Four and a half cents on the sales dollar isn't the kind of return that generates the large sums of capital required by an industry like steel-where a single facility in a single plant can cost many millions of dollars, and where several hun dred million dollars are spent every year in pollution control equipment alone. I t isn't the kind of return, either, that can cause the lending institutions to welcome steel com panies with open arms - although I'm not sure many steel companies would be interested in acquiring much more indebtedness. The in dustry as a whole is already carry ing more than five billion dollars of long-term debt - most of it ac quired while we were upgrading our facilities ... to become more efficient . . . to meet the foreign steel imports that during most of the 1960's the government told us weren't really a problem.

More recently, of course, the government has told our industry that our profit problem is not as important as the one it has with the overall fight against inflation. And while inflation has to be of major concern to every business and every American, I wonder how long we can continue to rob prof its to pay the price of containing 148 THE FREEMAN March infla tion. I don't claim to be an expert in economics, but I do know that among the causes of inflation is the inability of production fa cilities to supply growing demand. This was reflected just last sum mer in the spiraling prices of food and other commodities. The same theory is at work in real estate as the demand outruns the supply of Quildable land. So I fail to see any great eco nomic wisdom in containing the forces of inflation by restricting the profits that are the basis for expanding production. It may be politically expedient over a short period of time - but in the long run, it is economic folly. In fact, with the need for capital already great and growing in almost every sector of the national economy, the "long run" may be shorter than we think.

Look to the Market Now, what's the answer? Well, at the risk of bringing down the wrath of the economic gods here in Washington, I think it's time they restored their faith in the Ameri can free market system. After all, we didn't become the most produc tive nation in the world as a result of bureaucratic tinkering with the economy. Economic controls aren't some new device, created by mod ern economists. In ancient China, Egypt, Greece, Rome - in fact, for more than four thousand years the idea has persisted that govern ments can hold down prices simply by making it illegal to raise them. Yet in all this time, under aU man ner of circumstances, the results have usually been shortages and economic chaos, generating greater problems for the same people that the controls were. supposed to protect. The results are much the same here in the Twentieth Century. Al most daily, shortages and disloca tions caused by the current eco nomic controls are becoming more evident. And while the government says it is trying to find a way out of controls, there are hints that it may recommend some type of per manent agency which could, as Business Week phrased it, "keep the federal government in the con trols business forever."

Frankly, I believe it's time to put more freedom back into our free economy. It's not that I dis trust the planners here in Wash ington. It's just that I have a lot more faith in the private judg ments of the American public, whether they're acting as consum ers or producers - whether they consider themselves part of labor or management-whether they are packaging, selling, or buying real estate. In other words, I'd rather see the cost of living controlled by the millions of private decisions 1974 CAPITAL CONSERVATION 149 that are made every day in the supermarkets of this nation than by some super-authority located in our nation's Capital. The only true test of whether a product is worth its price, or a company worth its profit, is that ultimate decision that's made at the point of sale. So it seems to me that a very necessary first step toward prac ticing capital conservation in this country should be to "phase out"

the economic controls hampering the price structure and the rates of profit that are essential to in creasing the flow of capital in our type of economy. It would be a big help also if, somehow, we could get as many Americans interested in the conservation of this vital na tional resource as seem to be con cerned about the proper conserva tion of our other resources. Conservation Conscious We are rapidly developing, and in some respects already have a conservation culture here in Amer ica. Individually and in groups, large numbers of our people are actively engaged in a wide variety of conservation efforts. Conserva tion of energy ... conservation of our natural resources ... conser vation of land ... conservation of historical landmarks ... the list of things to be conserved and pre served is almost endless. I say "almost endless," because the one that has been mIssIng is the conservation of capita1. Cer tainly, it is this national resource that we need to conserve, if we are to accomplish the other objectives.

Yet the current trend seems to be one of putting most of the others first, often at the cost of increas ing the amounts of capital that will be needed to maintain the Ameri can way of life. As I've already mentioned, some of the largest amounts of capital investment to be made in the years ahead will be those by the energy producing industries. Supplying the growing energy needs of this country is going to be a costly job, and the longer we wait to get on with the job, the higher those costs will rise. But delay, rather than progress, seems to be the or~ der of the day in our approach to our energy p.roblems. Whether it is bringing oil from Alaska or gen erating electricity, months and even years go by while environ mental matters are given prece dence - and the costs of each proj ect climb. Don't misunderstand me. Pro tecting the environment is a high ly desirable goal. American indus try in general is working hard to do its part, spending billions of scarce capital dollars every year to meet various environmental needs.

Yet there is still no scientific basis for many of the pollution 150 THE FREEMAN March control standards that industry is being asked to meet. For example, at U. S. Steel's Fairless Works, north of Philadelphia, we are al ready controlling better than 99 per cent of the dust emitted from the open hearth furnaces of that plant. The equipment was expen sive - but it is effective. Now, we are being asked to remove all visi ble dust from this steelmaking fa cility. And if we are forced to go this final mile, the additional invest ment cost - in terms of the capital spent per pound of dust collected - will be two hundred times great er than the original investment we made to reach 99 per cent effect iveness. At the moment, however, no one knows whether this and similar expenditures at other plants are justified, for there is no scientific data to show that any harm is done by this relatively insignificant amount of dust. And I think you'll agree that an industry already facing a "capital crunch" can't af ford, and shouldn't be asked, to spend excessive amounts of capital for nonproductive equipment that may, in the end, be proved unnec essary.

In many areas, you can find other efforts that - however well intentioned - threaten to push the costs of growth beyond the range of capital available to bring about such growth. This is certainly evident in the rush to find legislative ways to cool off the land fever that's sweeping the country. As you know, a bill to establish a na tional land-use policy has been passed by the Senate. I understand that hundreds of other measures are before the Congress and state and local governments, dealing with everything from urban growth to "no-growth." In fact, much of this legislation seems designed to discourage the use of land,' despite the fact that land itself is a very vital resource. Aside from its surface value, the land of this country has beneath its surface other resources - oil and gas, coal and other minerals that we're going to need in ever larger quantities. The development of land, in cluding its use for the production of energy and minerals, is already a very costly business. And if common sense isn't applied in large quantities today, we may find at some point in the future that both the land and its mineral wealth have been legislated into a position where no one will be able to justify the capital outlays re quired to make it useful to the American people.

Seward's Folly You know, ladies and gentlemen, out of the more than two billion acres that comprise these United 1974 CAPITAL CONSERVATION 151 States of America, there is one plot of better than three hundred seventy-five million acres that now makes up our forty-ninth state, Alaska. At th€ time we acquired this land from Russia over a cen tury ago, the purchase price was seven million dollars. That was a lot of money in those days, and the whole deal was known as "Sew ard's Folly," because no one could see the value of those acres so far to the North. Today, of course, Alaska's min eral wealth alone has a value many, many times the original price, even if you were to measure it in one-hundred-year-old dollars. And the term, Seward's Folly, has been relegated to a brief mention in the history books. Let us hope that our efforts to generate growth in this second half of the Twentieth Century will turn out as well as did the pur chase of Aiaska in the second half of the last century. But let us also do more than hope.

Let's be sure that our economic policies and goals in this country are set by us, and not for us. Let's be sure that in your industry and mine, we make every effort to con vince those in government that our goals are also very much in the national interest. And let's be sure we use every opportunity to tell the American public that the con serving of capital is the one con servation effort that cannot be ig nored - because capital and the profits that create and attract cap ital are essential to whatever ob jectives we set for ourselves and for our nation. I) IDEAS ON LIBERTY Uneconomic Conservation WE CONSERV,E natural resources by using them, in the most effi cient and economic manner. "Uneconomic conservation" is a contradiction in terms - it is waste. But if politics dominates a conservation program, what we get is "uneconomic conserva tion." There are those who talk in grandiose terms about this or that river valley project and who urge us not to count the costs.

Actually, of course, there is no way of determining whether a given program is conservation or waste except by counting the costs. If a given project cannot pass the test of economics, that is a sure sign that it is not conservation but waste. ADMIRAL BEN MOREELL, Our Nation's Water Resources Policies and Politics SOCIALISM EDMUND A. OPITZ THE TREND away from ecclesiasti cal authoritarianism in the post Reformation period gave rise in the eighteenth century to popular sovereignty in the political realm, with such characteristic docu ments as The Federalist Papers and The Wealth of Na,tions. A dif ferent kind of dream gathered momentum during the nineteenth century, contemplating the per fected temporal life of man in a planned society, to be achieved by governmental direction of eco nomics and technology. Socialism is the appropriate generic term for this movement. The quintessence of modern So cialism is government ownership of productive property and the centralized management and di rection of economic life. Socialists are divided into parties, sects and hostile factions, but beneath the The Reverend Mr. Edmund A. Opitz 1S a senior staff member of the Foundation for Economic Education. This article, reprinted here by permission, is one he contributed to Baker's Dictionary of Christian Ethics, Carl F. H. Henry, editor, (1019 Wealthy Street, Grand Rapids, Michigan 49506: Baker Book House, 1973) 726 pp., $16.95.