Reindustrialization; W. Hawkins

The obvious catalyst for this movement has been the wave ofplant closings in the steel and auto indus tries which have cost tens of thouMr. Hawkins is a lecturer in economics and history at the University of North Carolina in Asheville. sands of workers their jobs. But these two industries are only the most vis ible examples of a general decline in the strength of the American econ omy. The foreign penetration of the American market and the decline in America's share of world trade are not due to any special attributes en joyed by our European and Japanese competitors but to our own poor per formance and mistaken policies. The key element in any modern economy is capital investment. It is by this investment that workers are provided with more and better tools with which to work. This is the key to productivity. Productivity mea sures the amount of output produced by each worker for some time pe riod. It was the great accomplish ment of industrialization, and is the goal of reindustrialization, to boost this output.

.Over the last two decades, the U.S. has lagged behind its foreign rivals in this effort. The myth that cheap 361 362 THE FREEMAN June foreign labor is the cause of our com petitive lag is just that, a myth, at least as far as our European and Japanese rivals are concerned. Wage rates in West Germany and Japan are on a par with U.S. rates. It is not that each worker overseas is paid less per hour, but that each worker has been increasing what he produces each hour that has eroded the American position. Our competitors have been improving their produc tivity at a faster rate than we have because they have been consistently outspending us on capital invest ment. u.s. Lags Behind In the period 1960-1978, the U.S. spent 13.41 per cent of its Gross Na tional Product (GNP) on new tools. This was half the percentage spent by Japan and significantly lower than the percentages spent by West Germany, Canada and France. Even England, long considered the cCsick man" of Europe, invested more of its resources on tools than did the U.S.

Table 1 shows the parallel between investment and productivity. Beneath these averages lies a most ominous trend. American productiv ity gains ar~ slowing. In the period 1968-73 annual gains were only 1.9 per cent. These gains dropped to only 0.7 per cent per year between 1974-79. For six quarters starting with the fourth quarter of 1978, pro ductivity actually declined at a - 1.8 per cent rate. There are many factors that have contributed to this recent poor record. The most central is the low rate of capital formation. An economy must generate capital before it can invest it. Personal savings, depreciation, and that portion of business profits retained for internal use are what combine to form the pool of capital from which investment must draw. 26.44 18.43 17.45 16.85 14.69 13.41 Japan West Germany Canada France England United States Table 1: 1960-1978 National Averages Investment Productivity Gain (% GNP) (increase in output per hour) 8.8 5.4 4.5 5.7 3.3 2.6 Source: American Iron and Steel Institute 1981 REINDUSTRIALIZATION: THE CAPITAL QUESTION 363 All of these sources of funds have diminished in recent years relative to the needs ofthe economy.

SavingsDiscouraged Throughout the 1970s, personal savings in the United States, as a percentage of disposable (after tax) income has been less than in the in dustrial states of Europe and Japan. Over this period only about 6 per cent of personal disposable income in the U.S. was saved as opposed to 20 per cent in Japanand 14 per cent in West Germany. The acceleration of inflation in 1979-80 further weakened savings dropping the rate to a mere 3.4 per cent. Inflation un dermines both the ability and the incentive to save. As inflation in creased faster than the average per son's income, many people cut back on savings in order to maintain their level of spending on consumer goods. Also, as inflation rages, the value of any idle funds, such as bank ac counts, insurance and pension pro grams decline in real value. As the prices of things go up, the value of money goes down so it becomes smart to begin moving out of money and into goods. But what is smart for in dividuals in such a situation is harmful to the overall economy.

Money that flows into gold or works of art as a hedge against inflation is money that is not available for pro ductive investments. Tax policy has also hurt savings in a variety of ways. Inflation pushes people into higher tax brackets be cause of our progressive tax system. As the percentage of income going to taxes increases, the percentage left for disposable income dimin ishes. Taxes on the income from sav ings and investment are higher than on normal income, and the U.S. con tinues to be the only major indus trial country to tax capital gains. The recent reduction in the capital gains tax rate had a profound stim ulative effect on mobilizing money in the equity market and there is every reason to believe that further reductions or the outright abolition of the tax would have additional beneficial effects. BusinessDepreciation AllowancesInadequate The other major sources of capital, business profits and depreciation have also become increasingly in adequate. As recently as 1965 busi ness firms were able to provide 90 per cent of the funds they needed from their own internal sources. But by 1979 this internally generated capital provided only 52 per cent of their requirements. This has placed increased pressure on the external capital pool generated by personal savings at the 'very time that saving has declined.

Depreciation provides the largest part of these internal funds. The shorter the number of years re364 THE FREEMAN June quired to recover the capital in vested in plant and equipment, the easier it is to finance new and im proved replacement equipment. Un fortunately, it takes twice as long, under U.S. tax laws, to write off an investment as it does in Japan and two to three years longer than in France or West Germany. This dis advantage is further magnified by the effects of inflation. Clearly, funds generated based on past costs are not going to be adequate to pay cur rent or future costs. There is widespread interest in liberalizing depreciation. Plans for basing depreciation on replacement costs rather than original cost, and adopting a 10-5-3 schedule for the number of years plant, equipment and vehicles, respectively, can be written off have attracted the most support from business. In the past, when depreciation was liberalized, the result has been as expected: the amount of capital investment in creased.

DecliningProfits The other source of internal funds is earnings retained from profits. Business profits as a share of GNP has declined from 13.3 per cent in the 1950s to 9.0 per cent in the 1970s. American business thus threatens to move into a vicious downward spiral. Lower profits generate less capital which slows productivity which loses markets to competitors which means a further lowering of profits. Currently, the Federal corporate profits tax takes 46 per cent of what profits are earned. Money taken by this tax is, of course, not available for investment. William E. Simon, when he was Sec":"etaryof the Trea sury, proposed reductions in the cor porate profits tax and advocated eventual elimination of the tax as the easiest way to boost capital for mation. While abolition of the tax is highly unlikely on political grounds, it is not beyond reason to hope that the tax can be reformed so that all or .. part of the profits that a firm would plough back into moderniza tion or expansion of its operations could be made exempt from taxa tion.

Impactof Inflation As if an inadequate capital pool were not enough of a problem, other government policies have had the effect of reducing the portion of that capital pool which is actually avail able for productive use. The Federal budget was in deficit every year of the 1970s. This deficit has to be fi nanced by borrowing from the capi tal pool. Robert Dunn of George Washington University has appro priately called this ((dissaving." Since the principal cause of in creased Federal spending over the last decade has been income trans fer programs, deficit financing has 1981 REINDUSTRIALIZATION: THE CAPITAL QUESTION 365 become a direct conversion of sav ings into spending. During the 1970s some $302.6 billion was so diverted from private domestic investors, ac cording to the Federal Reserve Bank of St. Louis. It might surprise many Ameri cans to realize that our foreign com petitors do not reside in countries that run deficits as large or as per sistently as we do. Table 2 shows the relationship between government spending, deficits and economic growth.

Surplus budgets have the opposite effect of deficit budgets. Instead of absorbing capital, surplus budgets pump money into the pool ofcapital. By paying off past debts, funds are released from a non-productive use and made available for productive uses. Increasing the pool of capital is the fundamental prerequisite for the reindustrialization effort. However, capital, once mobilized, must be free to flow to the uses which are most productive. This is not always al lowed to happen. Misallocation of Resources Governments at both the national and local levels have mandated a wide range of projects aimed at im proving the environment and the safety of the workplace. These may be worthy goals, but during the 1970s inadequate attention was paid to calculating the full cost of such proj ects. Business had to divert billions of dollars of capital away from plans for modernization and expansion in order to finance pollution and safety equipment. Whatever the merits of these programs, they are not pro ductive in the normal business sense of the term. They do not improve the competitiveness of American indus try relative to its rivals.

If the government is going to 10.4 14.0 16.2 20.4 23.2 20.7 Japan France Canada West Germany United States England Table 2: 1965-74 National.Averages Government Spending Budget (+ surplus (o/~ GNP)* - deficit as ok GNP) +1.39 +0.34 +0.78 -0.30 -0.71 -1.19 Growth Rate 8.7 5.8 5.2 4.1 3.3 2.5 Source: Hudson Research Europe Ltd. from OEeD data.. *1961-71 average.

366 THE FREEMAN June mandate that scarce capital be in vested in non-productive uses, it should recognize its responsibility to follow policies that will generate sufficient new capital to support such endeavors. An example of the dimensions of the problem, in regard to both capi tal availability and use, is the trou bled steel industry. The average age of American steel producing facili ties was 17.5 years in 1979. This means that the bulk of the Ameri can industry has not been able to incorporate the technological ad vances of the last two decades. Dur ing the 1970s, the industry invested $2.9 billion per year. To reindus trialize, the American Iron and Steel Institute estimates that the indus try will have to invest $7 billion an nually in the 1980s. Of this money, 11.4 per cent will go to meet envi ronmental and health standards. Given current tax laws and a mod erate rate of inflation (5 per cent) the AISI estimates that the industry will fall short of its goal by about $25 billion over the decade (in con stant 1978 dollars). Higher inflation or higher taxes will cause this short fall to be even larger.

Impact of Tax Reforms Six times over the last twenty years (1962, 1964,1967, 1971,1975, 1978) there have been minor changes in·the tax laws that have been ben eficial to capital. After each one, investment increased and the econ omy enjoyed real economic growth. But three times,the ((reforms" went the other way (1966,.1969, 1976) in creasing the tax burden on capital and slowing its formation and use. If the country is serious about revi talizing the economy, it will have to consistently reduce the obstacles to investment contained in our tax sys tem. There is a push to do more than this by having the government di rectly intervene to allocate re sources to specific industries. This may be useful in certain cases where an industry is in a transition period and the process needs to be speeded up so that the industry can become competitive again before it loses too large a share of its market. How ever, such programs must be ap proached carefully. Whenever gov ernment becomes directly involved in an issue, it politicizes that issue.

Direct aid programs attract special interests. We do not want an Amer ican reindustrialization program to become another exercise in ((lemon socialism." Lemon socialism is when resources and capital are poured into lost causes in order to please politi cally powerful groups. Such prac tices only create industrial welfare cases which are forever dependent and a drain on the economy. Rein dustrialization is meant to strengthen the economy and it can only do this if resources are allo1981 REINDUSTRIALIZATION: 'rHE CAPITAL QUESTION 367 cated efficiently to those projects that have the best chance of success. Businessand Labor Bear Shareof Blame Of course, government policies cannot be blamed for everything wrong with the U.S. economy. Busi ness and labor must bear their share of the responsibility as well. The steel industry in the U.S. waited too long to adopt the basic oxygen fur nace while there was no such hesi tation on the part of the Japanese.

The auto industry failed to realize the longrun effects of high-priced oil on the market for large cars. Cor porate management has gradually lost much of its entrepreneurial ag gressiveness. The corporation, that genius of American business, the in stitution that allowed earlier gen erations to mobilize capital, pene trate markets, develop mass production technology and engage in longrun planning has proven as vulnerable to bureaucracy and its stagnation effects as every other in stitution. Labor, for its part, has pushed for wage increases that have out stripped productivity, thus adding real costs to American products. These costs have to be reflected in higher prices. Labor has also re sisted automation, one of the most promising ways to boost output. La bor fears the loss of jobs to the ma chine, but has overlooked the greater loss of jobs that results when plants close because they. can no longer compete.

Historically, increased capital in vestment has increased employ ment. This is for the very logical reason that an expanding economy needs more workers than a contract ing economy. That is why mass un employment is associated with depressions and not with periods of prosperity. And since improved ma chinery is the only way to increase productivity it is also the only sound way to increase a worker's pay. There may be a short-term dis placement of workers from automa tion, and every effort should be made to provide retraining for any worker so affected. This is the practice in Japan where the goal is to eliminate all unskilled labor. Japanese firms are willing to take the time to re train their people, and with the ben efits of advanced technology they can afford to do so as well. The United States should do no less. Prospectsfor Recovery The United States economy has great residual strength. The U.S., though facing a serious energy prob lem, is far less dependent on OPEC oil than is Europe or Japan. A seri 0us program to develop alternate energy sources, which should be a part of any reindustrialization scheme, gives the U.S. a realistic ,chance of solving its problems and 368 THE FREEMAN opening a competitive advantage on its rivals who cannot do the same.

American technology is still the world's leader, even ifit does not en joy the complete dominance it once did. Nuc1ear and solar technology, aerospace and the revolutionary world of microelectronics are only the vanguard of the American sci entific capability. Behind this stands a highly educated population and an The Growth Objective educational system which spends billions of dollars annually develop ing the ~~human capital" of knowl edge. The framework thus still exists for reindustrializing the country as, indeed, it was industrialized in the first place. What is needed is a more enlightened allocation of resources to support the effort and a determi nation to see it through. ~ IDEAS ON LIBERTY ECONOMIC GROwTH is an objective with which few people eould quarrel. It means more useful things to serve the needs and desires of the people. It is what men have· always striven for in their individual lives and what economists have always pointed to as the greatest hope for ma terial progress in the future. It is an idea, an aspiration, and a reality as old as human history. Despite the immense obstacles placed in its way by ignorance, superstition, physical violence, and political interfer ence, it has been interrupted only temporarily, because it is a product of human nature and normal human behavior.

In a free society protected against violence and fraud, economic growth is an automatic process. It takes place as a result of the desire of indi viduals to better the material condition of themselves and their fami lies. In this endeavor, people save, invest, devise new and better tools, invent new products and new processes, and employ other people in order to operate more efficiently and on a larger scale. In this respect, individual proprietors and corporations behave in essentially the same way. Under the spur of competition and the profit motive, they strive constantly to produce more and better products at a lower cost. The result is economic growth. From The Guaranty Survey, March 1959 Edward C. Facey ZONING LAWS ALL men on earth are ceaselessly striving to substitute more· suitable conditions, as they view them, for the ones currently confronting them. They trade means for ends. because they value the ends more than they do the means.