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From The New International, Vol. XXIV No. 2–3, Spring–Summer 1958, pp. 129–137.
Transcribed & marked up by Einde O’Callaghan for ETOL.
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“Too many people are supplied with everything they need. Therefore, they do not buy.” |
THE PURPOSE OF THIS article is to analyze the causes and predict the future course of the current recession. Since any empirical investigation must utilize some theory, I will begin by discussing some of the underlying theoretical notions employed in this article. I hope thereby to present a rationale for my procedure as well as an explanation of it to the reader.
My analysis is primarily based on Keynesian theory. For those who are unfamiliar with this theory, the following highly simplified version of it may be helpful: total income is defined as equal to the total value of production and, also by definition, net savings is equal to income less consumption. If there is net saving, not all goods produced are purchased by consumers. Thus there will be overproduction unless that portion of production which is not bought by consumers is bought by investors, or some other class of buyer such as government. (In line with this formulation is the definition of investment as the purchase of newly produced producers’ goods.)
Since most pre-Keynesian theorists (Marx is a glorious exception) assumed that no one saves except with intent to invest, they concluded that overproduction was impossible, since what was not spent on consumption was automatically spent on investment. Keynes, however, pointed out that saving and investment are distinct processes, caused by different factors. It follows that a reduced desire to invest does not imply a reduced desire to save; i.e., reduced investment does not imply increased consumption. Thus if investment falls,there is overproduction which leads to cuts in production and income. Production and income keep falling until the amount of saving, which is directly dependent on the level of income, falls enough to be equal to the reduced level of investment, at which point there is no longer overproduction but there may be considerable unemployment. Thus investment is the crucial determinant of the level of production and income.
Keynesian theory is a static theory; it discusses only conditions of economic equilibrium. (Note that according to Keynes, equilibrium does not imply full employment; full employment equilibrium is a special case, an accident.) Other theorists have carried this analysis a step forward by adding to it a theory of the determination of the level of investment. This greatly dynamized the theory. [1]
As a first approximation, we can say that an increase in the demand for goods causes investment, because it creates pressure for the addition of new productive capacity. The amount of investment depends, therefore, on the rate of increase of demand. This is the reason that a capitalist economy cannot maintain itself on a high “plateau”: once demand stops increasing, investment must fall and thus income and demand start decreasing. In order for full employment to be maintained, it is necessary that consumer demand increase at an increasing rate. For if demand increases at a constant rate, then investment will not increase at all; and once investment stops increasing, demand stops increasing and thus investment must fall. [1*]
Certain other sectors of the economy have economic effects similar to investment, although they are differently caused. Among these are government spending, exports, and the purchase of homes and consumer durables. Government and foreign demand are clearly additions to consumer demand, but the demand for houses and consumer durables might be considered as part of consumer demand and therefore not meriting separate treatment. The main reason for treating them separately is that purchases of homes and durables are not financed out of current income, but out of past saving or current borrowing which result in additions to purchasing power. Thus an increase in the demand for these goods does not imply a decrease in the demand for other goods.
One final point should be discussed here: the role of inventories in business cycles. Inventory accumulation has the same effect on total demand as does investment: if inventories are rising, this means that businesses are buying up part of the product. Thus inventory accumulation is part of total demand. When inventories are increasing at a constant rate, this portion of demand is constant; only when they rise at an increasing rate can we say that inventory demand is rising. To take a numerical example, suppose that in a given year inventories rise from $80 billion to $85 billion, and in the next year they rise from $85 billion to $88 billion. This is properly interpreted as indicating a decrease in demand of $2 billion, a drop from $5 billion to $3 billion. Therefore, our interest must be centered not on the rate of inventory accumulation, but on changes in the rate of inventory accumulation.
There are a variety of factors governing, inventory accumulation. Three, I think, deserve mention in the present context. First, there is involuntary accumulation, which occurs when sales are below expectations. Second, businessmen try to accumulate inventories in periods of shortages or of rising prices. Third, inventories are adjusted to the actual or expected volume of sales. They must be sufficient to assure a smooth flow of goods, but yet no larger than necessary, for it is costly to carry inventories.
IN ORDER TO GET SOME UNDERSTANDING of the nature of the current recession, we must first examine the preceding prosperity and compare it with the two earlier postwar booms. Table I presents the necessary data. It shows the percentage growth in the main sectors of the economy from the beginning of each boom to its end (“trough-to-peak”). Those sectors which have higher rates of increase than the Gross National Product (GNP) can be considered the driving forces of the boom, while those with lower rates of growth show a more passive reaction. While this view is necessarily superficial, it is sufficient to bring out a few major points.
On the basis of the data in Table I we may briefly characterize each of the booms. It appears that far from the economy having enjoyed the even development praised by the liberal chorus, each boom had a unique character and the ensemble shows a peculiar development. The boom of 1946–48 was led by investment, housing, and consumer durables. In 1949–53, the boom was led by government spending, and to a lesser degree by investment. The 1954–57 boom was led by investment alone. The most striking change in this period appears to be that the demand for consumer durables and housing has ceased to be a highly dynamic force in the economy. Two complementary explanations may be given: first, that the demand has been relatively “satiated,” by which is meant that most of those who could afford those goods now have them; second, that home mortgage debt rose from $23 billion in 1946 to $99 billion in 1956, and that other types of consumer debt rose in the same period from $8 billion to $42 billion. [2] Another striking fact is that government spending, although at a very high level and thus in a sense sustaining the economy, has ceased to expand rapidly, and that its tremendous expansion in 1949–53 was easily absorbed and adjusted to by the economy. (In a sense, the 1954–57 boom was a minor postwar boom following a minor war.) Finally, we may note that all through the postwar period investment has increased at a very rapid rate; but only in the recent period has it been the only sector showing a major increase.
Now for a closer look at the most recent boom of 1954–57. Table II shows the year-to-year percentage changes of the main sectors of the economy. The beginning of the boom was led by considerable gains in consumer durables and housing, which in the latter portions of the boom actually declined. In 1956, there was a tremendous increase in investment which more than offset these declines. In 1957, investment was maintained at high levels but ceased to advance rapidly. Consumer demand increased at a steady but slow rate which was not enough to sustain a high level of investment, let alone induce it to advance rapidly. Without the spur of rapidly increasing demand by consumers or government, the high level of investment could not be maintained. Manufacturing firms, which in 1955 were on the average operating at optimum 92% of capacity, were, by September 1957, operating at 82% of capacity. [3] A huge amount of excess capacity had been developed in a very brief period, and the investment boom could not be maintained.
Why did businessmen allow so much excess capacity to develop? I think part of the answer may be found by referring to data on their expectations of future sales. [2*] (See Table III.) The big increase in sales which occurred in 1955 caught manufacturers by surprise and was partly responsible for the upsurge in investment in 1956. The increased investment in 1956 was in turn responsible for the continued, though slower, rise in sales. But it was impossible to continue to increase investment by 30% each year while sales were only rising by 5%. Thus in 1957, manufacturers considerably reduced the rate of increase of investment. Yet they expected sales to increase at the same rate as previously. In this period, however, when investment was the sole factor leading the boom, a decline in its rate of expansion had to mean a decline in the rate of increase of sales. In 1957, sales were expected to rise by 7% but the actual increase was only 2%. This failure of sales to increase according to expectations meant the development of excess capacity and a consequent cutback in investment plans. This began even in 1957; manufacturers had planned to increase investment in that year by 10%, but the sluggishness of demand caused them to cut back the increase to only 7%. And for 1958, a cut of 17% was planned. That this planned reduction in investment was not due to the impact of the recession but in fact preceded it is shown by a survey conducted by McGraw-Hill in October, 1957, which indicated a planned drop of 16%. [4] (The Commerce figure on planned investment is gotten from a survey conducted in the first months of 1958.) Thus the cut in investment – first in its rate of increase and then in actual amount – was not due to a reduction in sales, but merely to an insufficient increase.
Thus far, we have neglected the role of inventories, which have played a very important, though hardly decisive, part in postwar cycles. In years of expansion, inventories have increased at an average rate of $4 billion, while the average decline has been $2.5 billion. Table IV shows the rate of inventory growth, and the changes in the rate of inventory growth, as compared with the changes in GNP in each of the past four years. In 1955 inventory accumulation was an important source of increased demand, but in 1956, although inventories kept rising, they did so at the same rate as in 1955 and thus did not tend to increase demand over 1955. In 1957, partly because of the failure of demand to increase much, inventories increased very little; but the change in the rate of growth of inventories was negative, which meant an actual drop in demand for inventories. Thus the fact that inventories rose by $7.5 billion in 1956 and by only $1.9 billion in 1957 meant that the inventory demand of producers and merchants fell by $5.6 billion. Even before the actual reduction in inventories began in the fall, the reduced rate of growth was having ill effects on the economy.
All through 1957 there were indications that the prosperity had come to a halt and that a recession was imminent. The fact that the boom depended so exclusively on investment, the slowing down of the rate of growth, the development of excess capacity – all these added up to an economic downturn. The industrial production index had reached its peak in December 1956. Manufacturers’ new orders and sales reached their peaks at about the same time. Soon new orders began to fall, and between January and September unfilled orders were cut by $8 billion (12%). By the fall, the decrease in unfilled orders and in new orders led to the reduction in inventories which, together with a slight decline in investment, touched off the recession. (It seems likely that the fall in new orders which seems to have precipitated the decline was in large measure due to the reduced rate of inventory accumulation and to a cutback in plans for future investment.)
One further point requires discussion: the inflation of 1956–57. It is my opinion that this inflation was due to the efforts of businessmen to increase their profit margins, which had been falling because of rising wages and increased overhead (due to recent high investment). Because of the monopolistic structure of most industries, it is easy for them to pass higher costs on to consumers. However, doing so restricts the demand for their products. This was the first important effect of the inflation. The second effect was through government policy. The Administration and the Federal Reserve Board, seeing prices rise, concluded that demand must be excessive. This as we have seen was hardly the case. They then proceeded to tighten credit – incidentally, this is the charitable interpretation of their motives – which had the not unexpected effect of still further restricting consumer demand by reducing available credit. Thus at the very time that consumer demand was showing signs of stagnation, the government was discouraging consumers.
THE MOST IMPORTANT ASPECT of any prediction at the present time is not whether and when there will be a “recovery,” but whether any recovery that may occur will generate a period of full-fledged prosperity. For only an expanding economy will be able to absorb the growing labor force and stimulate high investment. According to Keynesian theory, it is possible for the economy to reach an equilibrium at any level of unemployment, depending on the level of investment. However, in so far as investment depends on growing demand, a stagnant economy will cause investment to fall to quite low levels. This reasoning implies that the economy must either advance more or less continuously or face stagnation with very high levels of unemployment. The latter circumstance was exemplified by the Thirties when unemployment fluctuated between the bounds of (roughly) 10 to 15 millions, and showed no sustained tendency either to increase or decrease beyond those bounds. (There is, of course, a third possibility – that government deficit spending maintains the economy at low or “moderate” levels of unemployment.) [3*] Thus in addition to asking what are the economic prospects for the next year or so, we must also inquire into the somewhat longer range prospects of the economy. We may remark that the crucial difference between a recession and a depression is, superficially, the length of time rather than the steepness of the decline.
Since the end of the war, the government has been conducting extensive annual surveys of industry to determine how much investment is being planned for the forthcoming year. These surveys have had a surprising record of success in making one-year predictions of investment. The results for the survey predicting investment expenditures in 1958 are presented in Table V. The data were collected between late January and early March of 1958.
For 1958 businessmen plan to reduce investment by $5 billion, or 13%. This is a very general trend appearing in almost every industry. The reduction in investment spending apparently will continue all through the year, since businessmen reported plans to invest at a (seasonally adjusted) annual rate of $34.03 in the first quarter of 1958 and $32.55 billion in the second quarter – which implies a second half rate of about $30.75 billion.
If anything, these data understate the reduction in investment. This has been the experience of previous downturns. It can also be seen by comparing these data with those from a survey of the same firms taken just a few months earlier. This earlier survey reported first quarter planned investment of $35.52 billion; the later survey indicated $34.05 billion (seasonally adjusted at annual rates). Also, if we compare the Commerce survey with the very similar survey conducted by McGraw-Hill last October the same result emerges; the McGraw-Hill survey foresaw a drop in total 1958 investment of about 6%, while the Commerce survey taken a few months later indicated a drop of 13%. [5] While the recession itself is not responsible for the reduction in investment, it will certainly accentuate it and has done so already.
As we saw earlier, manufacturers anticipate a sales drop of 2% in 1958. If the drop which actually occurs is much greater than this, then investment may be cut even more than is planned. If past history is any guide, this seems quite likely, for manufacturing sales fell more than 4% in 1949 and more than 3% in 1954, and in the first six months of the current recession (July to January) seasonally adjusted manufacturing sales fell 9%.
It is, of course, much more difficult to make predictions for 1958. First, we may note that in the recoveries of 1949-50 and 1954, investment continued to decline for a full year after the Gross National Product had started to rise. Second, we may consider a new body of data collected by the Commerce Department. In its last survey of investment plans, manufacturers were asked for information on the total value, when completed, of investment projects begun in 1957 and in 1958. Projects begun in 1957 had a total when-completed value of $14.05 billion, whereas projects planned to be started in 1958 had a value of $9.85 billion. If these data are to be relied upon – there is no earlier experience with them – we must conclude that in 1959 the backlog of work will be considerably smaller than in 1958. This conclusion is further supported by the fact that manufacturers expect to spend $6.12 billion in 1958 on projects carried over from 1957 (thus almost half of their investment spending will be on backlog projects), and expect to complete, in 1958, $7.08 billion of the $9.85 billion started in that year. [4*] Thus the backlog of work carried into 1959 will be quite small. Very likely the same will be true of non-manufacturing industries – some of which have been having exceptionally high investment in the past few years and are now leveling off. In public utilities, for example, projects started in 1957 had a total value of $5.94 billion, while the projects started in 1958 will have a final value of only $5.24 billion. [6] Similarly, in the railroad industry we find that unfilled orders for freight cars were cut in half in 1957, and at the present rate of reduction the backlog will not last a year. [7]
In view of the considerable overcapacity which has been developed in a number of industries, it is unlikely that any investment boom will begin until there is a considerable increase in either government or consumer demand. Before considering these, however, let us turn our attention briefly to the probably course of inventory fluctuations in the coming months and their significance for economic developments.
Between August and the end of February, manufacturers’ inventories fell by close to $2 billion (using seasonally adjusted data). The decline in recent months has been at an annual rate of $6 to $7 billion. [8] How long can we expect this decline to continue? In view of past experience it seems most unlikely that the total decline will be more than $4 to $5 billion. Thus the decline should be ended by summer. However, even a drop in the rate at which inventories are being reduced represents a rise in demand. Thus far, the inventory contraction has been contributing to the general economic decline, but soon it should be counteracting the decline. This too must be a temporary effect which may give the appearance of economic recovery.
The long term situation in the housing market may be seen in the following data: between 1930 and 1950 the number of non-farm households added to the population was over 14,000,000 while only about 8,500,000 new non-farm dwelling units were started; between 1950 and 1955, however, the number of new households rose by less than 5,000,000 while the number of new dwelling units was over 7,250,000. [9] Thus the housing industry, which has been working off a “backlog,” is faced with a decreasing market at least until the 1960’s, when a new upsurge in family formation is expected.
But in the short period it is possible that the level of residential construction may turn up for a year or two. In 1956–57 the level of residential construction was below the 1955 peak, and if we examine the data we find that the entire decline was concentrated in FHA/VA financed homes, while the value of “conventionally” financed construction actually rose. Between 1955 and 1957 the number of housing starts with FHA/VA financing fell by about 250,000; the percentage of total starts thus financed fell from 51% to 30%. [10] The reason for this decline appears to have been the tight money policy which made FHA/VA loans, fixed by statute, relatively unprofitable for lenders. The data suggest, therefore, that several hundred thousand would-be home buyers sought and were unable to get or were unwilling to take conventional loans. Thus a backlog of unsatisfied demand was created. Given lowered interest rates and not too unfavorable economic conditions, this backlog could lead to a mild and brief housing boom. Such a boom is not ruled out by a recession, provided it is not too severe. On the more pessimistic side, we may note the following interesting statistic: In the first months of 1958 the marriage rate fell 8% or by 120,000 on an annual basis. [11] This seems to indicate that in the face of the recession the public is showing an increased reluctance to enter into long term obligations.
Quite frankly, the automobile market is too erratic from year to year to be able to make any confident predictions. Two facts, however, do seem to be worth noting: first, that 1955 was an exceptionally good year for the automobile industry, and second, that 1958 has been an exceptionally bad year for the industry. I am inclined to conclude from these facts that sometime soon the automobile industry will have a good year. On the other hand, it is doubtful whether any such revival will last more than one year, for the industry has long since ceased to be a “growth industry.” This was conceded even by Fortune as long ago as 1954. [12] As for other consumer durables, most of them are closely tied to the housing market and, except for a few of the newer appliances, reached their growth peak a number of years ago, some even before the Korean War. For example, the following industries had their peaks in the years shown: television sets: 1955, radios: 1947, refrigerators: 1950, freezers: 1952, washers: 1956, vacuum cleaners: 1947, electric and gas ranges: 1950, dishwashers: 1956, woven carpets: 1948. [13]
This discussion of the major consumer markets has necessarily been uncertain and hedging. Nevertheless, one salient point seems inescapable: although some of these industries may register an advance in, say, 1959, none of them are growth industries any longer and none of them can sustain a real boom. Thus we must conclude that the basic economic pressures for the next few years will be downward.
1*. (a) A more refined account of this theory of Investment requires, as a necessary condition for investment, that producers be operating at “full capacity.”
(b) This does not purport to be a complete theory of investment, but only explains certain changes In the level of investment. Its significance lies in the fact that it makes investment depend on changes in income, and changes in income on changes in investment. This casual “circularity” can be used in constructing cycle theories which are formally analogous to the oscillatory feedback systems of electronics.
2*. The following treatment of sates expectations Is not at all a subjectivist or psychological approach. Businessmen are not as moody and subject to the winds of opinion as some journalists, their eyes too much on Wall Street, seem to believe. On the contrary, their expectations are usually a clear reflection of their most recent experience. They often guess wrong because their actions, based on these expectations, have unforeseeable effects which are at variance with the original expectation. “Human actions in history produce additional results, beyond their immediate purpose and ... beyond their immediate knowledge.” (Hegel) This is, concretely, what is meant by the Marxist phrase, “anarchy of production.”
3*. This discussion of the future of the recession will ignore the possibility of major government action. I feel it is best to consider the economic situation in abstraction from policies aimed at that situation.
4*. A survey conducted by the National Industrial Conference Board shows patterns in manufacturers’ new appropriations and appropriations backlogs which are similar in pattern to the plans reported by Commerce. See Newsweek, March 17. 1958. pp. 69–74.
1. The pioneer in this direction was Roy Harrod, Keynes’ biographer. See his Towards A Dynamic Economics.
2. Statistical Abstract of the United States, 1957, pp. 460, 778.
3. Business Week, November 9, 1957.
4. Ibid.
5. Ibid., Survey of Current Business, March 1958.
6. Survey of Current Business, March 1958.
7. Ibid., February 1958 and March 1958.
8. Ibid., March, 1958; New York Times, March 2, 1958.
9. U.S. Department of Labor, Economic Forces in the U.S.A., Fifth Edition, 1957, p. 84.
10. Survey of Current Business, February 1958.
11. U.S. News & World Report, April 18, 1958.
12. The Editors of Fortune, The Changing American Market, 1953, chapter 8.
13. Survey of Current Business, November 1957.