w BOUGHT WITH THE INCOME OF THE SAGE ENDOWMENT FUND THE GIFT OF HENRY W. SAGE 1691 arVl954 °°™*" ""'"e's'ty Library ''ffi&,„r?SS?...and prices, olin.anx 3 1924 031 714 656 The original of tliis bool< is in tine Cornell University Library. There are no known copyright restrictions in the United States on the use of the text. http://www.archive.org/details/cu31924031714656 PROFITS, WAGES, AND PRICES BY DAVID FRIDAY raoFEssoB. op political economt UNIVEESITT or MICHIGAN n NEW YORK HARCOURT, BRACE AND HOWE 1920 COPTRIGHT, 1920, BY HAKCOTTRT, BRACE AND HOWE, INC. THE QU1NN ft BODEN COMPANY RAHWAY. N. J. FOEEWOED In the antumn of 1916 my attention was first attracted to the enormous growth of profits which resulted from the business activity induced by European war demands. It has fallen to my lot since that time to collect a considerable amount of material on profits, wages, prices and related sub- jects, most of which is today not readily available except to the specialist. This little book has no more pretentious ambition than that of present- ing these facts briefly and in such form as to make them comprehensible to the general reader. The statistical material in this volume, essential though it be, will probably be more abundant than the general reader will have the patience to follow in detail. Nor is it necessary that he should do , so in order to get the point of view of the book or the gist of the author's conclusions. Though all of the chapters hang together, the meaning of almost any one of them may be grasped when taken by itself. The facts concerning profits, wages and prices do not indicate disintegration or economic weak- ness in America, although they have created end- iv FOREWORD less confusion in the public mind. What they do show is that the productive resourcefulness re- vealed by the war gives a substantial basis for social and economic optimism. David Feiday. Awn, Arbor, Jime 25, 1920. CONTENTS CEAFIBB FAGE ^I. The Cttese op Peace .... 1 n. The Gbowth op Peopits ... 14 III. Normal Pbofits and Profiteering . 31 IV. The Uses to Which Profits are Put 49 ~V. The Bate op Interest ... 69 VI. The Course of Wages . . . 100 ^Vn. The Division of the Product . . 112 VIII. How Europe Raised American Prices 133 IX. Prices Since the Aemistice . . 156 X. General Prices and Public Utilitt Bates 166 ^^I. The Theory op the New Taxes .. 176 ^^XII. Has the Excess Profits Tax Eaised Prices? ,192 XIII. The Part Played by the Banks . 207 —XIV. How Can Real Wages Be Baised? . 234 PROFITS, WAGES, AND PRICES CHAPTEE I THE CURSE OF PEACE When one compares the tone of American life during the spring and summer of 1918 with the state of public opinion and industrial activity of 1920, he wonders whether peace is reaUy a bless- ing. Edwin Cannan tells the story of a char- woman who remarked to a charity worker: "This war has made many a happy family, sir." She seems to have been a person endowed with acute powers of observation, and something of a prophetess as well. Her paradoxical remark ap- plied quite as much to America as to England. Not only the young men who were eager for an excuse to go in quest of adventure ^and the women suffering from ennui who had found relief in work were happy with the war. The whole nation had for once an end so direct and straightfor- ward, so stimulating to the imagination, that it found itself possessed of a unity of purpose which led to satisfying activity. On the side of industry 2 PROFITS, WAGES, AND PRICES there was complete employment of labor. "Wages were high and profits were large. An unprece- dented volume of product was flowing forth from our factories and workshops. Today no great national end is unifying public opinion; instead there are innumerable bicker- ings. Neither the size of real wages nor the growth of national capital is fulfilling the hope raised by our industrial output during the war. At that time we accomplished the amazing feat of producing enough so that we were able to de- vote fifteen billion dollars' worth of product to the support of our allies and to the prosecution of war on our own account, and at the same time to maintain the great mass of our people in a state of comfort fully equal to that which they had enjoyed in times of peace. But the moment the annistice came the word went forth that this state of affairs could not go on, that wartime profits must cease. So much we had rather expected. Likewise high wages and the "extravagant living" indulged in by the labor- ing classes during the war could no longer con- tinue. Now it really does appeal to one's common sense as preposterous that the laborers should bd thoroughly employed at good wages and should enjoy a high standard of living when the nation THE CURSE OF PEACE 3 was wasting fifteen billions a year upon war, but should find it impossible to maintain that standard when the waste of products had ceased. But the prophecy came true. Despite the return of sev- eral million men to industry, profits have de- creased and the laborer has barely succeeded in maintaining his new standard of living. The na- tional energy is being consimaed in strife and dis- pute over profits, wages, and prices. The public mind is in confusion. This confusion arises chiefly from the necessity of attempting to formulate our opinions without a sufficient basis of relevant fact. If only we knew the facts concerning the size of profits, both in relation to the capital which earns them and in comparison with normal pre-war profits in the same industry, the American public would be in some sort of position to form an in- telligent opinion on one question which is puzzling us. Is there "profiteering"? Do high profits cause high prices? Or does the chain of causation run from independent forces to increased prices and thence to high profits? We have little exact information about profits available in convenient form ; therefore we fulminate and wonder. The business men of the community insist in one breath that the excess profits tax is so oppres- 4 PROFITS, WAGES, AND PRICES sive as to constitute confiscation and discourage industry; that it is a brake upon the wheels of industrial reconstruction. In the next breath they tell us that it is the chief cause of high prices because the business man finds it necessary to add, or at least does add to the price of his product an amount equal to several times the tax. It is diffi- cult to understand how a tax which is paid by the consumer can stifle enterprise. How large profits actually are, what rate of return they constitute upon the invested capital used in earning them, what profits remain after paying taxes; on these fundamental and elemen- tary facts nothing is available to the intelligent citizen who is trying to arrive at some constructive conclusion upon which to base his political con- duct. In the discussion of prices there is even more confusion, although here more information is available in various publications. The rise in prices is the most obtrusive phase of the whole industrial situation today. Everyone is affected by it and is therefore conscious of it. How much have these prices risen, and how is the rise in prices measured? Did high profits and high wages come first, and bring about increased prices or were prices raised by other causes f In the lat- THE CURSE OF PEACE 6 ter event high money profits may have been merely a consequence of the price movement, and high money wages may have been another consequence. For high profits may result not from a selfish in- crease in price on the part of the entrepreneur, but as a fortuitous by-product of increased output and increased demand. Neither the good nor the evil that comes to any of us can be altogether ascribed to conscious intent and effort. It is proverbial that the rain falls on the just and the unjust alike. This seems irrational, as one would naturally suppose that the Almighty would cause rain to fall upon the just while the tmjust were suffered to shrivel up. No more do profits come always to those who strive after them with malice aforethought. "Will prices fall, and what forces may be ex- pected to bring about the decline? Is it simply that things which go up must come down, in the field of economics as in the sphere of gravitation? Is there a ''normal" level of prices which tends to be re-established after the events of war have pulled the price system away from the normal, or does a price level once established tend to main- tain itself? Another group of problems centers about bank credit and the money market. We have had dur- 6 PROFITS, WAGES, AND PRICES ing this turbulent period a quite unprecedented expansion of bank credit. There are persons of high financial position who see in this expansion the chief cause of the increase in prices. Did the expansion in loans actually precede the rise in prices or was it necessitated because a larger amount of purchasing medium was needed to effect the exchanges of the larger volume of goods at the higher prices? Along with all this expansion of bank credit we have had a very considerable rise in the rate of interest. Not for decades has capital commanded the price which is now being freely offered by manufacturing and public utility enterprises of unquestioned standing. What is the explanation of this rise; and will the high rate continue? And what of wages? The accusation of profi- teering is brought against labor almost as freely as against the business man. To accuse both em- ployers and laborers of profiteering is, of course, very much like indicting a whole nation, pro- verbially a futile performance. Just what has been the course of wages and have they risen in such manner as to increase costs to the point where present prices are no more than adequate to cover that increase? Money wages certainly have increased, tintil they are at least double what THE CURSE OF PEACE 7 they were in the pre-war period, or even in 1915. Have the laborer and the business man conspired to mulct the public? But here we are reminded that money is not always a dependable measure of true wages; real wages, the things which money wages buy, are the significant factor. If money wages have risen no more rapidly than prices, the real wages of labor have remained where they were; if prices have outrun money wages, the laborer is actually worse off than before. Is it possible to raise the real wages of labor, the things which labor can buy and enjoy with money wages ? If so, what are the conditions upon which these higher real wages def)end? Must profits be reduced? Or can it be accomplished only through an increase in productive output? And if the latter should prove to be the only prac- ticable method, can such an increase in productive output be maintained with our present social and industrial arrangements? Our amazing feats of war finance were made possible because of our large productive output, increased as it was, first under the stimulus of European war demand and high profits, and afterwards through the exuber- ance of spirit engendered by patriotism. It was a truly astounding feat, constituting nothing less than a great discovery, — this devoting fifteen bil- 8 PROFITS, WAGES, AND PRICES lion dollars of our national product to the aid of our allies and to the maintenance of our military and naval establishment — whUe we were feeding and clothing our common people probably better than they had ever been fed and clothed before. On the industrial side our experience during the war proved that it is possible to maintain all our people in a state of weU-being. The lesson which the war taught us should be conserved. And finally, how is this grand total of income which is brought forth through the united efforts of the nation carved up and parceled out as be- tween wages, taxes, interest and dividends? What portion of our national income is spent on living and what portion is devoted to increasing our physical, tangible wealth, such as manufacturing plants, railroads, residential and business build- ings? The federal government has, during the last three years, collected from the people an average of approximately four billion dollars per annum in taxes. This is five times the revenue raised in pre-war years. Judging from the utterances of public men and of the press, there seems to be a pretty general conviction that this five-fold tax burden has been the primary force which raised the price level. There is serious reason for be- THE CURSE OF PEACE 9 lieving that those who ascribe such remarkable powers of levitation to federal taxes are in error. For it is possible that large personal incomes, like business profits, were the indirect resultants of forces entirely outside the price system. In that case the government has done nothing more than to step in and take a small portion of the purely fortuitous profits and incomes which represent the by-product of war. These two lines of analysis of the excess profits tax are diametrically opposed. No study of the present situation can be thor- oughly illuminating without resolving this con- flict. Taxation is an active and abiding part of our whol^ social structiure. If it can be arranged in such manner that it falls only upon fortuitous and accidental gains, it will interfere little with the plans of individuals and business establishments. It will enable the government to secure the reve- nues needed for the prosecution of its functions without interfering with industrial progress. Whether in our newly found sources of taxation we have an instrument of this sort, or whether they are really oppressive measures which retard industry, is the most important question of public finance which has confronted this country in a half century. 10 PROFITS, WAGES, AND PRICES Answers to questions such as these are needed to furnish some rational guidance in the formula- tion of a program which will bring the course of our industrial development during the next decade into closer conformity with the ideals which we are seeking to realize in our national life. It is the purpose of this little volume to furnish some definite answer to such questions. The last five years have made available an amount of infor- mation of an exact quantitative nature such as we have never had before. The trouble is not that no information exists, but that it is scattered through a wide number of government publica- tions and studies made by individuals and busi- ness organizations. The task of collecting the material is an impossible one for the ordinary business and professional man or for the laborer and labor leader. The mere time required to do this makes it prohibitive to such men, even though they have the requisite technical knowledge and skill. Even after the material is assembled, its interpretation is no simple matter. To help those who are seeking for exact information on these problems an attempt is here made to assemble the available facts concerning profits, wages, taxes, and prices, and to set them in orderly relation one THE, CURSE OF PEACE 11 to another in such manner as to disclose their causal interdependence. In order to get more directly and vitaUy at the heart of this industrial process which we are seek- ing to understand we must start with an examina- tion of business profits. This follows from the very nature of our industrial organization. The central figure in modern industry as it easts today is the business man, — the entre- preneur, as he is called in the formal literature of economics. He stands at the center of the in- dustrial process controlling and directing it. If industry is prosperous, it is because the business man is prosperous ; if labor is fully employed and production is large, it is because individual entre- preneurs are hiring labor and using it in conjunc- tion with plant to bring forth products. When the entrepreneur sees no prospect of profits pro- duction lags, unemployment develops, and the current of industrial life stagnates. TJntU we know the course of profits and the forces which underlie their fluctuation, and until we have dis- covered how they effect wages and prices, the public mind must remain in darkness and confusion. It is a peculiar function of entrepreneurs to plan and direct the productive; activities of the people. 12 PROFITS, WAGES, AND PRICES They purchase labor, material, land, and plant; they decide what shall be produced, and combine the factors of production for the purpose of bring- ing forth the product. They select managers; they find the capital funds needed for the enter- prise. Finally, they market the product and out of the proceeds they pay wages, taxes, rents, ma- terial costs, and interest on borrowed capital. Of the remainder an amount is usually set aside to cover contingencies, and depreciation sufficient to keep the capital intact. What is left constitutes business profits. These profits comprise the fund available for distribution as dividends or for the accumulation of a surplus which may be used to extend plant, to increase current assets, or to pay debts. If we examine the part that profit plays in the determination of individual incomes and the part it forms of the national income, we find that next to wages it is by far the largest and most import- ant share. The total net income reported for the calendar year 1917 by corporations and by in- dividuals having incomes of $2,000 and over amounted to twenty billion dollars after eliminat- ing duplications. Of this amount $14,700 million consisted of business profits. It is clear then that the course of profits for THE CURSE OF PEACE 13 industry as a whole and for the dijfferent classes of industries must be one of the primary facts necessary to an intelligent understanding of our industrial situation. CHAPTER n THE GROWTH OF PROFITS Thk popular impression that the war has brought a large increase in profits is fully borne out by the facts. The growth has been, large, even after the payment of income and excess profits taxes. The profits of all corporations in the United States had never exceeded four billion dollars until 1913. Under the stimulus of war de- mand, with its high prices and increased produc- tion, profits reached the astounding figure of ten billion seven hundred million dollars in 1917, the latest year for which ofiScial published figures are available. These are the earnings which the cor- porations of the country reported for purposes of taxation, after deducting all operating expenses and interest on indebtedness. It was on this amount that their federal income and excess profits taxes were computed, and we may be fairly certain that the earnings are not overstated. For the five years preceding the outbreak of the European war corporate profits averaged some- what less than four billion dollars ; for the years 14 THE GROWTH OF PROFITS 16 1916-1919 they averaged nine billion dollars be- fore taxes and seven and one-half billion annually after paying federal income and excess profits tax levies. The profits for the years 1909 to 1917, shown in the following table, are those which appear in the Internal Revenue reports. Those for 1918 and 1919 have been estimated on the basis of the pub- lished reports of the corporations and upon a sampling of the returns which the companies made to the Bureau of Internal Eeyenue. It is not prob- able that the final published returns, when avail- able, will deviate from the estimates which are here presented by more than five per cent. The table shows the profits both before and after pay- ing federal income and excess profits taxes. NET INCOME OF ALL CORPORATIONS Net Income after Taxes $ 3,104,521,000 3,326,739,000 3,185,123,000 3,797,145,000 3,671,466,000 5,127,427,000 8,58i,095,000 8,587,914,000 •6,300,000,000 *6,700,000,O00 These figures show that the high-water mark of profits came in 1916 and 1917; and that contrary Year Net Income Federal before Taxes Taxes 1909 $ 3,125,481,000 $ 20,960,000 1910 3,360,251,060 33,512,000 1911 3,213,706,000 28,583,000 1912 3,832,151,000 35,006,000 1914 3,710,600,000 39,145,000 1915 5,184,400,000 56,973,000 1916 8,765,900,000 171,805,000 1917 10,730,360,000 2,142,446,000 1918 *9,500,000,000 •3,200,000,000 1919 *8,500,000,000 •1,800,000,000 * Estimated. 16 PROFITS, WAGES, AND PRICES to popular impression corporate profits have been declining since those years. If the figures of 1919 be adjusted for the fall in the purchasing power of the dollar, profits in that ye^ar after paying taxes are equal to only three billion pre-war dol- lars. This is an amount smaller than the earnings of any year since 1909. While the profits of all corporations in 1916 were double those of any pre-war year, the reader must not conclude from these figures that every class of industry earned twice as much in 1916 as in any pre-war year. The growth of profits in various types of industry has been widely different. This fact will appear if the increase revealed by the figures for all corpora- tions given above is compared with the figures shown in the table below. This table gives the earnings before deducting taxes for a large num- ber of mining and manufacturing corporations. The earnings of 251 corporations are available in their published reports for the years 1911-1918. In addition to these the earning of 168 corpora- tions whose reports are available only since 1915 have been tabulated. The last column of the table shows the combined income of the 419 corpora- tions for the years 1915-1918. THE GROWTH OF PROFITS 17 251 419 Year CorporationB Corporationa 1911 $ 458,781,665 1912 513,401,501 1913 542,109,388 1914 415,335,092 1915 698,703,872 956,396,653 1916 1,402,745,796 ' 1,969,963,281 1917 1,774,359,217 2,353,246,485 1918 1,591,207,084 2,119,829,456 These earnings axe compiled from the published reports of the concerns to their stockholders and not from their returns made for purposes of taxa- tion, but the comparative growth shown by the fig- ures is not materially different from that shown for those industries by the Treasury reports. The Commissioner of Internal Revenue gives net income by industries from 1909 to 1913 in his Annual Eeports for the years ended June 30, 1910 to 1914. 1914 and 1915 are not so shown. For 1916 and 1917 the Treasury has made an elabo- rate analysis of corporate incomes in the volumes "Statistics of Income" for these two years. The earnings for mining and manufacturing corpora- tions for the period 1909-1917 are as follows : Year Net Income 1909 $1,325,807,000 1910 1,436,061,000 1911 1,309,819,000 1912 1,670,334,000 1913 2,026,884,000 1914 not shown 1915 not shown 1916 5,026,372,000 1917 6,809,238,000 18 PROFITS, WAGES, AND PRICES The increase from 1913 to 1917 shown by these tax reports for all industrial corporations is prac- tically the same percentage as that shown by the figures taken from the published reports of the 251 companies above. According to both these tables the earnings of mining and msinufacturing corporations in 1917 were almost exactly 330 per cent, of those of 1913, the highest pre-war year. No such increase occurred for railroads and public utilities, whose profits are shown in the next table. Year Net Income 1909 $ 808,960,000 1910 843,855,000 1911 806,324,000 1912 930,388,000 1913 1,003,186,000 1914 not shown' 1915 not shown 1916 1,541,076,000 1917 1,303,824,000 These reached their highest point in 1916, when they stood at 153 per cent, of 1913, which was also their highest pre-war year. By 1917 they had fallen until they stood at only 130 per cent, of 1913. In 1918 these earnings fell off still more, and probably did not exceed one billion dollars. In 1919, owing to increased rates, the showing will be slightly better than in the previous year, but will not exceed that of 19|13 by an amount which THE GROWTH OF PROFITS 19 allows them any considerable return upon the large amount of additional capital invested during the last seven years. i In the field of banking and finance the best index to profits is found in the earnings of national banks shown in the reports of the Comptroller of the Currency. During the last decade these have grown as follows : Year ended Per cent, earnings to June 30 Net Earnings capital and surplus 1909 $131,185,750 8.72% 1910 154,167,489 ■ ' 9.67 1911 156,985,513 9.35 1912 149,056,603 8.59 1913 160,980,084 9.06 1914 149,270,171 8.39 1915 127,094,709 7.08 1916 157,543,547 8.76 1917 194,321,000 10.52 1918 212,332,000 11.09 1919 240,366,000 12.11 Here the earnings for the year ended June 30, 1919, are 50 per cent, larger than they were in 1913, and are almost twice as large as they were in the first twelve months after the outbreak of the European war. They have continued to grow and will be larger in 1920 than in any preceding year. The one important group of industries other than farming which remains to be considered is wholesale and retail trade. The returns made to / 20 PROFITS, WAGES, AND PRICES the Bureau of Internal Revenue for purposes of taxation are difficult to compare for the pre-war period and for 1917 because of the ever-increasing number of establishments which are shifting from the individual or partnership to the corporate or- ganization. 69,713 corporations reporting in 1913 showed net income of $473,212,000; in 1916 only 30,583 corporations were classified under this cap- tion in the Treasury publications. These showed net income of $464,876,000. The remaining com- panies previously included under this head seem to have been classified as "miscellaneous." In 1917 the Treasury publications show 91,057 trad- ing corporations with a net income of $1,481,- 061,000. "While the differences in numbers impair the usefulness of these figures, there is no doubt that the earnings of this group have increased more rapidly than those of any other except min- ing and manufacturing. Published earnings of 22 mercantile corporations show the following growth since 1915, before deducting federal taxes : Year Net Earnings 1915 $ 59,687,000 1916 71,860,000 1917 83,778,000 1918 105,277,000 Mercantile earnings were still larger in 1919 than in any previous year. The earnings of thir- THE GROWTH OF PROFITS 21 teen of these corporations which are available for 1919 show an increase of 15 per cent, over 1918. It is evident from these figures that the war has affected the profits of various enterprises in widely different degree. Mining and manufactur- ing industries have benefited enormously, at least on the showing of their money profits. This is true even after they have paid the excess profits and income taxes of which there is such persistent and bitter complaint. Wholesale and retail trade seem to come next in the benefit derived from the war. After these two the financial corporations show a much more moderate increase, but one which continued after mining and manufacturing began to fall off. Eailroads and public utilities benefited materially during 1916, were fairly well off during 1917, but since that time have been actually injured by the industrial events which ac- companied hostilities. The increase in profits in some lines has entirely obscured this decrease in other lines. Taking in- dustry in the aggregate, the profits of corporations in 1919 were no greater than they were in the pre- war period, nor are the prices of corporate securi- ties in the aggregate higher today than then. The truth is that the owners of certain kinds of mer- cantile and manufacturing establishments evi- 22 PROFITS, WAGES, AND PRICES dently increased their, profits at the expense of investors in other lines of business. This 'finds expression in the prices of the shares of these in- dustries upon the market. Twenty industrial stocks had an average market price in the first five months of 1920 of 103.49, as against 65.71 in 1913. Twenty railroad stocks averaged 76.22 in the cor- responding period of 1920, as against 113.69 in 1913. It is a striking coincidence that the indus- trials have increased 37.46 in price, and the rails have declined 37.78. A shift has also occurred in the position of dif- ferent investors in the same business. The stock- holders, especially in profitable concerns, have benefited at the expense of bondholders. The re- turn of the latter was fix;ed by contract; as the earnings of the business rose, the entire increase went to the stockholders. This finds expression in the lower price of bonds as compared with stocks. The average price of twenty leading bonds for the first five months of 1920 was 73.4, as against 94.8 for the corresponding months of 1913. The unusual gains represented by the in- creased value of the stock in profitable enter- prises has been purchased in large part at the expense of investors in bonds and in railroad and public utility stocks. ) THE GROWTH OF PROFITS 23 The tables which have been presented thus far show that the movement of profits has been quite unlike in different fields of industry, and that it is improper to assume that every line of business has benefited greatly by the war. "When we exam- ine the earnings of subdivisions of these larger groups, we learn that even among the most profit- able lines, such as mining and manufacturing, the high-water mark of earnings came in different years. Thus companies making arms and powder have steadily declined since 1916; iron and steel companies since 1917; while rubber and textiles reached their high-water mark in 1919. The table on the next page compiled from published earnings of 259 manufacturing and mercantile cor- porations shows this clearly, and gives us some in- dication as well of the general trend of industrial profits since 1917, the last year for which Treas- ury figures are available. This group of com- panies is for the most part identical with the group of 251 corporations whose earnings for the years 1911-1918 were shown earlier in the chapter. The situation of the banks is relatively better than the figures of profits indicate, while that of the other groups is less favorable than one would judge from the showing of money profits. The assets of the banks are all in liquid form, and are 24 PROFITS, WAGES, AND PRICES t-1 CO eo'eo e^oi oco o ■"-TcTi^oo Ot^QON'^Np-HTjIQOCOt-HO r-i OJ r-i -* i-t f-l :,c>^ea Gvi^o ^00 i^i^'-it^co 2 0^"^ t-Tb^ririo oa TiTtCin oo^cM S oo. «^ *^ "^.oo ^00 t- co^'-i^co CD J2 ca'oo''i>^co O cd"o oa^ifTco '-*?5'^cMoaea*^io«5t*Tt-< o oo o oo ■rlrt O O O m ."S o o o ii>:,«5,>« w CO CO '-*''* ocT 00 wo 1-H <-* pH CS OS CO o i>r oT CO CD* ■0«C0 co_os CO c> c n o •S a » a a p 3 So) §^^ S CO la IS ■* com «"« >Ort s^ -^oa CO CO CO in in o o CO CO ^ -«* o -^ « ooos t-^CO CO COTtti-l lO lOCQ 5 a o in C0 03 .-tcoinosoooaooos ■^oq^oi>-coini--tos oq.-H'^-^eoin'^cs b- o c» o^co i>^T»< ea V-Too CO eo t-Tca ■ >j .-HODa.'^'*oi50in(M"Ti< cj2 coooocoincii>-t^Tj4i[- ° fct FH OS^COiW CO^OO^TlJ^OS^Ca CQ m" a -2 TfTco csf lO t-^o CO CD N in Sa O rfCOb-'^CSCOOOIOS^Oi o3'^;>(M'^eot^ecot-'(j <— I fH © l-H G<| pH f-< ■^ CO ^ eo^ eo • ■OS o - S2 CO •— 1 O O CO CO • • (S o OqCO^COOCOW-^IH^ . « CS Tl< l^ CO CO o ', ■ « 00 t-H S o^^o^AOinoooio,^ ^h^i-in-toqcMcoTtHiat^O ^ 40 PROFITS, WAGES, AND PRICES particular range in 1917 with the previous year. The writer has made this compilation for a num- ber of industries. The results show that the spread in 1916 is quite as wide as in 1917. A comparison for a group of identical corpora- tions in 1918 with 1917 shows that the net income for 1918 was a slightly lower percentage of the in- vestment than in 1917. But the variation in the percentages earned by different corporations is quite as pronounced in one year as in the other. The niunber of corporations earning less than 8 per cent, was slightly larger ia 1918, and the number earning over 100 per cent, was slightly smaller. But the large middle group between 10 per cent, and 100 per cent, was almost exactly the same in number in the two years. What of the pre-war period? How do aver- age profits far 1911, 1912 and 1913 compare with these of 1916 to 1918 ? Is there a similar diversity in the rates which individual concerns earn on their invested capital? For 10,020 corporations taken as a sample, the average net income for the three years 1911-1913 totaled $552,349,682. Of this amount $46,000,000 was earned by people who made less than 8 per cent.; $168,000,000 by con- cerns earning between 8 to 12 per cent. ; $163,000,- 000 by people earning between 12 and 20 per cent. ; NORMAL PROFITS AND PROFITEERING 41 and $175,000,000 by corporations earning from 20 to over 100 per cent. The next table' gives the detailed distribution. AVERAGE NET INCOME OF 10,020 CORPORATIONS FOR THE THREE YEARS, 1911 TO 1913 Ratio of Net Income to In- Number Net Income vested Capital Under 6% 1,368 $ 19,010,762 6-8% 737 26,769,920 8-12% 2,415 168,246,274 12-20% 2,929 163,090,783 20-30% 1,366 93,003,819 30-40% 553 35,429,768 40-50% 233 17,817,160 60-75% 259 16,656,266 75-100% 75 7,605,757 100% and over 85 4,719,173 Total _. 10,020 $552,349,682 For nearly 7,000 of these corporations we have the invested capital and net income for identical corporations for the pre-war period and for 1918. This smaller group had an average net income in. 1911-1913 of $212,000,000. This was 11 per cent, upon their invested capital of $1,932,000,000. ' In 1918 they earned $427,000,000 on an invested capi- tal of $2,845,000,000, being at the rate of 15 per cent. The diversity in this sub-division is quite as pronounced as it is in the entire group of 10,000. In banking we have a field of industry in which we would expect less diversity in earnings. But a glance at the next table will convince the reader 42 PROFITS, WAGES, AND PRICES that the course of banking profits is by no means smooth and even. It shows the rate which all national banks in the city of' New York, in the country as a whole, and in various sections have earned upon their capital and surplus. There is pronounced diversity in the rate of profits in these different sections. This much we would probably expect. But more striking still are the fluctua- tions within the geographical districts. In New York City earnings moved from 7.75 per cent, in 1899 to 20.01 in 1902, then back to 8.54 in 1905. They rose from 7.77 per cent, in 1915, the first year of the war, to 19.04 in 1919. PER CENT. NET EARNINGS TO CAPITAL AND SURPLUS, NATIONAL BANKS Year New Middle Total ended : New York England Western Southern Pacific United June 30 City States States States States States 1900 .. .. 16.69 6.86 10.10 10.88 11.68 8.2 1901 .. .. 10.52 5.73 9.07 11.63 11.54 10.0 1902 .. .. 20.01 5.73 10.69 11.64 13.19 10.5 1903 . . .. 12.23 6.72 10.25 11.57 14.22 10.1 1904 . . .. 13.68 5.96 9.62 11.22 12.95 10.4 1905 .. . . 8.54 5.70 8.81 11.30 12.84 9.0 1906 . . .. 11.80 7.59 9.75 11.69 13.69 9.5 1907 .. .. 12.86 8.43 10.54 12.40 14.93 16.4 1908 . . .. 10.60 7.84 9.11 9.77 11.84 9.10 1909 .. . . 9.89 6.43 8.31 9.50 11.33 8.72 1910 .. .. 10.90 8.68 8.89 10.10 12.19 9.67 1911 .. . . 8.60 7.79 10.82 10.09 10.54 9.35 1912 .. .. 9.48 7.02 8.19 9.62 9.38 8.59 1913 .. .. 10.30 7.94 8.55 10.10 10.22 9.06 1914 .. . . 8.85 6.50 8.79 9.55 8.22 8.39 1915 .. . . 7.77 5.91 7.98 7.59 7.23 7.08 1916 .. .. 11.78 8.13 8.29 8.32 7.49 8.76 1917 .. .. 15.52 9.04 10.10 9.97 8.56 10.52 1918 .. .. 15.01 9.62 11.30 10.96 9.25 11.09 1919 .. .. 19.04 9.93 11.21 11.14 10.63 12.11 NORMAL PROFITS AND PROFITEERING 43 The variations in the earnings of individual banks are, of course, much greater than this, for in this table all the banks of a single section of the country are merged and the more radical departures from the average are erased. This is well illustrated by the figures for ten of the largest banks in New York City whose earnings were presented to Congress on May 18, 1920, by Sena- tor Eobert Owen. Their combined capital and surplus was $243,000,000, with earnings of $40,- 761,742, or 16.77 per cent. The earnings of the individual banks varied from 10.45 per cent, to 35.78 per cent, on capital and surplus for the year ended December 31, 1919. These are all well- established, prosperous banks. The outsider would naturally suppose that in a fully informed and highly competitive situation such as exists upon the New York money market, earnings must approximate a uniform rate of profits. Yet in the same year we find some of these in- stitutions earning a rate' three and one-half times as high as others. Bank No. 1 with a capital and surplus one-third that of Bank No. 9 earned almost exactly the same amount net. The capital and surplus and the net earnings of these ten banks were as follows : Per cent. Net Earnings to Capital and Capital and Surplus Surplus $20,000,000 35.8 12,000,000 24.3 12,000,000 24.0 30,000,000 17.7 10,000,000 17.0 12,000,000 16.7 17,000,000 14.7 50,000,000 13.7 60,000,000 12.2 20,000,000 10.4 $243,000,000 16.8 44 PROFITS, WAGES, AND PRICES EAENINGS OF NEW YORK CITY BANKS FOR THE YEAR ENDED DECEMBER 31, 1919 Net Bank Earnings No. 1 $7,155,804 No. 2 2,920,506 No. 3 2,885,553 No. 4 5,303,744 No. 5 1,698,945 No. 6 2,009,629 No. 7 2,505,638 No. 8 6,873,634 No. 9 7,318,864 No. 10 2,089,425 Total $40,761,742 It is difficult to secure the earnings of individ- ual banks for other parts of the country, but the Treasury volume, ' ' Corporate Earnings and Gov- ernment Eevenues," shows the invested capital and net income of 1,616 commercial banks, includ- ing both national and state. The results are shown below in tabulated form. 1,616 COMMERCIAL BANKS No. Invested Net Income Net Income Per cent. Earn- Firms Capital 1917 1916 ings to Capital 1917 Less than 8%. 107 $ 35,088,303 $ 2,303,042 $ 2,234,477 8-12% 380 107,332,335 11,150,823 9,487,297 12-16% 468 53,612,373 7,357,643 6,048,510 16-20% 296 21,597,526 3,770,289 3,217,548 20-25% 196 7,219,983 1,591,193 1,203,214 25-30% 81 2,124,708 576,610 459,309 30-40% 68 2,085,134 690,370 490,221 40-50% 16 409,188 173,747 140,496 50-75% 4 88,836 50,299 37,160 Total 1,616 $229,558,386 $27,663,216 $23,318,232 NORMAL PROFITS AND PROFITEERING 45 The average earnings of these 1,616 banks are not much higher than those of all national banks in the United States. It is reasonable to suppose, therefore, that a list of all banks -would show fully as great a diversity of earnings as is exhibited by these. In fact, the diversity would be greater, for this group contains only banks which earned 15 per cent, or more on capital stock. It is unnecessary to encumber this volume with further evidence concerning the wide diversity in the profitableness of individual enterprises. To the extent that the economists and the general public have based their reasoning about normal 'profits upon an assumed minimum toward which profits tend or an average around which they group themselves closely, they have proceeded upon an erroneous assumption. The most that can be said for normality of profits is that the amount of capital that earns the average rate of profits will remain a fairly constant percentage of all capital. Also, that the amount of capital that earns less than the average rate or more than the average remains about the same one year with an- other. But the average itself is highly variable and the diversity of earnings for individual establish- ments is enormous even in so conservative and steady a business as baiiking. In fields like manu- 46 PROFITS, WAGES, AND PRICES facturing and mining it has varied widely under the influence of war conditions. Even in times of peace there is a pronounced variation of earnings from industry to industry within the same year and in the earnings of the same establishment from year to year. It is quite probable that there were a considerable number of people, even in times of peace, who were earning at a rate fully as high as the so-called profiteers made during the war. The fact is that profits are a highly fortuitous and uncertain element. The causes of their fluctua- tion are many and complex, and when a new series of events which affects prices and demand are brought into play by a world war, the resulting in- creases in profits come about quite naturally and without malice aforethought by those who enjoy the fruits of industry. Large profits, like in- creased production and high prices, their chief causes, are a part of the inevitable grist which war grinds out of our industrial machinery. Noth- ing but our puritanical habit of seeking some criminal intent behind every difficult and xmdesir- able economic situation could have driven us into the state of mind in which the American public finds itself towards those who have enjoyed these profits. Unfortunate indeed is the nation that NORMAL PROFITS AND PROFITEERING 47 has no more seijsible way of dealing with unusual industrial results than to cast the beneficiaries into jail. England's method of handling a similar situa- tion was much more scientific. She accepted frankly the fact that war brings increased profits, and proceeded to take by taxation 80 per cent, of the additional profits attributable to war. This left the ordinary machinery of the market to go on undisturbed, and covered into the public treas- ury those profits which appeared as a by-product of the war, "Whether the American puWic wiU feel that these large differentials, which have always existed in the case of some corporations, shall remain in their hands or shall be subjected to an excess profits tax, remains to be seen. All that is attempted here is to set forth the facts in order that we may proceed with a fuller knowledge of the situation. Heretofore we have proceeded upon an assumption with respect to normal profits which was largely erroneous. No final explanation of the enormous rise in profits which has occurred during the war can be made without explaining the course of prices and of wages. That is the task of succeeding chapters. It is impossible to grasp the causes of war profits 48 PROFITS, WAGES, AND PRICES apart from the causes which, dominated war prices and war wages. Nor is it possible to say whether the existence of these enormous profits during the war has been good or ill until we have seen the uses to which those profits have been put by those who have received them. That is the task of our next chapter. CHAPTER rV THE USES TO WHICH PROFITS ARE PUT In order to pass judgment upon the effect of tlie growth of profits upon our industrial life we must know the uses to which these profits are put. The large profits which resulted from war prices and war production became, immediately speaking, the property of the corporations. They did not, however, go directly to the stockholders of these concerns as sums available for personal expenditure. First of all the government exer-"^ oised its sovereign power of taxation and covered a portion thereof into the public treasury. Next the management and directorate of these concerns decided that a large part of what re-, mained after taxes should be retained in the business for the purpose of extending plant or paying debts. A part was then paid to the stock- holders as dividends. Less than 45 per cent, of the~J net income of all corporations was distributed in dividends between 1916 and 1919, Since 60 per cent, of all dividends are paid to people with iu- comes of $20,000 and over, these in turn were sub- 49 50 PROFITS, WAGES, AND PRICES jected to high surtax rates, while a considerable portion of what was left to the individual after the payment of taxes was saved and invested in new enterprises and plant extensions. Only the remainder was spent on personal consumption. The first step, then, in the disposition of busi- ness profits is the payment to govenmient of a certain portion of these profits as taxes. In Chapter II we have shown the amount of taxes paid to the federal government apd the net income remaining after such payment. From 1909 to 1915 these taxes absorbed one per cent, of the corporate profits. In 1916 two per cent, was paid to the government. In 1917 the increase in the rate of the corporation income tax and the imposition of the excess profits tax increased the percentage of profits paid over to the federal government to 20 per cent, of the cor- ' porate earnings. In 1918 a further increase in rates and the addition of a war profits tax took 33 per cent, in taxes, while with a reduction of rates in 1919 the percentage fell again to about 21 per cent. Approximately seven billion dollars of corporate profits have thus been contributed to the federal government in three years. This is an amount equal to twice the average annual earn- ings of all corporations from 1909 to 1913. THE USES TO WHICH PROFITS ARE PUT 51 The amount paid in state and local taxes is available only for 1917. In that year the corpora- tions had paid to these political units taxes amounting to $1,040,621,000. These were included in operating expenses and deducted in reporting their net income to the Treasury. Since state and local taxes have been gradually rising for some years it is fair to assume that the taxes for 1916 are slightly less than one billion dollars while those for 1918 are somewhat in excess of the pre- ceding year. State and local taxes for these three years thus amoimted to three billion dollars. The total amount contributed during this period by the corporations of the United States to state and fed- eral governments was therefore ten bUlion dollars. We have included state and local taxes with federal taxes for the purposes of this discussion, despite the fact that those taxes were deducted in arriving at net income reported for federal taxation. For this deduction does not alter the fact that the taxes collected by the state and local governments constitute a subtraction from the in- come of the corporation. The table on page 52 shows the net income of all corporations by classes, and the amount paid in federal, state, and local taxes. The ratio of excess profits taxes to net income 52 PROFITS, WAGES, AND PRICES S I 2 S ^^6^^^ ^3' m O t— t Eh H ^ &: O OS m CD CH i-H e Si W O CO o n H ^ O « o u t^ rH V eg g) C O dj M O ^ 03 cq eq se- es Oi •>* CO , »-* CO . 00 o efoT cq to oj mo OO 00 OS Neoo J>- CO U3 CO 00 00 CO CO OS oa V CO CO CO ea oT-^ o 00 la g oToo CO lo w 'H coeq mei-di OS CO o Ooo'Tf CO CO(N 00^ ©3^00 ©foT CO eooo OS 00 CO «0^ l-H 6 CO 13 : S „« * ^ ■^ «>_ rp co" CO* o ei o i-i OS «■ 003 r-t 00 O i-H t* 00 OJ oco o CO t- CO oco_ CO ** r-^n o aot~ CO -*^r-( t- 1— ( o" S- ^ THE USES TO WHICH PROFITS ARE PUT 63 varies widely. It amounts to over 18 per cent, for industrial concerns and to less than 5 per cent, for public utilities and financial corporations. But when all taxes, federal, state and local, are compared with the net income of the different classes of corporations before paying any taxes the percentage of earnings ^contributed to the gov- ernment is surprisingly alik^ for the various classes, as is shown by the last column of the table. The reason is a simple one but is not generally understood by the public. An investigation of state and local taxation shows that railroads, jbanjis and public utilitie s pay a very much higher rate of tax on the value of their property or on the income earned than do mining, manufac- turing and mercantile corporations. One of the most striking illustrations is found in the situa- tion set forth by the Special Commission of In- quiry into Taxation for the State of Michigan in 1911. This Commission estimated that the rate of taxes upon property values in the case of railroads was over 2 per cent., in the case of banks and tmist companies 1.7 per cent., and in the case of manu- facturers .5 per cent. The taxes in that state amounted to over 30 per cent, of the net earnings of railroads and to but 6 per cent, of the net earn- ings of manufacturing corporations. 54. PROFITS, WAGES, AND PRICES The report of the Special Legislative Commit- tee on Taxation for the state of New York in 1915 shows a similar disparity in the percentage of income contributed for state and local taxes by various industries in New York. An independent report of a committee appointed by the Trust Companies Association in the same year places the ratio of taxes to net income at 20 per cent, for public utilities, 15 per cent, for trust companies and banks, and 3 per cent, for manufacturers. This situation has since been remedied to some ex- tent in New York by a state income tax of 3 per cent, upon manufacturing corporations. But the ten billion dollars taken from the cor- porations directly does not exhaust the story of the government's share in these prpfits. In 1916 $2,136 million of dividends were reported as in- come by individuals in their tax returns. In 1917 $2,848 million were so reported. Dividends are received primarily by people with large incomes, and are therefore subject to the highest surtax rates. The table below shows for such individ- uals the actual per cent, of dividends to net income for 1916 and 1917. They are not available for any later years. THE USES TO WHICH PROFITS ARE PUT 55 INDIVIDUAL INCOME TAX RETURNS Per cent, of dividends to net income 1916-1917 Income class 1916 1917 P 4,000 to $ 5,000 4.2% 8.4% 5,000 " 10,000 13.9 15.3 10,000 " 20,000 27.5 29.2 20,000 " 40,000 37.2 39.8 40,000 " 60,000 42.1 46.5 60,000 " 80,000 44.5 50.4 80,000 " 100,000 46.9 51.3 100,000 " 150,000 44.4 53.2 150,000 " 200,000 48.3 54.1 200,000 " 250,000 46.2 55.9 250,000 " 300,000 51.3 60.8 300,000 " ^ 500,000 46.8 57.0 500,000 " 1,000,000 53.0 67.7 1,000,000 " 1,500,000 51.7 76.6 1,500,000 " 2,000,000 54.4 66.9 2,000,000 and over 64.6 82.8 Average . 35.2 un During the three years 1917 to 1919 a total of more than one billion dollars was paid in taxes to the government by individuals on account of these dividends. Various income taxes were levied by the states in addition, but these were at compara- tively low rates. In all the federal, state, and local governments have taken in taxes nearly four billion dollars annually since 1917. This was the first claim upon profits. To the extent that taxes are paid in this manner, the general public shares in profits by being relieved of a correspond- ing amount of taxes which would otherwise be im- posed upon them. 56 PROFITS, WAGES, AND PRICES Profits wMch are not paid to the government as taxes or distributed to the stockholders as div- idends are retained as an addition to corporate surplus. These profits become either an addition to the liquid assets of the corporation in the shape of cash, bank deposits, or accounts receivable ; an addition to the tangible assets in the shape of plant facilities or additional materials and sup- plies or goods in process; or they are used for the purchase of government or other securities or the payment of debts. These corporate savings are one of the principal sources of capital accumu- lation in America. The failure to realize this fact is probably responsible for the derogation in which we have held ourselves in this matter of savings. The volume of savings in the United States as compared with other countries has usually been underestimated, partly because of the slight at- tention given to certain sources of accumulation and partly because of a failure to distinguish be- tween accumulation and investment. In such a country as France, for example, a much larger proportion of the annual accumulations pass through the investment market than in the United States. France is less industrial than the United States ; the corporate form of business organiza- tion is less common ; and there are fewer oppor- THE USES TO WHICH PROFITS ARE PUT 57 tunities within the country calling for capital. The consequence is that saving is likely to take the form of an investment through the purchase of securities, quite likely of foreign, securities. Such saving becomes evident and lends itself read- ily to statistical measurement. But a comparison of aimual savings based upon the sale of securities to investors would be valid only if the same pro- portion of savings in France and the United States were put into securities. There is in France little to correspond to the great volume of corporate savings annually accumulated in the United States. The additions to corporate sur- plus do not normally pass through the security market and so commonly attract little attention, but they are none the less real. The railroads and industrial concerns in the United States have grown at a rapid rate, and in recent years they have added largely to the capital accumulations of the country through their additions to surplus. The importance of the retention of corporate earnings as a source of capital accumulation is shown by the statements of state and national banks. On June 30, 1919, the capital, surplus, and undivided profits of national, state, savings, and private banks and loan and trust companies amounted to $5,445,248,000. Of this amount 68 PROFITS, WAGES, AND PRICES $2,437,365,000 represented the par value of the capital stock outstanding, and $3,007,883,000 rep- resented the surplus and undivided profits. Some of this capital stock was issued as stock divi- dends or purchased with cash dividends declared for this purpose and charged against previously- accumulated surplus ; and some of the surplus ap- pearing on the balance sheet was paid in as premium when the capital stock was issued. It is impossible to say how much each of these two items amounts to, but it seems certain that the stock dividends exceed the surpluses paid in as premiums on stock. The capital of the banks created through the retention of earnings cer- tainly exceeds that contributed by the stockholders by twenty-five per cent. It is by no means improb- able that the retained earnings exceed the original contribution of the stockholders by fifty per cent. In other lines of industry the data are not so complete or so satisfactory as in banking. Neither the accounting for plant and other assets which represent invested capital nor the statements of income and profits are on the same simple and dependable basis in such industries as railroads, public utilities, mining, and manufacturing, as they are in the case of banking. The charges to capital and charges to revenue allow compara^ THE USES TO WHICH PROFITS ARE PUT 69 tively little discretion in the banking business. The problem of depreciation is ahttost entirely- absent, and the item of maintenance and repairs is practically insignificant. All this is different in industrial enterprises. Here the decision to charge every doubtful item to operating expense rather than to capital will yield a -widely different showing of profits than would result if all doubts were resolved in favor of a charge against capital. In both cases an addi- tion to physical assets would result, but in one case this would show in the accounts as a rein- vestment of retained profits, while in the other case it would not show, but would be buried in operating expenses, the assumption being that this expense resulted merely in the maintenance of the property rather than in additions to capital. Upon the whole anyone experienced in such mat- ters is pretty well convinced that the accounts of most industrial corporations understate profits rather than overstate them. The same is prob- ably true of railroads and public utilities taken as a whole, though here the case is not so clear, espe- cially in the earlier stages of the enterprise. In the case of railroads this policy of build- ing up property out of earnings is well estab- lished. The policy of the Pennsylvania lines is 60 PROFITS, WAGES, AND PRICES proverbial, but no exact figures are available. An investigation of the accounts of the Lake Shore & Michigan Southern Railroad in 1913 showed that total earnings of that system from 1870 to 1914 inclusive amounted to over $322 million, after adjusting the accounts to bring the statement of earnings into conformity with the Interstate Commerce Commission classification. Of this amount $167 million was distributed in dividends, and $155 million, or 48 per cent, was retained as surplus. The total stock outstanding in 1914 was $50 million ; it had stood at this figure for many years. Nor has this practice been limited to prosperous lines. The Texas & Pacific Eailway, between 1888 and 1915, reinvested earnings amounting to over twenty-five million dollars. During this period it paid nothing whatever on its stock and less than ten million dollars on its income bonds. A tolerable estimate can be made of the total volume of corporate savings for railroads by using the income statistics shown in the publica- tions of the Interstate Commerce Commission, These show that during the decade 1890-99 the railroads reinvested only $125 million of profits. The next decade, 1900-09, saw ten times that amount reinvested. Since 1910 the amount re- THE USES TO WHICH PROFITS ARE PUT 61 invested has varied widely. 1910 itself saw the largest amount added to the property out of earn-, ings of any year up to that time, the total reaching $165 million. 1911 and 1912 were ordinary years. 1913 was another prosperous year, in which the corporate saving almost reached the high figure of 1910. In 1914 the dividends exceeded the earn- ings by $33 million, and the reinvested surplus was small in 1915. From June 30th of that year until the end of 1917, the railroads fared ad- mirably in this respect, and accumulated $1,350 million. Evidently a much smaller part of the invest- ment in the railroads of this country was made out of profits than in the case of banking. It is probably a safe estimate to say that the total reinyested profits of the railroad industry are not greater than four billion dollars, even after allow- ing for adjustments in accounting practice which bring the statements into conformity with the In- terstate Commerce Commission classifications. Manufacturing and mining corporations have no statistical record of net income and its dispo- sition, comparable to that which exists for banks and railroads. Figures compiled from the pub- lished reports of 251 corporations show the results set forth in the table below. Previous to the out- 62 PROFITS, WAGES, AND PRICES break of the war these corporations were retain- ing roughly one-third of their income for reinvest- ment. During 1916, 1917 and 1918 the proportion rose to over 60 per cent. For the eight-year period they retained an average of more than 50 per cent, of their net income for reinvestment ; the total amount thus retained and reinvested during this period approximated $3,600 million. NET INCOME, DIVIDENDS, AND SURPLUS OF 251 CORPORATIONS 1911-1918 Net Income Surplus Year After Taxes Dividends After Taxes 1911 $ 458,781,665 $307,249,292 $151,532,373 1912 513,401,501 320,491,288 192,910,213 1913 542,109,388 353,872,869 188,236,519 1914 , 415,335,092 316,471,173 98,863,919 1915 698,703,872 347,176,559 351,527,313 1918 1,402,745,696 555,822,063 846,923,633 1917 1,600,906,267 618,006,214 982,900,053 1918 1,341,207,084 582,776,283 758,430,801 These corporations have outstanding at the present time approximately $6,500 million of capi- tal stock. For the ten-year period, 1910-19 inclu- sive, it seems pretty certain that their total re- invested income will amount to $4,500 million, or 75 per cent, of the par value of their capital stock outstanding. There are numerous isolated cases of establishments which have reinvested in war profits alone an amount in excess of all the capital stock outstanding. Many of the extremely profit- able corporations, like Com Products Befining, THE USES TO WHICH PROFITS ARE PUT 63 have paid no dividends whatever. And others, like Republic Iron & Steel, have paid out only a small fraction of their earnings. Gigantic enter- prises, such as the Ford Motor Company, have been constructed entirely out of profits. For the smaller corporations, tho^e which are in fact corporations only in name, their stock be- ing closely held, the same thing is true. From the volume, *' Corporate Earnings and Government Revenues, " previously cited, we have selected 4,508 manufacturing corporations which have in- vested capital of $100,000 and over but which are not as large as the 251 corporations included in the table above. These corporations show capital stock of $1,619,045,004 and invested capital, as that term is defined under the 1917 excess profits tax law, of $2,947,538,517. Their invested capital amounts to 182 per cent, of their capital stock. Facts like these should help to correct the er- roneous popular impression concerning watered stock. It is true that these are selected from among the more profitable corporations, since only companies earning 15 per cent, or more on their capital stock were included in this volume. Yet this probably shows the result of a policy which is pretty generally pursued by directors in the management of corporate enterprises. The table 64 PROFITS, WAGES, AND PRICES on the opposite page gives the capital stock and invested capital for the companies by industries. What is the sum total of savings made in this manner by all the corporations of the country? It is possible to arrive at a tolerable estimate of the surplus reinvested out of the net income re- ported by the various classes of corporations, after deducting income and excess profits taxes. The amount reported as net income has been di- vided between dividends on the one hand and surplus on the other according to the ratios re- vealed by an extensive process of sampling. To obtain these ratios each class of corporations and each year has been taken by itself and a study made of the published reports. The results ob- tained by applying these ratios to the net incomes reported are set forth in the table below. ALL CORPORATIONS IN THE UNITED STATES REPORTING NET INCOME (000 omitted) Net Income Dividends Surplus Year After Taxes Paid Reinvested 1909 $ 3,125,481 $2,125,481 $1,000,000 1910 3,360,251 2,290,251 1,070,000 1911 3,213,706 2,226,685 988,021 1912 3,832,151 2,498,149 1,334,002 1913 4,339,551 2,871,435 1,468,116 1914 3,710,600 2,411,900 1,298,700 1915 5,184,400 2,594,700 2,589,700 1916 8,594,095 3,783,900 4,810,195 1917 8,587,914 4,651,900 3,936,014 1918 •6,300,000 4,250,000 2,050,000 1919 •6,700,000 3,900,000 2,800,000 * Estimated. THE USES TO WHICH PROFITS ARE PUT 65 > o ^ o o 1^ o ^05 o 00 CO(M . U5 t- O t^ Tji ■* iO CO iq^Oi^^ ^"^ CO O"-^ CO 00" WW 00 CO « r-l Tt< "^ «*3 &3 S d ONCSOb-05t*(0001Ti*U5 o RSt-ooinTcmrHt-iNiOTt'ts u S^03 ca e iM CO i-i ^ f-H 10 CO m 3 'S) '3^ ■ ft) ^ ^ , 00 V tn CQ S 03 a<-l (3 bo ^ mS SK "*S n^ 66 PROFITS, WAGES, AND PRICES Contrast one of these figures for corporate sav- ings, that of 1913, for example, with the total savings of other countries. The annual savings of England and Germany were generally esti- mated at two biUion dollars each for the years be- fore the war. In 1913 the corporate savings of the United States were three-fourths this amount. This takes no cognizance of the provision for depreciation amounting to another billion and a half. In a growing community only a small part of this replaces worn out plant ; it is all available for utilization of the latest improvements in the arts. Mr. Keynes gives us a spicy description of the psychology of capital accumulation under our present system in the following words; "The immense accumulations of fixed capital which, to the great benefit of mankind, were built up during the half century before the war, could never have come about in a Society where wealth was divided equitably. The railways of the world, which that age built as a monument to posterity, were, not less than the Pyramids of Egypt, the work of labor which was not free to consume in immediate enjoyment the full equivalent of its efforts. "Thus this remarkable system depended for its growth on a double bluff or deception. On the THE USES TO WHICH PROFITS ARE PUT 67 one hand the laboring classes accepted from igno- rance or powerlessness, or were compelled, per- suaded, or cajoled, by custom, convention, author- ity and the well-established order of Society, into accepting, a situation in which they could call their own very little of the cake that they and nature and the capitalists were co-operating to produce. And on the other hand the capitalist classes were allowed to call the best part of the cake theirs and were theoretically free to consume it, on the tacit underlying condition that they con- sumed very little of it in practice. The duty of 'saving' became nine-tenths of virtue and the growth of the cake the object of true reli^on. There grew round the non-consumption of the cake all those instincts of puritanism which in other ages has withdrawn itself from the world and has neglected the arts of production as well as those of enjoyment. And so the cake increased; but to what end was not clearly contemplated. Individuals would be exhorted not so much to abstain as to defer, and to cultivate the pleasures of security and anticipation. Saving was for old age or your children ; but this was only in theory, — ^the virtue of the cake was that it was never to be consumed, neither by you nor by your children after you." 68 PROFITS, WAGES, AND PRICES If the duty of saving was, as he says, nine-tenths of personal virtue before the war, increase of the capital equipment of the corporation through the retention of earnings involving little or no con- sciousness of painful abstinence on the part of the stockholders was niae-tenths of the wisdom of cor- porate management. It is vicarious saving in which the directorate takes upon itself all the groaning and backache involved in the decision to postpone consumption to the future. As a consequence only one-third of the enor- mous war profits ever got into the hands of the stockholders. That third the government insisted on sharing with them by subjecting it to surtaxes. A substantial portion of what the stockholder had left went to furnish the great body of the invest- ment funds of the country. It is no exaggeration to say that not more than one-fourth, and prob- ably not more than one-fifth, of the whole volume of corporate profits was actually spent by the stockholders of these concerns. The other 80 per cent, went for taxes, for loans to finance the war, and to furnish the funds for industrial expansion. CHAPTER V THE RATE OF INTEREST The significance of the statement that profits con- stitute the heart of American business, and that the fluctuations in profits are vital in explaining industrial and financial process, becomes apparent if we trace the course of the rate of interest dur- ing the last five years and the manner in which it has been affected by the course of profits. Amid all the confusion of thought which followed the outbreak of the war, everyone seemed confident that the rate of interest would rise sharply if the war continued for any considerable length of time. Instead, it remained low for more than two years and rose only after we entered the conflict. This movement of the rate of interest from the begin- ning of 1915 to date is so important that it deserves detailed treatment. Such an examina- tion should clarify and advance the theory of inter- est and should enable us to forecast the future movement of the rate with greater accuracy. Thinkers have always been put to it to explain why such a thing as interest existed at all. Aris- 69 70 PROFITS, WAGES, AND PRICES totle thought that there was no good reason for its existence. Money was barren ; it did not mul- tiply and reproduce itself, and therefore there seemed to him no good grounds for the payment of a hire for Its use. If I give to another the use of my fertUe field, he can sow it with wheat and his seed is returned to him twentyf old. It seemed natural that I might in all justice ask him to give me a portion of the product in return for the use of the field. It was productive and it seemed reasonable that the owner should share in the product. But if I loaned him a thousand units of my money and he placed it in his wallet or in a strong-box it remained one thousand units until the end of time. How could I justly ask that he return it to me with interest? Starting with Aristotle's point of view, the me- dieval church held that there was no ground for the payment of interest, and that the taking of it was anathema. The Socialist school of political economy today likewise asserts the injustice and unreasonableness of interest, and its abolition is one of the prime objects of Socialist reform. Today we look upon interest simply as a price for the use of capital, and we consider its exist- ence and reasonableness quite as natural as the prices for other commodities. Aside from the THE RATE OF INTEREST 71 Socialists no one is particularly concerned, as the ancients were, about the justice of interest. WhUe capital is usually loaned in the form of money, which is barren, we know that people desire not money but the goods which it will buy. These are productive. People who have tools, machines, fer- tile fields, and ships find them an aid in the crea- tion of goods and services as well as a source of profit. The objection which was based upon the barrenness of money capital has therefore dis- appeared. Most economists believe today that interest is an element which would have to be reckoned as a cost of production and which would therefore enter into price in any industrial sys- tem. Accepting interest as a part of the regular order of things, the business man and the finan- cier are concerned primarily with the forces which underlie fluctuations ia its rate. They wish to know the causes of the rise and fall in the rat© of interest so that they may forecast these move- ments and order their business conduct accord- ingly. The experiences of the war taught us that our knowledge of these causes is as yet quite in- adequate. The widespread belief of bankers and economists that the rates of interest in the United States would rise quickly and sharply as a result 72 PROFITS, WAGES, AND PRICES of the war in Europe seemed to have the support of logic and historical precedent. The rate of interest is the price paid for the use of capital. Being a price it is governed by supply and demand upon the money market. Pre- vious to 1914^ we had been receiving considerable supplies of capital from Europe; these would surely be cut off. In addition Europe was cer- tain to demand from us a return of some of the capital which she had loaned us in the past de- cades. She would also try to borrow through the flotation of her government bonds, but these, we rather thought, would not find a ready market in a country so little given to saving and invest- ment as America. Nor could we foresee an in- crease in the supply of American capital through new and additional savings sufficient to meet this demand and keep the rate of interest low. The consequence would be a rise in the rate of inter- est brought on by this checking of supply and the increase in demand. Certainly one never felt himself upon safer and saner ground than when prophesying after this manner in the class-room, on the platform, or in the press, and yet it did not come to pass. Our supply was cut off, to be sure. By the resale of American securities and by the flotation of gov- THE RATE OF INTEREST 73 eminent loans during 1915 and 1916 Europe was more successful in demanding and obtaining capi- tal here than either she or we had thought possi- ble. Between five and six billion dollars of capi- tal were drawn from this country during those two years. In addition to this export demand we were expanding our own industrial plants at an unprecedented rate. All expectations of an increased demand for capital in the United States were, therefore, realized two or three times over. But at the end of 1916 the rates for both short- time bank loans and long-time investment loans were still low. The course of American interest rates for the decade before the war had shown conclusively that they were especially sensitive to variations in demand. In 1903 it was possible to market high- grade railroad and other bonds on a three and a half per cent, basis. By 1913 the best that the most stable corporations were able to do was to market their obligations on a five per cent, basis. Eoughly, the rate had risen by 40 per cent. One consequence of this rise in the rate of interest was the financing of the capital needs of corporations through the issue of short-term notes, which were commonly put out at a rate which brought the cost of capital to more than six per cent. 74 PROFITS, WAGES, AND PRICES Throughout this decade, 1903-1913, there was "without doubt an increase in the supply of capi- tal available for investment. The individual de- posits of aU banks sho-wn in the Eeports of the Comptroller of the Currency were $9.5 billion in 1903 and $17.5 in 1913. The productivity of the nation and its volume of output was larger than it had been for any previous period of our his- tory. The output of copper had risen from 700 million pounds to 1,224 million; the production of iron from 18 million to 30 million ; the produc- tion of cotton from 10 million to 14 million bales j of wheat from 600 million to 760 million bushels. The value added by manufacturing industries had increased from $6.3 biUion to $10 billion, and the value of farm products from $6 billion to almost $10 bniion. The supply of capital was undoubt- edly growing throughout the decade. But demand for capital was increasing more rapidly than the supply. As a result an ever- rising rate of interest cut off the less important uses for that capital and reduced the demand to the point where it was covered by the available investment funds. The active causes of the in- crease in the rate of interest during' this decade must therefore be sought in the forces which were increasing demand. THE RATE OF INTEREST 76 One of the two principal uses of capital is found in the industrial needs for plant extension and for additions to working capital in the form of ma- terials and supplies. New factories, new machin- ery, larger and more expensive electric light and power plants, extensions in our telegraph and telephone systems, additional railroad equipment, additional railway tracks with heavier rails and rock ballast in place of gravel; all of these con- stituted a demand for capital. These additional plant facilities are capital in the time-honored eco- nomic sense of produced goods devoted to further production. Their distinctive characteristic is that their construction and use take time and so involve a period of waiting, or "abstinence," as the older economists called it. If they are to be produced, consumption must be postponed. A railroad is without doubt an efficient means of transportation, but one cannot exhaust its trans- portation uses in a single year. Its construction requires the expenditure of labor and materials in a project which wiU return the value of the orig- inal labor and material only over a series of years. Nothing can be devoted to the extension of our capital equipment except the excess of our produc- tion over our consumption. The demand for this capital equipment was 76 PROFITS, WAGES, AND PRICES growing at an enormous pace in the decade 1903- 1913. Our manufacturing capital alone as shovm by the Census of Manufactures increased from $12 billion to $22 billion during these years. De- spite the fact that the Census warns us that the statistics of capital are defective, it is pretty cer- tain that the increase in capital invested is fully equal to that shown by a comparison of the two sets of figures. The primary horsepower con- sumed in these establishments furnishes evidence that the growth of physical capital was roughly proportional to the increase in investment. In 1914 the primary horsepower in manufactures was 22 naillion, as against 13 million in 1904. In- dustries like automobile manufactures grew from insignificant beginnings in 1903 to first-rate pro- portions in 1914. Manufactures of such staples as textile fabrics increased the primary horse- power used and the value added by manufacture by 50 per cent. The comparable increase ia the manufacture of agricultural implements, was 40 per cent.; in women's clothing 100 per cent.; in electrical machinery 100 per cent. In practically all lines the increase had been tremen- dous. Even in the case of railroads the increase in physical equipment during this decade is com- THE RATE OF INTEREST 77 monly underestimated. The total tractive power of all locomotives in the United States during 1913 was 1,847 million pounds, as against 941 million in 1903; the capacity of freight cars 86 million tons, as against 48 million ia 1903. In other words, the amount of tractive power and freight car capacity added by the railroads in this decade was practically equal to that which had been accumulated in more than half a century pre- vious to 1903. The increase in the value of rail- roads and their equipment shown by the Census for the eight years, 1904-12, amounted to almost 50 per cent. Public utilities like the telephones and the elec- tric light and power plants showed the most as- tonishing growth in capital investment of any field of industry. The number of telephones in use in the entire Bell system in. 1903 was approximately 1,500,000. By 1913 it had grown to 7,500,000. The cost of construction of all telephones and equip- ment in the United States in 1902 was $389 mil- lion. Between that date and 1912 the Bell Tele- phone System alone invested over $500 million in plant equipment. The cost of construction and equipment and of real estate of street and electric railways increased from $2.1 billion in 1902 to $4.6 billion in 1912 ; while electric light and power com- 78 PROFITS, WAGES, AND PRICES panies increased from $504 minion in 1902 to $2,175 million in 1912. In short, in a very large part of American in- dustry, the capital investment of the decade pre- ceding the outbreak of the European war was equal to that which had been made in all the previous years. "" Since our recovery from the depression of 1893-1896 we have invested as much capital in manufacturing, railroads, public utili- ties and mines as we had invested in those indus- tries in all our previous history. Obviously this extension of industrial plant was one of the prime causes of the increase in the demand for capital which led to the higher rate of interest. But the production of goods devoted to further production is not the only source of demand for capital. Certain goods, like houses and automo- biles, which do not minister to productive activi- ties, require waiting for their construction and use as much as do factories and railroads. The construction of a house involves the putting forth of a greater volume of productive effort than can be enjoyed or consumed through its use within the year. The same is true of business and pub- lic buildings and of durable goods like automo- biles. Anyone who has observed the growth of our cities and the improvement in the quality of THE RATE OF INTEREST 79 every type of building, both public and private, during this decade before the war, must have been impressed by the volume of capital which these building operations absorbed. In the cities of the Middle West, like Detroit, Kansas City, Dallas, Akron, and dozens of others, there are acres upon acres described as "better residence sections" covered by dwellings whose erection has absorbed hundreds of millions of capital during the last two decades. The total assessed value of all build- ings in the City of Detroit in 1903 was $77,519,360. The city contained 17 wards at that time. In 1913 one ward had been added and the value of buildings stood at $170,931,030. The basis of as- sessment remained practically the same. This is entirely exclusive of such suburbs as Highland Park, where the Ford factory is located. The value of automobiles produced in 1914 alone ex- ceeded $500 million. A decade before it amounted to only $30 million. The demand for capital for those building operations and for the purchase of automobiles is the other factor which explains the increase in the rate of interest. With this experience as a basis for our fore- casts it seemed clear that the increase in the Euro- pean demand for capital would bring about a further rise in the rate of interest if the war con- 80 PROFITS, WAGES, AND PRICES tinned for more than a few months. Such was the judgment of those skilled in explaining the course of the money market. The obvious ex- planation of the failure of our prophecy would seem to be that the supply of capital had in- creased in such manner as to keep it equal to the demand even at a low rate of interest. This explanation is borne out by the facts con- cerning capital accumulation. These facts are not easily discovered, but a study of the avail- able statistics warrants the following conclusions : The excess of production over consumption in the United States in 1913 amounted to $6.5 bUlion. By 1916 it had risen to $14.5 bUlion, and by 1918 to $22 billion. The figures as stated for 1918 are before deducting our war expenditures. If the government had not taken these sums by extraor- dinary taxes they would have been available for investment, either in government bonds or in cor- porate securities. Since the close of the war the accumulation of capital has decreased materially. Despite the fact that figures today are expressed in fifty-cent dollars, the increase in capital dur- ing 1919 was probably less than $15 billion. There are at present no figures regularly com- piled which show directly the capital accumula- tion of the nation. This has long been the dark- THE RATE OF INTEREST 81 est portion of the whole field of economic statis- tics. It is necessary, therefore, to set forth in some detail the manner in which we have arrived at these figures for the growth of capital. The addition to the wealth of the nation through savings in the period previous to the European War was determined by comparing the wealth of the United States in 1912 with a similar inventory for 1904, as shown by the Census volume, "Wealth, Debt, and Taxation," 1913. In comparing these two inventories to determine the amount added by production during this period, it is necessary to eliminate increases due to price changes and to the increased value of land, because neither of these represents any increase in tangible wealth. After determining the increase, the amount was distributed among the various years on the as- sumption that the increase was progressive, and a like increase was assumed for 1913. ESTIMATES OP CAPITAL WEALTH IN THE UNITED STATES, 1912 AND 1904 (in hillionsof dollars) Item 1912 1904 Increase Eeal Estate $110,676 $62,341 $48,335 Live Stock, farm implements 7,607 4,919 2,688 Manufacturing, railroads, and public utilities 32,505 19,383 13,122 Gold and silver 2,617 1,999 618 All other 34,334 18,462 15,872 Total $187,739 $107,104 $80,635 82 PROFITS, WAGES, AND PRICES According to the above figures, the wealth of this coTUitry other than real estate increased by $32 billion during the eight years, 1904-12, or an average of $4 billion per annnm. Eeal estate in- creased $48 billion or about $6 billion per annum. Much of the increase in the money value of real estate does not represent savings, but is the re- sult of a rise in land values brought about by in- creased population and industrial activity in the community. The building permits issued in the larger cities give some evidence of investment in new buildings. This amounted in 1913 to about one billion dollars for 273 large urban communi- ties. Besides these improvements in the real es- tate of large cities there were large investments in towns and villages, and. in farm improvements such as draining, clearing, fence and road build- ing, and orchard planting and cultivation. An examination of the real estate assessments of twenty-four states which separate improvements on real estate from land values shows that im- provements constitute approximately 40 per cent, of the land values. This group includes such di- verse communities as Arizona and Idaho on the one hand, and Greater New York on the other. The total assessed value of these twenty-four states is over $32 billion; the total exclusive of THE RATE OF INTEREST 83 New York City is $24 billion. It has, therefore, been assumed that 40 per cent, of the increase in real estate values during the period 1904-12 was to be ascribed to improvements. The average an- nual increase in the value of real estate improve- ments was therefore $2.4 billion. This, added to the increase of $4 billion per annum, in other wealth, gives a total of $6.4 bUlion as the in- crease in produced wealth per annum for the period. Of this increase about one billion is due to a rise in the price level, and not to additional wealth production and saving, leaving $5 biUion as the average annual supply of capital for the period. But the increase during the years just before the war was more rapid, and undoubtedly reached the figure of $6.5 billion given above. This esti- mate is below the estimate of $7.5 billion made by George E. Eoberts, of the National City Bank. He, however, makes no deduction for the increase in the price level from 1904 to 1912. It is also slightly under the estimate of Sir George Paish, which appeared in the London Statist, May 23, 1914, in which he places the annual growth of wealth in the United States at £1.4 billion. "With this figure as a starting joint the next problem is to discover some method of arriv- 84 PROFITS, WAGES, AND PRICES ing at the increase in savings for subsequent years. We have had no oflBcial estimate of the national wealth since 1912, therefore it is impossible to proceed as in our pre-war estimates. A large part of the capital accumulated is invested in corpor- ate and government securities, so that the securi- ties absorbed by investors of the nation furnish an approximation to the volume of savings of the country. The table on page 85 shows the avail- able statistics concerning securities issued and marketed, together with gold and securities repur- chased from abroad during the period 1913-18. The amount increased from $2,053 million in 1913 to $6,563 million in 1916 and $14,010 million in 1918. In 1919 it had decreased to $8,483 million. These figures take no cognizance, however, of the corporate securities not listed by the Journal of Commerce. That these are considerable in vol- ume becomes clear when we compare the Journal of Commerce figures with the actual increase in capital obligations outstanding for all corpora- tions. The total capital stock and bonded and other indebtedness outstanding for all corpora- tions in the United States for the years 1910-13 are available in the reports of the Commis- sioner of Internal Revenue. During this period THE RATE OF INTEREST 85 ■ ■^O OO 1-1 ffiOJ OOIO 05 •-H O lO lO t* 04 U3 O o »^ r-1 Vi '!0 t:~ Q^ M O « OO O 00 ■*o ■* oTof o" «■ OO o s l-H O o« lO o rH TjT f-H EQ H n I o W CD o c> t-gjoco g; o j:;ioQOQo_-*t- ri 00 00 . OS o 5 l-H m ■ •* o_^ rl (kTi-T ■