Preventive Economics
I
ELLIS PARKER BUTLER once wrote about a cow that learned to climb a tree. Her antics fascinated those who watched her. She was much more exciting than the ordinary cud-chewing cow. But when she got home at night she did n’t give much milk.
Economists who went into the business of financial forecasting during the 1920’s were about as far from their regular job as Mr. Butler’s cow. But they were far more spectacular than their more orthodox colleagues. They were the fellows who got the headlines, and naturally they were regarded by the public as the leaders of their profession.
By 1929, many people had come to think of an economist as someone who could see over the next peak in the Dow-Jones stock averages. When the guesses of most of these financial soothsayers turned out to be bad, the entire profession of economic research suffered an undeserved loss of prestige.
What little faith the public retained in economists generally has been further shaken, since the coming of the Blight, by the advent of a new horde of self-styled economists promoting crackpot theories for the creation of wealth out of thin air. The boom-time prophets had promised riches for everyone who had a stake in the market. The new crop went them one better and promised Utopia for everybody.
What the public must be made to realize is that mere advocacy of an economic theory does not make a man an economist. In recent years there has been developed a kind of special pleading that passes for economic research, although it is n’t research at all in the true sense of the word. It starts out deliberately to seek facts in support of a preconceived premise. When economists went on some business man’s payroll, a change in their attitude necessarily occurred in most cases, whether they realized it or not. Most of them were turning out not economic treatises but sales-promotion material.
As compared with this, true research is impartial and unprejudiced. It seeks to prove nothing. It has no axe to grind. It is a pure fact-finding effort, seeking only the truth, and letting the chips fall where they may.
Even in those rare cases in which business-men economists remained free of sales pressure, their points of view were usually too restricted to permit the broad economic fact-finding and reasoning that were needed. Each was looking intently at his little portion of the general economic picture. If he found his sector to be reasonably sound, he issued assurances as to the future. Meanwhile, too few people were investigating impartially the fundamentals of our economic structure and their broad interrelationships.
Because of confusion as to what economic research really is, there seems grave danger that all faith in its value may be discarded. Such a result would be unfortunate, for never has there been a time when a greater need for it has existed. But the requirements of sound economic research are very difficult. In the first place, it requires complete objectivity. Next, it is too big a task for individual effort. It calls for the effort of an entire organization of trained people. Furthermore it requires a great deal of time and money, because, properly done, it is a long and tedious task. Much economic research has proved futile because conclusions have been based upon insufficient facts.
In strange contrast to the almost universal loss of reputations elsewhere in the field of economics has been the increasing respect accorded to an organization known as the Brookings Institution, whose name is heard more and more frequently in connection with economic questions. Perhaps the reason for the increasing prominence of the Brookings Institution is that it meets the requirements of scientific approach, organization, and fact-finding facilities which have been so frequently lacking in the field of economic research to date.
The Brookings Institution owes its existence to a public-spirited citizen named Robert Brookings, who before the turn of the century had amassed a fortune in private business and retired to devote himself to public service. While acting as a member of the Commission on Economy and Efficiency appointed by President Taft, Mr. Brookings was shocked to discover the haphazard methods followed in government financial affairs. Budgets, he discovered, were used neither by the Federal Government nor by the states. Impressed by this and other evidences of laxness in government operations, Mr. Brookings in 1916 was instrumental in establishing at Washington, D. C., the Institute for Government Research, the forerunner of the present Brookings Institution and now a division of the latter. Under the directorship of Dr. W. F. Willoughby, the Institute began its task of research.
It soon became evident that a tremendous need existed for broad research effort in social fields as well as in the field of government. In 1922, Mr. Brookings secured a grant from the Carnegie Corporation for the establishment of the Institute of Economics, of which Dr. Harold G. Moulton, University of Chicago economist, was appointed Director. The following year saw the establishment of the Robert Brookings Graduate School of Economics, which did not charge its students tuition, but instead granted fellowships for the pursuit of advanced study. In 1927, the three organizations were merged to form the present Brookings Institution, under the general direction of Dr. Moulton.
The Brookings studies of the uses of the budget in government finance were directly responsible for the adoption of a Federal Budget in the United States in 1921. Studies were conducted for various state governments, on request, including those of New Hampshire, Mississippi, North Carolina, Iowa, and Alabama. In addition, the Institution conducted researches into the activities and functions of various bureaus of the Federal Government. Its findings, published in sixty-five volumes known as the Service Monographs of the United States Government, have become standard reference works.
In the social and economic field, the first broad study of the Institution was on the subject of war debts. It appeared in a volume entitled Germany’s Capacity to Pay, which did much to clear muddled thinking on that subject. It showed the utter impossibility of the 100 per cent payment then so widely demanded, and was closely pondered by the Dawes Commission.
When ex-President Coolidge was appointed Chairman of the National Transportation Committee to study the position of the railroads and other agencies of transportation, he retained the Brookings Institution to conduct the fact-finding analysis on which the conclusions of the Committee were based. Brookings also made the most comprehensive survey ever attempted of the social and economic conditions of the American Indians, at the request of the Secretary of the Interior.
II
In 1932 the Brookings Institution undertook what is unquestionably the most complete study of broad economic fundamentals ever conducted. The project was financed by the Falk Foundation of Pittsburgh, and required the collaboration of Brookings economists over a period of three years. The purpose of the study was to ascertain, if possible, the reasons why our entire economic machine does not function more efficiently year in and year out. The results, entitled Distribution of Wealth and Income in Relation to Economic Progress, were published in four parts. The first dealt with America’s capacity to produce; the second with capacity to consume; the third with formation of capital; and the fourth with the relation of the distribution of income to economic progress.
This study succeeded in isolating what the Institution believes to be the fundamental reason why the material progress of the nation has been disappointingly slow. According to its findings, the reason is that industry has failed to pass on to consumers enough of the benefits resulting from technological advances, particularly in the past fifteen years. The answer, says Brookings, lies in more goods at lower prices.
This recommendation is directly opposed to much of the economic philosophy now current, and is a direct challenge to price-fixing schemes and stabilization devices. Under a capitalistic system, the savings made possible by improved technology are supposed to be passed along automatically to the public in the form of lower prices. But in recent years obstructions to a free competitive system have been built up in the form of price-fixing devices which have prevented consumers from receiving the benefits of lower prices that a free competitive system would have assured them. This conclusion, simple though it may sound, was arrived at only after the most searching inquiry ever made into economic fundamentals.
It was obvious to the casual observer that even in 1929, which was a period of great prosperity, there were not sufficient goods produced to meet the needs of millions of families that remained undersupplied. This raised the question whether the failure of the economic machinery to function as it should was due to the failure of production processes. Therefore, in the first phase of its study, Brookings turned its attention to the adequacy of the country’s productive facilities and the degree of their utilization.
The study showed that in 1929, the year of peak production, the nation’s productive facilities could have turned out approximately 20 per cent more goods than they did. The actual output for that year reached $81,000,000,000, as compared with a theoretical capacity of about $96,000,000,000. It was found, however, that wide differences existed between the amount of productive capacity utilized by various industries. The percentage of capacity utilized in 1929 varied from a low of 40 per cent for locomotives to 96 per cent for full-fashioned hosiery.
The compilation of figures for the relation of production to capacity for each year since 1900 showed that, contrary to popular opinion, there had been little increase in the proportion of unused capacity in the thirty years since the turn of the century. This disproved completely the argument so often heard that our troubles were due to constant increase in excess productive capacity over a long period of years.
Brookings found that in the fourteen years from 1922 through 1935 American productive facilities operated on the average at about two thirds of theoretical capacity. Much of this discrepancy was accounted for by the normal failure of a complex economic machine to adjust itself to 100 per cent efficiency.
Two conclusions, however, emerged clearly. There had been no marked increase in the percentage of excess productive capacity since 1900. But sufficient excess capacity existed to permit the country’s productive facilities to turn out more goods if called upon to do so.
Satisfied that the answer to the problem did not lie in any serious failure of the production machinery, Brookings in the second phase of its study turned its attention to income and its distribution. It was found that 21 per cent of all families in the United States had incomes of less than $1000 in 1929, and that 71 per cent of all families had incomes of less than $2500 that year. Only about 8 per cent of all families showed incomes of $5000 or more, and only 2.3 per cent reported incomes of $10,000 or more. It was also found that in the groups having incomes of $2500 or less most income is expended for consumption goods, and that savings were accumulated chiefly in the higher income groups.
It goes without saying that families with incomes of $1500 a year or less wanted more goods than they were able to buy. The addition of $1000 to the annual income of each family in this group would have provided sufficient additional purchasing power to have absorbed virtually all of the excess productive capacity existing in 1929.
Such a situation naturally raised the question of the benefits that might arise from the redistribution of income. On this point, Brookings found that if the entire income of the nation had been divided absolutely equally each person would have received only $665 in the most prosperous year the country has ever known. It found, moreover, that if all income derived from investment and all salaries received by corporation officials had been distributed pro rata to the public — and officials must get some salaries — it would have increased the average family income only $560 per year. The difficulty is that the total income, regardless of its distribution, has been inadequate to support on a satisfactory standard of living the number of people who must live on it.
It was clear from this study of distribution of income, however, that although production, and new capital to finance production, continued to expand, the total purchasing power of the masses did not increase rapidly enough to absorb the goods that could be produced. This led Brookings to the third phase of its investigation, which was the formation of capital and the relation of savings to income.
This study showed, as might be expected, that the higher the income of a family was, the greater were its savings, both in total and as a percentage of income. It was found that in 1929 the total savings of the nation were $15,000,000,000, of which $13,000,000,000 were saved by approximately 10 per cent of the people. Sixty thousand families with incomes of $50,000 or more saved as much as did 25,000,000 families having incomes of less than $5000. The 59 per cent of the country’s families which receive less than $2000 a year account for only 1.6 per cent of the nation’s total savings.
The most significant fact discovered was that in the post-war years up to 1929 there had been a substantial and steady increase in the percentage of the total national income available for savings and investment. Moreover, it was discovered that such funds were pressing for investment at nearly twice the rate at which they could be absorbed for new capital purposes. The natural result was an inflation of investment prices. If at this stage of our history, says Brookings, greater purchasing power had been available in the lower income groups for consumptive purchases, many of our subsequent difficulties might have been avoided.
This was the first time that such a situation had arisen in the United States, which until recently had never had sufficient surplus income to meet the new capital needs of its rapidly expanding business and industry. A basic change had occurred in the relation of savings to income in the years prior to 1929, the full significance of which was not appreciated at that time.
III
In the course of its studies, Brookings has exploded the widely held theory that vastly improved technology in recent years has made possible a tremendous potential overproduction of goods, and that our salvation from this glut lies in a reduction of working hours and restriction of output. Although there were wide differences found in technological improvements in various industries, Brookings discovered that, on the whole, improved technique of production had accounted for only an 18 per cent increase in productive efficiency between 1922 and 1929.
The Institution’s reports point out that people in the long run are paid only out of what they produce. The less they produce, the less they have with which to buy goods. The country’s present productive facilities, if operated at 100 per cent capacity, could not produce a sufficient volume of goods to assure a national income equivalent to $3000 per family. Hence Brookings thinks that the danger of overproduction and a glut of goods is nonexistent.
Brookings has no sympathy with the philosophy of scarcity now in vogue, and states that the adoption of the proposed thirty-hour week would be calamitous. Production, it says, must be expanded, for that is the only method by which the total income of the country can be increased to an amount sufficient to make possible an improved standard of living.
Production was expanding rapidly in the 1920’s; so was the country’s total income, which is determined by its production. But, says the Brookings study, industry did not pass along to the consuming public the benefits of increased efficiency. As a result, the purchasing power of the consuming public did not expand as rapidly as did production. The result was a basic maladjustment between production and ability to consume.
Brookings points out that if the capitalistic system had been operating in practice as projected in theory, this situation would not have occurred. But price competition, which should have been the corrective influence, had diminished. This condition came about through plans of price stabilization sponsored by large industrial combinations, trade associations, government monopolies, and other mechanisms of price-fixing.
In proof of this diagnosis, Brookings points out that whereas efficiency, as measured by the production per worker, increased 18 per cent for all industry and 25 per cent for manufacturing industries between 1922 and 1929, the prices of manufactured goods declined only about 5 per cent. Prices of raw materials as a group meanwhile remained practically stationary. The index of wholesale commodity prices declined only from 96.7 to 95.3. Retail prices showed virtually no decline. This situation is in sharp contrast to that in the period from 1870 to 1890, when great technological improvements were accompanied by sharp declines in prices.
Brookings has also examined the various ways in which this situation might be corrected in the future. The ineffectiveness of any attempt to redistribute existing income has already been discussed. Redistribution by taxation, says the Institution’s report, would not be sound because the money collected would not be spent for the things that individuals want or need the most. Moreover, the projects financed by taxes are usually not themselves taxable. As a result, the tax burden on private enterprise becomes heavier, and the inevitable result is to retard production.
The possibility of achieving the objective by increasing the money wages was carefully examined. This method was found to have certain merits, provided that meanwhile prices do not increase proportionately. But the weakness of this method lies in the fact that it can never be uniformly applied, because it reaches only about 40 per cent of the total working population. The Brookings study showed that small shopkeepers, professional people, and other workers outside the wage group comprise a total of 20,000,000 people in the urban centres alone. This takes no account of the farm population, whose interests are severely injured by high industrial wages, which tend at least in part to bring higher prices and consequent reduction in farm purchasing power. The tendency thus accentuates the already wide discrepancy between the purchasing powers of the urban and rural groups.
The best solution, in the opinion of the Brookings Institution, lies in a reduction of prices without any decrease in money wages. This method results in an automatic increase in the purchasing power of every consumer. It tends to increase the volume of production, which is the only way in which the standard of living can be substantially improved. Under such a policy, if the efficiency of production continued to increase over a period of years, the country could look forward not only to complete utilization of existing productive facilities, but also to the enlargement of such facilities, with more goods for each individual to enjoy. In its studies to date Brookings has not discussed any methods of ensuring price reductions, but expects to examine that subject in future studies.
The gist of the Brookings conclusions is ‘more goods at lower prices through elimination of price control.’ This calls for the free competitive system under which American business is theoretically supposed to operate. The trouble has been that it does not operate that way in practice. An examination of the economic theories recently or at present in greatest vogue shows that most of them are diametrically opposed to the Brookings recommendation.
In the 1920’s there was a notable laxity in enforcement of antitrust laws. This tended to foster monopoly and high prices. Trade associations in various industries were responsible for voluntary agreements among competing companies on the subject of prices. Attempts were made to maintain an artificial price level for various commodities, such as copper, through control of surpluses. This same method of price maintenance was also extended, under government sponsorship, to agricultural products.
Then came the New Deal, with a golden opportunity to sweep away many of the obstacles that in recent years had been interfering with the normal functioning of the competitive price system. Much of the economic policy of the Roosevelt Administration is known to have stemmed from the thinking of Mr. Justice Brandeis and Professor Felix Frankfurter of Harvard. Both these gentlemen have for many years been arch foes of monopolistic tendencies in business, believing that monopoly fosters an extortionate price level. It might therefore be supposed that the application of their theories would be a fair test of the Brookings findings.
A closer analysis of the BrandeisFrankfurter philosophy, however, shows that its objectives are primarily social, rather than economic. These men detest monopoly chiefly because of its social implications.
Mr. Justice Brandeis, for instance, says,‘There are still . . . persons who believe that the rapidly growing aggregation of capital through corporations constitutes an insidious menace to the liberty of the citizen . . . that the evils incident to the accelerated absorption of business by corporations outweigh the benefits thereby secured.’ This is a social, rather than economic, appraisal.
Mr. Justice Brandeis apparently favors the destruction of bigness in business even if the public must pay higher prices as a result.
This fact is evident in many of his statements, which make it plain that he does not object even to price-fixing provided that such a device is used to prevent increasing bigness. In a statement made before the House Committee on Interstate and Foreign Commerce in 1915, he said, ‘The denial of the right to establish standard prices results in granting a privilege to the big concerns.’ The privilege referred to is apparently the ability and willingness of large concerns to sell at lower prices than their smaller and less efficient competitors.
The social, rather than economic, emphasis in the Brandeis theories was again evident in a Supreme Court case known as American Column Company v. U. S., involving the Hardwood Manufacturers Association. The members of that group, accounting for about 30 per cent of the country’s hardwood production, had pooled information on sales, prices, and production. The Court held that such activities constituted a combination in restraint of trade. But Mr. Justice Brandeis, in a dissenting opinion, said, ‘May not these hardwood lumber concerns, frustrated in their efforts to rationalize competition, be led to enter the inviting field of consolidation? And if they do, may not another huge trust, with highly centralized control over vast resources . . . become so powerful as to dominate competitors, wholesalers, retailers, consumers, employees and, in large measure, the community?’ In brief, Mr. Justice Brandeis preferred pricefixing and restraint of trade by a group of companies rather than further bigness in business. As contrasted with this, application of the Brookings findings would permit business units of the most efficient size, whether large or small, and then assure free and open price competition between those most efficient units.
The Brandeis-Frankfurter theories are clearly evident in a number of laws and bills sponsored by the present Administration, all of which involve a penalty on bigness, regardless of whether such bigness results in more goods at lower prices. Notable among these are the 1935 Revenue Act which penalized the larger corporations as contrasted with the smaller; a bill proposing the elimination of discounts on volume orders, intended primarily to destroy the competitive advantages of the chain stores and the mail-order houses; and the new tax bill which levies heavy taxes on undistributed corporate income.
The weakness of these measures lies in the fact that mere destruction of bigness or strength all too often tends to increase prices to the consuming public. This weakness accounts for the failure of such legislation to foster the free and efficient competition recommended in the Brookings findings.
IV
The NRA, which, until it was declared unconstitutional, comprised the Administration’s chief recovery effort, was directly opposed to the Brookings findings. Under the Blue Eagle, fixed minimum prices were established, which resulted in a rigid and artificial price structure. The higher prices tended definitely to curtail production. Wages were arbitrarily raised in a misguided effort to increase the purchasing power of the people. Such increased wage costs were bound to be reflected in the selling prices of goods. Anticipation of this led to a sudden rush of buying that raised the price level farther and faster than wages had been increased. The result of this situation was a reduction in true purchasing power, rather than an increase.
Likewise the AAA, the Administration’s second great recovery effort, violated virtually every recommendation of the Brookings studies. The marketing agreements permitted under the AAA were definitely intended to raise prices by monopolistic tactics. Processing taxes caused a substantial increase in the prices of foodstuffs, and thus tended to reduce purchasing power and curtail production. Restriction of acreage and the destruction of crops were based upon a philosophy of scarcity which is at complete variance with the Brookings belief that an improved standard of living will come only with greatly increased production.
Moreover, the President has made it plain that he does not believe that lower prices increase either purchasing power or consumption. In his speech at the Jefferson Day dinner of the National Democratic Club in New York on April 25, Mr. Roosevelt said, ‘Other individuals are never satisfied — one of these, for example, belongs to a newly organized brain trust — not mine. He says that the only way to get full recovery — I wonder if he admits we have had any recovery — is to lower prices by cheapening the costs of production.’ This recommendation might be accepted as a fairly accurate statement of the Brookings conclusions.
Discussing the merits of this belief, Mr. Roosevelt continued, ‘Let us reduce that to plain English. You can cheapen the costs of industrial production by two methods. One is by the development of new machinery and new technique and by increasing employee efficiency. We do not discourage that. But do not dodge the fact that this means fewer men employed and more men unemployed.’
If that were so, there should be fewer men employed to-day in the motor industry than when cars were made virtually by hand. Labor to-day plays a relatively less important part in the manufacture of automobiles than was formerly the case. But instead of finding fewer men employed, as Mr. Roosevelt’s theory would imply, we find that employment in the motor industry has increased manyfold. We find also that collateral employment in road building, tire manufacture, oil refining, and other activities related to the motor industry has also gained tremendously.
‘Reduction in the cost of manufacture,’ Mr. Roosevelt continued, ‘does not mean more purchasing power and more goods consumed. It means just the opposite.’ In proof of this contention, which is diametrically opposed to the Brookings recommendations, he stated, ‘The history of the 1929 to 1933 period shows that consumption of goods actually declines with a declining price level. The reason is that in such periods the buying power goes down faster than the prices.’
There was a special reason why prices and buying power declined simultaneously from 1929 to 1933. It was because deflation, resulting from the collapse of high prices, had temporarily brought about a condition in which manufacturers could not sell their goods for the equivalent of their costs of production, no matter how low such costs were. Unprofitable operation and necessary retrenchment reduced purchasing power. Such a transient condition is no criterion by which to appraise the benefits or detriments of lowered costs of production that result in profitable business at lower prices.
This statement by the President that lower cost of manufacture did not increase consumption or purchasing power called forth a terrific storm of protest from economists, financial writers, and business leaders. Manufacturers of radios, refrigerators, motorcars, and other products whose markets had been expanded by volume production and constantly decreasing prices were shocked at this attack on the philosophy that they knew had been responsible for great increases in volume of business and employment in their industries. It was also pointed out that the TVA, one of the great New Deal agencies, was itself engaged in an attempt to reduce the costs of electricity on the theory that it would increase consumption; that private utility companies were being forced by governmental bodies to reduce their rates; that an attempt was being made by the Interstate Commerce Commission to increase the business and employment of the country’s railroads by means of drastic rate reductions; and that the government’s housing projects were intended definitely to achieve low costs.
The President did not recant. But two weeks after his New York speech he summoned Mr. Walter P. Chrysler to the White House and discussed with him the methods by which the market for automobiles had been expanded by a reduction in manufacturing costs. Mr. Roosevelt then expressed enthusiasm at the possibilities of applying the same technique to residential building construction. Whether the contrast between this attitude and his New York speech was intentional or unintentional is not known. But at any rate the incident served to quiet the uproar that followed the President’s Jefferson Day speech. Perhaps the Brookings theory of more goods at lower prices may yet be given an opportunity to prove its worth.