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A review by the Federal Reserve Bank of Chicago Business Conditions 1952 September Contents Life insurance investments 2 W o rld Economic Report 6 Department stores hold their own 10 City-financed new factories 12 Loan trends 16 The Trend of Business 8-9 Life insurance investments Private demands for funds continue to outrun savings inflow as life insurance company resources pass the 70 billion dollar mark. O n e m a j o r b e n e f i c i a r y of the average Amer ican’s desire for economic security for himself and his family is the life insurance business. Reflecting this drive for financial protection, sales of new life insurance policies in the post war years have been far above those of any earlier period. Total volume has been boosted not only by record purchases of ordinary poli cies by individuals, but also through frequent use of insurance in the fast-growing area of company sponsored retirement programs. As a result, the face value of all life insur ance in force at the end of 1951 had risen to 253 billion dollars. Although this amount is more than double that of ten years earlier, the gain has barely kept up with other economic measures. When adjusted for the rise in con sumer’s prices, life insurance in force is onesixth greater than in 1941; in terms of personal income after taxes, it has actually lost ground. Thus, despite record sales in the interim, the public is little better protected by insurance, but has greater financial ability to buy addi tional coverage than before the war. Reflecting the rise in insurance coverage dollarwise, however, life company resources have grown rapidly. Once committed, most people continue their policies in force, appar ently assigning the contractual premium pay ments relatively high priority in their pattern of expenditures. This inflow of premium funds plus investment income has exceeded payments to beneficiaries by steadily grow ing amounts since the early thirties as policy reserves have been accumulated against eventual repayment. In consequence, life in surance companies have become the largest depositaries of the public’s long-term sav ings, surpassing commercial banks, mutual 2 Business Conditions, September 1952 savings banks, savings and loan associations, and the Series E savings bond program in such holdings. Total assets recently passed 70 bil lion dollars, an increase of 25 billion since 1945 and 50 billion in the last two decades. Even more spectacular than this growth in resources has been the volume of private in vestments made by life companies in the post war period. Record expenditures for new residential construction and for expansion of business facilities have required large amounts of external long-term financing. Since 1946, life insurance companies have channeled vir tually all funds received from increases in resources and repayments on loans into private investments. In addition, they have liquidated over 11 billion dollars in Government security holdings acquired during the war years. Net selling of Governments has continued in recent months, but in appreciably smaller volume than during 1950 and 1951. This liquidation may even give way to some net rebuilding of holdings in the year ahead. Busi ness needs for outside financing, now at a rec ord high, seem likely to decline as defenserelated expansion projects are completed and higher depreciation charges, based on current capital costs, yield larger amounts of funds internally. Requirements for new residential mortgage financing probably will remain below the peak levels of 1950 and early 1951 while repayments of such debt continue to rise. Governm ent bonds the residual In common with all financial institutions, life insurance companies are faced with the ever-present problem of promptly putting their money to work. The size of the investment decisions that have to be made are measured not only by the growth in resources, but by this amount plus repayments, maturities, and refundings of loans already held. During the thirties the supply of funds which insurance companies had to invest far exceeded suitable opportunities for investment in private enterprises and in housing. Com panies turned to Government securities as an alternative outlet for their excess funds with the result that holdings increased from less than 350 million dollars in 1930 to nearly 6 billion dollars at the end of 1940. Purchases of Governments were further ac celerated during the war. During this period, restrictions on residential construction and many types of business spending choked off a large volume of potential life insurance invest ment. Moreover, resources increased at more than double the rate prevailing in the thirties. By the end of 1946, holdings of Governments amounted to 21.6 billion and comprised 45 per cent of total assets. This investment pattern was reversed shortly after the war’s end as private demands for investment funds became very large. The rate of return on life insurance investments, which reflected the concentration of holdings in Gov ernment bonds, had dropped steadily from 3.4 per cent in 1941 to 2.9 per cent in 1946 and 1947. Under these circumstances, the better yield obtainable from corporate securities and mortgage loans was especially attractive. Moreover, the shift from Governments to pri vate obligations could be made at a profit since all longer-term Government bonds acquired at par during the war were selling above that level in the 1945-50 period. Consequently, insurance companies liqui dated a large volume of Government securities in favor of corporate loans and real estate mortgages. From the end of 1946 through 1951 net purchases were made in only four months and total net sales amounted to 10.6 billion dollars. Reflecting this liquidation and the continued growth in resources, holdings as a proportion of total assets dropped from 45 Private investment holdings rise faster $68.3 billion per cent in 1946 to 16 per cent at the end of last year. Sales of Governments since the middle of 1951 have been considerably smaller than dur ing the preceding 12 month period. Several factors account for this. First, long-term Gov ernment bonds dropped well below par in the spring of 1951 for the first time in the post war period, reflecting a change in Federal Reserve support policy. This meant that insur ance companies could continue to liquidate these holdings only by taking a capital loss. Second, the decline in prices of Governments was accompanied by a general increase in inter est rates. The attractiveness of fixed interestrate FHA and VA mortgage loans was conse quently reduced and insurance companies cut back their heavy purchases of these invest ments. Third, holdings of Government securi ties have been cut to the point where many insurance managements believe that their investments are now satisfactorily balanced. A moderate decline in private capital spend ing, which has been anticipated for some time, would entail a more than proportionate reduc tion in outside financing needs. Since the flow of investible funds to insurance companies will 3 certainly be maintained and is likely to continue to rise, Government securities may become important once again in the life insurance in vestment picture as an outlet for residual funds. Business investments biggest Investment in corporate securities has con stituted one of the major uses of life insurance funds in the postwar period. In the years 1946 through 1951 net purchases of this group of earning assets totaled more than 17 billion dollars. As a result, corporate security holdings comprised 41 per cent of total assets at the end of last year as compared with a peak pre war proportion of 31 per cent in 1941. The postwar expansion in corporate holdings has followed a pattern significantly different from that of any earlier period. Railroad bonds, once the most important type of security held by insurance companies, rose only 12 per cent from 1945 through 1951. Reflecting large expansion programs and a corresponding need for long-term financing, on the other hand, holdings of public utility bonds jumped 6 bil lion dollars, an increase of 155 per cent. The most spectacular growth occurred in Net purchases of private investments have been financed in part by sales of Government securities the industrial and miscellaneous bond category, however. Holdings of industrial securities had been relatively small until the postwar period, amounting to only 1.9 billion dollars at the end of 1945. By the end of 1951, insurance companies had 11.4 billion invested in these bonds, an increase of more than 500 per cent. Record expenditures for expansion of industrial facilities forced many companies to seek large amounts of outside financing for the first time in nearly 20 years. Insurance companies have been the princi pal buyers of new corporate bond issues for many years. From 1946 through 1951 cor porate bond offerings totaled 31.4 billion dollars. In the same period, life insurance purchases of such obligations, including both new and old issues, amounted to nearly 24 billion or three-fourths of total new offerings. Investment in stocks is one major outlet for funds yet to be tapped in important volume by insurance companies. Holdings of preferred and common stock rose from 1 billion dollars in 1945 to 2.2 billion at the end of 1951. Despite passage of a New York law in early 1951 which permits investment in qualified common stocks up to 3 per cent of total assets, insurance com panies have reduced acquisitions in recent months. Major reasons may be the heavy de mand for funds from other sources and the historically high level of stock prices currently. billion dollars Mortgage loan boom N etchan g e in holdings o f : ■ B u s g o v e r n m e n t secu rities +8 foXXH corporate securities V//A mortgages all other investments - . total not MW investment +4 - 0 -4 ________________________________________________________________________________________________ 1947 1948 1949 1950 19 5 1 January through june at annual rates. 4 Business Conditions, September 1952 1952* Life insurance companies have always been active investors in mortgage loans. In fact, this was the most important type of asset holding prior to 1935 and accounted for 43 per cent of total resources in the peak years of 1926 and 1927. The dollar amount invested in mortgage loans dropped substantially in the early thirties, however, and recovered only gradually in the latter part of the decade and during the war years. Since life insurance resources were rap idly expanding during this period, mortgage holdings declined in relative importance to the point where they comprised less than 15 per Holdings of insured loans on non farm properties show the biggest rise B illio n P e r cent d o lla rs in c rea se 1945 1951 T o ta l 6.6 19.3 192 N o n fa rm : 5 .9 1.4 17.8 8 .4 204 4 .5 9 .4 531 111 .8 1.5 97 F H A and VA A ll o th e r Farm cent of total assets in 1945 and 1946. The postwar construction boom abruptly reversed this downward trend. Private expendi tures on residential construction totaled more than 50 billion dollars from 1946 through 1951; much of this required long-term mort gage financing. Unlike the corporate bond market where insurance companies are in a dominant position, other institutional investors such as savings and loan associations, commer cial banks, and mutual savings banks are active and vigorous competitors for mortgage loans. Nevertheless, purchases of mortgages by life insurance companies were so sharply accel erated that total holdings nearly tripled be tween 1945 and the close of last year. At that time investment in mortgages amounted to 19.3 billion dollars and accounted for more than 28 per cent of total assets. Most of the postwar expansion in mortgage holdings has been in loans on residential prop erty. These now comprise more than 70 per cent of the total mortgage portfolio as against 55 per cent at the end of 1945. Life insurance purchases of home mortgages have been facili tated by FHA insurance and VA guarantees. In addition to insuring lenders against much of the risk in mortgage investment, these pro grams assure that minimum construction standards have been met and enhance the mar ketability of mortgages after purchase. Despite the fact that interest yields range from Vi to 1 per cent lower than on conventional loans, over two-thirds of the postwar growth in residential holdings has been in the insured category. During the past year insurance companies have reduced their purchases of mortgages substantially. Acquisitions in the first six months of this year totaled only 2.0 billion dollars as compared with 2.9 billion in the comparable period of 1951. In part, this re flects the cutback in housing activity from the peak levels of 1950 and early 1951. In addi tion, the attractiveness of fixed interest FHA and VA loans has been reduced as a conse quence of the general rise in yields on long term bonds which occurred last year. Insurance companies may be expected to become more active in the insured mortgage market if other outlets for their investible funds contract in the months ahead. Nevertheless, future increases in mortgage holdings are un likely to equal those of 1950 and 1951, owing to the reduced amount of new mortgage financ ing and the steadily growing volume of repay ments on debts already outstanding. W hat of the future? Life insurance resources have grown without interruption from 8 to 70 billion dollars in the past 30 years and continued expansion seems assured. Sales of ordinary life policies set a new record in 1951 and have risen further in the current year. Even so, life insurance in force is smaller in relation to personal income after taxes than before the war. With the further growth in insurance cover age, the problem of keeping life company assets profitably invested is likely to become increas ingly difficult. The search for suitable invest ment outlets will be intensified in this event with greater activity in corporate stocks, small business lending, and direct ownership of real estate showing the most promise at present. Nevertheless, Government securities probably will be the major alternative to corporate bonds and mortgages as an outlet for investible funds for some time to come. 5 World Economic Report Underdeveloped countries continue to devote highest proportion of output to current consumption. T he p a s t t w o y e a r s have been marked by great economic volatility throughout the world. Since the outbreak of the Korean conflict, farreaching changes in the volume, direction, and composition of world trade have occurred. The remarkable boom and later reversal in the world demand for and prices of key raw mate rials—particularly rubber, tin, and wool— dominate the foreign trade story as reviewed in the UN World Economic Report for 195051. The reversal in international commodity de mand produced a deterioration in the terms of trade and the balance of payments position of the raw material producing areas. Further repercussions resulted in an almost worldwide tightening of foreign trade restrictions, the impact of which has not even yet been fully felt. These spectacular movements in interna tional trade have partially overshadowed some of the equally important domestic develop ments which have taken place during these months in many of the world’s economies. The UN Report presents a comprehensive review not only of over-all trade patterns but of the less publicized internal situation in a great many nations of the world. Gross national product compared In appraising and characterizing selected na tional economies, the Report uses the familiar concept of gross national product and its breakdown into private consumption, private investment, and government spending. The conventional division of GNP into private con sumption, private capital investment, and 1 World Economic Report, 1950-51, prepared by the Division of Economic Stability and Development of the United Nations. The 140-page report is the fourth of this series to be published. 6 Business Conditions, September 1952 government spending can be regrouped into consumption and capital investment since the third component, government spending, is com prised of expenditure for both capital invest ment and for currently consumed goods and services. The countries are dealt with in three broad groups. Predominantly free enterprise economies are divided into those which are highly industrialized and those in which indus try is relatively unimportant and living stand ards are generally low. The centrally planned economies—Russia, the Eastern European na tions, and China—are treated separately. As might be expected, the proportion of GNP devoted to each of these broad cate gories varies from country to country. In un derdeveloped countries a high proportion of total output is used to meet the day-to-day wants of their population. The highly indus trialized countries, on the other hand, need large investment to maintain their living stand ards while ever increasing their capacity to pro duce for greater future consumption. In the United States, as indicated in the accompanying charts, somewhat more than two-thirds of total GNP went into personal consumption and about 18 per cent into pri vate investment. The remaining 15 per cent went into Government expenditure. In sharp contrast, the underdeveloped countries used a much larger proportion of total output for current consumption. In Burma, for example, an additional 12.5 per cent of GNP went into consumption with less than 1 per cent going into private investment. In Latin America some countries devoted almost 8 per cent more of GNP to consumption than did the U. S.— Chile and Cuba, for example. In most of Western Europe a smaller pro portion of GNP went into personal consump tion than in the United States. This does not imply that these countries were “more indus trialized” than the U. S. Rather, they sacri ficed current living standards in order to allo cate more resources into investment. This in turn reflects two conditions. First, although these European countries had reached a high level of industrial development prior to the war, obsolescence and heavy wartime deple tion and destruction of plant and equipment as well as housing required substantial replace ment of capital. Secondly, and more recently, additional investment demands have arisen as a by-product of rearmament programs which — continued on page 15 National variations in GNP distribution . . . private capital investment World Economic Report data show a wide range in the proportion of national output allocated to each of the three major GNP components in 1950. Selected countries are compared with the U.S. United States 17.5 Canada 22.1 31 8.3 E urope* Denmark private consumption 15 Ol France Western Germany United States 68.7 13.0 Italy 19.5 Netherlands Norway §§g §g£§^ 256 I7.0| i3.7l ' Sweden, United Kingdom 1 8® 4 »6® 4 ■■I Australia Japan Burma 0 .7 ^ ® i_ _ 0 10 per cent 20 government spending United States 15.0 Canada Europe* !2.5|H 13.91® Denmark France Western Germany 12.51 1 .1■ 4 Italy 23316.5 Netherlands 15.0 Norway Sweden 3888888888883119.9 United Kingdom 16.6 Australia •simple arithmetic average of countries listed Note— components for each country may not add to 100 per cent because net imports of foreign goods and services are additional to GNP and conversely. 17.2 Japan £ 88888888883119.7 Burma 12 81 1 0 I _I 25 7 the r £ - > n r i of b u s i n e s s F or almost 18 months inflation has been kept waiting in the wings. During that time, good progress has been made in boosting the output of military material and civilian goods have been provided in the amounts consumers were able and willing to buy. Now that the arms program is nearing the maximum con templated effort, hopes for continued stability would appear to be enhanced. Nevertheless, fears are growing that another general rise in the level of prices is imminent. Some price increases have been announced in recent weeks and others certainly are in the making. Developments such as the after effects of the steel strike and drought in some agricultural areas are difficult to assess. It would be rash, nonetheless, to translate these signs into a forecast of strong inflationary pres sures. Barring, as always, a sudden turn in international tensions, the chance for a return to the rapid price rises of the post-Korea months appears remote. The main forces lined up on the inflationary side at present include the larger proportion of new steel channeled to defense, the at tempts to rebuild inventories, the current cycle of demands for higher wages, the weakened price control bill, and the growing Federal deficit. Moreover, lowered stocks of durable goods at both the retail and manufacturing level have placed business in a poorer position to meet a new upswing in consumer buying than at any time in recent months. Countering these developments are the more cool - headed reactions of businessmen and consumers to cries of “wolf,” the wage losses resulting from widespread work stoppages, the tighter grip of general monetary controls now 8 Business Conditions, September 1952 Milwaukee leads living cost rise that fixed support prices for long-term Gov ernments have been ended, the heavy tax load, and a greatly expanded industrial plant. Mean while, the highest hurdles foreseen two years ago have been cleared successfully, in part as a result of the stretch-out in the defense program. Before the steel strike, arms output had been absorbing strategic materials at a rate close to the expected peak. In addition, the defenserelated industrial expansion programs, in flationary before their completion, were over the hump. Wholesale prices which had been trending downward fairly steadily for almost a year and one-half turned up slightly in July and August. In midsummer the over-all index stood 11 per cent above the June 1950 pre-Korea level— not too bad considering the strains of the in tervening period. Consumer prices in midsummer were also 11 per cent above the pre-Korea level. A fur ther boost probably is in store for October as rent controls are eased or removed in various localities. In Chicago, authorities have agreed tentatively upon the desirability of a 10-15 per cent rise for controlled dwellings. Similar ac tion may be taken in Detroit and Indianapolis. In that case, cost-of-living indexes for other District centers will move closer to the level of Milwaukee where rents were freed two years ago. Fruits and vegetables, fresh and proc essed, were among the items decontrolled in the amended Defense Production Act. A short age of tin cans will reduce the size of this year’s pack and some price increases are doubt less in prospect as a result. Decontrol will not be a major factor in developments immediately ahead, however, since in most cases canned goods have been selling below ceiling. Another round of wage increases appar ently is afoot and is contributing to inflationary pressures. Rubber, meat packing, and elec trical workers and soft coal miners already have made their bids or are expected to do so soon. Price increases will accompany the higher busi ness costs in most instances. Auto industry Post-Korea inflation; United States and elsewhere United Stotes Canada Belgium United Kingdom Brazil France contracts are good until 1955, but most of these workers are covered by cost-of-living escalator clauses. Drought stricken crops are mainly cotton and tobacco; food costs are unlikely to be much affected. Midwest farmers, in contrast to those in the East and South, have continued to enjoy favorable weather conditions and have large harvests in process. Consumers have changed their attitudes toward high prices, according to the Survey Research Center of the University of Michi gan. Between January and June more indi viduals decided that current price levels are relatively permanent and buying need not be deferred in anticipation of better bargains later on. Instalment credit began to rise swiftly soon after controls were lifted on May 7. The end ing of the curbs apparently had a considerably greater effect than had been generally antici pated. Outstandings jumped almost 600 mil lion dollars during June to a record total of 14.4 billion. In June 1951 during the control period the rise was only 35 million dollars. Home appliance dealers have continued to re port better than anticipated business throughout the summer but supplies of household durables are expected to continue to be fairly adequate. Most auto workers were back on the job by September 1, but some steel strike-induced un employment will continue for several weeks. It is possible that the extent of production lost because of steel shortages has been exagger ated. Many firms which use steel in small quantities relative to the value of their prod ucts had sufficient stocks on hand prior to the strike to maintain operations until regular de liveries can be resumed. Some District firms profited as a result of timely ordering of sup plies from Belgium and Austria. Furthermore, a number of manufacturing concerns in this area ceased operations before steel supplies were exhausted in order to maintain inventories and facilitate a return to full-scale production. 9 Department stores hold their own Sales position maintained relative to competing stores, but share of total retail business has fallen. stores have been accounting for a smaller share of total retail sales in recent years than in the period prior to World War II. In the three years 1949-51 total retail busi ness exceeded the average of the 1939-41 pe riod by 195 per cent. During the same years department stores’ sales were higher by only 170 per cent. Available data does not suggest that the de partment store is a fading institution, however. Rather, the relative drop in their sales from prewar stems largely from the fact that a larger portion of consumer income is being spent on automobiles and food, lines in which depart ment stores are relatively unimportant. Compared with stores handling similar prod ucts, department stores have held their com petitive position. In each year from 1939 through 1951 sales of department stores and those of competing stores have followed a remarkably parallel course (See Chart). It is the shifting pattern of consumer spending rather than weak merchandising which has changed the role of department stores. D epartment Spending grows— pattern changes Personal income after taxes more than tri pled between 1939 and 1951. During that period prices of goods sold at retail doubled and the population of the United States rose by 34 million. Even after adjusting for prices and population, however, the average person had command over 40 per cent more goods last year than he had in the years before World War II. As might be expected, higher real income has been accompanied by modified in dividual spending habits. During the postwar period consumers have been laying out a larger fraction of their in 10 Business Conditions, September 1952 come on food and durable goods—autos, fur niture, appliances, and TV sets. They have spent less, relatively, on nondurables and serv ices such as shoes and clothing, rent, and electricity and gas. Over-all, 46 per cent of all consumption dollars have been spent on food and durables in recent years compared with 40 per cent prewar. Sales at retail stores have amounted to 70 per cent of all consumption spending com pared to only 60 per cent in the 1939-41 pe riod. Not all retail categories gained in the same degree, however. Biggest increases, of course, were recorded by the types of stores handling those goods in greatest demand. The main beneficiaries of the shift in buying have been the automobile dealers. Their share of total retail sales increased from about 13 per cent in 1939 to 17 per cent in 1951. As a result of the construction boom, retail sales of building materials outlets rose during the 1940’s from 5Vi per cent to 7 per cent of the total. In addition to the expanded demand for building materials, the housing boom brought with it more than proportionate increases in sales of home furnishings. Nondurable goods stores, in general, ac counted for smaller proportions of retail sales in the postwar period. Department stores slipped, relatively, along with the other types of merchandizing in this class, but sharper drops were recorded for jewelry stores, apparel shops, and drug stores. The variety of goods sold by department stores helped to maintain their pro portion of retail sales relative to some of the more specialized shops. Fluctuations in the sales of the automotive group have been most important in causing total retail sales to move contrary to depart ment store results in the postwar years. This component of total sales is highly volatile and is second only to the food group in over-all importance. Backlogs of demand for auto mobiles kept these sales rising during 1949 when most other types of retailing were ad versely affected. Since 1950 car production has been hampered by availability of materials which were under allocation. Departm ent store sales an indicator Although department stores typically account for only 7 or 8 per cent of total retail sales, they are watched closely by business observers. There are two main reasons. First, these stores handle a wide selection of goods although not necessarily in the same proportion as the na tional totals. Second, department stores are relatively few in number and their sales results can be collected and tabulated quickly. For almost 35 years the Federal Reserve System has published sales and inventory data for a large group of department stores in each of the 12 Federal Reserve Districts. Weekly sales changes from the previous year and sales indexes are released on the Thursday following the week in which the sales were recorded. Department store sales match competition w rc e n t, 1 9 4 7 -4 9 *1 0 0 Monthly and yearly indexes are also available. Dividing the retail dollar In the years ahead it is quite possible that department stores will regain their prewar slice of retail sales. More than that, their posi tion relative to competing stores may improve. Certain movements now in progress point toward these conclusions. The first consideration is negative in nature. Building materials and automobile sales in re cent years were of boom proportions. The nation is now better housed and more ade quately supplied with vehicles than ever before. Under these circumstances it is probable that a larger proportion of retail buying will be directed toward other lines such as those handled by department stores. The competitive position of department stores will be bolstered in some degree by the new price maintenance law insofar as its pro visions are applied to household durable goods. If price floors under refrigerators, washing machines, TV sets, and the like are more rig idly enforced the consumer will have less in centive to patronize the “discount houses.” More important, department stores are now engaged in a movement toward the suburbs where the large population increases have oc curred in recent years. The building of depart ment store branches on the periphery of cities and in the suburbs has been handicapped by material shortages, but is now proceeding more swiftly. In most large cities in the nation, including Chicago, Detroit, and Milwaukee, a number of large shopping centers located outside the city proper and offering adequate parking facilities either have been completed or are in the plan ning or construction stage. Most of these proj ects contain one or more department stores, usually branches of enterprises with head of fices in the heart of the city. In the thirties there was considerable dis cussion of the “maturity” of the department — continued on page 14 11 City-financed new factories Controversy over plans for public financing of industrial development in South and New England highlights limitations. T he grow th o f Am erica n in dustry has had widely divergent impacts on American com munities. Most have grown and prospered. But some have not. In general, these communi ties have been areas where such natural re sources as coal and timber have been ex hausted, where industry has migrated to more suitable locations, or where industry has sim ply failed to catch hold. These underdeveloped or depressed areas are characterized by income levels perhaps only one-half or two-thirds as great as in the more successful industrial sec tions. Usually they suffer from chronic unem ployment or underemployment, high public welfare costs, and out-migration by people in the most productive age groups. Thus, there is much interest both locally and as a matter of state and even national policy in job and income creating programs for these areas. The employment stimulating device cur rently in the limelight is the use of municipal or state government credit to build or buy new plants to be leased to private operators. It’s not new State and local government aids and sub sidies to private business are a part of our early history. In the nineteenth century, canal, turnpike, and railroad promotions were the principal beneficiaries. Some of these pro grams were spectacular failures and led to restrictions on the use of public funds for private benefit and on state-local borrowing in general, many of which persist to this day in the laws and constitutions of states, particu larly in the Midwest. In the pioneer period, the principal advan tage of public financing of industrial develop 12 Business Conditions, September 1952 ment lay in the fact that capital was generally scarce and private credit unavailable. Public borrowing often seemed the only effective method of developing the resources of the frontier. Today most companies can raise funds at reasonable rates on their own in ac cessible capital markets. Why then the revival of interest in the use of public credit for busi ness development? One answer is that there are still many firms which experience enough diffi culty raising funds privately so that the offer of public credit can attract them to an under developed or depressed community. Probably the most important attraction, especially for established companies, is the fact that the use of public credit offers substantial savings in interest and taxes. Current high Federal income tax rates allow the issue of taxexempt state and local securities at very low rates of interest. Since the occupants of pub licly financed plants pay rentals based upon the costs of debt service, most of this advantage accrues to them. In addition to lower interest costs, most of the existing and proposed pro grams offer exemption from real estate taxes or payments in lieu of property taxes on the new plants. Moreover, the public borrower assumes a large part of the risk involved in the invest ment. If a new publicly financed plant fails to earn enough to meet the rental payments, an underdeveloped or depressed community ordi narily will forego insisting on the company’s meeting its lease obligations rather than force cessation of operations and unemployment. In total, these factors may be a great inducement for an expanding firm to locate new facilities in a locality which offers such advantages. Program s adopted The oldest of the existing programs for in dustrial development through use of state and local government borrowing powers is Mis sissippi’s “Balance Agriculture with Industry” program, inaugurated in 1936 and re-estab lished in 1944 after a wartime lapse. Mis sissippi cities are authorized to issue general obligation bonds secured by the municipal tax ing powers for new construction. Two-thirds of the voters in the locality must approve each project and the State Industrial Commission must agree that the new firm is suitable to the city’s economy. Moreover, con tractual rental payments must be sufficient to service the debt and there must be a guarantee of a specified payroll, usually for five years. In the prewar period, about one million dollars in bonds were issued under the Mississippi plan. In the first few years of the postwar program, bond issues totaling nearly five million dollars, mostly for textile and apparel plants, were approved. Three other Southern states permit the sale of revenue bonds by cities to finance construc tion or acquisition of factory buildings. In these cases, the rentals paid by the firm consti tute the only backing for the bonds. Kentucky authorized such a program in 1946 and Ten nessee and Alabama did so last year. Proposals in New England Proposed programs considered in Massa chusetts and Rhode Island earlier this year provided for state rather than local government sponsorship. The securities would be issued by intermediaries and presumably would not be exempt from Federal income taxes. This arrangement was designed to meet the argu ment that this type of borrowing by state and local agencies, if it becomes widespread, might induce Congress to lift the tax exemption from all state-local bonds. The Massachusetts and Rhode Island proposals also provided for addi tional rental payments in lieu of real estate taxes to be remitted to local governments. Both proposals were rejected, at least for the time being. The attraction that these programs have for communities which are underdeveloped indus trially or suffer from unemployment because of out-migration is obvious. As long as the com pany lives up to its bargain—that is, continues operations and meets the required rental pay ments, the income of the community is in creased. Additional wages are paid to the workers in the new plant and local utilities, stores, and service establishments benefit by supplying the needs of the new plant and its employees. Usually, the increased state and local tax receipts will far exceed the costs of the additional public services required by the new factory and the influx of population. Losses could be large But what if the company fails to meet the terms of the contract? This can happen even though a firm is reputable and well managed. Any one company is always vulnerable to national, regional, or particular industry reces sions. Unless the plant can be converted for use by another prospective tenant, if rentals are not forthcoming, local taxes will have to be increased to meet debt service requirements on general obligation bonds. And even if rev enue bonds were the source of funds, many cities, particularly the smaller ones which ap pear to be most interested in programs of this type, might decide, if they could legally do so, to increase general taxes to service the bonds because a default, even on revenue bonds, could have long-term adverse effects on the city’s credit standing. If, in addition to failure to meet its rental payments, a company finds itself forced to shut down or drastically reduce operations, the community will be back where it started or even worse. In the short run, the unemployed workers and their families are not apt to leave their new homes and look for work elsewhere. The community may face not only reduced 13 levels of income, trade, and tax revenues, but even higher levels of governmental costs in the form of relief and other public assistance pay ments. Of course, these are risks involved in any new enterprise, whether publicly or pri vately financed, risks of which the community should be aware. Inefficiency m ay result For the country as a whole, the effects of public financing of industry may be “good” or “bad,” depending on the circumstances in each case. In communities with unemployed workers and unused factory buildings, or in areas where the labor resources are inefficiently uti lized on farms with relatively low productivity, a financing plan with a comparatively small element of subsidy may have greater leverage in increasing output than any other possible use of the funds equivalent to the value of the subsidy. On the other hand, output and income may be increased in a particular community at the expense of other communities and even of the country as a whole. In most cases, the expan sion of production would have taken place even in the absence of a municipal financing plan. Firms normally would locate their ex panded operations where over-all costs are lowest. However, a city offering a public financing scheme may attract firms from other locations where costs would be lower were it not for the subsidy element. In such a case, costs to the firm will be lower in the subsidized community, while costs to the economy will be higher, since the company’s costs plus the value of the subsidy are greater than the total unsubsidized costs would have been in alternative locations. Moreover, these programs may interrupt an established trend in the migration of the underemployed rural labor supply to the larger low-cost industrial centers in both the North and the South. On balance, there are probably many more poten tial cases in which industrial subsidization would operate to make the economy function 14 Business Conditions, September 1952 less efficiently than there are opportunities for “inexpensively expanding national output” via subsidy. Competitive bidding for industry One dangerous possibility is that the exten sion of industrial financing programs will re sult in cities bidding against one another in their efforts to attract new plants. To outbid rival cities, they would tend to expand the degree of subsidy. This would expose cities to even more adverse effects in the event of unfavorable economic developments. In the most likely event, the competitive subsidies would tend to cancel out and firms would locate where they would have gone without any public aids. Another drawback of these programs is that the tax abatement features involve redistribu tion of the tax burden. If the new plants do not pay property taxes, other property owners in the community face heavier tax burdens than they might otherwise bear. Similarly, the income tax exemption of the bonds sold to build new factories can mean, if these programs are more widely adopted and used, a shift in state and Federal income tax burdens from taxable interest income to other sources. Finally, widespread defaults on bonds issued for new plants, such as could easily occur in a major economic downturn, could impair the financial capacity of states and their local gov ernments to deal in future years with problems that are uniquely their own. Departm ent stores continued from page 11 store as an institution. Inroads, apparently, were being made upon its domain by specialty shops with less overhead and more merchan dizing vigor. Since that time managements have been successful in adapting to a rapidly changing environment. Current expansion pro grams indicate that equal success will be achieved in the years ahead. Economic report continued from page 7 many of these countries have undertaken. Although GNP is the value of a nation’s to tal output, a country may increase its con sumption or investment by importing more than it exports. This factor partially accounts for the relatively high proportion of private investment to total output in both Canada and Norway. GNP figures reveal some but not all national differences in economic structure. In some free enterprise economies such as the U. S. and Canada, the allocation of GNP between private consumption and investment is the result of countless independent consumer and investor decisions. The government may, of course, influence these decisions indirectly through fiscal and monetary policy. In countries such as Britain, Norway, and Sweden, government pol icy to a much greater degree determines levels of consumption and investment, either via in vestment controls and subsidies or through government spending itself. To the extent that a government provides goods and services for current consumption, the Government share of GNP increases while the share going into per sonal consumption appears limited. The variations among countries in the rela tive share of government spending are not as great as might be anticipated. For example, in the United Kingdom government spending accounts for only 1.6 per cent more of GNP than in the U. S. One major explanation for this is that business type government operations, such as nationalized railroads or factories, ap pear in the government sector of GNP only to the extent that they have net losses or prof its. This is because, like private businesses, nationalized industries sell their products rather than distribute them as government services. The bulk of their transactions thus appear in the GNP accounts as consumption or as private investment. In consequence, a coun try with numerous nationalized industries which operate without government subsidy need not show any more of its total output in the govern ment section than does a country such as the United States. Differences in GNP distribution reflect not only variations in basic economic structure, but also to a limited extent lack of uniformity in national income accounting practices2. De spite such problems in comparability, however, GNP data provide a useful gauge for assessing broad differences in over-all national economic development. The Report emphasizes the fact that those countries that are in greatest need of produc tive capital are still least able to provide it. Yet, if these underdeveloped areas are to make substantial progress toward higher living stand ards, they must obtain additional investment. If such investment comes from the more in dustrialized nations, the benefits are not con fined to the underdeveloped countries alone. They provide a market initially for machinery and other productive equipment and, as the underdeveloped countries progress, a demand for more and more consumer products is cre ated. Before these goals can be achieved, however, many of the obstacles to the free flow of capital—such as foreign currency restric tions and fear of possible nationalization of industry—remain to be surmounted by inter national organizations as well as by the in dividual countries themselves. 2 Fo r example, in Norway and Sweden expenditures on mainte nance and repairs are included as a part of gross private invest ment; in the United States th is does not enter into G N P . Norway, as w e ll as W estern Germany, includes investment in public enter prises in the investment sector, rather than In the government's share. Business Conditions is published monthly by the federal reserve bank of Chicago. Sub scriptions are available to the public without charge. For information concerning bulk mail ings to banks, business organizations, and edu cational institutions write: Research Depart ment, Federal Reserve Bank of Chicago, Box 834, Chicago 90, Illinois. Articles may be re printed provided source is credited. 15 t-r D u r in g the s ix ^m o n L h p e n d in g June 30 total loans Outstanding at District member . - - b&flcs changed little. Total outstandings, howv ever, hid divergent movements of particular loan categories. Moreover, over-all loan trends showed a marked contrast with the correspond ing period of 1951* when a 6 per cent gain was recorded. This year’s six months stability of loan totals reflected an easier tempo of economic activity. Prices changed little, many business firms marked down inventories, farmers reduced feeder loans, and fewer houses and business construction projects were begun. Less intense demand for bank credit was only part of the answer to the end of the loan rise, however. Many bankers began to consider themselves “loaned up” as outstandings moved up in relation to deposits and capital. In addi tion, the Federal Reserve System policy of limiting the supply of reserve funds available to banks in a period of precarious price bal ance served to restrict some lending. During the rapid loan rise in early 1951 all cities participated in the trend. This year, however, a decline in loans at the District’s big city banks offset a rise for banks located in smaller towns (See Chart). As usual in a period of transition the large centers led the way. Business loan totals are particularly sen sitive to changes in rates of activity and these loans are of lesser importance in smaller cities. All major types of loans showed increases for the District as a whole in the first half of 1951. No such uniformity existed in the January-June period this year. Business loans and loans to banks fell. Consumer loans, on the other hand, rose at a faster rate. Commercial and industrial loans declined 4 per cent in the first six months of 1952. The 135 million dollar drop, although less than might have been expected seasonally, contrasts with a 9 per cent advance last year. 16 Business Conditions, September 1952 Agricultural loans outstanding at District member banks declined 5 per cent during the first half of 1952 compared to a slight advance in the same period last year. Most of this year’s decrease was represented by a fall in non-real estate loans to farmers. Real estate loans rose at a slower rate dur ing the first half of the year. This smaller increase reflected a lower volume of home construction than in early 1951 and an in creased reluctance on the part of bankers to make fixed interest bearing FHA and VA loansAlmost all of the net increase in real estate loans occurred in banks outside the large cities. For the remainder of 1952 outstanding loans in most categories may be expected to rise. Seasonal trends will be reinforced by other developments. Business loans of weekly re porting banks reversed their downward trend in July; depleted inventories in many lines following the steel strike coupled with some higher prices will result in further demand for credit. Sizable crops in District states foretell a rise in commodity loans. Moreover, if mort gage controls are relaxed, real estate credit will be stimulated. Loans decline at large city banks —continue rise in other centers per cent chonge EfeSl I5 half 1 5 ' 91 . . . . . . _, . District Chicago iwi „ large cities* ♦Des M oines, D e tro it, Indiana polis, and M ilwaukee. um ci District bonks
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