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Business Review
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The Responsibility of Business and Industry
for Social Welfare in Today’s World

The Shrinking Trade Surplus

The Changing Profitability Gap

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The Responsibility of Business and Industry for Social Welfare
in Today’s World:
. . . Social responsibility is inherent in both theory and practice of modern business,
a change some have failed to note. Voluntary efforts, related to corporate objectives,
serve the community as well as the company.

The Shrinking Trade Surplus:
. . . Booming U.S. economy helps boost imports faster than exports. Implications
for balance of payments told by charts.

The Changing Profitability Gap:
. . . Since 1961, higher interest expense of Philadelphia member banks has caused
their earnings to lag behind those of Third District “ country” member banks. City
banks still have a higher rate of return on total assets and owners’ equity, but the gap
is narrowing.

BUSINESS REVIEW is produced in the Department of Research. Donald R. Hulmes prepared the layout and art
work. The authors will be glad to receive comments on their articles.
Requests for additional copies should be addressed to Bank and Public Relations, Federal Reserve Bank of Philadelphia,

Philadelphia, Pennsylvania 19101.

THE RESPONSIBILITY OF
BUSINESS AND INDUSTRY
FOR SOCIAL WELFARE
IN TODAY’S WORLD
by Robert N. Hilkert*

During recent times we have heard and learned

merit. There is no country which, in terms of ma

much about the bottom twenty per cent of the

terial living standards, has achieved so much for

American

Other

so many. That there is much left to be done

America.” Regrettably, an unconscionable state

should not blind us to what has already been

of affairs has been too much hidden from too

done. Attainments up to now should give us hope

many of us for too long. We should be thankful

of attainments to come.

people

who

comprise

“ the

that it has been brought out of the darkness into

It may well be true that our economic growth

the light by all those concerned people who have
given contemporary meaning to a question asked

has not been all that it might be. Conclusions

long ago, “ And just who is my neighbor?”
A social and economic order which permits to

and with these one may always quarrel. We must
admit, however, that very large numbers of

exist the present condition of the lower-fifth of

people are today living very well. To say this

the population obviously needs to be improved.
To the extent that it is within our power and

is not to be callous toward those who are not.

competence to effect improvement, not to do so

lem.

is immoral. The problems are not insoluble,

America which is accurately described both at

over time, but this is not to say that they will be

home and throughout the world as a land in

along this line involve many value-j udgments,

It simply serves to emphasize the moral prob
We

cannot feel

comfortable

about

solved by soft hearts unaccompanied by hard

which dire poverty exists in the midst of un

heads.

matched affluence. No one can read Michael

In the interest of perspective, we should not
lose sight of another point. There is an upper

Harrington, or Edgar May’s The Wasted Ameri
cans, or Leon Keyserling’s study on Poverty and

eighty per cent. While the American system

Deprivation in America and not immediately feel

needs improvement, needs it urgently, perhaps a

the need to fight what really is a just war— a war

system that has succeeded in raising the living

on poverty. However we may differ in our

standards of eighty per cent of the people to

thoughts as to means, I fail to see how we can

present levels deserves some sort of medal of

quarrel about ends.

*Mr. Hilkert, First Vice President of the Federal Reserve
Bank of Philadelphia, gave this talk at the Annual Forum
of the National Conference on Social Welfare, Chicago,
June 1, 1966. The views expressed in this paper do not
necessarily reflect the views of the Federal Reserve System.

Business and social well-being

We cannot say that our material attainments have
stemmed solely from the accomplishments of

b u sin e ss r e v ie w

business and industry. There have, of course,

But there is another reason, one which arises

been many factors and forces (including govern

from the traditional statements about the nature

ment, labor, education, geography, natural re

and function of business. It has often been said,

sources, etc.) which have contributed greatly to

verbally and in the literature, that social welfare,
as commonly construed, is not the primary, direct

our nation’s state of material well-being. How
ever, anyone who looks at the facts must affirm

concern of business. Under the American system,

the tremendous part played by business and in

so the story goes, it can hardly be the primary

dustry. We have been called, and I believe
rightly, a business society. Without business and

concern; and there is increasing evidence that it
cannot be under any other system.

industry there can be no “ Great Society.”
Looked upon historically, business has not al

It is not, however, quite this simple and bald.
It is difficult to clear up the semantic difficulties

ways shown a righteous concern for people. Much

involved in the thought, and it all gets mixed up

of the story, going back, say, to the Industrial

in the formulation of short-run vs. long-run

Revolution, has not been a pretty one. After all,

business goals. Above all, it is hard to categorize

children did work in the mines. There have been

situations in which self-interest and the public

“ robber barons.” The public-be-damned attitude

interest coincide, as they do in so many ways.

is not just a myth. Our industrial history contains
many incidents of violence associated with the

primary interest, it is a strong secondary one;

It is my view that if social welfare is not the

pursuit of human justice. Progressive legislation

and to indicate how significant a secondary con

has more often than not had to travel rough

cern can be, let me cite the world’s best illustra

roads. Yes indeed, from the annals of business

tion. It is the Christian admonition or command

and industry we learn that the welfare of people

ment which says, “ . . . and the second is like

has not always been of over-riding concern.
This is history. While it should not be forgot

unto it, thou shalt love thy neighbor as thyself.”
It may well be that the primary and secondary

ten, it should be looked upon as a part of the

concerns of business are not quite this close, but

past and not the present. Changes have occurred

I know of many instances in which they are

in business and industry. I don’t know why

almost as hard to separate.

people who recognize revolutionary changes that
have been taking place in nearly every other

Business goals

aspect of our society find it so hard to believe
that changes have also taken place in the organi

Essentially, the job of business is to produce
goods and services which society wants, at prices

zation, philosophy and conduct of American busi

which people are willing and able to pay. More

ness. And yet, I believe I can see two reasons for
skepticism.

fails, then all talk about its responsibility for

The first and obvious one is that there are
some black sheep in the family. There are some

social welfare is purely academic, and we can
forget it. But to survive it must be profitable, and

who violate the standards which society has a

to survive in today’s dynamic world it must

right to expect of us, and these receive the glar

grow. So the logic of the case, certainly as seen

ing light of intense publicity. While I offer it as

by the typical businessman in performing his

no excuse, I have to remind myself that man is,

duties, sets the main concern— to produce effi
ciently for society’s needs and wants, to he

indeed, somewhat lower than the angels.

over, the business must survive. If the business

b u sin e ss re v ie w

profitable, to survive, and to grow.

a highly restricted view of social responsibility

Profits must be high enough to permit the risks

which a pure theory of business enterprise might

of innovation, growth and expansion, because

logically permit, a view defended by many who

business enterprise must not only adapt to chang

are as deeply interested in attaining a good

ing times, it must be a producer of change.

society as are the rest of us. I feel it important,

Almost everything that modern business does

however, to point out that their view is not as

involves change, and hence, risks. Risks entail

narrow as many would like to believe. Their main

genuine costs even though they can’t always be

thought is that business is business, that it should

measured before the future becomes past. Ob

tend to its own knitting, that it should do— in

viously,

there must be some basic level of

honesty and in good faith— that which it is best

profitability adequate to the assumed risks, not
only for the survival and growth of the business

qualified to do: to produce goods and services

but in the interest of society itself. This principle

be economically justified, to make reasonable re

is different from that of profit maximization.

turns to shareholders, to provide appropriate

efficiently, to provide jobs for as many as can

I dwell on the subject of profits for a special

wages and working conditions for all employes,

reason. I spend a lot of time working in social

to operate with a view toward economic stability,

welfare circles, and in ecumenical church circles

to abide by the rules set by society as legally

where one encounters deep social concern. As

expressed through government, to survive, and

one might expect, I often hear remarks to the

to grow. The theory holds that if business does

effect that business is “ more concerned about
profits than about people.” There is an implica

only what it is supposed to do, and does it
honestly and effectively, then the social welfare

tion that we must hasten the day when this will
no longer be true. In the context in which the

of the people will be served as well as society

statement is made, I believe it is, more often than

has a right to expect of business. Business is not
government, it is not the church, it is not the

not, quite irresponsible though righteous.

educational system, and it is not a federation of

In response, however, let me point to the fol

voluntary agencies. It is business enterprise—

lowing quotation from a work by Peter Drucker,

which through being itself will best serve the

one of the foremost management philosophers of
our day:

national interest and the needs of people.
While all this may not be as inclusive as some

“ The need for profitability is objective. It is of

such as I might like, it certainly is not a narrow

the nature of business enterprise and as such is

view, and its comprehensive nature should be

independent of the motives of the businessman or
the structure of the ‘system.’ If we had archan

carefully studied by the more pious among us

gels running businesses (who, by definition, are

various kinds of social injustices which prevail
in our nation. Business, of course, is a perennial

deeply disinterested in the pro f t motive) , they

who may be seeking a scapegoat to blame for

would have to make a pro f t and would have to

target, and this includes my own occupation of

watch profitability just as eagerly, just as assid

banking.

uously, just as faithfully, just as responsibly, as
the most greedy wheeler-dealer or as the most

Social responsibilities of businessmen

convinced Marxist commissar in Russia.”

Now anyone who thinks that business in our day

It is not my plan to make a personal defense of

is not concerned with social responsibilities has

b u sin e ss re v ie w

not seen much of the recent literature of business,

control.

hasn’t kept up with the teaching in our modern

Corporation.

principal

sponsor

was

Bendix

schools of business administration, hasn’t at

2. Coming up this summer— a business-govern

tended the innumerable meetings, conferences,

ment conference at Ohio University which will

and conventions held by businessmen. (Yes, we

try to coordinate fragmented Federal programs

have them too!) Certainly our critics have not

for aiding Appalachia. Initiated by Nationwide

sat around many Board tables.

Insurance Company.

In the vernacular, social responsibility is “ in”
and the business “ in-groups” ar8 composed of
men who are deeply concerned about social re
sponsibility. I don’t for a moment believe that
the motivation is totally altruistic, and I don’t

3. IBM— bankrolling a $5 million, ten-year Har
vard study of the Social Impact of Automation.
4. 78 U.S. companies helping to finance a world
population study by the International Planned
Parenthood Federation.

believe that matters. Modern business knows that

5. Some Bell Telephone Companies— developing

society expects business to be socially responsible

programs of recruiting and training volunteer

and business today recognizes the importance,

workers, including many present Bell em

yes, the necessity, of being responsive to society’s

ployes, to counsel and tutor potential high

expectations. Business knows that society can

school dropouts. (The long-run gain here is

legislate it out of business. Since some of society’s

stated as “ aiding Bell to compete in the labor

expectations of business may be quite unrealistic,

market for high school graduates.” )

it considers part of its job to be that of influenc
ing the populace so that its expectations are

The main thing, as the article states, is that many

pertinent and reasonable and not irrelevant and
blue-sky.

concepts of what concerns business to a new

But we encounter a basic problem. Business

social and cultural advancement of the people

companies are “ moving far beyond traditional
theory that business will prosper from economic,

doesn’t really know in specific terms, beyond that

who work in its plants and buy its products.”

which is expressed in law, just what comprises
its social responsibility. It is not altogether sure

Some of the activities listed above may not be
earth-shaking, but great oaks from little acorns

of its appropriate roles. I don’t believe anybody

grow, and under this new theory business could

else knows either, and one reason is that the con

find its way in to almost any area of social re

cepts change so rapidly. All of us must progress

sponsibility. I doubt very much that it will lead

farther in our thinking along this line.

to a welfare state “ under new management.”
Let me, however, cite two illustrations to point

Business behavior and social welfare

up ways in which business decisions have great

It is enlightening to see a leading column in the

effects on social welfare. The first was used by

Wall Street Journal (April 7, 1966) for which

Abram Chayes in his Reynolds lecture at Amherst

the headline reads, “ Business Undertakes Broad

in 1958:

Social Programs, Reaps Gains Themselves.” The
text contains items such as:
1. A recently held four-day symposium in Phila
delphia which brought together leading think
ers, including Edward Teller, to discuss arms

“ In 1954, the announcement by General Motors
of a $1 billion expansion program was largely
credited with heading off the then threatening
recession. GM’s management might as easily, and
perhaps with equal justification, have put the

b usin e ss re v ie w

$1 billion in dividends, or wage increases, or
price cuts.”

few remarks in passing. The first is the concern
for good industrial relations and sound personnel

I pass up the temptation to ask which decision

administration. The fulfillment of the responsibili

we here might have made, and make only the

ties of business and industry toward its own em

following points: that corporate decisions of this

ployes, as human beings, entitled to justice and

kind have profound public effects; that business
has an obligation to make such decisions in terms

dignity, is too broad a subject for this paper. I
make just one moot point.

of the public interest; and that we must recognize

Over the years employers have taken on re

that judgments may differ as to what decision is

sponsibilities for many facets of employe wel

most in the public interest at a given time under

fare. But just how does one judge objectively—

the current circumstances.

let us say when the next fringe benefit proposal

A second example relates to the public stake

comes along— whether it is one for which the

in a wage settlement by a large corporation such

employer is socially or morally responsible?

as United States Steel. Invariably, the settlement

When is it the responsibility of society or gov

sets a pattern and a target, not only for other

ernment, or the community, and when is it the

steel producers but for other major manufactur

responsibility of the individual himself? Are

ing industries. It spreads directly and indirectly
to influence wage rates and other terms of em

there only pragmatic approaches? Are answers
to be obtained only through power-struggles?

ployment, and hence costs, in companies through

A second major area which can rate only a

out the land. It may lead to increases not only
in the prices of steel, but in a host of commodi

once-over-lightly, despite its importance, is that
of “ corporate giving” - referring to contributions
—

ties. There really are no private interests here
that are wholly separable from the public in

made to philanthropic, educational, scientific,
cultural, and civic organizations. (I don’t mean

terest. Both the corporation and the union have

to imply that by making gifts a company fulfills

great power and it must be exercised with great
care. The settlement must be neither too fat nor
too lean. And when big government steps in, as

its responsibilities to society.) These contribu

it occasionally does, it too must act responsibly.

make these contributions on the basis of some

It must not be hostile either to labor or manage

theory of corporate philanthropy is probably

tions run into hundreds of millions of dollars
annually. I make here only the point that to

ment and the motives must be primarily economic

unwise. A purely charitable role can become too

and not political. (I realize this is a counsel of

vague, ambiguous, and indefinable. (I leave out

perfection.)

legal problems.) My belief, however, is that a

I do think it important to say, however, that

purely charitable role is, yes, too restrictive. I

when it is reported that management is resisting

subscribe, at least philosophically, to the idea set

particular demands of labor it is not necessarily

forth by Richard Eells:

behaving in an antisocial manner. Indeed, it may

“ The only safe course is to relate the policy to

well be that it is in fact fulfilling a critically im

the specific business objectives of the company,

portant social responsibility.
I must call attention to the fact that in this

and to specify in some detail the ways in which

paper I am saying little about two important

for giving or contributing)

areas of business responsibility, except for these

prudent investment of corporate funds for the

corporate support payments (a term he prefers
can be used as

b u sin e ss r e v ie w

purpose of reaching those stated objectives. There

of the old familiar, but “ hard-sell,” places.

are the long-term objectives of the corporation in

There are so many items entailing social re

relation to the industry, to the economy as a
whole, and to the larger community it serves.”

sponsibility that must be passed over because
their complexities require elaboration. Some

In my judgment, corporate support payments

which come immediately to mind are: health and

should be justified in terms of company long-

safety (covering the entire front from food and

goals, which,

drugs to automobiles and planes) ; air and water

however, must be broadly and comprehensively
stated. They must permit the inclusion of various

pollution; careful administration of all natural
resources; truth in advertising, labeling, and

kinds of public responsibilities because business
simply doesn’t live, move, and have its being in

packaging; compliance with the spirit as well as
the letter of law in relationships with all others;

range (as well as short-range)

a private world or community. Business both

the entire field of decision-making within the

influences and is influenced by community condi

framework of not-always-clear business ethics;

tions, problems and issues, and it must be con

moral vs. amoral approaches to business prob
lems; participation in political activity, including

cerned with them, financially and otherwise.
To illustrate more specifically, the quality of

lobbying. The list could be quite extensive. Few

a community is important to business and in

of the answers are as simple as they seem to

dustry. We see this most clearly w'hen a new

people who are not in business.

business is seeking a location. It seeks not only a
ready source of labor and materials, but it looks

Business and poverty

for a community in which citizens have a con

Now let’s turn to the issue with which we started,

cern for, and give support to, health, education,

the poor who comprise the other America. Whose

recreation, and so on. It does not pick for its new

responsibility are they?

site a place in which the citizens are indifferent
to “ quality of community.”

tire society, and I don’t say this with any thought

It follows that businesses and industries can

that what is everybody’s business is nobody’s

not be beneficiaries only. They must be con

business. Rather, what has appeared to have been

tributors to community improvement. Just as the

nobody’s business is indeed the responsibility of

individual is taxed, so the business is taxed to
support the community. But just as the citizen

all of us. Since business and industry is a highly

is also a voluntary contributor, so must business

its full share of that responsibility. So must all

This situation is the responsibility of our en

important institution in our society, it must bear

be a voluntary contributor. I insist, however, that

other institutions: government, labor, the church,

this is not playing a charitable role. It is a

the schools and colleges, the voluntary agencies,

socially responsible business role which redounds

hospitals, prisons— just name them all. There are

to the long-run interest of the business itself. It

no exemptions.

is making an investment just as the individual

One thing that seems clear is that government

who contributes to the United Fund Appeal is

has ultimate responsibility. If the job isn’t done

making an investment. The new breed of men in

by others, it must necessarily pass into the hands

the managerial class is increasingly looking at

of government because government has final re
sponsibility for the welfare of the people. It
comes with ill grace, not to mention lack of

things in this way, and one even finds that strik
ing Pauline conversions are taking place in many

b u sin e ss re v ie w

reason, for any of us, including businessmen, to
be blatantly critical of government for endeavor

regular payrolls people who can’t do the work,
or whose work contribution is worth substantially
less than the pay exchanged for services ren

ing to meet its responsibility when it is not being
met by anybody else. I feel strongly about this

dered. (I suspect you wouldn’t want to justify

even though I am often tempted to marvel at the

running a social agency on that basis.)

government’s voracious appetite for such respon
sibility. As a crusader for voluntarism I am not

Poverty and education

anxious to feed that appetite unnecessarily. This

We must recognize that many failures to employ

means that I must, and I do, advocate citizen re

are caused by problems of basic educational de

sponsibility across-the-board; and this, of course,

ficiencies, and deficiencies in fundamental or

includes corporate citizens. Along with Richard

basic skills, the kind of deficiencies that do not

Cornuelle, I deplore the fact that so many seem

come within the scope of any reasonable training

to believe that the “ test of a good citizen is not

program for new employes. This educational and

that he takes responsibility, but that he success

training job belongs to the educational system,

fully sends it to Washington.”
In allocating our

obligations we must, of

the costs to be borne by the entire society through
the taxing process. Whatever the tax needs may

course, consider appropriateness of role. Each

be to do this basic job, business must and will

institution should do what it is best qualified or

pay its appropriate share.

equipped to do. Everybody shouldn’t get into
every act.

It may well be that there is some of this basic
skill training that, under special circumstances,

belongs in a variety of places, but it is uniquely

can be done better by business and industry than
by the school system, for both technological and

concerned with employment and unemployment.

psychological reasons. There are, as you know,

So, where does business belong? I think it

Poverty results from lack of income and, in our

experimental programs currently going on, and

current structure, incomes are associated with
jobs. We look rightly to business and industry

I believe that this practice should be continuously
and comprehensively explored. However, and this

for job opportunities. (I must forego any dis

is important, the cost is still a proper charge

cussion of guaranteed family incomes, negative

upon education and not upon business. It should

income taxes, “ demogrants,” etc., but I believe

continue to be supported by tax dollars. If

the writings of Robert Theobald and other avant-

business takes on in any extensive way the work

garde thinkers must be taken seriously.)

of the educational system, then it should be reim

— everybody?” The answer must be no; but this

bursed or compensated through some form of
tax incentive or allowance. It is even a rational

doesn’t let business off the hook. Society, how

use of anti-poverty funds. We have not begun

ever, must understand that there are rational

to explore all the ways in which business and in

and irrational approaches to problems of em
ployment. We don’t have to worry about business

dustry might contribute to training and to making

employing all the people it can effectively use—
that’s not the problem under discussion. We are
talking about those it cannot now effectively use.

are unable to meet market tests of employment.
Nevertheless, and this is a proper caveat, these

The question is, “ Job opportunities for whom

It is irrational for business to place on its

use of services of many types of individuals who

costs must not be saddled upon business.
( Continued on Page 12)

THE SHRINKING TRADE
by Kathryn Kjilmbach

BALANCE OF PAYMENTS— LIQUIDITY BASIS
MERCHANDISE BALANCE

Billions of Dollars

EXPORTS AS A PERCENT OF GNP

PERCENT ANNUAL CHANGE IN
EXPORTS AND IMPORTS

Billions of Dollars

1. The United States has run a deficit in its balance of payments
for many years.

3. And that is one reason why exports, which account for only
a small percentage of Gross National Product, are so important
in our economy.

2. These deficits have been held down by big surpluses in the
trade balance.

4. Recently, however, the trade surplus has been getting smaller
as the rate of increase for exports has fallen short of that for
imports.

HOURLY EARNINGS IN MANUFACTURING, 1961-1966
Index (1 9 5 8 = 1 0 0 )

ANNUAL CHANGE IN UNITED STATES EXPORTS
BY AREA, 1962-1965
Billions of Dollars

IMPORTS AS A PERCENT OF FINAL DEMAND*
I
I

UNITED STATES MERCHANDISE IMPORTSCHANGE— 1964-1965

Per Cent

11961-62
11962-63

Billions of Dollars

r ~ l 1963-64
I

11964-65

WHOLESALE PRICES, 1961-1966
Index (1 9 5 8 = 1 0 0 )

~ h llih
* Excluding services.
-*«lst.(|tr.; s.a.:a.r.

Western
Europe

Canada

Latin
America

Japan

6. and, on the other hand, increased demands of our presently
booming economy as well as long-term growth in the importance
of imports in our economic life.

7, Most of the recent gain in imports was accounted for by
increases in industrial supplies and consumer goods.

5. This reflects, on the one hand, a general slackening in the
expansion of demand for United States products as well as world
demand,

«r

<
r

competitive position in world markets showed little change. Wages
in this country have risen less than those in the major trading
countries. However, recent price increases have been somewhat
greater in some instances.

b usin e ss re v ie w

( Continued from Page 9)
Of course, society could say that business

run terms. Each must be sure that in its vision
for the long run it doesn’t become a business

should do all these things anyway, and consider

casualty in the short run, thereby having no long

their costs as the costs of doing business. But it

run.

should think twice about this because society will
not be relieved of the costs in any case. It will

Business-government cooperation

merely be faced with a choice, and the decision

I have spoken many times publicly on the need

will be an unfortunate one if it should require

for business and government to work together

business to dilute its operational results through

more closely on social welfare problems, for each

the adoption of outright uneconomic policies,

desperately needs the help of the other. My

however deeply they might be rooted in social

record of not looking upon government as either

motivation. There are no rabbits in this hat.

evil or incompetent, or lacking in dedication, is

In order to make clear the preceding point, I

also quite clear. However, I think I am seeing

have painted it in terms that are actually too

an increasing need for business and businessmen

black and white, too much either-or. There is

to work more closely with government, or vice

increasing evidence that business wishes to play

versa, in the field of anti-poverty programs. I

a more constructive training role than it has in
the past, and at its own operative expense. I

don’t mean to detract from the good that has
already been done, but I believe that there are

illustrate this by taking relevant sentences from

signs pointing to the fact that we are in trouble,

an interview with NAM’s President Gullander by

or at least that there are real trouble spots.

the business editor of the Christian Science Moni
tor:

Anti-poverty business is big business. In this
highly complex field, the insights, abilities, and

“ What happens when a company plays such

skills required are many and varied. Among

a community role (hiring high school dropouts,

these are executive and administrative abilities,

retaining displaced w orkers)? Three things: a

business judgment and foresight, analytical tal

grateful person finds a job again— and also be

ents, fiscal competence, economic realism as well

comes a spending consumer. The company gets

as social perspective, and a knowledge of history.

a needed employe. And a social problem is solved

These essentials, and many others, are not neces

locally, without expanding the role of govern
ment.”

sarily associated with low incomes. The qualifica
tions for handling huge, complex, and costly

The interview continues:
“ What about a company that doesn’t need any

programs go beyond sincerity, dedication, grass

new employes? Would the NAM urge it, too, to

income. I think we need a serious review of ideas

roots sociological insight, empathy, and personal

retrain workers for other jobs in the community?

as to who should be involved “ to the maximum

Yes, replied Mr. Gullander. In the long run it
would help both the community and the com
pany.”

extent feasible.”
I have been telling businessmen that these

There are important and difficult business de
cisions to be made in such areas of activity. Some
businesses can do more than others and each
business must think in both long-run and short-

programs are going to go on whether they are in
or out, and that I believe that it will be better
for everybody if they are in. Criticism from the
sidelines isn’t enough.
Whether by design or not—-and I believe not—

b u sin e ss re v ie w

an attitude has swept the country that to attain

ability to achieve unity of forces of all pertinent

success we must move away as far as possible

talents— to the maximum extent feasible. My

from the “ old establishments” — and these include

hope is that business talents will be among those

business, the existing political structures, the old-

used more extensively in this exercise of respon

line voluntary organizations, and even the social
work professions. This is utterly ridiculous and,

sibility for social welfare.

of course, tragic. What is all this talk about wast

We live in an era of tension and discontent.
This should result in hope, not despair. In line

ing human resources?

with this thought I close with a quotation from

I have also spoken publicly of the need to in

Macaulay’s History of England, published in that

volve, at all levels of responsibility, those who

politically turbulent year of 1848 which also

will be “ the beneficiaries” of anti-poverty pro

saw the publication of the Communist Manifesto.

grams. Their contributions and insights, and

Here are the relevant sentences:

direct involvement, are indispensable. But they

“ It is in some sense unreasonable and ungrate

can’t do the job alone, and I don’t believe that

ful in us to be constantly discontented with a

government ever intended that they could or

situation that is constantly improving. But, in

should. Yet, something has happened to create a

truth, there is constant improvement precisely

pervasive belief that others are, as the Pennsyl
vania Dutch might say, “ not wanted in.” This

perfectly satisfied with the present, we would

belief must change, and change fast.

cease to contrive, to labor, and to save with a

Responsible

citizen

action

rests upon

our

because there is constant discontent. If we were

view to the future.”

Third District banks had lagged behind all member banks in terms of profitability; and within the
district, profitability of country banks had lagged behind that of Philadelphia banks. However, recent
patterns of bank earnings have caused . . .

THE CHANGING
PROFITABILITY GAP
by William F. Staats
An analysis of bank earnings posted during the

sponsible for the performance during the past

five-year period, 1961-1965, revealed these de

half-decade.

velopments :
1. Earnings of country banks in the district rose

Country banks vs. Philadelphia banks

much faster than those of reserve city banks.

While earnings of Third District banks advanced

2. Bank earnings increased at a slightly faster

markedly during the five-year period, as shown

rate in the Third District than in the nation.

in Chart 1, earnings of country banks increased

Here we take a look at bank earnings and
profitability and highlight the major factors re

especially rapidly. Net income (plus change in

loan-loss reserves) of country banks rose by 34

b usin e ss r e v ie w

CHART 1

Table 2

NET INCOME PLUS CHANGE IN
LOAN-LOSS RESERVES

SO U R C E S AND U S E S OF FU N D S
TH IR D D IS T R IC T M EM BER BA N KS

Third District Banks (1956-1965)

(1 9 6 1 -1 9 6 5 )

Millions of Dollars

P h ilad elp h ia

Sources
Increase in:
Demand deposits
Time deposits
Other liabilities
Capital accounts
Decrease in:
U.S. Government
obligations
Total
Uses
Increase in:
Loans
Other securities
Cash assets
Other assets
Total
per cent, compared with 24 per cent for Phila
delphia banks. The difference was even more

C o un try

Banks

14.3 %
64.8
7.5
7.7

19.7 %

62.0
2.3
8.1

5.7

7.9

100.0 %

7 4 .7 %
11.9
8.6
4.8

7 0 .2 %
25.8
1.6
2.4

100.0 %

Source: Computed from Member Bank Call Reports,
Board of Governors of the Federal Reserve System,
1960-1965.

pronounced in terms of current earnings, as
shown in Table 1. For country banks and Phila

The principal reason for these disparities

delphia banks, current earnings rose 34 per cent

seems to be interest paid on time and savings

and 13 per cent respectively.

deposits. Interest expense on time deposits paid
by Philadelphia banks jumped 185 per cent dur

Table 1

ing the period, compared with 58 per cent for
country banks.

CHA N G E IN EARN IN G S OF
TH IR D D IS T R IC T B A N KS

Two factors, in turn, caused the rise in inter

P e rce n tage C h a n ge

est expense— an increased volume of time de

1956 1960

Country Banks:
Net Income Plus Change
in Loan-Loss Reserves
Net Income
Current Earnings Before
Income Tax
Philadelphia Banks:
Net Income Plus Change
in Loan-Loss Reserves
Net Income
Current Earnings Before
Income Tax

Digitized14 FRASER
for

1961-1965

37
53

34
37

or more— raised their average rate from 2.48

per cent in 1965. Smaller banks raised their rates

posits and higher rates of interest paid on them.
Large banks— those with deposits of $100 million

per cent of average time deposits in 1961 to 3.36
only slightly. Meanwhile, the amount of time
deposits nearly tripled at Philadelphia banks but

17
29

24
24

increased only 45 per cent at country banks.
Growth of interest expense far outpaced that
of current revenue from loans and securities,

b u sin e ss re v ie w

Table 3

EARNINGS RATIOS
TH IR D D IS T R IC T M EM BER B A N KS
(1 9 6 1 -1 9 6 5 )
Net Inco m e P lu s C h a n g e in
L o a n -L o ss R e se rv es as P ercentage
of Total C ap ital A cco u n ts

N et In co m e P lu s C h a n g e in
L o a n -L o s s R e se rv e s as Pe rce ntage
of Total A s se ts

Year

P h ilad elp h ia

Co un try

D ifference

1961
1962
1963
1964
1965

9.45
8.84
9.10
8.68
9.49

7.79
8.25
8.26
8.44
8.68

1.66
.59
.84
.24
.81

P h ilad elp h ia

.96
.90
.94
.88
.92

C o un try

.78
.82
.82
.83
.85

D ifference

.18
.08
.12
.05
.07

especially at Philadelphia banks. As a result, the

tinued to enjoy a higher return on total assets,1

proportion of current revenue available to cover

as shown in Table 3.
Similarly, while reserve city banks had a higher

expenses other than interest on time deposits
declined during the period. In 1961 Philadel
phia banks’ current revenue from securities and
loans amounted to 7.8 times interest expenses on
time deposits, but by 1965 the ratio had dropped
by one-half to 3.9. The ratio declined by a much
smaller amount for country banks.
In an attempt to counter the adverse effects of
higher interest expenses, Philadelphia bankers
were more aggressive than country bankers in
expanding loans to secure greater yields. As
shown in Table 2, Philadelphia bankers placed
nearly 75 cents of every dollar received during

rate of return on owners’ equity than country
1A high ratio of net income to total assets does not
necessarily mean that a bank is being successful in its
attempts to maximize profits (if indeed profit maximiza
tion is a goal of bank management). Actually, an in
creasing ratio of earnings to total assets would mean
that a bank was heading toward a maximum volume
of profits only if the amount of total assets was held
constant. Given the realistic case of asset variability,
profit maximization occurs when the return of additions
to assets equals the cost of the additional assets. The
diagram shows an arbitrary marginal rate of return

the period into loans while country bankers chan
neled just over 70 cents per dollar into loans.
However, country bankers led in acquiring “ other
securities” (primarily tax-exempt municipal se
curities) , using nearly 26 cents of each dollar for
that purpose, compared with 12 cents per dollar
by Philadelphia bankers.
While the net effect of these factors was that
country banks increased their earnings faster than
Philadelphia banks, they did not close the earn
ings gap completely. Philadelphia banks con

curve and a marginal rate of cost curve (which was
held constant for simplicity) which may exist for a bank
at a given time. If, (assuming a constant rate of costs)
a bank has total assets equal to $5, a high rate of return
is possible. But because the highest yielding investment
opportunities are used, the second $5 of assets will yield
a somewhat lower rate of return. Any assets in excess
of $25 cannot yield a return sufficient to cover the costs
( the 26th dollar may yield 3 cents but may cost the bank
3.5 cents) so the bank has attained the maximum amount
of profit when assets total $25 in this example. But the
ratio of earnings to total assets declines as the bank
moves toward profit maximization because the rate of
return on each additional dollar is less than that of the
preceding.

b u sin e ss r e v ie w

CHART 2

Table 4

RATE OF RETURN ON TOTAL ASSETS

CH A N G E IN EARN IN G S
OF M EM BER B A N KS

All Member Banks and Third District Member Banks

P e rce n tage C h a n ge
1956-1960

All Member Banks:
Net Income Plus Change
in Loan-Loss Reserves
Net Income
Current Earnings Before
Income Tax
Third District
Member Banks:
Net Income Plus Change
in Loan-Loss Reserves
Net Income
Current Earnings Before
Income Tax

1961-1965

42
65

| ALL M EMBER BANKS

30
23

Per Cent___________________________________________________________________

1961

1962

DISTRICT

1963

1964

1965

28
42

30
31

ability of Third District bankers to employ their
assets. For example, the ratio of earning assets to

total assets of banks in the district was higher
than that of banks in all other districts except

banks, the gap was closing.

one.
In 1961, profitability (net income plus change

Third district vs. the nation

in loan-loss reserves as a percentage of total

During the period, 1961-1965, the performance
of banks in the district relative to that of all mem

assets) was lower for banks in the Third Dis
trict than for banks in any other district; but in

ber banks improved sharply from the preceding

1965, the district ranked fifth among the 12

five-year period when earnings growth in the
Third District had lagged far behind, as shown

regions in profitability. The improved standing

in Table 4.

poor performances in some of the other districts
than the result of an outstanding improvement in

One reason for the improved performance is

of Third District banks was more the result of

that Third District bankers have been among

the

the leaders in shifting funds out of lower-yielding

actually declined during the period; while for

assets and into loans and other securities with

banks in the Third District, the ratio increased

higher after-tax income. As shown in Tables 5

slightly from .84 per cent to .88 per cent as

and 6, liquidation of Government securities pro

shown in Chart 2.

district.

Profitability

many

districts

vided 6.9 per cent of the total volume of funds

As indicated in Chart 3, the rate of return on

of district banks compared with just 4 per cent

capital in the Third District lagged behind that

for all member banks. District banks used a

of all member banks in the nation partly because,

larger proportion of their funds— 72 per cent—

in the aggregate, district banks had more capital

for loans.

for each dollar of assets. For example, at mid-

However, the average rate of return on loans
and on securities in the district was among the

1965, all member banks had $9.18 of capital for
each $100 of total assets, but banks in the dis

lowest of all Federal Reserve Districts. The un

trict had $9.83 of capital per $100 of assets.

favorable effect of relatively low loan and in
vestment yields on earnings was offset by the

Capital-asset ratio values were nearly equal for
reserve city and country banks in the district.

Digitized 16 FRASER
for

b u sin e ss rev iew

Table 5

SO U R C E S AND U S E S OF FU N D S
A LL M EM BER BA N KS IN U N ITED S TA TE S
(1 9 6 1 -1 9 6 5 )
Year
1961

Year
1962

Year
1963

4 2 .9 %
45.6
3.7
7.8

6 1 .6 %
16.2
6.3

5 5 .6 %
4.3
7.2

Decrease in:
U.S. Government obligations
Cash assets
Total

100.0%

5.3
10.6
100.0%

17.9
15.0
100.0%

Uses
Increase in:
Loans
U.S. Government obligations
Other securities
Cash assets
Other assets

3 4 .8 %
26.4
14.5
20.4
3.9

6 1 .0 %

Sources
Increase in:
Demand deposits
Time deposits
Other liabilities
Capital accounts

Decrease in:
Demand deposits
Other liabilities
Total

Year
1965

Period
1961-1965

4 5 .5 %
44.5
7.9

10.9%
58.9
8.5
8.6

19.9%
60.7
6.6
8.8

2.1

13.1

4.0

1 00.0 %

100.0 %

100.0%

6 5 .9 %

5 6 .2 %

7 9 .3 %

6 9 .7 %

23.3

24.6

2.1

2.9

10.3
28.5
3.3

16.6
0.3
3.8

19.7
6.9
3.7

13.6
100.0%

Year
1964

6.6

100.0%

100.0 %

1.7
100.0 %

100.0%

Source: Computed from Member Bank Call Reports, Board of Governors of the Federal Reserve System, 1960-1965.

CHART 3
RATE OF RETURN ON CAPITAL
All Member Banks and Third District Member Banks

The outlook
Bank earnings are of critical importance. First,
earnings are the prime source of protection

Per Cent

against insolvency of banks. In “ normal” times
current earnings are expected to absorb losses
on loans or investments. In “ abnormal” times
when a heavy volume of losses occurs, earnings
of previous years (in the form of reserves, sur
plus, undivided profits or even capital) provide
the bulwark of defense against insolvency. Second,
earnings represent a return on capital invest
ment. If growth capital is to continue to flow

busin e ss r e v ie w

Table 6

S O U R C E S AND U S E S OF FUNDS
TH IR D D ISTR IC T M EM BER BAN KS
(1 9 6 1 -1 9 6 5 )
Year
1961

Sources
Increase in:
Demand deposits
Time deposits
Other liabilities
Capital accounts

3 9 .0 %
50.4

Year
1962

Year
1963

5 1 .8 %
10.6
9.1

10.6

58.0%
10.6
5.8

Decrease in:
U.S. Government obligations
Cash assets
Other assets
Total

100.0%

25.2
0.4
100.0%

Uses
Increase in:
Loans
U.S. Government obligations
Other securities
Cash assets
Other assets

4 2 .6 %
32.1
5.4
15.7
2.2

Decrease in:
Demand deposits
Other liabilities
Total

6 4 .3 %
0.3
17.1

Y ear
1964

Year
1965

Period
1961-1965

4 4 .1 %
45.0
3.9

9 .3 %
56.6
7.1
5.1

17.1%
63.3
4.8
7.9

7.0

21.9

6.9

100.0%

100.0 %

5 8 .3 %

5 0 .8 %

7 7 .5 %

7 2 .4 %

26.7

14.4
28.4
1.8

12.4
2.3
7.8

19.0
5.0
3.6

4.6
100.0 %

100.0%

17.6
10.9

2.1
18.3

2.0
100.0%

12.9

100.0%

Source: Computed from Member Bank Call Reports, Board of Governors of the Federal Reserve System, 1960-1965.

return has to be realized on stockholders’ equity.

myriad of factors, many of which are unpredict
able. But it does appear that bank management is

If earnings are insufficient to provide an accept

now in a less flexible position to counter future

into the banking system, an adequate rate of

able return, the privately owned banking system

unfavorable influences within the traditional con

is in jeopardy. Therefore, the earnings perform

text of commercial banking. There is, for ex

ance of banks is of wide concern.

ample, a practical limit to redistributing assets

prosperity, bank earnings generally failed to

in search of higher yields to cover increased
costs. In the last ten years, Philadelphia banks

grow as vigorously as in the last half of the

have reduced the proportion of U.S. Government

1950’s. Will still slower growth prevail in the

securities from about 17 per cent of total assets

future? One cannot forecast future bank earn

to just under 9 per cent, while increasing loans

ings precisely because they are affected by a

from 48 per cent of total assets to 59 per cent.

During the last five years of widely heralded

b usin e ss re v ie w

CHART 4

ASSET DISTRIBUTION
Third, District Member Banks
Per Cent of Total Assets

How much longer can the trends depicted in Chart
4 continue?
In search of greater profit opportunities for
the future, some banks have already launched
into enterprises such as direct leasing, credit card
operations and computer services which are out
side the traditional sphere of banking. These
and other new activities may provide a hedge
against any future decline in the growth of earn
ings from loans and investments.

T H E C O N C EP T OF BANK EARNINGS
Bank earnings obviously represent the excess
of revenues over expenses. But there are three
concepts of bank earnings which may be useful
in an analysis of bank profitability. One is called
"current earnings” and is used to describe the
difference between so-called current revenues
(such as interest on loans and investments, serv
ice charges and various other fees) and certain
expenses which include wages and salaries,
interest on borrowed money and time deposits
and occupancy expenses. This concept of earn
ings concerns revenues and expenses which re
sult from a bank’s regular operating activities.
However, it ignores such items as gain or loss
from sale of securities, losses on loans, recov
eries of previously charged-off loans and income
taxes.
A more inclusive concept of earnings called
net income includes the effects of such non
recurring items as profits and losses on secur
ities along with recoveries and charge-offs of
assets. Net income gives a better indication of
the financial results of a bank’s total operations
during a given period of time than does current
earnings. However, net income is not a precise
measure of bank earnings because of the effect
of changes in valuation reserves. Most banks

maintain an account (called "reserve for loss on
loans,” or something sim ilar) to which transfers
are made from current revenue.* Since 1947
under regulations prescribed by the Internal
Revenue Service, banks have been permitted to
transfer annually to loan-loss reserves a taxdeductible amount which has exceeded actual
losses on loans at most banks. Consequently, on
a current basis, these transfers have resulted in
understating profit and reducing income taxes.
Therefore, reported net income of banks after
loan-loss reserves has been unrealistically low.
In order to secure a more complete measure
of bank earnings, it is necessary to add net
changes occurring in loan-loss reserves during
a given year to net income reported for that year.
All three concepts of earnings— current earn
ings, net income and net income plus changes
in loan-loss reserves— are used in this analysis.
*Some banks do not use a reserve for loss on loans,
preferring instead to charge off losses against revenue
in the year in which losses occur. In the Third Dis
trict, 74 per cent of the member banks used loanloss reserves in 1965 compared to 69 per cent in
1960. However, data indicate that the loan-loss re
serve method is used by about 60 per cent of banks
having deposits of less than $10 million and by almost
100 per cent of banks with deposits of $20 million
or more.

FOR THE R E C O R D . . .
BILLIO NS $

INDEX

Third Federal
Reserve District

SUM M ARY

United States

Per cent change

M 1966
ay
from
mo.
ago

MANUFACTURING
Production ....................
Electric power consumed
Man-hours, total* .......
Employment, total .........
W income* ...............
age
CONSTRUCTION** ...........
COAL PRODUCTION .......
BANKING
(All member banks)
Deposits .......................
Loans ............................
Investments .................
U.S. Govt, securities ....
Other ...........................
Check payments*** ......

year
ago

5
mos.
1966
from
year
ago

M 1966
ay
from
mo.
ago

+ 1
+ 4
+ 1
0
+ 1
-1 0
+51

- 1
+ 1
0
— 1
+ 3
- 2f

PRICES
Wholesale ....................
Consumer ....................

+
+
+
+
+
+

12
5
4
9
1
2

+ 8
+12
- 1
— 10
+ 11
+14t

+10
+ 6
+ 3
+ 9
- 4
—3

+
+
+
+

6
10
1
9
11
15t

year
ago

+ 10

Manufacturing

5
mos.
1966
from
year
ago

LOCAL
CHANGES
Metropolitan
Statistical
Areas*

Employment

Payrolls

Check
Payments**

Total
Deposits***

Per cent
change
M 1966
ay
from

mo.
ago

year
ago

—
+
—
+
-

1
1
2
4
1
2

+ 5
+ 3

+ 8
+ 13
+ 1
—9
+ 13
+20

mo.
ago

year
ago

mo.
ago

year
ago

mo.
ago

year
ago

+ 6
—7

+30

-1 3

- 6

—4

+ 2

- 8
—4

+ 12

- 2

+10

+ 2

+ 1 + 4
0 + 11
0 + 6
—2

+ 10
Wilmington .... + 1 + 4
Atlantic City ....

+ 1
+37

Banking

+ 9
+ 2

+
+
+
+
+

8
13
1
8
12
16

Trenton .........

1 + 4

— 1 + 1 + 3
Altoona ......... + 1
+ 13 - 4 + 11
Harrisburg ...... + 1 + 6 + 3 +10

Johnstown ...... + 1
0
Lancaster .......

+ 2
+ 9

- 2

+ 2
+ 1 + 18

0* + 3t + 2t

0
0

+ 3
+ 3

+ 4
+ 3

+ 7

Lehigh Valley ..

+ 2

+ 1 + 5

—3

+ 15
+16

Philadelphia....

+ 4

—4

+ 10

Reading .........

+ 3

+ 1 +n
- 1 + 8

Scranton .......

+ 2

- 6

+11
1 + 16

tl5 SMSA’s
^Philadelphia

+ 6

+ 5

+14

+ 5

+15

—2

+11

York .............. + 2

+ 4

+ 13

—2

+ 12

+ 5

+ 11

Wilkes-Barre .... + 1 + 6

’ Production workers only
‘ ‘ Value of contracts
“ ‘ Adjusted for seasonal variation

MEMBER BA N KS, 3RD F.R.D.

+11

+ 1 + 15
- 1 .+ 8
— 2 + 10

+ 8

1 +12
— 1 + 9

1 + 5
0

+ 6

‘ Not restricted to corporate limits of cities but covers areas of one
or more counties.
“ All commercial banks. Adjusted for seasonal variation.
‘ “ Member banks only. Last Wednesday of the month.