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F E D E R A L R E S E R V E B A N K OF S A N F R A N C I S C O MONTHLY REVIEW 1 91 4 IN THIS I SSUE North of the Border................. 55 Western Men of Science . 65 . . MARCH 1 964 FIFTIETH ANNIVERSARY 1964 Canada . . March 1964 M ON THLY REVIEW North of the Border This similarity of economic and political Americans are aware of Canada as a vacation spot, the home of the redinterests leads many people to take Canada coated Royal Canadian M ounted Police, andsomewhat for granted, so that its problems a land of adventure where Jack London char tend to be overlooked until some major event acters abound. We are also aware that we appears to encroach on U. S. interests. Such have shared with Canada for more than 100 an event occurred in May 1962, when Can years a common, unprotected border stretch ada devalued its dollar and returned to a sys ing almost 4,000 miles from the Atlantic to tem of fixed exchange rates. Since that time, the Pacific Oceans. Despite the fact that Can Canada has received more notice in this ada has been an independent member of the country as befitting a country of its size and British Commonwealth of Nations since 1867, economic and political importance. we in this country feel a close kinship with Canada, after all, is the second largest our neighbors to the north and share many of country in area in the world (next to the So the same interests and tastes. This kinship is viet U nion), a leading producer of primary heightened by the fact that English is the prin cipal language in Canada, although the coun commodities, and the Western W orld’s fourth try is officially bi-lingual and one-third of the most im portant trading nation. According to population is of French extraction. the latest figures available, Canada is the In the area bordering on each side of the world’s leading producer of newsprint, woodinternational boundary, moreover, topog pulp, nickel, and asbestos; the second most raphy, climate, resources, and products are im portant in production of platinum, gold, quite similar, and substantial trade is carried aluminum, zinc, uranium, and hydroelectric on between the two border regions. Over the power; third in wheat, lead, silver, and molyb years, the economic ties between Canada and denum; and fourth in lumber, copper, and the United States have strengthened-—even iron. C anada’s population, however, is only to the point of speculation about an economic one-tenth as large as that of the United States union in the distant future. The two nations, and is concentrated mainly in a strip within in addition, have worked together closely on the international political scene. 200 miles of the international border. M o st FEDERAL RESERVE B A N K OF S A N F R A N C I S C O Devaluation in limelight 56 C anada’s decision to devalue its currency was motivated principally by the fact that the premium on the Canadian dollar, caused by substantial inflows of foreign capital, had stimulated imports but had worked to the dis advantage of Canadian exports. The result ant deficit on current account transactions was largely responsible for the Canadian bal ance of payments deficits. Customarily, a trade deficit with the United States had been partly offset by a surplus in trade with other countries, principally the United Kingdom and the rest of the sterling area. But even a trade deficit of this size was undesirable in face of the steadily growing deficit on non merchandise transactions caused by rising in terest and dividend payments on foreign in vestments in Canada and rising (net) pay ments to foreigners for travel and transporta tion. The movement of short- and long-term funds into Canada, however, had for some years offset the current account deficit and masked the underlying weakness of the na tion’s domestic and international position. As a consequence, steps to reduce the current ac count deficit were not undertaken. Then, in June 1961, Canadian policymak ers moved to influence the rate for the Cana dian dollar in a downward direction, by an nouncing the Government’s intention to push the rate for the Canadian dollar to a discount against the U. S. dollar. This declaration of official intent subsequently resulted in specu lative pressures against the Canadian dollar, which eventually necessitated sizable official support operations and resulted in large re serve losses, especially from December 1961 through April 1962. Early in May 1962, the decision was reached to peg the Canadian dollar at 92.5 cents in terms of the U. S. dol lar, under the rules of the International M on etary Fund. Nevertheless, C anada’s ability to m aintain the rate at this lower level remained in question, and speculation continued until June 1962, when massive international finan cial assistance totaling more than $1 billion was mobilized and the central bank discount rate was boosted to a crisis level of 6 percent. C a n a d a sh o w s im provem en t in current accounts balance as capital inflows level off B illio n s of D o lla rs S ource: B an k of C anada. March 1964 M ONTHLY REVIEW Now more vulnerable? Since abandonment of the freely fluctuat ing exchange rate for the Canadian dollar, the Canadian domestic economy has been more vulnerable to economic developments abroad. Developments in the United States, in partic ular, have tended to provoke repercussions in Canada because of the close links between the two countries. Canadian policies designed to bring its payments position into better bal ance and to step up its economic growth rate in turn have affected this country. To check the inflow of foreign capital, which comes mainly from the United States, Canada has proposed more favorable tax treatment for “Canadian” industries (defined as industries 25 percent or more Canadian-owned) and has abolished preferential tax treatm ent of dividend and interest payments to foreigners. At the same time, the United States— in at tempting to correct its payments imbalance— has proposed a tax on U. S. investor pur chases of foreign securities. The introduction of the proposed interestequalization tax in July of last year hit Canada particularly hard, since it has been a consist ently heavy borrower in the U.S. capital m ar ket. Although Canada was assured that its new security issues in the United States would be exempt from the tax as long as the proceeds were not used to build up Canadian interna tional reserves, the Canadian securities m ar kets were unsettled by the surprise U. S. ac tion. Canada consequently felt impelled to raise its discount rate from 3 Vi to 4 percent early in August, wiping out the covered spread in favor of short-term investment in the United States that had emerged when the Federal Reserve Banks upped their discount rates from 3 to 3 Vi percent in July. Subsequently, Canada extended its system of tariff rebates on automobile transmissions (introduced in late 1962) to imports of all automobiles and parts, based on an equivalent dollar volume of exports of automobiles and parts. This action alone may increase Cana dian exports in this category by some $200 million, mainly to the United States. Although this move was part of the program to strength en C anada’s secondary manufacturing base and to expand markets for Canadian prod ucts on a continental basis, it also tended to reduce our trade surplus with Canada and thus complicated our efforts to reduce our own payments deficit. This capsule history serves to demonstrate the importance to each other of the inter locked Canadian and American economies. To some extent, the two countries have been faced with similar problems— high unemploy ment, excess productive capacity, and balance of payments problems. As a consequence, the policy requirements for stimulating eco nomic growth have seemed to conflict with policies essential for better payments equilib rium. But here the parallel ends. The factors behind the emergence of these problems are different for the two countries, and their inter actions present an additional dimension which must be considered by their policy-makers. Since the United States plays a more impor tant role in the Canadian economy than Can ada does in the United States, a closer look from the Canadian viewpoint might be useful. Importance of trade The Canadian economy is based largely on an abundance of natural resources— which are most economically and efficiently ex ploited where large scale production is pos sible and access to world markets is unob structed— and foreign demand for the prod ucts of Canadian forests, mines, and farms therefore is an im portant economic variable. Exports of goods and services from Canada account for about one-fifth of Canada’s na tional product, almost four times as much as in the United States. Exports of goods alone account for 40 percent of total Canadian out put of movable goods. FEDERAL RESERVE B A N K OF S A N F R A N C I S C O The level of exports is one of the principal determinants of Canadian income, employ ment, and investment. When export demand for Canadian products is strong, domestic in vestment rises in order to provide the addi tional capacity needed to meet prospective increases in foreign demand. Internally gen erated capital is supplemented by foreign cap ital whenever demand is particularly high and domestic savings inadequate, and much of this foreign capital is transferred in the form of goods and services. Larger export receipts and capital expenditures lead in turn to higher levels of domestic consumption and employ ment as the effect of the initial stimulus from higher exports spreads throughout the econ omy. As foreign exchange earnings increase, the ability of Canada to import foreign prod ucts— either in the form of consumer goods or capital equipment— also rises. W hen ex port dem and contracts, the reverse occurs: in come, employment, investment, and imports decline and the inflow of foreign capital falls off significantly. Because many of its exports are industrial raw materials, the Canadian economy is espe cially sensitive to production trends abroad, particularly in the industrialized countries. Its food exports, meanwhile, vary with the out come of harvests abroad. Canadian export earnings, however, tend to be more stable than those of most other prim ary producing coun tries because of the country’s greater eco nomic diversification, its use of long-term con tracts, its m aintenance of competitiveness, and the strong secular growth in demand for certain Canadian products. Importance of the United States 58 The tempo of business activity in the United States is a m ajor influence on the Canadian economy. This country has come to occupy an increasingly im portant role as the leading purchaser of Canadian exports and the leading supplier of Canadian imports, C a n a d ia n e x p o rts reflect shifts in U. S. industrial production; imports reflect export earnings 1947=100 B illio n s of Dollars Sources: B an k of C an ad a; B oard of G overnors of th e F ederal R eserve System . partly because of wartime developments which weakened Canadian ties with the United Kingdom and partly because of the rapid postwar growth in Am erican industrial material requirements. The U. S. share of Canadian exports has risen from an average of 36 percent in the 1936-39 period to 60 per cent today, while our share of Canadian im ports has risen from an already high level of 62 percent in the prewar period to almost 70 percent recently. Increased trade has been accompanied by a rise in service and capital transactions in both directions. A huge influx of American and other foreign capital for expansion of pro ductive facilities was stimulated a decade ago by the Paley resources report, which aroused fears of future shortages of m ajor industrial materials in the face of strongly rising de mands. In the 1950’s, foreign capital— in the form of new capital inflows, reinvested earn ings, and depreciation reserves— accounted for almost 30 percent of C anada’s gross cap ital formation. The net result of these develop ments was a sharp rise in the relative im por tance of the United States in Canadian inter national transactions. Reliance on the export sector has created a num ber of problems for Canada, which are March 1964 MONTHLY REVIEW partly alleviated by the fact that much of C anada’s exports to the United States— its principal market— do not fluctuate signifi cantly over the business cycle. Nevertheless, weakness in export demand— due to increas ing competition from other prim ary produc ers and a slower rate of growth in world m ar kets for industrial materials and foods— has had unfavorable repercussions on the rate of C anada’s economic growth. The increasing diversification of the domestic economy and the poor competitive performance of many Canadian manufactured products in foreign markets — despite the favorable short-term effects of devaluation— also have reduced the relative importance of the export sector and thus its stimulating influence on the domestic economy. Imports, on the other hand, have tended to vary with domestic economic activity and are highly responsive to changes in the level of domestic income. Small price changes have relatively little impact on import volume, since a significant proportion of Canadian imports consists of products not manufactured domes tically or of component parts imported for further fabrication and assembly by Canadian subsidiaries of U. S. concerns. Consequently, the devaluation of the Canadian dollar has not been fully reflected in a commensurate decline in Canadian imports. There has been some displacement of imports by domestic produc tion, however, which has offset part of the im pact of higher prices on import volume. Can trade surplus be sustained? The prospects for enlarging C anada’s trade surplus, which has emerged only within the past three years as a consequence of deprecia tion and the revival of export demand, are somewhat uncertain. The large wheat ship ments to the Soviet Union contributed to the improvement in Canadian exports in 1963, but these m ust be considered a temporary phenomenon. Exports jumped almost 10 per cent last year, while imports rose at only half that rate. The expansion of exports to coun tries other than our own of course minimizes the adverse impact on the United States of a larger Canadian export surplus. The United Kingdom and some of the European Common M arket countries, however, are now register ing growing trade deficits which they would be reluctant to widen. Continued high levels of economic activity in the industrialized countries (especially the United States) may permit Canada to realize its goal of increased exports. The reversal of C anada’s earlier policy against electric power exports also may contribute to export expan sion. (The impact on the United States will be kept to a minimum if the over-all rise in imports from Canada is not matched by a net outflow of capital to C anada.) Special meas ures, such as the rebate of import duties on automobiles and parts, might boost exports, but might also have undesirable repercussions on American trade. Then again, the path of export expansion is still blocked by various obstacles such as protectionist agricultural policies abroad. Canadian imports, meanwhile, probably could be held close to current levels despite the fact that im port demand in Canada is more responsive to rising domestic economic activity than it is in the United States. Dom estic production might be expanded with rela tively little pressure on costs and prices through encouragement of secondary m anu facturing and utilization of unemployed man power resources and existing excess plant ca pacity. U. S. manufacturers, however, should be able to hold their own in Canadian m ar kets, since Canadian industry is not yet fully geared to meet domestic requirements for capital and consumer goods— and since Ca nadian consumers still hold decided prefer ences for U. S. brand names and products. FEDERAL RESERVE B A N K OF S A N F R A N C I S C O U. S. acco u n ts for bulk of C anadian payments transactions RECEIPTS 4 2 PAYMENTS B illio n s of D o lla rs 0 2 4 Source: B ank of C anada. W hy trade surplus is necessary The necessity for a larger Canadian m er chandise trade surplus arises from the steady uptrend of net payments to foreigners on socalled “invisible” transactions, including tour ist expenditures, transportation, interest and dividends and payments for business services. Some progress has been made toward reduc ing the im port bill for tourism and travel, but all these transactions tend to be largely unre sponsive to changes in government policy as well as increasingly insensitive to variations in economic activity over the business cycle. Lack of response, particularly in the contrac tive phases of the cycle, tends to reinforce the dangers of a net outflow of capital to foreign countries during a downswing in Canadian economic activity. N et interest and dividend payments to for eigners, which totaled over $550 million in 1962, attract a great deal of attention because they arise from the sizable foreign investments m ade in Canada. Although foreign direct in vestment in Canada seems to be leveling off, investment income payments to foreigners are expected to rise at a steady pace as completed projects begin to show profits and as servicing of earlier investments continues. But, now, as part of its program to develop a more strongly Canadian-oriented economy, Canada is trying to discourage such investment through dis criminatory taxation of foreigners’ investment income or through preferential treatm ent for dividend and interest payments of Canadiancontrolled firms. Some observers have claimed, on the basis of the fact that U. S. firms control more than two-fifths of Canadian manufacturing facil ities, that Canadian subsidiaries of American companies have subordinated Canadian in terests to those of their parents. Admittedly, the percentage of U. S. ownership rises as high as 95 percent in the automobile industry, 90 percent in rubber products, and almost three-fourths in the petroleum and natural gas industry. U. S. investments also are siz able in electrical apparatus, chemicals, pulp and paper, and mining and smelting. But cit ing these figures does not prove the claim. Canada accounts for approximately one-third of this country’s total direct investments abroad, but these investments have benefited American manufacturers primarily by pro viding them with assured access to foreign raw material supplies and to Canadian m ar kets for consumer and industrial goods. A declining level of U. S. direct investment in Canada should assist the American balance of payments over the short run because in vestment income will continue to rise, al though exports to Canada may decline. Over the longer run, direct investments may not in crease as rapidly as in the past because Can adian export capacity is now ample in many lines of production and should remain so for some time to come. Other complicating inflows Portfolio investment in Canada has been influenced by yet another set of factors. Ca nadian corporations and governmental units have made sizable borrowings in the U. S. capital market, primarily because of a short- March 1964 M ONTHLY REVIEW U. S. e x p a n d s direct investments in C an ad a, but at slower pace B illio n s of D o lla rs Ratio Seal# --1952 1954 1956 Source: D ep artm en t of Comm erce. age of domestic capital. Lower costs of flota tion have been a relatively minor factor, al though there seems to be some correlation between the volume of corporate borrowing and the differential cost of borrowing in the two countries. The development of capital m arket facilities broad enough to supply all of C anada’s domestic requirements has been held back by heavy dependence on foreign capital during the nation’s formative years, by a relatively low level of domestic saving, and by practically unrestricted access to the U. S. capital market-—at least prior to the interest equalization tax proposal. In the past, most of the capital inflow from the United States to Canada helped to finance Canadian imports of goods and services as well as part of the deficit on nonmerchandise transactions with other countries. To the ex tent that capital exports from the United States were not accompanied by exports of goods and services, our balance of payments suffered. Under present circumstances, when the United States is engaged in a major effort to reduce its payments deficit, any contribu tion to a reduction of dollar drains— from this source or other sources— would be welcome. A shift in recent years in the nature of long-term borrowing by Canadians in the U. S. capital m arket has increased the significance of this type of capital export for our balance of payments. Provincial and municipal gov ernment expenditures in Canada for social capital purposes (such as school construction, highways, and public utilities) are rising at a rapid pace and are being met only in part from domestic sources of financing. The re m ainder must be obtained through recourse to foreign capital markets. But this type of ex penditure is less likely than other types to result in the direct export of goods and serv ices from the United States, and thus it is more likely to worsen our payments position. A further complicating feature of private capital flows between Canada and the United States is the rising relative importance of short-term capital. The sensitivity of short term capital to interest rate differentials tends to reduce the flexibility of monetary and debt management policies in the countries involved and to increase the significance to each coun try of policy changes in the other. Although only certain types of short-term capital flows are responsive to interest rate spreads, the existence of a large volume of relatively volatile funds poses the threat of fairly sizable capital flows. Economic and political stability Short-ferm funds, other long-term capital gain importance in U. S. capital exports to C a n a d a Porcont 80 r- Shorf-Term Capitol 1952 1954 1956 Source: D ep artm en t of C om m erce. 1968 FEDERAL RESERVE B A N K OF S A N F R A N C I S C O in the United States and Canada, moreover, increases the volume of funds susceptible to the lure of more attractive investment oppor tunities in the other country whenever they appear. Both interest rate differentials and relative profit prospects reflect relative rates of eco nomic growth— in this case, in the United States and Canada. In particular, merchan dise trade, the current account balance, and direct investments m irror the assessments by the m arket of the economic outlook in the two countries. Price relationships do not ap pear to play a m ajor role in trade between them. On the other hand, because of the greater economic importance of the United States in C anada’s balance of payments, de velopments here tend to exert a greater in fluence on the Canadian economy than Canada does on us, although there is some evidence that C anada is becoming somewhat less dependent on the United States than heretofore— and less dependent particularly during the expansionary phase of the business cycle. Canadian policies and actions, none theless, are still able to make a strong im pression on this country— as recent events so well attest. A tw o-year upsurge Despite devaluation of the Canadian dollar in May 1962 and the accompanying disturb ances, the Canadian economy’s growth record in 1962 was one of the best since the midFifties. Gross national product rose 8 percent, and the unemployment rate fell to 6 percent, around its lowest level for the preceding three-year period. The emergency program adopted during the exchange crisis succeeded in restoring confidence in the Canadian econ omy, and economic activity picked up. By October 1962, the reserve losses incurred during speculation against the Canadian dol lar had been completely recovered. Strength ening of C anada’s international reserve posi C a n a d ia n r e s e r v e s remain high after most emergency credits repaid B illio n s of D o lla rs tion facilitated the lowering of the central bank discount rate in three steps during September-November to 4 percent, and thereby encouraged the resumption of domestic eco nomic expansion. At the same time, the im port surcharges imposed in June were gradu ally removed. By the end of 1962, m uch of the international financial assistance had been repaid; by the end of M arch 1963, the import surcharges had been completely removed; and by May the central bank discount rate re turned to the pre-crisis level of 3.5 percent. (As already noted, however, the rate rose to 4 percent again in A ugust.) The rate of economic growth, nevertheless, seemed to lack vigor, and the hard core of unemployment seemed intractable. In the final quarter of 1962, despite a sharp im provement in C anada’s trade balance— due largely to the devaluation— economic activity leveled off. Business began to revive early in 1963, however, and the expansion has since continued robustly, interrupted only by a mid summer lull. By the end of 1963, the season ally adjusted unemployment rate had fallen to 5 percent, the lowest level since m id-1957. C anada’s balance of payments responded favorably and rapidly to the exchange meas- March 1964 MONTHLY REVIEW onal influence on the level of domestic eco nomic activity. Although high unemployment can be attributed partly to weakness of aggre gate demand, reinforced until recently by high public preference for cash because of inflation fears, the Canadian jobless problem contains some structural elements. In particular, the unemployed are heavily concentrated in the declining fields of agriculture, mining, for estry, and construction and among the less skilled and less educated groups. ures of 1962 and moved into surplus, due to a significant improvement in merchandise trade transactions and sizable long-term bor rowing abroad. Occasional pressures on the Canadian dollar, produced by the Canadian budget message of June 1963 and by Presi dent Kennedy’s interest equalization tax pro posal in July, were weathered with little diffi culty but with some loss of reserves. Canadian exports have subsequently been bolstered by the large wheat sales to the Soviet Union, while the rise in imports has been slowed. Problems for C an ada The Canadian economy, nevertheless, may soon encounter cost and price pressures and production bottlenecks. The competitive po sition of Canadian producers, which has im proved as a consequence of devaluation and the relative stability of Canadian prices, may be weakened, and further progress may be harder to achieve. In view of a decline in capital imports from the United States and a slower rate of export expansion, C anada’s economy may not be able to match the satisfactory performance record of the past two years. Rising productivity and ample sources of energy, however, are plus factors in the outlook. Unemployment in Canada tends to average somewhat higher than in other industrial countries because of the wide dispersion of the population across the continent and great extremes of climate, which have a strong seas Canada has other problems to solve as well. Domestic saving tends to fall short of domestic requirements, but active fostering of domestic money and capital markets may help to remedy this lack. Gross domestic in vestment in Canada, which has been among the highest in the Western World, is declining in importance and, as a consequence, plays a less vital role in stimulating economic activity than heretofore. A substitute to replace the impetus to the economy from this source therefore must be found. Finally, the consid erable slack in Canadian productive capacity must be taken up by increased demand before new investment can be profitably undertaken. Problems for the United States The success of Canadian efforts to achieve an equilibrium position in its balance of pay ments and to step up a hitherto sluggish rate of economic growth is of great importance to the United States. If fluctuations in the Ca nadian balance of payments do not react ad versely on the United States, we should be far better able to correct our own payments bal ance and stimulate our own economic growth. FEDERAL RESERVE B A N K OF S A N F R A N C I S C O On the other hand, the U. S. payments posi tion could be worsened by pegging of the Canadian exchange rate at a discount from the U. S. dollar and by C anada’s need for larger international reserves under a fixed ex change rate system. The economic ties between Canada and the United States will remain close, because of the meshing of consumption and income ef fects of transactions between the two coun tries and because of the difficulties involved in the expansion of markets elsewhere for Canadian products. The tariff reductions that may be negotiated under the Trade Expansion Act will be of little benefit to Canada because the principal commodities affected will be mainly manufactured products, which account for only 10 percent of Canadian exports, rather than the low-tariff or duty-free indus trial materials exported by Canada. But what ever happens, observers on both sides of the border are apt to remain acutely conscious of the fact that economic influences flow south as well as north. Canada and District close interrelationships between Can ada and the United States on a nationwide basis and their implications for national eco nomic policy are not without parallel in the Twelfth District. N ot only do a num ber of Dis trict industries— such as pulp and paper— rely heavily on Canadian raw-material supplies, but financial institutions in Canada and in the District handle a sizable volume of trade and financial transactions between Canada and the United States. T ih e The economic linkage between the Twelfth District and C anada is at the same time com plementary and competitive. Industries in the Pacific Northwest and California, for exam ple, have been using Canadian natural gas for several years, and plans have been made to extend the pipeline network for Canadian pe troleum products even further into the Dis trict. On the other hand, District lum ber pro ducers compete with W estern C anada lumber producers, not only in foreign markets but in U. S. eastern seaboard markets as well. MON THLY REVIEW March 1964 Western Men of Science I e r s o n n e l men and manpower experts Scientists, technicians increase have said a great deal— much of it un more rapidly in W est than elsewhere printable— about scientific research workers, Percent Change, 19 50*60 but all agree that the problems of recruiting 80r and utilizing trained scientific manpower are quite minor in comparison with the problems — mm 60 which would result from attempting to do Other District without this scarce resource. The well-stocked research laboratory more and more is regard 40 ed as an economic necessity, either in the Olhtr U.S. competition to reach the moon or in the more prosaic competition for earthbound markets. 20 Since the areas and the industries with the most brainpower are likely to be the pace setters in this typically Twentieth-century Labor Fore* Professional Natural Scientists Technical Workers competition, the ability to train and to attract Source: B ureau of th e Census. scientists promises to be a prime determinant of future business success. From the evidence fields, however, the picture is quite different. to date, which shows a striking success for the California alone boasted 17 percent of the na West in the nationwide (and even worldwide) tion’s physicists, 16 percent of its m athem a talent search, this area’s future should be ticians, and 11 percent of its geologists, in the bright indeed. 1960 Census year. O ther District States, The growth in the West’s labor force, of meanwhile, accounted at that time for 19 per course, has been strikingly large in all sectors cent of the nation’s agricultural scientists. but nowhere so large as in the scientific and 1876, not 1776 professional categories. Between 1950 and The crucial role played by scientists, both 1960, when the civilian labor force increased here and elsewhere in the nation, can be 36 percent in Twelfth District States (as op traced in large part to the m anner in which posed to 12 percent elsewhere in the nation), scientific innovators and industrial leaders the District recorded a 75 percent gain in have been trained throughout the past cen professional and technical workers and a 59 tury. M odem industry undoubtedly would be percent gain in natural scientists alone. In much different— and probably less advanced 1960, the District accounted for less than 14 — if the nation’s universities throughout this percent of the civilian labor force but for 17 period had not emphasized scientific train percent of all the natural scientists in the na ing, the research method, and the empirical tion. California alone accounted for more application of scientific advances to industrial than 11 percent of the nation’s scientists, and problems. Science may well be (as T. H. other District States accounted for another Huxley described it) “nothing but trained 5V2 percent— and, if anything, those propor and organized common sense,” but the man tions have increased since 1960. ner of training and organizing has proven cru In some fields, especially chemistry and bi cial for economic growth. ology, the W est’s share of the national total has not been disproportionately large. In other The year 1876— the date of the founding P 1 I L FEDERAL RESERVE BA NK OF S A N F R A N C I S C O W e st produces disproportionate share of nation’s scientists Percent of U.S. Doctorates, 1920-61 0 2 4 6 8 10 f------ I------------ 1------------ 1------------ 1------------ 1 G e o -Scien ce * n.,..:. 12 14 16 i------------ 1------------1 16 20 i | (7 2 5 ) .2 .:::... Physics (1572) N o te : F igures in paren th eses refer to to tal num bers of doctorates aw arded in T w elfth D istric t states in 1920-61 period. S ource: N atio n al A cadem y of Sciences— N atio n al R esearch Council. of the first graduate school (Johns Hopkins) — by these standards may be more meaning ful for Twentieth-century society than even 1776. When that school opened its doors, its founder declared that graduate education presaged “less misery among the poor, less ignorance in the schools, less bigotry in the temple, less suffering in the hospital, less fraud in business, less folly in politics; and, among other things, more security in proper ty, more health in cities, more virtue in the country, more wisdom in legislation, more intelligence, more happiness, more religion.” Some of these goals, of course, still remain unfulfilled. W hat has been achieved, however, is a vast increase in the number of research workers capable both of achieving scientific breakthroughs and of applying these break throughs to industrial progress. The graduate school emphasis on scientific research led to the production of 84,000 Ph.D .’s in natural science in the 1920-1961 period. In the 1920’s, the nation’s universi ties produced an average of almost 600 scien tists annually in such specialties as physics, chemistry, geology, and biology. In the 1940’s they produced about 1,550 scientists annual ly, and by the 1960-1961 period they had in creased their annual production to about 5,000. (Substantial increases also occurred, of course, in the production of scientists with M.S. and B.S. degrees.) The expansion in production of scientists took place in the face of a slight shift in em phasis in graduate education over the fortyyear period. Between the 1920’s and the early 1960’s, the natural sciences’ share of total doctorate production dropped from 49.2 to 48.0 percent. Some other fields also declined in relative importance— the social sciences slightly, the humanities precipitously— while the production of doctorates in the field of education increased from 9.6 to 16.4 percent of the total. Nonetheless, the universities’ eight-fold expansion of skilled scientific m an power during this period evidenced their suc cess in fulfilling their task of supporting science. The West’s graduate schools have continu ally produced more than their share of the Ph.D .’s in the natural sciences, and thus they account to a large extent for the West’s dis proportionate share of the nation’s scientific manpower. Over the 1920-1961 period, Dis trict States produced 12.6 percent of the doc torates granted in the natural sciences, and California alone produced 9.8 percent of the total. Consistently, in every decade, the Dis trict’s share of new science doctorates has March 1964 MONTHLY REVIEW outstripped its share of the nation’s popula tion. In 1960-1961, for example, the District accounted for 15.6 percent of new science doctorates, although it held only 13.6 percent of the nation’s population in 1960. Understandably, the District leads in the production of doctorates in certain specific fields, in the same way that it leads the list of active scientists in those fields. California, for example, has accounted for 14 to 15 percent of the total national production of physicists and geo-scientists over the past four decades. M a n y recent Ph.D.’s migrate to W est for education and jobs Top schools, footloose scientists The West’s disproportionate share of doc torate production is related to the location within District States of five of the 22 “best” universities in the nation. Loud arguments rage within educational circles over the ques tion of graduate school quality, but graduate school deans and faculty members generally tend to agree on the excellence of certain in stitutions, based on such criteria as the num ber of doctorates produced, the publication records of faculty members, and the intangi ble quality of prestige. The importance of these relative rankings—-according to the compiler of one such list, the sociologist Ber nard Berelson— is that “the higher the institu tional level of the doctorate, the higher the subsequent post in academic life (and prob ably outside it, to o ).” The West’s ability to advertise five of the 22 “best” graduate schools in the nation thus accounts for its ability to attract large numbers of top-flight students and thereby to produce a disproportionately large share of the na tion’s new scientists. Just as important, the research strength of these and other Western universities has attracted the “foot-loose” re search-oriented industries which have played such a dominant role in W estern development — and these industries in turn have helped bring about a further influx of skilled m an power. In the words of a Defense Department N o te : C h a rt shows regions in w hich recen t (1957-61) P h .D .’s w ere located a t each stage of life cycle. Source: N atio n al A cadem y of Sciences— N atio n al R esearch Council. analysis of research-and-development spend ing, “The process is circular, and it regen erates itself.” Not only do production con tracts follow research contracts, but the ac quisition of production contracts in turn leads to the ability to strengthen research staffs. The attractiveness of the West for foot-loose scientists is seen in a recent National R e search Council study of the migration habits of Ph.D.’s. This study shows that about 13 percent of all new Ph.D .’s during the 19571961 period were born in the West but that 16 percent of the total received their doctorate in Western universities— and at least 19 per cent of the total then obtained post-doctoral employment here. (The data refer to 13-state totals.) The West’s attractiveness was even more striking in certain scientific fields; in physics, for example, 10 percent of the new doctorates were born in the West, but more than 23 percent of the group went to work here after their graduate training. The West’s drawing power for scientists, as for other workers, can of course be attrib uted to climatic and economic considerations. According to the much-cited climatic argu ment, migrants have been primarily attracted FEDERAL R E SE RVE B A N K OF S A N F R A N C I S C O by the mild climate, and the resultant heavy influx of population has stimulated employ ment expansion by attracting foot-loose in dustries and encouraging the growth of indus try’s local markets. This argument is probably just as much applicable to scientists— and to science-oriented industries— as it is to other fields. Similarly, relatively high pay rates also have acted as a magnet to scientists, as to workers in other fields; for male natural scien tists, median earnings in 1959 were $8,180 in California and $7,750 in the nation as a whole. But the strength of the graduate schools — and the strength of the research centers and new industries that revolve in the orbits of the Western universities -— is perhaps the strongest underlying cause of the West’s con tinued leadership in scientific education and science-oriented industry. This factor helps account, for example, for the West’s leading role in the new aerospace industry; one-half of that industry’s workers are employed in District States, and more than one-third of the total are concentrated in California. Crucial role of human capital The stress which the West places on scien tific education and scientific research high lights the influence of “hum an capital” in vestment on economic development. No esti mates have been made of the quantitative effects of this factor on W estern economic growth, but the evidence of this factor’s sub stantial contribution to national growth sug gests that it may be closely involved in the West’s ability to maintain a higher growth rate than the nation as a whole. H u m a n c a p ita l investment— that is, Real G N P an d productivity rise at steady pace the contribution of despite rapid expansion of scientific talent and R&D e d u c atio n , o n -th ejob training, health, migration, and em ployment inform a tion — helps to ex plain the frequently o b served d isc re p ancy b etw een the ra te of grow th of ec o n o m ic o u tp u t and the much small er rate of increase in the measurable in puts of labor, capi tal, and resources. By far the greatest c o n t r i b u t i o n to g ro w th h as b een m ade by increased education and by re la te d a d v a n c e s in k n o w le d g e ; th e s e N o te : R eal G N P an d research-developm ent spending shown in b illions of 1962 dollars, p ro d u ctiv ity in fa cto rs ac co u n ted real G N P p er m anhour, an d num ber of scientists an d num ber of p a te n ts in thousands. Sources: D e p a rtm e n t of Com m erce, N ational P lan n in g A ssociation, N atio n al In d u stria l Conference for 43 percent of the B oard, N atio n al Science F oundation, F ederal R eserve B an k of San Francisco. March 1964 MONTHLY REVIEW total growth rate of real national income in the 1929-1957 period, according to estimates published by Edward Denison in his Sources of Growth in the United States. This twofold impact of education on growth — the quantity effect of increased amounts of education and the quality effect of increased knowledge— has been exerted through the efforts of the entire educational system, extending all the way from grammar school through graduate school. In coming decades, however, the stimulus arising from the increased quantity of education probably will decline (according to Denison’s esti m ates), simply because the largest increases in the num ber of years of schooling have al ready occurred. This means that future in creases in the educational contribution to the growth rate must come from advances in knowledge— which means in turn that uni versity training in the sciences, and especially the application of scientific advances to the development of new industries, must play an increasingly im portant role in economic growth. But will these applications actually take place? In particular, will there be a spill-over from the esoteric fields where the bulk of the scientific community is now concentrated? That question acquires some urgency since, according to critics of the manned space flight program, that one field alone requires not only about 350,000 technical people, but— more im portant— a substantial share of the several hundred truly original scien tific minds that the nation possesses. Admittedly, new scientific advances have occurred in wholesale lots, but the proper har nessing of these inventions to the economy is by no means assured. In the space agency, for example, a “technology utilization program ” has been set up to develop civilian applica tions of space-age scientific advances, but the Denver Research Institute recently analyzed this program and concluded that “relatively little importance can be attached to the direct transfer of products from the missile-space program to the civilian economy.” This criti cism was made despite the space pro gram’s development of wonder metals, new fuel sources, and new light and power sources, not to mention the Telstar (com munications) satellite and the Tiros-Nimbus (weather-forecasting) satellites. Serendipity: slim pickings? This criticism leads to the somewhat heret ical conclusion that the increased production of scientists and the rapid expansion of spend ing on scientific work may not lead to a pro portionate expansion of the civilian economy, at least not without a substantial time lag. The number of scientists has increased roughly fourfold in the last four decades, and research-and-development spending (price-deflated) has risen at least 25-fold, but real GNP and output per m anhour have in creased just about 2Vi times during that pe riod— and one major measure of scientific activity, the num ber of new patents issued, has failed to increase at all. One explanation, advanced by the econo mist R obert A. Solo in the pages of the Har vard Business Review, is that research and development have simply been misallocated in favor of aerospace and defense at the expense of growth-oriented civilian industries. Solo argues that economic growth depends upon the very limited num ber of creative industrial geniuses— men who are lost to activities which contribute to civilian technological growth if they are diverted (as they seem to be now) to aerospace research and develop ment. Thus, their loss can only be offset by an intense spill-over of aerospace technologi cal advances into the civilian sector. Economic growth can arise, to some extent, through a direct application of the frequently astonishing products and processes developed in aerospace exploration. Growth must come FEDERAL RESERVE B A N K OF S A N F R A N C I S C O predominantly, however, through the difficult mechanism of harnessing the new discoveries so that they initiate revolutionary advances in business techniques and consumer markets. No one may be able to visualize what those advances will be— who, looking at the first internal-combustion engine, could visualize a freeway-centered civilization?— but many observers feel that continued growth depends on the scientific community’s ability to make spill-over a perm anent reality. Speaking at a Stanford University convoca tion in 1906, the philosopher William James argued that “the wealth of a nation consists more than anything else in the num ber of su perior men that it harbors.” The West— by emphasizing both the training of scientists and the application of their research to industrial progress— has demonstrated throughout the subsequent half-century how that wealth can best be mobilized. Nonetheless, today’s spill over controversy shows that the West’s scien tific community cannot automatically assume that a direct path lies between scientific prom ise and economic fulfillment. The Foreign Contingent universities have contributed to A sia an d A frica now provide bulk of international as well as to domestic eco foreign students at U. S. schools nomic growth, by training large numbers of Number of Foreign B.A.’s young foreign scientists who then disseminate their new-found knowledge throughout the world. In the 1920-61 period, 9,290 students with foreign undergraduate degrees received their Ph.D .’s in this country; about 26 percent were from Canada, 10 percent from Western and N orthern Europe, 29 percent from IndiaN ear East-A frica, and 21 percent from East Asia. Students with foreign B.S. degrees have ac counted for 11 percent of all Ph.D .’s in the natural sciences awarded in this country since 1920. (The proportion has been even higher Source: N atio n al A cadem y of Sciences— N atio n al R esearch — 13.4 percent— at the West’s five leading Council. graduate institutions.) The foreign contingent vided relatively few students four decades accounted for 8 percent of American docto ago, in the 1960-61 period accounted for the rates in the 1920’s, dropped in importance in vast bulk of the total. In the recent period, the 1930’s, and then increased rapidly: in East Asia accounted for about 21 percent of 1960-61, this group received almost 16 per the total and India-Near East-A frica account cent of all science doctorates awarded in this country. ed for 34 percent; Canada, on the other hand, The recent inflow of foreign graduate stu saw its share drop from about one-half to less dents has come mainly from the Asian and than one-fifth of the total between the 1920’s and today. African nations. These nations, which prom e ric a n A MONTHLY REVIEW March 1964 Twelfth District and Other U. S. Condition Items of All Member Banks— Source: F ederal R eserve B ank of San F rancisco. (E n d -o f-q u arter data shown through 1962, and en d-of-m onth d a ta th e reafte r; d ata n o t ad ju sted for seasonal v ariatio n .) BA N K IN G A N D CREDIT STATISTICS A N D BUSINESS INDEXES— TWELFTH DISTRICT1 (Indexes: 1957-1959 = 100. Dollar am ounts in millions of dollars) Condition item s of all member banks2 Seasonally Adjusted Year and Month Loans and discounts3 U.S. Gov’t securities Demand deposits adjusted4 Total time deposits Bank rates Bank on debits short-term Index business 31 cities5, 8 loans7, 8 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 7,751 8,703 9,090 9,264 10,827 12,295 12,845 13,441 15,908 16,628 17,839 20,344 22,915 6,370 6,468 6,577 7,833 7,162 6,295 6,468 7,870 6,495 6,764 8,002 7,336 6,651 9,512 10,052 10,129 10,194 11,408 11,580 11,351 12,460 12,811 12,486 13,676 13,836 14,179 6,713 7,498 7,978 8,680 9,130 9,413 10,572 12,099 12,465 13,047 15,146 17,144 18,942 57 59 69 71 80 88 94 96 109 117 125 141 157 1963 January February March April May June July August September October November December 20,609 20,837 21,165 21,246 21,246 21,604 21,761 21,890 22,236 22,387 22,673 22,915 7,333 7,344 7,427 7,097 7,262 7,293 7,059 6,958 6,968 6,698 6,730 6,651 13,725 13,831 13,868 14,063 13,828 13,959 14,044 13,990 14,102 14,106 14,272 14,179 17,407 17,585 17,831 17,850 17,967 18,101 18,290 18,334 18,409 18,727 18,923 18,942 146 148r 150r 149r 152 153r 158r 162r 166r 167r 170r 167r 1964 January February 23,256 23,544 6,575 6,832 14,332 14,222 19,342 19,520 163 168 3.66 3.95 4.14 4.09 4.10 4.50 4.97 4.88 5.36 5.62 5.46 5.50 5.46 5.53 5.47 5.47 Industrial production (physical volume)6 Total nonagri cultural employ ment Dep't. store sales (value)® Lumber Refined8 Petroleum S teel3 80 84 86 85 90 95 98 98 104 106 108 113 117 68 73 74 74 82 91 93 98 109 110 115 123 129 99 101 102 101 107 104 93 98 109 98 95 98 102 87 90 95 92 96 100 103 96 101 104 108 111 112 97 92 105 85 102 109 114 94 92 102 111 100 117 116 116 116 116 116 116 116 117 117 118 118 118 127 128 130 118 129 127 128 132 125 127 130 136 104 106 107 93 96 97 95 102 105 108r 106 111 113 111 110 108 112 116 115 116 113 112 110 110 98 123 123 134 141 129 109p 105p I09p 104p 114p 112p 119p 135 111 116p 1 Adjusted for seasonal variation, except where indicated. Except for banking and credit and department store statistics, all indexes are based upon data from outside sources, as follows: lumber, National Lumber M anufacturers’ Association, West Coast Lumberman’s Association, and Western Pine Asso ciation; petroleum, U.S. Bureau of Mines; steel, U.S. Department of Commerce and American Iron and Steel Institute; nonagricultural employment, U.S. Bureau of Labor Statistics and cooperating state agencies. J Figures as of last Wednesday in year or month. s Total loans, less valuation reserves, and adjusted to exclude interbank loans. 4 Total demand deposits less U.S. Government deposits and interbank deposits, and less cash items in process of collections. 5 Debits to demand deposits of individuals, partnerships, and corporations and states and political subdivisions. Debits to total deposits except interbank prior 1942. 6 Daily average. 7 Average rates on loans made in five major cities, weighted by loan size category. 8 N ot adjusted for seasonal variation. p—Preliminary. r —Revised.
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