thirds of business investment, excluding net changes in inventories, represents replacement.1

5

In the financial terms, business investment, for example, during 1931-34 was alleged insufficient to maintain plant and equipment. But in "real" terms productive capacity seems not to have diminished. In short, accounting calculations of the net expansion or the net contraction of the amount of capital goods used by business enterprises do not necessarily reflect changes in industrial capacity. As A. H. Hansen explained:

It is quite possible that those capital outlays which were made on renewals and replacements, introducing through those capital outlays new technics and improved machinery, may have left your total capital plant as productive as before, despite the fact that the accounting figures would indicate a decline in the total capital stock."

And as he noted later:

The expenditures from depreciation and depletion allowances may often have no relation to any specific worn-out machines. Newly built plant and equipment will not need to be replaced for many years and sometimes even decades, yet the annual depreciation allowances on such equipment will be available year by year for expansion.'

The second important function performed by the investment process is graphically illustrated in chart XV. For it is investment that maintains purchasing power, the level of employment, and national income. It is clear from the chart that hoarding ultimately restricts national income, but putting money to work making goods increases national income.

These summary divisions of investment between maintenance and expansion must, however, be interpreted with caution. These allocations of investment between replacement and expansion are made in financial terms. They do not necessarily apply to real investment, to investment after adjustment for changes in prices, quality, and type of product. These adjustments are difficult, complicated, and theoretically unsatisfactory, and the separation of real investment into maintenance and replacement suffers accordingly. In any event, the very term "replacement" in a dynamic economy is misleading. The four-high continuous strip mill is not the same as the two-high discontinuous mill it replaces, nor is the new house the same as the old. The type, quality, and specification tolerances of the steel produced with the new machine, the standard of living and comfort in the new house, are different from the old. Gross investment, rather than net investment alone, changes the direction, tempo, output, and productive methods of the economy. For many purposes it is impossible, and even theoretically undesirable, to distinguish between replacement and expansion as components of gross investment.

Estimates of capital consumption due to depreciation differ from the provisions for depreciation made by business enterprises and others. Business enterprises keep records of depreciation to help them recapture funds invested in capital goods. To do so they charge current receipts for current depreciation. Hence depreciation is almost always based upon original cost. On the other hand, the subtraction of an allocated part of past investment, in terms of original prices, from present investment in current prices gives no indication of net investment. To compare gross investment and capital consumption, it is necessary to express both in the same prices.

Hearings before the Temporary National Economic Committee, Part 9, p. 3510. It should be noted that the concept of productive capacity is an elusive one. Some of its aspects are examined by George Terborgh in The Problem of Manufacturing Capacity, Federal Reserve Bulletin, July 1940.

7 Hearings before the Temporary National Economic Committee, Part 9, p. 3539. For an effective summary of evidence showing that investment during the late thirties has maintained productive capacity at least at the 1929 level, see T. J. Kreps, Consumption-A Vast Underdeveloped Economic Frontier, American Economic Review, vol. 30, No. 5, February 1941, pp. 177-199.

Chart XV

During the short periods represented by business depression, the income-distributing aspect of investment may well be more important than the capital goods production aspect. Considered only in their physical aspects, the postponement of a new road for a year or two would not greatly affect transportation costs, and a year's delay in constructing a new refinery would not substantially modify oil output or oil prices. Even the drying-up of investment for 2 or 3 years would not substantially affect the volume of consumption. The drying-up of investment does, however, seriously interrupt the flow of income. If $1,000 is saved and invested, the money turns up as income within the community; if $1,000 is saved but not invested, income is decreased, and production and employment follow suit. The unemployed suffer the most, but all parts of the community are affected. Concentration of control over the making of investment decisions is, therefore, of great importance. In this chapter three questions are treated.

1. Who makes investment decisions?

2. What types of goods do investment decisions produce?

3. To what extent is there concentration of control over investment decisions? and with what results?

WHO MAKES INVESTMENT DECISIONS?

In some cases those who make or control the savings also make the investments. This is particularly true of business concerns. In other cases, intermediaries take the savings and place them at the disposal of government and business.

Direct Investment.

American business enterprises have been able to finance the bulk of their investments in plant and equipment from internal sources. For example, while business outlays for plant and equipment in 1929 reached an all-time high of 10 billion dollars, gross business savings were 7.6 billion dollars, or sufficient to finance three-quarters of it. In the same year more than 10 billion dollars of securities were issued, less than 2 billion dollars of which were used for "productive" purposes.8

If in years like 1929 business firms required less than a quarter of their funds from outside sources, in ordinary years they are much more self-sufficient. Altman summarized the situation as follows:

In years of high business activity, business enterprises draw upon the capital market, that is, the savings of individuals and institutional investors, but never since 1922 for more than $2,000,000,000 a year. During years of low activity business enterprises do not require any funds from the capital market.

Instead, they contribute funds to the capital market, either by paying out dividends in excess of earnings or by converting depreciation and depletion allowances into bank deposits or securities, thus making them available to other types of investors."

Proof of this important point was provided in the T. N. E. C. hearings not only by specific examples of the largest domestic corporations but by figures for industry in general. For example, Edward R. Stettinius, chairman of the board of the United States Steel Corpora

Cf.

8 Hearings before the Temporary National Economic Committee, Part 9, p. 3688. Moulton, Edwards, Magee, and Lewis, Capital Expansion, Employment, and Economic Stability, Brookings Institution, Washington, 1940, pp. 349–354.

Hearings before the Temporary National Economic Committee, Part 9, pp. 3696-3697.

tion, testified that from 1921 through 1938 his company had invested $1,222,000,000 in plant and equipment. Ninety-six percent of the whole amount came from internal sources-$938,000,000 from depreciation reserves, $192,000,000 from profits retained, and $50,000,000 from tax refunds, a grand total of $1,180,000,000.10 Book value of plant between 1926 and 1937 decreased 18 percent, but physical capacity to produce increased over 13 percent.11

In a similar vein Owen D. Young testified that the General Electric Co. now has resources of $322,000,000. Of this, $192,000,000 came from undistributed profits, $92,000,000 from sales of stocks and bonds for cash, and $38,000,000 from properties acquired in exchange for stock 12 From 1921 to 1939, the company did not spend as much for plant and equipment as was accumulated in depreciation reserves.13 Again, Alfred P. Sloan, Jr., chairman of the board of General Motors Corporation, testified that his company had earned $2,300,000,000 in the last 18 years. Roughly, 80 percent of this had been paid out in dividends, 20 percent retained in the business.14 "In the 18-year period there has been substantially no outside financing," he testified.15 Total funds available from internal sources aggregated $1,100,000,000, with $520,000,000 from allowances for depreciation and $490,000,000 from undistributed profits. Total expenditures on plant were $770,000,000, leaving a balance of $240,000,000 with which to finance subsidiaries, inventories, installment sales, and so forth.18

Mr. NEHEMKIS. Would it be a correct statement, Mr. Sloan, to say that General Motors is in a position today to do most of its internal financing out of earnings, and, in addition to finance the ultimate consumers of your product as well? Mr. SLOAN. I think that is a correct statement of fact."

If the national income should jump to $80,000,000,000, requiring an increased demand for motor vehicles, "I am quite certain," said Sloan, "that we can handle anything * * * from the internal funds without going into the money market." 18 The present plant investment of the whole automobile industry has the capacity, in his opinion, to take care of all normal demands in the future.

F. B. Rentschler, chairman of the board of United Aircraft Corporation, likewise testified that his company intended to continue its policy of meeting expenditures on plant out of earnings and depreciation, and would have no occasion to go to the capital markets. He summarized the experience of his company as follows:

Our company has demonstrated its ability to expand its operations to meet all requirements and entirely from its earnings. We intend to continue this procedure as a matter of policy. Our company today is owned entirely by its approximate 29,000 common-stockholders, free of any indebtedness whatever, and we believe with adequate working capital for the future.19

John W. Barriger, III, chief examiner of the Railroad Division, Reconstruction Finance Corporation, presented figures on the railroad industry as a whole. From 1921 through 1937, Barriger testified, 72 percent of the expenditures by railroads for plant and equipment

were financed from internal sources, 19 percent from new issues of stocks and bonds, 9 percent from reductions in working capital.20

The financing of 58 large industrial companies for the years 193039 was likewise largely internal.21 The size of these companies is indicated by their $12 billion of assets in 1938; the composition of the sample was as follows:

During the 10 years studied, these 58 companies invested $5,557,000,000, as follows:

The funds for their outlays came principally from their gross savings. Undistributed profits, depreciation, and depletion provided about 83 percent of the total. External sources-the issue of stocks and bonds and the increase in current liabilities-provided 10 percent of the total. Conversion of assets provided the remaining 7 percent.

In the period studied, the 2 years of greatest investment were 1930 and 1937. The sample of 58 companies invested 1.3 billion dollars in the former year and 1.5 billion dollars in the latter. Whose money did they invest? In 1930, their own savings provided 40 percent of the funds. Conversion of assets-reduction of inventories, accounts receivable, and holdings of securities-provided 40 percent. They got only 20 percent from the capital markets. In 1937, their own

20 Ibid., p. 3571.

21 These are esentially the same figures discussed by Altman in Hearings before the Temporary National Economic Committee, Part 9, pp. 3693-3695, brought up to date. The data were prepared by the Division of Research and Statistics, Board of Governors of the Federal Reserve System.