Symposium on Money Management
Past, Present, and Future Business Outlook Charles Bailey, M.B.A.*
To review the past, survey the present, or predict the future for business outlook is a difficult task as one must first try to define the subject "business." Many industries such as plastics and its related products have been born, have seen rapid growth, and have now reached a maturity phase. Other industries, such as railroad, have declined during past decades and face real problems in the future. The energy source industry will see dramatic changes in future years. The service area of our economy has grown at a much faster rate than our manufacturing segment. Therefore, this study will be of the economy and business in general, realizing that these generalities will not apply equally to all segments. By way of an introduction I must explain that I am not an economist or business analyst. These are simply my observations of the business outlook as an independent business manager. Much of this article is related to the government and social areas as I feel these are going to have increasingly more influence on the business community. The Recent Past
Let us take a brief review of the past 50 years. A situation during the 1920's was somewhat similar to that of today. There was social concern as a result of the rapid growth of industrialization, similar rebellion of youth, and tremendous speculation in the investment area. There were no safeguards for the banking and investment community as we have today, so that the speculative investment was very loosely controlled. The depression of the 1930's was caused in a large part by the speculation of the 1920's. Housing was decreased by 90 per cent in a short period of years, capital goods were down 45 per cent, and *President, George S. Bailey Hat Company, Los Angeles, California Veterinary Clinics of North America- Vol. 6, No. I, February 1976
13
14
CHARLES BAILEY
unemployment reached 25 per cent. It was a perfect example of depressions that are born out of booms. It also is a textbook example of how booms can develop out of depressions. There are forces that always take shape in such times such as increased attention to technology, debt liquidation by business and consumers, and the need and desire to build up capital goods that were not replenished during the depression. The move toward World War II speeded the economic growth and started a social change that has not been reversed. That is the growing power of centralized government in taking action to control the economy. There has been a more activist attitude by government over our economic and social lives. A similar growth during the same period has been the concentrated power of the union in both the political and economic area. In many industries we have seen a trend toward a few large companies having a predominant share of the market. During the 1940's World War II created a tremendous defense industry. Most of these companies were able through defense spending to make substantial capital expenditures and to modernize their factories. Many of these firms managed to switch back to commercial production later and were able to benefit after the war by supplying the backlog of capital and consumer goods. Fifteen million military persons were released to the economic sector adding to the labor and consumer force. The United States benefited in the postwar years in that many of the countries throughout the world who had been severe competitors were left in bad shape from war damage and loss of their industrial facilities. In the late 1940's and 1950's we had 10 years of long and steady growth. Materialism created a demand for consumer products. There was a tremendous need for technological inventions and to rush new products onto the market. In 1957 this created a glut on the market for such products as television, housing, etc., and there was a temporary end of the boom and peak of return on capital investment. During the late 1950's and throughout most of the 1960's government tried to stimulate the economy to maintain the growth rate of the recent past. There was a "new economics" for deficit spending and use of the powers of the United States government to stimulate the private economy through tax reduction , investment credit, and similar means. This created an investment boom that lasted into the 1960's almost equal to that of the post World War II period. There was good price stability, and unemployment went down to 4 per cent. In 1965 there started an era of confusion and dissatisfaction. The Vietnam war, even though it took only 3 per cent of the economy (World War II took 45 per cent, and the Korean War 15 per cent) , created an atmosphere of division and confusion. From 1965 to 1968 the war cost went up to 30 billion dollars while nondefense spending increased 10 billion dollars a year almost without controls. In the early
PAST, PRESENT, AND fUTURE BUSINESS OUTLOOK
15
1970's there was confusion and disenchantment. The national crime rate increased. There was a rebellion of youth and a fight against materialism. The demands of the 1970's unfortunately are difficult to control by a free market. Problems such as ecology, housing, health, education, etc., in many respects requires a centralized control. The Current Situation
We now look at the present situation. During the current decade there is increased demand for social change and growth- not just economic. This growth will include education, health, and other social programs. There is tremendous temptation for politicians to start social programs without thought to fiscal responsibility. The monetary accountability of the United States government is weakening for political reasons. More votes are gained by fighting depression than by combating inflation. How does this affect business in the future? Growth will not be economic only but will mean additional programs in social and cultural areas. Deficit spending by the government will cause capital resources to be very tight for the private sector, particularly for smatl businessmen. We will start using the tax structure to a larger extent to meet social needs and more money will go to the government for these purposes. An opinion poll taken of business executives by the United States Chamber of Commerce shows that of the business executives who responded, 52.5 per cent expect their sales to be higher in 1975 than in 1974, and profits to be 40.0 per cent higher. These executives are optimistic about the immediate future for the following reasons: debt reduction by consumers, growing consumer demand, inventory liquidation, lower unemployment, and healthier farm economy. There were more mixed opinions as to the balance of the decade, especially in the area of capital availability. _ The decrease in the birth rate that started in the 1960's will affect many industries. Each will have to study future growth rate rather than relying on trends of the past. The energy shortage problem is not going to improve unless there is a dramatic technological discovery. This will affect most industries and our way of life. More economical use of fuel for transportation and living will affect many industries. Economic operation and low maintenance will replace luxury as the principal factor in purchasing decisions of many products. Along with the energy problem many industries are going to face a shortage (or at least a rapid price increase) of raw materials. Consumers and business are going to have to be less wasteful of such items as paper and other disposable products. There is some hope in the current government investigations of some of its own inflationary social programs. It is estimated that more than one-half of American families now receive a check from the government. Fewer productive workers are supporting more nonworkers.
16
CHARLES BAILEY
Unless there is a more responsible and less political approach to our social problems, and better fiscal accountability, this continued trend will have a definite impact on any future growth of the private sector. The current plight of New York is just the first example of a local government not showing fiscal responsibility over a period of time. It is hoped that other cities and states take heed, reverse the trend of deficit spending, and move toward more efficient control of their operations. Local governments do not enjoy the same opportunity of printing money to cover deficits that our Federal government does. Therefore, they cannot continue for as long a period of expenditures exceeding income. Hopefully we will see better fiscal controls on spending at the local and state level. Otherwise, all business and consumers can expect increased tax and reduced service from their local governments, especially in larger cities and industrial states where the welfare load is higher. Over the past I 0 years government spending, including transfer payments, has been increasing at an astonishing 9 per cent annual rate, more than double the 4 per cent rate for the private economy. That growth of government spending lies at the heart of the capital market strains that have appeared in the past year. Government deficits count as a claim against savings. In physical terms a government deficit means that the government is a net capital consumer, drawing more resources out of the economy than it is putting back in and eating into the margin between production and consumption. Capital Shortage: A Serious Problem for the Future
The amount of capital that the United States needs if it is to move back to its historic real growth rate of 4 per cent a year, and stay there, is enormous by any measure. Between I955 and I964, the United States economy consumed 760 billion dollars in capital in producing automobiles and television sets, in building houses, factories, and shopping centers that a growing population wanted. Between I965 and I974, the nation's consumption of capital doubled to 1.6 trillion dollars. Ac;:cording to best estimates available, the United States will need the·incredible sum of 4.5 trillion dollars in new capital funds during the next I 0 years. This capital, for the most part, will have to come from the savings of the American people and the profits of American business. The nation's total supply of capital will have to rise at a compound annual rate of 8. 7 per cent during the next decade, compared with a compound annual rate of 6. 7 per cent in the past decade. A capital shortage will affect all of us in various ways. The financial markets may be unable to provide the necessary funds to support the economy's expenditures at the rates of interest anyone can afford. The I 00 billion dollar federal budget of the past two years adds to the problem. Fortunately the loan demand by business is currently low
PAST, PRESENT, AND FUTURE BUSINESS OUTLOOK
17
because of the recession, but short-term interest rates have at least temporarily increased during this period of low demand. There is genuine concern by many in the financial field that higher interest rates will come with economic recovery and more loan demand. Recession, tight money, and higher interest rates cause reduced capital expenditures. This means that United States business is not increasing its capacity or modernizing its factories. Should this continue for any long period of time it would hurt our competitive position in the world. This is especially true if labor unions insist on inflationary wage demands without comparable increased productivity. Happenings in the financial markets represent the dollar analogy to the physical shortage of capital. Those who refrain from consumption provide funds to the financial intermediaries, the bank and other lenders, who then have the funds available to support investment. And a thin production-consumption margin leads to a thin supply of capital. The consequences of a thin capital supply are either rising interest rates as a strong demand for capital competes for the available supply, or moves by the Federal Reserve to make up for the financial market capital shortage by pumping more money into the economic system. But if the total amount of funds exceeds the amount that is generated by savings (the difference between production and consumption) the result is inflation. Most economists agree that business will be the key capital user during the next decade. Business investment in machinery will have to rise at a compound annual rate of 11.5 per cent during the next 10 years versus an 8.9 per cent annual rate between 1965 and 1974. To finance that spending, given an expected 5 per cent to 6 per cent inflation rate, companies will have to spend some 1.9 trillion dollars in the next decade against 670 billion dollars in the past decade. There are a number of reasons why capital spending will have to grow at an accelerated pace. To begin with, the rate of capital spending has been low relative to the rate of growth of output in the past decade as the government sector (federal and local) grew faster than the private sector. Also, the pollution and safety laws have increased the capital required for a given level of production. And, finally, there are signs that it is now taking more and more dollars worth of capital to produce one dollar's worth of output. Inflation will continue to take a substantial bite out of investment potential. For corporations inflation causes depreciation allowances to fall behind replacement costs. Therefore, companies have to make additional borrowings to replace capital equipment at the end of their useful life. Rapid technological changes have speeded the need for replacement and put more pressure on companies to borrow for modernization. This causes higher debt to equity ratios. It is unlikely that the financing techniques used by business in the
18
CHARLES BAILEY
past decades will do the job in the next decade. Balance sheet deterioration of rising debt-equity ratios will have less appeal to potential investors or lenders. Effect of Capital Shortage
A serious capital crisis is imminent in the future. The nature of the crisis is the need to invest more to keep the economy growing. There is strong likelihood that given the tax laws and corporate balance sheets as they are, and the economy as it is likely to be, there will not be enough capital to meet those investment goals. Some factors in this equation must change or the United States economy of the late 1970's and the 1980's will be unlike anything the American people have seen in nearly four decades-an economy marked by slower growth, higher unemployment, and few fulfilled promises for nearly everyone. If this capital shortage prediction is correct then the probable future business cycle profile will consist of short, feeble recoveries from recessions quickly aborted. Constant upward pressure on interest rates, and high inflation, will force the Federal Reserve into a tight money position early in recoveries, such as is occurring now. This will make prolonged business upswings improbable, but prolonged recessions to be expected. The capital-short economy discriminates against any company that does not have the highest credit rating because lenders of scarce funds can afford to hold out for only the very highest ratings. Already there is a small group of companies that can currently raise new equity capital, a larger group that can raise debt capital, and many that cannot raise any capital at all. There may not be a capital shortage for all, but there almost surely will be a capital crisis for some. More and more of these bottom tier companies will fall by the wayside as the capital shortage becomes more intense. Many strong companies will be able to acquire weak financed companies at an accelerating rate. The United States has managed to get by with a low savings-investment rate , and can still do so compared to most countries. However, the claims on that margin between production and consumption have increased-from business, the public, and government-as both the willingness and the incentive to save has weakened , but this trend is going to be an increasing influential partner of business and the professional sector of our economy. The more cautious approach by consumers will affect all industries. In my judgment there will not be the tremendous growth of any industry as we have had since World War II with the exception perhaps of new technological products. Union influence on legislators will probably increase and this will affect legislative bills coming from all levels of government, which will affect most industries and the profit picture.
PAST, PRESENT, AND FUTURE BUSINESS OUTLOOK
19
Other Influences on Future Business Outlook An important factor in the future will be the effect of international relations in trade on our country. The global resource and raw material shortages has a definite influence on the United States. Population explosions in many underdeveloped countries increase this demand for our resources and put pressure on their governments to get us to share with them. Foreign competition will continue to be an important factor in many consumer and industrial product lines. This is especially true in labor dominant industries. Inflation rate in man_y countries is running ahead of the United States and this may tend to equalize costs and lower the disadvantage that many of our companies have. The executive branch will try to maintain a balance in combating both inflation and depression. In a compromise inflation has more voting appeal, for the legislative branch particularly, so that we can probably expect increased inflation trends in the future . It hardly seems conceivable that there can be a World War III with uncontrolled arms use, but we probably will continue to have local regional wars in which the United States will be at least indirectly involved (particularly the United States Treasury). The hope is that there can be peaceful adaptation to a more moderately growing economy in the United States and throughout the world. There will undoubtedly be nonmilitary hostility between the communist and noncommunist world and they will continue in their efforts to drain our economy with various pressure tactics throughout the world. If there should be widespread economic collapse throughout the world, there would be pressure on those countries to start a large scale war. This will create a dilemma with our leaders to avoid too much economic drain and yet not let friendly countries collapse. Mergers of companies will probably increase from current level during the second half of the 1970's and the 1980's but certainly not at the rate we saw during the 1950's and 1960's. Consolidation of organizations will have better economic reasons such as combination of compatible product lines or for better distribution of existing products or services. The use of credit cards will grow in many fields and will get wider distribution among our population. This will affect business in many ways. Each company will have to measure the cost of this outside credit service against its internal credit department and review this in its operation and costing of product. Electronic banking will revolutionize the very concept of money itself. There will be a dramatic change in the banking and saving habits of millions of Americans. Every retail establishment must be set to make credit check verification and credit transaction as convenient as possible for its customers. Manufacturing and wholesale firms will want to study the use of factors , banks, or
20
CHARLES BAILE)
other financial establishment as an alternative to their . own credit departments. Priorities for the Future What can the individual businessman do to grow (or survive) in this social and economic climate? Assuming increasing demand by government for capital to finance deficit spending, we will probably continue to see a relatively tight money market at least in the forseeable future. _This means more intelligent use of capital and better financial control. Credit and collection policy will get more attention. Smaller companies are going to have to adapt to a tighter money market in the future, and budgetary controls are going to be a more important part of its operation. Expense items, inventory controls, and more detailed planning will take more of every top manager's time. An analysis of customers will be very important for manufacturing and wholesale firms. This will include more frequent contacts with important customers and analyses of others to determine profitability. The purchasing department is another area that will increase in importance. Undoubtedly, more orders will be on a cost bid basis and there will be less loyalty to an established source. The use of data processing will undoubtedly continue to increase in importance and usage, particularly as the cost decreases and becomes more available to smaller operations. The change in the computer industry is so dramatic that innovations which impressed us in one decade are considered obsolete in the next. Operating systems have grown both in size and sophistications. Many computers have entered the business scene providing hardware at a price that more businessmen can afford. Intelligent use of data processing can speed information back to the business executive, and if used correctly, improve inventory turnover and generally give the top executive more information for decision making. Business executives will have to make more frequent checks of performance by departments, individuals, and their company as a whole. ' Each company and industry must plan ahead to adjust to less investment capital, more controls. To accomplish this, individuals as tax payers and consumers are going to have to use more restraint on material requests and less demands on government to cure all ills. There will be smaller room for error as more cautious buying, increased capital costs, more labor demands, higher raw material costs, will all tend to lower profit margins and increase operating expenses. Realistic sales projections, expense and inventory budgets, and profit planning will be a must for most operations. Frequent checks and regular periodic analysis of operations will increase in importance. My personal feeling is that for some time to come consumers and businessmen are going to be more cautious in their purchasing and in
PAST, PRESENT, AND FUTURE BUSINESS OUTLOOK
21
their per cent of debt to equity. Materialism is not going to be as important as in the past 20 years, and value received for expenditure, quality of product, and service, will be important if a business is to be successful. SUMMARY
In conclusion, it is my judgment that the climate for business in at least the decade ahead will be more difficult than the years from World War II to the recession years of 1974-1975. Careful planning, better controls, and good business judgment will be needed more than ever. 14915 Ramos Place Pacific Palisades, California 90272
Past, Present, and Future Business Outlook Charles Bailey, M.B.A.*
To review the past, survey the present, or predict the future for business outlook is a difficult task as one must first try to define the subject "business." Many industries such as plastics and its related products have been born, have seen rapid growth, and have now reached a maturity phase. Other industries, such as railroad, have declined during past decades and face real problems in the future. The energy source industry will see dramatic changes in future years. The service area of our economy has grown at a much faster rate than our manufacturing segment. Therefore, this study will be of the economy and business in general, realizing that these generalities will not apply equally to all segments. By way of an introduction I must explain that I am not an economist or business analyst. These are simply my observations of the business outlook as an independent business manager. Much of this article is related to the government and social areas as I feel these are going to have increasingly more influence on the business community. The Recent Past
Let us take a brief review of the past 50 years. A situation during the 1920's was somewhat similar to that of today. There was social concern as a result of the rapid growth of industrialization, similar rebellion of youth, and tremendous speculation in the investment area. There were no safeguards for the banking and investment community as we have today, so that the speculative investment was very loosely controlled. The depression of the 1930's was caused in a large part by the speculation of the 1920's. Housing was decreased by 90 per cent in a short period of years, capital goods were down 45 per cent, and *President, George S. Bailey Hat Company, Los Angeles, California Veterinary Clinics of North America- Vol. 6, No. I, February 1976
13
14
CHARLES BAILEY
unemployment reached 25 per cent. It was a perfect example of depressions that are born out of booms. It also is a textbook example of how booms can develop out of depressions. There are forces that always take shape in such times such as increased attention to technology, debt liquidation by business and consumers, and the need and desire to build up capital goods that were not replenished during the depression. The move toward World War II speeded the economic growth and started a social change that has not been reversed. That is the growing power of centralized government in taking action to control the economy. There has been a more activist attitude by government over our economic and social lives. A similar growth during the same period has been the concentrated power of the union in both the political and economic area. In many industries we have seen a trend toward a few large companies having a predominant share of the market. During the 1940's World War II created a tremendous defense industry. Most of these companies were able through defense spending to make substantial capital expenditures and to modernize their factories. Many of these firms managed to switch back to commercial production later and were able to benefit after the war by supplying the backlog of capital and consumer goods. Fifteen million military persons were released to the economic sector adding to the labor and consumer force. The United States benefited in the postwar years in that many of the countries throughout the world who had been severe competitors were left in bad shape from war damage and loss of their industrial facilities. In the late 1940's and 1950's we had 10 years of long and steady growth. Materialism created a demand for consumer products. There was a tremendous need for technological inventions and to rush new products onto the market. In 1957 this created a glut on the market for such products as television, housing, etc., and there was a temporary end of the boom and peak of return on capital investment. During the late 1950's and throughout most of the 1960's government tried to stimulate the economy to maintain the growth rate of the recent past. There was a "new economics" for deficit spending and use of the powers of the United States government to stimulate the private economy through tax reduction , investment credit, and similar means. This created an investment boom that lasted into the 1960's almost equal to that of the post World War II period. There was good price stability, and unemployment went down to 4 per cent. In 1965 there started an era of confusion and dissatisfaction. The Vietnam war, even though it took only 3 per cent of the economy (World War II took 45 per cent, and the Korean War 15 per cent) , created an atmosphere of division and confusion. From 1965 to 1968 the war cost went up to 30 billion dollars while nondefense spending increased 10 billion dollars a year almost without controls. In the early
PAST, PRESENT, AND fUTURE BUSINESS OUTLOOK
15
1970's there was confusion and disenchantment. The national crime rate increased. There was a rebellion of youth and a fight against materialism. The demands of the 1970's unfortunately are difficult to control by a free market. Problems such as ecology, housing, health, education, etc., in many respects requires a centralized control. The Current Situation
We now look at the present situation. During the current decade there is increased demand for social change and growth- not just economic. This growth will include education, health, and other social programs. There is tremendous temptation for politicians to start social programs without thought to fiscal responsibility. The monetary accountability of the United States government is weakening for political reasons. More votes are gained by fighting depression than by combating inflation. How does this affect business in the future? Growth will not be economic only but will mean additional programs in social and cultural areas. Deficit spending by the government will cause capital resources to be very tight for the private sector, particularly for smatl businessmen. We will start using the tax structure to a larger extent to meet social needs and more money will go to the government for these purposes. An opinion poll taken of business executives by the United States Chamber of Commerce shows that of the business executives who responded, 52.5 per cent expect their sales to be higher in 1975 than in 1974, and profits to be 40.0 per cent higher. These executives are optimistic about the immediate future for the following reasons: debt reduction by consumers, growing consumer demand, inventory liquidation, lower unemployment, and healthier farm economy. There were more mixed opinions as to the balance of the decade, especially in the area of capital availability. _ The decrease in the birth rate that started in the 1960's will affect many industries. Each will have to study future growth rate rather than relying on trends of the past. The energy shortage problem is not going to improve unless there is a dramatic technological discovery. This will affect most industries and our way of life. More economical use of fuel for transportation and living will affect many industries. Economic operation and low maintenance will replace luxury as the principal factor in purchasing decisions of many products. Along with the energy problem many industries are going to face a shortage (or at least a rapid price increase) of raw materials. Consumers and business are going to have to be less wasteful of such items as paper and other disposable products. There is some hope in the current government investigations of some of its own inflationary social programs. It is estimated that more than one-half of American families now receive a check from the government. Fewer productive workers are supporting more nonworkers.
16
CHARLES BAILEY
Unless there is a more responsible and less political approach to our social problems, and better fiscal accountability, this continued trend will have a definite impact on any future growth of the private sector. The current plight of New York is just the first example of a local government not showing fiscal responsibility over a period of time. It is hoped that other cities and states take heed, reverse the trend of deficit spending, and move toward more efficient control of their operations. Local governments do not enjoy the same opportunity of printing money to cover deficits that our Federal government does. Therefore, they cannot continue for as long a period of expenditures exceeding income. Hopefully we will see better fiscal controls on spending at the local and state level. Otherwise, all business and consumers can expect increased tax and reduced service from their local governments, especially in larger cities and industrial states where the welfare load is higher. Over the past I 0 years government spending, including transfer payments, has been increasing at an astonishing 9 per cent annual rate, more than double the 4 per cent rate for the private economy. That growth of government spending lies at the heart of the capital market strains that have appeared in the past year. Government deficits count as a claim against savings. In physical terms a government deficit means that the government is a net capital consumer, drawing more resources out of the economy than it is putting back in and eating into the margin between production and consumption. Capital Shortage: A Serious Problem for the Future
The amount of capital that the United States needs if it is to move back to its historic real growth rate of 4 per cent a year, and stay there, is enormous by any measure. Between I955 and I964, the United States economy consumed 760 billion dollars in capital in producing automobiles and television sets, in building houses, factories, and shopping centers that a growing population wanted. Between I965 and I974, the nation's consumption of capital doubled to 1.6 trillion dollars. Ac;:cording to best estimates available, the United States will need the·incredible sum of 4.5 trillion dollars in new capital funds during the next I 0 years. This capital, for the most part, will have to come from the savings of the American people and the profits of American business. The nation's total supply of capital will have to rise at a compound annual rate of 8. 7 per cent during the next decade, compared with a compound annual rate of 6. 7 per cent in the past decade. A capital shortage will affect all of us in various ways. The financial markets may be unable to provide the necessary funds to support the economy's expenditures at the rates of interest anyone can afford. The I 00 billion dollar federal budget of the past two years adds to the problem. Fortunately the loan demand by business is currently low
PAST, PRESENT, AND FUTURE BUSINESS OUTLOOK
17
because of the recession, but short-term interest rates have at least temporarily increased during this period of low demand. There is genuine concern by many in the financial field that higher interest rates will come with economic recovery and more loan demand. Recession, tight money, and higher interest rates cause reduced capital expenditures. This means that United States business is not increasing its capacity or modernizing its factories. Should this continue for any long period of time it would hurt our competitive position in the world. This is especially true if labor unions insist on inflationary wage demands without comparable increased productivity. Happenings in the financial markets represent the dollar analogy to the physical shortage of capital. Those who refrain from consumption provide funds to the financial intermediaries, the bank and other lenders, who then have the funds available to support investment. And a thin production-consumption margin leads to a thin supply of capital. The consequences of a thin capital supply are either rising interest rates as a strong demand for capital competes for the available supply, or moves by the Federal Reserve to make up for the financial market capital shortage by pumping more money into the economic system. But if the total amount of funds exceeds the amount that is generated by savings (the difference between production and consumption) the result is inflation. Most economists agree that business will be the key capital user during the next decade. Business investment in machinery will have to rise at a compound annual rate of 11.5 per cent during the next 10 years versus an 8.9 per cent annual rate between 1965 and 1974. To finance that spending, given an expected 5 per cent to 6 per cent inflation rate, companies will have to spend some 1.9 trillion dollars in the next decade against 670 billion dollars in the past decade. There are a number of reasons why capital spending will have to grow at an accelerated pace. To begin with, the rate of capital spending has been low relative to the rate of growth of output in the past decade as the government sector (federal and local) grew faster than the private sector. Also, the pollution and safety laws have increased the capital required for a given level of production. And, finally, there are signs that it is now taking more and more dollars worth of capital to produce one dollar's worth of output. Inflation will continue to take a substantial bite out of investment potential. For corporations inflation causes depreciation allowances to fall behind replacement costs. Therefore, companies have to make additional borrowings to replace capital equipment at the end of their useful life. Rapid technological changes have speeded the need for replacement and put more pressure on companies to borrow for modernization. This causes higher debt to equity ratios. It is unlikely that the financing techniques used by business in the
18
CHARLES BAILEY
past decades will do the job in the next decade. Balance sheet deterioration of rising debt-equity ratios will have less appeal to potential investors or lenders. Effect of Capital Shortage
A serious capital crisis is imminent in the future. The nature of the crisis is the need to invest more to keep the economy growing. There is strong likelihood that given the tax laws and corporate balance sheets as they are, and the economy as it is likely to be, there will not be enough capital to meet those investment goals. Some factors in this equation must change or the United States economy of the late 1970's and the 1980's will be unlike anything the American people have seen in nearly four decades-an economy marked by slower growth, higher unemployment, and few fulfilled promises for nearly everyone. If this capital shortage prediction is correct then the probable future business cycle profile will consist of short, feeble recoveries from recessions quickly aborted. Constant upward pressure on interest rates, and high inflation, will force the Federal Reserve into a tight money position early in recoveries, such as is occurring now. This will make prolonged business upswings improbable, but prolonged recessions to be expected. The capital-short economy discriminates against any company that does not have the highest credit rating because lenders of scarce funds can afford to hold out for only the very highest ratings. Already there is a small group of companies that can currently raise new equity capital, a larger group that can raise debt capital, and many that cannot raise any capital at all. There may not be a capital shortage for all, but there almost surely will be a capital crisis for some. More and more of these bottom tier companies will fall by the wayside as the capital shortage becomes more intense. Many strong companies will be able to acquire weak financed companies at an accelerating rate. The United States has managed to get by with a low savings-investment rate , and can still do so compared to most countries. However, the claims on that margin between production and consumption have increased-from business, the public, and government-as both the willingness and the incentive to save has weakened , but this trend is going to be an increasing influential partner of business and the professional sector of our economy. The more cautious approach by consumers will affect all industries. In my judgment there will not be the tremendous growth of any industry as we have had since World War II with the exception perhaps of new technological products. Union influence on legislators will probably increase and this will affect legislative bills coming from all levels of government, which will affect most industries and the profit picture.
PAST, PRESENT, AND FUTURE BUSINESS OUTLOOK
19
Other Influences on Future Business Outlook An important factor in the future will be the effect of international relations in trade on our country. The global resource and raw material shortages has a definite influence on the United States. Population explosions in many underdeveloped countries increase this demand for our resources and put pressure on their governments to get us to share with them. Foreign competition will continue to be an important factor in many consumer and industrial product lines. This is especially true in labor dominant industries. Inflation rate in man_y countries is running ahead of the United States and this may tend to equalize costs and lower the disadvantage that many of our companies have. The executive branch will try to maintain a balance in combating both inflation and depression. In a compromise inflation has more voting appeal, for the legislative branch particularly, so that we can probably expect increased inflation trends in the future . It hardly seems conceivable that there can be a World War III with uncontrolled arms use, but we probably will continue to have local regional wars in which the United States will be at least indirectly involved (particularly the United States Treasury). The hope is that there can be peaceful adaptation to a more moderately growing economy in the United States and throughout the world. There will undoubtedly be nonmilitary hostility between the communist and noncommunist world and they will continue in their efforts to drain our economy with various pressure tactics throughout the world. If there should be widespread economic collapse throughout the world, there would be pressure on those countries to start a large scale war. This will create a dilemma with our leaders to avoid too much economic drain and yet not let friendly countries collapse. Mergers of companies will probably increase from current level during the second half of the 1970's and the 1980's but certainly not at the rate we saw during the 1950's and 1960's. Consolidation of organizations will have better economic reasons such as combination of compatible product lines or for better distribution of existing products or services. The use of credit cards will grow in many fields and will get wider distribution among our population. This will affect business in many ways. Each company will have to measure the cost of this outside credit service against its internal credit department and review this in its operation and costing of product. Electronic banking will revolutionize the very concept of money itself. There will be a dramatic change in the banking and saving habits of millions of Americans. Every retail establishment must be set to make credit check verification and credit transaction as convenient as possible for its customers. Manufacturing and wholesale firms will want to study the use of factors , banks, or
20
CHARLES BAILE)
other financial establishment as an alternative to their . own credit departments. Priorities for the Future What can the individual businessman do to grow (or survive) in this social and economic climate? Assuming increasing demand by government for capital to finance deficit spending, we will probably continue to see a relatively tight money market at least in the forseeable future. _This means more intelligent use of capital and better financial control. Credit and collection policy will get more attention. Smaller companies are going to have to adapt to a tighter money market in the future, and budgetary controls are going to be a more important part of its operation. Expense items, inventory controls, and more detailed planning will take more of every top manager's time. An analysis of customers will be very important for manufacturing and wholesale firms. This will include more frequent contacts with important customers and analyses of others to determine profitability. The purchasing department is another area that will increase in importance. Undoubtedly, more orders will be on a cost bid basis and there will be less loyalty to an established source. The use of data processing will undoubtedly continue to increase in importance and usage, particularly as the cost decreases and becomes more available to smaller operations. The change in the computer industry is so dramatic that innovations which impressed us in one decade are considered obsolete in the next. Operating systems have grown both in size and sophistications. Many computers have entered the business scene providing hardware at a price that more businessmen can afford. Intelligent use of data processing can speed information back to the business executive, and if used correctly, improve inventory turnover and generally give the top executive more information for decision making. Business executives will have to make more frequent checks of performance by departments, individuals, and their company as a whole. ' Each company and industry must plan ahead to adjust to less investment capital, more controls. To accomplish this, individuals as tax payers and consumers are going to have to use more restraint on material requests and less demands on government to cure all ills. There will be smaller room for error as more cautious buying, increased capital costs, more labor demands, higher raw material costs, will all tend to lower profit margins and increase operating expenses. Realistic sales projections, expense and inventory budgets, and profit planning will be a must for most operations. Frequent checks and regular periodic analysis of operations will increase in importance. My personal feeling is that for some time to come consumers and businessmen are going to be more cautious in their purchasing and in
PAST, PRESENT, AND FUTURE BUSINESS OUTLOOK
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their per cent of debt to equity. Materialism is not going to be as important as in the past 20 years, and value received for expenditure, quality of product, and service, will be important if a business is to be successful. SUMMARY
In conclusion, it is my judgment that the climate for business in at least the decade ahead will be more difficult than the years from World War II to the recession years of 1974-1975. Careful planning, better controls, and good business judgment will be needed more than ever. 14915 Ramos Place Pacific Palisades, California 90272
