How Bad a Squeeze?

President Kennedy's speech to the Chamber of Commerce was interrupted by applause only once--and that was when he said, "After all, we in the Government have a large stake in your profits." The remark was far more than a quip about taxes: the President is thoroughly aware that profits are the fuel for economic growth, stimulating businessmen to hire and to expand in order to make more profits. He also concedes that the U.S. economy is currently afflicted with a disease that has become known as the "profits squeeze."

By almost any standard, U.S. corporate profits have shrunk notably in the past decade. Some common measures:

> As a percentage of invested capital: By this gauge, which is the one that businessmen watch most closely, after-tax profits of U.S. industry have dropped from 6.7% in 1952 to 5.5% in 1961.

> As a percentage of gross national product: By this measure, whose breadth as an index makes it the one the Government favors most, profits have slipped from 5% in 1952 to 4.5% last year.

> As a percentage of sales: By this standard, which is the most popular with the public and small businessmen, profits in the past decade have declined from 3.1% to 2.7%.

Hunting a Cause. Businessmen themselves commonly blame the squeeze on rising labor costs. Factory wages have actually declined as a percentage of costs for U.S. industry as a whole, because productivity has risen faster over the past decade than the wages paid to production workers. But automation and more paperwork have produced an increase in white-collar salaries, with the result that total labor costs have grown from 22.6% of sales in 1950 to 25.5% in 1961.

Arguing that this increase is too small to be significant, the Kennedy Administration blames the profits squeeze on two other causes: soft consumer demand and the high overhead expense that industry incurs when a lot of its productive capacity lies unused. The Administration figures that as U.S. corporations boost their sales, profits will spurt. Last year's total corporate profits amounted to only $23 billion, barely $500 million above the level of 1950, but the Administration predicts a rise this year to $28 billion.

Rise in Write-Offs. A number of economists argue that the profits squeeze is partly the result of a permanent change in U.S. business habits. To keep pace with technological change, industry today is spending $7 billion a year on research, and while research holds out prospects of increased future profits, it takes a painful bite out of current income. Some economists hold that today's high corporate taxes stimulate managers to allocate increasing amounts for tax-deductible business expenses--everything from company planes to sales promotion trips--which in turn reduce profits. Says the vice president of a major Midwestern bank: "When a businessman looks at profit dollars today, he sees only 50-c- dollars. This makes for some inefficient expenditures."

In this atmosphere, many economists are paying less heed to profits as a measurement than to "cash flow," which is retained profits plus money set aside to cover depreciation of plant and equipment. Depreciation is not quite as good as profits--for example, dividends cannot be paid from it--but it does finance a huge amount of modernization and expansion.

And depreciation write-offs are soaring.

Since 1954, when the Government began permitting faster depreciation, annual write-offs have more than doubled, to $25 billion last year. Largely because of this, cash flow has performed far better than profits, rising by 72% in the past decade. Last year cash flow of U.S. industry reached $34 billion--a considerably handsomer figure than the $23 billions of profits.

Necessary Fact. Economists, including many employed by industry, generally do not take as dim a view of the profits squeeze as do businessmen. To laments that it has even cut into dividends, the economists point out that, in fact, dividends have been rising at a faster rate in the past ten years (see chart) than either wages or industrial production.

Yet the squeeze is real, and with sharpening competition to be expected both at home and abroad, few experts foresee any early return of the fat and easy profit margins of the years immediately after World War II. Some economists even see a virtue in the profits squeeze, because it forces businessmen to pare fat and seek new efficiencies. Says President George H. Ellis of Boston's Federal Reserve Bank: "There should be a squeeze. In most competitive economies, there is a profits squeeze. It is a fact of life."

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