Chrysler Corp. is appealing for federal aid, and Ford Motor Co. will lose $1 billion in its domestic operations this year. U.S. Steel Corp. is laying off 13,000 workers, and some railroads are already wards of the state. The obvious question is why so many of the nation's basic industries are in trouble.
Each industry has its own unique problem but most of them have a single major problem in common -- they are capital-intensive industries operating in an inflationary economy. That is a prescription for slow financial ruin.
Capital-intensive industries must generate the funds to replace and renew their plant and equipment if they are to remain healthy. In a period of stable prices, depreciation allowances on old capital equipment provide adequate funds for new equipment.
Those depreciation allowances become increasingly inadequate as inflation heats up. A factory that cost $10 million generates depreciation allowances of that amount, but at today's prices it may cost more than $20 million to replace the factory as it wears out. That leaves at least another $10 million to be found somewhere else just to keep the factory in operation.
In practice, the additional funds come from reported profits. for some capital-intensive companies with low rates of profitability, the funds required just to maintain the existing capital equipment may exceed the firms' total financial resources. The greater a company's capital intensity and the higher the inflation rate, the worse the resulting financial squeeze becomes.
In time, the financial squeeze becomes a slow death. Research and development funds for future products dry up as the company struggles just to maintain the capacity to produce its current products. Promotion opportunities for the best people become scarce in a dying company, and they often go elsewhere. Eventually the lack of good products and good people undermines the company's ability to compete with financially stronger firms at home and abroad.
A company that is unable to generate internally usually has problems finding it externally, too. As a source of new funds, the stock market is closed in practice to companies such as Chrysler and U.S. Steel because investors realize their plight all too well. Many troubled capital-intensive companies can't sell long-term bonds because they face bleak long-term futures. Bankers may be willing to lend them short-term money, but a number of Chrysler's bankers probably wish they had been more selective. Bankers prefer to loan money to companies that don't really need it, and captial-intensive companies need it badly.
The financial squeeze is being felt throughout broad sectors of American industry, most of which is still very resilent. If double-digit inflation continues, however, Chrysler and U.S. Steel may be just the beginning of a wave of troubled major companies in the advanced stages of industrial decay.
None of this is to deny that particular companies have made their share of mistakes. Chryslers' inventory policy and selection of models leave much to be desired. The steel industry's approach to new technology has no more been creative than the steel billets it produces. The mistakes that weakened these capital-intensive companies made them most vulnerable to the long-term effects of inflation.
Inflation's financial squeeze on capital-intensive industries is not unique to this country. Britian's inflation has been worse than ours and so have its consequences. Our steel and auto industries are still in much better condition than loss-plagued British Steel and British Leyland.
It is no coincidence that the countries with the strongest capital-intensive industries also have low rates of inflation plus abundant, low-cost capital for their vital industries. Japan, West Germany and Switzerland are examples of how strong industrial performance accompanies low inflation.
When asked what the government can do to solve the problem, many executives would reply that government is the problem. They point to the government's role in causing inflation through monetary and fiscal stimulation. They point to heavy costs imposed by government in the form of environmental regulations, new mileage requirements, etc.
The best thing that government can do is to bring inflation under control because that is the basic problem. The next-most-direct action the government can take is to improve depreciation allowances, a proposal under discussion in Congress.
The least attractive long-run path of government action is also the most compelling in the short run. The British have fallen into the trap of subsidizing their problem industries while neglecting ones with long-run growth potential. Their economists recognize the futility of pumping money into their losers rather than into their winners, but that is what politics there demands. The funds diverted to rescue Chrysler would be used more productively in a growth industry such as semiconductors, but workers who are employed now have more political influence than those who would be employed in the future in a growing industry.
Even our technological lead in semiconductors is threatened as that industry becomes more capital-intensive. Japanese and European companies have the advantages of government subsidies and low-cost funds. In response to a question about what our government can do to help, Hewlett Packard's David Packard spoke for more than his own high-technology company when she said, "If the government will fix the tax structure and get out of the way, we will take care of ourselves.