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Editors' Introduction and Summary Editors' Introduction and Summary THIS IS THE FIFTH ISSUE OF BrookingsPapers on EconomicActivity, a publicationthat appearsthree times a yearand contains the articles,reports, and highlightsof the discussionfrom conferencesof the BrookingsPanel on EconomicActivity. Financed by grantsfrom the AlfredP. SloanFoun- dation and the Alex C. WalkerFoundation, the panelwas formedto pro- mote professionalresearch and analysisof key developmentsin U.S. eco- nomic activity.Prosperity and pricestability are its basic subjects. The expertiseof the panel is concentratedon the "live" issues of eco- nomic performancethat confront the maker of public policy and the executivein the privatesector. Particular attention is devotedto recentand currenteconomic developments that aredirectly relevant to the contempo- raryscene or especiallychallenging because they stretchour understanding of economictheory or previousempirical findings. Such issues are typically quantitativein character,and the researchfindings are often of a statistical nature.Nonetheless, in all the articlesand reports,the reasoningand the conclusionsare developedin a form both intelligibleto the interested,in- formednonspecialist and usefulto the macroeconomicexpert. In short,the papers aim at several objectives-meticulous and incisive professional analysis,timeliness and relevanceto currentissues, and lucid presentation. The four principalarticles and seven shorterreports presented in this issue were preparedfor the fifth conferenceof the Brookingspanel, held in Washingtonon September9-10, 1971.These papersgenerated spirited discussionsat the conference.Many of the participantsoffered new insights 241 242 Brookings Papers on Economic Activity, 2:1971 and helpfulcomments; many had reservationsor criticismsabout various aspectsof the papers.Some of these commentsare reflectedin the sum- mariesof discussioncontained in this issue,some in the finalversions of the papersthemselves. But in all casesthe papersare finallythe productof the authors'thinking and do not imply any agreementby those attendingthe conference.Nor do the papersor any of the other materialsin this issue necessarilyrepresent the views of the staffmembers, officers, or trusteesof the BrookingsInstitution. Summaryof This Issue In the firstarticle of this issue, BarryBosworth analyzes recent patterns of corporateexternal financing, investigating particularly the growingvol- ume of new issuesof corporatebonds that has appearedin recentquarters. Total issues of bonds by nonfinancialcorporations jumped from $22.5 billion for the five-yearperiod 1961-65 to $70 billion in the 1966-70 in- terval.The volumeof issuesin 1971is exceedingthat of the entire1961-65 period. Bosworthexplains the volumeof corporatebond financingas partof the overallfinancial management of largefirms. Any excessof investmentand relateduses of fundsover the grossretained earnings of a firmrepresents a financingdeficit that must be matchedby an increasein short-termor long-termdebt, a reductionin liquidassets, or an increasein equityfinanc- ing. These alternativeways to financethe deficithave variousadvantages and disadvantages.Short-term borrowing generally involves a lower in- terestrate than does bondfinancing and it cannormally be negotiatedmore readily.But long-termdebt avoids the costs of renegotiationsand "roll- overs."Reliance on liquid assets permitsgreat flexibility;but it requires previousaccumulation of such assets,and that is costly, since nonfinancial firmsnormally earn lower interest rates on theirliquid assets than they have to pay on their debt. The issuanceof corporatebonds operatesthrough a gradualprocess of adjustmentto the growthin total financialliabilities. Basically, nonfinan- cial corporationscan be viewed as aiming at some target ratio of bond liabilitiesto total financialliabilities. Bosworth finds statistically that their approachto that target is delayedby particularlyhigh rates of interest, whichencourage postponement of bond issues;and it is spedup by growth Arthur M. Okun and George L. Perry 243 in retainedearnings, which add to the capacityof firmsto servicelong-term debt. Equityissues can be explainedby the same adjustmentprocess; they are particularlystimulated in the short run by low dividendyields. A similartarget ratio also appliesto short-termdebt, but the magnitudeof increasesin short-termdebt in any half-yearperiod is most heavilyinflu- enced by the size of the corporatedeficit in that period.A large current deficitis also mirroredin reductionsof liquid assets,but seemsto provide no immediatestimulus to bond and stock financing.Thus, short-term borrowingand liquid assets are used to cushionbond and stock financing requirementsagainst the short-runvariation in the total deficit. Bosworth'sstatistical results provide a reasonablygood explanationof the recentgrowth in corporatebond financing.The weaknessof corporate profits and the continuingstrength of investmentspending during the periodsince 1965generated a tremendousincrease in the size of the deficit requiringexternal financing, and that enlargeddeficit, in turn, swelledthe underlyingneed for bond financing.The sharprise in interestrates beyond their 1968 levels held down corporatebond financingby an estimated cumulativetotal of $7 billionduring 1969 and 1970,according to Bosworth. The recordvolume of corporatebond financingin 1971has reflectedboth the unsatisfiedbacklog from 1969-70 and the 1970-71 declinein interest rates.In short,Bosworth feels that the surgein corporatebond issuescan be explainedwithout invoking special or uniquedevelopments such as the psychologicalscars of the tight moneyperiod, or the liquidityworries en- genderedby the Penn Centralbankruptcy. Looking ahead, Bosworthanticipates a mild decline in the volume of gross corporatebond issuesfrom over $25 billion for 1971to $22 billion or $23 billionin 1972.For sucha volumeto be successfullymarketed, bond yieldsmust continueto attractindividual investors (as well as institutional buyers)by exceedingsignificantly the interestrates offeredon thrift de- posits.The continuedwillingness of householdsto purchasebonds will be particularlyimportant for 1972since mutualsavings banks cannot be ex- pectedto absorbcorporate bonds at the same high rate as in 1971,when their depositinflows hit recordlevels. The secondarticle, by WilliamH. Bransonand Helen B. Junz,analyzes trendsin U.S. internationaltrade and comparativeadvantage. The authors firstoffer a bird's-eyeview of U.S. tradein sevenmajor end-use categories over the period 1925-70.In the yearsprior to WorldWar II, the nation's 244 Brookings Papers on Economic Activity, 2:1971 net exportposition within each categorywas fairly stable. Capitalgoods and automobiles,for example,reliably yielded export surplusesthat dis- playedno majortrend upward or downward,while tradedeficits were typi- cal for consumergoods otherthan automobiles. Immediatelyafter the war,trade surpluses developed in nearlyall major categories,including even such consumergoods as textiles and shoes. World-wideindustrial recovery and devaluationsof other currenciesal- tered that unusualsituation. By the late 1950s,the United States moved into trade deficitsfor fuels and lubricantsand for consumergoods, and away from its substantialexport surplusfor automobiles.On the other hand, the net exportsurplus for capitalgoods expandeddramatically and that for chemicalsstrengthened. This dynamismof changeswithin sectors continuedduring the sixties: In general,the export surpluseswidened in areasof strength,and deficitsgrew larger in areasof weakness.The latter areasdeteriorated even duringthe earlysixties when the U.S. overalltrade balancewas improving;by the sametoken, surpluseson capitalgoods and chemicalsgrew substantially during the late sixtieswhile the overalltrade balance was deteriorating.These strong and persistentstructural trends withinmajor sectors can generatesubstantial variability in the overalltrade balance, even if relative overall prices, aggregatedemand, and output trendsstay in step amongnations. Branson and Junz offer evidence that the narrowingof the U.S. overalltrade surplus between the earlyand the late sixtieswas influenced,in part, by adversestructural forces (particularly in agricultureand nondurableconsumer goods), as well as by the excess demandand generalinflation in the U.S. economy. In the final portion of their paper, Bransonand Junz investigatethe sourcesof U.S. comparativeadvantage in manufacturedgoods. Theirfind- ings confirmthe well-known"Leontief paradox": Typically, the United Statesimports goods that are capital-intensiveand exportsgoods that are labor-intensive,even thoughthis nation has an outstandingabundance of capitalin relationto labor.They also reaffirma previouslyadvanced expla- nation for the paradox: The vast endowmentthe United States has in humancapital, embodied in the trainingand educationof its workers,is the basic sourceof its comparativeadvantage. Their results also provide statisticalsupport for the "productcycle" thesis.According to this thesis,the United Statestends to be a net exporter of newlyinvented products and thenbecomes a net importeras production of the good becomes standardizedand moves abroadto areas of lower Arthur M. Okun and George L. Perry 245 labor costs. The thesis impliesthat the United States can, and should be expectedto, lose competitiveposition in existingand matureproducts and yet can hold its own on overalltrade so long as new products,and hence new opportunitiesfor exportsurpluses, are developed.Branson and
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