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Chapter 12
INCENTIVES AND DISINCENTIVES
The young titanium industry is coming of age. As noted in earlier
chapters, it has established its place in the technologically sensi-
tive world market. Although titanium minerals are abundant in the
earth's crust in many places, some sources are much cheaper to exploit
than others and, accordingly, have been developed first. The panel
concluded that the nation's titanium problem is not so much the
dependence on imported minerals, but rather, the need is to create
sufficient, fully competitive capacity to reduce the raw materials to
metal and to process metal to the alloys and forms required for critical
military, aerospace, and commercial applications.
The U.S. titanium industry is large enough to meet normal, now
expanding, commercial and defense demands. However, it cannot be
expected to meet suddenly imposed, extraordinary military demands.
Timely additions to the established objective of the strategic stockpile
and use of provisions of the Defense Production Act, aided by a return to
the rapid tax amortization provisions of the Internal Revenue Act, would
be sufficient to stimulate industry to accept its share of the burden if
these measures were applied judiciously and funded consistently.
The titanium industry, although started under government impetus only
a third of a century ago, is still young. Because of the complexity of
its technology and its much lower production scale, titanium's cost of
winning virgin metal is an order of magnitude above that of the more
common construction metals such as copper and aluminum as indicated by
their relative prices (Table 43~. The energy cost to win virgin metal
is, in proportion to its total cost, much smaller and therefore a lesser
factor.
Although energy costs for producing sponge titanium are not a large
factor in determining sponge price, energy costs as a factor in
determining titanium mill product prices are large. Moreover, absolute
energy costs for all titanium processing steps are also large. The
custom-job-shop character of present mill processing is a major
contributor to these high energy costs as indicated throughout Chapter 8.
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TABLE 43 Examples of Relative Cost and Energy Consumption
Metal
Average Price
As Pe rcent
of Titanium
$/1 ~Price i/lbb
-Ec~sv ~L
Percent of
Total Costs
Aluminum 0. 75 10.4 24 32
Copper 0.8 5 11. 8 11 13
Titanium 7 .20 - 36 5
a Approximate average compiled by the panel from trade journals in
July 1981.
b Battelle Columbus Laboratories 1975.
The Markets
The development of titanium as a continuously profitable industry,
able to modernize as needed, has been seriously handicapped by the
industry's misperceptions of forthcoming military demands for aircraft
and their engines. The civilian aircraft industry, recently the largest
single market for titanium, although volatile, is not so unstable as to
be unmanageable from the corporate point of view in a market economy (see
Figure 1). A permanently strong industry capable of staying competitive
worldwide to back up military strength must have a significant part of
its market based in the civilian economy as well as in the steadier
routine items of military supplies. The civilian market has been well
developed in this direction as shown by an annual geometric growth that
has doubled every 5 to 6 years for the past decade.
The magnitude of potential civilian uses was described earlier. As a
not yet fully mature industry, the everyday use of titanium inevitably
will grow as designers work out the economic benefits of its use in their
designs.
As such demands grow and the relative price of titanium declines with
economies of scale, normal competitive forces will result in a steadily
growing titanium industry without artificial incentives. The science of
composite materials is gaining attention. Its products will both be in
competition with titanium for similar uses but also will foster use of
titanium as the preferred transition structure between composites and
massive steel and aluminum parts. There undoubtedly will be significant
differences in factors such as price and corrosion and heat resistance to
allow each to take its place in the economy.
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Ability of the Industry to Cope
During the early stages of growth in the industry , peaks and valleys ,
which ranged from surplus capacity to dependence on foreign sources for
raw materials and products in the first stage of fabrication, have made
investment a highly speculative venture. Nevertheless, the industry is
being expanded to meet the current estimates of the market. These do not
include major, now unforeseen, military demands or some large potential
new uses that are not yet firm and may not develop.
The panel was impressed with the will of the industry to grow and to
t eke ri sks involved in improvi ng technology and expanding to meet
anticipated growth in the market . The realization of its goals, however,
is limited by exterior political forces. The industry, in the view of
the panel, already has learned to meet the requirements of the civilian
aircraf t construction industry. The designers of civilian aircraft are
keeping the producing industry well informed on the advances in titanium
use, and they are capable of understanding what effect the rise and fall
of passenger usage has on the rate at which the airlines will need new
airplanes. These are within the limits that any industry, within a
market economy, can operate.
The basic issue is what can be done to meet sudden large increases
and decreases in estimated military demand. The advent of the B-1 bomber
program, its sudden abandonment, and now its reinfection into a program
that could easily be removed again if the new START talks are successful
illustrate the problem. The industry can meet the estimated requirements
for titanium for this airplane during the first few years of its
construction program; however, the industry will face the same problems
it has in the past if the demand estimates of the military are as erratic
as they have been in the past. Actual deliveries to military aircraft
builders have been steadier than those to civilian manufacturers (see
Figure 1), but the perceived demands, based on the military's
projections, have been very volatile. Under the present conditions and
in light of past experience, the industry cannot be expected to make
enormous capital investments to expand to meet such loosely conceived
requirements. The military itself recognizes the problems it has created
for the titanium industry and has taken constructive measures to improve
the situation (Appendix D). This is only one of many possible actions
even within the military. A broader scale approach needs to be conceived.
Alternatives
There are alternative methods of handling the problem of military
procurement without seriously upsetting the peacetime civilian market.
Most of these have been used by the titanium and other industries during
periods of active military confrontation (e.g., just recently such a
me thod has been utilized to meet the synthetic fuels program) . These
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methods are authorized in the Defense Production Act of 1950 (DPA). The
DPA was to expire on September 30, 1981, but Congress has extended it for
one year, with the expressed intention of strengthening it. These
desirable alternative methods are outlined below.
Reliable Estimates of Military Requirements
The panel, in searching for sound projections of demand, was faced
with the reserve of the Military,` imposed quite properly by the need for
the security of its prams for weapon systems. Security measures are
determined by each service separately. The Undersecretary of Defense for
Research and Development has the authority to consolidate the military's
needs and has designated an individual to do so, but the necessary staff
seems to be lacking. Some entity that has the ability to translate the
raw material requirements of military plans into estimates of material
requirements is essential. One member of the panel (James Boyd) was
involved in such activities during World War II and during the Korean War
in the army and civilian agencies respectively. That experience amply
demonstrated that consolidation and careful analysis makes the projection
process more rational. In wartime, such consolidation and analyses are
two of the prime essentials, but it is equally important during peacetime
since it minimizes security risks.
The excessive cost of hurried expansion of raw material production
facilities in times of emergency far exceeds, by orders of magnitude, the
maintenance of a small organization needed to keep material requirement
figures up to date. Such information, if it was made available through
government channels and gained industry conf idence, would permit better
corporate planning to meet demands. In fact, the cost of such a
military-requirements unit is so small that it is neglected, but its
absence surfaces with devastating results in the early days of
mobilization or when industries need to be expanded to meet defense
requirement s . In the absence of super-agencies such as those created t o
manage matters in wartime, the Office of the Secretary of Defense is the
only agency in a position to recognize def iciencies of this nature.
Incentives
Actions to use the DPA provisions would have to be initiated by the
Secretary of Defense even if carried out by another delegated agency such
as the Federal Emer=_?.cy Management Agency. In whatever steps are taken
to meet sudden or very- large military demands, it is beyond the unaided
ability of private enterprise to take such risks. Provisions in the DPA
have been effectively used for over 30 years. There is a tendency in the
DoD to consider that their requirements are now such a minor part of the
economy that they do not have to be concerned, because their needs take
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priority. This is not true in the case of titanium because it is the
overwhelming size of such a demand and the on-and-off-again appearance of
past military requirements that are the principal causes of concern in
this field. The DPA provides authorization to take a large part of the
ri sk of such sudden changes imposed on industry, but not all of them.
These provisions can make the additional investment sufficiently less
risky so as to attract the large blocks of capital required to modernize
and expand industrial capacity. Some of the larger plants in operation
today are using facilities that are over 30 years old, and were built
under earlier provisions of the DPA.
The titanium industry began during the Korean War period and was
built on these actions virtually f rom scratch. Should an analysis of
military requirements, inc. luding those required to f ill s tockpile
objectives, reveal a need to expand capacity beyond that now under
construction or planned, then the application of the provisions of the
DPA seems justified. The effectiveness of such DPA action has been
documented by Morgan ~ 1980~:
The application of the provisions of the 1)PA during the Korean War in
titanium was, in gross transaction certified as of June 30, 1956,
$895 million. The estimated probable ultimate net cost as of
September 1974--the last report on borrowing authority--was $129
million, about 15 percent of the gross transactions certified.
Stockpiles
Economic Stockpiles
The panel was made aware of suggestions that an economic stockpiling
program would solve the dilemma of periodic titanium shortfalls (i.e., a
procedure in which contracts would be let to provide titanium in an
approved f ohm for delivery to a stockpile, the material to be released in
times of shortages and purchased in times of surplus capacity). Such an
economic stockpile has many drawbacks, not the least of which is that it
would require judgments by individuals who are not directly involved. It
would remove an important element of competition from the marketplace and
reduce the f reedom of the industry to react quickly to the market .
Congress has debated this question many times, most recently in 1979 when
it passed the Strategic and Critical Stockpiling Revision Act of 1979
(P .L. 9 6-41) . This act specif ically excludes the concept of economic
stockpiles, but consolidates three existing stockpiles into the National
Defense Stockpile. It provides for more efficient management of the
stockpiles and for a National Defense Stockpile Transaction Fund.
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Strategic Stockpiles
The strategic stockpiling principle was established after years of
debate and has been amended several times. It provides a strategic base
for the economy, to enable it to overcome shortages arising from
interruption of foreign sources of materials. Commodities were never to
be released except in national emergencies. Almost every time this
principle has been violated (i.e., use of a strategic stockpile as an
economic s tockpile), markets have been severely disrupted; the presence
of an economic stockpile overhanging the market has inhibited expansions
to meet new demands.
Under the strategic stockpile principle, every pound of domestic
capacity is good for 3 pounds of material in stockpile since the
calculations in setting stockpile goals involve calculations of
capacities safely available to the economy under stress for a determined
period of time, currently 3 years of conventional war. Thus, the use of
incentives designed to increase capacities are cheaper and more effective
than stockpiling. Discussions with the leaders of the titanium industry
convinced the panel that stockpiling alone would not satisfactorily
alleviate the problems of sudden changes of large magnitude resulting
from changes in military demand.
Economic Incentives and Disincentives for Expansion
The principal disincentive affecting the titanium industry is the
unreliability of the military's estimates of its raw material needs.
Further, an economic stockpile tends to be a disincentive because it
throws one more uncertainty into the market. In view of these factors,
the panel believes that the time between the authorization of a military
procurement program requiring large amounts of titanium and the need for
the metal in the manufacturing plant is long enough to permit expansion
if the industry is given sufficient notice and incentive to do it on its
own. In addition, the industry needs some assurance that an announced
program will not be terminated before sufficient material can be sold to
recover an appreciable part of its investment. The DPA authorizes a
number of mechanisms that have been utilized with success in past
emergencies, at very little net cost to the government . These mechanisms
can be just as effective in peacetime before emergencies arise and have
been recently endorsed by the DOD ~ Appendix D) . They inc. Jude the i tems
d iscussed below.
In the past, the ability to accelerate the amortization of facilities
for tax purposes was all that was needed to encourage many pro jects
involving plant and capacity expansions. This provision is no longer in
the Internal Revenue Act, but there has been a strong movement to have it
reinstated. In using it, payment of some tax income is delayed if the
facility becomes a part of the economic structure, which has very
frequently been the case.
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The DPA authorizes floor price contracts in which the government
agrees to buy at a predetermined price for a limited amount of time
whatever the plant is unable to sell. This time could be adjusted for a
sufficient period so that a company could retrieve its investment without
loss and without prof it . If the military orders appear, nothing further
is required of the government. Only if the total market, including the
mill tary orders, f ails short of the capacity of these plant s will the
government be required to buy the product, which then should be put into
the strategic stockpile to be used only in a national emergency. Past
experience with this device has been good. Only fractional amounts of
the materials under such contracts have been "put" (purchase or
adjustment action) to the government.
In 1956, more than 50 industries were expanded with these aids under
contracts with obligations of 68.4 billion but at a cost to the
government of approximately $900 million (Morgan 1980~. Many of the
units created are still in existence, adding to the tax base. Such
devices reduce the government's supervision to a minimum and keep it out
of the marketplace. Industry assumes the responsibility at acceptable
risks. The normal profit motive remains the driving force. The
government risks only major changes in programs and the industry risks
that it will have created a facility for which there is not an immediate
market after the contract has expired.
Earlier in this report examples were given to show the disruptive
nature of sudden shortages in the titanium industry. Some have suggested
that allocations would alleviate such shortages since they tend to
stimulate "scare buying," which exacerbates the shortages. Experience
has shown that, even in time of national emergency, allocation is only a
last re sort since it virtually destroys the intimate customer and
supplier relationships of the free market. Suppliers are faced
frequently with making temporary allocations and, in some cases, they
have temporarily assumed government prerogatives.
In one case, the only important buyer was the Air Force and its
sup pit ers of titanium component s . An individual in the government wa s
assigned to determi ne where the shortages were hurting the procurement
program and where there were surplus supplies. Persuasion to exchange
priors ties for titanium supplies proved the shortage to be exaggerated.
With good will between all parties, supplies can be made to go much
f arther than might be expected . Turning such delicate operations over to
government employees Is not always the most effective means of solving
the problem, and this is what formal allocation means.
The system described above would work more efficiently to assure a
strong flexible industry if the strategic stockpile was allowed to work
as a part of the marketplace. At present there is a minimum amount of
titanium in the strategic stockpile, 21 , 465 tons against an objective of
195,OOO tons. Some of this material is unsuitable for many of today 's
industri al needs (see Chapter 6) and could be sold for purposes not
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requiring high-purity metal (e.g., for alloying in steelmaking). To make
the system work more simply, appropriations could be made to the
stockpiling authority to work against a long-range objective. Annual
appropriations would permit specific additions to the commercial titanium
requirements of the market. These appropriations, if limited to
purchases from domestic facilities, would strengthen the industrial base
and, thus, reduce the need for larger stockpiles. They would cease when
the objective was reached. It is clear to the panel that a large part of
present U.S. titanium sponge manufacturing facilities requires
modernization to compete in the world market. Full utilization of
facilities would improve profitability. A steady market and rapid tax
amortization would lead to modernization.
Re search and Deve lopment
To broaden the commercial market, research and development efforts
need to be strengthened. Chapters 8 and 11 deal with this aspect. In
recent years' tax deductions for research and development have not been
sufficient to encourage extensive research in the private sector.
Congress has already acted on granting some tax credits for this purpose
at the time of writing this report; perhaps additional tax credit
incent ive s may be worth considering .
REFERENCES
Battelle Columbus Laboratories. 197 5. Interim Report of Energy Use
Patterns in Metallurgical Processing. NTIS No. P8 246 357/AS.
Columbus, Ohio.
Morgan, J. D. 1980. Materials Availability for Automotive Applications,
SAE SP 462, Society of Automotive Engineers, Ince' New Yorke
Representative terms from entire chapter:
strategic stockpile
