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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. 163

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164 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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165 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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166 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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167 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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168 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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169 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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170 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