MIT Department of Chemical Engineering Centennial Convocation (4/6)
PRESENTER: This morning and again this afternoon, you heard about some of the department faculty who actually left to join industry and had a major impact in industry. Today, we have an example of a very distinguished alumnus who made his mark in industry, has finally seen the light, and has become a scholar, and is enjoying a second career as a professor.
And that's Ralph Landau, who all of you, I think, know. Ralph is going to talk to us about the role of chemical engineering in the growth of the chemical process industries. Ralph--
LANDAU: Good afternoon, ladies and gentlemen. It's a big honor to be here with you. I hope I won't let you down after the brilliant performances this morning.
But I should say, when Skip Scriven talked about chemical engineering in the old days, he said that the first curriculum was in 1888 at MIT and the second one at Penn in 1892, and that the Institute was founded in 1908. I should do what President Reagan sometimes says-- I remember those days well, since I went to Penn, was born in Philadelphia, and then at MIT.
My title had in the printed text the word "catalyst" for the chemical process industries. And Clark quite correctly pointed out that a catalyst is not supposed to be changed in the course of a reaction. And therefore, it's inappropriate for the title. I quite agree with him. He gave me the title, and I didn't have the sense to resist it.
So the truth is chemical engineering and its role in the chemical process industries had a very substantial interaction. And each changed the other over the years, as I will attempt to present in the next 35 to 40 minutes. And I have a special dispensation to run over a half hour, simply because I said I have to do it.
But that's how it is. Now that I'm an academic, I'm learning how to fill 50 minutes very well, but not quite.
Anyway, I want to paint the picture of chemical engineering and the industry with which it has been associated for so long in its economic context. Because obviously, what made chemical engineering arise out of chemistry and develop its own character was its economic context. And I will try to paint that economic context as we go along in the different eras that I wish to summarize.
This is based on a work that I'm still doing at Stanford and is therefore a short summary of a work in progress, which I hope will become a more extensive work as we get further into the analysis of our very fascinating industry. Let me just very briefly touch on chemical engineering in the period from the 1888 initiation until 1920 and describe it in the following short sentences.
The first course in 1988, as you heard earlier, was descriptive industrial chemistry, mostly inorganic. Industrial companies alone in that era possess the know-how to design and operate large-scale plants. And MIT was still an undergraduate engineering school.
When Arthur Noyes in 1903 saw to convert MIT into a science-based university including a graduate school oriented toward basic research, he felt that it would also better train young people for careers in industry. But William Walker, also a chemistry professor, had a different vision and emphasized that it should remain a school of engineering technology and train the builders and leaders of industry by focusing on applied sciences.
In his view, learning physical science principles was not enough. Understanding of large-scale problems drawn from industry was essential. So Walker reorganized the program in industrial chemistry, which was languishing when he came, converting its heterogeneous collection of courses into a unified program based on [INAUDIBLE] chemistry on a study of unit operations, which reduced the vast number of industrial chemical processes to the analysis of a few basic steps, such as you heard distillation, heat transfer, filtration, and the like.
Walker, who also founded the AIChE, as you heard, in 1908, established the research laboratory of applied chemistry in 1908 to obtain research contracts with industrial firms and to serve as the basis for graduate students in chemical engineering. In this year, a few firms had their own research facilities, whereas the rapid growth of the German chemical industry was due to close cooperation between university and academics.
To further the industrial linkage, Walker and his younger colleague, Warren K. Lewis, founded the school of chemical engineering practice, helped by Arthur D. Little. This gave students access to the expensive industrial facilities required to relate classroom instruction and union operations to industrial practices, but under the supervision of a faculty member.
These two viewpoints of Noyes and Walker never proved reconcilable. By the end of World War I, Noyes's influence in the chemistry department slipped, while Walker's program in chemical engineering grew in popularity and in students. The rapid expansion of the undergraduate chemical engineering program at that time paralleled and derived from the rapid expansion of the American chemical industry resulting from the war and the loss of German chemical imports.
This linkage of the industry and the profession has been pervasive ever since. By the end of 1919 therefore, Noyes resigned and, as you heard earlier, went to California Institute of Technology and helped create the modern Institute.
It's interesting to note that William Walker, who resigned shortly thereafter, left his mark at MIT in a different path altogether. I happen to be a privileged person in that I'm a trustee of both Caltech and MIT. And the different visions of Noyes and Walker still persist to a considerable degree to this day. Caltech is more of a science-based university, and MIT is more of an engineering-based university, although there are many exceptions to that general statement.
At the time, Walker seemed to be in the ascendancy. There was, however, opposition in other faculties at MIT to his aggressiveness and reliance on industrial ties. And he got into real difficulty in securing adequate funds for the RLAC, especially as a result of the post-war recession that came in about 1919, 1920. And therefore, the selectivity in choosing problems diminished.
Walker then, frustrated, resigned but left a legacy of industrial linkage for chemical engineering education. Now let me trace chemical engineering and petroleum refining in the era of 1920 to 1941. Warren Lewis inherited the research laboratory of applied chemistry, of course, and its difficulties, finances, and short-term projects.
While arising from industrial problems, chemical engineering researchers there were often led to the not immediately practicable, but having a perspective over a longer term. Lewis thus moved to quantify and extend the knowledge of the fundamental unit operations. The chemical engineering department became an intellectually powerful center during this period, and the pioneer text of the Principles of Chemical Engineering appeared in 1923 simultaneously with [INAUDIBLE], as you heard.
At the same time, Lewis developed a new relation with the petroleum refining industry, which had an enormous impact on the chemical process industries. The oil companies of the era foresaw the gasoline demand for mass-produced cars would boom after the war. They needed to develop and install large-scale improved continuous processes.
Now Amico, then standard of Indiana, a large refiner had developed the Burton-Humphreys thermal cracking process, which was a batch process suffering carbon deposits that require periodic shutdowns for burnout. Exxon revised this to the tube and tank process and hired Frank A. Howard from Indiana as head of its new development department.
Almost the first thing Howard did was to engage the best consultant around. And that was Warren K. Lewis. A partnership was formed that would have a profound influence on Exxon and on chemical engineering.
Lewis's first efforts were to provide precision distillation and to make the process continuous and automatic. Batch processes were clearly inadequate for the rising market demand for gasoline. By 1924, Lewis helped increase oil recovery by the use of vacuum stills. His designs became refinery standards, and coursework at MIT changed to embody these new design concepts.
By 1927, Howard began a series of agreements with the German IG Farben, gaining access to their work on hydrogenation and synthetic substitutes for oil and rubber from coal. Howard needed a whole new research group to handle this new technology, particularly knowledgeable about chemical process technology. Again he consulted Lewis and who in turn introduced to him Robert Haslam, whose name you heard earlier from Hoyt Hoddle, who was then the head of the Chemical Engineering Practice School.
Haslam formed a team of 15 MIT graduates who set up a research organization at Baton Rouge, headed by Haslam himself. Of those 15, those pioneers, one is with us today. And that is Bud Fischer. And Bud-- as the audience, I hope you will give him a big hand because he's a survivor.
6 of these 15 rose to high office and members of Exxon's board. Haslam himself became vise president in 1927 of the development department and a senior officer of the SO Company before he retired. Another staffer of the RLAC was [? Ari ?] Wilson, who as you heard earlier today became chairman and CEO of Amico.
Exxon during this period closely linked applied to innovative research, including the application of chemical catalysis. Much of modern petroleum refined processing originated in Baton Rouge. And it was basically an MIT chemical engineering group that got it going.
With the continuing advice of Lewis and later in 1935 of Ed Gilliland, Baton Rouge produced such outstanding process developments as hydroforming, fluid cat cracking, and fluid flex coking. And Hoyt Hoddle had also started consulting with exon Exxon on problems in combustion, which became reflected in Hoddle's longtime influence in teaching combustion theory and practice.
Thus, Lewis created a very different approach from Walker's. Instead of bringing industry to the campus as in the RLAC, he brought the campus to industry. Unlike the Practice School, which also did this, he helped solve the big problems of industry. And so he established modern chemical engineering education, proving that industrial consultation by professors enrich the employers and the Institute's educational program.
He created the precedent that able MIT faculty and students should go into industry and move it along, providing valuable experience and return potential funding for MIT. Ken Jamieson, the chairman of Exxon, was the man in charge of the drive. It got us our new chemical engineering building.
3-- Lewis focused chemical engineering on the design of continuous automated processing of a huge variety of products, first in petroleum refining and then in chemicals. Other chemical engineering departments as well as MIT's flourished and attracted the brightest students from all over the United States and abroad, who in turn moved into high positions throughout the petroleum and chemical industries.
Other engineering disciplines, lacking this history of direct involvement with a major growing industry, never developed such an overall systems approach, the design of continuously operating production plants, with the exception of the electric power industry.
Now, I would like to deviate a little bit and talk about the role of the process design firms in the early part of this century up till 1941. A little known aspect of the rise of chemical engineering as the design discipline has long resided in the engineering design firms, which contained all the skills necessary to build complete process plants, particularly in refining and chemicals. The most prominent emerged early in this century.
UOP was more research-oriented in its approach to petroleum refining and became the major source of process technologies for the smaller oil companies. M. W. Kellogg grew as a partner with some of the majors in the development of the fluid catalytic cracking process, hydroforming, and so on. Few oil companies had the complete organization necessary in those days to perform all the phases of plant design and construction.
Because of the obvious need for design of continuous automatically controlled units, these and other similar companies soon came to be dominated by chemical engineers, many trained by MIT. I'll briefly track the history of the chemical industry before 1941, although this is a very skeleton approach.
A few key features-- firstly, the First World War proved to the United States that it must become more self-sufficient in all important chemicals. And the number of companies and products grew. Secondly, in the depression, a world cartel in the major chemicals arose. Entry costs for new companies were prohibitive. The industry survived.
Three-- the industry was largely based on branch operations, and the chemical engineer was not yet perceived as a critical resource. And forth-- nevertheless, companies like Exxon, Union Carbide, Shell, and Dow, ventured into what were the first small-scale stages of the rise of the petrochemical industry, detailed in the excellent book on petrochemicals by my former colleague Peter H. Spitz, who I think is also here today.
Here the need for chemical engineering skills rose sharply as the scale of operations forced resorting to continuous processing, as previously in the petroleum refining industry. And chemical raw materials began their epochal shift from coal-based to petroleum-based.
The war years, again, can only be summarized in a few paragraphs. The United States had entered into a crash program to build many new facilities for synthetic rubber, petroleum refining, chemicals, munitions, light metals, et cetera. Much sharing of know-how and processes between competitors took place. Many new companies undertook chemical manufacturing, and personnel were widely interchanged.
Engineering design firms were swamped with orders, becoming an important reservoir of widely experienced chemical engineers. And as the war ended, the government insisted on selling the new plants to many newcomers and competitors of the traditional chemical industry. The European chemical industry lay in ruins, and the prewar cartel had ceased to exist. That was the picture at 1946.
Now I'll trace the two decades from '46 to '66, which I call the stable decades. And I will first talk about the broader economic climate in which our industry developed. And then I'll narrow the focus to the chemical industry itself.
And I should say at this point, when I talk about the chemical industry, I'm talking about what the Department of Commerce used to call Standard Industrial Classification number 28. That's a very broad industry with a lot of different segments. And while I'm speaking in the overall industry, the separate parts of it had very different histories and different characteristics. And there's no time to, in this talk, to give you a better picture of how widely divergent some of these parts were.
Anyway, during that period of '46 to '66, the United States had a unique world situation. There was a large pent-up domestic demand and need for reconstruction abroad. The United States was the only center undamaged in new industrial facilities and finances and had little competition.
The United States government maintained a low inflation, low interest economy with low cost of capital. Federal budgets were close to balance, and there was a positive trade balance overall. Despite the Korean War, the economic climate was favorable for growth.
The postwar real growth rate and GNP, real terms, reached historic highs averaging around 3 and 1/2 percent per year. Productivity growth was also good in this period, averaging 2 and 1/2 percent per capita in real terms until 1973.
This favorable world scene obviously greatly influenced the progress of the chemical industry. Firstly, it became international very quickly. Secondly, the entry costs were low. Competitive scale of plants was still small. Capital costs were low, building times rapid, and markets almost continually expanding.
Thirdly, technology spread rapidly around the world. Licensing by domestic producers and process design firms accelerated, while important foreign inventions such as Ziegler's polyethylene, Natta's polypropylene, and ICI's polyester fiber and high pressure polyethylene crossed the ocean to here. Licensing became an apparently profitable technique for companies unable to invest everywhere to earn additional revenue.
Fourthly, American chemical engineering, developing rapidly in our universities, proved to have an overwhelming competitive advantage abroad, where there were smaller and less diversified refineries, and chemical plants that had been largely designed by chemists unused to large scale-ups. Fifthly, chemical engineers rose to top management positions in oil and chemical companies. Thus, by this process, innovation was coupled to the marketplace and process design integrated with the product.
Sixthly, the growth in petroleum feedstocks for the chemical industry attracted the attention of the oil companies, who sought forward integration, while chemical companies looked for ways to integrate backwards. Seventh, there was a flow of new products, such as synthetic fibers, plastics, and detergents into the marketplace. Many of these were superior substitutes or novel applications of synthetic products for such fibers as cotton, wool, and silk, as well as plastics for paper, glass, and wood.
Eighth, there was a lack of pervasive intrusion by government in a variety of areas. Ninth, the chemical trade balance remained positive, a combination of strong innovation, favorable raw materials, some tariff protection, and the need to maintain a competitive edge against the rapidly reviving European chemical giants, which sharpened management skills.
10th, although profits of US chemical producers grew rapidly in the mid '50s, so did those of other basic industries. By the end of the 1950s, the exuberant expansion of the industry led to overbuilding and overcapacity. Nevertheless, the earnings of the industry grew about as fast as all manufacturing up until 1966, but the balance sheets were deteriorating.
The signs of competitive pressure, both domestic and international, were unmistakable. Unlike electronics and computers, where many small companies did much innovating, chemical did not have this. Entry costs were already too high.
As I attempted briefly to say earlier, with this kind of favorable, stable climate, many product lines and processes appeared. Among the many innovators were the process design-oriented engineering firms, described previously, which were basically responsible for developing and commercializing the key processes for petrochemical raw materials' manufacture.
These were ethylene cracking and distillation processes primarily by Lummus, Kellogg, Foster Wheeler, Stone & Webster, and aromatics extraction and production by UOP in the platforming process, Udex, and the like. The modern petrochemical industry would be inconceivable without these fundamental American chemical engineering developments. And they spread rapidly around the world to make petroleum and other hydrocarbon feedstocks the primary raw material source for the chemical industry.
But this also opened the door to many new and vigorous competitors to American firms. I've left out a lot of detail about other engineering firms like my own. And I think there's a paper in your booklet you got that describe some more detail about what we were doing.
And therefore, I can only say at this point that, in following Doc Lewis's concept of chemical engineering, apply the creative process design, I started our company in '46 with that basic model in mind. I wrote about this in the paper I describe.
And we have always searched, even though we licensed widely, for manufacture position, rather than in licensing, first in ethylene oxide in the late '40s, then in terephthalic acid in the mid '50s, which we sold to Amico, and finally successfully in the mid '60s, with our propylene oxide process, which formed the basis for our oxirane joint venture with ARCO.
During this period, we saw for ourselves how powerful were the tools of American chemical engineering by bringing this discipline to West Germany. Their design methods were clearly unsuited to the larger scale of the modern petrochemical industry. When we built our first ethylene oxide plant during the middle '50s for a major German chemical company, it was sized at 4,000 tons per year, a number that I find inconceivable today.
Soon after completion they wanted to quadruple the capacity to 16,000 tons per year. We offered them a design for a single 12,000 ton per year plant operating in parallel with the earlier one. But instead, concerned about a short continuity of operations, they insisted on three more 4,000 [INAUDIBLE] ton units in parallel.
I'll never forget seeing four 4,000-ton units, one side by side, inside a very large brick building, operating in the later part of the '50s using our technology. But the Germans soon learned from us and others and soon adopted many of the American practices and deployed American engineering, chemical engineering design, just like everybody else.
Our conclusions from this period, the first 20 years that I've described, were something along these lines. The world was now the marketplace for industrial companies. The risks of moving abroad in that era were low. Secondly, patented exclusive technical advantages are critical. And in our industry, they most certainly are in our form of capital. But the diffusion of technologies excrete increasingly rapid, and competition restricts profitability.
Third, chemical engineers participating directly in the laboratory with chemists, and frequent interchange between laboratory, the design room, plant startup, and the like, provide an integrating force-- and I use this word in a somewhat different context from what was used before lunch-- that spurs commercially valuable innovation in the shortest possible time.
By applying the latest fundamental principles aided by computers, we designed large-scale plants directly from a micro pilot plant. We could thus speed commercialization of new technology and gain an important position in the marketplace. Fourthly, a CEO who is technically sophisticated is the key to successful integration of technology with company strategy. Other technologically-based industries have also been learning this lesson, some more slowly than others.
Fifthly, the commercial applicability of an invention often precedes the underlying science. And I wanted to comment briefly on an earlier discussion that showed a model of science, invention, innovation, and so on, down to the marketplace.
We published an article in our book that I wrote with Nate Rosenberg of Stanford several years ago on the way innovation really takes place in industry, which we call the chain-linked model. And if you have a chance to read the chapter by Steve Klein and Nate Rosenberg, he'll show you how much more complex the real industrial process of innovation is.
Sixthly, process improvement is a major opportunity to gain profitability. Many of our developments are by no means breakthroughs. But they contributed continuous productivity improvements and cost advantages. Because in this era many companies focus their research efforts on new products, we and other design firms were able to demonstrate the great benefits of continuing process innovation.
Seventh, research efforts were almost entirely market-driven. And the federal government had no significant share in the industry's work. This era ended about the middle '60s with the arrival of Vietnam War, a Great Society, and the full-fledged recovery of the major competitors abroad. For our own company, it became very clear. A reliance on worldwide licensing and building could not be sustained, and self-manufacture became more urgent.
Now we enter what I call the turbulent period of 1966 to 1981. I'm sure many of you remember that very well. From about 1966, Americans' annual productivity improvements started to slow down and collapse by 1973. The merchandise trade balance also started to deteriorate. By 1972, the real trade balance became negative, although the nominal trade balance did not sink into the red until 1981.
Some industries were affected more than others. The first slide will show that only three of the research intensive industries, or high-tech industries if you will, have had consistent positive trade balances-- aerospace, chemicals, and scientific apparatus. And the green line with a little symbol of a chemical plant is, of course, our chemical industry.
Other industries started down early, especially petroleum after the 1973 oil shock, which I show in slide 2. Petroleum in this case is shown with a derrick, as you can see. American competitiveness in world markets had begun a long-term erosion. Vietnomics had begun to appear in macroeconomic policy, and it had powerful lasting effects on the world economy.
Firstly-- you can have the slide off now-- a great demand overstimulation took place. Inflation and rising interest rates appeared. There was a structural budget deficit. There was a sharply declining dollar in the early '70s. And the United States abandoned the Bretton Woods regime of fixed monetary exchange rates in 1971.
A significant flow of the savings pool of the United States into less productive residential and commercial construction took place as investors fled from financial to real assets in order to protect their capital. And of course, the cost of capital rose. There was a decline in capital investment per worker as the baby boom peaked. And hence, there was the decline of productivity gains.
In the 1980s, there has been some improvement, particularly in manufacturing. Japan, with two to three times as much annual capital investment per worker, had a high productivity gain. But the United States created a large number of jobs, mostly in small companies, unlike Europe, where unemployment arose. In the face of many new entrants, jobs became an important part of United States economic policies in that era.
There were two massive oil price increases in '73 and '79, which siphoned enormous wealth out of the industrial world. There was a rise of the environmental movement, resulting in much greater regulation and litigation. Businesses were required to invest large sums to clean up the excesses of many years in the past, and to do it pretty quickly.
Volatility of economic conditions appeared as a regular feature, and myopic planning horizons for business accompany them. And the intolerance of the ravaging effects of the inflation of the 1970s resulted in Jimmy Carter's appointing Paul Volcker as chairman of the Federal Reserve Board to subdue it in 1979. And that, of course, resulted in the recession of '81 to '82, which marked the end of what I call the turbulent period.
The chemical industry, needless to say, was very strongly affected by these immensely climactic changes. Firstly, in the shorter run, inflation and the war provided a large demand stimulus, which was misread by many companies as indicating a larger potential market than actually existed. This led to much overbuilding, especially of large world-scale plants, which each company thought would give it the advantages of scale, only to be dismayed as other companies rushed in with equally large facilities.
The notion of optimum scale expanded over time, aided by the very skills of the chemical engineers involved, who learned how to design and build ever large-- got larger single train plants. It was not until market conditions prevented operation at capacity that it became evident that smaller plants operating at full capacity could be more profitable than big plants operating at half capacity.
Economists have recently pointed out, in fact, that American managements invested more than financial considerations alone would have justified in the last 15 to 20 years. And that was part of what lay behind that. Secondly, profitability dropped significantly, as is shown in the next two slides.
Slide 3 shows the profit margin in terms of percent of sales for the chemical industry, which is marked in green, and the operating rate, which is marked in orange. And while the scale is relatively compressed, I think you can see that when an operating margin in 1985, for example, dropped down to just over 4%, the industry is not doing well. And it pretty much tracks the capacity factor as well, although not by any means one-on-one.
The next slide shows a slightly different measure of profitability of the industry as a whole. It's the return on assets in percent, also with operating rate in orange, and the return in green. As you can see, the return on assets also has gone from a high of over 10% in 1973 to a low of just over 4% in 1985, though we've had a very violently fluctuating history during this period.
Now-- you can turn the slide off, please. Managements found financial conditions in an era of rising inflation to be critical to survival. While technologists were still prevalent in this industry, MBAs and financial offices also became indispensable.
Four, although foreign competition aided by extensive licensing-- I described before; it's now very large-- the United States chemical industry still enjoyed scale factor, cheaper resources, the best chemical engineering in the world, substantial technological edges in many areas, and international presence. And our trade balance remained positive as it has to this day.
Fifthly, entry costs were becoming even greater. Only the large companies could now play. However, the oil companies moved forcefully into the already crowded and overbuilt arena.
Sixthly, many of the new technologies of the '40s and '50s were now being fully exploited to reduce costs, raise quality, and diversify product lines. So to step back just a moment, it was only after the war that the immense new markets and large-scale demand produced the great surge in petrochemical development and also in the demand for chemical engineers.
Some scholars have incorrectly contended that the innovative urge of the industry declined decade by decade. It hasn't. But it has changed in its character.
Until the middle '60s or so, major commercialization was accomplished for important young plastics and for the new fibers. Each required low cost feedstocks from the large new olefin and aromatics plants. Also, a large segment of the innovations made during this period included significant process improvements for precursors of plastics developed in earlier years.
After 1966, the tonnage plastics already in place became ever more differentiated. More sophisticated fibers and plastics such as Kevlar and composites were begun. And additional precursor process developments for previously commercialized polymers were introduced. Several involved switches and raw materials, as the energy price shocks were seen to be permanent.
In the more recent years, innovative developments continue to focus on further product differentiation and adaptation of lower cost processes for precursors. The oil and process engineering firms also did much innovating, as did foreign companies.
Because of vigorous international technological competition among chemical and oil companies, companies everywhere could commercialize innovation made elsewhere. Virtually all products were very large tonnage, which provided an economic basis for innovation and hence for the talents of chemical engineers grounded in design. But there was much new chemistry also and close cooperation between chemists and chemical engineers.
By the end of the 1960s, the depressed earnings of the industry were reflected in the discount to market of chemical equities. In the early 1970s, returns on capital had dropped to a level where differentiated producers could support new investments, while most others could not.
Optimism dropped after '76, when many companies finally realized that growth in the industry, which had been at least twice that of the GNP to this point, had slowed. Gross margins in the commodities had disappeared, and the increases in hydrocarbon prices would have a negative effect on future earnings.
Unfortunately, much new capital had been committed to the commodity sectors, partially because of the large plant syndrome, and partially because of the ease of adoption of the existing technology with a "me too" attitude, which was rather a cocky expression of hitherto successful operations. Many judgments about future markets turned out to be mostly in error. Hence, in the absence of large new capital investment possibilities, chemical companies turned to increasing R&D.
The chemical industry proved particularly vulnerable in the public's eyes to environmental and toxicity hazards. Some companies were spending up to one quarter of their capital on such investments, inhibiting other kinds of innovation. For our company, our agreement with ARCO permitted us to move rapidly abroad to Rotterdam, to Japan, and to Spain.
From a zero share of the market, we rose to not far from half and introduced some new products also. By not copying other companies and technology, but striking out boldly with new and riskier technology, we established a dominant enough position to benefit most fully from future exploitation and descend down a rapid learning curve.
By 1980, however, the traumatic events in the general economy that I had been describing could no longer be overcome, even by all the advantages we had that I have cited above. The prime interest rate in the winter of 1979 and 1980 rose to 21%.
At that point, our share and our venture's cash flow was going solely to the banks. The time horizon of management was very short indeed. It was the next quarterly payment of interest.
We were forced to sell out to ARCO. And after the recession of 1981 and '82, I sold the rest of my company. And I became an academic economists so that I could find out why all this had been happening to us at the height of our success.
Now I'll sketch in the present era, which I think you all know just as well as I do, if not better, '81 onward. The Vietnomics period that I described earlier was succeeded by what might best be called Carteromics, Reaganomics, because it started with Volcker in '79 and has continued to this day-- inflation followed by deflation.
A sharp recession occurred in '81, '82, followed by about six years of uninterrupted growth, some revival of gains in productivity, which had about 3 and 1/2% in manufacturing, some marginal tax rate cuts, and growing budget deficits. But the still high real interest rates combined with the need to finance the budget deficits, created by a strong international demand for dollars. And the dollar appreciated to where many exports became uncompetitive and imports cheap.
The current account deficit grew to the present minus 3 and 1/2% of GNP, reflecting the inflow of $160 billion for investment in the United States in 1987. American savings and investment declined relative to the Japanese. Investment faltered because industry was suffering from the overcapacity of the '70s.
Rapid technological change and the trade imbalance induced heavy competition for American companies, not only in international markets, but also domestically. The huge debt created by the government and the private sector moved first into the financial markets, rather than into the real world of goods and services.
This and the tax code, which permits deductibility of interest on debt but not dividends on equities, are among the primary factors that lay behind the junk bonds, corporate takeovers, leveraged buyouts, and other creative financial manipulations. The high interest rates and cost of capital contributed to short-term horizons.
While it's true that some mad managements were driven out by this process, the general atmosphere of fear in many companies also reduced propensity for risk taking. As the dollar weakened, by the middle '80s, exports to the United States improved but also encouraged foreign companies to buy assets in this country.
Beginning in some cases as early as '76 to '77, chemical companies did respond to their external pressures. Successful survivors needed a rapid improvement in their processes. High yields were essential for expensive raw materials. And high energy costs necessitated efficient heat conservation.
The chemical engineers' talents were indispensable in this year as well. The new ARCO propylene oxide plant in France, for example, using our technology operates without any external heat energy source at all under normal operating conditions.
Because many lacked these advantages, by late 1982, several major chemical company stocks sold at the same absolute stock level as 1959. Investors saw these companies as mature commodity manufacturers threatened by new sources of low-cost production in Canada, the Middle East, and so on.
This underestimated the degree of change or renewed innovation already taken place and the future potential. Even in the year of 1982, although many major areas were unprofitable, the specialty businesses of some companies contributed a large share of the profits, although accounting for only a small fraction of their sales and assets.
The productivity declines. And here I refer to multi-factor productivity shown in the next slide for the chemicals. The productivity index is shown in yellow, and the operating rate again is shown in orange-- suggests the extent of restructuring going on. And therefore, it very clearly points to a decline in capital productivity during this period, capacity utilization being obviously very critical.
When a better demand environment appeared-- you can turn this light off-- in 1983, the net result of such constructive changes was a rapid buildup of cash. From 1986 on, the industry is benefiting from lower oil prices, a weaker dollar, and growth in the world economies. Its restructuring has resulted in emphasizing its lack of labor intensivity.
Its total employment of slightly over 1 million has hardly changed in over 10 years, during which total sales nearly doubled, so that in real terms, labor productivity, after being essentially flat from 1973 to '81, has been improving rapidly by almost 50% since that time. This cash flow has been used to buy back stock and raise stock prices.
We expanded into new areas, promising future growth and increased related R&D expenditures, capital investment and modernization rationalization of major commodity of manufacture, and finally, some new capacity in certain sectors such as plastics. People still remember being burned by overcapacity, as you can imagine. And an export-led drive for a new capacity is a tenuous thing these days.
The chemical industry today combines a large commodity-based capital intensive substructure with a proprietary research-based overlay. These businesses require different skills, but this combination defines the competitive companies of the future.
In many ways, we are now in a golden age of American chemical manufacture. Few industries are so thoroughly pervaded by strategic and tactical issues involving product, geographic, and customer diversification, forward and backward integration, technology advances, economic and non-economic competitors, international financial structure, environment and safety questions, capital, marketing, and research intensity.
It supports probably the world's largest privately financed research and development budget. And it also is the strongest individual industry in Europe. And the Europeans have a trade balance of $27 billion surplus in chemicals alone.
The next slide shows the expenditures for R&D as a percent of sales for the research-intensive industries. Of course, this isn't terribly meaningful, since in some cases like instruments or aerospace, it's a very large component of their sales dollar. Our industry is, nevertheless, quite a high performer in this area.
And the next slide shows the current R&D expenditure table with an indication of where the funding is coming from. And as you can see, the funding of the chemical industry is essentially 97% privately funded, as contrasted with aerospace, which is 80% government funded. This is not the place to discuss the very different histories and characteristics of these two very successful companies and industries. But you can see that already there are some very profound differences in explaining them.
Certainly R&D alone is not enough to account for positive trade balances. Industries that are successful in trade have a number of the favorable factors I've been describing. The rapidly changing quality indices product is not reflected in these productivity figures. Certainly, many fibers, plastics, consumer products, and so on, are much better or more diversified.
Thus, I have to look at profitability in the international competitive position as indicators of the health of the industry. At present, our industry is operating close to 100% of realistic capacity. Nevertheless, the rapid pace of global technology will necessitate replacement of obsolete facilities.
And yet in spite of its technical accomplishments, which are immense, the industry over the past 30 years has not been able-- as you've seen-- to establish sustained high profitability. Foreign large buyers may yet raise their ownership of America's industry to a much higher level.
In the past three years, approximately one third of foreign investment in manufacturing in the United States has come into the chemical industry. And it probably is about 25% foreign-owned today. It may well be that there should be some mergers in this industry to fend off such takeovers by foreigners.
Some of our chemical companies are too small to stay in the race. One should take as a cautionary note that the American dyestuff service industry is not 100% foreign-owned.
Now let me dwell very briefly in my concluding remarks about the future. Nearly everyone thinks that domestic and world recession will come sooner or later. Our deficits may diminish. Oil prices are uncertain, but domestic oil production is clearly shrinking.
There is talk of yet more tax bills. A new administration may take office with few commitments. And no one knows exactly how to increase the savings and investment rate of American society. And companies need to catch up with the many more modern installations abroad.
When hurdle rates for new investments are 15% to 20% in the United States and perhaps 5% to 8% in Japan, where capital costs only 1%, it can be seen how big our capital problem really is. And this is especially true in financing, research, and development, which is at all equity financing.
The chemical industry has suffered in profitability for misallocation of capital to over large commodity type plants for quite a while. Given a reasonable macroeconomic climate, the American chemical industry will survive and grow and will certainly participate in the newer fields of materials, electronics manufacture, biotechnology, complete systems, including fabricated equipment and instruments, and so on, as well as in extending and deepening its own traditional products.
Take the last slide off, please. It may well become the world's leading industry in the 1990s. And what of chemical engineering?
There are some disturbing signs. College enrollments are down. Many more fields attract the best students as well as ours, spreading them more thinly. Chemical and oil company expansions are fewer. Companies feel they need talents different from those of the typical undergraduate-trained chemical engineer. And you heard about that from Jimmy Wei earlier.
The public sees chemicals as dangerous. There is an increasing lack of strong industrial orientation in many chemical engineering departments. A trend that began in the late '50s is government funding of university research became dominant, and engineering science moved the discipline closer to a more academic orientation.
Perhaps a partial return to a greater proportion of industrial funding would be a better balance. And here, I think we have it at MIT. The National Research Council's Frontiers in Chemical Engineering report, which Jimmy describes, has discussed many aspects of this question, including a forecast that even closer integration of process design, product development, and market needs in the newer areas, will represent the product opportunities of the future.
And let there be no mistake-- the new specialty of differentiated chemicals require continuously operating plans in many, many instances. And they need to be designed properly.
Chemical engineers should therefore stress their scale-up ability but in relation to both flexibility and economic considerations. If we cannot convey this ability to serve as leaders of a team having this focus, we risk the loss of identification and the employment contest to chemists, biochemists, material scientists, et cetera.
It was process design, tightly linked the market demands in research and development that fueled the rise of chemical engineering and the industries with which it has been associated. This model should serve not only as our paradigm, but also as one for other engineering disciplines, which as I said earlier, have not had this tradition. And I've seen the Japanese adopt such a model for the manufacture of many complex machines and objects.
Chemical engineering at MIT today is even now serving as a source of inspiration to other disciplines. Recently in connection with his bold new leadership for manufacturing initiatives-- led, of course, by Dean Lester Thurow, who will speak in a few moments-- MIT is adopting the model of our Practice School and some essential features by proposing to establish other such centers in a variety of manufacturing plants, so that students and faculty can study the process as a whole.
At the same time, we must be aware of the macro environment which shapes us. We are entering a new world of intense international competition, global markets, rapid diffusion of technology, and in many respects, obsolete national domestic policies, which are increasingly disciplined by the world financial markets.
We don't want to build facilities and conduct research for unprofitable plants because of infatuation with the technology, while overlooking the large role that financial considerations will play in the next decade in an era of high-cost capital. I have written some articles and books on this subject, but that's not a proper theme for today.
I end, as I think most other speakers have, in a salute to my greatest teacher, my greatest inspiration, the man who probably had more to do with the industry and the profession I've been describing than any other single individual, the real father of our profession, Warren K. Lewis. But I would be remiss if I didn't say that I think the present day chemical engineering department at MIT is once again in the same magnificent leadership position that it was in the days when I was there in the '40s and '50s.
A great deal of the success of this is due to the inspirational leadership of Jimmy Wei and the tremendous stars of the faculty that he has assembled. And I feel very comfortable about the future of chemical engineering at MIT as a consequence. And I'm extremely grateful to it for having made it possible for me to do all these things that I've been describing. Thank you very much, indeed.