We are agreed upon some points. It is admitted that it is not necessary for undertakings with large and varied properties to accumulate a "reserve for accrued depreciation" in order to provide for replacements. It is further admitted that in the valuation of the properties of such companies for the purpose of rate control the usual deduction for depreciation cannot be justified by appealing to the alleged necessity of providing in advance for renewals. But it is upon precisely that fallacious ground, and in most cases upon that ground only, that commissions and courts have based their rulings that depreciation must be deducted in such valuations. Are these findings to be approved in spite of their admittedly faulty premises? At this point Mr. Davis and myself part company. I see no principles on which the deduction for depreciation can be definitely justified in the case of the valuation of the properties of a company which has not accumulated a depreciation reserve. Mr. Davis thinks that there are such principles, even tho overlooked by commissions and courts, and attempts to formulate them.

But before proceeding to the discussion of the real issue, I must first enter a protest against Mr. Davis's interpretation of part of my argument. In view of the fact (on which we agree) that when annual replacement needs are fairly uniform there is no need to provide a fund for them in advance, I spoke of the reserve for accrued depreciation as "useless for replacement purposes." Mr. Davis fears that I have confused the depreciation reserve with " a thing essentially different, namely a segregated fund of particular assets, cash, securities, or what not, which may be drawn upon to meet ordinary or extraordinary repairs, renewals, and replacements." Now, I have no fault to find with the exposition of elementary accounting practice which Mr. Davis

introduces at this point. But I cannot understand how Mr. Davis has convinced himself that I fell into the error in question. A reserve of the kind under discussion is built up by credits of depreciation accruals and depleted by debits for replacements. Itself a liability account, its effect is to hold a corresponding amount of (unspecified) assets in the business and to prevent their distribution except at the expense of an equivalent diminution in stated liabilities. Only as replacements are made are these assets released. And so far as the reserve is permanent such assets cannot be released in exchange for replacements. To say that the reserve "cannot be used for replacement purposes "avoids much circumlocution and should mislead no one. Το use a depreciation reserve for replacements is just as commonplace a feat as to "pay dividends out of profits.' One assertion which Mr. Davis makes in this connection is, I think, a little too strongly put. He says:

The depreciation reserve proper has nothing whatever to do with ability to make expenditures for replacements or renewals, regular or irregular, except in so far as it may insure more comprehensive knowledge of the plant and thereby facilitate intelligent prevision of future needs for such purposes."

Now, of course, the existence of a depreciation reserve does not insure the existence of a body of " idle cash " or of easily convertible assets held against possible replacement needs. But it does make it certain that all needed replacements up to the amount of the reserve may be made without either cutting into surplus or increasing the deficit for the year. In practice the reserve for the depreciation of large and varied properties becomes much larger than can be " used " in this way for replacements, and to this extent is "unnecessary" for replacement purposes.

I must repeat a statement which Mr. Davis quotes from my paper: "Altho no investment of a separate depreciation fund is required [by the Interstate Commerce Commission], yet the writing down of the capital assets by the amount of the 'accrued depreciation' means in the long run either that other assets have to be larger in amount than they otherwise would have been or that liabilities have to be smaller. Usually the growth of the reserve for accrued depreciation means in practice that additional permanent investments are being made out of earnings." This statement is, I think, both accurate and perfectly general. It covers the three methods of handling the matter which Mr. Davis particularizes.

Mr. Davis probes much deeper, it seems to me, when he questions my use of the term " productive efficiency." My argument made some use of the assumption that a properly maintained plant in a state of normal depreciation would yet be in a condition of substantially unimpaired productive efficiency. Mr. Davis formulates his objection to this in two ways. In the first place, he suggests, the value of a plant depends upon its store of productive efficiency, and this involves the aggregate expectation of life of the various parts of the plant. This store of productive efficiency is less for a normally depreciated plant than for a new one. In the second place, productive efficiency, adequately interpreted, must have reference to the relation between the output and the total cost of producing it." When renewals have reached their normal level their annual cost will be greater than in a new plant. A plant requiring larger annual maintenance expenditures per unit of product than a new plant would (in the immediate future) cannot properly be said to be in a state of unimpaired productive efficiency.

The facts in the case are, of course, quite as Mr. Davis suggests. And very likely his use of the term productive efficiency" is better than mine. Taking all the factors in the situation into account the productive efficiency of a new plant is more than that of an older one. My statement, it will be observed, was carefully qualified. The productive efficiency of an old plant, properly maintained, is usually equal to that of a new one similarly constituted. That is, from the factors which may be said really to determine productive efficiency I put aside maintenance and made of it an independently given magnitude. But my argument

took full account of the fact that replacement costs are lower during the early years of a plant's life, before it has reached a state of normal average depreciation. Mr. Davis means one thing by " productive efficiency," while I mean another. But we see the same facts.

If the difference between us at this point were purely verbal, - if Mr. Davis merely preferred to give a name to A, B, and C which I had used for A and B, it would hardly be profitable to pursue the matter further. But to Mr. Davis the higher operating costs of the

depreciated" plant or its smaller store of productive life (both formulations come to the same thing) is a sufficient reason for reducing its valuation for rate regulation. His conclusion depends, however, upon a point of view which I believe to be untenable. It involves, more particularly, a questionable theory of the general nature and meaning of public valuation.

"The relative values of different capital goods," says Mr. Davis," are determined by the relative amounts of productive power they contain.” And he believes that "this productive power is the normal and proper criterion of the value of the physical plant, as for any unit or group of capital goods." With certain minor qualifi

cations I should concede this, if the "value" wanted were selling value in a supposedly open market. Under certain conditions of expressed or implicit contract with the government, relative productive efficiency (in Mr. Davis's inclusive use of the term) might properly be the dominating criterion of the price to be paid by the government in taking over a public service plant. But valuation for rate control is a very different matter.

There is no better word than value to denote the goal sought in the "valuation " of public service properties. It has the necessary amount of elasticity and it gives the proper suggestion of an ethical element in the problem, — of justice to be attained and apportioned. But it is value for a particular purpose; not the market value of the economists, nor value even as defined in President Hadley's well-considered phrase," what price ought to be," but value in the special sense of a capital sum on which a fair rate of return is to be conceded. The word value is here used as setting a problem, not as solving one. And one cannot safely attempt to solve the problem by applying principles derived from one specific use of the word. "Value" is nothing to conjure with. It has to be carefully sought.

No commission or court has ever given a set of hard and fast rules by which we might definitely determine the value it would impute to a particular plant. But we do know that no such body has ever made productive power or future earning capacity the fundamental criterion in such matters. Nor have commissions or courts attempted to make value a Janus-faced thing, looking both to the future and the past. Not that forward-looking considerations always have been thrown aside, but rather that emphasis has been placed on the retrospective view. Cost, investment, sacrifice, - these are the controlling factors. Otherwise such items as