Economic Reporting Review, June 25, 2001 By Dean Baker You can sign up to receive ERR every week by sending a "subscribe ERR" email request to [EMAIL PROTECTED] You can find the latest ERR at http://www.tompaine.com/news/2000/10/02/index.html . All ERR prior to August are archived at http://www.fair.org/err. All ERR after August are archived at www.tompaine.com. ******************* OUTSTANDING STORIES OF THE WEEK "Wall St. Advocacy Group Gets White House Help," by John Mintz in the Washington Post, June 17, 2001, page A2. This article reports on Treasury Secretary Paul O'Neill's cooperation with a financial industry lobbying group, which seeks to privatize Social Security. The article notes the peculiarity of the relationship, since O'Neill is a trustee of the Social Security system, with a fiduciary responsibility to it. "O'Neill Faults 'No Assets' Social Security," by Glenn Kessler in the Washington Post, June 19, 2001, page E1. This article reports on a speech on Social Security that Treasury Secretary Paul O'Neill gave before a group of financial industry executives in New York. In the speech, O'Neill asserted that Social Security has no assets. The article points out that as Treasury Secretary, O'Neill is also a trustee of the Social Security program. In that capacity he signed the most recent trustees' report, which shows that the system has more than $900 billion in assets. "States Expecting to Lose Billions from Repeal of U.S. Estate Tax," by Kevin Sack in the New York Times, June 21, 2001, page A1. This article examines the amount of revenue that states are expecting to lose over the next decade as a result of the recent change in the federal estate tax. The article points out that in many states the loss will be quite significant, with the total loss projected at 1.5 percent of projected state revenue over the next decade. The article also emphasizes the percentage of projected revenue that will be lost, rather the dollar amount. The percentage of revenue is a far more meaningful number to most readers. "Future May Be More Uncertain for Technology," by Gretchen Morgenson in the New York Times, June 20, 2001, page C1. This article reports on the findings of a new study by Merrill Lynch, which indicates that the reported profits of many leading tech companies may be significantly overstated. The main factors noted in the study were that firms did not write off the value of stock options issued to their employees as expenses, and they were able to deduct from their taxes the cost of buying shares (to maintain the stock price) when these options were redeemed. While these practices could inflate profits in a rapidly rising stock market, the sharp stock declines in this sector means that reported profits are likely to be far lower in the future. It is worth noting that some economists had called attention to these sorts of accounting problems in the past (e.g. "The Costs of the Stock Market Bubble," by Dean Baker, www.cepr.net/stock_market_bubble.htm). STEEL PRICES AND THE FREE MARKET "Of Politics, Free Markets, and Tending Society," by Tom Redburn in the New York Times, June 17, 2001, Section 3, page 4. This thoughtful article examines the factors that led President Bush to take steps to protect the domestic steel industry. At several points it asserts that South Korea's steel industry is more efficient than the U.S. industry because it can sell its steel more cheaply. This is not clear. The Clinton and Bush administrations have both pursued a high dollar policy, under which the dollar has risen 20-30 percent above a sustainable level. In the short-run this policy has the effect of reducing the price of imports by approximately 20-30 percent. In the long-run, the policy cannot be sustained, since it is causing the United States to borrow approximately $450 billion a year from abroad. This level of borrowing clearly cannot be maintained for more than a few years. When the dollar falls back to a sustainable level, it is not clear that South Korean steel will still be cheaper than steel made in the United States. THE TRADE DEFICIT "Trade Gap Narrowed in April," Business in Brief (compiled from wire service reports and Washington Post staff writers), Washington Post, June 22, 2001, page E2. "Weak Demand Helps Reduce Trade Deficit," by Bloomberg News in the New York Times, June 16, 2001, page C6. These articles report on the Commerce Department's release of trade data for April and revised data for March. The headlines are both somewhat misleading. The deficit figure reported for April was somewhat lower than the revised figure reported for March, but this was only due to the fact that the March figure was revised upward by nearly $2 billion. The April deficit was more than $1 billion larger than the deficit that had originally been reported for March, and was higher than the figure that most analysts had expected for April. It is also worth noting that the upward revision in the March deficit will lead to substantial downward revision to the GDP growth reported for the first quarter. Reporting on the trade deficit continues to be neglected in these papers. The Times article is a wire service story buried in the middle of the business section. The Post article was a three sentence brief. The economic impact of the trade deficit and the resulting accumulation of foreign debt is at least as large as that of a budget deficit of the same magnitude. While even the possibility of the latter is given enormous attention, the unsustainable trade deficits that the nation is currently running are being virtually ignored. COAL MINERS "Waiting for Extraterrestrials to Land in the Mines," by Francis X. Cline in the New York Times, June 19, 2001, page A12. This article discusses plans to bring in Ukrainian coal miners in order to keep down wages for mineworkers. It is worth noting that employees now regularly seek special permission to bring workers from other countries for many jobs in order to avoid paying higher wages. For example, a recent article in the Washington Post reported that hospitals in the Washington area were recruiting nurses from all over the world in order to avoid paying higher salaries to nurses already in the United States ("Hospitals Go Abroad To Fill Slots For Nurses," by Bill Brubaker, Washington Post, June 11, 2001, page A1). The ability to bring lower paid foreign workers has undoubtedly been a factor depressing wages in many occupations. However, many highly paid occupations, such as doctors and lawyers, have been able to erect legal and institutional barriers to make it very difficult to bring in qualified foreign workers as competitors. GLOBAL WARMING "Impasse on Gases: Who Moves First," by Andrew C. Revkin in the New York Times, June 16, 2001, page A7. This article examines the dispute between the European Union and the Bush administration over the Kyoto agreement, which limits greenhouse gas admissions. The article notes objections from the Bush administration and the U.S. Senate to the fact that the treaty does not apply ceilings to developing nations. It asserts that "countries like Saudi Arabia and China refuse commitments just as steadfastly as the poorest of the poor." This is not true. Developing nations have refused ceilings that would set strict caps on the growth of their emissions, comparable to the caps applied to the developed nations. Such caps would restrict the developing nations to emission levels that, on a per capita basis, are a small fraction of the emission levels of the United States and the developed world. Accepting these sort of caps would imply that people in the United States and other developing nations will forever have the right to pollute more than people in the developing world, because they had polluted more in the past. Not surprisingly, leaders of developing nations have not agreed with this position. However, there is no evidence whatsoever that developing nations would refuse caps that did not threaten to interfere with their economic growth. In fact, if developing nations were provided caps that were only modest reductions from their baseline projections of emissions, under a system of international emissions trading, it would effectively be providing them with large sums of money. With relatively low cost measures, these nations could easily cut emissions and fall under the caps, and then sell the difference to the developed nations. There is little reason to believe that developing nations would object to these sorts of caps. The example of Saudi Arabia as a developing nation opposed to caps is a poor choice. The vast majority of Saudi Arabia's income comes from fossil fuels. The value of fossil fuels is likely to be significantly reduced if the world moves ahead on a Kyoto-type agreement. It is more likely that Saudi Arabia opposes an agreement because of concerns about the impact it would have on the value of its oil, than for the difficulties it could encounter complying with emission caps. THE STOCK MARKET "Fed Wonders: Where's the Rebound?" by John M. Berry in the Washington Post, June 21, 2001, page A1. This article examines the economy's current situation and notes that there is little evidence of a recovery in spite of the Federal Reserve Board's sharp cuts in interest rates over the last six months. At one point it notes that stock prices have not risen through this period and asserts that "stock prices have remained stubbornly weak, particularly for high tech companies whose share prices have plummeted from their speculative peaks of more than a year ago." Actually, stock prices continue to be very high. The price-to-earnings ratio for the market as a whole is still close to 27 to 1, nearly double its historic average of approximately 14.5 to 1. The tech sector still has extraordinary price to earnings multiples, with the NASDAQ as a whole having a price toearnings ratio of 100 to 1, according to some estimates. STOCK RETURNS "Saving for a Brainy Day," by Albert B. Crenshaw in the Washington Post, June 17, 2001, page H2. This article discusses the implications of a new tax exemption that allows individuals to save money in accounts designated for their children's college education without paying taxes on the interest or capital gains. The article includes a chart showing the expected accumulations in these accounts, based on an assumption that returns would average 10 percent a year. It is inappropriate to use an assumption of 10 percent returns (just over 7 percent after adjusting for inflation), since there are no projections for returns on any standard financial assets (stocks, bonds, money market funds), which would provide returns close to this level. Projections of nominal stock returns, derived from projected profit growth, are less than 7 percent annually over the next decade. The use of more realistic assumptions would have reduced the projected accumulations by close to one third. THE BUDGET "Showdown Looms as Democrats Move to Burst G.O.P. Budget," by Phillip Shenon in the New York Times, June 19, 2001, page A15. This article assesses the likely points of contention in future budget battles. At one point it refers to comments from Democrats that there will be no room for additional tax cuts or spending "without a politically disastrous raid on surpluses in the Social Security and Medicare program." It is worth noting that under current law, these programs are not affected at all by whether or not Congress spends the surpluses currently being generated. In order to actually "raid" their surpluses, Congress would have to rewrite the laws that govern the trust funds for these programs. The article also includes comments from Senator Kent Conrad, the chairman of the Budget Committee, that he will look to reduce spending and/or raise taxes, if the slowing of the economy leads to a smaller surplus than is currently projected. Virtually all economists would recommend the opposite course. Standard economic theory suggests that it is desirable to cut taxes and/or increase spending in an economic downturn. Raising taxes and cutting spending is likely to make the downturn worse. EUROPEAN INFLATION "Europe: Consumer Prices Rise," by Edmund L. Andrews in the New York Times, June 19, 2001, page W1. This article reports on the release of new data on inflation in Europe. At one point the article notes that Europe's core (excluding food and energy) rate has been 2.1 percent over the last year, which it characterizes as "fairly steep." It is worth noting that the core inflation rate in the United States has been 2.5 percent over the last year. The Times ran another article warning of high European inflation the previous week ("Optimism Recedes as Europe Faces Long-Term Issues," by Edmund L. Andrews, New York Times, June 14, 2001, page W1). SOCIAL SECURITY "Two Sides Rally to Shape Social Security Discussion," by Richard W. Stevenson in the New York Times, June 18, 2001, page A12. This article discusses the plans of supporters and opponents of Social Security privatization, prior to Treasury Secretary Paul O'Neill's speech to a group of financial industry executives. At one point the article reports that "opponents of personal accounts say they could generate billions of dollars a year -- perhaps even tens of billions of dollars a year -- in fees and commissions for investment firms." This is accurate, but it is worth noting that supporters of privatization also acknowledge that privatization could generate fees of this magnitude. The State Street Bank, which has been associated with the privatization drive, designed a low cost bare bones system, which by its own estimate would generate approximately $5 billion a year in fees. Olivia Mitchell, an economist who has researched this topic extensively, and sits on President Bush's Commission, has shown in her work that other privatized systems spend up to 10-20 percent of their annual revenue in fees. The same ratio applied to the U.S. system would imply $40-800 billion in annual fees. By comparison, the administrative costs of the current system are less than $3 billion. In short, there is no dispute that a privatized system will incur billions of dollars of administrative fees.
