Economic Reporting Review
August 28, 2001

By Dean Baker, co-Director of the Center for Economic and Policy Research

OUTSTANDING STORIES OF THE WEEK

These Days, Layoffs Compete With Loyalty
Louis Uchitelle
New York Times, August 19, 2001, Section 3 page 4

This column examines how firms may attempt to alternatively motivate workers through the fear of layoffs or the promise of rewards for loyalty to the company. It notes that these paths imply very different relationships between workers and their employers.

Workers' Rights Suffering as China Goes Capitalist Erik
Eckholm New York Times, August 22, 2001, page A1

This article reports on the sorts of abuses at the work place, such as extraordinarily long hours, low pay, and physical punishment, which are becoming common as the private sector expands in China. Enforcement of labor laws is minimal, and few workers outside of the state sector are unionized.


The Stock Market

Federal Reserve Cuts Its Key Rate By Quarter-Point Richard
W. Stevenson New York Times, August 22, 2001, page A1

Distracted Wall St. Ignores Signs of an Economic Bottom
Alex Berenson New York Times, August 22, 2001, page C1

These articles both discuss the fact that the stock market plunged in response to the Federal Reserve Board's decision to cut interest rates by 0.25 percentage points. Both present their analysis of the market's behavior without ever considering its current level in relation to corporate profits.

For example, the article by Stevenson presents a comment from an economist at Merrill Lynch, who noted that each time the Federal Reserve Board had cut interests by this much in the last half century, the stock market was "up a year later, by an average of 28 percent."

The notion that the market can always rise in response to interest rate cuts, regardless of how high it already is, is absurd on its face. The same logic would have implied that the stock index in Japan could have risen from its 1989 peak of 40,000, in response to interest rate cuts by the Japan's central bank. (It's currently near 13,000.) Trying to determine the direction the market will move, without examining its current level, would be the same as trying to determine whether the price of a parcel of land will rise, without ever finding out its current price.

While the average price to earnings ratio in the market is down from the peak it reached in 2000, it is still over 25 to 1, more than 70 percent above its historical average of 14.5 to 1. Since the Congressional Budget Office projects that profits will barely grow in real terms over the next decade, it is difficult to imagine stock prices rebounding substantially, regardless of how low the Federal Reserve Board pushes interest rates.


Argentina

Argentina Gets $8 Billion Aid From the I.M.F.
Joseph Kahn
New York Times, August 22, 2001, page A1

This article reports on a new I.M.F. aid package for Argentina. At the end, the article points out that the I.M.F. is insisting that Argentina eliminate its budget deficit, a condition that the article describes as "traditional." Actually this insistence is at odds with traditional economic theory.

Argentina is currently suffering from a recession. During a recession budgets move towards deficit as tax collections fall and transfer payments, such as unemployment insurance, increase. Economists usually consider a modest deficit, like the one Argentina is currently running, a good thing when the economy is in a recession, since it helps sustain demand and employment. The predictable effects of the I.M.F.'s demand that Argentina balance its budget is a further rise in unemployment and a deepening of its recession.


The Euro

An Anxious Countdown To New Cash
William Drozdiak
Washington Post, August 20, 2001, Page A1

This article describes the preparations being carried through in the nations that use the euro for the introduction of the physical currency at the beginning of next year. The article implies that this change of currency is an extraordinarily complex task. Actually it is a fairly common event for nations to change their currencies, although it is most often done in developing nations after a bout of inflation. For example, both Argentina and Brazil adopted new currencies in the nineties.
The fact that developing nations have been able to successfully carry through currency transitions, without massive economic disruptions, suggests that the euro nations, with their modern transportation, communication, and financial systems, should also be able to carry through such a transition.

Currency Values

Dollar's Slow Slide Indicates Foreign Investors May Be Wary
of U.S.
Jonathan Fuerbringer
New York Times, August 18, 2001, page B1

This article discusses the prospects for the dollar against other major currencies. At one point, it mentions the Federal Reserve Board's interest rate cuts as a factor that led investors to buy dollars. It is not clear why lower interest rates would make investors more willing to hold dollar-denominated assets. As interest rates fall in the United States relative to other nations, the return on bonds and interest bearing accounts in the United States falls compared to what is available in other nations.

Lower interest rates do improve growth prospects for the economy, but this doesn't help holders of bonds and interest bearing accounts. Better growth could improve the outlook for stocks, except stocks in the U.S. remain enormously over-valued when measured against widely accepted profit projections, such as those from the Congressional Budget Office. Stocks in the U.S. would only appear attractive to investors who held an assessment of future profit growth potential that was wildly at odds with the one produced by the Congressional Budget Office.

Productivity Growth

Easing Up on Overtime
Sarah Schafer
Washington Post, August 19, 2001, Page H1

This interesting article presents a series of anecdotal accounts which suggest that employers are less frequently requiring that employees work overtime as a result of the economic slowdown. At one point, the article refers to the productivity data reported for the second quarter, noting that productivity "grew at an unexpectedly strong 2.5 percent rate," and later adding, "such numbers bode well for previously overtaxed workers."

It is worth noting that quarterly productivity numbers are extremely erratic, especially around turning points in business cycles. They are also subject to extremely large revisions (see ERR 8-20-01). It is more likely that the strong productivity growth reported for the second quarter was the result of quirks in the data than an actual uptick in productivity growth.

The Budget

Shrinking Surplus Is Budget Battle Cry
Glenn Kessler
Washington Post, August 19, 2001, Page A1

This article discusses the political battles that are shaping up around the lower projected budget surplus. This article includes a graph showing budget annual deficits over the last two decades. The deficits are measured in nominal dollars. This gives a misleading impression, since the economy has more than tripled in size over this period as a result of both inflation and real growth.

Readers would get a better picture of the relative importance of budget deficits over this period if they were measured as a share of GDP. This measure would give a substantially different picture. Measured in nominal dollars, the budget deficit peaked in 1992 at just under $300 billion. Measured as a share of GDP, the deficit peaked at 6.0 percent in 1983. By this measure the deficit fell through most of the eighties, although it did rise back to 4.7 percent of GDP in 1992, as a result of the recession in 1990-91.


Citing Drop in Surplus, Democrats Plan to Portray Bush as
Reckless
Richard W. Stevenson
New York Times, August 20, 2001, page A1

Bush Warns Against Delay In Acting on Military Budget
Frank Bruni
New York Times, August 20, 2001, page A10

These articles report on efforts by Democrats to attack President Bush because his tax cut has led the government to spend a portion of the Social Security surplus. Both articles refer to Democrats' efforts to portray themselves as promoters of "fiscal prudence" or "fiscal responsibility" as they try to prevent the Social Security surplus from being spent even as the economy enters a downturn.

It is worth noting that the Democrats' actions are the exact opposite of what most economists would regard as prudent or responsible. The government budget naturally moves towards a deficit when the economy slows, as tax collections fall and spending on programs like unemployment insurance increase. Virtually all economists consider this movement towards a deficit a positive development, since it helps maintain demand during the downturn. If the Democrats insist on cutting spending and/or raising taxes during a downturn in order to meet a surplus target, it will likely have the effect of making the downturn worse.

It may turn out that this strategy is good politics.
However, it is unambiguously bad economics.


Bush Backs Tax Cut, Blames Congress
Amy Goldstein
Washington Post, August 21, 2001, Page A2

Byrd Issues Warning on Shrinking Surplus
Glenn Kessler
Washington Post, August 21, 2001, Page A2

Bush Defends Size of Surplus And Tax Cuts
Frank Bruni
New York Times, August 21, 2001, page A1

These articles report on the efforts of President Bush and the Democrats in Congress to blame each other over the fact that a portion of the Social Security surplus will be spent this year, along with the entirety of the Medicare surplus. Readers of these articles may wrongly be led to believe that there is something of consequence at issue in this debate. For example, the Times article asserts that spending this money "could influence the nation's long-term fiscal health by limiting the money available to reduce the debt."

In fact, there is no fiscal or economic reason that the United States needs to reduce its debt. Its ratio of publicly held debt to GDP is just over 30 percent, the lowest it's been in almost 20 years, and one of the lowest of any industrialized countries. There is no reason that the United States could not maintain this ratio forever, which would imply continued borrowing.

The amount currently being spent from the two trust funds together is less than $30 billion, or less than 0.3 percent of GDP. The impact of borrowing of this magnitude on the nation's financial health is too small to even be measured.
Furthermore, as noted above, the immediate reason for the nation spending a portion of these surpluses is the economic downturn. The fact that the Federal government is running a smaller surplus is helping to stimulate the economy. Had the surplus remained at the level projected earlier, output would be lower and the unemployment rate would be higher.


Bush Projections Show Sharp Drop In Budget Surplus
Richard W. Stevenson
New York Times, August 23, 2001, page A1

This article reports on the downward revision of the budget surplus in updated projections from the Office of Management and Budget. At one point the article refers to an analysis from the Center for Budget and Policy Priorities (CBPP), which it describes as a "liberal research group." The CBPP has consistently argued for paying down the national debt rather than increasing spending on social programs. Based on its position on budget issues, it would be more accurate to characterize CBPP as "fiscally conservative," than "liberal."

Argentina

From No Aid to Bailout
Joseph Kahn
New York Times, August 22, 2001, page A1

This article reports on the conditions surrounding the Treasury Department's decision to support additional I.M.F. loans to Argentina. At one point the article refers to the possibility that Argentina would "collapse." But there is no obvious scenario in which the country would collapse, although there is a possibility that the nation will devalue its currency and/or default on its debt. These actions could prove very beneficial to Argentina. For example, after an initial period of instability, Russia achieved rapid economic growth after it devalued its currency and effectively defaulted on its debt in 1998.

There are several charts accompanying the article. These charts present Argentina's foreign debt and government deficit in dollar terms. It would have been more useful to readers to show them as a percentage of Argentina's GDP. Argentina's government deficit is currently projected to be approximately 2.2 percent of GDP, according to the chart. By comparison, in each of the last three recessions the deficit in the United States peaked at more than 4 percent of GDP. The I.M.F. is insisting that Argentina balance its budget, in spite of the fact that it is in a recession.

Social Security

Social Security Panel Says Cuts in Benefits Are an Option
Adam Clymer
New York Times, August 23, 2001, page A12

This article reports on the meetings of sub groups of President Bush's Social Security commission. It includes a quote from Richard D. Parsons, the commission's co-chair, which asserts that some retirees would have higher benefits with individual accounts than under the current system, "depending on the performance of the securities in which you invested."

While it is always possible that individual stocks will provide very high returns, President Bush has insisted that stock investment in these accounts will be restricted to broad indexes, which means their performance will match the market's performance. The only projections for the overall stock market that are derived from the Social Security trustees' profit-growth projections show that the market will provide returns that are only marginally higher than the government bonds currently held by the trust fund. [Click here to read about them.] This means that workers will not be able to increase their benefits over currently scheduled benefits with individual accounts.


Patents in Brazil

Brazil to Ignore Patent on AIDS Drug
Anthony Faiola
Washington Post, August 23, 2001, Page A20

Brazil Will Defy Patent on AIDS Drug Made by Roche
Jennifer L. Rich with Melody Petersen
New York Times, August 23, 2001, page C6

These articles report on the Brazilian government's decision to issue a compulsory license for an AIDS drug produced by Roche, a major Swiss pharmaceutical firm. The headlines of both articles assert that this decision is a violation of Roche's patent rights. Actually, the TRIPS agreement, which established international rules for patent enforcement, allows for compulsory licensing. The articles do not indicate how they determined that Brazil's actions do not comply with TRIPS or other laws pertaining to Roche's patent.


The World Economy

World's Economy Slows To a Walk In Rare Lock Step
Joseph Kahn and Edmund L. Andrews
New York Times, August 20, 2001, page A1

This article examines the worldwide economic slowdown. Most of the experts cited in this article are employees of financial institutions. The article predictably reflects this perspective, including comments that blame the strength of Europe's trade unions for its weak economy. Had the article included a broader range of sources, it might have noted the contractionary monetary policies pursued by the European Central Bank as a major cause of Europe's slow growth. (The article does comment on the impact of high European interest rates, but it attributes high rates to "a perceived inflation threat." It would have been appropriate to point out that Europe's inflation rate has consistently been lower than the U.S. rate.)

At one point the article presents the view of "conservative commentators" that "policy mistakes have caused investors to lose faith in many individual currencies ... like Turkey and Brazil." It would have been appropriate to also present the view of more progressive commentators who attribute many of the problems of developing nations to bad policy advice from the I.M.F. and World Bank.

The article also includes a comment from former Treasury Secretary Robert Rubin (now of Citigroup), that it is necessary to defend "free trade, fiscal discipline, and the spread of technology." It is not clear what Mr. Rubin means by "free trade" and the "spread of technology." The Clinton Administration had attempted to impose U.S. type patent and copyright restrictions on developing nations. These are impediments to both free trade and the spread of technology.

It also would have been appropriate to include the views of an expert, such as Wynne Godley at the Levy Institute, who was not surprised by the economic downturn (see also "Double Bubble: The Over Valuation of the Stock Market and the Dollar" and "The Costs of the Stock Market Bubble" by Dean Baker).

A picture accompanying the article shows a German stockbroker staring at a stock ticker. The caption asserts that he "surveyed the damage to the German economy." The broker is only surveying the damage to the German stock market. The well being of the stock market is directly related to the well being of owners of large amounts of stock, not the economy as a whole.