Economic Reporting Review By Dean Baker April 21, 2003

Economic Reporting Review
April 21, 2003

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

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OUTSTANDING STORIES OF THE WEEK

Scrushy Ran HealthSouth Real Estate on the Side
Gretchen Morgenson and Milt Freudenheim
New York Times, April 14, 2003, Page C1
http://www.nytimes.com/2003/04/14/business/14CARE.html?Ex=1050897600&en=3de419ba\92cc5494&ei=5007&partner=USERLAND

This article reports on the real estate dealings of Richard M. Scrushy, the chief executive of the HealthSouth Corporation, a major hospital chain. According to the article, Mr. Scrushy created a separate real estate company that had extensive dealings with HealthSouth. The article indicates that these dealings proved quite profitable for Mr. Scrushy.

Tax Inquiries Fall as Cheating Increases
David Cay Johnston
New York Times, April 14, 2003, Page A16
http://www.nytimes.com/2003/04/14/business/14TAX.html?Ex=1050897600&en=76425fc55\5026e2a&ei=5007&partner=USERLAND

These article reports on new data from the Internal Revenue Service, which indicate that its enforcement of the tax law has become more lax, even though there is evidence that cheating has become more common.

Inflation

Shoppers' Spree Improves Outlook
John M. Berry
Washington Post, April 12, 2003, Page E1
http://www.washingtonpost.com/wp-dyn/articles/A11038-2003Apr11.html

This article reports on new data on retail sales, consumer confidence, and producer prices. The article reports all three as evidence of a growing economy. In the case of producer prices, the labor department reported a 1.5 percent jump in the overall finished goods index. While the main cause of this jump was a 5.7 percent spike in energy prices, the core finished goods index, which excludes food and energy prices, also showed a sharp rise of 0.7 percent. The article quotes an analyst's assertion that this price jump is evidence of a growing economy because, "it would be hard for companies to keep prices at current levels, much less increase them, if the economy wasn't growing."

It is worth noting that many companies have been seeing rising costs due to higher import prices. In the last three months, non-oil imports have risen at more than a 6.0 percent annual rate. By contrast, they had been falling at more than a 2.0 percent annual rate in 2001. It is possible that companies feel the need to pass on these higher costs in the form of higher prices, even though the economy is weak, just as was the case in the recessions of 1974 and 1980,when firms passed higher energy costs on to consumers even as the economy sank into recession.

Bush Tax Cuts

Divided Economic Advice and the Lure of Politics
Daniel Altman
New York Times, April 12, 2003, Page C1
http://www.politicalposts.com/news/index.asp?id=174736

This article discusses the range of views among economists of President Bush's proposed tax cuts. At one point the article asserts, "most of the economists' differences on the current proposals depend on theory and evidence, but some suggest that political views have come into play - a potential worry for clients who pay for the economists' advice."

It is actually quite normal for political views to influence economists' assessments of public policy. For example, conservative economists like Harvard professor Milton Feldstein generally support policies that redistribute income upwards, whereas more liberal economists, like Princeton professor Paul Krugman, tend to favor policies that redistribute income towards those at the bottom. Most people who hire economists as advisors or consultants are usually aware of their political leanings at the time they hire them.

President Bush's tax cut proposal is actually unusual in that there is so little evidence or theory that suggests that it could make any positive contribution to growth. A series of forecasts made by the Congressional Budget Office, which is now headed by a former Bush administration economist, found that the tax cuts would lead to slower growth in most scenarios. The scenarios in which the tax cuts raised growth over the next decade were driven by the fact that taxpayers assumed higher tax rates in the years after 2013. This led them to increase work and savings in the relatively low tax years from 2003 to 2013. They would work and save less in the years after 2013 when taxes would have to be increased to address the deficits created by the tax cuts [http://www.cbo.gov/showdoc.cfm?Index=4129&sequence=0 ].

At one point the article contrasts the divisions among economists over the Bush tax cuts with the near unanimous support for the 1986 tax reform act. It actually should not be surprising that the reactions to the two tax changes are different, since they take the tax code in completely opposite directions. The key feature of the 1986 tax reform was that all income, whether from wages, interest, capital gains, or dividends, would be taxed at exactly the same rate. This eliminates the incentive to hide one type of income as another type. By contrast, the key feature of President Bush's proposal is to eliminate the tax on dividends on stock held outside of retirement accounts, while leaving the tax rate on other types of income unaffected. Any economist who believed that the 1986 tax reform was correct in taxing all income at the same rate would be expected to oppose the favored treatment of dividend income in President Bush's proposal.

The article also asserts that experts agree that "ending taxes on some dividends will help investors to allot capital more efficiently." This is not true for the reasons noted above.

Senate GOP Slashes Tax Cut
Helen Dewar
Washington Post, April 12, 2003, Page A1
http://www.washingtonpost.com/wp-dyn/articles/A10530-2003Apr11.html

Bush's Hardest Battle May Be Over Agenda at Home
Dana Milibank and Jim VandeHei
Washington Post, April 14, 2003, Page A1
http://www.washingtonpost.com/wp-dyn/articles/A19689-2003Apr13.html

Bush to Campaign for Tax Cut Plan
Richard W. Stevenson
New York Times, April 15, 2003, Page B10
http://www.nytimes.com/2003/04/15/politics/15ECON.html

These articles discuss President Bush's tax cut proposal. All three articles assert that the proposal would end the taxation of stock dividends. This is not true. Most stockholders hold most of their stock in 401(k) type retirement accounts. Under President Bush's proposal, these dividends would still be subject to taxation when the money is withdrawn after retirement, just as is the case now.

Trade Barriers

World Bank and the I.M.F. Say They'll Send Experts to Iraq
Elizabeth Becker
New York Times, April 14, 2003, Page B10
http://www.nytimes.com/2003/04/14/international/worldspecial/14BANK.html?Ex=1050\984000&en=f18ee3d09dad1383&ei=5007&partner=USERLAND

This article reports on the main agenda items at the spring meetings of the World Bank and the I.M.F. At one point the article reports an assertion by Nicholas Stern, the World Bank's chief economist that, "the worst trade barrier is the $300 billion in agricultural subsidies given to farmers in the world's wealthiest nations." It then goes on to say that these subsidies hurt developing nations by driving down the price of their exports.

According to a recent study by the World Bank, the removal of all rich nation barriers to trade in merchandise, both agricultural and non-agricultural, would raise GDP in developing nations by 0.6 percent. The World Bank's study implies that if rich nations removed all merchandise trade barriers, a poor nation like Ethiopia would see its per capita GDP increase from approximately $600 per year to $604 per year.

Subsidies to agriculture actually have a mixed effect on developing nations as many studies have shown. While subsidized exports can hurt agriculture in developing nations, low cost food can help sustain urban populations. In this way, the effect of subsidized exports is exactly the same as increased productivity. This is why some World Bank studies have found that rich nation agricultural subsidies have virtually no net effect on developing nations (e.g. http://econ.worldbank.org/files/1715_wps2595.pdf). Given this evidence, it is likely that trade barriers such as copyrights, patents, and licensing restrictions that prevent foreign professionals (e.g. doctors and lawyers) from working in rich nations, impose much greater costs on developing nations than do restrictions and subsidies on the trade in agricultural goods.

This article reports that foreign aid is now "less than half what it was in the 1960s." This is true when foreign aid is measured as a share of GDP. It actually has grown, measured in real dollars. The article also asserts that foreign aid would have to be increased by $50 billion to reach the United Nations goals on poverty reduction for 2015. This figure refers to the necessary increase in annual aid, not the total increase over the next 12 years.

Iraq Debt Relief

G-7 Agrees That Iraq Needs help With Debt
Paul Blustein
Washington Post, April 13, 2003, Page A37
http://www.washingtonpost.com/wp-dyn/articles/A15074-2003Apr12.html

This article reports on negotiations over Iraq's debt at the meeting of G-7 finance ministers. The article quotes Bush Administration Deputy Defense Secretary Paul Wolfowitz as saying that France, Germany, and Russia should write off money "lent to the dictator to buy weapons and to build palaces." It would have been helpful to note that this statement is a radical departure from the previous U.S. position on developing countries' debt. In the past, U.S. administrations held that it was very important that developing nations be forced to repay money lent to such dictators as Ferdinand Marcos in the Philippines, Mobutu in Zaire (now the Congo), or the Duvalier family in Haiti. This apparent switch in positions deserves more attention than it is given in this article.

The Stock Market

Many Corporate Pension Funds Assumed Outsize Gains
Mary Williams Walsh
New York Times, April 17, 2003, Page C1
http://www.nytimes.com/2003/04/17/business/17PENS.html

This article reports on a study of rate-of-return assumptions by pension plans at major corporations. The study found that most of the companies it examined appeared to be overly optimistic in their assumptions about the rates of return on their assets.

At one point the article asserts that "during the stock market boom, when pension funds were growing steadily each year, these assumptions did not prompt much concern." While this statement may be true, it implies that the pension fund managers and regulators failed to use simple arithmetic to analyze their assumptions. It was easy to show that the high rates of return assumed by pension funds were impossible when the market reached bubble levels of 1998-2000 (e.g. see "Double Bubble: The Implications of the Over-Valuation of the Stock Market and the Dollar," [http://www.cepr.net/columns/baker/double_bubble.htm ). The failure to use simple arithmetic to examine assumptions that placed tens of billions of dollars at risk was an extraordinary act of negligence.

The article also asserts that after three years of negative returns in the stock market, the high rates of return assumed by pension fund managers seem less plausible. Actually, these high rates of return are more plausible after the stock market has fallen. The dividendyield is now considerably higher than it was at the peak of the bubble, and there is a greater probability for good profit growth from the depressed levels of 2001-02 then from the levels of 1999- 2000, which were near business cycle peaks.

The Economy

The War Goes Well. So Where's the Dividend?
Steve Lohr
New York Times, April 13, 2003, Section 3 Page 1
http://query.nytimes.com/gst/abstract.html?Res=F60A13F73F5F0C708DDDAD0894DB40448\2

This article examines the economy's prospects, now that the war with Iraq appears to have ended. The article never mentions the housing bubble, which has caused housing prices to increase by 32 percentage points more than the overall rate of inflation since 1995, creating approximately $3 trillion of bubble wealth. Ignoring this bubble is comparable to discussing the economy's prospects at the beginning of 2000 without mentioning the stock market bubble.

Unions

Unions Risk Losing Their Relevance As Marketplace Conditions Change
Edward Wong
New York Times, April 17, 2003, Page C5
http://www.nytimes.com/2003/04/17/business/17LABO.html

This article discusses the diminishing importance of unions in the labor market over the last two decades. When presenting the list of factors that have reduced unions' power, the article includes productivity growth. It is not clear that productivity growth should hurt unions, since it can allow for both higher wage and profit growth. Productivity was growing considerably more rapidly in the fifties and sixties, at the peak of union power, than it did in the eighties or nineties.

The article does not include trade as a factor hurting unions. Virtually all economists agree that the fact that manufacturing workers in the United States now have to compete with very low paid workers in developing nations has eroded their bargaining power.

The article also doesn't mention the pro-employer shift in the National Labor Relations Board under President Reagan. Since the penalties for violations of the National Labor Relations Act (NLRA) are generally trivial, and the process of enforcement is often quite lengthy, employers can usually profit from even the most blatant violations of the NLRA, such as firing a worker for trying to organize a union. In the last two decades such hardball tactics have become standard practice for employers, making it extremely difficult for unions to organize new workers.

Airline Labor Costs

Flight Attendants Approve Concessions at American
Edward Wong
New York Times, April 17, 2003, Page C1
http://www.nytimes.com/2003/04/17/business/17AIR.html

This article reports on the concessions by the unions at American Airlines to keep the company out of bankruptcy. The article includes a chart that shows the labor costs per passenger mile for the major airlines. This method of comparing labor costs is not very useful, because some airlines, such as US Airways, specialize in shorter flights. These flights will typically have higher costs per mile flown, but passengers will also pay higher fares per mile flown. For example, the distance from the east coast to the west coast is more than ten times the distance from New York City to Washington, but the airfare is not ten times as high.

Copyrights

Plans Would Use Software, Not Devices, to Fight Piracy
John Markoff
New York Times, April 15, 2003, Page C5
http://www.nytimes.com/2003/04/15/technology/15CRYP.html

This article discusses a plan developed by a computer security researcher to prevent the duplication of copyrighted material through digital locks. The article repeatedly characterizes duplication as "theft" or "piracy." Digital locks prevent all types of duplication, including legal duplication - for example, making a copy of purchased material to use at second location or copying digital material in a country in which the copyright is not applicable. Therefore, the use of the terms "theft" and "piracy" were inappropriate.