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Outstanding Stories of the Week

Blue Skies and Green Yards, All Lost to Red Ink
Michael Moss and Andrew Jacobs
New York Times, April 11, 2004, Page A1

This article examines a housing development in the Pocono Mountains which was marketed heavily among moderate income New Yorkers. The article shows how the promise of owning a home led many families to make financially ruinous decisions. It also shows how government policy to promote homeownership encouraged this scam operation.


Drug Importation Foes Speak Out
Ceci Connolly
Washington Post, April 15, 2004, Page A3

This article reports on a hearing at the National Institutes of Health which examined the merits of allowing drug importation from Canada and other countries. The article points out that many of the opponents of importation were on the payroll of the pharmaceutical industry.


A Difficult Lesson 

Nell Henderson 

Washington Post, April 16, 2004, Page E1

This article reports on the success of job retraining programs. It points out that the commitment of resources has generally been insufficient to ensure that many of the graduates of these programs get the skills needed for available jobs.



Outsourcing

Outsourcing, Turned Inside Out
Ken Belson

New York Times, April 11, 2004, Section 3, page 1

This article reports on the growth of foreign direct investment in the United States, which it describes as "insourcing," and implies it has been a major source of job creation in the United States. The article's efforts to equate foreign direct investment with job creation in the United States are misplaced, there is no direct or indirect relationship between the two. The overwhelming majority of foreign direct investment in the U.S. takes the form of buyouts of existing companies. For example, when Daimler-Benz bought Chrysler in 1998, this was recorded as more than $40 billion in foreign direct investment, even though it did not directly create any jobs. (In fact, the merged company laid off many Chrysler workers in a restructuring.) Most foreign direct investment has taken this form.

While the article includes a quote from an economist who makes this point, it is completely ignored in the rest of the piece. In fact, the article even includes a chart showing the number of workers employed at foreign owned affiliates of U.S. firms, and U.S. affiliates of foreign owned firms. This chart provides no information whatsoever on the number of jobs created or lost through trade/outsourcing.

The article includes a number of inaccurate statements. For example, it describes supporters of recent trade agreements as "proponents of free trade." This is not true. These people are in fact ardently protectionist when it comes to restrictions on foreign professionals working in the United States and also on copyrights and patents. They generally only support reducing trade barriers when it has the effect of putting less-skilled workers in competition with workers in developing countries.

The article includes a quote from an economist asserting that the last recession would have been much worse, had it not been for the role of foreign direct investment. It is not clear what chain of logic could lead to this conclusion. Had there been less foreign direct investment, the dollar would have fallen, which would have increased net exports from the United States, thereby creating more jobs. It is difficult to construct a scenario in which foreign purchases of U.S. stock over the last three years has been a net creator of jobs.

The article also includes a reference to the jobs at a Honda plant in Ohio, which President Bush noted in criticizing efforts by Democrats to restrict trade. It would have been appropriate to point out that the jobs in the Honda factory in Ohio are there precisely because of efforts to restrict trade. When the U.S. auto industry was badly threatened by import competition in the eighties, the U.S. persuaded the Japanese manufacturers to agree to export restraints. In response to these restrictions, Honda and other Japanese manufacturers began to assemble cars in the United States. Trade and direct investment are often substitutes for each other. As a result of facing limits on trade, the Japanese auto manufacturers sought to meet demand in the U.S. market with direct investment.

In the second to last paragraph the article reports that foreign investment is on an upward path in the United States, observing that "foreign direct investment more than doubled last year, to $82 billion." It is worth noting that even after this increase, the 2003 level of foreign investment in the U.S. is down more than 75 percent from its 2000 level of $335.6 billion.

Immigration and Jobs

No Permit, No Work: A Price of Joining EU
Glenn Frankel
Washington Post, April 10, 2004, Page A8

A Shortage of Seasonal Workers Is Feared
Eduardo Porter
New York Times, April 10, 2004, Page B1

These articles both discuss the impact of immigration on jobs; the Post article in the context of restrictions on work permits in the European Union, and the Times article in the context of work visas for low paying jobs in the United States. Neither article clearly presents the economic issues involved in this political debate.

In both cases the issue is whether more low wage workers will be allowed to enter a high wage country or region and compete for less-skilled jobs. The predictions of economic theory in this instance are quite straightforward. The availability of more low wage workers will typically allow for more growth, since many jobs will be performed at a lower cost. However, the domestic workers who are in competition with the immigrant labor force for these jobs will be disadvantaged because their wages will be depressed.

This situation is analogous to what would happen if 500,000 doctors from India, China, and other developing countries were suddenly allowed into the United States. Given the pay differential between developing countries and the United States, these doctors would probably be happy to work for $40,000 to $50,000 a year, between 20 and 25 percent of the average pay (net of expenses) of doctors in the United States. This would provide enormous gains for the U.S. economy - saving consumers between $120 billion and $130 billion annually on health care expenses, which would free this money for other purposes - but it would seriously depress the wages of doctors in the United States.

In the cases being discussed in these articles, the potential immigrants would be competing for less-skilled jobs. While both articles imply that the domestic work force does not want the jobs that the immigrants take, this is clearly not true. The only reason that domestic workers do not want the jobs is because they come with low pay and benefits. If employers did not have the option to hire foreign workers at very low pay, then they would be forced to offer higher wages for these jobs. While the least productive jobs could disappear, because it would not be profitable to fill them at a higher wage (e.g. the midnight shift at a convenience store), the economic cost of not having these jobs filled is by definition minimal. (If there was a high economic cost to leaving the jobs vacant, then the jobs would pay more, and they would be filled.)

At one point the Post article asserts that labor shortages in western Europe are commonplace. This is not true. While some countries, like Ireland and Denmark have very low unemployment rates, countries like France, Germany, and Spain all have unemployment rates above 8.0 percent. This suggests the problem is too few jobs, not too few workers.

In support of the argument that western Europe is suffering from a labor shortage the article presents a quote from a cabinet secretary in Britain that "the usual cry at London dinner parties is not that the city is overwhelmed with foreign plumbers but there is not enough of them." The view on immigration that people hear at dinner parties probably depends on the neighborhood in which the party is taking place. If the guests are likely to be hiring plumbers, then they probably do complain about the lack of immigrant plumbers. However, if they are likely to work as plumbers, this sentiment would probably not be expressed at their dinner parties.

The Budget

Under the Hood
Washington Post, April 12, 2004, Page A17
Please note these charts are not available online.

This set of charts show the pattern of the government deficit, debt, and interest payments since 1940. While it shows the movements in both current dollars and constant (inflation adjusted) dollars, it does not show these items measured as a share of GDP. This is the only realistic way to make comparisons over such a long time horizon. For example, the chart shows that the deficits run during World War II as being only slightly larger than current deficits, when measured in constant dollars. However, the peak World War II deficits topped 40 percent of GDP (more than $4.4 trillion at present), while the current deficit is approximately equal to 5 percent of GDP.


Social Security

Tough Issues, Awaiting Their Turn
Edmund L. Andrews
New York Times, April 13, 2004, Page E1

This article discusses the financial situation facing Social Security and Medicare. The headline and substance of the article imply that there is some need to address the financial situation of Social Security (it even claims that Democrats face a problem, because key constituents oppose cuts in the program). However, none of the information presented in the article supports this contention. As the article notes, the most recent projections show that the program can pay all scheduled benefits until the year 2042 with no changes whatsoever. This means the program is in stronger financial condition than it has been through most of its existence (large tax increases were needed to sustain the program in each of the decades from the forties through the eighties).

The article would be equally accurate if it asserted that the United States had a need to default on a portion of its national debt (and that one of the political parties had a serious problem, if its supporters opposed such a move) as it is in putting forth its claims on Social Security. In the absence of any evidence that the program needs any changes in a reasonable political horizon, there is no obvious basis for the discussion in the article.

In its discussion of Medicare, the article claims that the Bush administration made the finances of the program worse with its Medicare prescription drug plan. While this is true, it would have been useful to note that it was not the prescription drug plan itself that caused the problem. The prescription drug benefit itself is being financed out of general revenue, not from the designated Medicare tax, and therefore does not directly affect the financing of the program. The Bush administration's bill worsened Medicare's finances because it included provisions for increased subsidies for private insurance plans as alternatives to the government run program. The subsidies for private plans moved up the projected date for the trust fund's depletion by seven years.

The article also includes an assertion that the Bush administration claims that privatizing Social Security would "save money in the long run." It does not provide any reference for this assertion. Every expert who has compared the operation of a privatized system to the U.S. Social Security system has found that a privatized system has considerably higher costs. For example, the Bush administration's Social Security commission estimated that a centralized private system on the same scale as the Social Security program would have administrative costs of approximately $20 billion a year. This compares to the $2 billion annual administrative costs of the Social Security system. A decentralized private system, like the ones in Chile and Britain, would cost more than $60 billion annually.

The article frames the whole discussion by asserting that there are major philosophical differences between the political parties on these issues. The article presents no evidence of the philosophical views of either party. It is clear that both parties have powerful constituencies who are deeply concerned about the future of these programs (senior lobbies and unions in the case of Democrats, the pharmaceutical, insurance, and financial industries in the case of Republicans). It is not clear that any of the prominent figures in this debate are motivated by their political philosophy and no evidence is presented to support this contention.

Stock Options

 Presidential Politics Divide Silicon Valley
Laurie J. Flynn
New York Times, April 12, 2004, Page C1

This article discusses the attitudes among Silicon Valley business executives to the presidential candidates. At one point it says that some executives want to "protect the board use of stock options in employee compensation."

There is nothing being proposed by either candidate that would in any way limit the use of stock options as employee compensation. The only item at issue is whether this form of compensation should be listed as an expense against profits, like every other form of compensation. Virtually every expert in economics and accounting has argued that such treatment is an essential part of honest financial reporting. Under new rules being put in place by the Financial Accounting Standards Board, firms will be able to issue as many options as they like, as long as they account for them accurately.

Prescription Drugs

Price of AIDS Drug Intensifies Debate on Legal Imports
Gardiner Harris
New York Times, April 14, 2004, Page A1

This article reports on the decision by Abbott laboratories to quintuple the price of its AIDS drug Norvir, raising the annual cost from $1,500 to $7,800. At one point the article refers to the drug industry's argument that the importation of the same drugs at the lower prices they are sold at in other countries "would effectively import foreign price controls." It also asserts that American consumers are subsidizing overseas patients because of the higher prices paid in the United States.

It is important to clarify the reason for high prices in the U.S. market relative to other countries. The United States does not allow drugs to be sold at free market prices, instead it gives drug companies unrestricted patent monopolies. In other countries, the government negotiates a price with drug companies - effectively setting a condition on the government's grant of a monopoly. The drug industry is absolutely opposed to a free market in drugs in the United States, rather they want to maintain their unrestricted monopoly, and ideally extend it to the rest of the world.

While this does lead to extremely high prices for U.S. consumers, this is only because the U.S. has opted for an extremely inefficient system. There is no obvious way in which this represents a subsidy for overseas consumers - drug research costs could easily be covered with the prices that they currently pay (see "Promoting Good Ideas on Drugs: Are Patents the Best Way?").

The article also raises the issue of low quality counterfeit drugs being imported from abroad. The problem of counterfeit drugs is a direct result of patent monopolies raising the price far above the marginal cost of production. Counterfeiting is also a problem in the domestic market, and it will grow as drug prices continue to rise relative to production costs.