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Outstanding Stories of the Week

China’s Elite Learn to Flaunt It While the New Landless Weep
Joseph Kahn
New York Times, December 25, 2004, Page A1

This article reports on how affluent Chinese are engaging in increasingly extravagant displays of wealth, often at the expense of the poor, who have few rights under China's legal system.

Supermarket Giants Crush Central American Farmers
Celia W. Dugger
New York Times, December 28, 2004, Page A1

This article reports on the impact that the growth of supermarkets in Central America is having on the farmers in the region. According to the article, the supermarkets are placing demands for quality and regular supply that most small farmers are unable to meet. As a result, many small farmers are finding it more difficult to sell their output and are being pushed out of business.

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Stock Returns and Social Security

The Risky Assumption in Social Security Change
Daniel Altman
New York Times, December 26, 2004, Section 3, page 4

This article discusses projections for average annual stock returns in a privatized Social Security system. It notes that returns in the future are likely to be less than in the past. The article implies that lower stock returns are probabilistic, like betting on dice. In fact, lower returns are actually a logical implication (e.g. as in two plus two equals four) of the low profit growth projections of the Social Security trustees, coupled with the relatively high price-to-earnings ratio in the stock market at present

The Social Security trustees project that profit growth (measured against the consumer price index) will average just 1.5 percent annually over the seventy-five year Social Security planning period. This means that if the price-to-earnings ratio remains constant, stock prices will rise an average of 1.5 percent annually. (No economist has suggested the alternative, that the price-to-earnings ratio will rise indefinitely.)

The current price-to-earnings ratio in the stock market is just over 20 to 1, far above the historic average of 14.5 to 1. This means that if firms pay out 60 percent of their earnings as dividends or share buybacks (saving the rest for re-investment), then the average dividend yield will be approximately 3.0 percent (earnings are 5 percent of the share price). This produces a total return of approximately 4.5 percent (1.5 percent capital gain plus 3.0 percent dividend yield)

No economist has been able to show a set of capital gains and dividend yields that will produce the 6.5-7.0 percent returns assumed by proponents of privatization. (See the “No Economist Left Behind” test)

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Social Security

Social Security Underestimates Future Life-Spans, Critics Say
Robert Pear
New York Times, December 31, 2004, Page A1

This article reports on the claims of some experts that the Social Security trustees' projections are overly pessimistic in their assessment of future life-spans and that people will be living substantially longer in the second half of the century than is currently projected. The article implies that this poses a major problem for Social Security

In fact, if the optimists prove correct, and people do enjoy longer life-spans than currently projected, then the increased cost of longer retirements will be largely offset by reduced expenses associated with lower disability rates. In fact, over the next twenty-five years, the projections show that the gains from greater than expected reductions in disability rates would actually exceed any costs associated with longer retirements. (It also seems unlikely that rapid improvements in longevity will occur side by side with the near-record-low rates of productivity growth assumed in the trustees' projections.)

In the very long-term (after 2050), the costs of supporting a longer retirement would likely exceed the gains from lower disability rates, but the cumulative cost over the seventy-five year period is relatively limited - approximately 0.15 percent of GDP or approximately one-eighth of the increase in annual defense spending associated with the war on terrorism.

In every decade from the forties to the eighties voters have been willing to support much larger tax increases than this in order to sustain the Social Security system. It is not clear why anyone would be concerned they would not be able to deal with this prospect forty or fifty years in the future, when real wages will be about 60 percent higher than they are today.

It is also not clear why policy makers should be concerned about this issue now, when there is so much uncertainty about the future. It is especially difficult to understand the prominence given to this question, since policy makers today are not even deciding retirement policy for the years in question. The exact mix of taxes and benefits that are in place in the years after 2050 will be decided by subsequent Congresses, not the one elected at present, just as we have substantially altered the Social Security system from the one put in place fifty years ago.

At one point the article asserts that experts do not see a reversal of the trend toward early retirement. According to the Bureau of Labor Statistics household survey, workers over age 55 have accounted for 83.5 percent of the growth in employment over the last four years. The rise in employment among older workers has been driven by soaring health care costs and plunging 401(k)s.

In Ads, AARP Criticizes Plan on Privatizing
Robert Pear
New York Times, December 30, 2004, Page A14

This article reports on the decision by AARP to run a series of ads criticizing President Bush's proposal to privatize a portion of the Social Security system. At one point the article reports President Bush's claim that Social Security is facing a crisis now. While the article does present a statement from a representative of AARP that the program does not face a crisis, it would have been helpful to include actual data on the program's situation.

According to the latest report from the Social Security trustees, the program will be able to pay all scheduled benefits for 38 years, with no changes whatsoever. Even after 2042, when it will no longer be able to pay the full scheduled benefit, it will always be able to pay a higher real benefit than current retirees receive. An independent analysis by the non-partisan Congressional Budget Office (CBO) showed the program to be in even better shape. CBO projected that Social Security could pay all scheduled benefits for 48 years with no changes whatsoever. Based on these analyses, if Social Security is currently in a crisis, then it has been in a crisis for most of its existence.

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Germany

Jobless Germans Face a New Round of Benefit Cuts
Carter Dougherty
New York Times, December 30, 2004, Page W

This article reports on a sharp cut in Germany's unemployment benefits that goes into effect at the beginning of 2005. At one point the article implies that the benefit cuts are necessary because "the German state is broke." It then points out that Germany's budget deficits have been near 3 percent of GDP. It is worth noting that the U.S. budget deficit is currently running at about 4 percent of GDP.

The article never mentions the role of the European Central Bank (ECB). When the United States economy fell into a recession in 2001, the Federal Reserve Board acted aggressively to boost the economy, lowering interest rates from 6.5 percent in the middle of 2000 to 1.0 percent by the summer of 2003. This action is widely credited with sustaining demand in the U.S. and preventing a prolonged downturn in the wake of the stock market crash.

The ECB has provided no comparable boost to Europe's economy, keeping interest rates significantly higher than the Fed did during this period, and never allowing its short-term rate to fall below 2.0 percent. If the ECB had pursued policies that were more in line with the Fed's, it is likely that Europe and Germany's economy would have grown more. This additional growth would have both reduced unemployment and lowered Germany's budget deficit, since lower unemployment would mean more tax revenue and less money being paid out in benefits

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Agricultural Subsidies

Dollar's Fall Tests Nerve of Asia's Central Bankers
Big Farms Reap Two Harvests With Subsidies a Bumper Crop
Timothy Egan
New York Times, December 26, 2004, Page A1

This article reports on recent trends in government farm subsidies. At one point it notes that "farm income has doubled in two years, federal subsidies have also gone up nearly 40 percent over the same period."

While this statement is literally true, it gives a very incomplete picture, as the chart accompanying the article shows. In 2002,(the base year for this comparison) subsidies fell to approximately half of the average level for the prior three years (1999-2001). While farm subsidies for 2004 are 40 percent higher than they were in 2002, they are still about 30 percent lower than they were five years ago (in real dollars).

The article also comments on the fact that farmers receive crop subsides based on a history of growing a particular crop (e.g. they get wheat subsides because they used to grow wheat), not their current output of the crop. While the article implies that this is one of the absurdities of current farm policy, it was actually a widely applauded change. This was the major point of the "Freedom to Farm Act," passed in 1996.

The point was to separate farm income from the production of a particular crop. Rather than paying farmers to grow wheat, when there may already be a glut of wheat, the bill proposed to give farmers roughly the same subsidy, but let them grow whatever crop will yield the highest profit. Most economists (and newspaper editorials) argued that this change would lead to greater efficiency in the agricultural sector.

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Tax Reform

Bush Expected To Delay Major Tax Overhaul
Jonathan Weisman and Jeffrey H. Birnbuam
Washington Post, December 28, 2004, Page E

This article discusses the likelihood that President Bush will propose any major changes to the tax code. It indicates that instead of seeking a major overhaul of the tax system, he will likely try to focus his efforts on increasing the exemptions for income from savings. According to the article he will seek to pay for these tax breaks by closing some tax breaks that largely go to middle class families, most importantly by ending the tax-exempt status of employer-provided health insurance.

It would have been useful to note that this proposal involves a large redistribution from middle class to upper class families. The vast majority of middle class families can already shelter all the savings they want from income taxes, so raising the ceiling on these shelters provides them no benefit whatsoever. On the other hand, the vast majority of middle-income families receive employer provided health care insurance. If the value of this insurance (which is currently tax free) were made subject to the income tax, it would be a substantial tax increase for most middle-income families. If a family of four, with an income of $60,000, had to pay tax on employer provided health insurance policies worth $10,000, it would amount to a tax increase of $2,500 a year.

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Trade

Average Wage-Earners Fall Behind
Jonathan Krim and Griff Witte
Washington Post, December 31, 2004, Page A1

This article discusses the mix of jobs that the economy will offer in the future. It argues that only workers with exceptional skills and creativity will be able to count on good paying jobs in the future. Actually, the main determinant of pay in the current labor market is the extent to which jobs enjoy protection from international competition. While workers in manufacturing must compete with the lowest paid labor anywhere in the world, this is not true for most highly paid professions.

The government would shut down a university or newspaper that sought to compete by hiring professors or reporters from developing countries at a fraction of the wage these professions typically receive in the United States. It is this legal protection, much more than skills or creativity, which provides relatively high salaries for university professors and reporters at major newspapers.

Learn English, Says Chile, Thinking Upwardly Global
Larry Rohter
New York Times, December 29, 2004, Page A4

This article reports on the efforts of the Chilean government to promote the study of English among its population. At one point the article refers to "free trade" agreements that Chile has recently negotiated with the United States and other countries. Actually, the agreement with the United States was not a "free trade" agreement. While it did liberalize trade in some areas, it also increased some forms of protectionism, most notably for patents and copyrights. It would be more accurate to simply refer to this pact as a "trade" agreement.

It would have been worth noting, in the context of this article, that Chile is promoting the study of English just as China is on the verge of becoming the world's largest economy. According to the World Bank's growth projections, China should pass the United States as the world's largest economy by 2014, before many current students in Chile have finished their education.

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The Budget

Looking for Cuts, Pentagon Turns to Jet Fighter Program
Eric Schmitt
New York Times, December 29, 2004, Page A15

This article assesses the prospect that plans to build the F/A-22, a new fighter plane, may be curtailed in order to save money. The article reports that the full projected cost for the planes is currently $71.8 billion. It would be helpful if the time frame for this spending was made clear in the article, in addition to placing the expenditures in the context of the budget as a whole. If the spending takes place over 10 years, then annual spending would be equal to 7.2 billion, or approximately 0.3 percent of the total budget. This amount is equal to approximately half the size of annual farm subsidies, and is about 40 percent of the current appropriation for TANF, the reformed welfare program
 century, during which it was pursuing neo-liberal policies, provides another set of examples.)

The article also includes a paragraph expressing concerns that China may become more internationally competitive if its domestic demand floundered - thereby creating a push for even more exports. Actually, virtually all economists expect that China's currency will be rising in the near future, which will reduce its international competitiveness.

The article also raises the prospect that China will need to be bailed out by the west after a crash of its economy. This does not seem likely, since it holds more than $600 billion in reserves.