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Outstanding Stories of the Week

In Great Expectations for Stocks, Danger for Pension Plans
Mark Hulbert
New York Times, January 2, 2005, Section 3, Page 5

This article examines the likely return on stocks over the next ten or twenty years given current price-to-earnings ratios and profit projections. It points out that private pension plans typically assume that annual stock returns will average 7.0 percentage points more than the rate of inflation. It points out that returns are likely to be just 3.5 to 4.5 percentage points above the rate of inflation. This difference in returns will create a funding gap of several hundred billion dollars in the pension system.

Panel Seeks Better Disciplining of Doctors
Robert Pear
New York Times, January 5, 2005, Page A19

This article reports on the finding of a study commissioned by the Bush administration, that found the bulk of malpractice suits were attributable to a relatively small number of doctors. The study concluded that malpractice costs could be substantially reduced, if the medical profession more effectively disciplined bad doctors.

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Social Security

A Big Push On Social Security
Jim VandeHei
Washington Post, January 1, 2005, Page A1

This article reports on President Bush's effort to push his plans for privatizing Social Security. In listing the items that are agreed upon by all sides in the Social Security debate, the article notes that annual benefit payments are expected to exceed annual revenue before 2020. The article implies that everyone agrees that it is a problem if annual payments exceed annual revenue.

In fact, this was exactly the situation designed by the Greenspan commission in its 1983 reforms. They deliberately planned for Social Security to build up a large surplus in the trust fund to help defray the cost of the baby boomers' retirement. Anyone who supported the commission's proposals (Congress was nearly unanimous in approving them) would not view the projected annual shortfall as a problem.

The article reports that President Bush wants to deal with the projected shortfall through privatization, but has not decided yet whether or not he wants to cut benefits. If he doesn't cut benefits, then privatization will have no impact on the projected shortfall. In fact, the most widely discussed proposal from President Bush's Social Security commission, which he indicated would be the basis for his final proposal, calls for phasing in large cuts in benefits. A worker who is twenty at the time the plan is implemented would see a cut of close to 40 percent in his projected benefit. The plan proposes a subsidy for workers who choose private accounts, which would allow them to make back approximately one-third of this cut.

The article also refers to the $10.4 trillion unfunded liability for Social Security over an infinite horizon. Since most readers are not likely to be familiar with projections for the infinite future, it would be more informative to report that the shortfall is equal to 1.2 percent of future income, with the bulk of the shortfall occurring after the program's 75-year planning period.

Social Security Formula Weighed
Jonathan Weisman and Mike Allen
Washington Post, January 4, 2005, Page A1

This article reports on the likelihood that President Bush will propose cutting benefits to future retirees by linking the growth in benefits to prices rather than wages. Since the annual rate of wage growth is projected to be 1.1 percent higher than the rate of growth of prices, this translates into cuts of approximately 1 percent a year in benefits (e.g. a worker retiring in ten years would see a cut of approximately 10 percent, a worker retiring in 20 years would see a cut of approximately 20 percent).

The article asserts that "the White House hopes that some, if not all, of those benefit cuts would be made up by gains in newly created personal investments accounts." While the White House claims that its Social Security cuts would be largely offset by the gains from personal accounts, it has never produced a set of capital gains and dividend yields that support the returns that it is assuming from investing in the stock market.

If the White House actually believed the claims it is making about stock returns, then it would take no more than twenty minutes to write down the capital gains and dividend yields that would provide these returns. Therefore it is reasonable to question whether the White House actually believes that high stock returns will actually make up for its Social Security cuts, or whether this is simply something said to advance its privatization drive.

GOP Divided on Social Security Push
Jonathan Weisman and Jim VandeHei
Washington Post, January 6, 2005, Page A4

This article reports on divisions among Republicans on the best path to promote their plans for privatizing Social Security. At one point the article notes that benefits are indexed to wages, rather than prices, and asserts that this has assured "robust" growth.

Actually, the growth of benefits has been far less rapid than projected. The Greenspan commission in 1983 expected that annual wage growth would exceed inflation by 2.1 percentage points a year. During this period, real wage growth has averaged less than 1 percent a year. If wages had grown as fast as projected by the Greenspan commission, the average benefit for a worker retiring in 2005 would be more than 25 percent higher. Had Greenspan's projections on wage growth proved correct, the additional tax revenue would have left Social Security solvent far into the second half of the century, in spite of the higher level of benefits.

Is Norway's Oil Pool Deep Enough
Alan Cowell
New York Times, January 1, 2005, Page W1

This article examines Norway's efforts to build up a reserve fund with its oil wealth to help pay for future retirement benefits for an aging population. The article implies that Norway, like other industrialized countries, faces a crisis because at some future point it may have to raise taxes to support a larger ratio of retirees to workers.

In fact, there has been a growing ratio of retirees to workers all through the industrialized world for the past century. Since wages rise through time, workers have consistently been willing to set aside a portion of their wage increases to fund a longer retirement through a higher tax rate during their working years. Given the overwhelming popularity of this pattern (governments have regularly instituted such tax increases and usually had no difficulty being re-elected as a result), there is little reason to believe that the future will be any different. In other words, there is no evidence to support the contention in this article that Norway or any other developed country faces more of a crisis in the future paying for its retirement system than it did in the past.

At one point, the article asserts that the projected cost of the baby boomers' retirement is motivating President Bush's effort to privatize Social Security. Actually, all projections show that the system will be able to largely or completely cover the baby boomers' retirement with no changes whatsoever. The Social Security trustees' latest projections show that the system can pay all benefits through the year 2042, when the youngest baby boomer will be age 78 and the oldest 96. Projections from the Congressional Budget Office show the system is fully solvent through the year 2052, at which point the youngest baby boomer will be 88 and the oldest 106.

The article also discusses the Swedish Social Security system as a model along the lines that President Bush is proposing, because it includes mandatory contributions to private accounts equal to 2.5 percent of wages. Actually, this system has a U.S.-style defined benefit system that is approximately one-third larger than ours, being supported by a payroll tax of 16 percentage points. It is unlikely that President Bush would embrace this sort of expansion of Social Security even if it were accompanied by government-mandated contributions to private accounts.

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The Stock Market

Late Stock Market Rally Makes 2004 a Winning Year
Jonathan Fuerbringer
New York Times, January 1, 2005, Page C1

This article discusses the stock market's prospects in 2005. It never mentions the current price-to-earnings ratio of the market. This is comparable to assessing the value of rental property without noting the annual rent it produces. In fact, the current price to-earnings-ratio in the market is more than 20 to 1, approximately 50 percent higher than their historic average. This implies that the market can be expected to provide lower than average returns, although the outcome in any particular year will always be unpredictable.

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Tsunami Relief

U.S. Greatly Boosts Tsunami Aid
Ellen Nakashima and Colum Lynch
Washington Post, January 1, 2005, Page A1

U.S. Vows Big Rise In Aid For Victims of Asian Disaster
David E. Sanger and Warren Hoge
New York Times, January 1, 2005, Page A1

These articles report on the decision by President Bush to increase the amount of aid for victims of the tsunami to $350 million. This amount is equal to approximately 0.014 percent of federal spending or 0.003 percent of GDP. It would be more informative to report this spending relative to the size of the budget and the economy, since few readers can understand the importance of $350 million to the United States.

It is especially appropriate that this spending be expressed relative to the size of the U.S. economy since the generosity or stinginess of the U.S. response to the tragedy has become a major international issue. The only appropriate measure for international comparisons is the size of the contribution relative to the size of the economy.

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Immigration

Bush Immigration Plan Meets GOP Opposition
Michael A. Fletcher
Washington Post, January 2, 2005, Page A6

This article examines the prospects for immigration reform in the current session of Congress. At one point it reports that supporters of a temporary worker program for foreign workers argue that a "supply of highly motivated, low-skill workers" would provide a boost to the economy.

While standard economic theory indicates that increasing the supply of less-skilled workers would provide economic gains, this would come at the expense of lower wages for less-skilled workers (both immigrant and non-immigrant) already in the country. It is worth noting that increasing the supply of higher-skilled workers (e.g. doctors, lawyers, economists, etc.) would also provide an economic boost. Since there is a much larger gap between the pay these workers receive in the United States and the pay they receive in developing countries (for workers with comparable education) there would be much larger economic gains from increasing the number of highly skilled workers entering the country. This economic gain would be associated with greater wage equality.

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The Dollar and the Budget Deficit

The Long Arm of the Dollar
Paul Blustein
Washington Post, January 4, 2005, Page E1

This informative article examines some of the implications of a decline in the dollar for U.S. economy. At one point the article cites John Williamson, an economist at the Institute for International Economics, as arguing that reducing the budget deficit would curb demand, and thereby reduce imports and the trade gap.

It is worth noting that reducing the budget deficit reduces demand by slowing growth and raising unemployment. Since the U.S. imports approximately 16 percent of what we consume, if GDP growth were to decline by 1 percent ($115 billion), then imports would fall by an amount roughly equal to 0.16 percent of GDP ($18.4 billion). If the U.S. were to reduce its trade deficit through this route (rather than a fall in the dollar), it would require depression era levels of unemployment to bring the trade deficit down to a sustainable level.

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Malpractice Insurance

Bush to Seek Limits On Lawsuits
Jim VandeHei and John F. Harris
Washington Post, January 5, 2005, Page A3

Bush Campaigns to Curb Lawsuits
Peter Baker
Washington Post, January 6, 2005, Page A6

Bush Begins Drive to Limit Malpractice Suit Awards
Robert Pear
New York Times, January 6, 2005, Page A21

These articles report on President Bush's efforts to promote legislation that would limit damage awards and in other ways restrict the ability of patients to sue for malpractice. All three articles report President Bush's contention that frivolous lawsuits are pushing up insurance premiums and forcing many doctors to give up their practices.

It would have been helpful to note the findings of a study commissioned by the Bush administration, that a large share of malpractice claims are attributable to a small number of bad doctors ( see "Panel Seeks Better Disciplining of Doctors," by Robert Pear, New York Times, January 5, 2005, page A19).