Economic Reporting Review
By Dean Baker
May 20, 2002

Outstanding Stories of the Week

The Whole Story?
Steven Pearlstein
Washington Post, May 12, 2002, Page H1

This article discusses the extent to which corporate financial statements continue to conceal important information about the health of companies. It gives several examples of major corporations that are being deceptive in the disclosures in their annual reports.

Will It Be California Redux?
Reported by Neela Banerjee, David Barboza, Richard A. Oppel Jr, and
Joseph Kahn
written by Joseph Kahn
New York Times, May 12, 2002, Section 3, page 1

This article examines the ability of regulators to prevent the sort of market manipulations that Enron and other traders successfully exploited during California's energy crisis. It indicates that regulators may lack the ability to prevent similar schemes in the future. 

Suit Says Company Promoted Drugs in Exam Rooms
Melody Petersen
New York Times, May 12, 2002, Page C1

This article reports on a lawsuit filed against Warner-Lambert, a major pharmaceutical manufacturer. The reports on some of the documents filed in the case, which indicate that company representatives talked to patients in doctors' exam rooms and promoted the company's drugs, in some case for uses that had not been approved by the Food and Drug Administration.

California's Budget Crisis

California Stunned to Find $20 Billion Hole in Budget
James Sterngold
New York Times, May 12, 2002, Section 1, Page 12

This article reports on the state of California's current budget crisis. The state expects to run a deficit in its current fiscal year of between $20 to $25 billion, which is equal to more than a quarter of its $80 billion annual budget. According to the article, the main cause of the shortfall is a sharp drop in the revenue that the state collects from capital gains, which is due to the collapse of the bubble in tech stocks.

The article presents comments from both the state controller and the director of the Department of Finance, implying that this drop off in revenue was completely unforeseeable. For example, the controller is quoted as saying that "everyone was taken by surprise." The article also informs readers that "state officials are not in the business of making stock market forecasts." 

Actually, state officials are in the business of making stock market forecasts - they did exactly this when they made their revenue projections. As the article indicates, the revenue projections assumed large amounts of capital gains tax revenue. The state would have received this revenue only if the tech bubble persisted into 2001, which means that the budget officials were effectively projecting the continuation of the tech bubble.

This projection has proven to be wrong, with disastrous consequences for the state. Contrary to the claims of the budget officials, the collapse of the tech bubble, and the resulting decline in capital gains revenue, were entirely predictable events that many people did in fact foresee (e.g. see Budget Byte
[http://www.cepr.net/Bytes/cbo_budget_byte010131.htm] and Letter to Dan Crippen, [http://www.cepr.net/Dean%20CBO%20letter.htm]). People working in most occupations, such as teachers, nurses, custodians, or dishwashers, are likely to lose their jobs when they make a very serious mistake. According to the article, it does not appear that the officials responsible for the erroneous revenue projections are being held accountable at all. In fact, the article indicates that they have not even been forced to acknowledge their error. 

Electricity Deregulation

Power Giants Have Trouble Raising Cash For Plants
Alex Berenson
New York Times, May 16, 2002, Page C1
 
This informative article discusses the problems that many power companies are now facing in raising the capital needed to build new power plants. The article reports that because many of them had engaged in questionable trading practices and used dubious accounting methods, investors are reluctant to trust them with more money. 

At one point it discusses the push toward deregulation in the electricity industry, which began in the eighties. It attributes this push to view of "industry experts and some big users that the regulated system had failed." It is important to note that the regulated system was explicitly designed to subsidize small users, homes and small businesses, at the expense of larger users. Regulators were well aware of the fact that it was generally possible to supply large users at a lower cost than what they were being charged. This rate structure was left in place as a result of a political decision that it was desirable to let small users have low cost electricity.

The existence of this cross subsidy gave large users a powerful incentive to push toward deregulation regardless of how they viewed the efficiency of the regulated system. Deregulated systems would eliminate the cross subsidy, providing lower-cost electricity for large users, even if it raised prices for homes and small businesses.

Welfare Reform

G.O.P. Dispute Delays Vote on Welfare Bill
Robert Pear
New York Times, May 16, 2002, Page A18

This article discusses the Congressional debate over the new welfare bill. At one point it reports the boasts of Dennis Hastert, the Speaker of the House, that the disaster predicted by the opponents of the 1996 welfare reform did not occur. It is worth noting that in 1996, virtually all economists - including those making government economic and budget projections -- accepted that
the unemployment rate could not fall below 6.0 percent, without leading to accelerating inflation. In fact, it was widely expected that the Federal Reserve Board would raise interest rates and deliberately slow the economy, if the unemployment rate began to sink significantly below 6.0 percent.

As it turned out, the Federal Reserve Board allowed the unemployment rate to drop to 4.0 percent before it took significant steps to slow the economy. This allowed approximately 4 million more people to get jobs, than would have been the case if the Federal Reserve Board had clung to the accepted economic wisdom at the time welfare reform was passed. As a result, the people pushed off the welfare rolls had far more job opportunities than was expected to be the case at the time that welfare reform was passed.

Productivity Growth

Factory Output Up in April
John M. Berry
Washington Post, May 16, 2002, Page E1

This article reports on the Federal Reserve Board's release of data on industrial production in April. At one point the article notes that manufacturing output increased in April even though hours reported to have been worked decreased. It describes this as "an indication that productivity continued to rise sharply."

Monthly hours and output are both measured very poorly, so it would be a mistake to infer anything about the rate of productivity growth based on this data. For example, the March data showed that hours worked in manufacturing increased at an 8.1 percent annual rate, while output rose at a 5.2 percent annual rate. This would imply that productivity was declining at a 2.9 percent annual rate. 

It is implausible that productivity actually declined this sharply in March and then began to grow rapidly in April. The more reasonable explanation is that measurement errors led to an understatement of productivity growth in March and overstatement in April.

Social Security

Wary Words on Social Security
Mike Allen and Juliet Eilperin
Washington Post, May 11, 2002, Page A1

This article discusses the concerns of Republican members of Congress, that their stand in support of partial privatization of Social Security will hurt them in the fall election. At one point the article refers to Republican plans to challenge opponents to produce their own plans to keep Social Security solvent. It is worth noting, that according to the Social Security trustees, the system will be fully solvent for the next 39 years with no changes whatsoever. Even after 2041, when the system is first projected to face a shortfall the program will always be able to pay a larger real (inflation
adjusted) benefit than what current retirees receive.

It would be appropriate to point out these facts, because tens of millions of workers are confused about the current financial state of the system. Many workers believe that the system is already on the edge of collapse and that it is likely that it will not pay them in benefits when they retire. In fact, there was no point in the program's first 45 years of existence when it was as sound as it is at present. It would have been more reasonable to demand that a candidate have a plan to maintain Social Security's solvency in 1942, 1952, 1962,1972, and 1982 than in 2002.

Farm Subsidies

Bush Signs Bill Providing Big Farm Subsidy Increases
Mike Allen
Washington Post, May 14, 2002, Page A1

Reversing Course, Bush Signs Bill Raising Farm Subsidies
David E. Sanger
New York Times, May 14, 2002, Page A16

These articles report on the new farm bill signed by President Bush. Both articles describe the bill as providing a large increase in farm subsidies. For example, the Times article reports the bill "increased spending by nearly 80 percent over the cost of existing programs." The new bill provides an average of $19 billion a year in farm subsidies, or a total of $190 billion over the next decade. In the last three years farm subsidies have averaged more than $20 billion annually. Approximately half of this money has been in the form of emergency appropriations, which Congress passed due to the fact that many farmers were facing severe financial difficulties. While the new bill does increase subsidies when measured against the last farm bill passed in 1996, approximately 60 percent after adjusting for inflation, it will actually decrease subsidies when compared to the amounts currently being paid.

It is also worth noting that farmers' problems have been serious exacerbated by the high value of the dollar. They would be getting to 20-30 percent more money for most of their crops if the dollar fell to a sustainable level.

Pay Scales at U.S. Airways  

US Airways Plans to Apply for a Federal Loan
Edward Wong
New York Times, May 11, 2002, Page B1

US Airways Tells Unions Details of Cost Cutting Plan
Edward Wong
Washington Post, May 17, 2002, Page C1

These articles report on the financial circumstances that are leading US Airways to seek a government guaranteed loan. Both articles refer to the need to reduce the airline's labor cost, noting that its operating costs are the highest of any major airline, measured on a passenger-mile basis (the cost of flying one seat one mile).

This is not a useful measure of costs, unless the calculation factors in the average flight distance. The cost of operating shorter flights is much higher on a per mile basis than longer flights. To compensate for the higher costs, airlines typically charge much higher fees per mile on shorter flights than longer flights. For example, it is sometimes possible to fly coast to coast (approximately 3000 miles) for just $100 each way. At the same price per mile, a trip from New York to Washington, DC (approximately 200 miles) would cost about $7.  Even heavily discounted tickets are likely to cost ten times this amount.


French Budget Debates

In Role Switch, Socialists Fault Chirac Team's Pledge to Spend
John Tagliabue
New York Times, May 14, 2002, Page A3

This article reports on a debate between the French Socialists and President Jacques Chirac over budget policy. The Socialists claimed that Chirac's spending proposals will lead the European Central Bank (ECB) to raise interest rates, which will then lead to higher unemployment. The additional spending supported by Chirac will stimulate growth and lead to more jobs. While a larger French budget deficit may help prompt the ECB to raise interest rates, there is no reason to believe that the job loss due to higher interest rates will be larger than the job growth that results from the additional spending.

It is also important to note that the ECB's high interest rate policy has been a major factor contributing to budget deficits in France and elsewhere in Europe. By slowing the economy and pushing people out of work, high interest rates reduce government tax revenue and increase payments on transfer programs such as unemployment benefits. One of the main factors that allowed the U.S. to run budget surpluses in 1998-2000 was the low unemployment rate that the economy was able to attain. The ECB has kept interest rates far higher in Europe than the Fed has in the United States, even though Europe has a lower rate of inflation and a higher rate of unemployment.