Economic Reporting Review
By Dean Baker
December 23, 2002

OUTSTANDING STORIES OF THE WEEK

Deciding on Executive Pay: Lack of Independence Seen
Diana B. Henriques and Geraldine Fabrikant
New York Times, December 18, 2002, Page A1
http://www.nytimes.com/2002/12/18/business/18PAY.html

This article examines the process that determines the compensation for top executives at major corporations. It shows that in many cases the committees that set compensation are closely tied to the executives whose pay they are setting.

Treasury Nominee To Get Big Pension
David Cay Johnston
New York Times, December 17, 2002, Page A1
http://www.nytimes.com/2002/12/17/business/17CHIE.html

This article discloses the details of the pension package that John W. Snow, President Bush's nominee for Treasury Secretary, will receive after leaving his position as CEO of CSX. He will be given a pension of $2.5 million annually (in addition to other benefits). To reach this sum, Mr. Snow was credited with several additional years of service in excess of the time he actually worked for the company.

After a Boom, There Will Be Scandal. Count on It.
Kurt Eichenwald
New York Times, December 16, 2002, Page C3
http://www.enrongate.com/news/index.asp?id=161865

This article examines the current wave of corporate corruption in the context of past waves of corruption that were exposed after the collapse of speculative bubbles. The article notes that a speculative bubble creates a situation in which corruption is virtually inevitable.


Europe and Japan

In Euro Zone, Woes Abound
Mark Landler
New York Times, December 16, 2002, Page C10
http://www.nytimes.com/2002/12/16/business/businessspecial/16EURO.html


Rumors of Japan's Recovery Are, It Seems, Exaggerated
James Brooke
New York Times, December 16, 2002, Page C11
http://www.nytimes.com/2002/12/16/business/businessspecial/16JAPA.html?tntemail0

These articles discuss the prospects for economic growth in Europe and Japan in the next year. Both articles include assertions that deregulation of various types is essential for these economies to return to normal growth paths. For example, the article on Europe asserts that, "Germany, and to a lesser extent France and Italy, have structural problems in their labor markets and welfare systems that Britain tackled two decades ago during the free-market revolution of Margaret Thatcher."

While some economists have claimed excessive labor market regulation is the main cause of Europe's slow growth, and protection of an antiquated financial structure is the main cause of Japan's problems, this view is not accepted by all economists. Many prominent economists, such as Nobel prize winner Robert Solow and Princeton University Professor Paul Krugman, have argued that the largest immediate impediment to growth in these economies is the overly restrictive monetary policy set by their central banks.

There is actually very little evidence that the anti-labor policies pursued by Margaret Thatcher are effective in stimulating growth and reducing unemployment. Some nations, such as New Zealand, have pursued such policies with considerable vigor, with little obvious gain. Several nations with low unemployment, such as Austria, Ireland, Denmark, and Sweden, have labor market policies similar to those in Germany and France (see "Labor Market Institutions and Unemployment: A Critical Assessment of the Cross-Country Evidence," [http://www.newschool.edu/cepa/papers/archive/cepa200217.pdf]).

It is worth noting that neither article discusses the possibility that restrictive monetary policy has played a role in limiting growth, although the Landler article does note that the European Central Bank (ECB) recently lowered interest rates in response to slow growth. The ECB has kept its key interest rate 1.5 percentage points higher than the Federal Reserve's rate over the last year and a half. The U.S. economy would certainly be far weaker today if the Federal Reserve Board had followed the same interest rate policy as the ECB.

The Landler article concludes by asserting that for now, "Europe remains dependent on the United States to lift it out of its torpor." The value of Europe's merchandise exports to the United States are at present approximately $240 billion annually. If rapid growth in the U.S. led Europe's exports to increase by 10 percent (a very sharp increase), then it would generate $24 billion in additional demand. This increase in demand is equal to less than 0.3 percent of Europe's GDP. The impact on an increase in exports of this size would barely be noticeable in Europe.

These articles rely exclusively on experts in the financial industry. The five identified sources are associated with Goldman, Sachs in London, Deutsche Bank, Goldman Sachs Japan Ltd., Deutsche Securities in Tokyo, and Goldman Sachs Asia.

Japan's Central Bank Eases Rules on Its Loans to Banks
Ken Belson
New York Times, December 18, 2002, Page W1
http://www.nytimes.com/2002/12/18/business/worldbusiness/18YEN.html

This article reports on the Japanese Central Bank's decision to weaken its regulations to make it easier for banks to meet minimal capital requirements. At one point the article warns that this decision could have a "perverse effect," by "taking pressure off borrowers to make painful cuts in payrolls and costs that would improve their debts eventually."

While such a "perverse effect" is a possibility, the more likely effect of following the path advocated in this article (not easing requirements) would be a further contraction of Japan's economy, as newly laid off workers cut back consumption, leading to a further decline in demand. This would lower profits further, reducing investment and causing more loans to go bad. The article ignores this simple macroeconomic dynamic, which undoubtedly played a key role in the central bank's decision.


China

China's Hot, at Least for Now
Joseph Kahn
New York Times, December 16, 2002, Page C11
http://www.nytimes.com/2002/12/16/business/businessspecial/16CHIN.html?tntemail0

This article examines growth prospects in China for the near-term future. When it assesses the importance of China's economy in the world, the article uses an exchange rate conversion, which places China's GDP at just over $1 trillion. (A chart accompanying the articles in this section does the same.) China's importance in the international economy is probably better captured by a purchasing power parity measure of its GDP, which is over $4 trillion.


The U.S. Economy

This Testy Economy Refuses to Be Charmed
Alex Berenson
New York Times, December 16, 2002, Page C1
http://www.nytimes.com/2002/12/16/business/businessspecial/16CONF.html

This article evaluates the current state of the U.S. economy and its near-term prospects. The article discusses the strength of the housing sector, but never considers the possibility that housing
prices are in a bubble, nor the implications of a collapse of such a bubble. Home prices have outpaced the overall rate of inflation by more than 30 percentage points over the last seven years. This sort of run-up in home prices is unprecedented in the post-war era. The housing wealth created by the appreciation of home prices in excess of inflation is approximately $3 trillion. If just half of this wealth were lost due to a collapsing bubble, it would reduce annual consumption by close to $100 billion through the wealth effect.

The article also does not mention the current account deficit. This is ironic because it does include warnings about the budget deficit, which is at present less than $200 billion. The current account deficit, which according to standard economic theory has a comparable impact on future living standards, is presently above $500 billion.


The Stock Market

Bush Calls for an Extension Of Unemployment Benefits
Richard W. Stevenson
New York Times, December 15, 2002, Page A32
Available for $2.95 at
http://query.nytimes.com/gst/abstract.html?res=F30714F7345E0C768DDDAB0994DA404482

This article reports on President Bush's request for Congress to approve an extension of unemployment benefits for workers who have been out of work for more than 26 weeks. At one point the article asserts that the stock market is "in the doldrums." Actually, the market is still quite high relative to corporate profits, by historical standards. The current price to earnings ratio of the
stock market is approximately 18 to 1, measured against trend corporate earnings. (It would be close to 20 to 1 when measured against current earnings levels, which are depressed as a result of the recession.) Historically, the price to earnings ratio has averaged 14.5 to 1.

Budget Deficit Climbs Steeply in California
John M. Broder
New York Times, December 19, 2002, Page A18
http://www.nytimes.com/2002/12/19/national/19CALI.html

This article reports on the worsening budget crisis in California. It notes that one of the major causes of the current shortfall has been a plunge in capital gains tax revenue due to the downturn in the stock market. The article quotes California Governor Gray Davis as saying that no expert had forecast the current weakness of the economy and the stock market.

It would have been appropriate to point out that some experts did in fact forecast the downturn in the stock market and the economy. These downturns were entirely predictable. Between 1998 and 2000 the market reached price to earnings ratios that were clearly not sustainable. It was also virtually inevitable that the market's adjustment to more normal levels would lead to a recession (see "Dangerous Minds: The Track Record of Economic and Financial Analysts," [http://www.cepr.net/dangerous_minds.htm]).


The Dollar

Dollar Loses More Ground to the Euro
Jonathan Fuerbringer
New York Times, December 14, 2002, Page B1
http://www.nytimes.com/2002/12/14/business/14DOLL.html

This article reports on the recent fall in the dollar against the euro. At one point the article comments that "analysts are not predicting a big decline for the dollar, in part because America's chief commercial rivals .... are weaker economically than the United States." Approximately 60 percent of the foreign owned assets in the United States are held in fixed interest deposits such as money market accounts or bonds. The returns on these accounts depend only on the interest rate - they are not affected by the relative rates of growth of the U.S. and European economies. At present, both real and nominal interest rates are higher in Europe than the United States. Unless investors are willing to forgo a higher interest rate simply because they enjoy having their money in a fast growing economy, the current difference in interest rates means that it is rational for them to switch their money to euro deposits.

While the analysts consulted for this article apparently do not anticipate a decline in the dollar, it is worth noting that few analysts anticipated the collapse of the sock market bubble.


Retail Inventories

Price Index For Producers Is Off 0.4%; Optimism Up
Bloomberg News
New York Times, December 15, 2002, Page B2
Article available for $2.95 at
http://query.nytimes.com/gst/abstract.html?res=FA0C16FF355E0C778DDDAB0994DA404482

This article discusses the release of three different economic reports. At one point the article notes that Commerce Department data show an increase in retail inventories in October, which it describes as due to retailers "restocking their shelves ahead of the holiday season." Actually non-auto retail inventories fell by $1.1 billion in October to $284.3 billion, from $285.4 billion in September. The entire reported increase in inventories was attributable to rising inventories of unsold cars and trucks.


Tax Plans

New Tax Plan May Bring Shift In Burden
Jonathan Weisman
Washington Post, December 16, 2002, Page A3
http://www.washingtonpost.com/wp-dyn/articles/A59577-2002Dec15.html

This article discusses plans by some Republicans to make the tax code more regressive, under the view that too large a share of non-Social Security taxes are paid by wealthy people. While the share of non- Social Security taxes paid by the wealthy has increased, it would have been appropriate to point out that the wealthy are paying a much lower share of their income in federal income taxes than they have through most of the post-war period. This is due to the fact that the personal and corporate income tax account for a smaller share of the federal budget than in the past, approximately 55 percent presently, compared to 70 percent in the fifties.

It also would have been worth noting that in the last two decades the government has adopted a wide variety of policies that have the effect of redistributing before tax income upward. For example, it has adopted trade policies that put U.S. manufacturing workers in direct competition with low wage workers in developing nations. At the same time, it has maintained or strengthened protectionist measures that prevent high paid professionals like doctors and lawyers from being subject to the same sort of competition. It has also changed the enforcement of labor laws to make it extremely difficult for workers to organize unions in the private sector. Any assessment of the fairness of tax burden should also consider measures the government has taken that affect the before tax distribution of income.


Copyrights

Russian Company Acquitted of Digital Piracy
Matt Richtel
New York Times, December 18, 2002, Page C4
http://www.nytimes.com/2002/12/18/technology/18DIGI.html

This article reports on the decision by a federal jury to acquit a Russian software company, which was accused of violating the 1998 Digital Millennium Copyright Act. The company sold software that allowed users to circumvent locks placed in electronic books.

The article notes that supporters of this act argue that extensive protections of copyrights are needed to "prevent the theft" of intellectual property. The article should have used a more neutral term such as "reproduction." Whether or not the act of reproducing copyrighted material constitutes theft is determined by the law. If there is no law prohibiting such reproduction, then it is not "theft."

The article notes that some legal scholars have opposed measures, like the Millennium Copyright Act, because they interfere with the fair use of copyrighted material - for example a consumer copying a CD to listen to it at a second location. It would have been appropriate to also present views of economists who view copyrights as an increasingly wasteful form of protectionism. With the costs of duplicating material falling to virtually zero, and the costs of enforcing copyright increasing, standard economic theory indicates that copyrights are becoming a much less efficient means of supporting creative work.