Economics Reporting Review
Week of February 24 - March 2

Dean Baker is co-director of the Center for Economic and Policy Research.

OUTSTANDING STORIES OF THE WEEK 

"A Benefit for the Few Weighs on Many," by Gretchen Morgenson in the New York
Times, February 25, 2001, Section 4, page 1. 

This article discusses the impact that large grants of stock options to company
executives have had on the performance of share prices. It reports the finding of a
recent study that the stock of companies with large amounts of outstanding options
provides lower returns than the market as a whole. 



"Reversing Decades-Long Trend, Americans Retiring Later in Life," by Mary Williams
Walsh in the New York Times, February 26, 2001, page A1. 

This article examines a recent rise in the percentage of people who continue working
past age sixty-five. This percentage had been consistently falling throughout the
post-war era, but has been rising gradually since the late 1980s. The article
examines the extent to which this change is due to choices allowed by increased
opportunities for employment and improved health, and the extent to which it is
forced as a result of diminished savings and reduced pension coverage. 



"Wealthiest Pay a Declining Share of Their Income in Taxes," by David Cay Johnston
in the New York Times, February 26, 2001, page C2. 

This article reports on a new study from the Center on Budget and Policy Priorities
showing that the richest families paid a smaller share of their income in taxes in 1998
than at any point since 1992. 



"The Mindset of a Slowdown," by Louis Uchitelle in the New York Times, March 2,
2001, page C1. 

This article reports on recent developments in output, employment, and investment
in several major manufacturing sectors. It includes several executives' assessments
of their plans in these areas in response to the economy's slowdown. 



"Excerpts from Chairman Show Revision of Views," in the New York Times, March 1,
2001, page C9. 

This article presents several statements from Federal Reserve Board Chairman Alan
Greenspan's most recent congressional testimony, alongside statements from his
testimony two weeks earlier. The juxtaposition shows clearly how his assessment had
become significantly more negative in this period. 




ENERGY AND THE ENVIRONMENT 

"Senate GOP Bill Proposes Arctic Refuge Drilling," by Eric Pianin and Peter Behr in the
Washington Post, February 27, 2001, page A2. 

"GOP Energy Bill Is Likely to Set Off Fierce Policy Fight," by Lizette Alvarez in the New
York Times, February 27, 2001, page A1. 

These articles discuss a Republican Senate bill that would open large areas to oil and
gas drilling, including the Arctic National Wildlife Refuge in Alaska. Both articles report
assertions by tthe bill's proponents that new sources of oil and gas will increase the
nation's energy independence. 

It would have been appropriate to point out that the resources pulled out of the new
areas opened to drilling will only temporarily ease the nation's dependence on foreign
energy sources. Unless the U.S. faces some hostile action during the period in which
the new fields are being depleted -- comparable to the Arab oil embargo of the 1970s
-- there will be virtually no economic and security gains for the United States as a
result of this new drilling. Once these fields are depleted, the nation will be more
dependent on foreign sources of energy, since it will have forever lost these
reserves. 



THE LONG-TERM BUDGET 

"Bush Tries to Avoid GOP's Past Pitfalls," by Glenn Kessler in the Washington Post,
March 1, 2001, page A8. 

This article examines some of the long-term assumptions in President Bush's budget
proposal. It lists several items that may cause the surplus to be smaller than he has
assumed. It would have been appropriate to include the assumption on capital gains
tax revenue in this list. The projections from the Congressional Budget Office (CBO)
assume that the government will collect approximately $1 trillion in capital gains tax
over the next decade. At the same time, CBO assumes that corporate profits will
only rise by about 10 percent, in real terms (adjusting for inflation) over the decade.
In order to generate the tax revenue assumed by CBO, the ratio of stock prices to
corporate earnings would have to rise above its record levels of last year. 

It is worth noting that CBO does not make projections for the stock market. It
assumes that capital gains will always bear a fixed relationship to GDP. This implies
that the stock market will rise by the same amount when it is valued at
approximately 0.6 as large as GDP, as in the late 1970s, or when it is valued at close
to twice GDP, as was the case last year. There is no economic theory that would
support this view. 

It is also worth noting that such criticisms of the budget -- that its ten year surplus
will be lower than projected -- assume that Congress will somehow be unable to
adjust for such circumstances. While it has never been popular, Congress has passed
significant tax increases at numerous points in the past, for example in 1982, 1983,
1990, and 1993. It is difficult to see why current budget policy should be assessed
under the assumption that Congress can never pass a tax increase at some point in
the future, if it proves necessary. 



SOCIAL SECURITY AND THE BUDGET 

"Bush Plans to Study Overhaul Of Social Security," by Amy Goldstein in the
Washington Post, February 27, 2001, page A1. 

"President To Seek Cuts of $2 Trillion Of Debt In Decade," by Richard W. Stevenson
in the New York Times, February 27, 2001, page A1. 

These articles report on what are expected to be the main items in President Bush's
first budget proposal. Both articles include numerous comments asserting or implying
that the Social Security program faces an imminent funding shortfall. For example,
the Times article refers to the "dire financial outlook" for Social Security and refers
to plans for "shoring up" the program's finances so that it can support the retirement
of the baby boom generation. The Post article refers to "the 77 million baby boomers
will place enormous strains on both programs [Social Security and Medicare] once
they reach retirement age in a decade." 

These assertions are contradicted by the projections in the Social Security trustees'
report, which provides the accepted basis for the policy debate on this assertion.
According to the most recent trustees' report, the program can pay all scheduled
benefits until the year 2037, with no changes whatsoever. Even after this date, the
program would always be able to pay a larger real (inflation adjusted) benefit than an
average retiree receives at present. 

Furthermore, it is likely that the projections will show an even brighter picture in the
2001 trustees' report that will be released in late March or early April. The
Congressional Budget Office recently released new economic and budget projections,
which increased the projected rate of economic growth by 0.3 percentage points
annually. If the Social Security trustees make the same adjustment to their
projections, then the program would be able to pay full scheduled benefits until 2042.
At that point, the youngest of the baby boomers will be seventy-eight years old,
while the oldest will be ninety-six. Few, if any, baby boomers need worry about the
program's finances during their lifetimes. 

It is also worth noting that Social Security's projected finances are currently better
than its actual finances have been at any point in its history, prior to the reforms put
in place in 1983. 

The Times article does not indicate the basis for its negative comments on Social
Security. The Post article includes a variety of sources, all of whom support
overhauling Social Security. One of its sources, the Concord Coalition, is identified
only as "a nonpartisan group that supports entitlement reform." It is worth noting
that the Concord Coalition has repeatedly issued documents grossly exaggerating the
size of future federal budget deficits. For example, in December 1996, as the budget
deficit was disappearing, the Concord Coalition issued a report titled, "In the Eye of
the Deficit Hurricane," which warned that deficits would approach $300 billion by the
year 2001. It would have been appropriate if these articles had included sources that
were supportive of the Social Security system and/or had been more accurate in
their previous predictions. 



JAPAN 

"Japanese Stock Index at 15-Year Low Despite Leaders' Vow," by Clay Chandler in
the Washington Post, March 2, 2001, page E3. 

This article reports on the decline in the Nikkei, Japan's major stock index, to its
lowest point since 1985. The article reports this decline as more evidence that Japan
needs to have a major overhaul of its economy. According to the article, "virtually
every Western economist" says that such an overhaul is unavoidable if the Japanese
"are to revive their feeble economy." 

The article does not indicate how it has determined the views of "virtually every
Western economist." One very prominent Western economist, Princeton Professor
Paul Krugman, has argued repeatedly that the most important thing that Japan needs
to do to revive its economy is to stimulate consumption and investment through a
small amount of inflation. At present, prices are falling, which means that real
interest rates stay relatively high. Other Western economists have expressed
agreement with Professor Krugman's assessment. The only sources cited in the
article are two analysts working for financial firms. 

As has been noted in previous articles (e.g. "U.S. Urgings Perplex Japanese," by Doug
Struck, Washington Post, February 7, 2001, page A12), most Japanese continue to
enjoy a relatively comfortable standard of living. It should not be surprising that they
are not eager to embrace economic measures of questionable efficacy. 

It is also worth noting that decline of the Nikkei is exaggerated by the fact that
several Japanese tech stocks were added to the index when they were near their
peak values. Some of these stocks subsequently have had the same sort of price
collapse as companies like Amazon.com and Priceline.com. This led the index to fall
by a larger amount than if it had just included a fixed set of stocks, or if it had
captured both the rise and fall of these tech stocks. 



TURKEY AND THE IMF 

"IMF Creates Unit to Spot Early Signs of Foreign Crisis," by David Stout in the New
York Times, March 2, 2001, page C11. 

This article reports on the IMF's plans to set up a new division that would try to
detect early warning signs of financial crises in countries where it has lent money.
This decision comes in the wake of a financial crisis in Turkey. It is worth noting that
the IMF has repeatedly expressed its intention to be more attentive to early warning
signs in the past, notably after the Mexican financial crisis in 1995 and the East
Asian financial crisis in 1997. 

"Bush Backs Turkish Efforts to Resolve Economic Crisis," by Douglas Frantz and David
E. Sanger in the New York Times, February 24, 2001, page C1. 

This article reports on a call from President Bush to Turkey's prime minister, indicating
his support for the IMF's program for Turkey. At one point, the article refers to the
IMF's program as a "bailout" for Turkey, and also refers to a previous IMF program as
a "bailout" for Russia. It then indicates that, in spite of previous statements by
President Bush and his Treasury Secretary, Bush is now feeling the political need to
support the bailout of an important U.S. ally. 

This is a dubious characterization of the situation. Most immediately, in Turkey, as in
the previous case with Russia, the IMF program ensures that creditors continue to be
paid on schedule. In the absence of IMF support, both nations would have been
forced to renegotiate their debts with creditors. In Russia's case, this is exactly what
ultimately happened, as it proved impossible for the government to continue to
comply with the IMF's program. When Russia ceased to follow the IMF program, its
currency plunged in value, which eventually sparked a boom in exports. Its economy
is now growing at the most rapid pace since the collapse of the Soviet Union. Russia
is still trying to work out acceptable terms with its creditors, but this problem does
not seem to have seriously harmed Russia's economy. 

Since Turkey is a smaller country and more dependent on trade flows, it is not clear
that it would be able to successfully follow the same path as Russia. However, it is
important to note that the IMF program does not necessarily amount to a bailout of
Turkey, as it is possible that it is doing more harm than good to the country. It would
be more accurate to report simply that Bush is supporting an IMF program for Turkey,
not a bailout. 

It would also be appropriate to note that the collapse of the Turkish lira, which
precipitated the current crisis, is yet another example where an IMF program failed,
following such cases as Brazil in 1999 and Indonesia in 1997, in addition to Russia in
1998. The IMF's track record in designing successful recovery packages has not been
good. And, as an article in the Post noted, this was the seventeeth time in fifty-four
years that an IMF program for Turkey failed ("In Turkey, a Quieter Day To Examine
Core Problems," by John Ward Anderson, Washington Post, February 27, 2001, page
A19). 



GOVERNMENT SPENDING AND INFLATION 

"Bush to Contend Both Taxes, Debt Can Be Reduced," by Glenn Kessler and Mike Allen
in the Washington Post, February 25, 2001, page A1. 

This article discusses President Bush's budget plans. Near the end of the article it
includes a quote from Lawrence Lindsey, Bush's chief economic advisor, in which he
argues that baseline budget projections should not include an annual inflation
adjustment. Lindsey argued that the private sector is experiencing 2.0 percent
annual productivity growth, and that we should expect the same thing in the public
sector. Therefore, he argues, it is not necessary to include an annual inflation
adjustment in baseline budget projections. 

There is a basic problem in this logic, since real wages are expected to rise roughly in
step with productivity growth. If wages keep pace with productivity growth, then
inflation would not increase, but would be expected to stay at the same level -- thus
we still see rising prices in the private sector. If real wages and productivity in the
public sector both rise at the same pace as in the private sector, then it would be
expected that costs in the public sector will increase at approximately the same rate
as the overall rate of inflation. Assuming zero increase in costs in the public sector,
as Mr. Lindsey seems to be advocating, either implies an expectation that
productivity growth in the public sector will be substantially more rapid than in the
private sector, or that the real provision of public sector services will be cut each
year. 



THE STOCK MARKET AND THE ECONOMY 

"It's Up, It's Down: Playing Games With the Economy," by Richard W. Stevenson in
the New York Times, February 25, 2001, Section 4, page 16. 

This article reports on the extent of uncertainty about the near term future of the
economy. At one point the article contrasts views among economists, some of whom
see the current situation as the beginning of the deflation of a stock market bubble,
and others who see it as "readjustment to a more sedate pace of growth and a less
frothy stock market." 

It is not clear which economists would hold the latter view of the stock market. Few,
if any, economists believe that the stock market can consistently rise faster than
corporate profits, since this would imply a continually rising price-to-earnings ratio.
The Congressional Budget Office, whose projections are considered to be
authoritative in budget matters, projects that profits will grow at a real (inflation
adjusted) rate of just 1.0 percent annually over the next decade. If stock prices rise
at the same pace, this would imply real growth of stock prices of 1.0 percent
annually. When this is added to the current dividend yield, which averages
approximately 2.0 percent, it gives a total return on stocks (capital gain plus
dividend yield) of 3.0 percent. This is less than the 3.6 percent return than can be
obtained on a completely safe inflation indexed government bond. It is unlikely that
any economist would claim that people would hold stocks for a lower return than
what they could receive on a completely safe asset. 

The only way to make sense of current stock prices is if a much faster rate of profit
growth is anticipated than what CBO, and almost anyone else, projects. This would
contradict the other part of the statement in the article, that these economists
envision "a more sedate pace of growth." 

In short, if a more sedate pace of growth is expected in the future than in the
recent past, then the only way that stocks will be able to offer returns that provide
some sort of premium against government bonds and other assets is if they fall
significantly in price. When stocks fall in price, the dividend yield rises, since the
same dividend will be paid on a lower share price. For example, if a stock pays a $2
dividend and is priced at $100 per share, then the dividend yield is 2.0 percent. If
the share price falls to $50, and it still pays a $2 dividend, then the dividend yield is
4.0 percent. 

To restore the historic premium of 4.0 percentage points of stocks over government
bonds, a decline of approximately 60 percent would be needed. To restore a premium
of just 2.0 percentage points, stock prices would still have to decline by close to 40
percent from current levels. In short, the expectation that the economy will grow at
a more sedate pace in the future virtually implies that the stock market has a bubble
that will deflate. 

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