Economic Reporting Review
February 27, 2002

By Dean Baker, co-Director of the Center for Economic and Policy Research

OUTSTANDING STORIES OF THE WEEK

Enron Had More Than One Way To Disguise Rapid Rise in Debt
Daniel Altman
New York Times, February 17, 2002, Page A1

This article reveals how Enron was able to hide a significant
amount of debt from its auditors using "pre-paid" swaps. These are
exchanges of income flows (e.g. interest payments on different types
of bonds), where one party pays its side in advance. Apparently,
Enron's auditors were unable to recognize that this effectively
constituted a loan to Enron.


U.S. Corporations Are Using Bermuda To Slash Tax Bills
David Cay Johnston
New York Times, February 18, 2002, Page A1

This article reports on the growing use of Bermuda as a tax
haven by U.S. corporations. By locating their headquarters in
Bermuda, corporations can escape paying many corporate income taxes.


Fiber Optic Fantasy Slips Away
Simon Romero and Seth Schiesel
New York Times, February 17, 2002, Section 3 page 1

This article reports on the way in which manufacturers of
fiber optic cables were able to use swaps to inflate the revenue
shown on their financial statements.


The State of the Economy

Industrial Production Falls Only 0.1 Percent
John M. Berry
Washington Post, February 16, 2002, Page E1

This article discusses the release of new data from the
Federal Reserve Board, which showed only a slight decline in
industrial production in the month of January. At one point, the
article reports on new data on consumer confidence, which showed a
sharp drop from the previous month's reading. The article then goes
on to note (correctly) that "the link between attitudes and spending
is not very tight," and therefore this decline may not presage a
falloff in consumption.

The weak link between the consumer confidence index and
consumer spending has been noted in past articles with the same
byline, when a consumer confidence index fell (see "Consumer
Confidence Fell Again in Nov.," by John M. Berry, Washington Post,
November 28, 2001, page E1). However, a strong reading in these
indexes has frequently been presented as a basis for optimism about
consumer spending patterns ("Economy Gains As Consumers Keep
Spending," by John M. Berry, Washington Post, July 14, 2001, Page E1
and ERR 7-23-01; "Economic Reports Show Gains," by John M. Berry,
Washington Post, June 27, 2001, Page E1 and ERR 7-2-01; "Economy
Beats Expectations," by John M. Berry, Washington Post, April 28,
2001, Page A1 and ERR 5-7-01; and "Reports Offer Positive Economic
News," by John M. Berry, Washington Post, April 3, 2001, page E1 and
ERR 4-9-01).

At one point the article infers a strong rate of productivity
growth in manufacturing in January, based on the fact that reported
hours fell by 0.9 percent, while output in manufacturing was reported
as being unchanged. This inference is incorrect. The monthly measure
of hours worked is very erratic. It is more likely that the large
reported drop in hours was attributable to an error in measurement
than an actual reduction in hours. In December, manufacturing output
fell by 0.4 percent, while hours in manufacturing were reported as
unchanged. Using the article's methodology, this implies that
productivity in manufacturing fell byy 0.4 percent in December, or
4.2 percent at an annual rate.


Copyrights

Case Could Shift Balance In Debate on Public Domain
Amy Harmon
New York Times, February 20, 2002, Page C7

This article examines the potential importance of a case
before the Supreme Court, which is examining a law that extended the
duration of copyright protection, retroactively, to 95 years after
the death of the creator. The article should have included comments
from someone who could have given an assessment of the economic
effects of weakening this form of protectionism. Since copyrights
raise the price of protected by items by several hundred percent (or
more) above their competitive price -- in contrast to other forms of
protectionism, which rarely raise prices by more than 15-20 percent --
the economic costs of copyrights are quite large, and should be
discussed in this sort of overview.



Enron and the Collapsing Stock Market Bubble

Why a Scandal Became a Spectacle
Richard W. Stevenson
New York Times, February 17, 2002, Section 4 page 1

This article examines the implications of the Enron scandal
for the public's view of the role of markets and government. At one
point, the article characterizes the "consensus view" of the economy
last summer, that "the expansion has slowed but not expired and that
its bounty -- most notably the huge projected federal budget surplus -
- remained intact."

In fact, this was not the consensus view of the economy last
summer. There were economists who had warned of the structural
imbalances being created by an over-valued stock market, high levels
of consumer indebtedness, and the growing level of foreign debt
(see "As the Implosion Begins …? Prospects and Policies for the
U.S.
Economy: A Strategic View." by Wynne Godley and Alex Izurieta, The
Levy Economics Institute, July, 2001; Double Bubble: The Over-
Valuation of the Stock Market and the Dollar, by Dean Baker, Center
for Economic and Policy Research, June, 2000
[http://www.cepr.net/columns/baker/double_bubble.htm]; and "The Costs
of the Stock Market Bubble," by Dean Baker, Center for Economic and
Policy Research, November, 2000
[http://www.cepr.net/stock_market_bubble.htm]). These papers warned
that the correction of the economy's imbalances was likely to largely
eliminate the huge budget surpluses that were being projected at the
time. These papers also warned of accounting irregularities that were
likely to come to light as the stock market bubble began to deflate.

These dissenting views were largely ignored by the media
(including the Post and the Times) and most of the policy-making
community. However, it is important to recognize that the economy's
current problems were entirely predictable, and were in fact
predicted. Such predictions were almost completed ignored by those in
a position to act upon them.


End of Recession Is Seen, but Strength of Recovery Is Unclear
Richard W. Stevenson
New York Times, February 22, 2002, Page A19

This article reports on the assessments of "economists and
government officials" that "the recession had almost certainly come
to an end." It is worth noting that many economists and government
officials had failed to anticipate the onset of the recession.
The "Blue Chip" top 50 forecasters all forecasted strong growth for
the 2001, as did the Congressional Budget Office. These economists
were subsequently embarrassed when their forecasts were shown to be
so far off the mark (see " Why a Scandal Became a Spectacle," by
Richard W. Stevenson, New York Times, February 17, 2002, Section 4
page 1). There are economists who differ with the perspective
presented in this article. Their views should have been presented.



Japan

Struggling Japanese Leader Set to Greet Bush
Clay Chandler
Washington Post, February 17, 2002, Page A30

Bush Starts Trip Today to Much Less Formidable Japan
James Brooke
New York Times, February 17, 2002, Page A17

Bush, on Tokyo Visit, Calls Koizumi 'a Great Reformer'
Elisabeth Bumiller
New York Times, February 18, 2002, Page A7

These articles examine the economic situation in Japan at the
time of President Bush's visit. All three paint a very dire picture
of the economic situation and assert that the country must have
structural reforms in order to recover. This has been a repeated
theme in reporting on Japan over the last five years.

While many economists hold this view, some prominent
economists, most notably Princeton University Professor Paul Krugman,
have argued that the most pressing problem facing Japan is deflation.
This can best be remedied by simply having the central bank print
more money with the explicit goal of generating a modest rate of
inflation (2.0-3.0 percent). As Krugman points out, there are no
supply constraints in Japan right now. The country has a large
current account surplus, and huge amounts of excess capacity and
unemployed labor. It also has plenty of capital -- interest rates on
corporate debt are far lower in Japan than in the United States. (The
real interest on high quality corporate bonds in Japan is
approximately 2.0 percent, compared to 3.8 percent in the United
States.)

The constraint impeding Japan's growth is simply a lack of
demand. Eliminating less efficient producers and government waste
will not generate more demand. Similarly, in a context where interest
rates are already very low, forcing banks to cut off bad borrowers is
not going to free up capital for new investment -- the capital is
already there. In short, while there may be a case for structural
reforms in Japan, they are unlikely to pull its economy out of its
slump; in fact, they could make the slump worse.


Tax Cuts and the Economy

Cheney Says Tax Cuts Eased Recession
Karen DeYoung and Glenn Kessler
Washington Post, February 16, 2002, Page A5

This article reports on a new study by President Bush's
Council of Economic Advisors (CEA) which finds that last year's tax
cuts had a substantial impact on growth and job creation,
significantly reducing the severity of the recession. The article
then cites research which seems to question this finding, since most
of the tax cut was saved.

These two findings are not inconsistent. If just one fourth
of the tax cut were spent over a three month period, this would
translate into $36 billion of additional spending at an annual rate
($9 billion multiplied by 4), which is equal to approximately 0.35
percent of GDP. This $36 billion represents the increase in that 3-
month period, compared to a counter-factual where there was no tax
cut. If this increase is annualized (implying that each quarter grows
at the same pace -- which is the way GDP growth is calculated), it
translates into an increase in the growth rate of approximately 1.4
percentage points (0.35 percentage points multiplied by 4). It is
conventional to assume that a significant portion of this money is re-
spent, leading to a multiplier effect of any spending induced by the
tax cut. The multiplier is usually estimated at approximately 1.5,
which means that the tax cut could have led to an increase in the
rate of GDP growth of close to 2.1 percentage points (1.4 percentage
points multiplied by 1.5). Therefore, the claims by the CEA are
plausible, even assuming the majority of the tax cuts were saved.


Accounting Rules

Tech Firms Fight Shift in Rules on Options
Jonathan Krim
Washington Post, February 20, 2002, Page E1

This article discusses the debate over whether firms should
have to list the cost of stock options as an expense against profits
at the time they are issued. It presents the argument of firms in the
tech sector that requiring this accounting treatment would lead to a
large fall in their share prices. It would have been appropriate to
present the views of an economist in this article. If the tech firms
are correct, then their share prices are being inflated by the fact
that many investors don't understand the true cost of options;
otherwise, this change in accounting would have no effect on share
prices.


Argentina

In Argentina, Going Without
Paul Blustein
Washington Post, February 19, 2002, Page E1

This article discusses Argentina's efforts to cope with the
financial crisis following the default on its debt. At one point, the
article discusses Argentina's efforts to negotiate a new loan from
the I.M.F. It comments that the fund "has so far insisted that the
Duhalde government must take a number of politically painful steps to
put economic policy on a surer footing." This assumes that the I.M.F.
is a good judge of what constitutes sound economic policy. Its record
in countries such as Brazil, Russia, Indonesia, and even Argentina --
where it supported its policy of pegging the peso to the dollar, even
when it was clear that it could not be sustained -- indicates that it
is not necessarily able to recognize sound economic policy.

The article also makes a passing reference to a loan from the
I.M.F. to Brazil in 1999, which it credits with helping to stabilize
Brazil's economy. While this is accurate, it ignores the fact that
the I.M.F. insisted that Brazil maintain its exchange rate at
unsustainable level. The over-valued exchange rate led to high
interest rates, large current account deficits, and a recession.
Growth only resumed after Brazil broke with the I.M.F. and devalued
its currency.