Economic Reporting Review
June 25, 2001

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

OUTSTANDING STORIES OF THE WEEK

"Wall St. Advocacy Group Gets White House Help," by
John Mintz in the Washington Post, June 17, 2001,
page A2.

This article reports on Treasury Secretary Paul
O'Neill's cooperation with a financial industry
lobbying group, which seeks to privatize Social
Security. The article notes the peculiarity of the
relationship, since O'Neill is a trustee of the
Social Security system, with a fiduciary
responsibility to it.

"O'Neill Faults 'No Assets' Social Security," by
Glenn Kessler in the Washington Post, June 19, 2001,
page E1.

This article reports on a speech on Social Security
that Treasury Secretary Paul O'Neill gave before a
group of financial industry executives in New York.
In the speech, O'Neill asserted that Social Security
has no assets. The article points out that as
Treasury Secretary, O'Neill is also a trustee of the
Social Security program. In that capacity he signed
the most recent trustees' report, which shows that
the system has more than $900 billion in assets.

"States Expecting to Lose Billions from Repeal of
U.S. Estate Tax," by Kevin Sack in the New York
Times, June 21, 2001, page A1.

This article examines the amount of revenue that
states are expecting to lose over the next decade as
a result of the recent change in the federal estate
tax. The article points out that in many states the
loss will be quite significant, with the total loss
projected at 1.5 percent of projected state revenue
over the next decade. The article also emphasizes the
percentage of projected revenue that will be lost,
rather the dollar amount. The percentage of revenue
is a far more meaningful number to most readers.

"Future May Be More Uncertain for Technology," by
Gretchen Morgenson in the New York Times, June 20,
2001, page C1.

This article reports on the findings of a new study
by Merrill Lynch, which indicates that the reported
profits of many leading tech companies may be
significantly overstated. The main factors noted in
the study were that firms did not write off the value
of stock options issued to their employees as
expenses, and they were able to deduct from their
taxes the cost of buying shares (to maintain the
stock price) when these options were redeemed. While
these practices could inflate profits in a rapidly
rising stock market, the sharp stock declines in this
sector means that reported profits are likely to be
far lower in the future. It is worth noting that some
economists had called attention to these sorts of
accounting problems in the past (e.g. "The Costs of
the Stock Market Bubble," by Dean Baker,
www.cepr.net/stock_market_bubble.htm).


STEEL PRICES AND THE FREE MARKET

"Of Politics, Free Markets, and Tending Society," by
Tom Redburn in the New York Times, June 17, 2001,
Section 3, page 4.

This thoughtful article examines the factors that led
President Bush to take steps to protect the domestic
steel industry. At several points it asserts that
South Korea's steel industry is more efficient than
the U.S. industry because it can sell its steel more
cheaply. This is not clear.

The Clinton and Bush administrations have both
pursued a high dollar policy, under which the dollar
has risen 20-30 percent above a sustainable level. In
the short-run this policy has the effect of reducing
the price of imports by approximately 20-30 percent.
In the long-run, the policy cannot be sustained,
since it is causing the United States to borrow
approximately $450 billion a year from abroad. This
level of borrowing clearly cannot be maintained for
more than a few years. When the dollar falls back to
a sustainable level, it is not clear that South
Korean steel will still be cheaper than steel made in
the United States.


THE TRADE DEFICIT

"Trade Gap Narrowed in April," Business in Brief
(compiled from wire service reports and Washington
Post staff writers), Washington Post, June 22, 2001,
page E2.

"Weak Demand Helps Reduce Trade Deficit," by
Bloomberg News in the New York Times, June 16, 2001,
page C6.

These articles report on the Commerce Department's
release of trade data for April and revised data for
March. The headlines are both somewhat misleading.
The deficit figure reported for April was somewhat
lower than the revised figure reported for March, but
this was only due to the fact that the March figure
was revised upward by nearly $2 billion. The April
deficit was more than $1 billion larger than the
deficit that had originally been reported for March,
and was higher than the figure that most analysts had
expected for April. It is also worth noting that the
upward revision in the March deficit will lead to
substantial downward revision to the GDP growth
reported for the first quarter.

Reporting on the trade deficit continues to be
neglected in these papers. The Times article is a
wire service story buried in the middle of the
business section. The Post article was a three
sentence brief. The economic impact of the trade
deficit and the resulting accumulation of foreign
debt is at least as large as that of a budget deficit
of the same magnitude. While even the possibility of
the latter is given enormous attention, the
unsustainable trade deficits that the nation is
currently running are being virtually ignored.


COAL MINERS

"Waiting for Extraterrestrials to Land in the Mines,"
by Francis X. Cline in the New York Times, June 19,
2001, page A12.

This article discusses plans to bring in Ukrainian
coal miners in order to keep down wages for
mineworkers. It is worth noting that employees now
regularly seek special permission to bring workers
from other countries for many jobs in order to avoid
paying higher wages. For example, a recent article in
the Washington Post reported that hospitals in the
Washington area were recruiting nurses from all over
the world in order to avoid paying higher salaries to
nurses already in the United States ("Hospitals Go
Abroad To Fill Slots For Nurses," by Bill Brubaker,
Washington Post, June 11, 2001, page A1).

The ability to bring lower paid foreign workers has
undoubtedly been a factor depressing wages in many
occupations. However, many highly paid occupations,
such as doctors and lawyers, have been able to erect
legal and institutional barriers to make it very
difficult to bring in qualified foreign workers as
competitors.


GLOBAL WARMING

"Impasse on Gases: Who Moves First," by Andrew C.
Revkin in the New York Times, June 16, 2001, page A7.

This article examines the dispute between the
European Union and the Bush administration over the
Kyoto agreement, which limits greenhouse gas
admissions. The article notes objections from the
Bush administration and the U.S. Senate to the fact
that the treaty does not apply ceilings to developing
nations. It asserts that "countries like Saudi Arabia
and China refuse commitments just as steadfastly as
the poorest of the poor."

This is not true. Developing nations have refused
ceilings that would set strict caps on the growth of
their emissions, comparable to the caps applied to
the developed nations. Such caps would restrict the
developing nations to emission levels that, on a per
capita basis, are a small fraction of the emission
levels of the United States and the developed world.
Accepting these sort of caps would imply that people
in the United States and other developing nations
will forever have the right to pollute more than
people in the developing world, because they had
polluted more in the past. Not surprisingly, leaders
of developing nations have not agreed with this
position.

However, there is no evidence whatsoever that
developing nations would refuse caps that did not
threaten to interfere with their economic growth. In
fact, if developing nations were provided caps that
were only modest reductions from their baseline
projections of emissions, under a system of
international emissions trading, it would effectively
be providing them with large sums of money. With
relatively low cost measures, these nations could
easily cut emissions and fall under the caps, and
then sell the difference to the developed nations.
There is little reason to believe that developing
nations would object to these sorts of caps.

The example of Saudi Arabia as a developing nation
opposed to caps is a poor choice. The vast majority
of Saudi Arabia's income comes from fossil fuels. The
value of fossil fuels is likely to be significantly
reduced if the world moves ahead on a Kyoto-type
agreement. It is more likely that Saudi Arabia
opposes an agreement because of concerns about the
impact it would have on the value of its oil, than
for the difficulties it could encounter complying
with emission caps.


THE STOCK MARKET

"Fed Wonders: Where's the Rebound?" by John M. Berry
in the Washington Post, June 21, 2001, page A1.

This article examines the economy's current situation
and notes that there is little evidence of a recovery
in spite of the Federal Reserve Board's sharp cuts in
interest rates over the last six months. At one point
it notes that stock prices have not risen through
this period and asserts that "stock prices have
remained stubbornly weak, particularly for high tech
companies whose share prices have plummeted from
their speculative peaks of more than a year ago."

Actually, stock prices continue to be very high. The
price-to-earnings ratio for the market as a whole is
still close to 27 to 1, nearly double its historic
average of approximately 14.5 to 1. The tech sector
still has extraordinary price to earnings multiples,
with the NASDAQ as a whole having a price toearnings
ratio of 100 to 1, according to some estimates.


STOCK RETURNS

"Saving for a Brainy Day," by Albert B. Crenshaw in
the Washington Post, June 17, 2001, page H2.

This article discusses the implications of a new tax
exemption that allows individuals to save money in
accounts designated for their children's college
education without paying taxes on the interest or
capital gains. The article includes a chart showing
the expected accumulations in these accounts, based
on an assumption that returns would average 10
percent a year.

It is inappropriate to use an assumption of 10
percent returns (just over 7 percent after adjusting
for inflation), since there are no projections for
returns on any standard financial assets (stocks,
bonds, money market funds), which would provide
returns close to this level. Projections of nominal
stock returns, derived from projected profit growth,
are less than 7 percent annually over the next
decade. The use of more realistic assumptions would
have reduced the projected accumulations by close to
one third.


THE BUDGET

"Showdown Looms as Democrats Move to Burst G.O.P.
Budget," by Phillip Shenon in the New York Times,
June 19, 2001, page A15.

This article assesses the likely points of contention
in future budget battles. At one point it refers to
comments from Democrats that there will be no room
for additional tax cuts or spending "without a
politically disastrous raid on surpluses in the
Social Security and Medicare program." It is worth
noting that under current law, these programs are not
affected at all by whether or not Congress spends the
surpluses currently being generated. In order to
actually "raid" their surpluses, Congress would have
to rewrite the laws that govern the trust funds for
these programs.

The article also includes comments from Senator Kent
Conrad, the chairman of the Budget Committee, that he
will look to reduce spending and/or raise taxes, if
the slowing of the economy leads to a smaller surplus
than is currently projected. Virtually all economists
would recommend the opposite course. Standard
economic theory suggests that it is desirable to cut
taxes and/or increase spending in an economic
downturn. Raising taxes and cutting spending is
likely to make the downturn worse.


EUROPEAN INFLATION

"Europe: Consumer Prices Rise," by Edmund L. Andrews
in the New York Times, June 19, 2001, page W1.

This article reports on the release of new data on
inflation in Europe. At one point the article notes
that Europe's core (excluding food and energy) rate
has been 2.1 percent over the last year, which it
characterizes as "fairly steep." It is worth noting
that the core inflation rate in the United States has
been 2.5 percent over the last year. The Times ran
another article warning of high European inflation
the previous week ("Optimism Recedes as Europe Faces
Long-Term Issues," by Edmund L. Andrews, New York
Times, June 14, 2001, page W1).


SOCIAL SECURITY

"Two Sides Rally to Shape Social Security
Discussion," by Richard W. Stevenson in the New York
Times, June 18, 2001, page A12.

This article discusses the plans of supporters and
opponents of Social Security privatization, prior to
Treasury Secretary Paul O'Neill's speech to a group
of financial industry executives. At one point the
article reports that "opponents of personal accounts
say they could generate billions of dollars a year --
perhaps even tens of billions of dollars a year -- in
fees and commissions for investment firms."

This is accurate, but it is worth noting that
supporters of privatization also acknowledge that
privatization could generate fees of this magnitude.
The State Street Bank, which has been associated with
the privatization drive, designed a low cost bare
bones system, which by its own estimate would
generate approximately $5 billion a year in fees.
Olivia Mitchell, an economist who has researched this
topic extensively, and sits on President Bush's
Commission, has shown in her work that other
privatized systems spend up to 10-20 percent of their
annual revenue in fees. The same ratio applied to the
U.S. system would imply $40-800 billion in annual
fees. By comparison, the administrative costs of the
current system are less than $3 billion. In short,
there is no dispute that a privatized system will
incur billions of dollars of administrative fees.