Economic Reporting Review
November 26, 2001

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

OUTSTANDING STORIES OF THE WEEK

Telecom's Pied Piper: Whose Side Was He On?
Gretchen Morgenson
New York Times, November 18, 2001, Section 3 page 1

This article examines the role of Jack Grubman, an analyst at
Salomon Smith Barney, in promoting stocks of telecommunications
companies in the late nineties. The article notes that Mr. Grubman's
analysis of the industry was consistently far more optimistic than
that of other analysts. It also points out that Salomon Smith Barney
earned large fees underwriting stock and bond issues from the
telecommunications industry during this period.

What Detroit Can Teach Washington
David Leonhardt
New York Times, November 18, 2001, Section 3 page 4

This article discusses the stimulus that has been provided to
the economy by the decision of the major auto manufacturers to
provide zero interest financing as an incentive to car buyers.

Sept. 11th Fallout Likely to Trim Trade Deficit
John M. Berry
Washington Post, November 18, 2001, page H1

This article examines the impact on the September trade
deficit of the insurance payments resulting from the September 11th
attacks. It points out that payments from foreign re-insurers will
lead to a large fall in the size of the reported deficit for the
month.


Increased Spending on Drugs Is Linked to More Advertising
Melody Peterson
New York Times, November 21, 2001, Page C1

This article reports on the findings of a study by the
National Institute for Health Care Management, that higher
advertising spending has led to substantial increases in spending for
certain drugs.


Russia

At Last, Signs of Economic Revival in Russia
Michael Wines
New York Times, November 18, 2001, Page A1

This article reports on the recent upturn in the Russian
economy. At one point it notes that the basis for this upturn lay in
part in the financial collapse of 1998 [which is wrongly
characterized as an "economic collapse"], which led to a devaluation
of the ruble and made Russian goods more competitive internationally.
It is worth noting that the I.M.F. and the Clinton Administration
worked hard to prevent the devaluation of the ruble. They claimed
that devaluing the ruble would be disastrous for the Russian economy.
This perspective was generally reported uncritically in the media at
the time (e.g. see "Yeltsin Must Resort to Reform by Decree," by
Sharon LaFraniere, Washington Post, July 18, 1998, page A14; "Russian
Bailout Fails To Ease Market Fears," by Sharon LaFroniere, Washington
Post, July 28, 1998, page A1; and "Yeltsin and Crew Are Sinking Like
the Ruble," by Michael Wines, New York Times, August 22, 1998, page
A1).

The article asserts that "the average Russian is only starting to
approach the level of real income enjoyed when the Soviet Union fell
10 years ago." According to data from the World Bank, per capita GDP
is Russia is approximately 40 percent less than it was 10 years ago.
It also asserts that "much of Eastern Europe navigated a period of
disarray and began racing toward Western-style prosperity and
democracy." According to data from the World Bank, Poland is the only
country that is currently enjoying a living standard that is
significantly above its 1989 level. Most East European countries have
seen a decline in per capita GDP since the collapse of Communism. In
the extreme cases, like Bulgaria and Lithuania, the World Bank's data
shows per capita GDP falling by more than 25 percent.


Argentina

Argentina's Provinces Struggle to Stay Afloat
Clifford Krauss
New York Times, November 18, 2001, Page A3

This article examines the difficulties that Argentina's
provinces are facing in trying to pay their bills. At several points
it attributes the source of the provinces problems to the central
government's budget deficit, which it repeatedly characterizes as
excessive -- at one point describing it as "ballooning." The latest
estimates put Argentina' s budget deficit this year at approximately
2.6 percent of GDP. This deficit is occurring as Argentina is
entering the fourth year of a recession. Because tax collections fall
and benefits related to unemployment rise in a recession, deficits
generally increase during recessions. During the relatively mild
1990-91 recession in the United States, the deficit peaked at 4.7
percent of GDP.

This article never mentions Argentina's decision to peg its
currency to the dollar as a source of the provinces' economic
problems. This decision has both reduced the competitiveness of
Argentina's goods in international markets and led to much higher
interest rates, since many investors believe a devaluation is
inevitable. High interest rates hurt the provinces both directly and
indirectly. The indirect effect is through the damage they cause the
economy. The direct effect is the higher interest payments that the
provinces must pay on loans.


Japan

Reformist Premier Finds Japan Difficult to Change
Howard W. French
New York Times, November 17, 2001, Page A3

3 Asian Exporting Countries Show More Signs of Trouble
Ken Belson
New York Times, November 17, 2001, Page C3

These articles both discuss Japan's economic downturn. Both
articles imply that Japan must adopt the path of a major structural
overhaul of its economy in order to resume economic growth. The first
article ignores, and the second does not take seriously, the argument
put forward by many prominent economists, most notably Princeton
University professor Paul Krugman, that Japan's main focus should be
on reversing its current deflation, by having its central bank set a
target of modest inflation.

The first article reports, without any critical comments,
Prime Minister Junichiro Koizumi's view that Japan's "old postwar
recipe for success has become a recipe for collapse." The second
article presents an argument attributed to the finance minister that:
"the main tool for controlling inflation once it begins -- higher
interest rates -- would be disastrous for government finances."

Given the importance of the argument for using inflation to
restart Japanese economic growth, both within the economics
profession and in Japanese political circles, reporters should
present the case fairly. The point about government finances is
largely incoherent -- to generate inflation the central bank would be
buying up government debt. Also, the value of outstanding debt would
be eroded by inflation --therefore inflation would improve the
government's financial situation. Furthermore, if the policy worked,
it would lead to more growth and tax collections, and lessen the need
for stimulus policies and transfer payments. Therefore the government
deficit would be sharply reduced.


Insurance Against Terrorism

Debating the Limits of Liability
Juliet Epstein
Washington Post, November 17, 2001, page A8

This article discusses the debate over government limits on
insurers' liability for claims resulting from terrorist attacks, with
the government paying for damages in excess of the limit. This
article, like others on the topic, overlooks an important policy
decision in this debate.

Some activities or structures are more prone to terrorist
attacks than others. For example, planes seem more susceptible to
terrorist attacks than trains or cars. Similarly, large high rises
may prove to be both a more inviting target for terrorists and have a
greater likelihood of deaths from an attack, due to the difficulties
of escaping from high floors.

If the government were to provide fallback insurance against
all terrorist attacks, at no cost, it would effectively be
subsidizing the activities that are more likely to be targeted by
terrorists. In other words, air travelers will have a portion of the
risk associated with flying paid for by the government. It is not
clear that this is a desirable policy, since the government may not
want to encourage behavior that makes individuals more vulnerable to
terrorist attacks, as opposed to safer alternatives. But regardless
of the outcome, the public should at least be aware of these
implications and choices when Congress is deciding on liability
limits.


Fiscal Stimulus

Neither Side Blinks as Ideological Rift Stalls Progress on Stimulus
Package
Richard W. Stevenson
New York Times, November 17, 2001, Page B6

This article reports on the political standoff over the
Democratic and Republican proposals for a stimulus package. The
article attributes the differences to deeply held ideological views.
It is questionable whether this is actually the basis for the
differing positions.

As noted previously (see ERR 11-19-01), the Republicans have
justified their past support of tax cuts for high income individuals
by claiming that they are more likely to save this money. In standard
economic theory, when the economy is near full employment, higher
savings will lower interest rates, which in turn will increase
investment, and thereby promote economic growth.

However, when an economy is a recession, higher savings
simply deepens the recession. Therefore, if the Republicans believe
their argument for tax cuts oriented to the wealthy, than they can't
really believe that their proposal is a good stimulus package for the
current recession.

The article also includes an assertion that monetary policy
is "more or less non-ideological." It does not indicate the basis for
this assessment. Monetary policy involves a tradeoff between some
higher risk of increasing inflation versus lower unemployment. The
willingness of a central bank to take these risks will depend on the
relative importance it assigns to reducing unemployment as opposed to
maintaining low rates of inflation.


The Recession

Rebound Expected Soon, but Strength Is Unclear
John M. Berry
Washington Post, November 22, 2001, page E1

This article reports on the views of several analysts the
economy is on the verge of a recovery. One of the main reasons for
this view is the fact that the stock market has risen significantly
from its recent troughs, and these analysts expect that it will rise
further. The article reports the assertion of one analyst that stock
prices have historically risen just before the bottom of a recession,
which is presented as evidence that the bottom is near.

When making historical comparisons it is worth noting that
the economy has never entered a recession with the price to earnings
ratio in the stock market as high as it is at present. The stock
market has currently has a price to earnings ratio of close to 23 to
1, measured against the peak corporate earnings of 2000. This
compares to an average price to earnings ratio of just under 15 to 1
over the last seventy years. This ratio usually falls just before a
recession. Before the 1975 and 1981 recessions, the price to earnings
ratio in the stock market fell to less than 10 to 1.

The article attributes much of the hope for a recovery to an
expected rebound of inventories. It cites one analyst who expects
this quarter's GDP data will show that the inventory-to-sales ratio
is lower than at any point in the1990-91 recession. While this is
true, it is not clear that it implies that firms are going to start
rebuilding their inventories. There has been a persistent decline in
the inventory-to- sales ratio over the last two decades, as
improvements in information technology have allowed firms to minimize
their holdings of inventory. According to data from the Commerce
Department, the inventory to sales ratio for 2000 averaged 1.33. By
comparison, its low point in the last recession was 1.48, which it
hit in August of 1990.

The article includes an analyst's assertion that "if
businesses just stop cutting inventories in the first three months of
next year, that alone would add nearly 4 percentage points to the
first quarter growth rate." Inventories were reported as declining at
a $50.4 billion annual rate (in 1996 dollars) in the third quarter.
This decline in inventories is subtracted from GDP. If inventories
remain unchanged in the next quarter, then it would effectively add
$201.6 billion to the rate of GDP growth in quarter (the quarterly
change is multiplied by four, since GDP growth is reported as an
annual rate.) GDP was reported as $9,334 billion in the third quarter
(in 1996 dollars), which means that if inventories remained flat, it
would add approximately 2.2 percentage points to the growth rate.

The Post has consistently reported the views of analysts who
underestimated the severity of the downturn and did not anticipate
the recession. For example, see "Economy Gains As Consumers Keep
Spending," Washington Post, July 14, 2001, Page E1 and ERR 7-23-01;
"Economic Reports Show Gains," Washington Post, June 27, 2001, Page
E1 and ERR 7-2-01; "Economy Beats Expectations," Washington Post,
April 28, 2001, Page A1 and ERR 5-7-01; and "Reports Offer Positive
Economic News," Washington Post, April 3, 2001, page E1 and ERR
4-9-01. It should present a broader range of expert opinions in its
coverage.