Economic Reporting Review
By Dean Baker
November 4, 2002

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NOTE: We apologize for the delay in posting this message, as our internet was down this morning. In addition, links to articles are not included this week due to problems accessing the Washington Post and New York Times websites.


OUTSTANDING STORIES OF THE WEEK

Auditor Overseer Cited Problems in Previous Post
Stephan Labaton
New York Times, October 31, 2002, page A1

This article revealed that William Webster, who had just been selected by the Securities and Exchange Commission (SEC) to head a board overseeing the accounting industry, had previously been involved in an accounting scandal of his own. He chaired the audit committee of a company that is being accused of fraud. While Harvey Pitt, the head of the SEC, was aware of this fact, the other commissioners of the SEC were not told of this issue at the time they voted on Mr. Webster's appointment.


Documents Show Efforts To Promote Unproven Drug
Melody Petersen
New York Times, October 29, 2002, Page C1

This article reports on evidence that Warner-Lambert sought to promote an epilepsy drug for a variety of uses that had not been approved by the Food and Drug Administration. According to the article, the company had not performed the clinical trials that would have been necessary to get this approval.


Phony Prices May Hide Import-Export Profits From IRS
Jonathan Weisman
Washington Post, November 1, 2002, Page E1

This article reports on a new study which shows that firms have often concealed profits, and thereby evaded taxes, by exaggerating the prices paid on imported items or undercounting the price received for exports.


Trade

Leadership Struggle Inside Canada's Governing Party Intensifies
Clifford Krauss
New York Times, October 27, 2002, page A6

This article discusses the battle within Canada's liberal party to replace Jean Chretien, the current prime minister. At one point it notes the major battles of the recent past, and refers to "free trade" with the United States. This comment refers to the trade agreement with the United States that Canada put in place in 1989. It is inaccurate to refer to it as "free trade." Some of the provisions increased protectionism, most notably a clause that imposed stricter patent rules for prescription drugs in Canada. As a result of this provision, Canadians have been forced to pay more than they had in the past for many drugs.


Brazil

Predicted Winner in Brazil Faces Great Expectations
Scott Wilson
Washington Post, October 27, 2002, Page A18

This article discusses the situation in Brazil on the eve of Luiz Inacio Lula da Silva's election as president. At one point the article refers to the run-up of the government debt during the current administration. It comments that the debt "now equals almost half of the country's gross domestic product." Actually, the debt is currently equal to 62 percent of Brazil's gross domestic product.

The article notes that Brazil recently received a $30 billion loan from the IMF because "of fears that Brazil was following neighboring Argentina down the path toward financial collapse." It is not clear that this was the motivation for the loan, since it appears that even with the loan, Brazil is not on a sustainable path. Unless it has a fundamental departure from the path dictated by the IMF, a default on its debt is virtually inevitable ("see "Paying the Bills in Brazil: Does the IMF's Math Add Up?"). While it did not get Brazil on a sustainable path, the IMF loan did temporarily boost the price of Brazil's currency and its debt. This provides holders of its debt, such as foreign banks, an opportunity to sell it at a higher price than would have otherwise been the case.

The article refers at three different points to a "free-trade"
agreement with the United States. While the proposed agreement with
the United States would reduce barriers in some areas, it would raise
them in others, most notably in the case of patent and copyright
protection. It would be more accurate to refer to the proposed
agreement as simple a "trade agreement."


Brazil's President-Elect Pledges To Fight Poverty but Pay Debts
Scott Wilson
Washington Post, October 29, 2002, Page A13
(not currently available on the web)

Leftist Brazilian Victor Moves to Calm Nervous Markets
Larry Rohter
New York Times, October 29, 2002, page A3

These articles discuss the situation facing Brazil's newly elected president, Luiz Inacio Lula da Silva. At one point the Post article lists "fiscal restraint" as one of the policies (in addition to free trade and privatization) of the current president, Fernando Henrique Cardoso. Under president Cardoso, Brazil's public debt has risen from 29 percent of GDP to 62 percent of GDP. By comparison, the debt-to-GDP ratio rose by less than 19 percentage points of GDP in the eight years of the Reagan administration, which was America's largest ever
peacetime debt build-up.

The Post article then notes that the Cardoso policies have yet to alleviate poverty in Brazil. They have also yet to produce growth. Per capita GDP growth has averaged just 1.3 percent annually under Cardoso. By contrast, Brazil's per capita GDP grew at a 4.5 percent annual rate from 1960 to 1980.

The Times article concludes with a quote from U.S. Treasury Secretary Paul O'Neill, that he hopes Lula "will follow the policies Cardoso had in place." If Brazil's debt increases at the same pace under Lula as it did under Cardoso, it will reach 95 percent of GDP at the end of two presidential terms, a level that would guarantee default. (Given current interest rates, the debt burden may already be so large as to guarantee default.)


Japan

They're Alive! They're Alive! Not!: Japan Hesitates to Put an End to Its Zombie Businesses
James Brooke
New York Times, October 29, 2002, page C1

A Sick Banking System Resists Therapy
Ken Belson
New York Times, October 29, 2002, page C1

These articles examine the current economic situation in Japan. The main theme of both articles is that Japan's recovery is being prevented by the continued existence of a large number of bankrupt, or "zombie," companies. These companies are able to continue to get credit from Japan's banks because of longstanding personal and political ties.

Much of the discussion in these articles is self-contradictory. For example, the article by Belson states at one point that the loans to zombie businesses pose a problem because these loans mean that "there is less money available to help newer more promising businesses." However, the article later asserts that banks feel little pressure to stop making such loans because short-term interest rates are almost zero and the central bank is "promising easy credit" to banks in trouble. This suggests that credit is quite plentiful, so that loans to prosperous businesses are not being restricted by loans to the zombie businesses.

Furthermore, both articles suggest that the central bank is willing to provide even more credit, if the banks ever stop supporting the zombie businesses. This implies that any shortage of credit for new businesses is attributable to the policy decision of the central bank to constrain credit, not an inherent shortage of credit in Japan.

A shortage of credit could only be attributable to the zombie businesses if it reflected real supply constraints in the form of labor and physical capital. Presently Japan has large amount of unemployed labor and idle capacity; therefore it does not make sense to claim that the zombie businesses are constraining the economy. It is also important to note that a business that is losing money in a recession is not necessarily an unprofitable company. The U.S. automakers typically experience losses in a recession, but they make up for these loses with large profits during the upturns. It is possible that many of the zombie companies would prove profitable if Japan's macroeconomic situation improved as a result of an increase in demand.

At one point, the Belson article comments that "Japan is not the only country where bank lending is driven by policy imperatives and cronyism." It adds China, Taiwan, Malaysia, and Thailand to this list of nations. The characteristic that these nations hold in common, along with South Korea, which is usually included in this group, is that they have enjoyed the fastest sustained economic growth of any nations in the history of the world. The economic performance of this group of nations has been vastly superior to the performance of nations that have followed the U.S. financial model.


Trade

Global Trade in Elmwood Park: Familiar Saga With a Twist
Anthony DePalma
New York Times, October 29, 2002, page E11

This article discusses the impact of trade on Elmwood Park, a small industrial city in New Jersey. The article uses the term "free trade" in at least four different places where it would be more accurate to simply say "trade." The United States has not systematically pursued a policy of free trade. It has increased protection in recent years in some areas, for example by making it more difficult for foreign doctors to practice medicine in the United States. It has also sought to increase barriers worldwide by increasing the strength of copyright and patent protection. Therefore, it is wrong to describe the policy as "free trade."


Europe

Europe Strains To Put Laggards Back in Line
Mark Landler
New York Times, October 27, 2002, Section 3 page 1

This article discusses the current fiscal situation of the governments that take part in the Euro zone. It notes that several have budget deficits that exceed the 3 percent of GDP limit set in the "stability pact" that is supposed to restrict the fiscal policy of member states. The article repeatedly warns that this sort of restriction on the borrowing of member natons is necessary to sustain the credibility of the euro.

It is not clear that this is true. There is no national rule restricting the borrowing of states in the United States. It is generally understood that if a particular state began borrowing in a reckless manner, it would be eventually denied access to credit in financial markets. There would be no obvious negative consequences for
the dollar.

It would also have been worth noting that the tight monetary policy being run by the European Central Bank (ECB) has slowed European economies and worsened their deficits. The ECB has kept relatively high interest rates, even as the European economies have virtually stopped growing. The short-term rate set by the ECB is currently 3.25 percent. This compares to the 1.75 percent rate set by the Fed, which is widely expected to be lowered later this year. Even the IMF has criticized the ECB for this contractionary policy.

The article also includes a discussion that warns of the budgetary costs of supporting a larger population of retirees. It features a table that shows the projected increase in spending on the elderly, measured as a share of GDP, over the next forty years. It would have been helpful to note that the increase in spending on the elderly over the last forty years has been comparable. This increase in spending on the elderly did not prevent an enormous improvement in living standards for most Europeans over the last forty years, and there is no reason to expect that it will have a serious negative effect over the next forty years.

The table shows that the expected increase in spending in Britain is markedly less than in other countries. It is important to recognize that Britain mandates that workers contribute a significant portion of their wages to individual accounts. While this money is not classified as government revenue, it is not under the control of the worker, and for most purposes should be viewed as comparable to the taxes used to support public pensions.


Is Germany Looking Like Japan?
Mark Landler
New York Times, November 1, 2002, Page W1

This article assesses Germany's economic prospects. It repeatedly asserts that it is necessary for Germany to reduce its protections for workers, such as the generosity of its unemployment benefits, in order to support healthy economic growth. The article indicates that lower wages and less security for workers are "pain" necessary for the gain of better growth.

In fact, the evidence for this assertion is very limited. There is a significant body of economic research indicating that the main cause of Germany's unemployment and slow growth is the contractionary monetary policy of the European Central Bank. This view should have been presented in the article. The four sources cited in this article all came from the financial industry (two from Goldman Sachs).


Global Warming

Hostility in Canada's West Threatens Climate Policy
Clifford Krauss
New York Times, October 28, 2002, page A9

This article discusses efforts by groups in Canada to prevent the government from ratifying the Kyoto agreement, which would require it to reduce greenhouse gas emissions. At one point the article refers to studies that show that the agreement could cost Canada 200,000 jobs by 2010. It is worth noting that, in these models, job losses result from the fact that the real wage will be slightly lower as a result of the agreement (e.g. 1.0 percent) and therefore 200,000 more people will
voluntarily choose not to work at the lower wage.

It would also be helpful to put this figure in some context. For example, these models would show that the United States would lose a comparable percentage of its jobs as a result of the recent increases in military spending and homeland security. This amount of job loss has been considered too trivial to even enter the political debate over these spending increases in the United States.


Social Security

Iowa Could Tip Balance
Jim Vandehei
Washington Post, October 28, 2002, Page A1

This article discusses the Senate and congressional races in Iowa. At one point it notes that a democratic candidate, John Norris, is attacking Tom Latham, the Republican incumbent, for "allegedly putting Social Security at risk." Norris is attacking Latham for supporting the partial privatization of Social Security, which would replace a portion of the defined benefit with an individual account. This is a
position that Latham in fact held, although he, like many Republicans, is now trying to conceal this fact from voters. The article should simply describe Latham's position on this issue, rather than implying that his political opponent is simply making an unsubstantiated allegation.


Education Spending

Education Measure Roils Florida Race
Michael A. Fletcher
Washington Post, October 26, 2002, Page A3

This article discusses a ballot initiative that would require the state to reduce class size. The article reports the claim of opponents that the bill would cost $27.5 billion over eight years. It would have been helpful to readers to note that this is equal to approximately 5 percent of Florida's projected budget over this period.


The Economy

Fed Seems Headed For Interest Rate Cut
John M. Berry
Washington Post, October 26, 2002, Page A1

This article examines the likelihood that the Federal Reserve Board will cut interest rates later this year. The article neglects to consider the potential impact of the collapse of the housing bubble. Home prices have risen by more than 30 percentage points in excess of the overall rate of inflation over the last seven years. This is an unprecedented run-up in housing prices, which has added more than $3 trillion to household wealth. The collapse of this bubble is likely to seriously dampen consumption and economic growth. The article also fails to include the views of any economists who had anticipated the collapse of the stock market bubble.