Economic Reporting Review, 2/27/01, By Dean Baker

["Robert Naiman" <naiman@xxxxxxxx>]

Economic Reporting Review, 2/27/01
By Dean Baker

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OUTSTANDING STORIES OF THE WEEK

"By Listening, 3 Economists Show Slums Hurt the
Poor," by Louis Uchitelle in the New York Times,
February 18, 2001, Section 4, page 4.

This article discusses the research of three
economists who examined the experience of
families who were able to escape poor
neighborhoods by getting government housing
vouchers. The researchers found that, while
there were no clear gains in income or school
performance, the families that left poor
neighborhoods had better health outcomes and
their children had fewer behavior problems, as
compared to the families left behind. "Drop in
Business Investment Big Factor in Economy's
Stall," by Steven Pearlstein in the Washington
Post, February 20, 2001, page A1.

This article examines the impact that a slowdown
in investment spending is likely to have on the
economy, and the reasons that a slowdown may be
prolonged. It points out that because of over-
investment in many sectors, investment may be
depressed for some time into the future.

"Court Papers Depict Scheme in Drug Billing," by
Melody Petersen in the New York Times, February
20, 2001, page C1.

This article describes a case brought by federal
prosecutors against a doctor who prescribed drugs
for Medicare and Medicaid patients in exchange
for kickbacks from a drug manufacturer. This sort
of kickback scheme is exactly the kind of
behavior that economists would predict from the
monopoly pricing system created by patents. Since
patent monopolies allow drug companies to sell
their products at prices far above their cost,
they have strong incentives to use both legal and
illegal means to increase sales of their drugs.




THE TRADE DEFICIT

"Price Index Rose 0.6% in January," by John M.
Berry in the Washington Post, February 20, 2001,
page E1.

"Inflation Index Jumps Due to Energy Costs," by
Michael Brick in the New York Times, February 22,
2001, page C1.

These articles report on the release of January's
consumer price index by the Labor Department and
the release of trade data for December and the
whole last year by the Commerce Department. The
discussion of the trade deficit is very brief and
only appears at the very end of both articles.

The trade data deserved far more attention than
it received. The United States had a record trade
deficit in 2000 of 3.7 percent of GDP, or $369.7
billion. This brings the nation's accumulated
foreign debt close to $2 trillion, and the
country is currently accumulating debt at the
rate of close to $450 billion a year.

The impact of foreign debt on the economy is
comparable to the impact of government debt. In
other words, accumulating foreign debt at the
rate of $450 billion a year presents roughly the
same problem as a budget deficit of $450 billion.
Both newspapers have devoted large amounts of
space to spending or tax cut proposals which
could cause the federal government to run
relatively modest deficits five or ten years into
the future.

There is no economic reason that the possibility
of modest budget deficits at some point in the
future should be seen as more important than the
large trade deficits that the nation is currently
running. The record trade deficit reported for
2000 should have been treated as one of the most
important economic stories of the year.


TAXING STOCK OPTIONS

"Stock Option Blues: Slide Leaves Little But a
Big Tax Bill," by Matt Richtel in the New York
Times, February 18, 2001, Section 1, page 1.

This article discusses a tax problem that has hit
many people working at high-tech companies. Under
current tax law, workers are taxed on the gains
on stock options at the time they choose to
exercise the options. This means that if their
options give them the right to purchase 1000
shares of stock at $10 per share, and they
exercise the option when the stock is at $50,
then the difference between the price at the time
of purchase and the option price is taxable
income ($40,000 in this case -- a gain of $40 per
share on 1000 shares). Since many workers
continued to hold their stock after exercising
their options, and the stock prices subsequently
plummeted, many workers find themselves with
large tax liabilities for near worthless shares
of stock.

The article repeatedly presents this issue as a
problem of the tax system not keeping pace with
changes in the economy. The article does not
present any economists' assessment of this
problem, but it is unlikely that economists
would agree with the view presented in the
article.

The main problem for these workers is that they
have chosen to place a large portion of their
earnings in extremely risky assets, including
money that they should have set aside to pay
their taxes. They have run into trouble not
because of the tax code, but because of their
risky investments. For example, imagine that a
cab driver -- who is likely to owe taxes on his
tips -- took all of his money and put it in a
risky land deal. If the cab driver then had
trouble paying his taxes after the deal
collapsed, no one would consider this to be a
problem caused by the tax code.

This is exactly the situation being faced by
these workers. If the tax code were to be changed
to accommodate these workers, not only would it
be unfair to other taxpayers, it would also
encourage foolish risk-taking. In fact, the
gamble being taken by these workers is especially
risky, since their jobs also depend on the well-
being of the company. In the situations described
in the article, workers can lose both their jobs
and their savings if their company does poorly.
As any economist would almost certainly have
Pointed out, it would be extremely irresponsible
to structure the tax code in such a way as to
encourage this sort of risk-taking.


PRODUCTIVITY GROWTH

"More Gains in Productivity Likely, Fed Official
Says," by John M. Berry in the Washington Post,
February 21, 2001, page E3.

This article reports on a talk on productivity
growth given by Edward Gramlich, one of the
governors of the Federal Reserve Board. At one
point the article refers to an analysis presented
by Gramlich showing that productivity growth has
been slowing in most European countries in recent
years, while it has been accelerating in the
United States. It is worth noting that according
to OECD data, most European nations enjoyed far
more rapid productivity growth than the United
States, until the last few years. Over the period
from 1980 to 1995, the OECD reports that the
annual rate of productivity growth averaged just
1.2 percent in the United States compared to 2.1
percent in Germany and 2.2 percent in France and
Italy. It is not uncommon for there to be erratic
movements in productivity growth for a few years,
so it may be too early to draw any conclusions
about the recent speed-up in productivity
growth in the United States.

In this respect, it is also worth noting that
after adjusting for measurement changes, over the
last four years the Social Security trustees have
actually lowered their projections for long-run
productivity growth by approximately 0.2
percentage points.


OIL IN THE ARCTIC NATURAL WILDLIFE REFUGE

"The Void Without the 'Great Beyond,'" by Sam
Howe Verhovek in the New York Times, February 18,
2001, Section 4, page 1.

This article discusses the importance of the
Arctic Natural Wildlife Refuge (ANWR) as one of
the country's few relatively untouched regions.
At one point it presents an argument by
proponents of oil drilling: that the oil which
comes out of ANWR will enhance national security
by reducing the nation's dependence on foreign
oil. This is a peculiar argument, since it is
only true as long as the oil is in the ground.

At present, and in almost any foreseeable future
scenario, the U.S. can buy all the oil it chooses
to buy on world markets. If it drains the oil
from ANWR during a period in which oil is readily
available, then it has eliminated a reserve that
may be important at some point when oil is not
available. The national security argument on ANWR
would seem to be that the oil should be left
there, to protect against the possibility that
the U.S. will be unable to get foreign oil at
some future date.


EUROPE

"Old World, New Economy," by William Drozdiak in
the Washington Post, February 18, 2001, page H1.

This article examines the current economic
situation in Europe. It contrasts the relatively
strong growth of the last year with what it
portrays as European stagnation in prior years.
For example, the article includes a quote from a
Harvard business professor who asserts: "the
mystery is why, with all these strengths, Europe
has fallen so short of the United States."

The image of stagnant European economies
presented in this article sharply conflicts with
data from the OECD. According to these data,
until the last few years, European nations
regularly maintained far more rapid rates of
productivity growth than the United States. In
the period from 1980 to 1995, productivity growth
averaged growth in the United States averaged 1.2
percent annually. By contrast, it averaged 2.1
percent in Germany, and 2.2 percent in Italy and
France over this period. In the years since 1995,
productivity growth in the United States has been
somewhat more rapid than in Europe, but not
nearly so much as to reverse its relative
weakness over the prior period. Economists view
productivity growth as the main determinant of
living standards in the long-run.

The article also refers to a general
disenchantment in Europe with what it terms
"socialism," referring to the social welfare
systems that exist across the continent. The
article interviews a number of business
executives who appear to express this
disenchantment. However, it is worth noting that
the elected governments in every country in
Europe, except Spain, include Socialist or
Social Democratic parties in their governing
coalitions. The major shift in public sentiment,
as expressed by its votes, has been away from the
conservative, more market-oriented parties that
held power in many countries in the eighties.


DOLLAR POLICY

"O'Neill Reaffirms Strong-Dollar Policy," by
William Drozdiak in the Washington Post, February
18, 2001, page A3.

This article reports on Treasury Secretary Paul
O'Neill's statements that the Bush Administration
is committed to a strong dollar. The article
includes no analysis of the impact or
desirability of a strong dollar.

It is worth noting that in the 1980s most
economists viewed a strong dollar as highly
undesirable. The conventional view of the impact
of the Reagan era budget deficits is that the
deficits led to high interest rates. This in turn
encouraged a large in-flow of foreign money, as
foreign investors sought to take advantage of the
high interest rates available in the United
States. The in-flow of money raised the value of
the dollar. This had the negative effect of
making U.S. goods less competitive in world
markets, which led to record setting trade
deficits in 1986-1987. It is also worth noting
that the money pulled into the U.S. by high
interest rates might otherwise have been invested
in developing nations, a point often argued by
economists who favored reducing the federal
budget deficit.

The current high dollar policy has led to even
larger trade deficits than those of the 1980s,
measured as a share of GDP (3.7 percent in 2000,
compared to a peak of 3.0 percent in 1987). As a
result, the United States is currently
accumulating foreign debt at the rate of more
than $400 billion annually. If the trade deficit
stays at its current size in relation to GDP, the
foreign debt will exceed $10 trillion by the end
of 2010. Since it is not apparent that large
U.S. trade deficits and foreign debt are
positive, it would have been helpful if this
article presented some analysis as to why a
strong dollar would be viewed as desirable.