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Economic Reporting Review

October 25, 1999

Explaining away the trade deficit; Congress' "spending binge"; South Korea's rebound

By Dean Baker

Trade | Federal Budget | Social Security | Stock Market | South Korea | Outstanding Stories

TRADE

"Trade Gap Narrows as Exports Rise"
John Burgess
Washington Post, October 16, 1999, page E1

"Trade Deficit Narrowed in August as Exports Grew"
Robert D. Hershey Jr.
New York Times, October 21, 1999, page C1

These articles discuss the trade deficit in the context of the Commerce Department's release of trade data for the month of August. Both articles downplay the importance of the trade deficit in ways unjustified by the data, and misrepresent the causes of the deficit.

For example, the Post article contrasts the concerns in the 1980s, when "trade deficits were important political issues," with the present period, when it is just "a debating subject for academics and policymakers." The Times article comments that "the deficit raises far fewer alarms than it did in 1980s; it is less than 3.0 percent of gross domestic product, about half a percentage point less than a decade ago." The Times article goes on to assert that the current deficit should not present grounds for concern because "American industry is making immense investments in new equipment that should raise productivity."

Actually, over the last few months, the trade deficit has been just over 3.2 percent of GDP. By comparison, it peaked in the '80s at just under 3.0 percent of GDP in 1986. A decade ago, in 1989, the deficit was down to 1.5 percent of GDP. While industry is investing more now compared to the '80s, it is actually investing less than it did in the '70s, measured as a share of GDP. In the most recent quarter, investment in new plant and equipment was 11.2 percent of GDP. By comparison, at the peak of the '70s cycle in 1979, investment was 12.6 percent of GDP.

It is also important to recognize that the country is less well-situated to sustain large trade deficits today than in the '80s. When the '80s deficits peaked in 1986, the United States was a net international creditor, with a surplus position equal to 2.9 percent of GDP. At present, the United States is on net an international borrower, with a deficit position that is approaching 20 percent of GDP.

If the trade deficit is receiving less attention today than it did in the '80s, it is for political reasons, not economic ones. It is worth noting the difference between the attention devoted to the budget deficit and the trade deficit. By most economic criteria, the latter poses a much greater long-term threat.

Both of these articles present a potential fall in the dollar as one of the possible problems of the trade deficit. This reverses the chain of causation. The deliberate decision of the Treasury Department to support a highly valued dollar over the last three years has been one of the most important factors in propelling the trade deficit to record levels. A higher dollar decreases exports by making U.S. goods more expensive to foreigners and making imported goods cheaper for people in the United States. While low-priced imports have the desirable short-term effect of reducing inflation and raising living standards, the resulting trade deficit cannot be sustained indefinitely. Inevitably, the dollar must fall to correct the imbalance.

"Endorsement Brings Big Labor Test for Gore"
Steven Greenhouse
New York Times, October 17, 1999, Section 1 page 20

This article discusses the relationship between organized labor and Vice President Al Gore in the aftermath of the AFL-CIO's decision to endorse Gore for president. At one point the article notes that "many middle-of-the-road Democrats and business executives are cautioning the administration not to become tools of labor and comply with demands that they deem protectionist."

While many centrist Democrats and business executives have denounced trade policies advocated by unions as "protectionist," this could not possible be their actual basis for opposing such measures. These constituencies have been very content with policies that limit the ability of foreign doctors to practice in the United States. These protectionist measures raise the income of doctors in the United States and cost consumers and the government tens of billions of dollars in higher medical bills each year.

Centrist Democrats and business executives have also been major proponents of extending copyright and patent protection throughout the developing world. These protectionist measures are enormously costly, since they can raise the price of products 500-1000 percent or more. In short, these constituencies could not possibly object to the trade policies advocated by the AFL-CIO because they are protectionist; rather, their objections must be based on which groups the policies are designed to protect.

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FEDERAL BUDGET

"Ideology as Much as Money Underlies Standoff on Budget"
Richard W. Stevenson
New York Times, October 20, 1999, page A1

This informative article examines the issues underlying the current budget standoff between President Clinton and the Republican Congress. In its last paragraph, the article asserts that over the last two decades, "the mounting budget deficit was one of the most serious economic and political problems facing the country."

While the large deficits of the 1980s clearly would have posed a serious problem if they had been sustained, tax increases and spending cuts implemented in the '80s were already reducing the size of the deficit, and by 1994, the ratio of debt to GDP was declining. The nation can perpetually run a budget deficit as long as its debt to GDP ratio is stable or falling.

"Congress Making Greater Use of Creative Accounting"
Eric Pianin and George Hager
Washington Post, October 16, 1999, page A15

This article reports on the efforts of Republicans in Congress to keep the non-Social Security budget in balance. At one point it comments that "independent budget experts on the right and left say Congress is masking the true size of its spending binge."

The characterization of the proposed levels of spending as a "binge" is dubious. While the exact amount of spending is yet to be determined, it is almost certain that spending will actually fall from 1999 to 2000, when adjusted for inflation. It is absolutely certain that it will fall when measured as a share of GDP.

It is also worth noting that it is not clear that any budget experts on the left were sources for this article. The two independent budget experts quoted in the article are Stephen Moore from the Cato Institute and Robert D. Reischauer from the Brookings Institute. Stephen Moore and the Cato Institute are both strong advocates of laissez-faire policies that would generally be viewed as conservative. By contrast, Robert Reischauer has been associated with moderate centrist policies, and should not be considered a representative of the left.

The article also errors in its calculation of the size of across the board spending cuts that would be necessary to meet budget targets. The article states that to meet its targets, Congress needs to cuts $13-20 billion from next year's budget. It then suggests that this can be accomplished with "an across-the-board spending cut of 1 to 2 percent." The discretionary portion of the budget, which is the area currently subject to debate, was $575 billion in 1999. To achieve savings of $13-20 billion, it would be necessary to cut this budget by between 2.3 to 3.5 percent.

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SOCIAL SECURITY

"President Plans to Battle Congress on Spending Bills"
Eric Pianin
Washington Post, October 18, 1999, page A1

"Democrats Accuse GOP of Distorting Facts on Social Security"
Eric Pianin and Juliet Eilperin
Washington Post, October 22, 1999, page A6

"House Sends Clinton Another Spending Bill He's Sure to Veto"
David E. Rosenbaum
New York Times, October 22, 1999, page A18

The first article discusses President Clinton's budget agenda. At one point, it asserts that he wants to ensure that the "the Social Security surplus is protected." Similarly, the last two articles both make references to Republican claims that the Democrats intend to "raid" Social Security.

As has been noted in some previous reporting, the Social Security surplus will be lent to the government in exchange for bonds regardless of how much this Congress chooses to spend (see "Noble Talk of Saving Social Security Is Muted by Political Gamesmanship," by Richard W. Stevenson, New York Times, 9/29/99, page A20 and "Hands-Off Social Security Vow Ignores Reality, Experts Say," by George Hager, Washington Post, 10/10/99, page A5). This means that the program's finances will be in no way affected by the outcome of the current debate. (See ERR, 9/27/99, 10/4/99).

"2.4% Rise, Biggest in 3 Years, Set for Social Security Benefits"
Associated Press
New York Times, October 20, 1999, page A18

This article reports on the size of the annual cost-of-living increase in Social Security checks beginning next January. At one point the article discusses proposals to reduce the size of the annual cost-of-living adjustment "to help avert a financial crisis that, in the absence of a change in law, is expected to besiege Social Security after baby boomers begin retiring."

According to the most recent projections from the Social Security Trustees, the system will be able to pay all scheduled benefits through the year 2034, with no changes whatsoever. By 2034, the youngest baby boomers will already be 70, three years past the normal retirement age. Based on these projections, the system will not have any financial problems until after all the baby boomers have retired, 26 years after the first baby boomers begin collecting retirement benefits.

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STOCK MARKET

"Stocks Tumble After Warning by Greenspan"
Ianthe Jeanne Dugan
Washington Post, October 16, 1999, page A1

"Buy Into Stocks, Not Wall Street Worries"
Fred Barbash
Washington Post, October 16, 1999, page E1

"Wholesale Prices Rose 1.1% in Sept. "
John M. Berry
Washington Post, October 16, 1999, page E1

"Producer Prices Show Gain of 1.1 Percent, Biggest in Nine Years"
Richard W. Stevenson
New York Times, October 16, 1999, page B1

All of these articles include inaccurate or misleading statements about the stock market. The first Post article examines the movement of the major stock indexes thus far this year, and notes that most of the increases can be attributed to a relatively small number of high tech stocks. At one point, it notes that the Wilshire 5000 index is "down 1.8 percent for the year." It points out that 290 Internet stocks account for about 7 percent of the Wilshire index, and that these stocks have risen by 51.27 percent this year. The article then quotes a vice-president at Wilshire asserting that "if you took these Net stocks out, you'd reduce the return by 75 percent." Since the return was negative, even including the Net stocks, this assertion does not make sense.

The second Post article argues for the merits of long-term investing in the stock market. The article suggests that it is reasonable to expect the stock market to provide average nominal returns of 8 percent annually over the next ten years.

Since the current dividend yield is on average approximately 1.5 percent of the price of a share of stock, in order to get an 8.0 percent return, the stock price would have to increase by 6.5 percent annually. At this rate, stock prices will have risen by approximately 90 percent by 2009.

The Congressional Budget Office (CBO) projects that nominal corporate profits will rise by 35 percent over this period. This means that the ratio of a price of a share of stock to its earning will be close to 45 to 1 by 2009, approximately three times it historic average. Virtually no economist believes this is plausible, which means that if the CBO profit projections are correct, this article has hugely overstated the potential returns available in the stock market.

The third Post article and the Times article both refer to comments from Federal Reserve chair Alan Greenspan, suggesting that it is very difficult to determine whether current stock prices are sensible, since it is not possible to know whether expectations about future profits are correct.

The Congressional Budget Office and other government agencies routinely make profit projections along with their other economic projections. These projections provide the basis for planning budget policy, as well as the monetary policy conducted by the Federal Reserve Board. If Greenspan really views these projections as being so unreliable in providing a basis for valuing the stock market, then presumably they are of little more use in guiding budget or monetary policy.

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SOUTH KOREA

"Korean Jobless Rate Drops"
Bloomberg News
New York Times, October 22, 1999, page C4

"9% Korean Growth Seen"
Samuel Len
New York Times, October 22, 1999, page C4

Both of these articles present evidence that South Korea's economy is recovering rapidly from its recession. The first article reports on a 0.9 percentage drop in the unemployment rate in the month of September, to 4.8 percent. According to the article, this is the lowest level in 20 months. The second article reports on an upward revision in this year's growth projection to 9.0 percent by one of the country's leading economic research institutes. This growth rate will more than fully offset the 5.8 percent contraction in 1998.

It is interesting that the evidence that Korea's economy is rebounding strongly was given such little attention. These are both one paragraph articles in the "World Business Briefing" section of the Times. This information was not reported anywhere in the Post.

Both papers have repeatedly given prominent attention to complaints that South Korea has not taken sufficient steps to reform its economy to make it more like the United States. (E.g., see "Skepticism Over Korean Reform," by Stephanie Strom, New York Times, 7/30/99, page C1; and "Asian Rebound Derails Reform as Many Suffer," by David E. Sanger and Mark Landler, New York Times, 7/12/99, page A1; see ERR, 7/19/99, 8/2/99.) The evidence in these new reports suggests that the failure to reform its economy in the manner recommended by the IMF and the U.S. government has not impeded Korea's recovery.

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OUTSTANDING STORIES OF THE WEEK

"Fed Learns Bartenders Are More Popular Than Bouncers"
Floyd Norris
New York Times, October 22, 1999, page C1

This article discusses the dilemma facing Alan Greenspan as he tries to reign in the stock market. On the one hand, he does not want to bring on a crash. But, if he does nothing, there is the risk that the market will go higher, making the eventual correction even larger.

"Many Banks Make Money on Lending"
Richard A. Oppel Jr.
New York Times, October 22, 1999, page C8

This article examines the record on bank lending in poor areas and points out that it generally has proved profitable. Much of this lending has been prompted by the Community Reinvestment Act, which was passed in the late '70s to promote lending in poor communities. The status of the Community Reinvestment Act is one of the central issues in the current debate over restructuring the laws regulating the financial system.

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Dean Baker is a senior research fellow at the Preamble Center and at the Century Foundation.


Recent articles can be found on the websites of the New York Times and Washington Post.

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