Eduardo Porter had a very good piece in the Times this morning on the huge run-up in the foreign exchange reserves of developing countries. The basic point is that these reserves are held in short-term deposits that typically pay little or no real return. In poor countries that have great need of capital, diverting money to foreign exchange reserves has a large opportunity cost.

The fact, that developing countries feel that they need such large reserves is a testament to the failure of the international financial system. If the system were working well, they would have no more need of reserves at present (relative to their GDP) than they did twenty years ago.

We did a short paper on this topic a few years back. It is good to see the issue finally drawing more attention.

--Dean Baker

The passing of John Kenneth Galbraith is a real loss. His works made major contributions to public debate over the entire post-World War II era, and continue to have an impact. The New York Times had a mostly fair commentary today on Galbraith's life and work. (Brad DeLong does a good job pointing out the ways in which it is not fair.) The Post apparently did not learn the news in time for the Sunday edition, or alternatively it had not prepared an obit in advance.

Any assessment of Galbraith's life invariably includes the comment that his work had more influence outside of economics than within the profession. This is unfortunate for the economics profession. While we can benefit from mathematical modeling and new econometric techniques, I believe that Galbraithian insights will ultimately prove far more important in advancing our knowledge of the economy and society.

--Dean Baker

Eric Dash at the New York Times had a very good piece this morning on a backdoor $500,000 bonus that Denny's gave to its CEO, Nelson Marchioli, by allowing him to buy stock at below the market price. Of course Denny's is free to pay Mr. Marchioli whatever it feels is appropriate, but by making the payment in the form of stock options priced at below market values, it was able to conceal this payment from all but the most vigilant analysts. As the article points out, Denny's is not the only company making such surreptitious payments to its top executives.

There are two important points here. First, this sort of surreptitious pay deal demonstrates a continuing problem in corporate governance. Companies are not supposed to be run for the well-being of their CEOs. If the pay could not be disclosed openly, then it is not proper, end of story. It would be reasonable for the laws to mandate that all compensation packages for top executives have to be subject to shareholder approval at regular intervals. This is not government intervention, this is the government setting workable rules for corporate governance, just as it sets rules that ensure equitable treatment for minority shareholders.

The second point is that the corruption that allows exorbitant pay for CEOs has ramifications far beyond the money pilfered from corporate coffers. The multi-million dollar pay packages for corporate CEOs set standards that affect pay scales throughout the economy. As a result, we see inflated salaries for high level executives not only in business, but also in government, universities, and even charities.

For this reason it is important to redress the imbalance in corporate governance that allows CEOs to get such outsized payments. This topic is addressed at more length in my new book, The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer (coming soon to a website near you).

(Angry Bear has corrected me [and the article] on the valuation of the stock options given to Mr. Marchioli. Using the Black-Scholes valuation method, the value of the options is close to $1 million.)

--Dean Baker

To those following the issue, the Washington Post still has not corrected the error in its reporting on Mexico's post NAFTA growth rate ("Mexican Deportee's U.S. Sojourn Illuminates Roots of Current Crisis," 4-17-06:A1). My April 18th post noted that the growth data reported in this article implied that Mexico had enjoyed an average GDP growth rate of 17.5 percent a year in the post-NAFTA era, which would be a world record. The IMF data show Mexico's growth rate at a weak 2.9 percent.

While the Post has taken a strong pro-NAFTA position on its editorial page, I wrote and continue to believe that this error was an honest mistake. The failure to correct this error after it has been called to their attention is harder to explain. (I also noted a similar error on growth in the Post's Sunday Outlook section, but we can give opinion writers more leeway.)

Since the Post will make an effort to correct misspelled names in wedding announcements, it is difficult to understand its refusal to correct a major error in a front page news article.

--Dean Baker

Proponents of drilling in the Arctic National Wildlife Refuge are happy to make whatever outlandish claims are convenient to advance their cause. A few years ago, they were pushing the line that drilling in the Refuge would generate 500,000-750,000 jobs, citing a study by WEFA, one of the country's leading economic forecasting firms. We did a short analysis showing the faults of this study. When WEFA refused to stand behind its study, this outlandish job claim quickly disappeared from the debate.

But the nonsense continues. President Bush claimed today that the country would be producing another million barrels of oil a day if President Clinton had allowed drilling in the refuge. He presumably meant this claim to impress his audience, implying President Clinton's opposition to drilling in the refuge is a major factor behind today's high oil prices.

A few simple facts indicate otherwise. First, there is a world market for oil. What matters in determining the price of oil is how much oil is supplied in the world, not how much is supplied in the United States. If we were getting an additional 1 million barrels of oil a day, then its impact would be the same on prices in the United States whether the oil comes from Alaska or anywhere else. One million barrels is less than 1.2 percent of world oil supply. That is not trivial, but it will not hugely affect the world price of oil.

The second point follows directly from the first. Iraq's average oil output is approximately 1 million barrels a day less than it was before the war. In other words, the Iraq war has reduced world oil supplies by approximately the same amount that drilling in the refuge might have increased it.

The third point is that the oil in the Refuge is a temporary fix. According to the Energy Information Agency, it would take approximately 10 years to reach the peak production of 1 million barrels a day. This peak production would continue for approximately 10 years, and then it would trail back down to zero over roughly 10 years. This means that if we had begun drilling in the Refuge the day Clinton took office in 1993, then we would have hit peak production just over three years ago, and we would begin to see a decline in output beginning in 2013. This is not exactly long-term energy security.

Of course, there is plenty that Clinton can be blamed for regarding energy policy. For example, if he had introduced mileage standards that increased average mileage by just 10 percent, this would save the country 1 million barrels a day of oil consumption, which would have the same effect on oil prices as increasing production by the same amount.

But, we can't talk about these issues seriously unless reporters do more than just mindlessly report what politicians say.

--Dean Baker

As the housing bubble starts to unwind people will be looking for villains in this economic disaster. There are many, with the list including Alan Greenspan, the bulk of the economics profession, and of course, the reporters covering the housing market.

As was the case with the stock bubble, there was very little attention paid to the underlying fundamentals in the market. Anyone who bothered to look at the data could have quickly recognized that the run-up in home prices in the years after 1997 had no historical precedent. From the early 1950s until 1997 (the years for which we have good data), house prices largely followed the overall rate of inflation. In the years since 1997, house prices have increased by 50 percent after adjusting for inflation.

If housing prices have tracked the overall price level for 50 years, and then suddenly take-off relative to other prices, this is a fundamental change in a key sector of the economy. Fundamental changes in the economy are not impossible, but they don't happen very often. Unless there is very good evidence, it is reasonable to assume that there has been no fundamental change. In this case, that means assuming that the run-up in house prices is a bubble and will be reversed.

I have debated most of the key actors in this debate and none have given an explanation for the run-up in house prices that passes the laugh test. They would say things like people value the security of homeownership, that homeownership is the American Dream.

Did this first become true in 1997?

There is a limited supply of land and many of the areas with the most rapidly growing housing prices are uniquely attractive places to live.

Did New York, Boston, San Diego, Washington, and San Francisco first become nice places to live in the late 1990s?

Environmental restrictions have limited the supply of new housing.

Did environmental restrictions become stricter after the Republican takeover of Congress and many state houses in 1994? If they did, why has homebuilding been going on at a near record pace over the last 4 years?

Immigrants are pushing up the demand for housing.

How many recent immigrants are buying $450,000 homes (the median home price in places like San Francisco and Boston)? More importantly, didn't we just have a national debate over Social Security, the main premise of which was that population and labor force is growing slowly?

Finally, I had my key check on the state of the fundamentals in the housing market: rents. If the run-up in house prices reflected fundamental conditions of supply and demand, then there should have been a comparable run-up in rents. There wasn't. Rents rose somewhat more rapidly than the overall rate of inflation in the last 90s and the beginning of the current decade, but had nowhere near the run-up as home sale prices. More recently rents have trailed the rate of inflation. No economist has been able to give an explanation for how fundamentals could lead to a run-up in house sale prices, while having no noticeably effect on rents.

Good reporting would have prominently noted the evidence that the run-up in house prices would not be sustained, that it was a bubble. In fairness, the media paid considerably more attention to the possibility of a bubble in the housing market than they did to the stock bubble in the late 1990s, which managed to almost completely escape the notice of economic reporters. Still, most of the reporting had the same cheerleading attitude to house prices that reporters routinely apply to stock prices. Unfortunately, when the cheering stops, it is the homeowners, not the reporters, who feel the pain.

--Dean Baker

Last Tuesday, I pointed out that a front page Washington Post article had overstated Mexico's growth in the post-NAFTA era by a factor of five (Mexican Deportee's U.S. Sojourn Illuminates Roots of Current Crisis, 4-17-06:A1). It appears that the Post's problems with arithmetic are continuing.

The front page of the Sunday Outlook section had an article that refers to the rise to power of Hugo Chavez in Venezuela and Evo Morales in Bolivia (Old States, New Threats, 4-23-06;E1). The article comments that "social tensions have exploded as a result of the unleashing of market economies that create rapid but uneven growth."

Growth in Venezuela and Bolivia may have been uneven, but it certainly was not rapid. According to data from the Penn World Tables and the World Bank, per capita GDP in Venezuela was more than 10 percent lower when Hugo Chavez took office in 1998 than it had been in 1980. In Bolivia, per capita GDP had fallen by almost 15 percent between 1980 and 2005 (see also "Bolivia's Challenges").

The Post is a serious newspaper. It should be able to at least get basic facts like economic growth rates right.

--Dean Baker

In many economic policy debates, the worst possible adjective is "protectionist." All right thinking people know that protectionism is bad. According to the economic in-crowd, only ignorant and reactionary people support protectionism measures. (The Post gives a nice example of this thinking in a piece explaining how the IMF will act to prevent protectionism in an economic crisis: "IMF Calls for Cooperation Ahead of Imbalances Meeting.")

The image of hoary protectionism lurking on the horizon can be very effective for powerful interests seeking to push their agendas, but it has nothing to do with real world economic policy. The United States has all sorts of protectionist barriers, the most important of which apply to professional services like physicians' services and lawyers' services. These barriers take the form of licensing requirements that are deliberately designed to make it more difficult for foreign professionals to practice in the United States.

If the United States was interested in free trade in professional services, it would have worked to standardize licensing requirements so that a student living in India or Mexico could as easily prepare to meet the requirements as a student in New York or Los Angeles. (The U.S. could have higher standards, but they would have to be transparent and meet legitimate health and quality concerns, just as the W.T.O. requires with other regulations.)

The United States did not standardize licensing procedures for doctors and lawyers because the people who make trade policy are protectionists, they want to ensure that doctors and lawyers continue to earn high salaries. They only want to make autoworkers, textile workers and other less-skilled workers compete against workers in the developing world.

The arguments about how protectionism is harmful to the national and world economies are every bit as true when doctors and lawyers are protected as when autoworkers and textile workers are protected. (In fact, the harm is greater, protectionism for doctors adds $80 billion a year or more to the country's health care bill.) Remarkably, all the people who express great concern about the prospect of economic damage from protectionism in the auto and textile sectors say nothing about the harm from protection for doctors or lawyers.

I don't know whether the selective protectionism of the "free traders" is due to dishonesty or simply bad economics, but reporters should be able to treat the issue more seriously. There are no free traders in policy positions in the United States, and the media should not allow those who favor protection for highly paid professionals get away with calling themselves "free-traders." They should also not let anyone get away with making the ridiculous argument that the country will somehow suffer great harm from protection in the auto or textile industry, while totally ignoring the harm that it is currently suffering from protection for doctors and lawyers.

--Dean Baker

I had earlier promised to give my explanation for the fact that articles on the budget fail to put budget numbers in a context that would make the millions, billions and trillions meaningful to readers. While laziness is part of the story, the bigger factor is simply inertia, why change? Reporters may agree that it would be very simple and more informative to express budget numbers as percentages of total spending or dollars (or cents) per person, but this is not how their papers did it last year. Including this information is a change, and doing things differently can put you on the spot. In short, since no one put budget numbers in context last year, no one will do it this year.

There are forces that overcome inertia. For example, if inaccurate or incomplete reporting was giving readers a bad impression of Microsoft or the pharmaceutical industry, their lawyers and lobbyists would be haranguing reporters and editors on a daily basis, demanding a change in practice. While the media does occasionally stand up to powerful interests (the New York Times has regularly produced outstanding stories exposing abuses by the pharmaceutical industry, for example), it will give in when it is wrong. In other words, they will not persist in bad reporting that hurts the interests of Microsoft or the pharmaceutical industry.

The same is not true of bad budget reporting. As I argued earlier, this budget reporting has serious consequences. People hugely overestimate the shares of the budget that go to programs like Temporary Assistance to Needy Families (TANF) or foreign aid. Surveys find that people believe that 20-30 percent of the budget goes to these programs. In reality, the shares are 0.6 percent and 0.1 percent, respectively.

As a result of this misconception, voters are far less likely to support additional spending in these areas, and often support candidates who propose cutting such programs. Given their understanding of the budget, resistance to further spending is reasonable. After all, if we're already spending 30 percent of the budget on TANF or foreign aid, and we still have so much poverty in the United States and so much hunger in the developing world, why would anyone think that spending even more would improve the situation. (I am aware that people choose their "facts" to support predispositions, but I think this can only explain a small portion of the widespread ignorance about the budget.) In short, the widespread misconceptions about these programs are a major obstacle to increasing funding.

Of course there are organizations (policy and advocacy groups) that do try to promote increased spending on programs like TANF and foreign aid. While they may not pack the same punch as the pharmaceutical industry, they probably could effectively push for more informative budget reporting if they pressed the case with reporters and editors. Why don't they take up this cause? They didn't do it last year. Inertia is the most important force in politics.

--Dean Baker

This is not a grand existential question; I am referring to the size of its economy. According to most news reports, China's GDP is approaching $2 trillion, rivaling Germany for the #3 ranking in the world, behind the United States and Japan. In fact, this figure grossly understates the size of China's economy. It is already far larger than Japan's economy and is likely to surpass the size of the U.S. economy in less than a decade.

The error is simple. The standard number reported for China's GDP is based on a "currency conversion" measure of GDP. This method takes China's GDP, calculated in its own currency, and then converts this number into dollars, using the official exchange rate. However, China's currency is hugely under-valued, so this method provides a very poor measure of the value of goods and services produced in China each year.

The method preferred by economists for most comparative purposes is a "purchasing power parity" measure. This measure adds up GDP by using the same set of prices for all the goods and services in all countries. In other words, it applies the same price to a bushel of wheat or a haircut in China as to a bushel of wheat or a haircut in the United States.

According to the CIA's World Factbook, China's purchasing power parity GDP in 2005 was $8.2 trillion. This compares to a U.S. GDP of $12.5 trillion. Adding in Hong Kong's GDP puts the size of China's economy at $8.4 trillion in 2005, just over two-thirds the size of the U.S. economy.

China's economy has been growing at the rate of 8-9 percent a year, and most projections assume that it will maintain this rate of growth for the near future. If China's economy grows at the rate of 7 percent annually, its GDP will be approximately $16.5 trillion in 2015, almost the same as the projected $16.8 trillion GDP for the United States (both numbers in 2005 dollars). At 8 percent growth, China's GDP will be $18.1 trillion in 2015, and at 9 percent growth it will be $19.9 trillion.

There is considerable inaccuracy in international comparisons of GDP, but the basic point is that China's economy will be approximating the size of the U.S. economy in the near future, and under plausible growth assumptions, will soon be considerably larger. This has important implications for the position of the United States and China in the world. I will allow others to work through those implications, but we have to start by recognizing how big China actually is.

--Dean Baker

Readers of the Washington Post might have been surprised to read that since the passage of NAFTA, "Mexico's gross domestic product has ballooned, multiplying nearly seven-fold, from $108 billion in 1993 … to $748 billion in 2005" ("Mexican Deportee's U.S. Sojourn Illuminates Roots of Current Crisis," 4-17-06:A1). This amounts to a world record 17.5 percent average annual rate of growth in the 12 years since NAFTA was implemented.

Readers should be surprised to read this in a front page story in the Washington Post because it is not true. Mexico's economy has not "ballooned" since NAFTA. According to the IMF's most recent World Economic Outlook, Mexico's GDP grew by just 40.2 percent over this period, an average annual rate of 2.9 percent. This translates into per capita GDP growth of 1.3 percent a year. This is weak growth for any country, but it is especially weak for a developing country. (Mexico sustained per capita GDP growth of almost 4.0 percent annually from 1960-80.)

This mistake was not just a typo; it was an important theme in a front page article. It raises the obvious question of how such a fundamental error was able to get by the Post's editors and whatever fact-checking process the paper has in place. It is especially disturbing that the error happens to coincide with the strong editorial position that the Post has taken in support of NAFTA.

It is implausible that anyone at the Post deliberately inserted such a ridiculous misrepresentation of Mexico's economic record to support the paper's editorial position. But it is plausible that the favorable predisposition of Post editors toward NAFTA made them less likely to catch such a blatant error. The Post has never run a piece that has highlighted Mexico's weak economic performance in the post-NAFTA years, so most Post readers are probably unaware of the gloomy track record of Mexico's economy during this period. It is reasonable to assume that the Post editors are equally ignorant of the basic facts about Mexico's economic performance.

It is certainly possible that NAFTA is not the cause of Mexico's weak economy over the last 12 years. Perhaps its economy would have grown even less without NAFTA, but it is not possible to have a serious discussion of the issue until the basic facts are on the table. I look forward to the Post's article on Mexico's economy in the post-NAFTA era.

--Dean Baker

A New York Times story on Iceland provides a good opportunity to discuss the asymmetry in reporting on government budget deficits and national current account deficits. While news of the budget deficit routinely appears prominently on the front pages (in addition to occupying considerable space on editorial and op-ed pages) discussion of the current account deficit is generally relegated to the inner pages of the business section. Since the long-term impact of the two on the economy is comparable, there is little justification for the difference in treatment.

This is another Econ 101 story. A budget deficit is supposed to be bad because it pulls money away from other more productive purposes. Specifically it is supposed to raise interest rates and thereby crowd out private investment. (The deficit hawks have a hard time telling this story at present, with real interest rates in the U.S. at near post-war lows.) The result is slower growth and a poorer country in the long-term. There is also a secondary concern, that when the annual deficit and/or debt grow sufficiently large relative to GDP, lenders could begin to question the government's creditworthiness and then demand very high interest rates. This would have serious consequences for investment and growth.

A current account deficit means that the United States is selling off assets (e.g. stocks, bonds, real estate) to foreigners. As a result, in the future, income from these assets will go to foreigners rather than people in the United States. In other words, the United States will be poorer, just like with a budget deficit. There is also a secondary concern, that when the annual current account deficit and/or foreign debt grow sufficiently large relative to GDP, lenders could begin to question the country's creditworthiness and then demand very high interest rates. This would have serious consequences for investment and growth.

Okay, I shouldn't have used the exact same words to describe the nature of budget crises and current account crises. The latter will typically take the form of a plunging currency, leading to higher inflation (import prices rise when the currency falls, leading to higher prices generally) and higher nominal interest rates. The result is likely to be a recession, with several years of stagnation and high unemployment (e.g. the East Asian financial crisis in the 90s). A budget crisis is likely to be resolved with sharp cuts in spending and/or large tax increases, also likely to lead to a period of stagnation and high unemployment. (The discussion of both deficits must be filled with numerous caveats, which I am leaving out for brevity.)

While there are good grounds for concerns about the U.S. budget deficit, the current account deficit is considerably larger and is growing rapidly. The unified budget deficit for 2006 is projected at 2.6 percent of GDP (4.0 percent of GDP, including the money borrowed from Social Security). By comparison, the current account deficit is 6.2 percent of GDP.

The Iceland story is an occasion to mention the current account deficit because Iceland presents the most extreme case of a rich country with a large current account deficit. Its deficit was almost 15 percent of GDP last year. New Zealand comes in second at 9.0 percent, followed by the United States and Spain, both at just over 6.0 percent. Iceland appears to finally be hitting the wall, its currency fell by 15 percent in the last year according to the article. This is pushing inflation up, with interest rates rising as well.

The same factors that are causing problems for Iceland, most importantly diminished capital outflows from Japan and possibly China, are likely to also cause problems for the other big deficit countries in the not distant future. When this happens, the media will have to explain why it devoted so little attention to the growing current account deficit and the crisis that would almost certainly be implied by its reversal.

--Dean Baker

The New York Times ran a front page story on Sunday that could have been a case study of why it is essential to put budget numbers in context. The article, "Medicaid Rule For Immigrants May Bar Others," explains how new rules intended to prevent illegal immigrants from getting Medicaid may also prevent many eligible beneficiaries from getting assistance. The problem is that many low income people don't possess the necessary documentation (e.g. drivers licenses or birth certificates) needed to receive Medicaid under the new rules.

The key flaw in an otherwise excellent article is the brief reference to the potential budget savings from the new rules. The article reports that the Congressional Budget Office projects the savings as $220 million over five years and $735 million over ten years.

Many readers may have been misled into thinking that this is real money. The projected savings are equal to 0.0015 percent of projected spending over the next five years and 0.0022 percent of projected spending over the next decade. Or, in Brad DeLong's formulation, of the $49,800 per person that the federal government is projected to spend over the next five years, the new rules are projected to save approximately 73 cents.

The context here is crucial, because it tells readers that this rule is not about saving taxpayers money. The cost of Medicaid benefits improperly provide to illegal aliens is trivial. People may still be upset that immigrants who are not in this country legally are getting health care benefits from the government, and therefore support this crackdown. But it is important for them to realize that this measure will have no visible effect on their taxes or the government's finances. Most Times readers probably do not realize this fact simply because they have no idea how unimportant a savings of $220 million over five years is.

--Dean Baker

I want to follow up quickly to a couple of notes on my posting where I referred to the "Die at the Border" policy. I was not arguing for open borders. I don't think that anyone who has given the issue serious thought advocates open borders, since a literal open border policy would almost certainly imply an inflow of hundreds of millions of people in the next couple of decades.

My point is that we don't have open borders; instead we have very serious limitations on immigration. Immigration is restricted both by the danger of the border crossing and the prospect of deportation due to a random encounter with law enforcement (e.g. a traffic ticket). These threats ensure that most immigrants will not be well-educated, since well-educated people in the developing world will not take these risks to work in the United States.

This means that less-skilled workers in the United States have to worry about competition from undocumented workers, while the people who design and debate immigration policy (economists, lawyers, reporters) don't have to worry about professionals from developing countries slipping over the borders and undercutting their wages. The implication of the current immigration policy is that the people who design and debate it are largely its beneficiaries, since they can get low cost home repairs, bargain restaurant prices, and cheap nannies.

We can debate whether this is good immigration policy, but we first have to acknowledge the policy in place. The reason that most immigrants are less educated is not because of any shortage of more educated workers willing to immigrate to the United States, it's because our policy acts to exclude them.

As far as the evidence of the link between immigration and the declining wages of less-skilled workers, I can point to the papers by Borjas, Katz, and Freeman, but I confess to being more influenced by what I take as the stylized facts. If immigration was being driven by a shortage of people willing to take certain jobs, then we should expect to be seeing sharp increases in the relative wages of the occupations that have large shares of immigrant workers. In other words, we should have expected to see sharply rising wages in construction, restaurant and hotel work, as employers raised wages in a desperate effort to attract more workers. In fact, we see the opposite. Wages in these industries/occupations have fallen sharply relative to the wages of more skilled workers.

In a similar vein, accepting the view that the minimum wage has little impact on employment implies a belief that the demand for labor is relatively unresponsive to changes in wages. (In other words, a 15 percent hike in the minimum wage has little effect on the number of workers that firms are willing to hire.) Those of us who believe that the minimum wage has relatively little impact on employment, have a difficult time explaining how a large increase in labor supply will have little impact on wages. (If the demand for workers does not respond much to changes in wages, then it would take a large decline in wages to keep fully employed a workforce that has grown substantially due to immigration.)

Finally, a note on the immigration/wage studies, none of the studies seem to have examined the possible effect of immigrants on local housing markets. (I am prepared to stand corrected, if someone knows of such a study.) There are substantial differences in housing costs and the rate of rate of growth of housing costs across cities. For example, between 1980 and 2005, shelter costs rose by 181.3 percent in Los Angeles (4.2 percent annually), while they rose by just 133.4 percent (3.4 percent annually) in Detroit. (This is taken from the CPI shelter index.) This is a difference of 0.8 percentage points a year. Of course, Los Angeles has seen a large inflow of immigrants, while the Detroit area has seen a much smaller inflow.

Shelter accounts for 30 percent of family expenditures on average, and a considerably larger share for low-income families. If shelter costs rise more rapidly in cities with large immigration flows, then this would imply lower real wage growth, given the same nominal wage growth. This could have a substantial impact: in the LA-Detroit comparison, the difference in the growth of shelter costs would translate into a difference in real wage growth of 0.2-0.3 percentage points annually, for the same nominal wage growth.

A serious study would have to look at a large set of cities, and ideally at the housing actually occupied by lower income households, since there are likely different rates of housing inflation for different types of housing. However, given the importance of housing in consumption baskets, and the differences in price trends across cities, this could be an important part of the picture.

--Dean Baker

The elections in Italy prompted another round of knowing comments about how Europeans must get over their silly attachment to employment security (e.g. "Europe Stalls on Road to Economic Change"). None of the comments I saw even considered the possibility that the contractionary policies of the European Central Bank (ECB) play any role in Europe's economic weakness.

The basic story here is fairly simple. While Alan Greenspan lowered the overnight interest rate in the United States to 1.0 percent in the summer of 2003, the ECB never lowered its overnight rate below 2.0 percent. This is in spite of the fact that inflation in the euro zone has been the same or lower than in the United States and the euro zone has consistently had higher rates of unemployment. The story does get more complicated (the Fed's overnight rate is now 4.75 percent, compared to 2.5 percent in the euro zone), but I would argue that the ECB has consistently been more contractionary than the Fed in its policies. Everyone recognizes that the Fed can stimulate the economy with low interest rates and slow growth with high interest rates, why don't we think that the European economy works the same way?

It is striking how commentators can make seemingly contradictory claims about Europe's dire fate with great confidence. The basic story is that Europe's high wages and labor market protections lead to high unemployment. This is crisis # 1, too many workers.

Then we find crisis # 2 on the horizon, a surge in the ratio of retirees to workers, which is compounded by Europe's slow population growth. The essence of crisis #2 is not enough workers. There are economists who will try to rationalize this picture to explain how Europe will be in crisis from both too much unemployment, while also suffering from a labor shortage, but on its face this does seem to be a stretch. (The link runs through high labor taxes discouraging work. The problem with the story is that after-tax wages, not labor taxes, determine willingness to work. The impact of high before tax wages, caused by the labor shortage, should swamp the impact of higher taxes.) In other words, the Europe critics seem to be telling completely contradictory scare stories, without even recognizing this fact.

There is another scare story that some of us have been telling that the Europe critics have largely ignored. This is about the imbalances created by housing bubbles. The United States is just one of several countries that are experiencing inflated housing prices. It is hard to gage how much of the run-up is justified and how much is due to irrational exuberance without some very careful country by country analysis, which I have not done. (For example, Ireland has had among the sharpest run-ups, but it has gone from being a relatively poor European country to ranking among the richest in the last two decades.)

However, the imbalances created by bubbles are easier to recognize. These show up in low domestic savings rates and high current account deficits. The countries that stand out on this list are the United States and Spain, with current account deficits of more than 6.0 percent of GDP, and New Zealand with a deficit of more than 9.0 percent of GDP. These deficits are unsustainable, as virtually all economists agree. The adjustments from large current account deficits to manageable deficits are almost always painful. Typically the adjustment is associated with rising inflation, and then high unemployment as central banks raise interest rates to stop inflation. (Think of increasing annual tax revenue and/or cutting government spending in the United States by $600 billion, the order of pain is comparable.)

The countries on which the Europe critics focus their wrath (France, Italy, and Germany) have small current account deficits or surpluses, meaning they don't face the painful adjustments that loom for the Spain, the United States, and New Zealand. This means that when the adjustments actually occur, we may have a different assessment of which countries' economies look good and which ones look bad. Until then, we will have to listen to many more tirades from the Europe critics, whose voices go virtually unanswered in the media.

--Dean Baker

One of the great absurdities in the debate over immigration policy is the frequently repeated claim that the U.S. economy is generating more "low wage" jobs than can be filled by the domestic workforce. This line has been endlessly repeated in news stories on the issue.

Quick trip back to econ 101: recall the concepts "supply" and "demand." What makes a job a "low wage" job? In econ 101 world, a job will be a "low wage" job if the supply is high relative to the demand. When there is insufficient supply, then the wage rises. My students didn't pass the course if they couldn't get this one right. Econ 101 tells us that there is not a shortage of workers for low wage jobs; it tells us that there are employers who want to keep the wages for these jobs from rising.

Immigration has been one of the tools that have been used to depress wages for less-skilled workers over the last quarter century. Many of the "low-wage" jobs that cannot be filled today, such as jobs in construction and meat-packing, were not "low-wage" jobs thirty years ago. Thirty years ago, these were often high-paying union jobs that plenty of native born workers would have been happy to fill. These jobs have become hard to fill because the wages in these jobs have drifted down towards a minimum wage that is 30 percent lower than its 1970s level.

In response to this logic, the "low wage" job crew claims that if the wages in these jobs rose, then businesses couldn't afford to hire the workers. It's time for more econ 101. Businesses that can't make money paying the prevailing prices go out of business, that is how a market economy works. Labor goes from less productive to more productive uses. This is why we don't still have 20 percent of our workforce in agriculture.

So the economic side of the debate over immigration is a question about employers wanting access to cheap labor. That part is pretty simple. There are other questions in this debate about human rights and basic decency. It's outrageous to threaten people with deportation and imprisonment who have worked in this country as part of a conscious government policy. (No one enforced employer sanctions. That was a deliberate decision by the government.)

There is another side to this debate that gets less attention. The fact that immigrants are mostly less-skilled is not an accident. The current "die at the border" policy (so-called because you get the opportunity to work in the United States if you are willing to risk death in a dangerous border crossing) ensures that the flow of immigrants will be primarily less-skilled workers. Workers in developing countries with few employment opportunities might be willing to take this risk, in addition to the risk that they could be subsequently deported if they get picked up for a traffic ticket or some similar offence.

However, an established doctor, lawyer, or economist in the developing world will not try to slip over the border to work off the books in the United States. This fact ensures that the highly educated people who design immigration policy, and their professional colleagues, will not be subjected to the same sort of competition as less-skilled workers.

We could design an immigration policy that encourages highly educated people from the developing world to work in the United States. Such a policy would provide enormous economic gains, while also making income distribution in the United States more equal. While this could create a problem of "brain drain" from the developing countries, it is easy to design mechanisms to ensure that developing countries benefit from this immigration flow as well.

Since professionals are not working under the table (many actually have to be licensed by the government at regular intervals), it would be very easy to apply a modest tax to the earnings of immigrant professionals. This tax could be paid to the immigrants' home country, so that they can educate 2-3 doctors, lawyers, economists, etc. for every one that comes to work in the United States.

U.S. trade negotiators have not pursued such policies, because trade and immigration policy has been deliberately intended to redistribute income upward. We can debate whether this is a desirable goal for trade policy, but only if the media stops making silly claims about "low wage" jobs.

--Dean Baker

A couple of days ago, I gave my standard diatribe about the importance of putting numbers in context, especially budget numbers, which as isolated billions or trillions are virtually meaningless to the typical reader. In some cases, the issue is not just one of being uninformative, it's also a question of actually being wrong.

In budget reporting, the most obvious case in which out of context is wrong, is when comparisons of the deficit are made through time. There have been many news reports pronouncing the Bush deficits the largest in history based on the fact that nominal deficits (which peaked at $413 billion in 2004) were larger than the size of the deficits in any prior year.

This statement is true, but sufficiently misleading to be wrong. The impact of the deficit on the economy, and the potential debt burden it poses to taxpayers in the future, depends entirely on its size relative to the economy. This is the Bill Gates principle. If Bill Gates chooses to borrow $1 million for some reason, it is not a big deal for him, since he can easily repay this sum. However, if most of us had $1 million in debt, this would be a very big deal for us. It is entirely possible that Bill Gates actually has borrowed millions of dollars for various purposes, but a comparison of our wealth with Bill Gates' wealth that focused only on his debts, without including his assets, would be ridiculous.

That is effectively what reporters do when they compare budget deficits through time, without comparing them to the size of the economy. The proper measure is to describe the deficit relative to GDP. By this measure, the 2004 deficit did not come close to historic peaks. The unified deficit in 2004 was equal to 3.6 percent of GDP. Ignoring the huge World War II deficits, the country had a larger deficit every year from 1982 to 1986 (peaking at 6.0 percent in 1983) and from 1990-1993 (peaking at 4.7 percent in 1992). In short, the 2004 deficit was nowhere near a record.

Arguably, the appropriate measure of the deficit is the "on-budget" deficit which adds in the money borrowed from Social Security. This brings the 2004 deficit to 4.9 percent of GDP, still well below the peaks of 1980s and 1990s. So, it is simply inaccurate to claim that the 2004 deficit was a record.

(A side point: REPORTERS, not politicians, use the Social Security surplus to hide the deficit. Reporters, or their editors, decide which numbers get in newspapers or on the news. If they think that the on-budget deficit is the right one to report, then it is their obligation to report it. It appears directly in every budget document, so they do not even have to do the arithmetic.)

There are many other, less political, uses of numbers where out of context is wrong. A comparison of baseball salaries, or movie revenue, that doesn't adjust for inflation is meaningless. If the time-span is only a couple of years, this is not a really big deal, but the $80,000 that Babe Ruth was paid in 1929 would be close to $1 million in today's dollars. Reporters should adjust for inflation, and their editors should take them to the woodshed when they don't. There is no argument on the other side.

--Dean Baker