[Economic Report of the President (2002)] [Administration of George W. Bush] [Online through the Government Printing Office, www.gpo.gov] CONTENTS Page Overview ....................................................... 15 Chapter 1. restoring prosperity ................................ 23 Macroeconomic Performance in 2001: Softer Economy, Harder Choices ......................................... 23 Aggregate Demand During the First Three Quarters ..... 23 Preliminary Evidence on Aggregate Demand in the Fourth Quarter ..................................... 30 Labor Markets ........................................ 33 Inflation ............................................ 34 Productivity and Employment Costs .................... 34 Saving and Investment ................................ 35 The Cyclical Slowdown .................................. 36 Moderation After Very Rapid Growth ................... 36 Decline in Equity Values ............................. 37 Surge in Energy Prices ............................... 37 Higher Interest Rates ................................ 38 Collapse of the High-Technology Sector ............... 38 Lingering Effects of Y2K ............................. 38 Effects on Inventories and the Capital Stock ......... 39 From Slowdown to Recession ........................... 41 Policy Developments in 2001 ............................ 43 Fiscal Policy Before the Terrorist Attacks ........... 43 Tax Relief in 2001 ................................... 44 Monetary Policy Before the Terrorist Attacks ......... 45 The Macroeconomic Policy Response After September 11 . 46 Economic Developments Outside the United States ........ 51 The Economic Outlook ................................... 52 Near-Term Outlook: Poised for Recovery ............... 52 Inflation Forecast ................................... 54 Long-Term Outlook: Strengthening the Foundation for the Future ...................................... 54 The Policy Outlook: An Agenda for Economic Security .... 61 Chapter 2. strengthening retirement security ................... 65 Rationale for a National Retirement System ..... 66 Insurance Against Uncertainty .................. 66 Foresight and Planning ......................... 67 Redistributive Goals ........................... 68 Sources of Retirement Security ......................... 69 Social Security ................................ 69 Employer-Sponsored Pensions .................... 71 Individual Savings ............................. 72 Labor Earnings ................................. 72 Public Assistance .............................. 72 Challenges Ahead ....................................... 73 Social Security: Past and Present ...................... 74 Origins of the Current System .................. 74 Social Security and National Saving ............ 76 The Future of Social Security .......................... 79 Advantages of Personal Accounts ................ 79 The Financial Sustainability of Social Security. 86 Other Sources of Retirement Security ................... 92 Employer-Sponsored Pension Plans ............... 93 Individual Saving .............................. 94 Fostering Self-Reliance ........................ 96 Meeting the Challenge of Retirement Security ........... 96 Chapter 3. realizing gains from competition .................... 99 Motivations for Organizational Change .................. 101 The Role of Agency Costs in Organizational Change 102 Mergers ........................................ 103 Other Organizational Forms: Joint Ventures and Partial Equity Stakes .......................... 107 Incorporating Economic Insights into Competition Policy. 112 Competition Policy, Corporate Governance, and the Mergers of the 1980s and 1990s ................. 114 The Role of Corporate Governance Changes ....... 116 Policy Lessons for Promoting Organizational Efficiencies 117 Policy Lessons from Joint Ventures ............. 118 Shaping Policies to Address Partial Equity Stakes 120 Policy Toward Vertical Relations ............... 123 Cross-Border Organizational Changes .................... 125 Multijurisdictional Review ..................... 125 Elements of International Policy Convergence ... 127 Core Principles of Competition Policy .......... 127 Dynamic Competition and Antitrust Policy ............... 130 Sources of Incentives for Innovation ........... 132 Fostering Innovation Through Organizational Structure .................................... 136 Dynamic Competition as Repeated Innovations .... 137 Implications of Dynamic Competition for Competition Policy ....................................... 138 Conclusion ............................................. 142 Chapter 4. promoting health care quality and access ............ 145 Encouraging Flexible, Innovative, and Broadly Available Health Care Coverage ........................................ 149 Recent Trends in Health Care Costs and Coverage. 149 Addressing Barriers to Effective Competition in Health Insurance .................................... 154 Increasing Health Insurance Coverage ........... 159 Making Medicare Coverage More Flexible and Efficient .................................... 166 Better Support for High-Quality, Efficient Care ........ 171 Shortfalls in the Quality of Care .............. 171 Disparities in the Health Care System .......... 173 Empowering Providers to Improve Quality of Care. 175 Empowering Patients to Make Informed Health Care Choices ....................................... 176 Fulfilling the Promise of Medical Research ............. 179 The Benefits of Biomedical Research ............ 180 Many Unanswered Questions About Existing Medical Treatments .................................... 182 The Role of the Federal Government in Supporting Research ...................................... 184 Conclusion: Fulfilling the Potential of 21st-Century Health Care ......................................... 185 Chapter 5. redesigning federalism for the 21st century ......... 187 Institutional Design in a Federal System ............... 188 Fostering Partnerships, Competition, and Accountability. 191 Elementary and Secondary Education ..................... 192 Setting Standards and Measuring Progress ....... 193 Expanding Options .............................. 194 Providing for Vulnerable Populations: Government Partnerships ................................. 196 Summing Up: Getting Incentives Right ........... 199 Welfare ................................................ 199 Focusing on Results ............................ 200 The Importance of Measurement .................. 202 The Value of Incentives ........................ 203 The Benefits of Flexible Approaches ............ 204 Encouraging Broad Participation ................ 206 Medicaid and SCHIP ..................................... 207 Limitations and Shortcomings of the Current System ....................................... 208 Fostering Market-Based Health Insurance ........ 210 Conclusion ............................................. 213 Chapter 6. building institutions for a better environment ..... 215 The Government�s Role in Environmental Protection ...... 219 Measuring the Benefits and Costs of Environmental Protection ........................................... 221 Types of Environmental Regulation ...................... 223 Command-and-Control Approaches ................. 223 Standard Market-Based Approaches: Permit Trading and Fees ..................................... 223 Other Flexible Approaches: Informal Markets and Tradable Performance Standards ........................ 226 Myths About Flexible Approaches ........................ 228 Case Studies in Flexible Environmental Protection ...... 232 The Sulfur Dioxide Permit Trading Program ...... 233 Tradable Quotas in the Alaskan Halibut and Sablefish Fisheries .................................... 237 Informal Permit Trading in the Tar-Pamlico River Basin ........................................ 240 When Markets Don't Work ........................ 243 Lessons for Future Policy: Climate Change .............. 244 Base Policy Action on Sound Science ............ 245 Choose a Flexible, Gradual Approach ............ 245 Set Reasonable, Gradual Goals .................. 246 Provide Information and Encourage Reductions ... 248 Give Technology--and Institutions--Time ........ 248 Chapter 7. supporting global economic integration .............. 251 The United States in the International Economy ......... 252 Trends and Patterns in U.S. and World Trade .... 252 Trends and Composition of Capital Flows ........ 260 The Benefits of Globalization .......................... 265 The Benefits of Trade .......................... 265 The Benefits of Capital Flows .................. 268 The Role of Migration .......................... 270 Some Myths About Trade and Globalization ............... 271 Trade and the Environment ...................... 271 Trade and Employment ........................... 272 Trade and Relative Wages ....................... 273 The Effects of Trade on Developing Nations ..... 274 International Policy Issues and the Role of International Institutions ........................................ 275 International Trade Institutions and the Benefits of Trade ........................................ 275 Role and Reform of International Financial Institutions ................................. 281 Conclusion ............................................. 300 Appendixes A. Report to the President on the Activities of the Council of Economic Advisers During 2001 ........................................... 301 B. Statistical Tables Relating to Income, Employment, and Production ...................................... 313 List of Tables 1-1. Administration Forecast ................................ 53 1-2. Accounting for Growth in Real GDP, 1960-2012 ........... 55 1-3. Accounting for the Productivity Acceleration Since 1995. 61 7-1. U.S. Manufacturing Trade as Share of Shipments and Consumption, 2000 ............................ 255 7-2. Estimated Gross Private Sector Capital Flows ........... 261 7-3. Estimated Net Private Sector Capital Flows ............. 263 7-4. Estimated World Cross-Border Claims and U.S. International Investment Position, Year-End 2000 ................... 264 List of Charts 1-1. Real GDP Growth ........................................ 24 1-2. Real Consumption Growth ................................ 27 1-3. Growth in Real Gross Private Domestic Investment ....... 29 1-4. Standard & Poor's 500 Composite Stock Index ............ 33 1-5. Growth in the Real Capital Stock ....................... 41 1-6. Consumer Sentiment ..................................... 42 1-7. Discount Window Borrowing .............................. 49 1-8. Effective and Target Federal Funds Rates ............... 50 1-9. Productivity Growth Around Business Cycle Peaks ........ 60 2-1. Income Sources of Aged Households, 1998 ................ 70 2-2. Pension Plan Participants by Type of Plan .............. 71 2-3. Ratio of Working-Age to Retirement-Age Persons ......... 88 3-1. Announced Mergers and Acquisitions Involving U.S.-Headquartered Firms ..................... 104 3-2. Fraction of U.S. Mergers and Acquisitions Involving a Foreign Buyer or Seller ...................... 104 3-3. Industry-Funded Research and Development and Patents Granted for Inventions ....................... 131 3-4. Sales Revenue of Selected Prescription Anti-Ulcer Drugs. 140 4-1. Health Care Expenditures ............................... 150 4-2. Expenditures on Components of Health Care .............. 150 4-3. Mortality Rates for Coronary Heart Disease ............. 181 4-4. Survival Rate After AIDS-Defining Infection ............ 181 5-1. Children in Federally Supported Programs for the Disabled 199 5-2. The Changing Allocation of Welfare Funds in Six States . 205 6-1. Emissions of Major Air Pollutants ...................... 217 6-2. Reductions in Average Ambient Concentrations of Major Air Pollutants, 1981-2000 ........................ 217 6-3. Sulfur Dioxide Emissions and GDP in Canada, United Kingdom, and United States ............................ 218 6-4. Sulfur Dioxide Allow ances Traded Between Economically Distinct Organizations ...................... 236 6-5. Emissions from Phase I Facilities in the Sulfur Dioxide Trading Program .............................. 236 6-6. Nutrient Loading by the Tar-Pamlico Basin Association .. 243 7-1. World Merchandise Trade Volume ......................... 253 7-2. U.S. Trade Relative to National Output ................. 254 7-3. U.S. Trade by Sector in 2000 ........................... 267 7-4. Import-Weighted Average Tariffs, 1999 .................. 277 List of Boxes 1-1. Better Tools: Improving the Accuracy and Timeliness of Economic Statistics .......................... 24 1-2. Capital Overhang and Investment in 2001 ................ 39 1-3. Increased Security Spending and Productivity Growth .... 56 1-4. Is There Still a New Economy? .......................... 58 2-1. National Saving, Personal Saving, and Growth ........... 74 2-2. Does Social Security Alter Retirement Behavior? ........ 78 2-3. The Effect of Social Security on Income Distribution ... 82 2-4. The Effectiveness of Saving Incentives ................. 95 3-1. A Co-Production Agreement and a Partial Equity Stake: Pixar and Disney ............................. 111 3-2. The Primestar Acquisition .............................. 122 3-3. Dynamic Competition in the Market for Prescription Anti-Ulcer Drugs ............................. 139 4-1. Managed Care: Good, Bad, or Somewhere in Between? ...... 151 4-2. The Need for Good Risk Adjustment ...................... 156 4-3. Federal Employee Health Insurance Plans ................ 169 4-4. The Puzzle of Geographic Variations in Medicare Expenditure .......................................... 174 4-5. Survival Rates and Mortality Rates ..................... 183 5-1. Why Have Welfare Caseloads Declined? ................... 201 5-2. The State Children's Health Insurance Program .......... 209 5-3. Community Health Centers ............................... 213 6-1. Trends in National and International Environmental Quality .............................................. 216 6-2. Environmental Fees in Other Countries .................. 225 7-1. Vertical Trade and Production Sharing .................. 256 7-2. Crisis and Restructuring in Ecuador .................... 288 7-3. Elliott Associates versus Peru ......................... 296