Paul Krugman is triumphant on the failure of Britain’s austerity:

Last week the National Institute of Economic and Social Research, a British think tank, released a startling chart comparing the current slump with past recessions and recoveries. It turns out that by one important measure — changes in real G.D.P. since the recession began — Britain is doing worse this time than it did during the Great Depression. Four years into the Depression, British G.D.P. had regained its previous peak; four years after the Great Recession began, Britain is nowhere close to regaining its lost ground.

Nor is Britain unique. Italy is also doing worse than it did in the 1930s — and with Spain clearly headed for a double-dip recession, that makes three of Europe’s big five economies members of the worse-than club. Yes, there are some caveats and complications. But this nonetheless represents a stunning failure of policy.

And it’s a failure, in particular, of the austerity doctrine that has dominated elite policy discussion both in Europe and, to a large extent, in the United States for the past two years.

Not so fast says Scott Sumner:

But I am seeing article after article claiming that the coming recession is due to fiscal tightening. I was curious to see just how tight British fiscal policy actually is, so I checked the “Economic and Financial indicators” section at the back of a recent issue of The Economist. They list indicators for 44 countries, including virtually all of the important economies in the world. Here are the three biggest budget deficits of 2011:

1. Egypt 10% of GDP

2. Greece: 9.5% of GDP

3. Britain: 8.8% of GDP

Egypt was thrown into turmoil by a revolution in early 2011. Greece is, well, we all know about Greece. And then there’s Great Britain, third biggest deficit in the world.

I suppose some Keynesians work backward, if there is a demand problem it must, ipso facto, be due to lack of fiscal stimulus. If the deficit is third largest in the world, it should have been second largest, or first largest.

A slightly more respectable argument is that the current deficit is slightly smaller than in 2010 (when it was 10.1% of GDP.) But that shouldn’t cause a recession. Think about the Keynesian model you studied in school. If you are three years into a recession, and you slightly reduce the deficit to still astronomical levels, is that supposed to cause another recession? That’s not the model I studied. Deficits were supposed to provide a temporary boost to get you out of a recession. At worst, you’d expect a slowdown in growth.

To cast a slightly broader net on the austerity which European countries are practicing the only two in which something that meets the intuitive definition of austerity are Sweden where the budget is balanced and Switzerland which is running a fiscal surplus of 1% of GDP. Sweden’s GDP growth rate is about 5.5%; its unemployment rate is 7.4%. Switzerland’s GDP growth rate is 2.6% (roughly the same as ours); its unemployment rate is 3.3%.

My point is not that austerity works. I have two points:

1. Whatever Greece and Britain are doing, it’s not austerity.
2. There’s no obvious, simple, straight line connection between fiscal policy and growth. In either direction.

Go on over to Barry Ritholtz’s Invictus at The Big Picture’s post on GDP and take a look at the first graph. It’s from the invaluable FRED database of the St. Louis Federal Reserve and juxtaposes real gross domestic product from 1990 to the present with a purported potential real gross domestic product.

Leave aside that GDP is a construct (by construct I mean an artifact that may or may not have a real world referent; its relationship to a real world referent is assumed) as is real GDP, derived by adjusting the calculated gross domestic product by an imputed rate of inflation. Potential real GDP is, apparently, GDP if it increased at a fixed annual rate.

IMO there is very good reason to believe that potential real GDP is hooey—something with no real world referent. To believe otherwise is to believe that misallocation of resources has no effect on the economy.

Consider real GDP during two different periods on the graph: 1994 through 1996 and 2000 through 2003. Rather clearly real GDP during those periods grew more slowly than the presumed trend. Each of those periods was succeeded by a bubble, the dot-com bubble and the housing bubble, respectively. The interpretation implicit in the potential real GDP story is that these two bubble were merely a return to trend.

IMO that flies in the face of the facts. Those two bubbles were specific responses to events and policies, in the case of the first bubble a change in the treatment of capital gains under the tax law and in the second Federal Reserve policies. Rather than returns to the previous trend they were artificial and non-sustainable attempts at subverting the new trend.

There’s a reason there’s a $1 trillion hole in the economy: it was never there to begin with. We just thought it was. We’re not as rich as we thought we were.

Update

Take a gander at the updated real GDP graph drawn by regular commenter Andy. Note particularly the update—the green line. I understand why one would prefer to believe in the potential real gross domestic product as calculated. I’m not convinced that it describes anything that’s not an artifact, is realistic, or sustainable.

I want to draw your attention to what to my eye is an excellent primer on tax incidence. Hat tip: David Henderson

One point the example doesn’t mention is that the tax results in a $50 deadweight loss or 1% reduction in total economic activity as a result of the tax.

The Watcher’s Council has announced its winners for last week. First place in the Council category was The Mellow Jihadi’s Lance Corporal Donald Hogan, Marine Hero.

First place in the non-Council category was Family Security Matters with Muslim Children in America are Being Taught to Hate.

You can see the full results here.

Although Switzerland is nominally a representative democracy like the United States since by law practically every law enacted by its legislature must be ratified in a popular referendum, in practice it’s the largest direct democracy in the world. Right now the Swiss are preparing to vote themselves the highest minimum wage in the world: annualized it comes to $50,000 per year. By comparison the annualized minimum wage in the U. S. is around $15,000.

The Swiss, like most Western European, tend to be very law-abiding, all the more so since their laws have preponderantly been approved by popular vote. By comparison I’ve always thought that this little speech from the old John Wayne movie, The Comancheros, was quintessentially American:

Major here has told me what your troubles are. I’ve been thinking it over and in light of my forty years experience in legal jurisprudence, I have come to the positive conclusion that there ain’t no way to do this legal and honest… but being good sensible Texans, we’ll do it illegal and dishonest! Now all the boys here in the room have agreed to sign a paper I have prepared. They all are going to commit perjury. That’s legal language for just a plain, dumb blasted lie.

That line was said by the wonderful character actor, Edgar Buchanan. now best known for portraying Uncle Joe in the TV shows Petticoat Junction, Green Acres and The Beverly Hillbillies. Based on my experience in Germany I think the Germans would find that sentiment horrifying, I think the Swiss would as well, while Americans would merely shrug.

Switzerland’s unemployment rate is under 4%.

In the U. S. so high a minimum wage would undoubtedly cause widespread under-the-table deals and, probably, induce increased illegal immigration into the country, as well as, in the unlikely case of it actually being obeyed, causing a major increase in unemployment. IMO in law-abiding Switzerland with so low a level of unemployment it’s unlikely to have much effect at all other than to reduce the number of low wage jobs that will be created and it’s probably intended to reduce immigration into Switzerland.

Hat tip: Bruce Krasting

Here’s a question for you. Imagine that all laws were subject to referendum in the U. S. as they are in Switzerland. Ignoring the cost of such a program, what would happen? What laws would the people underwrite? Which would they reject?

Note that the opinions of most Americans on subjects like trade, immigration, taxes, healthcare, debt, and social policy differ substantially from what are, apparently, the views of their elected representatives.

I strongly suspect that the most important effect in the short term would be to increase the power of the Supreme Court enormously. In the middle term I strongly suspect it would result in the power of the Supreme Court being curtailed.

Here’s what the Consumer Metrics Institute had to say about the Bureau of Economic Analysis’s report on 4th quarter 2011 GDP yesterday:

If the changes [i.e. in inventories] are real, it is likely that manufacturers were rebuilding inventories after being overly cautious during the third quarter, following their classic pattern of a lagging over-correction. In that scenario we should expect this line item to revert to long term trend lines during the first half of 2012, lowering the headline numbers at that time. However, if the numbers are the phantom result of changes in commodity pricing (particularly oil) impacting inventory valuations even as physical levels remain largely unchanged, then the headline number is largely meaningless and we can expect the quality of the GDP numbers to continue to be held hostage by the BEA’s price deflaters.

and

Consumer spending on goods surged, but was largely offset as consumer spending on services sagged. The aggregate improvement of 0.21% in consumer spending was accomplished even as “real” per capita disposable income was flat, indicating that some of that improvement (particularly since it was focused on goods) may simply be retail sales brought forward as a consequence of deep holiday discounting on the part of retailers.

They conclude by noting that the BEA’s data are so awful that any policy based on them is bound to suck as well.

I honestly don’t see how increases in consuming spending in the absence of increases in consumer income are consistent with increased consumer de-leveraging.

Riffing on my last post, I can’t help but wonder if there’s something that we lose track of too easily. We really have no idea of the state of technology in the very distant past. We’ve deduced what life was like 3,000 or 5,000 or 10,000 years ago based on the presence or absence of implements made of bone, stone, pottery, and metal, the vestiges of things that have lasted over the millennia. However, there may well have been things made of leather, wood, basketry, and cloth of enormous complexity and sophistication. Those things have vanished.

There are some reasons to believe that’s true based, for example, on the design of pottery which makes little sense as pottery but makes a good deal of sense if the shards we’ve found were made in imitation of the design of baskets. But we’ll never really know.

My first reaction to this article, titled “Complex Fish Traps Over 7,500 Years Old Found in Russia”:

An international team of archeologists, led by Ignacio Clemente, a researcher with the Spanish National Research Council, has discovered and documented an assemblage of fish seines and traps in the Dubna Basin near Moscow that are dated to be more than 7,500 years old. They say that the equipment, among the oldest found in Europe, displays a surprisingly advanced technical complexity. The finds illuminate the role of fishing among European settlements of the early Holocene (about 10,000 years ago), particularly where people did not practice agriculture until just before the advent of the Iron Age.

was “I wonder if they caught anything?”

My second reaction was to wonder if they’d found containers that might have once held beer in the vicinity of the traps.

I have old and fond memories of helping my Uncle George (he wasn’t my blood uncle but rather the husband of my maternal grandmother’s best friend and the closest thing I had to a grandfather) tend his trout lines. For several years running when I was a kid I spent a week with them in their house on stilts “down on the riverr”, on the banks of the Meramec River. I don’t ever recall his catching anything but I do recall his consuming a certain amount of beer in the process.

You know what they say: give a man a fish and he’ll eat for a day; teach a man to fish and he’ll sit in a boat and drink beer all day.

In the Wall Street Journal this morning there’s a very interesting open letter, signed by sixteen prominent scientists that

1. Urges calm in “de-carbonizing”
2. Condemns the Lysenkoism-like enforcement of orthodoxy in an area in which there is no consensus

Why is there so much passion about global warming, and why has the issue become so vexing that the American Physical Society, from which Dr. Giaever resigned a few months ago, refused the seemingly reasonable request by many of its members to remove the word “incontrovertible” from its description of a scientific issue? There are several reasons, but a good place to start is the old question “cui bono?” Or the modern update, “Follow the money.”

Alarmism over climate is of great benefit to many, providing government funding for academic research and a reason for government bureaucracies to grow. Alarmism also offers an excuse for governments to raise taxes, taxpayer-funded subsidies for businesses that understand how to work the political system, and a lure for big donations to charitable foundations promising to save the planet. Lysenko and his team lived very well, and they fiercely defended their dogma and the privileges it brought them.

My own views are that

1. I think that the increase in carbon dioxide in the atmosphere is legitimate cause for concern and deserving of substantial study.
2. The proposals for dealing with whatever problems carbon dioxide in the atmosphere may cause are draconian, don’t do a great deal about the problem, but would create a ruling oligarchy.
3. The lack of increase in global warming over the last ten years has, shall we say, cast a cloud over the models that predicted global warming.
4. A considerable proportion of the increase in extremes of weather in recent years can be explained by the Asian Brown Cloud, which now extends into central China.

I’ve been in favor of a Pigouvian tax on gasoline for the last 35 years, mostly but not exclusively for geopolitical reasons. The only significant presidential candidate to propose such a thing was resoundingly defeated at the polls. Technology and exhaustion of the Middle East oil fields among other reasons may render that view obsolete. We’ll see.

I think it’s ironic that the rush to do something about carbon dioxide emissions embodied in the defunct Kyoto Protocol may have actually induced some of the problems it was intended to solve. More of European reduction in carbon emissions has been accomplished by off-shoring manufacturing to China (where the problem becomes intractible) than by their cap and trade system which, fortunately, we have elected not to emulate.

I’m also concerned that political correctness has caused us to ignore the tremendous concentration of population in enormous cities in India, China, and the rest of the developing world creating substantial heat islands which themselves would seem likely to influence weather at least locally and, possibly, intercontinentally. But that’s a subject for another post./li