As you may know, both real and nominal GDP growth were a bit disappointing in the fourth quarter, especially nominal growth.  On the other hand real final sales rose at the fastest rates in more than 20 years.  This led David Beckworth, Bill Woolsey and Marcus Nunes to suggest QE2 was already working (recall it started strongly raising stock prices and reducing the value of the dollar as early as September.)

I was a bit skeptical about the final sales numbers, partly due to issues raised by Jim Hamilton and his commenter “rootless” (at 3:49pm.)  I see the optimists as making an implied prediction that production would rise strongly in 2011:1, as firms restock depleted inventory.  And now we have the first indication that the optimists may be right:

WASHINGTON (AP) — Factory activity expanded in January at the fastest pace in nearly seven years, as manufacturers reported a sharp jump in new orders.

Still, builders spent less on projects in December, pushing annual construction spending down to a decade low.

The Institute for Supply Management, a private trade group, said Tuesday that its index of manufacturing activity rose last month to 60.8, from 58.5 in December. The sector has expanded for 18 straight months, and January’s reading was the highest since May 2004. Any reading above 50 indicates expansion.

People who have brains that are “wired Keynesian” often ask me where will the extra demand (from QE2) come from.  Businesses have lots of slack and don’t need to invest, and without more investment how will cash-strapped consumers have enough income to spend?

They are essentially arguing an economy can’t be raised up by its bootstraps.  This is because they don’t understand how nominal shocks can have real effects.  There’s an old movie line “build it and they will come.”  In this case it’s more like “provide the extra NGDP, and the RGDP will come” (when there’s lots of slack.)  The transmission mechanism is asset prices.  Here’s some more info from the article, which explains where the demand is coming from:

Consumers are spending more on autos, appliances and other goods, while businesses have invested in more industrial machinery and computers. Those trends boosted economic growth to a 3.2 percent pace in the October-December quarter, the Commerce Department said last week.

Duesterberg said orders for mining and drilling equipment and for airplanes and airplane parts are also rising.

Factories’ healthy pace of expansion is likely to continue in the coming months. Manufacturing firms surveyed by ISM said their backlog of orders jumped in January, pushing an index measuring that activity to 58 from 47.

U.S. factories are also benefiting from rising overseas sales. The index of export orders jumped to 62 in January, from 54.5 the previous month. That matches a recent peak reached in May and is otherwise the highest level for that index since December 1988.

The employment index rose to its highest level since 1973, a sign that manufacturing companies are hiring more workers. But Duesterberg cautioned that the ongoing boom in productivity in manufacturing would likely limit hiring.

We’ll need a few months more data, but so far it looks like the recovery is going from almost nonexistent during May through August, to moderate.  That’s progress.

PS.  Does anyone know how meaningful this index is?  That phrase “highest level since 1973” certainly caught my eye.  And it also seems to have caught Wall Street’s eye.

I’m going to argue that Tyler Cowen’s new book showed something important, but not what everyone is debating.  Most of the discussion revolves around the issue of whether real economic growth has slowed dramatically in recent decades, and is likely to continue to disappoint over the next few decades.  Perhaps what it really showed is that real GDP is itself becoming an increasingly meaningless concept.

Much of the debate revolves around whether we have accurately measured inflation.  But this debate assumes there is a “true” inflation rate out there, and we just have to correctly measure it.  OK, but what is inflation and real GDP growth trying to measure?  How much more stuff we have?  Or how much more happiness?

I vaguely recall that price indices are supposed to measure how much more money we’d need to keep the same level of utility.  But what is utility?  Lots of economists seem to think it means something like ‘happiness.’   But that can’t be right, as surveys indicate little or no increase in US happiness over time, yet even the pessimists agree that RGDP/capita has grown significantly since 1945.

If RGDP is supposed to measure how much “stuff” we have, then how do we compare items?  Is an iPod more or less stuff than a washing machine?  Is an hour with a pet psychologist more or less stuff than a microwave?  Sometimes when a new product arrives, its value can be estimated by looking at how much more it sells for than an older version of the product.  But this won’t work if the early adopters are wealthy people willing to pay much more for a slightly improved version of flat panel TVs. The masses won’t buy that slightly improved version until its price falls to the old version, and when people take it home they won’t notice much difference when actually watching TV shows.

Maybe inflation doesn’t exist out in reality, rather is merely a concept we create with statistical tools.  Indeed according to the smartest man in the world, it’s not even clear that any sort of reality exists:

Hawking gives a good description of how scientists come to the conclusion that something is real.  We construct intellectual models that, within some range of phenomena, and to some degree of approximation, agree with observation.  But he calls this “model-dependent reality,” and suggests that this is all there is to reality.

Questions about the nature of reality have puzzled scientists and philosophers for millenia.  Like most people, I think that there is something real out there, entirely independent of us and our models, as the earth is independent of our maps.  But I believe this because I can’t help believing in an objective reality, not because I have good arguments for it.  I am in no position to argue that Stephen Hawking’s anti-realism is wrong.  [from a book review by Steven Weinberg]

That’s right, Stephen Hawking says it’s turtles . . . er . . . it’s models all the way down.

But I’m also a pragmatist.  During the 100 years leading up to 1973, RGDP was a reasonable way of thinking about the obvious fact that lots more of almost every type of “stuff” was being churned out.  Living standards were clearly rising as we accumulated vastly more cars, TVs, appliances, restaurant meals, etc.

But how will we measure RGDP growth in the information-oriented economy that Tyler Cowen describes?  We’ve gone from watching TVs with 4 channels, to watching computer monitors with 100 million “channels.”  What is the monetary value of that?  What’s the utility value?  Tyler points out that many of the info tech innovations produce surprising little revenue.  I’d add that in the long run that’s also true of biotech, the other great technological hope.  A complete cure for cancer will initially earn great revenue, but after coming off patent will sell for relatively little, despite continuing to cure cancer.

Tyler Cowen’s book as been both a marketing coup and an intellectual game changer.  It has gotten people to focus on issues they intuitively knew were out there, but for which they lacked a framework for thinking about.  The WSJ recently called him a 21st century Thomas Friedman.  That got me thinking about Friedman’s famous “suck on this” comment.  Well here’s my own suck on this:

If we are serious about utility being the be all and end all of economic growth, then isn’t it possible that there was little economic growth between 1945 and 1973, but lots of growth since?  Suppose all that postwar growth in “stuff” didn’t really make people any happier.  But then after 1973 the widespread use of anti-depressants made people much happier than before.  In that case, isn’t it possible that utility has actually risen faster since 1973?  Economists think they are just technicians, collecting data about the economy.  No need to think about what the purpose of life is.  No need to read Nietzsche.  But if we don’t know what we are measuring, how likely is it that we will come up with accurate measurements?

As soon as I saw Tyler Cowen compared to Thomas Friedman, I knew that his commenters would ridicule him mercilessly.  And I was right.  But those sarcastic comments come from little people, envious of great men like Thomas Friedman.  I’m not too proud to try to emulate the great sage of the 1990s.  Hence the title of this post.

PS.  God I hope that the “sensory impression of snow outside my window” isn’t real; I really don’t want to do anymore shoveling.  Do any others readers have a similar sensory impression?  Confirmation from others won’t show that the snow is “real,” but it will accurately predict whether I am about to suffer.  And pain is real.  That’s because pain (and happiness) are the only things for which the reality and the perception are one and the same.

One of my favorite Adam Smith sayings is that “There’s a great deal of ruin in a nation.”  When reading others, I often think that people get too pessimistic about this or that country, based on a few highly visible problems.

But another way of thinking about this idea is that maybe even very well run countries fall far short of their “potential.”  I use quotation marks, as potential seems like a very slippery and unscientific concept.  After all, there may be deep-seated reasons why countries struggle to come up with good governance.  Still, you never get anywhere without setting goals.

Bryan Caplan and Will Wilkinson have been discussing the possibility of a regime of open immigration, and whether it could co-exist with a modern welfare state.  I can’t answer that question, but I will argue that we are very far from the “policy possibilities frontier” for liberaltarianism.  Imagine a country:

1.  Which accepts more immigrants per capita than almost any other nation on earth, despite being the most densely populated country with more than 5 million inhabitants.  So densely populated that they need to reclaim land from the sea in order to find places to put people.

2.  Has very high taxes on activities that produce environmental externalities, yet remains the most free market country according to several indices of economic freedom.

3.  Has a very comprehensive welfare state including national health care and pensions for all, yet still maintains a highly efficient tax system at rates far below that of other developed countries.  And if that’s not enough, runs gigantic budget surpluses year after year, despite the ultra-low tax rates and very generous welfare state.

You think that’s utopia?  No place like that could exist?  Think again.

This example tells me that while there may be some political limits to how many immigrants we can absorb, and we may not be able to provide the same welfare benefits to immigrants as to native-born Americans, we aren’t even close to the policy frontier.  We can have much lower taxes, a much more complete welfare state, and much higher rates of immigration.  And while we’re at it, let’s also run a gigantic budget surplus.  We just need to try harder.

And here’s a nice side effect.  Success get emulated.  As others see how well you are doing with the liberaltarian model, they’ll want to copy the policies.  That speeds up the day when the entire world can become a giant Schengen area.

PS.  I cheated a bit in point #2 above.  As my wife keeps reminding me, Hong Kong is not a “country.”