Government austerity begins, and your subsidy gets cut off. You are now losing $.10 per widget, so you close your business. The GDP drops $1.00.
Is this austerity a failure? Or was the prosperity resulting from that subsidy a false prosperity?
And GDP is a joke. If I buy your laptop for $1 bln, and you buy it back from me for $1 bln, nothing will change for us, but it will look very good on the GDP.
EDITS (replies to below):
In the case of the two poems, as archgoon points out, the government will collect sales and income taxes which is why that situation never happens... ever. And if you didn't report the transaction to the government to avoid taxes, GDP will be unaffected because GDP is a statistic that is reported by the government, which can't report things it doesn't know about.
Technotony is right about the smashed windows paradox. You could argue that the "value" that is added is the tradesman gets paid (income), and the shopowner gets a new window.
The GDP is not a perfect measure of the strength of an economy. There are plenty of valid criticisms. But it's certainly one of many useful data points.
This is taking the edge case and extrapolating it over the rest of the curve of possible activities.
Maintenance and repair are a subset of all business and economic activities. AFAIK its a subset of GDP calculations.
The rest of the value additive portions of the economy are captured, which is what GDP is supposed to roughly reflect.
Further, if there was a spurt of such activity, such as an earthquake - GDP output would fall, because now while work is being done to repair things, profits from more valuable actions such as making high margin products stops.
Your GDP growth rate, for that year drops, if not total GDP output, because now effort and energy is being directed at maintenance and not wealth creation.
If everybody is doing this, prices rise aproprietely, and GDP corrected for inflation is still a good indicator.
EDIT: BTW there's a reason people don't generally sell cheap things for billions of $ - you'll both have to pay tax from that sale :)
And even if we assume no inflation - government can now invest these money, fueling economy, so this sale had at least some positive effect on economy.
It doesn't have to. Sure, subsidies can help the overall economy. But when you're falling off a fiscal cliff, the debt ceiling is rising, and your credit rating has already been downgraded, you have to be careful to take long term eventualities into account. If a significant number of US businesses are relying on government subsidies and programs to be profitable, and that funding dries up, we're gonna have a bad time. Such subsidies and programs are a tiny fraction of US spending, but they are also low-hanging fruit when it comes time for cuts, as compared with military, medicare, and social security spending. Not saying that will happen, but leaning towards austerity may have been a better choice in the long run than trying to "jump start" the economy, especially if we double-dip (knock on wood!). Time will tell. Interestingly, US and UK unemployment rates as of October 2012 are identical at 7.8.
> For every $.20 the widget company gets, some other company is taxed $.20
There are many sectors of government where spending can be reduced to increase available revenue for subsidies or tax cuts. You need taxes, tolls, tariffs, etc to generate absolute government revenue, but subsidies can be carved out of existing budgets without new taxation. The question of the right balance of both taxation and austerity, to maximally benefit the recovery of the economy, in both the short and long-term--that is the real issue. Seems nobody's discovered the magic formula yet.
If you assume that people will always work at full capacity then austerity makes sense.
But people don't. If their work doesn't seem "worth it" to them, they'd rather relax and do nothing. And that's why austerity causes problems: It makes people not work at full capacity since it doesn't seem worth it.
i.e. artificially pay someone extra and suddenly he is motivated to work extra. The extra work helps the economy.
In theory a solution would be that everyone on unemployment must work on government projects, and that the government would guarantee a paying job to everyone (doing real productive work). The trouble is the details: Not all jobs are equally valuable and there is 0 chance the government will get it right.
http://www.econlib.org/library/Bastiat/basEss1.html
The economy is not a zero sum game. The inefficient production of widgets will be shut down, but the labor and capital used will be put towards a better end. They will not sit idle and rot.
In sum, by shutting down the widget company, you avoid the tax on the populace as a whole and free the labor and resources used in widgets to be used towards a better end.