The building boom to come
The construction slump is well out of proportion to the bubble of the mid-2000s. But policymakers haven't responded appropriately.
By J. Bradford DeLong
In the mid-2000s, the United States had a construction boom. From 2003 to 2006, annual construction spending rose to a level well above its long-run trend. Thus, by the start of 2007, the country was, in essence, overbuilt - about $300 billion in excess of the long-run trend in construction spending.
When these buildings were constructed, they were expected to more than pay for themselves. But their profitability rested on shaky foundations that didn't hold up, including optimism about real estate as an asset class.
By 2007, therefore, it was reasonable to expect that construction spending would be depressed for some time to come. Since construction spending was $300 billion above normal, it would have to fall $300 billion below normal to return to balance.
So, in 2007, everyone expected a construction-led slowdown. And, starting that year, construction spending did indeed fall. But we were expecting a minor decline - $150 billion a year for two years, or $100 billion a year for three years. Instead, spending plummeted $300 billion below the long-term trend in 2007 alone, and it has remained depressed for four years. Moreover, there is no prospect of a rapid return to normal levels.
Therefore, when this construction cycle has run its course, U.S. building will have seen a boom of $300 billion above normal followed by a much bigger slump of $2 trillion below normal. The net effect will be a construction shortfall of at least $1.7 trillion. That is a lot of unbuilt houses, apartment buildings, offices, and stores, and it is a truly radical difference between the size of the recent construction boom and the size of the current construction bust.
Indeed, this radical disproportion makes nonsense of all arguments that the current distressed state of the U.S. economy is in some sense necessary, deserved, or inevitably resulting from the overexuberant mid-2000s building in the desert between Los Angeles and Albuquerque, N.M. Otherwise, the construction-led economic slowdown would not be today's $1 trillion in annual lost production. It would be one-tenth the size of what the country is enduring, and it would be largely confined to the construction sector. And, in that alternative universe, having worked off the entire burden of overbuilding, we would by now have returned to normal levels of production, employment, and demand.
There is one silver lining as we contemplate our macroeconomic wreckage: When incomes, production, and employment return to their long-term levels, Americans will demand an extra $1.7 trillion worth of buildings. And because those buildings will not exist, construction demand will come roaring back. If America does recover to the level of the previous long-run trend, the next decade will likely witness a construction boom that puts the mid-2000s boom in the shade.
But that is not now. And it is not for some years to come.
There is another lesson here. The economists Kenneth Rogoff and Carmen Reinhart argue that recovery after a financial crisis is almost always slow. But there is at least one important sense in which America's current construction bust suggests that they are wrong. One factor behind slow post-financial-crisis recovery is that nobody knows how the division of labor will be rearranged. But right now we know a lot about that.
We know that when Americans become confident again - when they believe they could find new jobs if they lost their current ones, and when they can no longer tolerate doubling up with their in-laws - they will demand more dwellings than the country has. If incomes and demand were normal, we would want a lot more new construction then we do now.
But even though we can see the magnitude of the construction shortfall and understand how large it will be when recovery is complete, it doesn't help right now. Right now, incomes are slack, households have become crowded, and there is a surplus of housing on the market - all because nominal demand is still far below the long-term trend.
In 20 years, historians will interview the then-aged monetary, banking, and fiscal policymakers of the 2000s. They will ask why they did not take more aggressive steps to return incomes and demand to trend levels when they were sitting in the hot seats. I already wonder what their excuses will be.