Saturday, October 17, 2009

Recession & Recovery

One of the broad assumptions behind recessions and recoveries is that during the "boom", excess capacity is built into the system as manufacturers & service providers expand to meet increasing needs (today, and in the future). During the recession, manufacturers & service providers pare back, leaving capacity idle.

Part of the reason that the recovery (typically) gains steam is that bringing back this idle capacity (both in physical and human capital) is cheaper than building (or training) new, and it allows the economy to "roar" back into high gear. In some high level sense WW2 leveraged all of the physical and human capital that was idled by the great depression; while huge plants were built and millions of workers mobilized much of the initial lift was caused by leveraging what we had that was unused at the time.

When I look at this "boom" and recession, however, from the point of view of the USA, it doesn't seem that we over-invested in productive capacity. Much of the investment was in residential real estate and commercial real estate for distribution, retail and services.

Outside my window I see at least a dozen new high rise buildings for commercial and residential buildings that weren't here 5 years ago. On the commercial side, especially, they are taking tenants from older buildings (like One IBM Plaza) and bringing them into the new buildings. I can see the lights go on in the sixty story building in front of me and while I am sure that it is nicer working in the new building that old building is still also sitting in plain site and I am scratching my head a bit to see how this makes us significantly more productive.

On the retail side, it is even worse. The number of vacant shops here in River North is astounding, made worse by the fact that most of the new buildings (residential, commercial) put retail in their ground level units. There can only be so many tile stores, furniture stores, hair salons and the like, apparently.

Around the US there was a massive investment in residential real estate, along with upgrades of existing houses. Everyone can see what has happened there; this "bubble" wealth has evaporated and house prices are down significantly. More importantly, the nation pushed our investment incentives into real estate (through the deduction on mortgage interest and now the $8000 tax credit and artificially low long term government backed mortgages) and not into something that is creating "real" wealth for the nation.

In general, I think that our over-investment in real estate, not manufacturing and productive capacity, will make this recovery much slower. It will be a long time before we fill up all of this empty real estate, and moving from the old still-functioning building to the new "glossy" building didn't significantly raise productivity in the first place.

Cross posted at Chicago Boyz

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