Two Phases of Recovery for the Economy

Two observations about the present situation:

1. There is excess capacity virtually all across our economy.
2. Some of that excess capacity will not come back into service.

The first claim is pretty obvious from the aggregate data, but here's a chart for those of you who like charts:

The second statement derives from the previous housing boom. We built up the capacity to construct two and a quarter million units per year, when we only need three-fourths of that amount. By the time we are once more ready to build over two million new housing units in a year, the backhoes, nail guns and pickup trucks will have rusted out. In an economic sense, that capacity is gone today, just as a buggy-whip factory wouldn't add much to our economically-viable total capacity.

The first stage of the recovery will be to fully utilize the capacity outside the old boom sector. That's most everything outside housing construction and its supply chain (lumber, doors, windows, carpet, etc.) and outside of closely related industries (title insurance, mortgage brokerage, etc.).

The second stage of the recovery reconfigures our capacity to meet the new demands. If housing construction is to be a smaller proportion of total GDP, something else will be a larger proportion. We will need to build up capacity in those "something else" sectors. (More on that topic in a later post.)

(Note for econo-geeks: the estimates of Potential GDP that are used in the Taylor Rule should be reduced to account for the loss of economic capacity.

Another note for econo-geeks: we should thank our friends from the Austrian School for reminding us that composition of demand and production is important.)

Business Strategy Implications: Plan on a recovery that is not a strong as past recoveries. We will rebound, we will get back up to normal growth rates, but we will not have the excellent growth needed to get back to where we would have been absent the recession.

Comments

[wawsa1:]

It depends on the industry. High tech has cut inventories back dramatically and cut workers to right size the businesses. You discussion is just too broad and nonsensical in that regard.

Apr 26 09:24 AM

[H. T. Love:]

Quoteth the author:
"The second stage of the recovery reconfigures our capacity to meet the new demands. If housing construction is to be a smaller proportion of total GDP, something else will be a larger proportion."

A self-evident statement. However, there is an implication that "something else" capacity will need to be increased. This does not necessarily follow just because proportions have changed.

The determining factor will be the capacity of "something else" vs. the new demand for "something else". If the capacity of "something else" was not destroyed in proportion to the then-realized demand destruction, the capacity of "something else" may not need to be increased substantially at all.

For traiding/investing this means that one needs to consider capacity vs. demand, just as in the past.

HardToLove

Apr 26 09:50 AM

[Ferdinand E...:]

"Friends from the Austrian school". They are not my friends because I don't know anything about them, and intend to keep things that way.

Apr 26 10:17 AM

[Spartacuss:]

Again we are treated to a word manipulation where a new paradigm will save the day. A reallocation of resource and effort.

The thing to wrap your head around is that all sectors will feel this backlash to one degree or another. Sure, there are positives, my son in laws seed company is on a tear, the home gardens are booming with a reported 30 percent uptick in seed sales year over year. And I would suppose other scenarios of this nature are occurring also.

I think what is missing here is that the American economy is driven by financial institutions with manufacturing making up only about ten percent. Everything and everybody is in hock big time and all this debt and associated derivatives are going to have be substantially written off. In the mean time we are all going to have to readjust our life styles and expectations, especially in equities.

The author picks up on a refreshing theme but fails to recognize the bigger picture.

Apr 26 10:32 AM

[irisatrx:]

I'd hoped to find some meat in the article. There's far more, unfortunately, in the comments.
We have a chart with no reference to its origin or validity, a vague comment about excess capacity, a firm statement that says "some excess capacity will not come back, a statement that the housing construction industry capacity is "gone" and will take years to rebuild, and we need to rebuild "capacity in something else."

Wow. Talk about enlightening! Reminds me of some of the blather of my undergraduate econ instructors dribbled to make us feel undereducated.

Bottom line, the economy is cyclical. We will emerge from this downturn just as we have from every previous one. A percentage [specifically vague] of investors and the population at large will be severely damaged, but the economy at large will survive.

The financial system consists of smoke and mirrors, and is, in a sense, a giant Ponzi scheme. So long as everyone has confidence in it, it works. Greenspan began destroying it in 1999 with his concern over inflation because investors in the dotcom industry were generating cash exponentially, thus the money supply grew -- exponentially. Greenspan interpreted [incorrectly] this growth in the money supply as inflationary, and tightene credit to the point that small businesses [employer to 90% of US labor] could no longer function -- causing the first of a series of economic downturns. By 2001, we were in a downward spiral that made the current one look like a gust of wind.

The ONLY thing that helped us recover from that was 9/11 and the subsequent infusion of cash into a war-driven economy.

Well, we don't have a war to spend money on now [Afghanistan isn't expensive enough, and we've commited to exiting Iraq], so what's left? "Shovel ready" minimum wage contracts to fix roads and bridges? Not much distribution of wealth or business building there other than cement, structural steel, etc. Food and seed? Same answer. Health? Well, we now have the Swine Flu panic [hmmm, 30 cases reported in Mexico -- gots to be a pandemic!]; pharmaceuticals might be a good buy.

Space -- the New Frontier! Now there's a place we can spend big bucks, create all kinds of home grown industry, and we can start building our construction colonies on the Moon, like we should have 20 years ago.

Apr 26 11:17 AM

[nerdyy:]

wow,that's so old school(and I can tell from you hair that you are still living in the Good old days). Wake up, the 21th century reality is if there are extra demand, all you need to do is go to China and find a supply 1/4 the price of doing it here. The US economy is down not just because the demand is down, but the capacity was build to meet the domestic demand but found out it is met by other country. This is not going to change in a foreseeable future.

Apr 26 01:41 PM

[nerdyy:]

why r u still stuck in the "spend spend spend" growth theory? Did China spend anything on the moon or on the war?


On Apr 26 11:17 AM irisatrx wrote:

> I'd hoped to find some meat in the article. There's far more, unfortunately,
> in the comments.
>

Apr 26 01:44 PM

[Rob Viglione:]

Finding the new capacity equilibrium will be interesting, as a return to pre-bust levels certainly will not occur and would not be advantageous to long-run economic health.

Apr 26 07:09 PM

[old101:]

To apply this generalized chart to a particular industry is nonsense, particularly the building industry. The capacity determinant in the home building industry is the availability of labor and capital and space. Each industry has it's own capacity chart. It is probably true that a highly automated plant like auto-assembly will be too expensive and out of date to re-open if it has been closed for a long time.

Every re-birth of industrial activity after a recession involves a lot of modernization of closed plants, thus increasing their capacity, not decreasing it.

Apr 26 10:43 PM

[Ben Simonton:]

The recovery will be a slow one because of government interference much as occurred during the Great Depression. In addition, government has become more anti-business and anti-iinvestors thus encouraging both to invest less in the U.S. and more overseas. We are copying the old European low-growth policies just as they are trying to escape them. And the dollar? What a blast it is in for when the deficit spending overcomes us.

Consumers had better hunker down and reduce their exposure to debt and become risk-averse.

Best regards, Ben

Apr 27 06:06 AM

[TeresaE:]

Industrial capacity is overstated to begin with.

The "experts" and Washington apparently have not driven through their local industrial parks, nor sat down and spoken to former business owners.

"Recovery" is a pipe dream, we off shored it to China. Too bad "free trade" didn't work both ways, then we might have a chance.

And inflating "green industry" while bankrupting real businesses won't work for anything. We have been doing this exact same thing in Michigan for over 6 years.

Results? Even fewer jobs but every tiny "green" company that opens up with 5 employees is front page news. Meanwhile, the closings with dozens and dozens of employees are buried and ignored.

There is no "saving" new industry. And collapse of the entire economy looks more imminent every day.

Apr 27 09:48 AM

[Jade Queen:]

I live in Oregon, with reputedly dismal statistics. Yet coffee shops and night spots seem busy. We had a forest and high-tech economy, supposedly, so that is why we are advertised to be in such bad shape. Nonetheless, real estate hasn't tanked as badly as some other places. Are there things off the charts that fuel the spending I see? I'm sensing there is more to the story than the old ways of reporting things are showing.

Apr 27 07:26 PM