Economic growth is expected to be modest over the next several years. (See my review.) There are several structural reasons why growth may be constrained. Today I would like to just highlight two of these factors that seem to be in the headlines these days.
The real estate area is one of these factors. What has struck me in recent days are estimates of the number of foreclosures expected over the next three to four years. The latest figures I have heard place the numbers in the hundreds of thousands for each year in this time span. If one out of every five homeowners are "underwater" on their mortgages and if one out of every five individuals of working age are under-employed, the estimates of possible foreclosures in the near future do not seem excessive.
This is a structural problem created by fifty years of government credit inflation affiliated with an excessive emphasis upon creating incentives for home ownership ultimately resulting in the subprime debacle of the past decade or so. One of the constant conclusions of economics is that there are consequences of the incentives that you artificially set up.
A corollary of this is that oftentimes the people these incentives are set up to help actually end up worse off in the longer run. We now have another example to add to the economics literature of why this insight is true. As the Nobel prize-winning economist Robert Mundell has recently stated, the "free lunches" that politicians promise voters in order to get elected often come back to harm the very people they were set up to help.
The restructuring that is needed in the housing market will take years to accomplish. And, accomplishing this restructuring will not just involve the generating new housing starts, housing prices hitting a bottom, and a growth in rental properties. When you distort incentives for years and years, it takes a long time the economy to re-adjust.
The restructuring will involve a continued shift of wealth from the less wealthy to the more wealthy…a continued increase in the inequality of the income/wealth distribution in the United States. We see this occurring in many instances, like the wealthier picking up all sorts of properties at very cheap prices to build "portfolios" of "fixer-uppers to fill with tenants.
The same thing might be said about what has happened to municipal governments. There are some real disasters being confronted in this area at the present time. Take Detroit…please. And, Stockton, California. And, Harrisburg, Pennsylvania. And, Jefferson County, Alabama.
During the fifty years or so of credit inflation that was particularly successful in inflating property prices, local municipal governments thrived. Not only did the governments themselves thrive, but the municipal labor unions thrived to the extent that public labor unions came to represent more workers in the United States than did unions in the area of manufacturing.
Labor unions could thrive in this sector of the economy because they were a monopoly and because it was easy to pass along the increase in salaries and benefits to property owners. Property owners had the best "piggy bank" going during these wonder years, the "piggy bank" being their homes whose prices were inflating far beyond the general level of consumer prices. Furthermore, these municipalities found an almost unlimited financial market to issue debt into and, if any questions arose about their financial condition there were always accounting gimmicks that could be used to make "things" lot better.
The problem is…to draw on the analogy presented by Warren Buffet…that the tide has gone out and this has revealed the fact that some of the people in the water were not wearing bathing suits!
Times have changed for municipal governments and this means that there must be a substantial restructuring of how these organizations do business. Detroit is a prime example. Here the city government became the welfare agency of the population and the population ceased to work. This was not lost on a lot of people as the population of Detroit declined from over two million citizens in the 1950s to less than eight hundred thousand today. The "free lunch" is over for the people of Detroit and those left in Detroit do not want to see their welfare go away.
Again, we see that the problem of getting back to higher levels of economic growth is that a major restructuring has to take place in municipal organization and finance. Major restructurings take time and resources. And, a situation that has been created over many, many years cannot be turned around on a dime.
Economic growth is going to continue in the United States but it is not going to be robust. The past fifty years has created many dislocations in the country that must be worked out. Those discussed today are just two of the many.