Yesterday on ABC’s This Week Robert Reich made a very interesting point during the roundtable discussion:
I think this is the big long-term question. I mean we have a short-term issue, how do you get the economy back and what does it mean to get the economy back?
He then got back “on-message”, meaning that he emphasized the importance of healthcare reform. Frankly, I don’t think that’s the big question. I think the big question is what does it mean for our economy to recover?
For the last decade or more the American economy has been highly I believe overly dependent on retail and much of that purchasing was done with borrowed money. Further, the primary engines of job creation over the period of the last decade have been the government, healthcare, and home construction.
The current stock of houses coupled with the reality that houses don’t look like quite as good an investment as they did four years ago probably means that housing construction isn’t going to lead the economy back into recovery as it typically did in past recoveries. Frankly, I doubt that construction will ever reach the importance in the economy that it has had ever again. But notice that we have yet to see the fallout from that. I believe we’re still going to see lots and lots of bankruptcies from home builders.
We’re also enormously over-invested in the financial sector. Somewhere around here there’s a link from a prof at the Wharton School of Business who’s estimated that the sector needs to decline about 30% to bring it into alignment with historic norms.
Healthcare already constitutes about 15% of the economy. My own view is that huge government subsidies over a period of 40 years has resulted in our being enormously over-invested in healthcare, too.
Note that when we’re over-investing in retail, construction, the financial sector, and healthcare (not to mention government), that means we’re under-investing in other areas. What areas? I’ve expressed the view in the past that export and agriculture are two areas that should be getting more attention.
As to other areas, I’m open to suggestion. But unless we stop over-investing in relatively non-productive areas in favor of more productive ones I don’t see how growth can be anything but phlegmatic.
As any common sense observer (or schoolboy) has observed, economies must adjust to the realities and creative initiatives of the day…….or become Eastern Europe circa the 80’s.
I’m thinking adjusting to very long term trends: agriculture to industrial to information dominated economies. I’m thinking intermediate trends (a decade or two) like the chain vs ma and pa retailer trend. And I’m thinking short term, perhaps within a decade, say, as the dot.coms appeared.
And we all know what retards these adjustments: regulatory or monopolistic protections, government support, and lack of investment capital.
Now let’s look at the sectors identified above as overinvested
Construction
Driven by a demographic: the baby boom.
Driven by governmental policy: mortgage interest deduction, zero capital gains as of 1997 (vis a vis other investment options) and pushed by social engineering like CRA.
Health Care
Driven by government subsidy and transfer payments. Too bad…..beacuse:
Soon to be driven by demographics.
Government
Driven by government by definition.
Retail
I don’t understand this one, except to observe that people have spent rather than saved out of either out and out irresponsibility……..or the notion that retirement will somehow be taken care of by government. And heavens knows that’s implicit in most pols speeches.
Finance
I understand the obligatory swipe. But the rise of global capital markets over the past 30 years is something that has been overwhelmingly positive
and an arena where America has prospered. Yes, we may right now be overinvested, but we will contract in light speed time.
Which brings me to my point. Yes, the private markets will slip and slosh getting into excess here and in deficit there. But they correct, and they do so with almost lightning speed if not interfered with. eg The dot coms had to correct, but look how fast that occured.
Now let’s look at the “overinvested” sectors of construction, health care, government etc. Look at the level of government influence. Expect a correction? I wouldn’t hold my breath. And even if so, it will be at glacial speed. And look at the posture of our current government, basically protecting buggywhip manufactures and just waiting to punish investment and entrepreneurship with the tax code.
As you may suspect by now, I’m not optimistic. With every passing day I see Japan redux.
Mr. Reich can contemplate his navel all he wants, but I suggest we let the free market tigers out of the cage. No doubt Mr. Reich, as will Barack Obama, see to it that they are tranquilized and on leashes.
Drew, I think the answer to retail is that this sector saw the greatest benefits from free trade with many goods diminishing in cost either in inflation-adjusted dollars or after adjusting for increased value. I would expect the retail sector to remain healthy or expand, depending on China and India’s contribution to the global economy.
Not to discount the role of borrowing on retail though.
Let’s look at the prospective effect on retail another way. What proportion of retail sales were generated as a consequence of HELOC’s? My WAG is 5-10%. That can’t be adjusted for by reducing margins. For most retailers these days 5% margins are the good old days. Margins are in low single digits.
That means that they can’t adjust to the reduced sales by lowering margins only by raising prices or bankruptcy. Raising prices will just reduce sales further. I think we’re going to see quite a bit of drop-off from retailing.
Do the historic norms for the financial sector really apply?
We’ve seen a massive increase in both the size and integration of the global economy over the past few decades, and one of the things that seems to be important to that economy in its current state is a global financial sector. Since, in many of these cases, business develops where the appropriate means for doing business are available, that means that the financial sector ended up being concentrated in a few countries that were already heavily invested in the financial sector (the US, UK, and so forth), and more specifically in a few financial power cities, like New York and London.
It seems inevitable that this type of financial development was going to happen somewhere, and due to economic and political reasons it happened where it did.
Brett –
For an interesting read that makes your point see: The World is Curved by David Schmink.
Dave –
Without even inspecting statistics on retail space……… The vacancies here in the western suburbs are almost astounding, whether the big cjhains or the ma and pa’s. Shopping in downtown Naperville on Saturday I was amazed at the closures.
However, for some, I have little sympathy. Did we really need a shop on Main Street that does nothing but sell hats and tee shirts with cute quotes on them?
We’ve already seen a few national retail chains close their doors and at least one major delivery service. I expect to see more of both.
And for the contraction I’m expecting of the financial sector I think that the very generous compensation schemes that prevailed up until the last couple of years suggest that there’s quite a bit to give up.