Sunday, November 22, 2009

Oh, for the sounds of hammers

San Diego Union-Tribune article "Oh, for the sounds of hammers" (November 21st, 2009) appears to miss the special nature of durable goods like housing in the "business cycle." The government should not delay our arrival at a long run housing market equilibrium by building more.

One, be thankful for complex civic projects, the kind that take longer to complete. We’re talking about Vista’s new civic center, fire stations and amphitheater or Escondido’s new police station, almost finished. Or school bond issues, passed last November. The money’s available, but winning state design approval takes time. Districts that act nimbly will be able to stretch their dollars by purchasing material and talent while prices are low. Public projects will keep the construction industry alive while the private sector struggles to shake off the bust part of the boom and bust cycle. [Emphasis added]

Buildings last a long time. We build a very low percentage of houses that go into the market every year, because houses last so long. If we have, due to a shift in our expectations about the need for construction, built too many houses, too many office buildings, too many McDonalds, it must be recognized that it will take some time for us to shift supply back down. We have to wait for enough buildings to depreciate so that we are back to a lower, more appropriate steady-state. Until then, we find ourselves in a situation where investment is zero (or very low), as depicted below.

The government can do one of two things to stimulate the sound of hammers: it can commission public woks projects or it can build houses (for example, by subsidizing building costs for new houses). The government should not to to prop up the construction industry by encouraging public works projects because these projects are already at their steady state (there was no famous public works bubble). If government, on the other hand, props up the housing market by building houses out of equilibrium, they will delay investment. This is because by increasing the quantity of new houses on the market to above equilibrium levels, the government causes the price of housing to remain lower for a longer period of time. This means that the "steady state" time period depicted below (click the image to enlarge) occurs later than it would without government intervention. Ultimately, we see no reason for the government to force such suboptimal levels of production.

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