Two Recoveries: The Economic Forecast Has Two Distinct Phases

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.