Times/Krugman: Safe as Houses

NY Times
August 12, 2005
Safe as Houses

By PAUL KRUGMAN

I used to live next door to a Russian =E9migr=E9. One day he asked me to
explain something that puzzled him about his new country. "This place
seems very rich," he said, "but I never see anyone making anything. How
does the country earn its money?"

The answer, these days, is that we make a living by selling each other
houses. Since December 2000 employment in U.S. manufacturing has fallen
17 percent, but membership in the National Association of Realtors has
risen 58 percent.

The housing boom has created jobs in two ways. Many jobs have been
created, directly and indirectly, by a surge in housing construction.
And rising home values have fueled a simultaneous surge in consumer
spending.

Let's start with home building. Between 1980 and 2000, which was before
the housing boom, spending on the construction of new homes averaged
425 percent of G.D.P. In the most recent quarter, however, the figure
was 5.98 percent. That difference is equivalent to about $200 billion a
year in additional spending, generating roughly two million extra jobs.

Then there's the jump in house prices. Over the past five years housing
prices have grown much faster than the overall cost of living, adding
about $5 trillion to the public's wealth. Typical estimates say that
each additional dollar of housing wealth adds about 3 cents to annual
consumer spending, as families reduce their savings and borrow against
their newly valuable homes. So we're talking about an additional $150
billion in spending, and roughly 1.5 million more jobs.

Does anything else in the U.S. economy rival housing as a source of job
creation? Well, there's also the military buildup. The Economic Policy
Institute estimates that increased military spending over the past four
years has created 1.3 million private-sector jobs.

And, yes, there are the Bush tax cuts, which the administration insists
are the source of everything good in the economy. And it's true that
some portion of the tax cuts, which amounted to $225 billion this year,
must have been spent in ways that created jobs. Given reasonable
estimates of the effect of tax cuts on spending, however, they were
probably a smaller force for job creation than the military buildup,
and dwarfed by the housing boom.

So it's an economy driven by real estate. What's wrong with that?

One answer is that it has been a pretty disappointing recovery. Two new
reports, one from the Center on Budget and Policy Priorities and one
from the Congressional Budget Office, compare the current economic
expansion with other postwar recoveries. By any measure except
corporate profits, which have done very well, this one comes up short.

Even the good months would have been considered subpar in the past: the
administration hailed last month's job growth as something wondrous to
behold, yet there were 68 months during the Clinton years when
employment grew faster.

Still, the economy is expanding. But because that expansion depends so
much on real estate - without the housing boom, the economic picture
would look dismal indeed - you have to wonder how much to trust it.

I've written before about the reasons to believe that current house
prices in much of the country represent a bubble. When that bubble
begins to deflate, so will housing-related employment.

Beyond that, there's the disturbing point that we're paying for the
housing boom (and the military buildup and tax cuts) with money
borrowed from foreigners.

Now, any economics textbook will tell you that it's fine to borrow from
abroad if the money is used to expand the economy's productive
capacity. When 19th-century America borrowed from Europe to build
railroads, it was also enhancing its ability to repay its debts later.
But we aren't borrowing to build productive capacity. As a share of
GD.P., investment other than housing construction is below its average
between 1980 and 2000, and way below its level at the end of the
1990's.

In other words, a fuller answer to my former neighbor would be that
these days, Americans make a living selling each other houses, paid for
with money borrowed from the Chinese. Somehow, that doesn't seem like a
sustainable lifestyle.

How solid, then, is America's economic recovery? The British have a
phrase that applies: "safe as houses." Our economy is as safe as
houses. Unfortunately, given current prices and our dependence on
foreign lenders, houses aren't safe at all.

=20