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Built to Bust

BERKELEY – In the mid-2000’s, the United States had a construction boom. From 2003-2006, annual construction spending rose to a level well above its long-run trend. Thus, by the start of 2007, the US was, in essence, overbuilt: about $300 billion in excess of the long-run trend in construction spending.

When these buildings were constructed, they were expected to more than pay for themselves. But their profitability depended on two shaky foundations: a permanent fall in long-term risky real interest rates, and permanent optimism about real estate as an asset class. Both foundations collapsed.

By 2007, therefore, it was reasonable to expect that construction spending in the US would be depressed for some time to come. Since cumulative construction spending was $300 billion above trend, it would have to run $300 billion below trend over a number of years in order to return to balance.

So, in 2007, everyone expected a construction-led slowdown. And, starting that year, construction spending did indeed fall below trend. But we were expecting a minor decline: a fall in construction spending below trend of $150 billion a year for two years or $100 billion a year for three years or $75 billion a year for four years. Instead, spending fell $300 billion below trend in 2007 alone, and has remained depressed for four years. Moreover, there is no prospect of anything like a rapid return to normal levels.