An Economic Review Of The Decade

In a word: ugly. That's what economist Paul Krugman thinks about the past decade. He calls it "the big zero," since there was no significant growth in any measure of the economy. Zero job creation, zero increase in median income, zero gain for home prices, zero gain for stocks. While I sort of agree with his assessment of how awful a decade it was in economics, I think there are a few reasons why it was such a disastrous decade that he misses: the wars in the Middle East and the U.S.'s reliance on its real estate market.

What does Krugman mostly blame on this lost decade for U.S. economic progress? Not enough regulation and not learning from our mistakes:

Even as the dot-com bubble deflated, credulous bankers and investors began inflating a new bubble in housing. Even after famous, admired companies like Enron and WorldCom were revealed to have been Potemkin corporations with facades built out of creative accounting, analysts and investors believed banks' claims about their own financial strength and bought into the hype about investments they didn't understand. Even after triggering a global economic collapse, and having to be rescued at taxpayers' expense, bankers wasted no time going right back to the culture of giant bonuses and excessive leverage.

As I've mentioned before, bubbles are notoriously difficult to avoid. Although the Federal Reserve might have been able to take some action to make the real estate bubble less severe, I find it hard to believe that government intervention could have avoided it altogether -- unless he means that the government should not have allowed Fannie and Freddie to grow so large. But somehow, I don't think that's the kind of government action he's talking about.

As for regulation, some definitely would have helped prevent the crisis. For example, higher capital requirements may have helped. Better disclosure, allowing investors to understand all of the hidden leverage within banks, would also have helped. If you had better limited banks' leverage, or required more capital, then the purported bonus problem would have taken care of itself, as bankers' earnings would have been necessarily lower.

I would add a few additional causes to Krugman's list, however. One is the wars in the Middle East. The tab from Iraq and Afghanistan is approaching $1 trillion. That money is a pure economic lost. When you blow up a bomb, or fire a bullet, it's like burning money. I guess you could argue that it's an investment in U.S. security, if you believe that the nation is really all that much more secure as a result of the military action in the Middle East. Given the nearly successful terrorist attempt even just this past weekend, I'm not particularly convinced that was $1 trillion well-spent. Imagine if Americans had paid $1 trillion less in taxes, how much economic activity that might have spurred.

Additionally, I think anytime a nation gets too carried away with real estate, it's a bad sign for long-term growth. Real estate investment doesn't really create wealth in the same way that producing goods and services can. There's no technological innovation involved; there's no exporting of goods and services. All a domestic real estate market can really do is supply demand for houses as population increases and old homes need replacing. While some additional supply can be created through second homes for the wealthy, you would hardly want to establish an economy dependent on that.

A prime example of this is Florida. Other than tourism, over the past decade, the real estate market drove its economy. Once the housing bubble popped, it became clear that the state was in big trouble: it has no other major industry other than tourism to pick up the slack. If, instead of trying to develop such a strong real estate market, it focused its efforts on developing other industries like solar energy, high-tech manufacturing or even something like entertainment, it might not have such awful employment prospects in the years that follow. Last month, when virtually every state saw fewer jobless, the unemployed continued to increase significantly in Florida. Far too much of its population growth depended on real estate industry jobs. Now that the music has stopped, there are too many people and too few jobs.

And that's a good analogy for the broader U.S. economy over the past decade. Unless it concentrates on industries that can actually drive sustainable growth, it will remain stagnant. Even when the tech bubble popped, not all was lost. Silicon Valley remains a hub for technological innovation. There was some sustainable growth there through technological advances and jobs that would endure. There will always be a real estate market, and a need for construction and housing. But it should never drive GDP, jobs, or U.S. growth. Other industries can do far better.