Ask the expert – Nouriel Roubini on prospects for 2009

An excerpt from a fascinating Q&A with Nouriel Roubini:

Is the solution to just keep re-inflating bubble after bubble to recapitalize our consumer driven economy or is it time for a huge systemic paradigm shift away from consumerism? What type of shift would you envision and would it destroy the economy as we currently know it?
Robert Singer, Oregon, USA

NR: For the last 30 years the US has been growing fast only during periods of asset bubbles that eventually burst with significant economic and financial costs.

The 1980s real estate bubble went bust in the late part of that decade leading to a severe banking crisis for the Savings and Loan banks, a credit crunch and a severe recession in 1990-91; next the 1990s tech/internet bubble went bust in 2000 leading to the 2001 recession; massive monetary and credit easing – as well as lax supervision/regulation of mortgages and credit – led to another housing and credit bubble that has now gone bust creating a severe financial crisis and recession.

The current monetary easing may lead to another bubble but we are somehow running out of bubbles to create.

Housing, credit, equities, commodities, hedge funds, private equity bubbles: they have all gone bust now. We need to create an economic system that is less prone to bubbles and more likely to lead to sustainable stable growth.

For the last few years the US has overinvested in the most unproductive form of capital – residential housing stock that increase utility but not labor productivity – and not enough into physical capital that increases the productivity of labor.

Also we overinvested in the financial sector, a corollary of the housing boom: when the S&P500 market capitalization of financial firms was 25 per cent of the market and when over a third of the profits or earnings of S&P500 constituents came from financial companies, that was an excess of finance.

And having a country where there are more financial engineers than computer engineers or mechanical engineers means a misallocation of human capital as well.

So we need to create a growth model relying less on housing/real estate, less on finance and less on having the brightest minds of the country going into financial services rather than into the production and innovation of new and improved goods and services.

via FT.com / Markets / Ask the expert – Nouriel Roubini on prospects for 2009.

The above discussion by Roubini gets at the heart of what is often not given enough importance in the discussion on the government’s role in helping fix the economy.  Propping up bubbles is akin to a kid on a candy binge — a euphoric sugar rush followed by a crash.  Talking heads often assert that falling housing prices are at the epicenter of the current crisis, and then proceed to say the only way to fix the economy is to prop up housing prices.  The most insightful statement Roubini makes above is that

For the last few years the US has overinvested in the most unproductive form of capital – residential housing stock that increase utility but not labor productivity – and not enough into physical capital that increases the productivity of labor.

More investment should go to sectors of the economy that increase productivity, so that in future the economy can produce more of what we all want.  The economic growth of this past decade was largely an illusion — rising home prices led people to believe they had more wealth, causing them to spend more.  But excessive growth in housing adds nothing to the productive capacity of the economy.