Richard Florida
by Richard Florida
Sat Nov 29th 2008 at 9:13am UTC

The Way to Recovery

My Globe and Mail column says we gear the stimulus to growing the new economy, not propping up the old.

Financial recovery needs a massively different mindset

RICHARD FLORIDA

President-elect Barack Obama has announced his intention to restart the American economy with hundreds of billions in new spending on transportation, public works and energy. Ever since John Maynard Keynes, economists have seen such fiscal stimulus as the key tool for leading economies out of recession. In 1971, Richard Nixon famously remarked, “We are all Keynesians now.”

But what worked during the Great Depression may not work quite as well today.

By the time Keynes published his classic General Theory of Employment, Interest and Money in 1936, it was clear that government had to spend money to counter economic decline, and it was also clear where it should be spent – on big construction projects such as highways, public works, even housing. At the time, Keynes famously remarked that the economy would be better off even if all workers did was dig ditches and fill them up again.

While few economists believe the global economy will fall into a 1930s-style collapse, a similar approach to the current financial crisis may not work as well now for a simple reason: Today’s economy is largely driven by the creative industries that have grown up over the past two or three decades. The overall picture now bears more resemblance to the early industrial economy of the mid-to-late-19th century – when industries such as automobiles, chemicals and electronics were just emerging – than to the relatively mature industrial economy of the 1930s.

Restarting economic growth this time around will require a new social and economic framework that is in line with the new idea-driven economy.

The trouble is: We remain trapped in the mental models of the old industrial economy. The bursting of the tech bubble in 2001 held back the emergence of the new order. Scaring investors out of technology, the Internet and emerging economic sectors, it sent capital flowing out of the creative economy and back into the safety of housing and real estate – from “clicks to bricks,” so to speak. This is why attempts to prop up housing prices or to bail out Detroit are giant steps backward.

The way out of the current crisis involves creating the social and economic conditions within which the new system can evolve. While it is impossible for anyone – least of all government policy-makers – to know what this system will look like, there are several things that can help it along.

The first step must be to reduce demand for the core products and lifestyle of the old order. The industrial economy more than a century ago required a revolution in agriculture – one that improved productivity and reduced the share of agricultural labour from roughly 50 per cent of all workers in North America in 1900 to less than 5 per cent today. Cheaper food then freed up disposable income for cars and other household products.

What’s needed now is to massively shrink expenditures on houses and cars to free up spending for newly emerging goods and services. Part of this rollback will naturally occur as the real-estate bubble deflates and housing prices fall. But we need to take it a step further if we truly want more demand for new kinds of economic activity.

Our reliance on single-family homeownership is a product of the past 50 years – and the experiment has outlived its usefulness. Not only is it now readily apparent that not everyone should own a home, and that the mortgage system is a big part of what got us into the current financial mess, but homeownership also ties people to locations, making it harder for them to move to where work is. Homeownership made sense when most people had one job and lived in the same city for life. But it makes less sense when people change jobs frequently and have to relocate to find new work.

Housing production remains a cottage industry that needs to be brought into the 21st century. As a sector, it holds huge potential for making environmental gains, reducing energy use and overall consumption, and introducing new technology.

Government can also encourage a shift from ownership toward flexible rental housing. Instead of bailing out homeowners who have fallen behind on their mortgage payments, tying them to houses and locations for life (and taking up 38 per cent of their income or more), why not take the houses off their hands and rent them back at a much more affordable rate? This would allow people to move more freely as their job, career and lifestyle prospects change. Government incentives spurred a massive increase in homeownership after the Second World War; it can do the same for the expansion of new, more flexible forms of rental housing today.

Both energy and transportation must become significantly cheaper before we can shift into a new era of economic growth. Every economic revolution has been premised on the rise of new and less expensive sources of energy to power growth, and a drastic reduction in the costs of moving goods, people and ideas. The car will surely remain part of our life, but we need to improve rail, subway and bus transit. We should also make a major effort to reduce widespread commuting patterns.

Imagine a future where people live in plug-and-play rental housing units – able to move quickly when they change their jobs, with many shrinking their commute to a short walk or bicycle trip and many others able to trade in their cars for accessible mass transit.

Last but not least, government investment can help to revolutionize the way we develop people. Human capital investments are the key to economic development. But many of our schools are giant creativity-squelching institutions. We need to reinvent our education system from the ground up – including a massive commitment to early-childhood development and a shift away from institutionalized schooling to individually tailored learning. This will require a level of public and private investment of a magnitude larger than the widespread creation of public schools and modern research universities a century ago.

Only by catalyzing such a wholesale shift in our underlying socio-economic system – and thereby unleashing the massive innovative and productive potential of our time – can government investment restore our economy.

28 Responses to “The Way to Recovery”

  1. Harold Jarche Says:

    It sounds like it’s more a question of what infrastructure government should invest in. Two areas that I can think of – rail and broadband – are support the creative economy. Rail allows knowledge workers to work while traveling and broadband reduces the need to travel as frequently.

  2. hayden fisher Says:

    Richard, excellent piece!

    The housing solution you propose, however, eliminates a tried and true (long-term) vehicle of wealth creation and leaves only income increases + savings as a means to create unless one accepts the proposition that market investments could replace housing investments– but those are much less stable than even housing. Without increased equity derived from real estate investments over time (and the enormous tax breaks that come with them), where do parents develop the wealth, for instance, to pay for college education for their kids or elder-care needs for themselves? I agree the market is heading towards a more flexible housing model but I’m not sure it will be rental-based; but we’ll see.

    Entrepreneurship will be the absolute path to economic recovery and broad economic opportunity. Education and the student loan programs provide opportunities to acquire an education and job; but not to open a new business. With so many talented people now unemployed, entrepreneurship and economic growth could soar as people are forced to take the risks and plant the seeds they might otherwise have been to complacent or otherwise “safe” to take. But the capital to do so must be available.

    We need to put our SBA programs on steroids to ensure the delivery of capital to those who can use it to start new businesses and enhance SBA offices to also provide more assistance with the process of starting a new business. Forget the banks, they’ve shown why they should be obsolete as business-generators; the government must direct-lend and cut out these marauding corporate middle-men. Seed and enhance the SBA programs and the garden will grow again.

    Infrastructure always can use improving and broadband would be nice but more than anything we need people starting new businesses and creating economic impacts for themselves and the economy as a whole via entrepreneurship. Less big box and publicly traded businesses; more specialty boutique providers who operate independently through networks of service providers and product design, development and sale teams.

  3. Wil Says:

    I am surprised to see the suggestion that demand for a house and car of one’s own should be reduced. I actually read a similar notion on a survivalist website a few months ago ( I am a somewhat indescriminate reader). The claim was that in the “New World Order” the government would own all real estate, and the population would be tenants.
    I don’t see homeownership as an “experiment” that has failed. A very large percentage of people achieve wealth via some facet of the real estate business. I would be willing to bet that those who advocate discouraging home ownership for others, in fact own their own houses. Personal mobility via car ownership is also one of the keys to freedom. If you can’t even own a house and car what are you working for ? Is it to buy trinkets to put in your rental unit?
    The keys to solving the economic crisis include: meaningful public works projects, reduction of taxation, reduction of process, and “red tape”, the return of free community colleges, greater freedom, and less fear written into laws. People don’t need a paternalistic arrangement with the government baby sitting entrepreneurs, freedom will provide plenty of opportunities.

  4. Swordsman Says:

    Outstanding article!

  5. Eric Fredine Says:

    Lately, I’ve been thinking a lot about local advertising – primarily from the point of view that electronic media (mobile and internet) are about an order of magnitude more efficient than traditional media outlets.

    Reading your article made me realize that current expenditures on cars and houses are also propping up a lot of traditional media.

    A few weeks back I had a look at the advertising in my local newspaper – it was dominated by cars and houses. In fact, I’d venture to say that without this source of revenue, my local paper would fail to exist – at least in its current form.

    This kind of advertising is wildly inefficient since only a small percentage of the audience is in the market for an automobile or house. By one estimate, automobile manufacturers spend an average of $2000 per automobile on advertising.

    One huge infrastructure challenge is that most businesses – especially smaller local ones – don’t know how to effectively advertise with these new media. So they are missing out on the potential efficiency improvements.

  6. Sharon Chisholm Says:

    Rethinking housing policy is essential. Looks like pushing low income households into homeownership in questionable markets didn’t work. People are looking for the security and control that homeownership offers without the risk. That can be offered in different ways. Residents in social housing, co-op housing and even market rental housing could get some kind of tradable equity in housing when they prove to be good tenants. Too many tenants of affordable housing are locked into a housing unit, fearing loss of their housing should they move for a better opportunity. What if they could take some security with them, trade up to better housing, or to a smaller housing unit or a better located one? Tenants need choices and the ability to steer their ‘housing career’, moving as their circumstances change. There are a number of interesting models out there, but some radically different ones are needed. Younger households do not see affordable housing options that work for them. Locked out of homeownership, by high prices, low wages and student loans; given few choices in a declining and deteriorating stock of rental housing and giving up on long waiting lists for social housing, they need to be able to begin to define what will work for them. What about a housing club that promoted mobility? What about more sustainable housing forms, like smaller houses, no parking, less (or no) reliance on fossil fuels? Investments to rescue the economy could and should be tied to providing housing solutions that work for them, for the economy and for the environment. I agree with Richard. Let’s not waste this crisis by only offering up yesterday’s solutions.

  7. CR Says:

    “…individually tailored learning” As a homeschooler, I would love to see that happen on a national scale.

  8. Wil Says:

    Regarding housing, the governement is not necessarily the solution, what is most needed by those looking for housing is knowledge. A person can even find a single family house in the San Francisco Bay area for under 100k, if they look hard enough see:

    http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2008/11/30/MNCB147SV4.DTL

    If the Bay Area isn’t of interest, simply do a boolean search on craigs list in any US city with “owner financing” as a search term. Chances are that you will find plenty of easy housing.

    A recovery for creative people is simply provided by freedom, and autonomy. The essence of creativity is figuring out solutions, using the resources at hand.

  9. Jason McFarlane Says:

    Richard,
    Thought provoking article.

    I’m not entirely sure that writing off home ownership for the masses as a means of wealth creation is the answer. Traditionally, attaining a first mortgage required discipline in saving for a deposit and providing a savings record for a bank. Habits formed in just getting a loan formed the basis for long-term wealth creation and economic sustainability. In the era of easy credit such habits are not fostered within the population decreasing resilience when the good times turn bad. The same habits are crucial in entrepreneurs, plan to exist within your means, and understand the implications of the risks that you take when you step beyond them. . My belief is that a crucial factor in long-term economic development for a population is institutions returning to the reinforcement of sensible spending habits from the outset.

  10. hayden fisher Says:

    Wil, good comment! But policy does matter. A lot. Creativity grows and empowers relative to the surrounding context. Siphoning several trillion dollars out the American economy and spending it on a new deal will not foster growth in the creative sector. That money needs to be in the hands of talented entrepreneurs to become a true investment in the future by the government.

    People who believe the current system isn’t broke simply had not lived in it. The asset-backed lending system is the problem, plain and simple. I would not argue in favor of doing away with traditional banking altogether as tempted as I am to do so. But we have to devote more resources to SBA programs.

    The guy who started fed-ex did so by using an inheritance he had received against the advice of everyone around him. But he had a vision and the commitment and zeal to bring that vision to life. And he did. There are far too many would be entrepreneurs who simply lack that inheritance to start; or they’re younger with no assets having yet been accumulated. By the time they do, they’re in their late 30’s or 40’s, have lost much of their passion for their ideas and are saddled with child-care and family commitments that leave starting a new business as a too risky or otherwise unappealing choice. Or their spirits have been stamped-out by corporate American. We need an SBA program that gets capital into the hands of the capable much earlier in life.

  11. hayden fisher Says:

    And in the same vein, the current economic crisis is a product of the asset-based lending system. The notion that real-estate investments are safe and “secure transactions” because they’re backed by tangible real estate that will not lose its value. We have seen the result. We need a government-sponsored lending system predicated on idea, concept and human-talent based lending; not asset backed lending. Our college and university system does this extremely well. Quite frankly, so does the military, case in point, the Marines, and their quest for “a few good men”. The government should sponsor more entrepreneurship. Not the hedge funds and venture capitalists who look to steal the ideas and businesses once they’re launched. The government should to it because it has an interest in developing sustainable new businesses that pay taxes, employ citizens and further commerce, thereby creating more tax bases and jobs. Not make quick buck like the venture capitalists aim to do. Certainly the private market will continue to have a huge role but government must became very pro-active in this arena. Right now, it’s a joke in the process.

  12. Wil Says:

    Your example of FedEx being started with personal assets from an inheritancce is a good example of how an individual’s particular situation can allow him/her to become an outlier. Incidentally, that is one of the themes of Gladwell’s new book. However, we can’t expect, nor do we want, the government to be in the role of benefactor. What we can hope for, is for the government to allow positional capital in the form of less regulation, and more freedom. It is true that darwinism is unfair, and that many will not be able to successfully carry out their ideas, but ultimately, those who are most focused and dedicated to creating their businesses will emerge. They always have…. What do you think of the dot com boom? It was, at least theoretically, powered by talent-backed kending.

  13. Zoe B Says:

    Infrastructure isn’t just roads. I am more concerned about pipes: water and sewer pipes in metropolitan areas. We have been living off investments made as long as 100 years ago. Urban density is safe only when we have taken basic public health measures such as clean water and proper sewage disposal. And this issue should not be caught up in red/blue rhetoric. Everyone needs clean water.

  14. Buzzcut Says:

    Interesting comments, but each one predicated on the idea that the government has to “do something”.

    Each one is predicated on the idea that the right policy put forth by the right people will get the job done.

    I think the evidence shows that we are just going from one bubble to the next, one crisis to the next. The government is the problem.

    If the government took a neutral stance on housing, education, infrastructure, etc. we’d be all a lot better off over the long term.

    Sure, we’d be in for the nastiest recession any of us have ever seen. But it could be over quickly (like the ‘82 recession) and we’ll all be on to bigger and better things.

  15. hayden fisher Says:

    Wil, I dissent. Wall Street funded and fed the .com bubble, and next, the housing bubble. That is, the private sector trying to make quick profits, not the government attempting to seed a sustainable economic system that rewards productivity and talent while ensuring opportunity for all. We don’t need more or less regulation as a rule of thumb; we need smart common-sense regulation.

    Buzzcut, if you think that policy doesn’t matter, you should recall the stark contrasts between East and West Germany after the Berlin Wall came down. Policy matters. We need pro-growth policies and more public-private partnerships across the board. I would not want the government as owner-operator of any business–just look how they’ve wrecked Amtrak. But as passive investor and lender, I would take government over the heavy-handed and vulture-esque private sector any day.

  16. Michael Wells Says:

    Here’s a strategy that would fit Richard’s goals for new housing, boost the economy, use some of the bank bailout funds, help struggling families and end some homelessness.

    Ever since the Reagan administration, federal funds for low income housing have plummeted. This has affected everything from the housing bubble to homelessness. What happened at the same time is that federal policy moved to developing housing using nonprofit Community Development Corporations (CDCs), which financed their projects using tax credits which banks bought as part of their Community Reinvestment Act(CRA)requirements, as well as for tax writeoffs. Now that banks are losing money and don’t need tax writeoffs, financing for affordable housing has dried up and there are planned and permitted but unbuilt projects all over the country.

    So here’s a plan:
    • Modify bank CRA requirements to include using some of their bailout money for low income tax credits — maybe give them extensions to take the tax writeoffs when they’re profitable in the future.
    • Use federal HUD funds to cover the inevitable shortfalls between the tax credits and construction costs if projects start within 3 months — get that money into the economy.
    • Expand the HUD 202 and 811 direct construction programs for low income seniors and supportive housing.
    • For the Republicans and to lower costs, exempt these programs from Davis Bacon requirements that basically require union labor on federal projects. The unions will howl, but ultimately go along.

    There could of course be energy efficiency requirements, putting projects near transit, etc. Many of these are already being done. Some housing could be opened up to low income students and artists.

    I like this so much I think I’ll post it on the Change.gov website.

  17. hayden fisher Says:

    Michael, great suggestions. I would add to the list enhancing SBA programs and seeding them with more capital–essentially revolving credit lines. So that we do not just build houses but also businesses; the criteria would be that the new business must confirm to an agreed-upon master plan. This would deliver truly diverse and interesting mixed-use urban development.

  18. hayden fisher Says:

    If you launched one of these programs in a place like Detroit, just imagine the explosion in creativity as many of the former labor-hands leave the assembly lines to strike-out on all kinds of different endeavors, turning hobbies and passions into new thriving businesses of all kinds.

  19. Michael Wells Says:

    Hayden,

    Great idea. The new market tax credit program for starting businesses in depressed areas (enterprise zones) is already in place, and in fact are another way that banks can satisfy CRA requirements, which were put in place to fight redlining.

  20. hayden fisher Says:

    I know Michael, I have a company doing exactly that. Problem is that those tax credits are only available on the back end and most banks don’t want to do any kind of deals in “risky” areas. I spent lots of time finding one to do our project and we conformed to traditional lending criteria. But it should not be this hard. The economic development folks are very aware of the problem and the solution but they’re politically precluded from asking for increased revolving credit lines. This is a major issue. Urban revitalization will never be anything near what it could be until these issues are resolved. Why do developers keep building out suburbia? Because that’s what satisfies the lending models. It will never change until we power-up our SBA programs at a minimum. Soon we will reach a point of stagnation as banks will become averse to lending in suburbia too. That’s what we’ve been seeing over the last year actually. The result is devastating. Business cannot grow or even be sustained without available capital. Even T. Boone Pickens cannot get the funding he needs to build his wind farms; first the banks wanted 20% down, then 30%; now they won’t do the deal.

  21. Buzzcut Says:

    Buzzcut, if you think that policy doesn’t matter, you should recall the stark contrasts between East and West Germany after the Berlin Wall came down.

    You have to explain that one to me. My recollection is that money was thrown at the formerly East German areas, to very little effect. The problem was the work ethic of the formerly East German people, not surprising given how they were conditioned for 45 years.

    I don’t think that policy doesn’t matter. It does. But it usually matters in terms of unintended consequences. I’m not a liberal because liberals don’t ackowledge the Law of Unintended Consequences.

    Has any one of you thought through your policy suggestions to think about what unintended consequences it might create?

    I rest my case.

  22. hayden fisher Says:

    Buzzcut, the point is that East Germany was in a horrible condition compared to West Germany. No infrastructure, etc. When the markets were opened, you’re right, the other systemic infrastructure was not there to launch business. It had much less to do with lack of human talent (although many spirits had been stamped-out and human growth halted during the intermittent period to be sure) and much more to do with the lack of systemic infrastructure such as a dependable and fluid system of finance, well-developed bodies of law and educated lawyers and judges to effect it, etc. As another example, I point to the difference between Mexico and the US. We have a stronger federal government that is well-balanced against the interests of business; the Mexican government does not. Etc., etc.

  23. Buzzcut Says:

    As another example, I point to the difference between Mexico and the US. We have a stronger federal government that is well-balanced against the interests of business; the Mexican government does not. Etc., etc.

    I wouldn’t characterize Mexico’s problem as one of a weak federal government. They have very weak property rights and government owned monopolies in key industries, especially oil.

    In another words, socialism is their main problem. Ironically, there is an elite in that country that benefits from the socialism, along with a peasantry that romanticises it.

    Not unlike the Democrat party! ;)

  24. Wil Says:

    Hayden, I am shocked to realize that you are left of me, I thought that the only people left of me were living in communes…. I have trouble with the idea of entrepreneurs looking to the government for funding and support, to start up a business. I like the idea of the government providing infrastructure; both physical, in the form of broadband, utilities,and railroads, etc..and social, in the form of universal healthcare (like Canada), and less taxation and regulation, etc… I like less government, but it looks like the pendulum is swinging the other direction right now.

  25. hayden fisher Says:

    That’s the first time I’ve been called left wing, I have to confess!

    I don’t care whether it’s left, right or center; the point is, what will work? Is the federally backed student loan program socialism? If so, I might be a socialist, because I couldn’t have gone to law school and later earned large sums of money that I paid tax on (and my student loans) without it.

    Socialism implies handouts for everyone and government controlled businesses. I’m proposing government financed businesses and cutting out the middle-men (since all banks borrow from the Fed anyway). I’m proposing an enhanced public-private partnership model that creates revenue for the government in terms of interest payments that will ultimately allow it to stop taxing productivity and instead create more of it.

    This is not a new concept, Alexander Hamilton and the federalists has the right in the beginning before the agrarians took them off path. And that duel thing.

  26. Wil Says:

    I agree that what works is much more important than ideology…
    Three of the problems I immediately see are :

    1) Since everyone doesn’t get “handouts”, who decides which businesses are financed, and who has input in the decisions about the criteria for qualifications ?

    2)Is a bailout culture being created?

    3) Are businesses that are not supported by the government disadvantaged in any way?

    Your mention of student loans touches on what I said earlier about free community college. Education, health, etc are part of the social infrastructure that provides positional capital for all citizens. I’m not suggesting that the government fund law school, but imagine how much scientific, and technical knowledge could be disseminated….

  27. hayden fisher Says:

    1– tricky subject, but that would be left to the local SBA organizations or the regional equivalents and based upon public policy, some of which exists and some of which does not; for cities, the criteria would be that the new business would have to conform to the city’s master plan. Equally important, the merits of every application would have to be evaluated much the same way as colleges evaluate applicants

    2– i’m not sure it’s a bailout culture, the government aims to make a lot of money off of these deals in the long-term much the same way that it did following the great depression. For better or worse, the federal government is the only institution with enough liquidity to ride out the storm and restore market confidence at the same time, ie, foreclose the panic

    3–businesses that do not support public policy become more disadvantaged; the strip club and casino districts probably will not get funding, as gross examples. But I would not have the government supplant the private market, I would propose having them become substantially more proactive as economic developers and business funders.

    I agree with your points on free community college and trade schools as well. We need the healthcare industry out of the control of the insurance companies without completely nationalizing it. Obama’s plan is nearly perfect. Hillary’s was too far left, McCain’s plan was great in theory but it ignored the tremendous bargaining disadvantage individuals and small businesses face against insurance giants that can afford to deny claims and drag claimants (sophisticated and unsophisticated) through the legal system until they surrender. Government needs to intervene in the current system to insulate against those tactics.

  28. Ryan Austin Clarke Says:

    Mr. Flordia,

    What planet are you living on?

    The notion Americans should become a nation of RENTERS will only foster one creative thought which may have slipped your mind. HOW TO REVOLT!!!!

    Being free from monthly payment obligations such as rent is paramount to allowing the human being to create. The burden of debt only creates slavery and SERFDOMSHIP.

    The fact that housing bubbled to the degree it did – was not only the result of the Fed allowing such an event to occur – but also of the American individual’s desire to be free – namely free, long at last, from monthly payment obligations.

    Because the ruling class of this country would not allow a natural capitalistic depression to occur with the bursting tech bubble we now will experience a pseudo currency demise with yet another bubble the ruling class of this country will not be able to solve.

    Get ready for the energy bubble five years from now. You’ll be walking to work regardless of your ability to afford a car, train ticket or any form of transportation you presently take for granted!!!

    Regards,

    Ryan Clarke