Is Keynesian Economic Theory Good for the Commercial Real Estate Market?

A couple of weeks ago, my column on this blog entitled “Higher Taxes Mean Sluggish Employment” created a significant number of responses and provided a microcosm of on of the biggest debates going on in Washington today. It is the debate between those who believe that the government should create another round of stimulus, thereby increasing spending to stimulate the economy versus a focus on deficit reduction.

The pending expiration of the Bush tax cuts, which are scheduled to sunset at the end of this year, is prompting heated debate in Washington regarding which of these two strategies, or a combination of each, to implement. If you read the comments made in response to the above mentioned column, you will see what appears to be a debate fit for an episode of Face the Nation rather than a commercial real estate blog.

So, you may be asking why a real estate investment sales broker cares so much about government policy as described herein. The fact is, that our real estate market relies heavily upon the performance of the economy as that economic performance greatly impacts the employment picture. Employment is the economic metric which most profoundly impacts the underlying fundamentals of our real estate market. This is why policy is so critical and is worthy of close scrutiny.

During the past two years (yes it did begin under the Bush administration), we have seen an unprecedented level of government intervention in the form of stimulus spending. Unfortunately, this spending has not produced the desired results and it appears that, to the majority of Americans, spending our way into prosperity is going out of style (according to this morning’s Rasmussen poll, 58% of Americans are pessimistic about the U.S. economy). Most economic indicators are falling well short of the administration’s expectations given the massive intervention.

The U.S. economy is losing momentum and, in the second quarter, consumers remained frugal and employers failed to create jobs at any level near what is necessary to begin eating into the 8.4 million jobs lost in any meaningful way. The latest and most far reaching snapshot of the U.S. economy showed that gross domestic product, which is the value of all goods and services produced by the economy, grew at a 2.4 percent annual rate during 2Q10. This figure was down from an upwardly revised 3.7 percent in 1Q10 and 5 percent in 4Q09. Unfortunately, this low GDP growth level bodes poorly for the balance of 2010.

Also, last Friday, the government released revised GDP numbers for the past three years showing that the recession was worse than previously thought. With GDP growth stalling and the specter of future tax increases, higher interest rates and more government control over nearly every aspect of the economy, businesses nationwide are stuck in a holding pattern relative to job creation. Consumer confidence and consumer spending are low, the housing market is petering along and exports are not nearly at the level that anyone would like. For these reasons, consumers are also stuck in a holding pattern, unwilling to open their purse-strings.

The inertia in the economy is being fueled by the tremendous uncertainty in the marketplace. As we know, markets like nothing less than uncertainty. Uncertainty revolves around, not only future tax policy, but the impact on businesses and individuals of healthcare and financial regulation. There has also been a lot of talk about cap and trade and a potential value added tax. How can businesses and consumers do anything but take a conservative approach under these circumstances? These are not the conditions which motivate private sector investment.

For nearly three years now, the world’s economic policy has been dominated by a revival of the once popular idea that massive amounts of public spending could cure a recession and create a new era of government led prosperity. Unfortunately, this Keynesian economic theory has, once again, proved incapable of doing so.

Now the political and fiscal IOU’s are coming due and, unfortunately, U.S. and European economies are moving forward well below expectations. Many European nations have implemented austerity programs while our present administration has maxed-out our credit cards and appear to be willing to obtain more cards from other willing lenders in order to keep their spending capability intact.

The current Keynesian revival began under George W. Bush with a spending program of about $168 billion which was “urgently needed to boost consumer demand”. This first round of stimulus produced a statistical blip in GDP growth in mid-2008 but it didn’t stop a more severe downturn in the economy accompanied by the failure of Lehman Brothers and many other significant U.S. institutions.

“Stimulus Two” occurred under the present administration which was originally to be a $500 billion package. As the pork-laden bill became law, the amount blew up to $862 billion. The White House told us that with the passage of this bill, unemployment would not rise above 8 percent. Clearly, this was not the case. And, of course, we know proponents of the stimulus will say that unemployment would be significantly higher without the stimulus and millions of jobs have been “saved”, a position which is nearly impossible to prove.

Today, a third phase of stimulus is being considered. This is causing a heated debate between the spenders and the cutters. The recent revival of Keynesian economic strategy, and the results observed thus far, seems to prove that the failures of this theory (which became evident in the 1970’s) had been lost on present policy makers. Forgotten is the much longer than usual period of prosperity experienced in the U.S. from 1982-2007. During this period Reagan and Clinton implemented strategies of lower taxes and spending restraint. Under G.W. Bush, GDP grew by 15% in eight years but spending ballooned, increasing by 58%.

Unfortunately, today the U.S. Federal balance sheet has exploded and all of the “stimulus” has produced underwhelming results thus far. The fantastical multiplier effect of government spending under the Keynesian model is demonstrably not meeting expectations. A theory which says that a large government body can deploy capital more effectively and efficiently than a private individual simply has no merit. Government cannot do things better than the private sector can. For example, in New York, Off Track Betting is the only bookie joint in history that looses money. The amount of waste, fraud and abuse imbedded in government oversight can simply not be denied. Every dollar the government spends is “taken” from a private individual (in one form or another) and how much of that dollar gets put back into the economy after taking into consideration “administrative costs”, waste, fraud and abuse?  

Recent economic data seems to provide clear evidence that Keynesian theory does not work.

The mid-term elections in November will present an opportunity for the American people to weigh in on these issues. From a real estate perspective, market participants hope that those voices lead to policies which eliminate uncertainty and put us on a path for economic and employment growth. Nothing would be better for our real estate market than that. 

Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty Services in New York City and has brokered the sale of over 1,075 properties in his career having a market value in excess of $6.5 billion.