Don’t Wait on Housing

With last week's barrage of data, the beleaguered US housing market has once again come into the spotlight. But while the week's data provided some room for cautious optimism—existing home sales increased more than expected, construction activity rebounded, and the supply of homes for sale fell—there's no denying the fact that the housing market remains impaired.

Though home sales staged a bit of a rebound in 2009, a portion of this was likely driven by one-time tax credits included in the stimulus package. With the expiration of these tax credits, home sales tumbled and the prospects for further recovery remain unclear. However, there are clearly many more homes for sale than there are buyers, and residential construction activity remains at anemic levels—down nearly two-thirds from its peak.

The conventional wisdom assumes the housing market will remain impaired, and as a result the US economy will be condemned to a prolonged period of below average growth. But while recovery in the housing market would indeed help the economy—and could be a source of unexpected growth—history shows that housing is not a necessary ingredient for continued economic recovery.

A historical examination of economic recoveries following the last 10 recessions shows that even if housing's contribution to growth were excluded, the economy still would have grown at a healthy clip. During the first three years of economic recovery, GDP has historically advanced at an average annual rate of 4.6%, with housing providing slightly less than 10% of the growth. Thus, even if housing were entirely excluded from the economy, growth still would have been a very robust 4%.

Moreover, even when housing does decline, it doesn't mean the rest of the economy follows suit. In the second year of economic recovery following the last 10 recessions—the historical parallel to the present period—residential construction activity has weakened four times. In three of these instances, economic growth remained positive—even in instances when construction activity fell at a double-digit rate.

The notion that housing is a prerequisite for economic expansion is likely rooted in the widely held belief that the residential construction boom in the middle of the last decade was the key growth driver in an otherwise bleak economy, and is therefore critical to further expansion.

Residential construction activity did indeed expand rapidly from 2002 through 2005, advancing 2.5 times faster than the overall economy. But despite its high growth rate, the residential construction market was only responsible for 14% of the total economic expansion during this period—personal consumption, business investment and exports all made substantially larger contributions to growth. And even if the direct impact of the boom in residential construction were excluded, the US economy would still have grown at a relatively robust 2.5% annual rate. Moreover, even though the housing market peaked in 2005, US GDP posted two more years of respectable growth.

Thus, while the US housing market was undeniably a tailwind during the last economic expansion, it surely wasn't the primary driver. In fact, the primary driver of the last economic expansion didn't come from the US at all. Fueled by the rapid expansion in the global middle class and an unprecedented infrastructure build out in Emerging Markets, the global economy grew at a 4.7% annual rate from 2004-2006, the fastest three-year expansion in 30 years. The powerful structural trends that drove this expansion remain very much intact and should serve as the foundation for global economic growth moving forward.

Ultimately, a recovery in the housing market would be a welcome surprise. But even if housing remains stagnant, there's no good reason to believe the economic recovery cannot continue.