01 December 2008
Dude, where’s my misallocation?

I like the Austrian School of Economics. Its theories are simple, logical and almost completely avoid recourse to numbers.  And it also has the best explanation I have come across for the current Depression.

That explanation, incidentally, goes something like this: because interest rates were too low, the money supply increased, bubble activities were encouraged and resources were misallocated. The Depression is the process in which resources are re-allocated but this time to the correct activities.

This is fine as far as it goes.  It certainly goes a long way to explaining what happened in the US where they built too many houses.

But what about the UK?  Here building has pretty much been outlawed.  Sure, there’s been a bit of in-filling going on but was it really enough to cause the downturn?  So, where in the UK is the misallocation?  What activities have been going on in the UK that shouldn’t have been?  I am sure it has something to do with the housing bubble but although prices went up it is difficult to see how activity was altered from what it otherwise might have been.

Since writing those lines it occurs to me that the lack of infrastructure activities: new roads, better railways, power stations etc could be part of it.  They might not be bubble activities but they could well be the other side of the coin: things that should have been done but weren’t.  Also, the huge amount of activity directed by government especially into things like recycling and CO2 reduction.  That looks like a classic bubble activity.

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  1. The housing and consumer-credit bubbles were the misallocation. Capital went to fund these binges rather than fund “correct activities”. If you are looking for misallocated activity then look no further than the public sector.

    Posted by Kit on 01 December 2008 at 03:26am

  2. The actual misallocated investment went into consumer goods and services, that people purchased because they thought (based on bubble valuation of assets) that they had more wealth than really existed.

    This is the opposite of some descriptions of Austrian theory, which describe the process as one of low interest rates leading to overinvestment.  The “overinvestment” in this case was not in housing per se, but was in consumers. Rather than allocating capital to building a house, in the false belief it would be salable at a profit (which as you observe was largely illegal - although there were some bad housing developments, such as Thamesmead or some Northern city apartment blocks), capital was allocated to lending to consumers in the form of mortgages, for them to spend on overpriced coffee and games consoles, in the false belief that the borrowers would be able to service the debt from the property bubble.

    Kit says the same thing above - I’m just elaborating where the wealth was actually “used up”, rather than just being passed around from lender to borrower.

    Posted by AMcguinn on 01 December 2008 at 09:12pm

  3. I’d like to take a stab at this one.  Actually, the misallocation of resources was into the US housing market.  The British invest in and own more property in the US than any other nationality save US citizens.  When we started to implode you were dragged along because you, until now, sound investments dropped value like they had anchors on them.  This caused stress on British financial institutions and ultimately stress on the British economy.  My only hope is that our financial down turn doesn’t completely bankrupt you guys. 

    I suspect that the speculation in US real estate markets and mortgages may cause quite a bit of grief globally.  With our economy contracting to something sane we’re seeing the financial blast wave battering the economies of nearly all of our trading partners, there are laid off workers in China who are rioting because of the layoffs.  Our allies the British have taken a shot to the fiscal groin coupled with some interesting domestic blows applied by PM Brown’s government.

    Europe in general is heading down because of their trading ties to us and China.  It’s kind of an economic version of the political collapse that started World War I only instead of mutual defense treaties and security pacts it’s economic treaties and trade agreements.

    Posted by Maldain on 02 December 2008 at 11:49pm

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