US capital stock: Fewer buildings, more knowledge

Universities are supposed to be repositories of knowledge. That, of course, doesn’t mean the literal buildings, which is a good thing because buildings are becoming less important for the US economy while knowledge is becoming increasingly important. Neither The Great Recession nor the resulting decline in housing-related construction over the past five years are the culprits. Instead, most types of nonresidential construction have been stagnant for a long time, suggesting the changing structure of the US economy is having some surprising impacts on the construction sector.

More people equipment and knowledge but not more buildings

According to the US Census Bureau, the US population grew 40 percent between 1980 and 2014. Yet, despite the larger population, nonresidential construction didn’t grow at all. In 1980, real nonresidential construction spending totaled $441 billion, and by 2014, it only expanded to $455 billion. And it’s not just the recession. Figure 1 shows private nonresidential investment over the past 35 years. Of course, nonresidential construction fluctuates with the business cycle. With peaks in the $500 billion range and troughs in the $350 billion–$400 billion range, the sector is one of the most cyclical of all components of GDP. But there is no overall upward trend. That’s very different than most of the other components of GDP, including consumer spending and exports.

This is very, very odd. GDP grows over time, reflecting growing population, productivity, and incomes. A larger, wealthier population consumes more goods and services, which in turn, requires more capacity to produce goods and services—and more capital to produce those goods and services. So we would expect investment to grow along with the overall size of the economy.

Investment¹ takes three forms: buildings, equipment, and intellectual property. Real investment in equipment and intellectual property have grown along with the overall economy, just as we might expect. In fact, according to data from the Bureau of Economic Analysis, investment in these categories has grown more quickly than the economy. In 2014, investment in equipment was 4.7 times the 1980 level (twice the rate of GDP growth), and investment in intellectual property was 7.8 times the 1980 level (three times the rate of GDP growth). Only investment in nonresidential structures lagged GDP growth.

The demand for all types of structures is weak

Stagnation is common to most major types of nonresidential structures. Figure 2 shows four categories that represent the most important types of nonresidential construction. I’ve ended the figure in 2009, before the largest impacts of the huge real estate crash were felt.

• Office construction is very cyclical, and it has not grown, despite growth in the white-collar workforce. The cyclical peak in office construction in 1985 was not surpassed, even by the peak in 2000. All those dot coms apparently didn’t really need much office space.
• Manufacturing and multimerchandise shopping also show no trend. Construction for manufacturing may even be slowly falling. Office and manufacturing construction were both higher in 1982—also the time of a severe real estate recession—than in 2009.
• Only lodging shows an upward trend over the 30 years shown in the figure.
• Mining (not on the figure) is the other main sector of nonresidential construction. Fluctuations in mining construction are almost entirely driven by the price of oil and natural gas, since most mining investment is in those sectors.

Who needs buildings?

Stagnant construction is more than just a curiosity for the sector. It means that we need fewer buildings to produce a unit of GDP today than we needed in 1980. Figure 3 shows a unit of GDP requires 25 percent less building capital today than it did in 1987. In contrast, producing GDP today requires a lot more equipment—and even more intellectual property.

The long-term trend is very clear. Over time, we have replaced structures with equipment and intellectual property. No wonder construction of nonresidential structures has been stagnant for so long.

What does it mean?

The transformation of the US economy over the past few decades has been extraordinary. The nature of what Americans produce and consume has changed dramatically. Two trends seem especially salient: more services with (relatively) fewer goods, and more knowledge and health care with (relatively) fewer products of traditional manufacturing. And most observers understand what this means for job growth, but it has also changed the capital we need for production.

Information technology may also be playing a role. Although the stagnation of nonresidential construction dates from the 1980s, the increasing “virtuality” of economic activity is likely playing a role. Instead of going to a shopping center, buyers sit at home and order online. More workers than ever can work out of their homes—and companies are increasingly adopting open floor plans that promote collaboration and require less space per employee.

All of this is having a big impact on our physical environment: Old factories, offices, and even malls are being rebuilt as residential structures. Despite a significant housing boom and crash, the long-run demand for residential buildings is set to continue growing along with the population, but the long-term outlook for nonresidential structures doesn’t look as positive.