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Published: June 03, 2007 04:39 pm
Skyscrapers and economic busts — cause or correlation?
By Arthur Foulkes
The Terre Haute, Ind. Tribune-Star

TERRE HAUTE — Do super tall buildings have anything to do with economic recessions and depressions?

Economists, notably James Grant, Andrew Lawrence and Jason Barr, have noted a correlation between the construction of record-breaking skyscrapers and economic and financial busts.

Of course, correlation is not the same as cause. For instance, ice cream sales and crime tend to increase and decrease at the same times of year, but this does not mean eating ice cream causes crime.

As it turns out, during the 20th century, many economic downturns occurred shortly after the ground-breaking ceremonies for record-breaking skyscrapers. For instance, work on the (then-world’s tallest) 47-story Singer building in New York began shortly before the economic panic of 1907, as did construction of the 50-story Metropolitan Life building.

Likewise, just prior to the onset of the Great Depression, work began on three consecutive New York record-setting skyscrapers: The 40 Wall Street building, completed in 1929; the Chrysler building, completed in 1930; and the Empire State building, completed in 1931.

This correlation between the world’s tallest skyscrapers and economic busts appeared again in the 1970s and, in Asia, in the 1990s.

Is all this just coincidence or is there something deeper at work here?

The answer to this question may be more than just academic.

There is presently a rash of new super-tall skyscraper projects in the works. Mammoth skyscrapers are being planned or are under way around the world in New York, Dubai, Abu Dhabi, Kuwait, Saudi Arabia, South Korea and China. As the Economist magazine recently noted, around 40 percent of the tallest buildings on earth have been constructed since 2000.

Economic and social phenomena are complex, so it’s not really possible to say tall buildings always lead to economic busts. Indeed, the “skyscraper index” developed by Lawrence has sometimes missed economic downturns or “predicted” some that did not happen.

But still, as economist Mark Thornton recently noted, unlike many other forecasting methods, the skyscraper index’s ability “to predict severe changes in the business cycle is strong.”

Why might this be?

Thornton looks beneath the statistics and, using something called Austrian business cycle theory, attempts to suggest some real “economic linkages between construction booms and financial busts.”

Often economists attribute wide-ranging (or “macro”) economic phenomena to psychological causes. For instance, many economists attribute swings in business cycles to hard-to-pin-down causes, such as sudden drops in consumer demand or, as John Maynard Keynes wrote, the “animal spirits” of investors. In a similar way, Alan Greenspan famously attributed part of a booming stock market to investors’ “irrational exuberance.”

Austrian business cycle theory, on the other hand, attributes swings in the business cycle to real causes found in the monetary system itself. Money is one of the few tangible economic factors that is at play all across an economic system, so it seems to make sense that something found throughout the economy might account for an economy-wide (or “macro”) occurrence.

Austrian business cycle theory is a little complex, involving things like savings, investment, interest rates, monetary policy and capital, but, in a nutshell, it says that economic booms are often the result of monetary policies that make interest rates too low relative to where they would be without some sort of manipulation of the monetary system, usually by the government.

One reason interest rates are important is that they provide a signal for how much investment is available for “capital goods,” such as fishing boats, factories, mines or skyscrapers. How much investment in these types of things there can be depends to a large extent on interest rates — and interest rates depend upon real savings.

Think of it this way: Imagine you are alone on an island. You can either survive by using your hands to gather food or you can invest in some kind of “capital good,” such as a fishing net, farming tools or a bow and arrow. If you decide to invest in capital, you eventually will increase your productivity, but this will take time. You are still working to get food, you’re just doing it in a more “roundabout” way.

It’s also important to note that to invest in such “roundabout” methods of production, you will want to have enough food supplies on hand that the cost to you of investing in your capital is not too high. For instance, if you have a lot of food stored up, the cost of spending the whole day working on a fishing net is not terribly high. If you have only a little food stored up, the cost of spending the day building a net is, for you, much higher.

Your stored-up food on your island also can be called your savings; therefore, we can say that when your savings are high, the cost of capital investment appears lower. When your savings are low, the cost of capital investment appears higher.

In a free market, interest rates reflect how much real savings is available for capital construction projects, such as skyscrapers. If interest rates are low, skyscrapers and other long-term capital investments seem less costly relative to shorter term investments. Thus, low interest rates have the effect of making long-term capital projects appear relatively less expensive.

There is nothing wrong with skyscraper construction, per se, and there is no reason that just building tall buildings should cause an economy to tank. However, unfortunately, many modern economic booms are fueled by interest rates that are artificially reduced by government policy.

Some economists have compared the use of easy money and credit on an economy to the effect on people of caffeine or alcohol. When the drug is first taken, there is a brief “high.” But there is always a return to earth — the caffeine crash or the hangover.

What does all this have to do with skyscrapers? As Thornton noted:

“The world’s tallest buildings are generally built when there is a substantial and sustained divergence between the actual interest rate [determined by government officials] and the natural rate of interest [determined by real savings], where the actual rate is below the natural rate.”

During the “caffeine buzz” created by easy credit, skyscrapers and other long-term capital projects appear attractive to investors. But when the buzz wears off, the projects often appear to have been poor investments after all (because real savings never actually increased), bringing about the “bust” part of the business cycle.

Record-breaking skyscrapers have not always been built at the start of economic downturns, but they often have. The reason may not be that investors are “irrational” or that their “animal spirits” are out of control. The reason for the correlation may have more to do with true macroeconomic phenomena, such as money and interest rates and their effects on capital investments.

Arthur Foulkes is a native of Terre Haute and a longtime resident. The Tribune-Star reporter writes a weekly column on business and economics. He can be reached at (812) 231-4232 or [email protected].
 

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Its a bit "well duh"...

Giant commercial buildings are mooted when confidence is high and there is expected to be demand for them, this happens during periods of economic growth. As they take several years to progress from initial proposal to actually beginning to rise, and as periods of economic downturn often follow a few years after periods of growth, it follows that these buildings rising will often coincide with recessions. I stress the word coincide... Its a coincidence... Its not as if supertalls suck the life out of the economy as they rise.

The pattern is being shattered anyway, as new world's tallests are coming thick and fast and there has been no global recession for 15 years now.
 

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If we will notice as a construction boom progresses, larger, taller and ever more grandiose proposal come off the drawing board. Eventually in a boom, we usually get a building set to be really tall, if not the tallest in that locale or worldwide. So naturally when there is a recession, other projects are put on hold or canceled. Therefore, only those with good funding manage to build up. Maybe the Al burj will be the final structure out of the latest worldwide boom.
 
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