The economy may be cooling outside the Beltway. But things in Washington have never been better.
By John Helyar

(FORTUNE Magazine) – HOMEBUILDERS LIKE TOLL BROTHERS are warning of a real estate slowdown ahead. Drugmakers are struggling to find the next blockbuster. Blue chips like Microsoft and Wal-Mart are searching for ways to revitalize their growth. But businesses that service government--steady, recessionproof, and apparently bottomless--are booming. Particularly in our nation's capital.

In the District of Columbia, politicians on both sides of the aisle loudly proclaim that small government is better than big, that empowering private industry is more effective than the dicta of John Maynard Keynes, who advocated government spending to "prime the pump" of the economy. Yet in practice, the politicos have delivered a flood of pump priming to the metropolitan Washington area, to spectacular effect. While the major tech capitals of San Francisco and Boston suffered job losses over the five years ending in 2004 (88,000 and 72,000, respectively), Washington added 287,000 jobs. That's by far the best employment growth of the nation's top 15 cities, about 50% more than No. 2, Miami, according to the George Mason University center for regional analysis. The catalyst: Since 2001, Uncle Sam has bestowed some $185 billion in contracts on businesses in the region. Sixteen cents of every federal procurement dollar is now spent in greater Washington. That has transformed this once sleepy government town into arguably the nation's most robust metro economy.

Washington's economy underwent a brief double dip a few years back: first after the tech wipeout, and then following the 9/11 attack. But with President Bush's vow to kick Osama's butt, things jumped into high gear. Local IT defense contractors were among the biggest beneficiaries. Computer scientists hired on in giganumbers. Tech entrepreneurs abandoned moribund commercial markets to pursue projects for the Department of Homeland Security. The boom reverberated along K Street: The lobbyist population has more than doubled, to 35,000, in five years. Declares software entrepreneur Julian Waits, who relocated from Houston to D.C. for the abundant opportunities: "It's the al Qaeda economy."

D.C. once had a prosaic private sector, dominated by what locals called "the three A's": attorneys, accountants, and (trade) associations. The new boom has been driven by what might be called "the three C's": conservatives, computers, and crisis. Ronald Reagan pursued his dual goals--slimming the bureaucracy and humbling the Soviet Union--by contracting out defense functions. Today, just 11% of the D.C.-area workforce is on Uncle Sam's payroll, vs. 19.8% in 1984. Yet the economy is more closely yoked to government than ever. Federal contracting has surged to an estimated $57 billion in fiscal 2005, from $4.2 billion 25 years ago. In fiscal 2004 alone, says George Mason's Stephen Fuller, the figure grew by $7.8 billion.

"Every week we have a new best friend from Silicon Valley or Boston trying to figure out how to feast off this," says Rogers Novak of local VC outfit Novak Biddle Venture Partners. D.C. is rife with a new breed of private-equity firm that melds Wall Street bankers and ex-government honchos, and plies a lively M&A market for defense and homeland-security outfits. Former Defense Secretary Bill Cohen and former Bank of America deal guru Ed Carter have teamed up at the Cohen Group--as Carter puts it, "a marriage of Washington and New York, power and capital."

Can even a federally underwritten economy become overheated? Fuller sees contracting growth moderating a bit--up a mere $7 billion this year. The Katrina public-works project may siphon off funds; any wind-down of the Iraq war certainly would. "As the Defense budget flattens out, there's bound to be consolidation; there's going to be volatility and turbulence," says Cohen. For now, though, the D.C. business spirit is soaring--converting crises into cash.