Skip to Content

Support MinnPost

Why the Great Recession was even worse than you thought

REUTERS/Christopher Aluka Berry
The effects of recession are felt in the short and long terms.

What are the effects of a recession? If you ask a macroeconomist they’ll start with a picture like this:

The blue line shows what the US economy actually produced each year (i.e. its real GDP) from 1981 through mid-2014. The red line traces out the economy’s potential output, i.e. the amount the economy would have produced each year had employment, capital utilization, and productivity grown at their usual rates.

The macroeconomist will then point out that there are gaps between the blue and red lines. Macroeconomists call these output gaps and measure them as a percentage of potential output; for instance, in the second quarter of 2014, the output gap was about 5 percent of potential. In essence: the bigger the gap, the worse the recession.

A five percent gap may sound small. But it means we’re not producing about $800 billion dollars of goods and services that could put people to work, put income in their pockets, and reduce the unemployment rate.

This story is fine, as far as it goes. But it raises another question: Does potential output fall or grow more slowly when there is an especially harsh recession? In other words, do recessions damage an economy in the long run as well as the short run?

Laurence Ball of Johns Hopkins University tackled this question in a recent paper. His answer: yes, recessions harm economies both in the short run and in the long run. In particular, Ball notes that “potential output falls because a recession reduces capital accumulation, leaves scars on workers who lose their jobs, and disrupts the economic activities that produce technological progress.”

For instance, the chart below (drawn from Ball’s paper) shows the US situation:

Courtesy of Laurence Ball

The ­black line shows what happened to US GDP from 1995 to the present. The green line with the circles shows the path of potential output up to 2009 and what economists predicted it would do after that.

The red line shows the long-term effects of the Great Recession: potential output is both lower than it was predicted to be after 2009 and it is growing more slowly. As Ball puts it, in the US “potential output has fallen significantly below its pre-crisis path, but the current growth rate of potential is not far from its old normal.”

That’s not the case, however, in countries that were hit harder by the recession. Take Ireland:

Courtesy of Laurence Ball

Here, potential output is significantly lower than it was predicted to be and it is growing far more slowly after 2009 than it was before then.

Greece, Hungary, Spain and a number of other countries exhibit the same pattern: The current recession caused large output gaps and high unemployment in the short run, and if current trends hold the Great Recession will damage the long run potential of these economies for years to come.

It doesn’t have to be this way. History tells us that despite a deep recession, potential output can both continue to grow and even grow at a faster rate.

Alexander Field of Santa Clara University makes this point in a series of academic papers and in his book A Great Leap Forward: 1930s Depression and U.S. Economic Growth. (Field presented his findings in a talk at College of Saint Benedict and Saint John’s University this past March.) In particular, he analyzed U.S. data from the late nineteenth century to the present and found that potential output grew more rapidly from 1929 to 1941 than any other period in U.S. history.

Field focuses on two important factors behind this great leap. First, the U.S. government invested in infrastructure, generally, and the road network, in particular. This both increased the growth of physical capital and created benefits for the private sector by allowing for rapid productivity increases in trucking, warehousing, distribution, and public utilities.

Second, “government- and university- financed research and development during the 1930s provided the foundation for the acceleration in both housing construction and housing productivity (flow of real rental services per unit of housing capital) that took place between 1948 and 1953 and continued at somewhat slower rates in the postwar period.”

In fact, the accelerated productivity growth of 1929 to 1941 had deep, long term benefits. It first created the foundation for our ability to quickly mobilize production in 1940-41 and maintain output at high levels throughout World War II. It also provided the basis for high rates of growth from 1945 until the early 1970s by putting in place a transportation and distribution network that could be utilized and improved for years to come.

The lesson for today is clear: We are missing a golden opportunity to enhance our future living standards by not investing in broadband networks, scientific research, and our nation’s human capital that are possible today with interest rates at historic lows. The recession damage identified by Ball is real and deep. However, rather than being an inevitable consequence of deep recessions these effects are self-inflicted wounds that can be mitigated and even reversed through government policy that focuses on investments in long-term growth.

Get MinnPost's top stories in your inbox

Related Tags:

About the Author:

Comments (20)

Low interest rates

I have never understood why governments at all levels haven't been borrowing huge sums of money these past few years, when they can get it practically for free.

Obstructionism at all levels

Did they have to deal with anything like Tea Party obstructionist ideology trumping all else back in the 30s and through the periods of growth and recovery that this article discusses?

Obstructionism

The Roosevelt administration did indeed have to deal with idealogical obstructionism. Republicans at the time insisted that Roosevelt dial back on government spending, which he did in 1937. That lead to a dip in the economy, which deepened the Depression just when we were seeing some real progress.

It wasn't until WWII, the biggest government spending program of all time, before we finally saw the Depression lifted.

We are on the right track then

Government spending continues to push the country further and further into prosperity (and debt) and it becomes more apparent every day that we are getting more and more for our money. Remember, every dollar paid in unemployment returns something like $1.20 or $1.30 according to Rep. Pelosi.

Thanks

Thanks to George W. Hoover and his 2001-2007 co-conspirators.

Contrast

While watching portions of Ken Burn's series on the Roosevelts, it was striking to see the difference in the response to economic crisis between FDR and Obama. The crises did differ in degree, but it was interesting to see FDR's bold, activist positions and the way he led the nation in such a way to make millions of ordinary Americans fell like he knew and understood them personally. And this from a man born with a silver spoon in his mouth.

Despite claims by his detractors that he was leading the nation into socialism, Obama's response was tepid at best, with half measures that blunted the impact of the Great Recession just a little.

When American's thoughts turned to Obama in 2009 & 2010, did anyone feel like he had their best interests at heart, as opposed to the Wall Street barons his Justice Dept. didn't even consider prosecuting?

President Obama did not have enough support in Congress

to perform "bold, activist positions" like FDR. In fact the Stimulus is still rejected out of hand by the Grover Norquist educated nihilist piggy-bank economists that occupy Republican brains.

Republicans insisted on 1/3 of the Stimulus in "slow-acting" tax cuts, and refused to consider what economists like Krugman calculated as needing to be DOUBLE the size it was.

As to your accusation that President Obama's actions were on behalf of the very people who crashed and burned the economy in the first place, Tim Geitner admitted it, and explained that despite the unfairness of it, it was required to bail out the too-big-to-fails. I worried that many Republicans would allow the entire financial system collapse rather than bail out the Wall Street and shadow banking sectors.

We have the Federal Reserve and Ben Bernanke to thank for keeping us from the abyss, through monetary policies that bought up the bad debt. Despite the Fed's help in mitigating the effects of the recession, Congress is full of Republicans who dislike and distrust the Fed and would even dissolve it if they could.

It bothers me to see the President criticized for not doing more. His terms have been crippled from the outset by destructive and misguided forces who simply would not accept his legitimacy as POTUS.

Grow Forever?

Is that the solution, Louis? Figure out how to grow out the latest setback? Is that forever to be the measure of the health our economy, that it is "growing"? What does that entail, anyways? Pretty much inevitably: More people, more resource consumed? Problem? One planet. Limited resources. The argument that "technology" will come up with another solution is hubris. The price for this point is already paid with human-induced global warming. Now we have impending water battles in the SW US. The new mass-extinction of species resulting from habitat devastation. The Bakken yield, along with the fracking frenzy, are temporary fixes.

The global conditions we have created and are living under are a very recent creation. The economic model of forever growing out of every new crisis is also very recent. It is unsustainable. Maybe the real fix is to look to an economic model that is less wasteful and does not depend on making more people to consume more resources.

Solutions

Correct me if I'm wrong, but my take on the situation is we'll need to look at several avenues of solutions, both short and long term. Yes, we need to change how consumers buy as the current system is unsustainable. Consumerism drives 70% of our economy, which is wonderful if you're selling people things. But from an energy/water/pollution point of view, the planet just can't handle that kind of hammering.

But that doesn't mean there isn't room for investment and innovation too. Investment in infrastructure will help goods get to market (that darn consumerism again), but it also helps to move people and ideas around. Improved roads, rail, and trails (among other forms of transportation) move bodies to and fro so they can seek out jobs. Broad band internet access moves ideas across the globe, creating a more rapid development of solutions.

Longer term, investment in research today will produce new solutions ten and twenty years from now, solutions that no one has even thought of yet.

Personally, I would throw it all on the table as we need all the help we can get.

Thank you, Mr Hathaway.

There is no message more firmly engrained than that of growth as the foundation of prosperity. We are incapable of, or prohibited from, distinguishing between the importance of growth in less developed societies to meet basic needs versus the ever-increasing consumption to meet manufactured demand in developed societies that erodes quality of life and leads rapidly toward environmental and social collapse. Orthodox economics doesn't distinguish between the need for food and the socially determined desire for the iPhone 6.

Those with the greatest ability to determine society's messages have a profound interest in keeping our collective social imagination from evolving past the growth mindset. Capital taxes each unit of economic production; without growth, capital loses its ability to extract social rent and its value relative to labor declines. So don't expect to hear differently from politicians, pundits or economists.

Most decisively, we are all held hostage to a growth imperative by the absence of a thoughtful collective approach to wealth distribution/redistribution. Instead, "growth" is our wealth distribution policy - all most folks have as a means to make their economic way in our society is the hope of a job, which requires that the economy ever expand, whether the new production is in society's interest or, as is more often the case, simply finds its justification and profit in the interstices of market failure. It is this over-privatization of economic survival that implacably blocks the most critical of national/global economic shifts: away from fossil fuels and toward a high quality-of-life, low consumption economy.

investing our way to growth

Paul Krugman and other economists that are not hogtied to neoliberal economic philosophy and actually base their predictions on facts and history have been pointing this out for years. The austerity that Germany is inflicting on the rest of Europe has dramatically hindered that continents recovery. Unfortunately, it will take more than investment and infrastructure spending to drag our country to prerecessionary productivity. The recession exploded an expanding trend of costs and decreasing benefits to middle class families while also generating more income potential to the wealthy. This is now a structural problem with our eonomy characterized by very expensive higher ed, declining investment in public schools, decreasing benefits and wages for middle class workers and depressed retirement accounts, all conditions that have created massive debt increases on individual consumers. This chokehold on the collective throats of US consumers does not allow our consumer based economy to fully expand or function. Unfortunately, conservative wealth simply is so focused on short term gain and profit that long term growth based on a healthy and income gaining middle class is ignored or misunderstood.

Well duh

It's way past time to acknowledge the fact that this experiment with small government, free market, Chicago School magical thinking has been a bust.

There are two other factors of our post war prosperity that Mr. Johnson over looks. In addition to investments in infrastructure and research, we paid off the war debt and financed the investments with progressive income taxes. We had top income brackets as high as 94% for the really wealthy. We also had a much more equitable income distribution resulting from strong union participation that produced higher wages and salaries, and the tax structure that checked excessive wealth accumulation. Kevin Phillips refers to this era as: "The Great Compression".

Obama has been a disappointment. He talked of hope and change but we needed him to fight for big investment and he didn't fight, he sought consensus with his oponents. You can say he didn't have the support but remember for the first two years he had the House AND the Senate. Sure the Blue Dogs were a problem but Roosevelt had problems as well. Obama and Democrats just didn't think big enough. Roosevelt didn't have to contend the pseudo-filibusters that stall legislative action. With simple majority votes Obama could've gotten bigger stimulus packages, transportation, energy infrastructure, and IT infrastructure packages. He could also have made a lunge for a national health care plan based on expanding Medicare and Medicaid, or at least gotten a public option into Obamacare. Obama and the democrats needed to think big, change the rules, and produce real change and success. Instead we ended up with a glacial and wildly imbalanced economic recovery. We also ended up with a health care bill that offers some improvements that are so obscured by roll-out fiasco's and mixed results that American's can't get a clear read whether it's good or bad.

Obama made all kinds of promises that he quickly jettisoned and kept the ONE promise that he should have jettisoned before all others... the promise to pursue bi-partisan support. That search for bi-partisan support rather than partisan success and progress doomed his agenda. Obama and his team should have realized within months if not weeks that the republicans were going to everything they could to stall him no matter what the over-all on the nation. He needed to work around them instead of wasting time trying to work with them.

Roosevelt saw what was needed and lunged for the big solutions that produced results that snow-balled into popularity. Obama did the exact opposite, instead of lunging for the big solutions he campaigned on he lunged for consensus that produce at-best, half measures which melted into unpopularity.

In many ways Obama's problem is that he followed Jimmy Carter's example instead of Roosevelt's. A lot of people don't seem to remember the fact that Carter actually championed a lot of conservative small government legislation. Carter himself likes to brag about his legislative achievements but the problem that most of that legislation was regressive. Carter did more de-regulating than any other president. And when it came to our economic safety nets he converted the discourse into a moral argument based on his religious beliefs rather than an economic argument. Basically Carter forgot or didn't understand the economic rationale behind safety nets and regulation. Then Reagan came along with a compelling argument for different morals and magical thinking and the democrats were caught flat footed. They found themselves competing for republican votes instead of building a liberal base and the rest is history.

A few good men

Sometimes I wonder if politicians that are lawyers are less prone to fight big fights because of their training or disposition. It seems like some lawyers have the "Few Good Men" mentality that you don't go to trial and make arguments unless you KNOW you will win. The default is to plea bargin instead of risking a loss in court.

In the political arena maybe this translates into an aversion to big fights and arguments? Although both Roosevelt and Obama were/are lawyers.

Scale

A few years back I had to help my daughter explain how people can mislead with graphs as part of her homework. One of the key tricks was to show the data that supports your perspective, show part of the scales to make the difference look bigger, etc

When I look at a bigger picture like this, I have to question where these economists choose to draw their lines? What slopes they use? Etc.
http://images.huffingtonpost.com/2014-06-02-EconomyandenvironmentallawsV...

The sales force at my previous employer did a long term forecast on a regular basis. The funny part is that it never showed the cyclical dips that we knew came about every 8 years. Somehow economists and sales people seem to forget that economies don't grow in straight lines. And that for every peak there is a valley.

Graphs

This is not an issue of a peak or valley, but rather a realignment of a trend. The trend is still there and stilling sloping upwards, but now it's starting at a lower point and is not making up for lost time.

Basic Stats

You can see the slope on the graph.

Your employer isn't a researcher or submitting his work for peer reviewed publication. This is why peer reviewed journals rather than web site or "reports" issued by think tanks or "institutes" are more reliable sources of information.

Basically with a line graph like this the danger is in extending or contracting the x axis (the horizontal line). If you contract it you exaggerate the trend, if you elongate it, you flatten the trend out. Professional peer reviewed publications and accademia have standard rules that prevent such distortion. Basically with line graphs like this the 3/4 high rule applies. The y axis shouldn't be more than 3/4 higher or longer than the x axis. You have some leeway, you can get by with 2/3 or 3/5 but it's pretty easy to spot proper proportions if you know what your looking for. http://www4.uwsp.edu/psych/stat/4/graphing.htm

I would hope Mr. Appelen's daughter learned this basic rule.

"These" economists have properly proportioned their graph, the trends are not exaggerated or flattened. Statistics are not inherently dishonest. You can "lie" with stats if you want, but like any other lie, you will get caught if anyone checks into it.

Good Link

The challenge of "peer review" is, which peers do the review? If a bunch of Keynesian Economists check each other's work, it will yield a very different critique than if the peer group includes Economists from various schools of thought.

Somewhat like our medical negligence discussion, is a treatment method correct just because a number of Doctors in a Health System use a common process?

Or if all the CAGW believer scientists interpret the data the same way, does that mean they are correct? Would the result be different if the analysis needed to be supported by scientists who see things differently.

I am sure there are economists out there that think 2008 was too high because of unsustainable government intervention. (ie war spending, insuring questionable mortgages, etc) Thus it was a peak and a correction was needed.

Peer review

John,

You might be a little confused about the function or nature of peer review. To begin with, reviewers are selected by the potential publisher based on their technical skills and familiarity with the subject matter and prevailing methodology. Reviewers don't "agree" or "disagree" with the results, they evaluate the methodology. Reviewers aren't looking for ideological conformity, they're looking bad methods. This is a basic gate-keeping function, not a ideological filter. Once published, other researchers will agree or disagree, or challenge the findings, and sometimes the methodology.

As for the rest of your questions, they are all addressed in any introduction to scientific method and consensus. You can always find someone in a field that disagrees with a consensus but unless they have sufficient evidence to convert the paradigm they're typically wrong.

When I was in academia, I had papers peer-reviewed

and reviewed other people's papers.

The first thing you need to know about writing academic papers is that they start with what is called a "literature review." That is, you have to explain what other people have written on the topic. You don't have to agree with them, but you have to describe their claims and conclusions.

Only then can you describe your experiments (if you're in the lab sciences) or case studies (if you're in medicine or social sciences), results, and interpretations of the results. This may include explanations of why the authors mentioned in the literature review are right or wrong.

A reviewer looks for omissions from the literature review, flaws in the setup of the experiment, flaws in the data, failure to take other case studies into account, etc.

It doesn't matter if you are know the original author or if you are of a similar ideological orientation. Your job is to see if you can pick the author's arguments apart. If you can, then the article may be rejected.

Yes

Yes, I did a literature review when I wrote my thesis. People are given quite a bit of latitude, especially if the peers are of a like mind.

Tell us more about "the article may be rejected". By who and for what rationale?