It’s Even Worse Than You Thought: Deep Recessions Leave Lasting Effects on Output

It’s Even Worse Than You Thought: Deep Recessions Leave Lasting Effects on Output

The immediate effects of the 2008 financial crisis and the subsequent global recession were tangible and camera-ready — skyrocketing unemployment, riots over austerity in Greece. As nations struggle to return to pre-2008 levels of prosperity, the subtler, long-term effects of the Great Recession won’t be as palpable; but they’re just as depressing.

In a new paper published by the National Bureau of Economic Research, Johns Hopkins University economist Larry Ball posits that despite the official end of the recession, the economy may not recover to to pre-crisis levels of output for much longer than convention would hold. Traditional economics finds that when demand drops and a recession ensues, a country’s output dips below its potential, or normal, GDP. When the recession ends, activity rises back to its potential level, which is negligibly affected. But Ball’s research challenges this notion. In cases of deep recession, the economy doesn’t just contract; its potential output — the economy’s productive capacity — decreases.

Why? Ball, examining losses in 23 OECD countries, writes that reductions in capital, long-term unemployment, and slow overall productivity hinder growth. Severe recession, in other words, leaves deep scars.

Hard numbers range from nothing in the case of Switzerland to more than 30 percent in Greece. Other countries on the edge of the eurozone — Ireland and Hungary, for example — also suffered. The United States, on the other hand, escaped relatively unscathed.

Beyond those grim reductions, Ball also observed a 0.7 percent slowdown in the growth rate of possible output. While the United States’ growth rate only slowed a tick, Ireland went from a 5.8 percent growth rate in its possible output during the pre-crisis years to a predicted 0.9 percent over 2014-2015. Over the same period, Greece fell from 4 percent to -0.2 percent. If those rates stay depressed, Ball observes, “then the losses of potential output relative to pre-crisis trends will grow rapidly over time.”

The bleak situation doesn’t have to remain the status quo. Rather, Ball argues that it should serve as a wake-up call to governments for expansionary measures aimed at renewing capital investments and raising employment. While the pre-crisis track may be unattainable, at least nations could keep the damage from spreading.