A double-dip recession is one thing, but a lost decade is something far more sinister. In the US, there is growing concern that the worst recession since the Great Depression has damaged the economy’s capacity to grow.
Indeed, there are good reasons for worrying that the US and other advanced countries will now be consigned to a long period of sub-par growth. Having been burnt by the crisis, banks have tightened their lending standards, and will now be subject to more stringent capital and liquidity requirements. As a result, bank credit will be harder to obtain.
A more limited supply of bank credit will mean higher capital costs. Small- and medium-size firms—the most important sources of innovation and employment growth—will feel the effects most acutely.
Governments, for their part, will come out of the crisis more heavily indebted, which implies higher future taxes, less investment, and, hence, slower rates of growth.
Another worry is that the crisis will create a hard core of long-term unemployed whose skills atrophy and who become stigmatized in the eyes of potential employers. Rising structural unemployment will reduce labour input and efficiency. It is harder to grow when construction workers and hedge-fund managers have to be retrained to work as welders and nurses. This mismatch between skills supplied and demanded represents a serious drag on employment growth.
All of these effects were evident in the wake of the Great Depression, too. In the US, there was zero growth in bank lending between 1933—the trough of the Depression—and 1937—the subsequent business-cycle peak. Investment suffered. Stocks of both equipment and structures were actually lower in 1941 than in 1929.
Similarly, mismatch problems hindered the transfer of human resources from declining to expanding sectors. In Britain, where coalminers were unemployed in large numbers, the expansion of the motor-vehicle and engineering industries was hindered by a shortage of skilled mechanics. Everywhere, long-term unemployment became acute.
Skills were lost, and the hard core of unemployed were stigmatized and demoralized. An influential 1933 study of the Austrian town of Marienthal by the sociologist Paul Lazarsfeld painted this dismal picture in detail. George Orwell graphically described it in The Road to Wigan Pier (1937).
The result was a disappointing, all-but-jobless recovery. In the US, unemployment was still 14% in 1937, four full years into the recovery, and in 1940, on the eve of the country’s entry into World War II.
But there was another side to this coin. Output expanded robustly after 1933. Between 1933 and 1937, the US economy grew by 8% a year. Between 1938 and 1941, growth averaged more than 10%.
Rapid output growth without equally rapid capital-stock or employment growth must have reflected rapid productivity growth. This is the paradox of the 1930s. Despite being a period of chronic high unemployment, corporate bankruptcies and continuing financial difficulties, the 1930s recorded the fastest productivity growth of any decade in US history.
How could this be? As the economic historian Alexander Field has shown, many firms took the “down time” created by weak demand for their products to reorganize their operations. Factories that had previously used a single centralized power source installed more flexible small electric motors on the shop floor. Railways reorganized their operations to make more efficient use of both rolling stock and workers. More firms established modern personnel-management departments and in-house research labs.
There are hints of firms responding similarly now. General Motors, faced with an existential crisis, has sought to transform its business model. US airlines have used the lull in demand for their services to reorganize both their equipment and personnel, much like the railways in the 1930s. Firms in both manufacturing and services are adopting new information technologies—today’s analog to small electric motors—to optimize supply chains and quality-management systems.
So, even if there are good reasons to expect a period of sub-par investment and employment growth, this need not translate into slow productivity or gross domestic product growth.
But this positive productivity response is not guaranteed. Policymakers must encourage it. Small, innovative firms need enhanced access to credit. Firms need stronger tax incentives for research and development. Productivity growth can be boosted by public investment in infrastructure, as illustrated by the 1930s examples of the Hoover Dam and the Tennessee Valley Authority.
Productivity growth makes many things possible. It makes it easier to eliminate budget deficits, and it makes it possible to increase education spending and to fund training schemes for the long-term unemployed. But, even if rapid productivity growth is possible under current circumstances, it cannot be taken for granted. Policymakers need to act.
Barry Eichengreen is professor of economics and political science at the University of California, Berkeley.
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