acterised the GFC as being qualitatively different from the mainly cyclical recessions of the post-World War II era.
However, modern research has widened the field of knowledge and experience of different economic crises beyond recent history.
Studies of deep depressions in earlier times have identified the highly persistent effects of hysteresis-influenced inputs on long-term output.
And as Lawrence Summers, an economist of academic distinction who has had practical policy experience at the highest level, remarked back in April: “The financial crisis has confirmed the doctrine of hysteresis more strongly than anyone might have supposed."
Now Professor Laurence Ball from Johns Hopkins University in Baltimore has published a paper on the long-term damage that the GFC has caused in 23 OECD countries.
He measured the effects by comparing the current estimates of potential outputs in each economy published by the IMF and OECD with the path that potential outputs were following in 2007, according to estimates at the time.
Ball found that the losses in potential output by 2015 based on current IMF and OECD forecasts ranged from almost nothing in Australia and Switzerland to more than 30 per cent in Greece, Hungary and Ireland. The total damage from the Great Recession is slightly larger than the loss if Germany’s entire economy disappeared.
The average loss, weighed by economy size, would be 8.4 per cent in 2015.
To put that figure for potential output loss caused by the deviation from the pre-2007 trend, it’s worth noting that Germany accounts for 8.2 per cent of the aggregate economy of the 23 economies in the study.
If you prefer thinking in dollar terms: for the entire sample, the weighted average of the loss in potential output amounted to 7.2 per cent in 2013, rising to 8.4 per cent in 2015.
Measured in 2015 US dollars, the 8.4 per cent loss for the 23 countries added up to $4.3 trillion.
Fiscal stimulus and exports
So how did Australia avoid this carnage?
According to Ball, Australia was almost unscathed because of factors including fiscal stimulus and strong exports to Asia. In other words, by going early, going strong and going households plus by being lucky, in that China also opted for an expansionary fiscal stance pouring yuan into energy and steel-hungry infrastructure construction.
That expansionary strategy successfully carried China through the GFC. But, it came with a considerable legacy cost in terms of a property bubble inflated by debt courtesy of a lightly-regulated shadow banking system.
From the petro-dollar recessions of Latin America in the 1980s to Japan in 1990 and the Asian contagion of 1997, we have seen how debt–driven recessions struggle to recover compared with inflation or inventory cycle recessions.
The more extended the struggle, the more likely it is for hysteresis to be an issue. In such recessions, the rate of capital accumulation is sharply reduced. Labour markets are particularly vulnerable, often with long-term consequences that are most apparent in declining participation.
It is also common to have a slowdown in the growth of total factor productivity as businesses are slow to move to more technologically advanced equipment.
Naturally all of these developments feed into financial markets.
Japan since 1990 provides the best case study in the way in which hysteresis can emerge in a weakened economy that provides an ideal habitat.
Ball’s simple model of the power wielded by hysteresis is dependent for its credibility on the official growth estimates of the IMF and OECD.
These have been revised down across most countries of late. If correct, that would make the outlook worse and the potential damage to the global economy all the greater. As Nobel laureate Paul Krugman wrote last week: “One possibility is that the output gap numbers are wrong; we’re actually having a very hard time figuring how much slack there is.
“Another possibility is that it’s just a coincidence that underlying growth slowed at the same time as the crisis. But if you take the numbers seriously, they do seem to indicate