Depression or Recessions?

THE PARADOX OF DEPRESSION

While most economists feel this will be a plain old-fashioned recession, a few economists fear we are heading for a depression, a huge decline in output of as much as 10%. It is worth asking, even if an economic depression is in the cards, why is that so bad?

To understand this seemingly bizarre question, consider the following: How was your standard of living just a few years ago, in 2004? If you are like most people, your material standard of living then was just fine. It was considered a good year for the economy, a year of low unemployment and high growth around the world. Since then, the economy of the industrialized world has grown about another 10%. So even if output in 2009 declines a full 10%, the economy will be approximately back where it was in a fairly recent, fairly rosy time.

This insight is far from new. John Maynard Keynes, in his famous 1930 essay “Economic Possibilities for our Grandchildren”, explained that the Great Depression that was just beginning did not mean a true end to prosperity. At that time the decline in output was considered enormous, over 7% of output. But Keynes reassured his audience us. He acknowledges that a market economy is subject to temporary dislocations and adjustment, even severe ones. But he adds:

And even so, the waste and confusion which ensue relate to not more than 7½ per cent of the national income; we are muddling away one and sixpence in the £, and have only 18s. 6d., when we might, if we were more sensible, have £1 ; yet, nevertheless, the 18s. 6d. mounts up to as much as the £1 would have been five or six years ago.

It is also likely that official production figures really overestimate the downturn. After all, even in times of zero growth the world progresses: new cures will continue to be found for diseases, new medicines will be introduced and old ones will go off-patent and the price plummets; the sophistication of mobile phones will continue to advance.

Adding to the puzzle, the villain in economic downturns always seems to be “excess capacity”. That means we have more factories than we need. That too is a paradox. It seems logical that the more capacity, the better. Wasn’t the Garden of Eden a place where all man’s needs were amply provided for?

Let’s get to the bottom of these puzzles. There are two main reasons that going back to the production level of 2004 would be traumatic. The first, less important one is that during the last few centuries we human beings have become accustomed to continuous progress, despite the fact that historically progress has been the exception rather than the rule. Modern man feels that if he is not moving forward, he is moving backward.

The more important reason is that the downturn does not affect everyone equally.Most people will see their standard of living stable or even rising. They continue to draw their old salaries, which will probably buy even more than before due to falling prices. But rising unemployment means that some people will find their standard of living plummeting. In normal times a lot of people lose their jobs too, but the vast majority of them find comparable jobs before their unemployment benefits run out. But in a recession it’s hard to find a good new job; many people remain unemployed or find jobs that pay much less than the old one.

It is not only a lack of a job that gets people down; the fear of job loss is also unsettling. In many countries, job security is the foremost concern for most workers. (According to the World Values Survey, about two thirds of workers in the average country named job security as either the first or second most important consideration in choosing a job. Interestingly, in dynamic Israel the figure is much lower; less than half have job security as such an important concern. In the rough and ready US, it is only about a third.)

So even though it is the overall loss of national income that defines a downturn as a recession or a depression, the slightly lower overall standard of living is not what makes it depressing. Much worse is a general feeling of stagnation and instability. When policy makers formulate a stabilization plan, they should make sure it addresses the underlying source of distress in economic downturns.