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Editorials

The Damage Done: Recovery Would Now Require Massive Investment that Won’t be Soon Forthcoming

(Editorial) This content might be viewed as an informed observation based on continued non-recovery of the US economy. Economists have noted that factors of production can deteriorate through years of disuse. This is now likely occurring in the US.

Many cite the case of WWII as an example when productivity proved resilient – after more than a decade of stagnation – as proof that hysteresis is not so quick to set in. But this ignores the fact that recovery during WWII was coincident with massive government spending – spending that is not likely to be forthcoming without an existential threat of world war.

It is quite likely that both labor and capital benefited greatly from deficit war spending. In terms of labor, millions received training in an effort to win the war. In terms of capital, guaranteed profits allowed for safe investment by business, restoring the capital stock to a level sufficient to allow for a return to post-war growth. Absent the war, it is very unlikely that either labor or capital would have received the necessary investment to restore productivity.

It is sad to say, but the time when thoughtful policy action could have cheaply restored our economy to its pre-recession potential has probably past us by. Large investment, that will not be forthcoming from either the private or public sectors of the economy, is most likely now necessary to counteract the effects of hysteresis. A depressed state of longterm economic growth is now foreseeable simply because of diminished expectations that arose in the aftermath of the financial crisis.

Animal spirits have done real harm, perhaps permanently, to our economy. Estimates of the US economy’s potential that continue to track a pre-recessionary trend are most likely too optimistic, for they do not take into account any potential deterioration from hysteresis to factors of production since the recession. The chart above shows published estimates of the economy’s potential (dotted line) vs. the economy’s actual path (solid line). There is a clear, stable gap between these lines that shows no sign of closing.

Was this a necessary path in the aftermath of the recession? No. Policymakers could have supported a plan for greater fiscal stimulus. Policymakers could also have supported large, unconventional monetary stimulus earlier than they did. Of course, this assumes rational, unified policymakers who are not constrained by irrational politics – something no informed observer would say of Washington today.

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