Robert J. Samuelson
WASHINGTON – The latest study from Harvard economists Carmen Reinhart and Ken Rogoff provides a sobering reminder of how much the stumbling economic recovery may be a hostage to history. They are the authors of the 2009 book This Time is Different: Eight Centuries of Financial Folly, which surveyed historical financial crises. Their conclusion: Economic slumps involving financial crises are harsher than garden-variety recessions, with recoveries that are much weaker and take longer.
It’s the dominant explanation of why the U.S. recovery from the Great Recession has consistently disappointed – and might do so again. The reason, Reinhart and Rogoff contend, is that economists and others compare this recovery to previous post-World War II expansions. That’s wrong, they say, because those earlier business cycles didn’t involve a financial crisis, as the Great Recession did. The apt comparison is to prewar and 19th-century downturns, often intertwined with financial crises. The argument remains relevant, because once again economists are predicting that the U.S. recovery will speed up and, once again, economic indicators (especially on housing and jobs) contradict the forecasts. The shortfalls are blamed on cold weather. That’s plausible, but what if the weak data are no fluke?
Financial crises feature bank panics and failures, large credit and asset losses – loan defaults and stock market collapses. The new Reinhart-Rogoff study (Working Paper 19823 of the National Bureau of Economic Research) examines 100 financial crises in more than three dozen countries since 1857. The findings are stark: • The average decline in economic output in these crises was a staggering 12 percent. For comparison, the average drop in post-World War II U.S. recessions prior to 2007 was 1.8 percent. • It typically took a country seven to eight years to regain its previous peak of economic output. (Reinhart and Rogoff measure output as gross domestic product per capita – the average income for each person.) Some recoveries lasted a decade or more. • In nearly half the cases (45 percent), countries experienced two recessions – a “double dip” – before regaining their previous economic peak. The biggest obstacle to faster recoveries, Rogoff said in an interview, is the damaged financial sector, mainly banks. “The financial sector doesn’t heal quickly, so you don’t get much lending,” he said. Large public and private debts are repaid or written off (“deleveraging”) which also stymies spending. There’s a vicious circle. Weak economies undermine confidence; low confidence weakens economies. Financial crises sometimes cause national debt crises because government borrowing soars to recapitalize broken banks and boost the economy. That’s what happened this time in Europe.
The good news for Americans is that, relatively speaking, the U.S. economy has fared well. Its loss of per capita GDP in the Great Recession was 4.8 percent – large compared to other post-World War II recessions but mild next to most other countries. These include GDP per capita losses of 24 percent for Greece, 12.9 percent for Ireland, 11.3 percent for Italy and 7.1 percent for the United Kingdom. Of the 12 countries that recently suffered financial crisis, only the United States and Germany have regained pre-crisis peaks. It took the United States six years, from 2007 to 2013, to reach its previous peak. So the question now is: Does the economy’s slowdown reflect the weather or history? Could we be fooled one more time? Is this deja vu all over again?
Robert J. Samuelson’s column is distributed by The Washington Post Writers Group.