What form will the recovery take?

In this column, Jean Pisani-Ferry believes a ‘zombie economy‘ is the worse threat to growth in the coming years. To avoid such an outcome, the author suggests policy measures outline in the policy brief 'Handle with care! Post-crisis growth in the EU' written by himself and Bruno van Pottelsberghe: countries should not try to diminish unemployment by driving people out of the labor force but keeping workers close to the labor market through temporary work-sharing schemes to avoid the costly destruction of human capital; the banking sector should be swiftly restructured; and finally, R&D should be supported. A falling R&D today would translate into a lagging productivity tomorrow.

After months where the main concern was to deal with the possibility of an outright collapse of the world economy, there are indications that we are approaching the bottom. The emerging debate between economists about the shape of the recovery is therefore timely. There are reasons for optimism – inventories are low and the resumption of world trade can act as a powerful accelerator - but experience with financial crises leads to circumspection: recent by BIS and IMF economists suggests that credit crunches and house price busts are linked to deeper and longer recessions, and that on average countries are unable to return to their previous growth path.

Taking stock over a smaller sample of four financial sector-induced recessions in OECD countries (Sweden, Finland, Japan and Korea), Bruno van Pottelsberghe and I have observed in a recent Bruegel Policy Brief that countries normally do not return to their earlier growth path. Labor markets hysteresis and the ineffectiveness of the normal Schumpeterian cleansing effect of recessions during financial crises explain this outcome. Importantly, strains in the banking system clog the virtuous reallocation of capital from ailing industries and firms towards new sectors and young growing companies. Productivity can therefore be affected.
However, there is variation in country experiences. It is during the recession that the seeds of future growth performance are sown – or not. Here the comparison between Japan and Sweden is striking: while the latter managed to accelerate its growth after the crisis and the recoup the entire output loss, the latter suffered a long slump often quipped the ‘lost decade’.
Policy therefore matters considerably and this is apparent along five channels:
- the size of the stimulus packages,
- their content,
- labor market policies,
- the restructuring of banks, and
- innovation policy.
While the size of the stimulus has been widely debated, content is also important. In the EU national stimulus packages are often tilted towards the non traded sector. But the fear of ‘trade leakages’ often leads to put too much emphasis on demand to supply-constrained sectors. The Swedish experience also suggests that countries should not try to diminish unemployment by driving people out of the labor force.
Keeping workers close to the labor market, through temporary work-sharing schemes may avoid the costly destruction of human capital. Most importantly, the banking sector should be swiftly restructured.
It took seven years for Japanese banks to recognize half of its losses, but only three in Sweden. A ‘zombie economy’ is the worse threat to growth in the coming years. Finally, R&D should be supported. It is both highly cyclical and important for productivity in the next decade. A falling R&D today would translate into a lagging productivity tomorrow.
While international comparisons encourage more for pessimism than optimism about the speed of the recovery, they also yield important conclusions that should inspire policymakers.