Laurence Ball wrote an article called The Great Recession’s Long-term Damage. He writes about how potential output has been reduced in many countries after the recession…
“Through what mechanisms do recessions reduce potential output? This question is addressed in a number of recent papers (see Ball 2014). While the results vary, it appears that recessions sharply reduce capital accumulation, have long-term effects on employment (largely through lower labour force participation), and may slow the growth of total factor productivity. This last effect is poorly understood – one possible factor is a decrease in the formation of businesses with new technologies.”
The 3 causes that he lists…
- reduced capital accumulation
- low labor force participation
- slow growth of total factor productivity
can all be explained by lower effective demand. Low demand reduces incentive to invest in capital when low demand reduces the need for employing more labor and capital. So low effective demand explains the first two points.
What about productivity? Is it really poorly understood?
Low effective demand limits productivity. See graph above. This idea is new but even as the world does not understand why productivity is not rising, an answer must exist. The pattern in the graph above is clear. When real output per labor hour reaches the effective demand limit per labor hour, productivity stalls.
The problem is that economists do not have a model for how effective demand manifests. (see here for one model)
Lambert, Edward. Relax DeLong & Krugman… Productivity advances will appear when there is demand space. Effective Demand blog. December 3, 2013.
Lambert, Edward. Productivity really is Demand Constrained. Effective Demand blog. July 27, 2013.