Recession’s Long-Lasting Scars

CU360
December 17, 2009 | COMMENTS

Economic recessions are often portrayed as short-term events. But high unemployment, falling incomes, and reduced economic activity can have lasting effects. Job loss and falling incomes, for example, can force families to delay or forgo a college education for their children. Frozen credit markets and depressed consumer spending can stop the creation of otherwise vibrant small businesses. And lower levels of investment lead to cutbacks in research and development and technology innovations.

In each of these cases, an economic recession can lead to “scarring”—long-lasting damage to individuals' economic situations and the economy. A report from the Economic Policy Institute examines the consequences of long recessions. Findings include:

• Educational achievement: Unemployment and income losses can reduce educational achievement by threatening early childhood development, reducing families' abilities to provide a supportive learning environment, and by forcing a delay or abandonment of college plans.
• Opportunity: Recession-induced job and income losses can have lasting consequences on individuals and families. The increase in poverty that will occur as a result of the recession, for example, will impose long-lasting costs on the economy.
• Private investment: Total non-residential investment is down 20% from peak levels through the second quarter of 2009. The reduction in investment will lead to reduced production capacity for years.
• Entrepreneurial activity: New and small businesses are often at the forefront of technological advancement. With the credit crunch and the reduction in consumer demand, small businesses are experiencing a double squeeze.

There's also substantial evidence that economic outcomes are passed across generations, with economic hardships for parents creating more economic hurdles for their children.

A recession, therefore, should not be thought of as a one-time event that stresses individuals and families for a couple of years. Rather, economic downturns will affect the future prospects of all family members, including children, and will dampen the broader economy indefinitely.

To take just one example of lost opportunity, college graduates entering into the workforce during a recession will earn less than those entering in non-recessionary environments. Each single percentage point increase in the unemployment rate creates an initial wage loss of 6% to 7%, and even after 15 years the projected wage loss is still 2.5%.

Non-college graduates are likely to fare worse, as those with less education and with lower incomes face much higher unemployment rates than others.

The Next Generation

There are currently about 15 million people who are unemployed—twice the number as at the start of the recession—with roughly one in six workers un- or underemployed. Record levels of workers have been unemployed for more than six months. Income loss can persist for years, even with a new job, which is often taken at a lower salary.

Now, a range of findings suggest that economic outcomes— especially one's position in the income and wealth distribution—are often carried over from one generation to the next. In a study directly related to unemployment, researchers looked at labor market earnings of children whose fathers experienced a job loss. Not only did the job loss lead to a persistent loss in family income, but the next generation also had earnings 9% lower than similar children whose father did not experience unemployment.

Stunted Start-Ups

Aside from the general downturn in investment activity, recessions—and particularly ones that involve a credit crunch—can hamper small business formation and entrepreneurial activity. Delays in new business formation could mean delays in the development and adoption of new technologies, causing long-run damage to the economy.

There are several ways recessions can slow business formation and expansion. Most obviously, new businesses need new customers. During an economic slowdown, people looking to start a new business might decide to delay ventures until demand returns to normal. Second, new businesses need new investors and creditors. Lower incomes and wealth levels may mean that new business will find it more difficult to find individual investors, and credit constraints might limit borrowing from financial institutions.

Not only do recessions make it more difficult to start a new business, they also can undermine new start-ups that are struggling to get by. There might be many new businesses (and business models) that would be successful in ordinary times but are unable to succeed due to a lack of demand or credit. In 2008, 43,500 businesses filed for bankruptcy, up from 28,300 businesses in 2007 and more than double the filings in 2006.