The Worst Economic Recovery in History

By EDWARD P. LAZEAR, WSJ

How many times have we heard that this was the worst recession since the Great Depression? That may be true—although the double-dip recession of the early 1980s was about comparable. Less publicized is that our current recovery pales in comparison with most other recoveries, including the one following the Great Depression.

The Great Depression started with major economic contractions in 1930, '31, '32 and '33. In the three following years, the economy rebounded strongly with growth rates of 11%, 9% and 13%, respectively.

The current recovery began in the second half of 2009, but economic growth has been weak. Growth in 2010 was 3% and in 2011 it was 1.7%. Who knows what 2012 will bring, but the current growth rate looks to be about 2%, according to the consensus of economists recently polled by Blue Chip Economic Indicators. Sadly, we have never really recovered from the recession. The economy has not even returned to its long-term growth rate and is certainly not making up for lost ground. No doubt, there are favorable economic numbers to be found, but overall we continue to struggle.

During the postwar period up to the current recession (1947-2007), the average annual growth rate for the U.S. was 3.4%. The last three decades have experienced somewhat slower growth than the earlier periods, but even in the period 1977-2007, the average growth rate was 3%. According to the National Bureau of Economic Research, the recovery began in the second half of 2009. Since that time, the economy has grown at 2.4%, below our long-term trend by either measure. At this point, the economy is 12% smaller than it would have been had we stayed on trend growth since 2007.

Worse, the gap is growing over time. Today, the economy is four percentage points further from the trend line than it was the first quarter of 2009 when this administration's nearly $900 billion fiscal stimulus efforts began. If forecasts of around 2% growth turn out to be accurate, we will add to that gap this year.

Contrast this weak growth with the recovery that followed the other large recession of recent decades. In the early 1980s, the economy experienced a double-dip recession, with contractions in both 1980 and '82. But growth rates in the subsequent two years averaged almost 6%. The high growth that persisted throughout the 1980s brought the economy quickly back to the trend line. Unlike the current period, from 1983 on, the economy was in rapid catch-up mode and eventually regained all that had been lost during the early '80s.

Indeed, that was the expectation. As economist Victor Zarnowitz of the University of Chicago argued many years ago, the strength of the recovery is related to the depth of the recession. Big recessions are followed by robust recoveries, presumably because more idle resources are available to be tapped. Unfortunately, the current post-recession period has not followed the pattern.

The 2007-09 recession was induced by a financial crisis and some, most notably economists Carmen Reinhart and Kenneth Rogoff (authors of "This Time is Different: Eight Centuries of Financial Folly"), argue that financial crises pose more difficult recovery problems than do policy-induced recessions.

The early '80s recession could be viewed as induced by the Federal Reserve's tight monetary policy (i.e., raising interest rates), which was designed to rein in inflation. Growth returns more rapidly, they argue, when the policy hindering it changes (i.e., the Fed lowers interest rates) than when the economy is struggling after a severe credit crisis like the one we experienced after the 2008 collapse of Bear Stearns.

But some, Stanford economist John Taylor being their leading spokesman, argue that the current recession was caused by Fed policy as well—rates remained too low for too long in the lead up to the subprime mortgage fiasco. The Great Depression also began with a financial crisis but saw high growth rates following contractionary years, and the output lost in negative years was eventually regained through higher subsequent growth.

Are there other factors that may have contributed to the slow recovery that we are experiencing? It would be difficult to argue that government polices over the past three years have enhanced confidence in the U.S. business environment. Threats of higher taxes, the constantly increasing regulatory burden, the failure to pursue an aggressive trade policy that will open markets to U.S. exports, and the enormous increase in government spending all are growth impediments. Policies have focused on short-run changes and gimmicks—recall cash for clunkers and first-time home buyer credits—rather than on creating conditions that are favorable to investment that raise productivity and wages.

There are some positive developments. The labor market is improving, albeit slowly. Profits remain high and the stock market has enjoyed some recent success. We can hope that these indicate better times and higher growth ahead. But unless we move to a set of economic policies that are aimed at growing the economy rather than at promoting social agendas, this may be the first "recovery" in history that fails to see us return to long-term average growth.

Mr. Lazear, chairman of the President's Council of Economic Advisers from 2006-2009, is a professor at Stanford University's Graduate School of Business and a Hoover Institution fellow.