November 12, 2015    5 minute read

The Long Shadow of the Financial Crisis – A Lost Decade?

   November 12, 2015    5 minute read

The Long Shadow of the Financial Crisis – A Lost Decade?

At a time when the first developed economy considers to start hiking their interest rates for the first time since 2006, the long-term impact this financial crisis will have remains historical. Martin Wolf, the chief economic commentator at the Financial Times, gave a guest lecture at The London School of Economics recently speaking about the new additions to his book “The Shifts And The Shocks.” This article will mention some of the aspects raised by Wolf, with his main point being that the crisis has casted a big shadow on the future of the economy. The following will give a brief introduction into some of the issues mentioned in his talk, without delving into most of them in any greater detail as this would exceed the scope of this article.

“The Shadows”

An obvious effect we have seen in the high-income economies was a loss in overall GDP as well as in GDP growth, both of which are still not back at pre-crisis levels. From this (very obvious) aspect, other consequences follow.

CGgeNeZUgAALL5tRecovery Pace Divergence

Over the last 8 years there has been a clear divergence in the pace of recovery between the two largest Western economies, namely the US and the EU. In the EU, Q1 2015 GDP was still lower than in Q1 of 2008, while domestic demand remains weak as well. The US, in contrast, has seen above pre-crisis GDP since 2010 within an increasing trend up to today.

Living Standards Divergence

One could now argue that in the current environment we should be happy to have at least some sort of recovery after all, no matter how fast or slow this might be. However, looking at the divergences in living standards shows the huge impact of such slow recovery. Divergence in living standards, in the (admittedly simplistic) measure of GDP per head, shows how countries like Germany (and also the US and UK) are above pre-crisis levels while other European countries have in fact seen a decrease in their GDP per head over the last 7 years. Note that the difference between Germany and Italy real GDP per head growth is about 20 percentage points. This is huge!

Collapse In Productivity Growth

A further aspect weighing heavily on the recovery of the global economy  since the crisis has been the decrease in productivity growth. But why did productivity growth collapse? One explanation is the collapse of investment we have seen in the major economies.

Another interesting explanation is the following: As  technology had certainly been evolving very fast, at least that’s what one feels, over the last 10 years or so, how is it possible that we still see a decrease in productivity? One theory is that traditionally, the sector where productivity (technology) improvements have been implemented the fastest, was the manufacturing industry. However, today manufacturing only accounts for 1/7 of some developed economies’ output. Therefore, an increased level of productivity might simply not arrive in a big chunk of the economy.

Emerging Markets Slowdown

Beside the major impacts for developed economies, there is also an argument to be made about  the emerging economies. Although EM still got through the crisis relatively smoothly, recent growth figures have shown how for example China’s economy is slowing down. It will be a major challenge for China to complete the transition from its export-driven economy to a more consumption-oriented model.

The Policies Stemming From the Crisis 14-12-08_europe_gdp3

Historically Low Interest Rates

First of all, the impacts mentioned have led to historically low interest rates, some people call it a “free money environment“. The success of this attempt to tackle the crisis appears questionable, given that Japan has maintained ultra-low interest rates  for almost 20 years now, without the desired effects.


The example of the UK shows how austerity has been a major consequence of the many impacts the financial crisis has had. What’s interesting to note here is that the current recovery (according to what we can say 8 years after the crisis began) is much slower than, for example, the recovery from 1929 to 1938. Some people argue that this is due to the (too) early adoption of austerity policies in some of the major economies.


So what are the key points to bear in mind? Firstly, there are massive long-term impacts on economic growth and also on productivity growth. Some experts fear that the current situation will lead (or has in fact led to) a “lost decade“. This consideration becomes even more alarming when thinking about the non-economic impacts that such a “lost decade“ could have. It can certainly be argued that the crisis represents one of the main reasons that the public perception of the role of elites in politics, mainly in Europe, has massively suffered. We see raging populism and an increasing amount of extremist parties gaining power in their respective countries (Greece, Spain, France etc.). This is certainly connected to the huge rise in unemployment stemming from the crisis, especially in some Southern European countries.

Secondly, the current crisis has raised the question, whether the Eurozone should be considered a failed project. And an increasing number of people would agree with that. They see two of the main goals of establishing the monetary union, namely the creation of greater financial stability and political integration as further away than before the Eurozone came into existence.

To end on a positive note after this admittedly quite pessimistic summary of the current economic situation, a crisis always provides opportunities to improve the current systems and approaches to avoid making the mistakes in future crisis scenarios. These could be aspects often raised by experts, for example, that governments have moved to fiscal austerity too early, the reconstruction of debt in the financial sector is too slow and that we need to be much more aggressive in the next crisis in order to avoid the same long-term implications we are facing right now.

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