Important way the 2008 financial crisis was worse than the Great Depression

Bankrupt investor Walter Thornton tries to sell his luxury roadster for US$100 cash on the streets of New York City following the 1929 stock market crash. Photo / Getty Images

COMMENT: Now that we have a little historical distance from it, we can definitively say that the 2008 financial crisis was nowhere near as bad as the Great Depression except in the way that mattered most: how we recovered from it.

By that measure, we're actually on track to do quite a bit worse this time around.

How is that possible? The easiest way to think about this is that we're comparing how much we reasonably could have expected the economy to grow if there hadn't been a crash with how much it actually did.

The relevant question, then, is whether the recovery was strong enough to make up for all the ground we not only lost during the recession but also didn't gain during that time but "should" have.

In other words, whether the economy was able to get back to its pre-crisis growth trend or was permanently pushed onto a lower path.

Now, while it certainly took awhile - and had the benefit of a massive stimulus project known as World War II - the important thing is that the economy did eventually bounce all the way back from the Great Depression. It wasn't always clear that it would, though.

Consider that by 1939, a full 10 years after the initial downturn, the economy was still 18 per cent smaller than its pre-crisis trend said it should be, due in no small part to the double-dip recession that President Franklin D. Roosevelt had blundered into a year earlier.

It almost makes our recent performance look somewhat respectable, given that, at the same point after the most recent crisis began (when Lehman Bros. collapsed in September 2008) our economy was "only" 12 per cent smaller than we would have expected based on our more innocent pre-Lehman experience.

The difference, though, is what happened next. As our World War II spending ramped up, the gap between where the economy was and where it should have been disappeared. By 1940, it was back to being 13.5 per cent below its pre-crisis trend; by 1941, just 3.5 per cent; and by 1942, it was actually 4.4 per cent above it.

Our current recovery, meanwhile, has had trouble just making sure we don't lose any more ground, let alone making up any that we already lost. The result is that while the Great Depression was far worse in Year Four, the Great Recession is going to be end up being a bit worse in Year 12 and beyond. In that sense, the 2008 crisis is still with us to this very day even though it officially ended almost a decade ago.

That leaves us with two questions: Was our Great Recession solely responsible for all of this damage, and is there any way for us to undo any of it at this point?

That first part isn't as obvious as it might seem because we now know that the Internet-fueled increase in productivity growth - basically how quickly we're figuring out how to do more with less - that began in the mid-1990s had already started to fizzle out by 2005.

So even if there had never been a housing bust to darken our prospects, our economic future still wouldn't have been as bright as we thought it was in, say, 2007 due to what turned out to be pretty anemic productivity growth thereafter.

That said, it's still pretty clear that the 2008 crisis really was to blame for the majority of our poor performance the past 10 years.

At least that is what economists from the San Francisco Federal Reserve found when they looked at how much previous financial shocks had hurt the economy to try to figure out the impact of the 2008 crisis.

Indeed, according to their calculations, the economy "only" would have been about 5 per cent below its pre-crisis trend right now instead of the current 12 per cent below if there hadn't been the type of all-out panic there was after Lehman collapsed. That, the researchers point out, would be equivalent to every household being on average US$70,000 ($102,266) richer than it is today.

That's the bad news. But the good news, insofar as there is any, is that this doesn't have to be the end of the story if we don't want it to.

Look again at what happened during the Depression, specifically in 1937. Back then, FDR's premature turn toward austerity had helped push the economy back into recession, which, combined with the fact that southern Democrats had allied with northern Republicans to block any further action, meant that we were in a deeper hole then than we are now with a government that was no longer willing to do anything about it. All of which is to say that things looked pretty bleak.

Now, it is true, as Berkeley economist Brad DeLong points out, that the economy still managed to rebound from this fairly well in 1939 and 1940 even before our military buildup had really gotten going, but it still had a long, long way to go.

Until, that is, Pearl Harbor forced us to spend so much money that the recovery finished almost overnight.

The point is that it's never too late to give the economy the stimulus it needs. That ideally wouldn't involve a war but rather the sense of urgency we bring to one. That's how we need to think of investing in infrastructure, green technology and our future in general.

If we don't, the Great Recession will have to get a new name.