In a post a few weeks back, I raised the question of what additional production factor one would have to include into the current production function framework in order to have a plausible story about the recent crisis.
That post included a set of conditions any candidate would have to pass in order to fit the current crisis and be interpretable as a true factor of production. From the ensuing reactions, two main candidates emerged: a mystery factor that gives a role to lines of credit (suggested by James A); and input and output linkages (suggested by doctorpat, Ian King, and, implicitly, _Tel).
Let us now add more information to this question and see whether the proposed production factors have something to say about other major economic crises that we have known in relatively recent economic history.
The hope is that we need only one factor to generate a reasonable story for several major downturns. If we’d need a very different new factor to explain each different major economic downturn, then the exercise of looking for new production factors becomes more futile because there is then less hope that having a good explanation for each of the previous downturns will say anything of much use to inform us about what to do to prevent or cope with the next one.
Below is a graph that summarises the GDP movement of three other major economic downturns.
The blue line shows the Great Depression, in which case the 0 point on the X-axis denotes 1929; the red line shows the collapse of the Russian economy after the changes in 1990; and the green line shows the Indonesian collapse after the Asian Financial Crisis of 1997. In each case, GDP is normalised to be 100 at the start of the crisis and time is re-set to 0 at the start.
The first striking observation is that these three crises are far bigger in magnitude than the current crisis. Indeed, the Russian collapse was so spectacular that I have long wondered how it is possible that our macro-textbooks are not full of insights gained during such a spectacular macro-event. Stiglitz already noted in the 90s that the Russian collapse shouldn’t have occurred under the conditions we still teach as good descriptions of the aggregate economy, but it clearly hasn’t mattered for Western textbooks that a large economy on the periphery did something interesting.
The main question to briefly consider though, is whether the two candidate factors X are known to have been involved in these downturns too? Lines of credit were certainly important in the Russian case (as in the whole of the former USSR), where firms had large amounts of outstanding debt with other firms and the unwinding was a tricky business.
Lines of credit were also important in Indonesia and the Great Depression. Hence credit lines can at least potentially ‘fit’, though it should still be worked out via which actual production factor they affect sold production.
Linkages are clearly of relevance in the Russian case where the whole central coordination mechanism fell away and the ensuing ‘disorganisation’ (A phrase used by Blanchard and Kremer 1997) created many firms who had no suppliers and no clients. Campos and Coricelli in their 2002 Journal of Economic Literature article also point to within-sector reorganisation of links as a probable factor in the collapse.
Whilst linkages are probably relevant in the Asian Financial crisis, it is not well-documented how they might have played a role. We know many city labourers went back to the countryside, however exact numbers are unknown because most people who originally came from the country to find urban employment are unregistered and therefore not included in unemployment and migration data etc (explanation paraphrased from a paper by Tran Tho Dat).
We also know that the capital embedded in collapsing firms was not quickly re-used by others, but there’s no specific account I know of that discusses the collapse in terms of broken linkages.
For the Great Depression, on which acres have been written, I also do not know of anyone looking at it through the lens of links. One might say it is implicitly there when people talk about the issue of bankruptcy, as bankruptcy to a perfect market economist merely means the freeing up of previously inefficiently used production factors. From a link point of view, the importance of bankrupcy is that people and capital are idle for quite a while before they are ‘re-linked’.
Any ideas on how we should think of disruptions in lines of credit and its impact on the real economy via a production factor in these three crises or the current one? Any anecdotes on links?
Core Economics 
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