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Three Long Term Costs of Sharp 
Deep Downturns 
Ravi Kanbur 
www.kanbur.dyson.cornell.edu 
Presentation to Strategic Forum 
Rome, 22-23 September, 2014
Panel Members 
• Martine Durand, OECD 
• Ravi Kanbur, Cornell University 
• Joseph Stiglitz, Columbia University 
• Ignazio Visco, Bank of Italy 
In the presence of Giorgio Napolitano, President 
of Italy.
Introduction 
• We are being asked to consider the long term 
consequences of sharp and deep reversals of 
macroeconomic fortune. 
• In effect, we are being asked to consider whether 
there is a strong asymmetry between the 
downside and the upside of the trajectory of 
economic and social variables. 
• Can the effects of a sharp drop during bad times 
be made up by a symmetric rise in good times? 
Both theory and evidence suggest not.
Health 
• Let me first of all consider health, and in particular 
child development. 
• The strongest evidence we have is on child 
development in developing countries. Child 
development in the hungry years, as quantified by 
anthropometric measures, is not made up by an equal 
number of good years when food is plentiful 
(Hoddinott and others). 
• Similar evidence on persistence of the effects of 
childhood circumstances is to be found for developed 
and developing countries in the work of James 
Heckman and collaborators.
Health 
• Thus macroeconomic downturns which lead, 
whether through decline in private income or 
through decline in public expenditures, to 
short terms negative consequences for health, 
will also have long term consequences for 
health, productivity and economic growth.
Social Tensions and Social Cohesion 
• Let me start with an extreme example from a 
developing country context. 
• Prior to the 1997 financial crisis, all standard 
indicators in Indonesia were improving. 
• A few weeks into the crisis, ethnic riots began, 
resulting in considerable loss of life before 
order was restored. 
• The social tensions created by those riots 
persisted long after the crisis ended.
Social Tensions and Social Cohesion 
• I propose a two part hypothesis. 
• First, a sharp and deep downturn magnifies social tensions, 
as jobs and housing become rationed. Pre-existing divides 
are sharpened and crystallized by political entrepreneurs. 
• Second, the divides once crystallized have persistence; they 
do not just dissolve away when the economic crisis 
dissipates. 
• There is evidence on the link between the rise of extremist 
parties and sharp recessions in Europe. Less well 
researched is the persistence of the platform of these 
parties in the political discourse, as the mainstream parties 
modify their own positions in response.
Prospect Theory and Wellbeing 
• The third area I want to highlight is perhaps somewhat 
technical and esoteric. 
• The way we typically measure the economic wellbeing 
of an individual or a household is to take a snapshot of 
income or consumption at a point in time. 
• But the Nobel prize winning work of Daniel Kahneman 
suggest that there is more to it than this. 
• His “Prospect Theory” suggests that individuals assess 
their wellbeing relative to a reference point and, 
relative to this reference point, falls in consumption or 
income are weighted more negatively than increases 
are weighted positively.
Prospect Theory and Wellbeing 
• So the assessment of wellbeing at a point in time is affected by the 
full pattern of ups and downs, rather than single snapshot. 
• If the reference point is the level of consumption before the 
recession, then a deep downturn will be weighted heavily 
negatively. 
• If the recession persists long enough that the low level of 
consumption becomes the reference point, then an upturn which 
takes consumption back up to the pre-recession level will of course 
increase wellbeing. 
• BUT wellbeing will not go back up the pre-recession level. This is 
because, following Prospect Theory, the positive change is given 
less weight than an equal and opposite negative change. 
• Thus, even if consumption is restored to the pre-recession level, 
wellbeing will not be, which is a long run cost of the recession.
Conclusion 
• Sharp deep recessions will have long term 
consequences in terms of health, wellbeing 
and social tensions. 
• All the more reason to avoid them in the first 
place!
Thank You!

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Three Long Term Costs of Sharp Deep Downturns

  • 1. Three Long Term Costs of Sharp Deep Downturns Ravi Kanbur www.kanbur.dyson.cornell.edu Presentation to Strategic Forum Rome, 22-23 September, 2014
  • 2. Panel Members • Martine Durand, OECD • Ravi Kanbur, Cornell University • Joseph Stiglitz, Columbia University • Ignazio Visco, Bank of Italy In the presence of Giorgio Napolitano, President of Italy.
  • 3. Introduction • We are being asked to consider the long term consequences of sharp and deep reversals of macroeconomic fortune. • In effect, we are being asked to consider whether there is a strong asymmetry between the downside and the upside of the trajectory of economic and social variables. • Can the effects of a sharp drop during bad times be made up by a symmetric rise in good times? Both theory and evidence suggest not.
  • 4. Health • Let me first of all consider health, and in particular child development. • The strongest evidence we have is on child development in developing countries. Child development in the hungry years, as quantified by anthropometric measures, is not made up by an equal number of good years when food is plentiful (Hoddinott and others). • Similar evidence on persistence of the effects of childhood circumstances is to be found for developed and developing countries in the work of James Heckman and collaborators.
  • 5. Health • Thus macroeconomic downturns which lead, whether through decline in private income or through decline in public expenditures, to short terms negative consequences for health, will also have long term consequences for health, productivity and economic growth.
  • 6. Social Tensions and Social Cohesion • Let me start with an extreme example from a developing country context. • Prior to the 1997 financial crisis, all standard indicators in Indonesia were improving. • A few weeks into the crisis, ethnic riots began, resulting in considerable loss of life before order was restored. • The social tensions created by those riots persisted long after the crisis ended.
  • 7. Social Tensions and Social Cohesion • I propose a two part hypothesis. • First, a sharp and deep downturn magnifies social tensions, as jobs and housing become rationed. Pre-existing divides are sharpened and crystallized by political entrepreneurs. • Second, the divides once crystallized have persistence; they do not just dissolve away when the economic crisis dissipates. • There is evidence on the link between the rise of extremist parties and sharp recessions in Europe. Less well researched is the persistence of the platform of these parties in the political discourse, as the mainstream parties modify their own positions in response.
  • 8. Prospect Theory and Wellbeing • The third area I want to highlight is perhaps somewhat technical and esoteric. • The way we typically measure the economic wellbeing of an individual or a household is to take a snapshot of income or consumption at a point in time. • But the Nobel prize winning work of Daniel Kahneman suggest that there is more to it than this. • His “Prospect Theory” suggests that individuals assess their wellbeing relative to a reference point and, relative to this reference point, falls in consumption or income are weighted more negatively than increases are weighted positively.
  • 9. Prospect Theory and Wellbeing • So the assessment of wellbeing at a point in time is affected by the full pattern of ups and downs, rather than single snapshot. • If the reference point is the level of consumption before the recession, then a deep downturn will be weighted heavily negatively. • If the recession persists long enough that the low level of consumption becomes the reference point, then an upturn which takes consumption back up to the pre-recession level will of course increase wellbeing. • BUT wellbeing will not go back up the pre-recession level. This is because, following Prospect Theory, the positive change is given less weight than an equal and opposite negative change. • Thus, even if consumption is restored to the pre-recession level, wellbeing will not be, which is a long run cost of the recession.
  • 10. Conclusion • Sharp deep recessions will have long term consequences in terms of health, wellbeing and social tensions. • All the more reason to avoid them in the first place!