Mobility Constraints, Productivity Trends, and Extended Crises

In this paper we propose an interpretation of the current Global Financial Crisis which emphasizes sectoral dislocation following localized technical change in the presence of barriers to labor mobility. This tale is reminiscent of a similar tale concerning the Great Depression. In the 30s technical change was localized in agriculture, where income fell because rising productivity could not be offset by a shrinking labor force due to the costs of moving out of agriculture for unemployed workers, inelastic demand for agricultural output meant that as output increased income declined. As individual incomes fell below the level necessary to finance the transition to manufacturing, excess labor became trapped in agriculture, reducing wages and exacerbating the rise in output. Shrinking incomes in agriculture reverberated on the other sectors, mainly manufacturing causing a large depression. Nowadays, it is manufacturing that plays the role of epicenter of technical change. Falling incomes in manufacturing yield a lack of demand for goods produced in the rest of the economy, namely the service sector. This may be the deep rooted cause of the long lasting slump and the painfully slow recovery.