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An economic collapse is a devastating breakdown of a national, regional, or territorial economy. It is essentially a severe economic depression characterised by a sharp increase in bankruptcy and unemployment. A full or near-full economic collapse is often quickly followed by months, years, or even decades of economic depression, social chaos, and civil unrest. Such crises have both been seen to afflict capitalist market economies and state controlled economies. However, in either case the causes and cures are quite different. The economic forecasting community is of two minds on the likely outcome of the financial and economic crisis that erupted in 2008. Some commentators consider it to herald an international economic collapse while the majority, including governments and international organisations, predict a sluggish economy or a recessionary trend.

Cases of economic collapse

There are not many cases of economic collapse in modern history and in most cases the economies made a slow but eventual recovery. Interestingly, the advent of crisis has been traced to imbalances in the financial systems which broke down and paralyzed the real economy. Only after purging out bad debts and driving asset prices to lows, with employment levels and wages severely reduced, have the economies begun a painful and long standing process of recovery.

The Great Depression of the 1930s

The decade of the 1930s witnessed the most traumatic economic collapse since the start of the Industrial Revolution. In the USA, the Depression began in the summer of 1929, soon followed by the stock market crash of October 1929. American stock prices continued to decline in fits and starts until they hit bottom in July 1932. In the first quarter of 1933, the banking system broke down: asset prices had collapsed, bank lending had largely ceased, a quarter of the American work force was unemployed, and real GDP per capita in 1933 was 29% below its 1929 value. The ensuing rapid recovery was interrupted by a major recession in 1937-38. The USA fully recovered by 1941, the eve of its entry in World War II, which gave rise to a boom as dramatic as the Depression that preceded it.

Economic collapse of Soviet Communism

During the 1980s, the Eastern Bloc, which relied on a stagnant form of plan economy, experienced a decade-long period of stagflation, and eventual collapse from which it did not recover, culminating with revolutions and the fall of communist regimes throughout Central and Eastern Europe and eventually in the Soviet Unionmarker. The process was accompanied by a gradual but important easing of restrictions on economic and political behaviour in the late 1980s, including in the satellite states.

Russian collapse of 1998

A severe financial collapse took place in the Russian Federationmarker in August 1998. It was caused by low oil prices and government expenditure cuts after the end of the Cold War. In real terms, economic activity plunged and may have dropped as much as 50 per cent of peak output reached in 1988 . Other nations of the former Soviet Union also experienced economic collapse, although a number of crises also involved armed conflicts, like in the break-away region Chechnyamarker. Despite a crackdown on the oligarchs and allegations of a clampdown on the freedom of the media and political opposition, the Russian economy has made a significant recovery in the past decade due in part to proceeds from the sale of oil and gas in neighboring countries, notably in Europe. In the autumn of 2008, Russia suffered a renewed collapse of confidence in its financial markets.

Present economic trends

At present, most nations, but especially the developed market-based economies, are faced with rapidly contracting demand impacting economic activity and employment. A bursting of asset bubbles in the equity and housing markets has resulted in a "wealth shock," affecting confidence and saving behaviour. More seriously, bank lending has slowed to a trickle, despite massive injections of liquidity into the banking system by governments. As the recession in Japan in the 1990s showed, public expansion of the base money supply does not always translate into money creation through bank lending. The bank multiplier breaks down when banks become reluctant to lend due to precautionary behaviour. Already, unemployment in the USA, UK and elsewhere is rising sharply and concerns about bank lending lead many analysts to predict a sharp contraction in real GDP in coming quarters. The on-going financial crisis results not from a cyclical or managerial failure, but from a structural one: more than 96 other major banking crises occurred over the past 20 years, and these crashes have happened under very different regulatory systems and at different stages of economic development.

Theories of economic collapse

Neo-classical economic theory does not offer a theory of economic collapse. Rather, the insights it offers concerning economic collapse are that they result from exogenous shocks, mismanagement of monetary policy or failures of regulation and supervision of lending practices. Other schools of economic thought, however, offer fundamental theories of such economic phenomena.

Austrian school

Some economists (i.e. the Austrian School, in particular Ludwig von Mises), believe that government intervention and over-regulation of the economy can lead to the conditions for collapse. In particular, Austrian theoretical research has been focused on such problems emanating from socialist forms of economic organization. This however is not a theory of economic collapse involving the breakdown of freely functioning financial markets. Rather the focus is on economic malfunction and crisis emanating from state control.

Georgist explanation

In his posthumous work "The Science of Political Economy" published in 1905 Henry George traced the many financial crises in the USA in the 19th century to bank lending practices linked to asset bubbles in the market for land. As land is a scarce resource, it lends itself to such speculation. The speculative bubble bursts when the banks run out of money and can no longer lend for such speculative investments. Bank insolvencies follow as the asset price drops and speculators are unable to pay back the loans. This is similar to subsequent speculative bubbles in other asset markets, including equity and mortgages. In short, this is not a theory of economic collapse proper but an explanation of shortcomings in bank lending as a cause of financial crisis and economic collapse.

Indian theory

The Indian philosopher P.R. Sarkar and his disciple Dr. Ravi Batra, hold that the "concentration of wealth in few hands" and "stoppages in the rolling of money" are root causes of such crisis of capitalism. The concentration of wealth engenders an euphoric phase accompanied by rising asset prices and further excesses which are eventually followed by a correction in asset prices, a liquidity crisis, insolvency and collapse. Government efforts to inject liquidity into the financial system or bolster demand can postpone the crisis but not avoid it. At best, a trade-off is seen to exist between unemployment and inflation. In the Great Depression of 1930s, mass unemployment developed along with deflation in the USA. Some believe that expansionary economic policies may be able to avoid high levels of unemployment but at the cost of high inflation. However, high inflation and high unemployment brought the Weimar Republicmarker to its knees in the early 1930s. While the economic system may eventually absorb the losses, it does so only after considerable suffering by the general population. Unlike Communism, capitalism has so far weathered such storms because its inherent dynamic properties have eventually engendered a recovery. However, should a sufficiently traumatic collapse occur, it could serve to reduce the legitimacy of capitalism and lead to upheaval and radical societal changes.

Economic disaster

An economic disaster is a widespread disruption or collapse of a national or regional economy, due to natural causes, such as hurricanes, volcanic eruptions or droughts, resulting in famine or plague. Some of these occurrences are short-lived, while others may last for years. Economic disasters are different from economic collapses due to human agency or economic forces, such as imbalances in the stock market or mistakes in the conduct of monetary policy.

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  1. Real GDP per capita was $7099 in 1929 and $5056 in 1933; NIPA Table 7.1, row 9.
  2. Lietaer, B., Ulanowicz, R., and Goerner, S. (2008) “Options for Managing a Systemic Bank Crisis”. S.A.P.I.EN.S. 1 (2)

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