What is the potential GDP of a quasi-capitalist economy during a deep and prolonged recession ?

How accurate are the potential GDP numbers ( or the differences between GDP and potential GDP ) being cited for prolonged and deep recessions in certain economies ? We are talking about economies with combinations of large private sectors and government welfare systems. The overall economic contraction is marked by businesses that have to lay people off or shut down due to declining profits. Is it possible that the potential GDP numbers being cited consist of overestimations because of, say, huge over-investment in particular sectors ( investment that wrongly anticipated demand levels by very large amounts ). This is one example where the potential GDP concept becomes murky. Have the corrections due to the capital associated with this over-investment been taken into account while calculating potential GDPs ? In other words, capital associated with unprofitable businesses can become a significant percentage of total capital during deep and prolonged recessions. This needs to be taken into account while calculating potential GDPs in quasi-capitalist economies. Since it is not easy to make unprofitable businesses profitable instantly in quasi-capitalist economies, the GDP at any time during a deep and prolonged recession is probably very close to the possible GDP at that time. Growth of GDP and potential GDP then becomes strongly dependent on the creation of new capital that is associated with profitable and sustainable businesses. Capital associated with unprofitable businesses may need to be modified or augmented or allowed to perish. Or one may have to wait for a long time before this capital becomes usable again. And the nominal value of capital associated with unprofitable businesses may have to be allowed to decrease significantly till it is priced correctly according to the pricing mechanisms available in quasi-capitalist economies. Large-scale market failures of the type we saw recently in the US and in Europe in the real estate sector can indicate a need for drastic decrease in the nominal value of existing capital in that sector and possibly in other sectors. That this revaluation takes very long and that the market takes many years to reach the right price levels and the right modification of capital or augmentation of capital or perishing of capital in that sector and in sectors where its spillover effects are felt means that it may be difficult to calculate what the actual potential GDP is in nominal terms. In real terms, capital that is expected to be idle for a long time ( no prospect of speedy re-use ) needs to be excluded from useful measures of potential GDP. Capital that needs costly modification before re-use needs to have the right value attached to it for potential GDP calculations. This may mean that for certain deep and long recessions, the GDP at any time may not be that far from actual potential GDP at that time ( where the effect of idle capital has not been overestimated ).

by C. Jayant Praharaj ( send comments to cjpraharaj.blog@gmail.com )