American statesman Benjamin Franklin once said: “In this world, nothing can be said to be certain, except death and taxes.” If he were alive today, he would probably add another certainty: economic recessions. Former UK Prime Minister Gordon Brown once claimed he had abolished economic “boom and bust”. How wrong he was. Just ask today’s Germans.
But are the consequences of a recession all so bad? The International Monetary Fund argues there is no official definition of recession, but the term is recognised as a period of decline in economic activity. Very short periods of decline are not considered as recessions. As a practical definition of recession, most economists and analysts use two consecutive quarters of decline in a country’s real GDP.
Between 1960 and 2007, there were 122 recessions in 21 advanced economies. Typically, a recession lasts about a year; on average, modern economies experience a recession about every three-and-a-quarter years. So, recessions happen, and governments and individuals can successfully prepare for them to ensure that when they occur, they make the necessary changes to strengthen their countries and their personal prosperity.
Governments, businesses and most individuals often resort to hubristic mismanagement of their finances when economic or financial success blunts their judgement. They spend their own or taxpayers’ money as if there was no tomorrow. Reality habitually brings us back to our senses when we forget that good times never last forever.
Recessions happen for several reasons, but their consequences are always bleak. People lose their jobs, wages fall, homes and stocks lose value, and some companies struggle to survive or go bankrupt. So, where is the silver lining of such a depressing scenario?
Too often, change only happens when countries, businesses and individuals have their backs against the wall because they failed to acknowledge weaknesses in their economic or financial strategies.
During economic downturns, we are reminded of how important it is to live below our means or, at least, within our means
Imagine what would happen if the economy never slowed. Unchecked growth leads to higher wages, which may sound great until you realise that those higher wages can cause high inflation and increase the cost of everyday goods. The more everyday goods cost, the less consumers can keep pace. Recession brings the entire process to a crawl long enough to reset prices to a more manageable level.
Another advantage of a recession is that it ensures that inefficient companies that find it too challenging to stay afloat wind down. Economic declines remind companies to scrap excess inventory and cut their overheads. It forces them to engage in process re-engineering in a way that saves on costs but still meets the needs of their customers.
Perhaps the most significant benefit of an economic recession is that it eliminates hubris and mismanagement of resources. During economic downturns, we are reminded of how important it is to live below our means or, at least, within our means. It prods us to save for the next rainy day, keep our emergency funds topped up and re-evaluate how we manage money. Put simply, it changes our mindset.
At some stage, when a recession is nearing, people save money. This does not help economic recovery, but since most families have inadequate savings, many people would benefit from saving more.
Sadly, most governments focus too much on the feel-good factor to improve their prospects of retaining power. They encourage households to spend more, subsidise unviable zombie businesses that would not survive without taxpayers’ support and fail to take action to update their economic strategies. This is never a wise approach.
The change in mindset that often happens in a recession forces weak businesses to restructure or wind down their operations. Few countries have the resources to prevent inefficient enterprises from surviving forever by supporting them indefinitely.
A recession also ensures that costs are kept from escalating. This could positively affect capital projects that help countries and households invest in their future prosperity. In a low-opportunities market, margin concessions are easier for contractors and equipment vendors to negotiate. This makes a recession the perfect time to save money on a purchase, thereby increasing the return on investment.
Both at a country’s level and for individuals, spending money on efficiency gains now will pay rich dividends in the future, especially during the next downturn.
A recession allows governments, businesses and individuals time to press the reset button, a move that many will ignore when the economy is booming. It is the ideal time to prepare ourselves before the recovery begins by defining strategies that improve our longer-term prospects.