Most people agree that recessions are terrible events that cause widespread fear;
raising financial anxiety about having sufficient savings, livelihood, or even the next meal.
On a nationwide level, economic downturns are akin to natural disasters;
both of which wreak massive damage, and for the most part,
are widely accepted by society as an “inevitability”, rather than a “rarity” …
But do we really need recessions?
In this video, we’ll answer that question by exploring why most economic downturns are actually
man-made. and are ultimately the result of people saying I don’t want to materially improve my
quality of life for a little while. We’ll see exactly how that works later on in the video
but what the takeaway here is that this is a manmade issue that should be entirely
possible to undo with the same kind of manmade response right?
To add to this For most of human history, economic recessions were relatively uncommon.
Even in cultures societies with highly complex economic systems, the world we saw
good times and bad times – but that was almost always the result of something tangible,
like wars or droughts. or any of that other fun stuff.
The few “purely economic” downturns that did exist outside of this were extremely few and far
between, which is a dramatic departure from our modern world with televisions pundits forecasting
recessions every decade – making predictions about how we’re “overdue” for the next big crash.
But, of course, just because a market crashes seemingly every decade,
doesn’t mean that it will crash every decade. All of this begs the question:
“Do we actually need economic recessions?”
To properly explore this, we need to as always break this question down into a few parts
What is a recession – outside of the generic canned response
of two quarters of negative growth Why have they become so prevalent
And are they actually all that bad? If we can go a ways to understanding these,
we may not ever take one of these mysterious economic happenings for granted ever again.
This is an economics explained video, if you enjoy these video’s please consider
liking and subscribing, but without further adu lets really understand the economic
boogieman that is a recession. “What is a recession actually?”
So most people watching Economics Explained video’s already have a relatively foundational
knowledge of economics, and I would hazard a guess that at least a few of you are saying well this is
simple, a recession is just 2 quarters of negative growth, done and dusted. And you know what
this is technically true, at least this is how we measure a recession. But two quarters of negative
growth is more the symptom of a recession rather than it’s true underlying cause.
Things that cause recessions basically come in two flavours, demand shocks, and supply shocks.
For regular folks the supply side recessions are probably the easiest to understand.
Lets take a relatively small island nation as an example of our little economy here, and say
that their industries are made up of farming, fishing and tourism primarily. This is kind of
the case for most small pacific island nations so we are not straying too far from reality here.
Now lets say there is a massive hurricane that hits this little hypothetical nation completely
wrecking its fishing fleet, flooding its farmlands and blowing over its lovely hotels. Well obviously
this nation is not going to be able to output as much, and if it takes more than two quarters to
get back up to speed on everything well then they would have by definition gone into a recession.
These are the types of recessions that we tend to see throughout history but in reality they would
actually be called something else, something like a famine or tragedy or whatever… this is partially
because people didn’t really study economics as a discipline throughout history, but more so because
there is something more logical to point fingers at for the collective misery of the nation.
To use our example of our little island nation, its possible that most people would
just say the nation is going through a bit of a rough patch rebuilding from a disaster
without actually calling it a recession even though that is what it is.
All of these examples are supply side recessions, these external events have massively decreased
the ability of the nation to provide goods and services and since growth is measured in GDP
and GDP is a measurement of the consumption of goods and services
and since you can’t consume goods and services if there are none to consume you get a recession.
Cool, this all makes sense but in reality these types of recessions are pretty rare these days,
especially if you look at a nation like the united states it is unlikely that any kind of
normal natural disaster is going to have enough of an impact to really single handily push the whole
nation into a recession. Ohh yeah well apart from that one….. [show news of coronoavirus]
Now, as a blanket statement to answer the question presented in this video,, do we need these types
of recessions? Well yeah, short of completely controlling for every war, or natural disaster,
union strike or trade deal gone awry there just really isn’t any way to stop these sorts
of events coming around. All that you can really do is ensure that your economy is big and diverse
enough to sort of tank these adverse events. For a more in depth discussion of this topic
you can watch out video on the economics of disasters.
But for now let’s look at the second type of recession, a demand based recession.
These are the ones that are far far more common and are pretty much the
driver of the decade long business cycle that we have more or less come to expect.
Demand based downturns are far more difficult to understand because they are sort of hard to
look at rationally. At their most fundamental level demand based economic recessions are
just people electing not to consume as much, not because there isn’t as much to consume,
but simply because there are forces at play that dictate they simply don’t want as much.
Consumer confidence is a big determinant of this, if people are unsure if they are
going to have jobs in the future, or if their hours have already been cut they are going
to be much less likely to spend what money they do have on bottle service at da club,
shakeweights, gamer girl bathwater or whatever else it is our economy runs on these days….
Instead they will hold onto their money to make sure they will have enough
if they do end up loosing their jobs to pay for the bare essentials.
Again since growth is measured in GDP and GDP is a function of consumption,
less consumption means less GDP and less growth,
so if this kind of more conservative consumer spending goes on for more than 6 months,
hey presto you got yourself a recession. So why is it that these sort of events
happen so frequently these days, and why didn’t they happen in the past?
Modern Industry The Age of Plenty
Around the turn of the previous century, there was a fundamental shift in a select few nations,
most notably the united states. The great war was over and the age
of mechanisation had begun. Machines were being utilised for all area’s of production,
once artisanal factory units were being converted into production lines that were feeding an
increasingly intricate national supply chain. For the first time in history
mankind was no longer constrained by how much it could produce, but rather only by how much
the producer could convince people to buy. In the past, things like farms and basic
factories were desperately trying to keep up with the needs of the people but if we think
about our reality today we will see that we waste a tremendous amount of food, and are
probably not really producing as much stuff as we could if we had an endless customer base.
Think of an automaker like ford, they produce about 7 million cars a year, but if they really
wanted to they could easily produce 20 million. The only thing they are actually limited by
is how many they can sell, if the consumer demand for ford cars is 7 million cars a year,
you better believe they aren’t going to produce anymore because that would be a horrendous waste
of money to make inventory that they would have to store or sell off for a massive discount.
The consumers ability to consume has become the bottleneck in a modern global economy
so this is why we pay so much attention to it. So now that we understand how and why consumers
are as important as they are its important to understand what it is that makes them work.
How much a consumer can consume is in the long term a function of 2 things,
how much they earn, and how much they want to spend. If people earn more money it stands to
reason that they will be able to buy more stuff and if they spend a larger portion of their pay
check they will also be able to buy more stuff. During good times this sort of feeds off itself,
lower unemployment means that people can demand higher wages because employee’s are
harder to come by so businesses have to pay up and perhaps more importantly people are
happy to spend a little bit more of their cash because they fall into the trap of thinking
that these good times will go on forever. This all gets so much more interesting though
when you take debt into consideration Economists argue about the long-term impacts
of debt but in rality debt needs to be paid back, so the actual effects are relatively minor
over a long enough time period in most cases Its really in the short an medium term that debt
is particularly influential and that is because it can give consumers a massive boost to their
consumptive power. We explore this in much further detail in the first video in this series, do we
need Debt. But the takeaway from this is that lets take our auto manufacturer from earlier.
Most People will struggle to pay for a car in cash, but if you offer car loans well than
people can get into that brand-new fiesta for only $300 per month over 120 months. What a win right?
Offering this type of debt will mean more people will be able to buy more houses and
cars and boats and buy new golf clubs and fancy dinners on their no limit American express cards…
and wow isn’t this great? This is an economy that is producing an extremely high standard
of living for its participants which is the really the only goal of an economy.
The problem of course arises the next year when the latest model fiesta comes out and nobody
buys it because they still have 9 years left on their loan and their trying to save some extra
cash to pay down their American express bill. Demand based economic downturns can be caused
by anything that scares consumers really, but the thing that scares consumers most
is debt and knowing that they need to find some way to pay for yesterday.
An Alternative Is there a better way?
Ok so in a nutshell most recessions happen because people living in
modern developed nations today are spoilt brats that get scared of their own excess.
They have more than they know what to do with and gorge themselves living beyond their means and
regretting it later on when the bill arrives. Most economists are well and truly on top of
this reality, and have come to accept it, but is there an alternative?
Well yes, we actually already have systems in place to alleviate these dramatic ups and downs,
they are counter cyclical fiscal policy and counter cyclical monetary policy.
We are seeing this right now in the world today with nations giving out huge stimulus cheques to
everybody while dropping interest rates all in an attempt to boost economic activity to counteract
the effects of this global economic crisis. But of course most of you watching know about
these economic policies, and these are more of a bandaid to the issue anyway rather
than something that stops them existing. At the most fundamental level, no we do not
need recessions, they do not need to exist, but to get rid of them we just need to massively reduce
the debt that people get access to and limit output to below what people actually demand.
By doing this you effectively stop the global economic machine overheating by just letting
it idle along. But therein lies the problem. Recessions are actually a sign of a healthy
economy…. At least in the long term. Recessions are an effective way of
economies sorting out their issues so that the next boom can be even better. Recessions
alleviate misallocated debt, over speculated markets and avoids slack labour. They are in a
way the economic equivalent of cutting the fat, which is seen most prominently in employment.
One of the greatest casualties of a recession is employment figures.
People see high unemployment rates and they think of people lined up outside job centres or welfare
offices and its an all round pretty awful outcome. But it does have an underlying advantage.
When lots and lots of people loose their jobs there are going to be lots more people looking
for new jobs, which is great for businesses that are still healthy during a recession
because they will get to bring on more high skilled staff and they will truly get the pick of
who it is that they bring on board. If there is only 10 job listings and
100 people looking for work then the businesses that are hiring may be able to bring on board a
Harvard MBA as a junior analyst, who in theory should excel in their role, this
makes the business that much more efficient and means they will be able to prodice more output.
The opposite is also true, if we are in an economy approaching full employment
and a company is looking to hire a new senior manager, it will very quickly find that it is
very hard to fill this position. Everybody who is qualified already has work and perhaps the
only option you have is to attract someone who is already employed to come over to your company
by offering them a higher salary. If all businesses are doing this then
they are going to have far higher staffing cost which means they will have to pass this along
to their consumers as more expensive goods and suddenly you have inflation.
You may have hear the term nairu before and it stands for the Non accelerating inflation rate of
unemployment. But the same thing is true for lots of things in an economic boom not just employment,
and this is one of the key drawbacks of a sustained economic boom, things just get too
damn expensive which means that people’s actual quality of life is not improving even thought GDP
figures look great simply because of inflation. Recessions control all of this by allowing the
economy to really catch its breath, decide what it is that is working, what it is that is not,
and allocating resources by force to industries that are going to deliver the greatest sustained
benefit to society in the long term. Final Thoughts.
Recessions are not a necessity, but they do serve a purpose. In the same
way that nobody really enjoys an intense workout and diet plan,
sometimes a bit of short-term pain is worthwhile for a more sustained long turn benefit.
The idea that a recession will help to re-allocate resources and assist with long term economic
growth may provide little comfort to those that have their lost jobs, or their business or their
retirement savings but it is still the reality. If we look at the economies that have been
its hard to find examples of economic crises’ as we know them today, and that’s not because
people back then were better economic managers or even because they were more responsible with debt,
it because they weren’t on the same rocket ship of growth that we are on today.
Recessions are simply the product of prosperity.