since industrialization modern
consumer-focused economies have followed
the business cycle the business cycle is
the observed cycle of economic
expansions during periods of high
employment consumption and consumer
confidence and contractions during
subsequent periods of low consumption
employment and consumer confidence these
booms and busts as they are more
casually known tend to have a frequency
of about seven to ten years and some
economists have added that these cycles
take place within larger cycles that
play out over decades or even centuries
thankfully most economists will also
point out that these cycles tend to
trend upwards as economies grow over
time despite some temporary setbacks
that's all fascinating but is this boom
and bust pattern of modern economics a
bug caused by human nature or is it a
feature of the systems that we have
built that provide us with some kind of
benefit a necessary evil of sorts
we are currently living through one of
the most trying times in our global
economy for the past five decades the
world has shifted to favor free trade
and globalization all for the
arrangement to be challenged with a
global pandemic disrupted supply chains
labor crises trade wars and actual wars
taking place on the doorstep of the
largest economic region in the world
despite this most economic metrics are
looking pretty good in the us growth is
strong unemployment is below four
percent and asset markets are hovering
around all-time highs
but has this only been achieved by
subverting the natural order of things
with the most expensive and expansive
fiscal and monetary policy decisions in
history are we entering a new age where
serious downturns caused by genuine
economic hardships can be avoided with
piles of cash or is this all just
putting off the inevitable and
potentially making it worse further down
the road
most of you watching probably have a
good grasp of the forces of supply and
demand the quantity supplied and the
quantity demanded determine prices and
prices in return determine how much of a
good or service is supplied and demanded
this reciprocity means that markets tend
to form an equilibrium where supply
meets demand and everyone is happy if
supplies rise or demand falls then
prices fall if demand rises or supply
falls then prices rise again i imagine
this is probably not used to most of you
watching where this does get interesting
is that economists can apply this same
logic across entire nations using
aggregate figures aggregate supply and
aggregate demand are the terms that
economists use to describe the total
supply of goods and services in an
economy and the total consumption of
those goods and services respectively
economic growth can be achieved by
increasing either of these factors but
in the long term you really need to
increase both of these together to
achieve stable economic prosperity let
me demonstrate why say an economy
creates some new manufacturing method
that makes building everything much
easier that economy would then be able
to produce more things which would
increase aggregate supply increase
supply without increased demand would
mean more goods and services are
consumed all with the added benefit of
lower prices but deflation as this is
known is not sustainable long term we
explore the issues of deflation in depth
last month in our video on japan so i
don't want to repeat too much here but
while on the surface falling prices
might sound great it causes issues of
stagnating wages investment and
consumption because people have no stick
at their back prodding them to put their
money to good use economic growth caused
by increasing demand without increasing
supply is also possible although equally
unsustainable in the long term satan
economy gears 1400 checks to all of its
citizens that means everyone has more
money and can buy more things this
increases total demand if demand grows
without an equal growth in supply then
people are going to have to compete with
one another to get their hands on the
goods and services that they want this
competition normally comes in the form
of just paying more money the increasing
price level of goods and services in an
economy is inflation and obviously this
can do serious harm as well so the trick
is really making sure that an economy
achieves growth by growing supply and
demand more or less in unison so how is
this done
growing supply is simple in theory you
just increase the factors of production
land labor and capital you grow and
train and experience workforce or
attract foreign workers to your country
you then give them the space and
facilities they need to add value to the
market be that working in a factory
researching new technologies providing
financial services or anything else of
value that can be supplied to the
aggregate market of course simple in
theory does not equal simple in practice
and forcing supply-side growth is
unbelievably hard for governments to do
for a few reasons the first is that in
almost all major economies the
government is not the primary supplier
of goods and services most of that is
handled by the private sector this means
that the government can't just order 100
new factories to be built in order to
increase output they have to somehow
encourage the private sector to do it
there are some very direct ways that the
government can do this like awarding
government contracts to build anything
from fighter jets to bridges where this
direct supply side spending fails though
is that it doesn't normally supply the
goods that are truly demanded by
consumers public goods are very
important and as we have seen in recent
weeks there is true value in having
things like fighter jets to protect your
country but you can't build an economy
around stuff like this look around your
own house and try and find anything that
was built by the government rather than
the private sector it would be
challenging so the real solution for
governments is to use more indirect
methods to encourage supply-side growth
in their economies this can be done
through government grants to motivate
research and development or it can be
done through forging mutually beneficial
trade deals or it can be as simple as
making it easier for people to start a
business of their own one other more
controversial strategy is the
privatization of public industries the
theory is that the private sector can
produce things more efficiently than the
public sector because they have market
competition and a profit motive you can
probably see why this is controversial
all i'll say is that there are some
industries that are best handled by the
private sector and there are others that
are best handled by government deciding
where to draw that line is really the
hard part nevertheless there are
thousands of government policies in
place across the world that are there to
try and stimulate business activity of
course all of this means nothing if the
demand is not there to go with it
businesses are ultimately profit driven
entities so they are not going to
operate unless a market exists for them
to sell their goods and services
fortunately demand is a lot easier for
governments to control demand is a
function of consumers businesses or
government entities who are willing and
able to buy a good or service aggregate
demand is a function of all of these
participants in an economy's ability and
willingness to consume all of the goods
and services that economy provides
increasing demand is as simple as
putting more money in more people's
pockets and making them willing to spend
it the more money part is actually easy
just cut taxes increase welfare or in
extreme circumstances give money to
people directly getting people to
actually spend that money can be a
little bit trickier because of course
they could just choose to save it this
is why consumer confidence is talked
about so much in the news in general
though more money in more people's
pockets will mean more people that are
willing and above all else able to
consume okay great economies grow by
increasing supply and demand it's harder
for governments to intervene in supply
and it's relatively easy for governments
to influence demand but why does all of
this mean that we need recessions
there are two broad classifications of
economic downturns that we experience
and by now you can probably hazard a
guess at what those are demand and
supply downturns demand-based recessions
are the ones that we are most familiar
with and they are the foundation of the
cyclical business cycle during good
times people get good jobs they use
those jobs to take out big loans they
use those loans to buy lots of things
and the companies making those things
use this revenue to give people good
jobs this debt eventually needs to be
paid back which is what causes the debt
cycle if someone was making a hundred
thousand dollars a year after tax they
could spend a hundred thousand dollars
per year but at some point they might
want to purchase a new car holiday boat
holiday home or whatever that would mean
that they are spending more than they
are making in that year they have two
options to make this possible the first
is to forego consumption for a few years
to save up the money needed for the big
purchase to economists this person's
consumption would be below their
household income level for a few years
and then spike in the year they finally
end up buying whatever it was that they
were looking for of course no one saves
for anything anymore we just get a loan
and what this does is effectively the
same but in reverse economists will see
a huge spiking consumption for the given
consumer followed by a period of
consumption below their household income
level as they pay back this loan in
aggregate these peaks and troughs in
household spending feed back off one
another as we saw earlier as soon as a
few people start tightening their belts
to pay back their debts company revenues
fall and those businesses are forced to
lay people off once those jobs are lost
those people stop taking out loans to
buy new things once people stop buying
new things the businesses selling new
things start laying off workers adding
the fact that even people with jobs
would be afraid of taking on new debts
during a period when all their
colleagues are getting laid off and you
can see how this can get out of hand
pretty fast governments can intervene in
this loop by injecting money into the
system to compensate for falling
household incomes and consumer
confidence counter-cyclical monetary and
fiscal policy has been used for decades
now to smooth out the debt cycle and
while they cannot eliminate these booms
and busts entirely they can smooth them
out to make recessions less severe at
the expense of making the booms less
extreme at least that's the theory now
the other type of economic downturn is
what we call supply shocks these are the
downturns that are caused by real
tangible damage done to an economy's
ability to produce value wars natural
disasters trade disputes and even things
like global pandemics can all impact an
economy's ability to produce goods and
services supply shocks reduce supply
which limits an economy's growth but as
we saw earlier it's much harder for
governments to stimulate supply because
that isn't really their domain even
privatization as controversial as it is
probably isn't the right tool for the
job during a supply shock because
governments are not going to get very
good deals by selling off their
infrastructure during an economic
downturn the thing that a lot of
economists and especially politicians
shy away from is admitting that
sometimes economies will have rough
patches and trying too hard to avoid
these downturns entirely can push this
delicate balance out of whack causing
worse issues down the road inflation is
the obvious problem at the moment as
government stimulus has spruced demand
to all-time highs while supply struggles
with stagnant domestic production and
disrupted global supply chains but it's
more than just that economic downturns
caused by both demand and supply side
issues play a crucial role in sustaining
long-term growth in economy because they
act as a filter to weed out poor
economic practices that are only
surviving thanks to good economic times
the easiest place to see this is in
investments during good economic times
there is a lot of money flowing around
the economy and businesses will find it
very easy to attract investors who are
themselves more likely to invest because
of the confidence that comes with an
economic boom if investors start to
think that growth can continue forever
they will throw money at any business
they can find at best this will create
asset markets with unreasonably high
valuations at worst this will facilitate
investments into bad businesses that
don't make economic sense
investors have a very important job they
determine how an economy's capital is
deployed in order to maximize output if
investors can endlessly count on
government stimulus to prop up markets
they have no reason to take this job
seriously economic downturns act as an
impetus for the weakest businesses in an
economy to fall to the wayside and allow
for businesses with better products
better management and better systems to
fill the vacuum for lack of a better way
of putting it it's survival of the
fittest and unfortunately natural
selection can't take place without a bit
of adversity be it a lion or an economic
downturn
these same downturns also create new
opportunities for businesses which are
robust enough to make it through if a
car manufacturer goes out of business
during a downturn they will be forced to
liquidate their machinery and lay off
their staff that is capital and manpower
that can be utilized by a company that
was able to survive this downturn of
course not all of these workers will be
rehired which is another way that
recessions can kind of do some good most
economists are extremely hesitant to
talk about any benefit to economic
downturns and even fewer want to talk
about this particular perk yeah this one
is going to get me some down votes but
fortunately youtube has decided that
that doesn't matter anymore so here goes
in the same way that recessions get rid
of underperforming businesses they are
also effective in getting rid of
underperforming workers if an economy is
at full employment then businesses will
find it very hard to attract new
employees because there is no one
looking for a job this means that
attracting workers becomes more
expensive because businesses need to
compete with one another to offer the
highest salary for a given position it
also makes getting rid of bad employees
much harder because a bad employee is
often still better than no employee
australia once had a relatively large
automotive industry with four gm holden
and toyota having major operations in
the country these operations have since
closed and one of the biggest reasons
for their departure was not the expense
of australian labor which was comparable
with germany and the us but rather the
attitude of the australian workforce the
motor companies reported instances of up
to 50 of their workforce faking sick
days to extend public holiday long
weekends the workers could get away with
this because they knew that they were
hard to get rid of and replace
obviously this was not sustainable long
term even with the australian government
literally paying these companies to stay
in the country and today australia has
no car industry of its own economists
model something called the nehru or the
non-accelerating inflation rate of
unemployment this tracks the
relationship between inflation and
employment the more people that are
employed the higher the inflation rate
will be as the increased cost of
salaries and unproductive workers are
passed along to consumers this is
compounded by the increased aggregate
demand coming from the same households
that will be demanding those higher
wages economies work best when
participants have to compete businesses
have to compete against other businesses
for a limited pool of customers and
investors and workers have to compete
against other workers for good paying
jobs an economy where customers have to
compete for the honor of being able to
purchase consumer goods and businesses
have to beg workers to stick around is
inevitably going to be played by higher
prices and lower productivity a surefire
way of reintroducing this competition is
to have a recession one of the more
colorful economic professors i had
during my time at university probably
said it best economic downturns are
painful but pain serves a very important
purpose it lets people know what's going
wrong and points to areas that need to
be fixed there is nothing wrong with
governments giving out painkillers to
avoid the worst of this necessary evil
but take too many or take them for too
long and you're going to end up with
some bad side effects all while doing
nothing to avoid the issues that cause
the pain in the first place