Does the ‘West’ need a recession?
We appreciate that recessions have negative connotations and often create hardship for many. However, when viewed from an economic standpoint, they can be a necessary evil to lower prices, correct imbalances and serve as a catalyst for restructuring and removal of wasteful endeavours. If we look through the unique COVID-19 period, we have not had one of these ‘corrective’ episodes since the Great Financial Crisis, which was over 15 years ago!
Politicians and central bankers, quite sensibly from a political point of view, will throw the kitchen sink at avoiding recession. Yet, long periods of economic expansion can lead to inefficient resource allocation, unsustainable business models and inflated asset prices. The June 2024 Bank of International Settlements (“BIS”) Annual Economic Report showed that c.13% of all US corporates are ‘Zombies’ (unprofitable firms whose earnings are less than interest payments and the ratio of market value of their assets to replacement cost is below the industry median). They remain in business when interest payments are low, and lenders find it easier to ‘extend and pretend’. Some companies borrow simply to service existing debt and/or avoid bankruptcy/restructuring. The BIS go on to state that “…empirical evidence confirms this contributes to the misallocation of labour and capital by crowding out more productive businesses.”
Ultimately this hinders competition, which can mean more expensive products for consumers or negatively impact innovation, reducing productivity and contributing towards stagnation. Long-run these factors reduce GDP growth, which will have a knock-on impact on living standards for households too.
A simple technical recession is classed as two consecutive quarters of GDP decline. A more prolonged or deeper one has typical characteristics that all sound bleak – economic contraction, decreased consumer spending, business failures, rising unemployment and falling asset prices etc. However, a recession can prick asset bubbles and rebalance economic activity. It can force innovation, efficiency and productivity gains, within an industry through creative upcycling and new product creation, but also within an economy to regear for industries of the future through invention and discovery. Broadly speaking, households, businesses and governments must alter their mindset and focus on their budgets to live within their means. This can often end up improving long term debt burdens and fiscal positions after times of contraction. All these items lay the foundations for an economy to push through the cycle into expansion again.
Recessions can effect dynamic change and lead to a price reset which otherwise can never happen, and without which a perpetual expansion leads to fiscal troubles, cost of living crises and large wealth inequality. Unchecked growth leads to increased demand and higher prices which necessitates higher wages and can then lead to a wage / inflation spiral. A short period of deflation can help those on fixed incomes. Reduced asset prices can create opportunities for opportunistic or strategic buyers. Companies can reshape, as skilled workers may be willing to accept lower wages or new career paths.
We do, however, absolutely recognise the human cost of any recession and appreciate that it is a delicate balance to manage the economic cycle and the very real impact of job / salary cuts to individuals and households over a significant period. However, the previous era of peaceful globalisation and its many benefits may well be over. A return to more traditional economic policies could be beneficial, where growth and inflation cycles are better controlled by managing debt, demand and supply through recessions and expansions. In this regard, the developed world may have a lot to (re)learn from its emerging counterparts.
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