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Why Recessions Are Good For Our Economy

I know what you’re thinking: How can high unemployment rates, declining stock markets, and having less cash in your wallet be good things? We like to think that in a perfect world, we would never have to endure the hardships associated with economic downturns like lost jobs, watching our 401(k) accounts dwindle, or worrying about how we’re going to keep the lights on and the refrigerator stocked.

But the truth is: recessions are part of a normal economic cycle in capitalist societies. In other words, recessions are necessary evils.

On the bright side, there are three reasons I believe recessions are actually good for the economy:

  1. People’s attitudes change (for the better)
  2. We see growth and innovation in underdeveloped sectors and shrinking of overcrowded, bloated sectors
  3. We have the opportunity for self-evaluation

Attitude Change

Recessions naturally create shifts in our thinking and behaviors. On average, over the course of a recession, we go from being irresponsible, irrational spenders to frugal, prudent savants who make much better financial decisions.

Even ordinarily financially-savvy consumers begin to make even more frugal decisions during a recession. We abstain from making unnecessary purchases, we put in that extra effort to find the same item for a better price elsewhere, or we learn to forgo paying more for expensive, brand-name good. According to a December 2009 McKinsey & Company report, “…in any given category, an average of 18 percent of consumer-packaged-goods consumers bought lower-priced brands in the past two years.”

Such attitude shifts can have lasting impact on consumers.

For example, spend some time with Americans who lived through the Great Depression and World War II, and you will quickly realize how deeply their worldview (and consumption decisions) have been affected by the hardships they endured decades ago. Many who learned resourcefulness and frugality during hard times never unlearn those behaviors.

On a personal level, if today’s recession hurts even a little bit, your subconscious starts telling you work harder and spend more conservatively. That recession mindset might tell you to pass on that cashmere crewneck at J. Crew or to cook yourself a healthy dinner at home instead of eating a fatty Chipotle burrito. And we all know that saving money here and there certainly won’t hurt you in the long run.

Now, imagine what happens when hundreds of millions of people collectively experience a deep recession. These subtle attitude changes on an individual level combine to create a much wiser, financially-responsible populace. Now we’re talking.

Sector Contraction and Expansion

The academic definition of a recession is a period when the excess “fat” is removed from the economy, paving the way for expansion. Until this purging is complete, the economy will be less efficient and will continue to drag along.

In theory, recessions punish both companies that have made bad decisions (by putting them out of business) and incompetent workers who put their employers at risk (by putting them out of work).

In the process, laid-off employees intuitively find other work at firms in underdeveloped sectors that are in need of more labor. Thus, work is distributed more efficiently elsewhere in the economy where there is more demand for labor. Subsequently, the weakest players in bloated sectors do not survive, and the strongest businesses in those sectors become leaner and more efficient.

The recent collapse of the financial services industry is a perfect example. There were too many pigeons fighting for the last bread crumb, which led to firms taking excessive risks and engaging in dubious practices. Something had to give, and it did; first Lehman Brothers collapsed, and soon the entire industry began a quick and forceful contraction.

This cycle of contraction and expansion is not always perfect. Sometimes, contraction within one sector can be so violent, it doesn’t create a small ripple in the economy; it starts an avalanche. In such a case, if nobody stops the avalanche, businesses in every industry are at risk.

Most recessions, however, do us a service by correcting and rebalancing the economy, which helps young, promising industries develop. In fact, economic downturns (including the current one) are often tied to increases in entrepreneurship and small start-up firms. Thus, recessions have a way of sparking innovation as well.

Opportunity for Self-Evaluation

Finally, recessions allow us to step back and reevaluate ourselves. Imagine you started a career in a once-trendy industry for the glamour and big paycheck, but in a recession the industry collapsed and left you jobless. What would you do?

In situations like this, recessions may allow some people to pursue their true passions, which may make their work more enjoyable, which may lead to higher productivity, which may lead to a better lifestyle, and so on. Too many of us get stuck at jobs that pay the bills but don’t really inspire us. We do the daily grind and, before we know it, years have come and gone. Often times, we don’t give our dreams a second thought.

Case-in-point, a friend’s father was a long-time employee at a large investment bank. Over the years, he developed a side-business running a ski lodge, which he loved, but never had time to completely devote himself to the operation. In an indirect way, the recession provided an impetus to retire from the corporate world and focus on his ski lodge full-time, and he’s happier.

Similar stories arising from the current recession abound (like the thousands of laid-off women now making a full-time living selling their crafts on Etsy).

I’m not saying that I love recessions and am looking forward to the next one, but they serve an important role in the larger picture of the capitalist economy. And as those who learned sounder financial habits, found more rewarding work, or began to follow a dream have learned, a recession change that looks like a lump of coal may actually contain a diamond.

Comments

  1. agreed- that is why the government’s attempt to “fix” the economy by encouraging consumers to spend more is completely misguided

  2. while I agree with most of your points; there are two exceptions to your conclusions where I disagree. The first is that labor will get redistributed. Unfortunately, way too many jobs are outsourced outside of this country. The second is that a majority of these companies were not punished; they were rewarded with government bailouts using our tax dollars. insurance companies do not keep the amount of money they are supposed to have on hand to pay off claims because they used that money to make investments in sectors they were not competent to make decisions about. I am not saying the bailouts did not help cushion the recession, because they did. I would just feel a whole lot better if they had seized the assets of the people getting the million dollar bonuses instead of using our tax dollars!

  3. Steve,

    I agree with your two points. In my opinion, working labor is moved abroad for a couple reasons.

    First, as we live in a more global economy, labor abroad (where it’s cheaper) is more accessible. Thus, many large companies have their back office/production sites abroad to save money. In a way, on the production side, this is taking advantage of an inefficiency in a broader, global economy, thus redistributing labor more efficiency on a global level.

    The second reason is due to lack of job opportunities in a given field. For example, recent MBA graduates have certain expectations on salary levels in a specific field of interest. If they can’t attain it here, they might look abroad for such opportunities instead of deciding to “redistribute” themselves elsewhere in the US economy.

    As for the bailouts, I agree that rewarding them with bailout money is not the best practice, as it “spoils” companies for future bailouts. In this case, as I mentioned in my post, the avalanche in the financial sector was too great. Without stopping the avalanche some how, the whole economy could have failed. Bailouts certainly did cushion the recession but raises question as to who gets bailed out and who pays for their own mistakes (Lehman).