This is going to be cruel, but – as it happens to be true – it needs saying.
Recessions are not always a bad thing. There seems to be this belief held by economists that growth is just something that happens, and every time an economy grows below trend, well that’s an opportunity lost for ever. So, if growth was 1 per cent lower than trend one year, then the economy will always be 1 per cent poorer as a result.
But think about that. If you are walking, say, from John O’Groats to Lands End, and you take a rest for a few hours – maybe even sleep – does that mean it will take longer to complete your journey? The answer is, of course not. If you never stop, you will end up suffering from exhaustion, and the journey may never get finished.
It is like that with the economy, too. And to illustrate how this works, consider some data out yesterday. It is not the kind of data that makes the headlines – yet ironically, it is just about the most important economic data there is. It concerns how effectively we work. And it tells us how strong the economy really is.
According to the US Labor Department, total output in the US shrunk by 1.5 per cent in the third quarter of this year. But the total number of hours worked contracted by even more. In fact, hours worked by all persons – employees, proprietors, and unpaid family workers – fell 2.8 per cent.
So what does that mean? Well, it all boils down to this: business sector output per hour grew 1.3 per cent in the period.
So, as unemployment falls, those who work produce more.
Actually, when you think about this, it makes sense. Economic theory has this concept known as marginal productivity of labour. The idea is that in a workforce, each successive employee you recruit is slightly less productive. You continue to recruit until the marginal productivity of labour equals net profit per employee. That is to say, you carry on recruiting until it is no longer profitable to do so.
But the interesting bit is what happens next, and it is here where economic theory rather falls down.
The firms that shed labour will often restructure. The clean-out provides an opportunity to change the way things are done, will make the firms more efficient, and when they start expanding again, the expansion will be based on stronger foundations.
At the same time, as firms shed labour, the potential labour pool grows and wages fall. This can encourage new employers to enter the labour market-place.
As these new employers expand, they can often exploit economies of scale. They were previously crowded out of the market-place, and may have been unable to gain traction. The changing economy creates new opportunities for these firms.
Recession can force an economy to adjust – it ends up with less resources being employed in traditional areas that may have peaked, and frees-up resources to work in new burgeoning areas.
An economy which never contracts and never has recession isn’t afforded the opportunity to change. It ends up living in the past.
Recession can be the building block of future prosperity.
