How does consumer psychology change during a recession?

Recession leads to lower income, which leads to lower spending and lower consumption. One man's spending is another man's income, thus it resembles a vicious cycle. Consumer psychology turns conservative and looks to spend less due to the uncertainty caused by the recessionary curve.

The world is going through a tough time. The year 2020 is turning out to be a nightmare. There is a deadly pandemic trying to destroy humanity and threatening everything we have ever held dear. Also, the lockdown is pushing us towards the necessary evil called recession I am not somebody who is usually negative and resembles the gloomy London weather, but I am a little circumspect in the backdrop of Coronavirus pandemic, so when I see the positive cabal (people talking about the positive aspects of coronavirus pandemic and how India can take advantage of this altered worldview post Covid) around me, I ask myself - If they are pretending or are they simply ignorant? 

Many businesses, malls, cinemas, automobile companies, bookstores, real estate companies, online platforms and even restaurants are not going to earn any revenue during the lockdown. The plight of small business is much worse. People like tailors, dry cleaners, shops selling ready-made clothes, barbers, pan and cigarette vendors etc, are even finding it hard to survive.

The cabal feels all this is a temporary blip, the economy is in a state of induced coma and it will spring back into its full glory once we are through this pandemic. They think once the lockdown ends people are going to turn up at stores in herds and spend like never before. I do not fully disagree with that belief, in fact I agree with it to some extent. Some industries will benefit from the pent-up demand like grooming industry for example hair cutting salon etc. I mean everyone needs a haircut unless he or she doesn't have any, so all the postponed haircuts will be taken care of once the lockdown ends. Hence barbers and hairstylists will gain to that extent. But this logic won't apply throughout the industry. If a smoker hadn't had access to cigarettes during the lockdown, he or she is not going to make up for the cigarettes he or she didn't smoke during the lockdown. Similarly, the sales that restaurants lost isn't going to be filled retrospectively. This concludes my theory about a lot of economic activity having been destroyed already, which is turn prevented businesses and people from earning the money they could have earned.

Anybody even with fundamental knowledge of economics would know that at an individual level, income drives consumption but at an aggregate level it is consumption which drives income, or to put it simply, one man's spending is another man's income. Let's try and understand this with a simple example. We all work for some company or the other, in return the company pays us. This is the main form of our income and we spend this for our living. Hence income drives spending at an individual level. There is an interesting question that arises, where does the company gets the money to pay us from? It probably manufactures and sells something or offers a service for which people are willing to pay it back. Hence the company makes money when other people consume its products or service and that in turn helps the company pay their payroll.

Let's understand another theory- what's good at an individual level may not be good for the society as a whole. If an individual decides to spend less and save more, it makes perfect sense to save for a rainy day and access your savings later when it is needed. But if society as a whole start saving more than they have been, this increased saving leads to a cut back in consumption, which simultaneously leads to reduction in income of many. Since one man's spending is another man's income, its bad news for the economy as a whole.

I will explain this by an example. There is a person X, who usually eats a pizza at his/ her local pizzeria every evening. He/she decides to forego one pizza every week to accumulate some savings. This plan will certainly add to his/her savings as long as he/she sticks with the new plan. The interesting question here will be, what if all the customers of that particular pizzeria did the same as person X? Would the reduction in consumption of pizzas raise aggregate saving? The answer is negative. Why not? Because the pizzeria will not sell as many pizzas, they will begin to lay off people and reduce procurement of raw material to assemble or cook the pizza. The people who lost their jobs will have to cut down on their consumption further and this will lead to further job losses and a further fall in income. This is how the multiplier effect will work but in reverse.

Can we overlap what we learnt in present scenario? Yes, we can. Now with very less consumption during the lockdown, the income of many businesses will significantly go down, since consumption drives income at an aggregate level. With incomes going down, consumption will further go down post COVID-19 for a few quarters, which in turn will further negatively influence income and the cycle keeps playing out. Same holds true for service industry as well to an extent.

There will be consequence of this vicious cycle playing out. Businesses will go under, employees will get laid off, pay cuts, sent on holidays, no fresh hiring, no increments etc. In turn people who will get negatively impacted will cut back on their consumption. There will be an environment of fear and negativity which will lead people to save for the approaching rainy day. At an overall economic level, this will mean lower consumption and thus lower income. As, people act in their self-interest, the economy will go into a black hole.

Recession is defined as contraction of economy for two consecutive quarters. It is safe to say we are starring at a recession with one quarter under lockdown and with a spill over effect on the next. We are in this for some time now.

Conclusion:

The psychology of consumer reflects their confidence. If they are confident about their future and their income, they will go out and spend. If they are not very sure of their income staying i.e. if they fear losing their job or source of income, they might want to cut back on their spending and would rather try to save for a rainy day. Now when a population starts worrying about their job or income and reduces spending, it has a really negative effect on the overall economy and less consumption leading to less manufacturing leads to a vicious circle of economic slowdown.