Why recession is a necessary evil?

Recession brings a lot of pain and suffering, but if we think carefully, this pain and suffering is just a resetting of expectations in terms of lifestyle and never-ending quest for material well-being.

In good times we seldom think about the ugly side of economy, but since nature has provided us this unique opportunity in our lifetime, blessing us with the coronavirus pandemic, in the worst year ever i.e. 2020, it's time for us to take a quick peek into this economic dungeon and understand its ugly side i.e. the Recession. Is Recession really necessary or we can just do away with it once and for all?

Most economic downturns are entirely man made, originating out of the greed of some influential people. The good news being, since recession is a man-made issue, it should be certainly avoided by proper response. To add to that, throughout human history, humankind experienced good times and bad times but never something as today's recession. Reason for this is the fact that there was always something tangible like war, drought etc, leading to any event of boom or bust. That is a big departure from today's scenario where we forecast a downturn every decade or so to keep global sanity. This leads us to beg the question, do we need recession?

What is a recession? why have they become so prevalent? and are they actually all that bad? These are some of the questions we need answers to, for effectively understanding and breaking the cycle. Defining recession is fairly simple. It is two consecutive quarters of negative growth. Well this is technically true, but if you think about it, it's just a symptom that we are talking about and not the underlying cause. Things that cause recession basically comes in two flavours, Demand shocks and Supply shocks.

Supply side recessions are fairly easy to understand, take the example of a small island nation and let's say its economy is made up of farming, fishing and tourism primarily. This case is similar to many small pacific island nations so it is relevant. Let's say this small island nation is hit by a hurricane completely devastating its fishing fleets, flooding its farmland and blowing off its hotels etc. Now this country will not be able to have the required output it needs to serve itself, and if this continue for two quarters or more than it is safe to say this country is in recession. It can also be said that the country is faced with a natural calamity and thus forced into a rough patch but technically it falls under the definition of a recession which is predominantly supply-side recession. These external events seriously hamper the capacity of a country to produce goods and services. Since growth is measured in terms of GDP and GDP is the measurement of consumption of good and services, but you can't consume goods and services since there is none to consume, it is called supply side recession. In reality, these types of recessions are rare these days or that's what we thought till we were faced with COVID-19, or at least the initial part of it.

The second type of recession which is far more complex is the demand side recession. Demand based downturns are much difficult to understand because they are hard to look at rationally. At a basic level demand-based downturn are just people electing to not consume as much. Consumer sentiment is a big determinant to this. People are less likely to spend their money on non-essentials if they are not sure of their job or pay cut etc. They will just hold on to their money just to make sure they have enough in case they end up losing their job, for survival. This causes a change in consumer psychology during recession. Again, since economic growth is measured in GDP and GDP is the function of consumption, less consumption will lead to less GDP which then leads to less growth. If this kind of more conservative consumer spending goes on for more than two quarters, you've got yourself a recession.

How much consumers consume is a long-term function of two things, how much they earn? and how much they want to spend? During good times, usually people have jobs and they are earning well so they are able to spend more. During bad times, unemployment affects the economy and people don't consume as much. Things are fine up until now but it becomes rather crazy when we bring debt into consideration. There are various theories being floated about debt by various economists but the fact remains that debt needs to be paid back. In the long term the actual effect of debt can be minor but in the immediate term, it gives a major boost to consumption and spending. Take for instance a car buyer. If you ask a person if he can afford a card he might say no, but if you can provide a loan to buy that car the person would buy it. This uncontrolled debt keeps ballooning until the bubble bursts.

There lies the necessary evil of recession. Recession basically resets the economy and stops it when it is overheating. The amount of output is reduced and debt is deleveraged. It starts acting as a detox for the economy. We can say recessions are the sign of a healthy economy. In the long run recessions are a way of sorting out issues so the next boom can be even better. Recessions are not a necessity but they do serve a purpose, same way nobody enjoys an intense workout or a diet plan but a short-term pain is good for the long-term health of the economy.

Conclusion:

Recession is basically the slowing down of an economy where for more than two consecutive quarters we have negative growth. This being the technical definition, it is important to know, recession acts as a natural healer of the economy. It rids the economy of the bad things it has taken on, much like healing a human body. When the human body ingests a foreign substance, which is not good for the body, the body tries to throw it out. Much like exercising your body induces pain, but it is good for you in the long run. same way recession rids the economy of the negative and bad leverages, leading to a healthy economy in the long run.