Recessions get a bad rep. It’s perfectly understandably why: recessions suck. No one likes to lose their job, or have to budget. Recessions are messy, ugly, and frightening. But they can also be good. To understand why, it is important to understand what a recession is.
A recession is more than just a country-wide thing. Firms and individuals undergo recessions fairly frequently. All a recession is is when economic activity (production and/or consumption) drops. This could be due to the loss of a job, or the ending of a product line, or even a career choice. What is typically known as a recession is when these individualized instances aggregate.
Recessions are typically an indication of misapplied resources. Remember that the goal of all economic activity is to produce value. Without value, there can be no exchange, and no wealth is generated. Therefore, any activity that doesn’t generate wealth contains therein misapplied resources. Recessions will occur to encourage the owners of the resources to stop applying them to the non-valued ventures. Take, for example, the fairly recent bankruptcy of Kodak, a film and imaging company. In a time of nearly ubiquitous digital cameras and digital photo storage, the concept of film became obsolete and Kodak stopped offering value. As such, it went into a recession. The resources at Kodak’s command are now freed up to pursue other more valuable ventures. In other words, Kodak’s recession actually stands to benefit the economy.
This is the big lesson here: recessions drive out unproductive and non-valued products and free up resources for more productive uses. They do suck, but it’s the way the economy heals. Political policies designed to hinder recessions actually hinder economic growth by preventing the reallocation of unproductive resources. For example, if a (politically connected) industry is facing recession, a typical response is to bail them out. This just encourages the bailed out firms to keep doing what they were doing; they felt no costs and thus had no incentive to reallocate their resources (it also sets up a dangerous precedence, but that’s for another post). When we get sick, we run a fever and may vomit. It sucks, but it’s how the body heals. Recessions are the same way.
Economic actors should always strive to produce value, but if they are faced with a recession, the best thing to do is to recognize it and reallocate.