How does recession affect a business

What is a Recession

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Different economists define a “recession” term in different ways but in general they all agree that a recession is general slowdown in overall economic activity, lasting long enough and universal in its character. In case of a recession economical decline spreads across all country, distinguishing it from structural crisis in separate industries. More over true economic recession can only be confirmed if it lasts for a period of two or more consecutive quarters in order to nullify seasonal effects. Due to globalization of modern business recession easily crosses national borders and strikes whole regions or World economy entirely.

A recession becomes visible through decline of all major macroeconomic indicators: GDP (Gross Domestic Product) growth slow down or goes negative; production, investment spending, household incomes and spending decline while bankruptcies and the unemployment rate rise.

Being a part of natural business cycle a reception inevitably follows any economic boom. Usually a normal business cycle consists of four successive phases: expansion, boom, recession and crisis. Each phase is important for transition of a cycle. Not only different social and economic contradictions gain momentum during a recession and crisis but also a basis for future growth is build. Over long-term period, the highs and lows of business cycle form the trend, or average, economic growth rate.

Numerous factors that may cause a recession could be divided in two large groups – internal (endogenous) and external (exogenous). The last one is represented by various force majeure obstacles of catastrophic nature: wars, revolutions, natural disasters. Economy of agricultural countries may be influenced by climatic changes, crop failure etc. Economists working in the neoclassical tradition also consider State regulations, labor unions acts, business monopolies and technological shocks as exogenous factors of a recession. In most cases external factors explain all crises prior to The Great Depression in 1930s. The longest and deepest depression of the 20th century happened during period of political stability and was caused by structural crisis in USA.

Internal causes of a reception could be resolved to accumulation of fundamental contradictions in an economical system. For example, Asian financial crisis in 1997-1998, which lead to global recession, was

caused by overheating of private sector. Excessive investments in real-estate and production did not earn acceptable return. Large scale corporations used political leverage to create so called “cronyism” where resource allocation is based on personal relationship between managers rather than risk/return assessment. As a result foreign investors made risk valuation adjustment; overloaded private debt coupled with capital outflow sparked currency crisis.

World financial crises in 2008 and current recession are also caused by internal factors. It was triggered by The United States housing bubble – extensive lending of American banks into high-risk “subprime” and adjustable rate mortgages resulted in default rates overgrowth and downfall of banking sector financial indicators. Defaults and losses on other loan types also increased significantly as the crisis expanded from the housing market to other parts of the economy. Bankruptcy of several high rated investment banks started panic on the inter-bank loan and stock markets. Rapid growth of interbank interest rates and international liquidity crisis made serious impact on emerging markets, especially Russia and Ukraine. Soon recession became global leading to GDP fall, heightened unemployment and economic hardship in many countries.

Adequate government regulation may significantly reduce negative outcome of a recession. Experience of several last years is carefully examined by international organizations and institutes. As a result new approaches to elimination of existing global imbalances are formed. The OECD recommends to its member states to proceed with essential structure reforms in order to improve transparency and stability of financial system. Countries will also need to deal with too-big-to-fail problems associated with systemically important financial institutions, whose failures have exposed significant vulnerabilities in many countries during the crisis. Other tasks are to achieve better capital adequacy and liquidity standards; strengthen the quality of financial infrastructures; refining legal frameworks and to orient the investment inflows toward the longer term.

It is important to remember that any crisis is exposure of structural misfits and is intended to overcome them by the price of social and political shock. A recession shows “weak links” in economic system, destroys them and releases resources for new undertakings. Decline in business activity forces companies to follow strict financial discipline, abandon non-effective business practices, improve their productivity. It also opens a way for new ideas, technologies and business models.


Category: Personal Finance

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