Economists
generally believe that recessions occur due to a more than normal drop in
spending by both the private and public sectors; some of the causes this drop include financial crises, as was the case in 2008 when the
world suffered the consequences of a global financial meltdown due, in part, to the burst of the US housing bubble; an external trade or adverse supply shock –
for example, some OPEC member countries like Nigeria and Venezuela who were
heavily impacted by the drop in crude prices, which led to about 50% drop in
revenue and, consequently, resulting in a drop in importation of some critical
consumer goods, seem to be sliding into economic recession. The situation is
further exacerbated where a nation could not produce enough of these consumer goods
locally to offset the shortfall in importation. Some of the consequences of a
recessed economy include the following:
Effects on Employment
One of the
consequences of recession is unemployment which tends to increase, especially among the low-skilled workers, due to companies and even government agencies
laying off staff in order to curtail expense. Unfortunately, this results in
further restriction in overall spending which is needed to pull the economy out
of recession. Where family or individual income is drastically reduced due to
loss of employment or underemployment, discretionary spending, or disposable
income, is mostly eliminated in the budget. This reduction in income, in turn, results in
non-payment, or delayed payment of debt obligations – especially credit cards -
which further reduces the funds available for financial institutions to lend
out to businesses for expansion/investment to increase production. Investments which could
have resulted in increased employment, income, and discretionary spending that could help pull
the nation out of recession.
Effects on Businesses
Another
consequence of recession is fall in output or productivity and business
closures. The fall in output may to last until weaker companies close shop; eventually, output picks up again among the surviving firms. During recessions,
stronger companies tend to swallow up weaker and smaller ones, and this
negatively affects the competitive environment; some level of product scarcity, artificial
or real – begins to emerge, and prices of goods creep up in response. These
mergers or outright acquisitions also result in job losses; thereby, further
depressing family incomes, and reducing discretionary spending that is needed
to combat recession. A combination of job losses, scarcity of goods, and
increased prices, help drives families further into economic difficulties.
Effects on Society
With more
people out of work, and families increasingly unable to make ends meet, the
pressure on demands for government-funded social services increases. Since
governments experience drops in revenue collection during recession (something
that, in some cases, lead to the recession in the first place), it becomes
difficult to meet the increased demands on social services. Worst hit are those
who are either on fixed income – social security checks –, or on Medicaid, and
Medicare services (the elderly and disabled). Unlike those on wages and
salaries who experience little or no reductions in salaries, the fixed income
earners usually see experience cuts in their benefits and services provided by
the government, and these cuts increase the level of hardship these families
are already feeling. Another, and probably the most devastating, social effect
of economic recession is destabilization of families. With the loss of a job,
every plan for the future – college education, home purchase, vehicle
replacement, and other family-enhancing plans are all suspended, and may never
be reactivated or achieved.
All of the
above enumerated effects of an economic recession father exacerbates the
situation the longer it lasts. It is more of a vicious cycle – a
cause-and-effect; effect-and-cause situation. Now, how does a nation get itself
out of an economic recession?
Tax cuts & Government Spending
The most
popular, or most recommended, policy for any country to dig itself out of
recession is expansionary fiscal policy, or fiscal stimulus. This is usually a
two-pronged approach – tax cuts and increased government spending. Let us
address these two approaches separately:
1. Tax cuts: the
idea of tax cuts in times of recession is to increase family disposable income,
in the hope that these families will go out and spend the extra money which, it
return, will spur increased production in companies; the increased production
is expected to result in increased hiring, and so on, and so forth. Sounds all
too simple and wonderful. But, is it that simple? We must remember that in
periods of recession, families borrow money, either from financial institutions
or their credit cards, to stay afloat. Now, suppose they elect to use the extra
disposable income from tax cuts to pay off these accrued debts, how does that
help achieve the government’s expected goals increasing consumer spending?
While one could argue that the financial institutions will lend the extra
revenue (paid loans and credits) to businesses for investment; the question is:
how many financial institutions make loans in recession?
2. Increased government spending: this is more advocated than tax cuts; however, since most
of government revenue is generated through taxes, levies, and duties on imports
and exports, the receipts from these sources usually diminish in recessive
economic periods, because many companies are closing shop and the few that
remain open are cutting cost by decreasing staff and output. So, where is
government expected to get the money it is supposed to invest in these capital
projects? Yes, it is true that government capital investments injects money
directly into the economy through creation of massive employment and its
attendant multiplier effect, and construction of infrastructure, like roads,
rail, ports, etc., which have direct impact on economic growth; but the money
has to be available in the first place. Since tax cuts result in reduced
government revenue, the only other recourse is external borrowing. This only
works, or makes sense, if the money is directed at the right capital investment
for the purpose of creating employment and causing a multiplier effect in the
economy. For example, the Nigerian government believes that massive investment
in agriculture will make the country less dependent on oil revenue; so, it
might make sense to invest any external borrowing on agriculture. However, if
you invest on cultivation and harvesting of raw products without any investment
on the secondary, and more prosperous, segment of agriculture (processed goods
for export), then the revenue generated may not be adequate for use in
repayment of the loan, and reinvestment in other segments of other sectors of
the economy. So, it is not so much about where you invest the loan, but how you
do so.
Currency Devaluation
Apart from
the two above, devaluation of the local currency is another suggestion usually
put forward by economists. A currency devaluation is expected to cause a boost
in aggregate demand of goods and services; that is, if the nation produces what
other nations need. For industrialized nations with diversified economies and
multiple products, a currency devaluation in periods of recession will be
beneficial to export products; for nations with mono-product economies, like
some African nations, currency devaluation will not have much positive impact in
times of international supply glut. So, even though the product will be cheaper
to export, the market may not be available. Now, the other effect of
devaluation is to increase demand for domestic goods. Where such goods are
produced domestically, this plan will work; but, where the absence is the case,
then the purpose of currency devaluation is roundly defeated. It is very
difficult for most Third World economies to get out of recession through
currency devaluation, because they are mostly mono-product economies with
devastating international competition, and little diversified domestic
production. One thing to keep in mind with devaluation in mono-product
economies is that the likelihood of competitive devaluation – in an attempt to
gain competitive edge – does exist. For example, suppose that in a global
recession Nigeria decides to devalue its currency to boost oil export, the
expectation that Angola, Venezuela, and many other oil-dependent economies will
follow suit is very real. In the end the market is flooded with cheap oil that
no one want; so, everyone suffers from this policy decision, instead of
benefiting.
Quantitative Easing
This is a
policy applied by central banks to increase/decrease money supply when interest
rates are already at, or near, zero. When all other options are exhausted, or
in addition to the option earlier enumerated, central banks can manipulate the
money supply by buying government bonds to increase the volume money in
circulation. This increases bank reserves which will, in theory, encourage
banking lending to businesses. The other effect of this central bank action is
a reduction in bond interest rates, which is expected to help increase
investment spending. Some of the drawbacks, or dangers, of quantitative easing
are possibilities of financial losses by the central bank, difficulty in
gauging exactly how much money in needed for injection into the economy,
likelihood of loss of confidence in the economy -especially by external
investors-, and the danger of the plan not working out as intended.
Conclusion
What tool(s)
or option(s) a government elects to use to get its economy out of recession
depends on what caused the recession in the first place, and which one will
have the most minimal adverse impact on the people, or drive the economy deeper
into recession or outright depression; but, it must choose something. In
choosing, it must also consider the areas or regions of the nation, or section
of the economy where the option will work best, especially in terms of fiscal
stimulus policy. Which regions of the nation, or segments of the economy, will
a fiscal stimulus generate the most multiplier effect? Also, which policy will
have the most immediate impact on the economy, tax cuts, fiscal stimulus,
credit relaxation, or quantitative easing? It is important to consider all of
these before choosing an option, or a combination of options.
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