Economic data reported through March have been pointing to a recession under way. If there truly is a recession, it may have started last December. Certainly, that is not good news. But what looks to be a silver lining may be starting to shine through.
If recent history is any guide, by the time you read this article we will have passed the midpoint of the possible recession. That means that the recovery should begin either in June or July. In my opinion that isn't silver we're looking at.
I recently had the opportunity to address an annual meeting of one of this industry's suppliers. During the Q&A period, I was asked if the recession was going to be weak or severe. There was a noticeable reduction in the oxygen level when I said, “It will not be nearly severe enough.”
I explained that the macroeconomic theory that I was taught provided a foundation for the belief that an economic downturn is necessary to sustain the potential economic growth of a society. Potential economic growth is not steady growth. It is the trend growth that the economic resources can sustain given the participation of the population at a given period of time. There are some who believe an average growth of 2.5% over time is the potential economic growth. That is less than the 3.5% estimate of just a decade ago. Whatever it is, it needs a recession to meet that potential.
Among the benefits provided by a recession are: the reallocation of scarce resources, a pruning of inefficient activities, fundamental changes in behavior, and a resetting of general priorities.
Since we are a nation with abundant resources, we often do not focus on the scarcity of these same resources, i.e., arable land, clean water, clean air, raw materials for producing goods, transportation capacity, talented labor, investment capital, and facilitating governance.
In order for resources to be effectively allocated, there must be a mechanism that rewards the most efficient users and penalizes the least efficient users. Within the framework of free markets, the least efficient user is not expected to survive for long. A recession goes a long way to help that pruning, but it needs to be severe enough to be effective.
The reallocation of scarce resources can be a long process, but if there is not enough pain to initially put the needed change in motion, we may see virtually no progress.
The labor pool is a good example. I grew up in New England, when the textile industry was a major employer. It certainly took a while for the labor market in that region to recover — and some pockets are still struggling to this day. The recovery initially put in place created new labor demand in the high tech and machinery production industries, which have now reached a growth plateau, and a new source for job creation will have to be developed to provide potential growth for the entire region.
Fundamental changes in behavior are already being seen as auto sales reflect a new preference for more fuel-efficient vehicles. This major shift required personal discomfort, which was driven by a lack of economic growth. It remains to be seen if the discomfort was significant enough — one that requires a severe recession.
One of the major dangers we face in this downturn is the desire to manipulate the natural course of events. We are treading in very dangerous waters when we decide to restructure contracts either by fiat or by the wisdom of a judge trained in law, not economics. Once we go down that path, future pruning will be difficult and dangerous wildfires could be the result.