Research Paper On Recession Economic Impact
The cyclical nature of the economy can be explained by either a change in aggregate demand at a constant value of the aggregate supply (aggregate expenditure growth leads to a rise and their reduction causes a recession); or any change in the aggregate supply at a constant value of aggregate demand (reduction of aggregate supply is the decline in the economy, its growth – recovery). Recession is predicted, expected process, an integral part of the development cycle. The concept of a recession is intended to accompany the logical-dip slump in the graph growth territory.
As one of the stages of the economic cycle, the recession is inevitably followed by a period of economic recovery. Business cycle usually consists of four consecutive phases, namely recovery, the peak, recession and the bottom (the crisis). Each phase plays a special role in the deployment cycle. There the conditions and prerequisites for the transition to the next stage of the cycle are prepared. During the recession and the crisis all socio-economic contradictions not only aggravate, but also the prerequisites for entering a new stage of economic growth are created (McConnell, Brue and Flynn, 2014).
It is known that recession has very negative impact on all businesses. Gradually, the business becomes insolvent and bankrupt as a result. Bankruptcy can be pulled. After the recession should be the development of the economy.
There are different approaches to the definition of recession, but most of them comes to the realization that this is a general decline in business activity, for quite a long time and global in nature. Recession covers the economy as a whole that sets it apart from the structural sectoral crises and significant duration – from seasonal fluctuations in business activity. In addition, in the context of globalization of modern business crises almost always cover not individual countries, but regions or even the world economic system as a whole.
Definition of Recession
The recession is slowing production, which is characterized by zero or negative growth as the main macroeconomic indicator, which is the gross domestic product. The decline is characterized by duration of six months or longer intervals. The recession is one of the phases of the cycle economy. It always follows a period of economic growth, which is accompanied by the achievement of the highest point of business activity. Recession is a phase before the economic crisis and depression. Currently the economy of many foreign countries is in this state, in a recession. Thus, economic growth is necessarily replaced by the recession (McConnell, Brue and Flynn, 2014).
Formally, the recession means the decline in GDP for two or more quarters, that is, roughly speaking, a situation where all the factories began to produce fewer goods than before, fewer stores sell, and consumers buy less (Krugman, 2008).
Chart 1. The Place of Recession among Economic Cycles
Therefore, recession is the phase of the economic cycles, characterized by a mild, non-critical decline in production in the country. Also, it means slowdown in GDP growth or deterioration, accompanied by rising unemployment, reduced bank lending and a decrease in the volume of investment in fixed assets.
Reasons and Types of Recession
There are several main reasons for the recession, depending on the level of economic development. For the commodity-based economies the lower prices for oil, gas and other minerals exported become the cause of the decline. Commodity price falls, the budget loses income, there is a deficit, which is necessary to compensate. To compensate tax rates are increased and social spending (education, health, etc.) is reduced. These actions further reinforce the decline in production. In the developed (industrial and post-industrial) countries the recession is manifested due to the change of technological structure, for example, because of the emergence and development of information technology (McConnell, Brue and Flynn, 2014).
Specified causes of the recession cannot be influenced. They arise from the objective laws of the economy, so the recession will appear at the level of a single national economy sooner or later. Downturn in one country may lead to recession in other economies, which will result in a global crisis. There are reasons that arise under the influence of the market participants. The downturn in the economy may be caused by problems in the banking sector. For example, commercial banks issued too many loans that are not paid. Then the financial institutions are forced to raise rates and to raise funds in domestic and foreign markets. In a situation, when the amount of such banks becomes too high, the number of loans granted falls, so the company cannot borrow money and due to the lack of funds stabilize or cut production (de Soto, 2012).
Because of this, unemployment increases, people and companies do not pay loans, banks are tightening the rules, the situation is part of a vicious circle, and getting worse. The economy could plunge into a recession by force majeure, such as war or drastic changes in energy prices. The way out the stagnation is possible only with the participation of the state, which will “pour” money into the economy, supporting a variety of industries and stabilizing the currency.
Thus, depending on the reason that causes the beginning phase of the downturn in the economy, there are three types of recession:
In the first case, the economic recession appears under the influence of unplanned and very profound configurations of market criteria. Among the events that entail such consequences and in fact the recession it is possible to define war or a sharp change in global prices for natural resources, and more precisely – oil. Economic recession caused by the similar phenomena is separately unsafe. Such a recession is unrealistic to anticipate, predict, because it has very painful effect on the economy.
Prerequisites of the second type of recessions are faster political or even psychological in nature. They include the lowering of the level of consumer confidence or uncertainty in the midst of growing businesses or investors. This recession is the least harmful to the country’s economy, with this entire situation quite easily can be corrected by lowering interest rates or the artificial creation of a certain excitement in the economy.
Recession of third type occurs, when the economy loses its balance, and is characterized by rapid growth of debt and the fall in prices in the capital markets and equity markets.
Consequences of Recession and Its Impact on Business
The recession in most cases leads to a strong drop in the index on the stock exchange. Most often, the economy of a country is dependent on the economies of other countries, thus the economic slowdown in any other country could lead to economic decline in other countries and even to the collapse in global stock markets. Recession also has many other features of recurring crises, such as the rise in unemployment (de Soto, 2012).
When the recession started, the company’s sales fail. The company’s management will try to find ways to return to previous earnings. They will stop hiring new workers, or the dynamics of employment may simply decline. To reduce costs, the company will spend less on advertising, research and purchase of new equipment. It can also stop the production of new goods that have not yet brought the desired profit. These actions, in turn, will affect the company’s partners, such as advertising companies, equipment manufacturers, etc., as their profit will be reduced.
When the time to publish financial statements will come, it will be seen that the company’s profit falls. Such news immediately affects the company’s share price, i.e. they immediately begin to fall. As a result of declining profits, the company can reduce the payment of dividends, or stop paying at all. The Board of Directors and shareholders of the company may appoint a new executive team (i.e. directors). Also probably the advertising department will be reorganized to adapt the new economic situation.
An important aspect of the fall of stock prices is that institutional investors will sell shares, when they see that they drop in price. They just pick a promising company and transferred the money into it. It should be understood that institutional investors (banks, government offices) operate on large blocks of shares, and therefore the sale of their stakes in the company’s share will drop the price even lower.
Accounts receivable is a very important article in the company’s balance sheet, which describes the total debt from customers, partners, etc. During a recession, accounts receivable will increase because indebted companies will pay their debts delayed, incomplete, or not pay at all. Growing accounts receivable, in turn, will affect the company’s ability to repay its debts to the creditors. As a result, the attractiveness of the company in the market of loans will fall, i.e., its bonds become unattractive and risky, and major lenders (banks) will not lend to the company due to mistrust of the payment of debts (Martins, n.d.).
Default on the bonds will lead to further reduction in funding. In a situation, where the company is unable to obtain additional financing and cannot take on the debts from debtors, the final stage comes, when the company needs to take serious measures. As a rule, the first thing the company will review the loan conditions and repayment of debts. If the company is not able to meet them as well as debtors, the company will have to seriously restructure. But as a rule, it does not reach to the reorganization and the company ceases to exist as such.
The impact of the recession on small business is the same as on large companies. But due to the fact that small business volume is less, often small businesses are more likely and much faster than a large company to go bankrupt. If small businesses do not have provisions of cash and liquid investments, probably this small business will get out of the way very quickly. Unfortunately, the small and medium business much easier and faster disappears during recession than big companies. Small business may not only cease to make a profit for its owners, it can also affect the welfare of the community or region, where it operates (Sandilands, n.d.).
Ways to Overcome Recession
One of the ways to overcome recession is the strategy of massive layoffs of personnel. It is effective during the recession, because it can significantly reduce the cost of wages, so each remaining employee will have to work harder. Another method of dealing with the recession may be to reduce the cost of production. Such a strategy, in turn, lead to a lowering of product quality, and then to its market appeal. This technique will lead to further decline in sales, but given that the market situation will deteriorate as a whole, can give the company more time. The recession leads to cut costs to support departments that are not directly related to the performance of the company. The departments of marketing and advertising are the first in this list. Refusal of advertising means that companies, products and services will remain undetected for potential buyers, which in turn heralds the decline in companies’ sales of goods and services (Roberts, 2009).
A significant role in mitigating the negative effects of the economic recession may belong to a reasonable state regulation. For example, expansionary fiscal policy is carried out in the case of recessionary gap, when the economy is operating below its potential, and at the expense of growth in government spending and tax cuts that usually leads to an increase in the budget deficit.
Chart 2. Expansionary Fiscal Policy in Recession
So, OECD calls on member states to carry out in-depth structural reforms aimed at improving the reliability of the financial sector. The main objectives are seen in the improvement of liquidity and capital adequacy of banks; reduction of the dependence of financial system by the major players; and the prevalence of long-term investment over short-term.
Recession negatively affects all types of businesses. The main effects of the recession in the economy are the following: the decline in production; the collapse of the financial markets; decrease in loans granted; rise in interest rates on loans; increase in unemployment; decline in real incomes; fall in the rate of GDP. Despite the fact that there are a number of methods to combat the recession, it is still reflected badly on large companies and small businesses. But it is important to remember that development is next stage after recession, during which companies can work hard and become rich.
de Soto, J. H. (2012). Money, Bank Credit, and Economic Cycles (LvMI). Ludwig von Mises Institute; 3 ed.
Krugman P. (2008). The Return of Depression Economics and the Crisis of 2008. W. W. Norton & Company.
Martins, T. (n.d.). 5 Recession Effects on Your Business and How to Control them. Retrieved from http://www.mytopbusinessideas.com/control-recession-effects/
McConnell, C., Brue, S. and Flynn, S. (2014). Macroeconomics: Principles, Problems, & Policies. McGraw-Hill/Irwin; 20 ed.
Roberts, M. (2009). The Great Recession. Lulu Enterprises, UK Ltd.
Sandilands, T. (n.d.). Effect of Recession on Small Businesses. Retrieved from http://smallbusiness.chron.com/effect-recession-small-businesses-61164.html