The Unstoppable Collapse of the Global Market
Since industrialization, modern consumer-focused economies have followed the business cycle. The business cycle, is the observed cycle of economic expansions, during periods of high employment, consumption, and consumer confidence, and contractions during subsequent periods of low consumption, employment, and consumer confidence.
These booms and busts, as they are more casually known tend to have a frequency of about seven to ten years. Some economists have added, that these cycles take place within larger cycles that play out over decades or even centuries. Thankfully, most economists will also point out that, these cycles tend to trend upwards as economies grow over time, despite some temporary setbacks that's all fascinating. But, is this boom and bust pattern of modern economics, a bug caused by human nature or is it a feature of the systems that we have built, that provide us with some kind of benefit a necessary evil of sorts? We are currently living through, one of the most trying times in our global economy.
For the past five decades, the world has shifted to favor free trade and globalization. All for the arrangement to be challenged with a global pandemic, disrupted supply chains, labor crisis, trade wars, and actual wars taking place on the doorstep of the largest economic region in the world.
Despite this, most economic metrics are looking pretty good in the United States. Growth is strong, unemployment is below four percent, and asset markets are hovering around all-time highs. But, has this only been achieved, by subverting the natural order of things with the most expensive and expansive fiscal and monetary policy decisions in history? Are we entering a new age, where serious downturns caused by genuine economic hardships can be avoided with piles of cash, or is this all just putting off the inevitable, and potentially making it worse further down the road?
Most of you reading, probably have a good grasp of the forces of supply and demand. The quantity supplied, and the quantity demanded determine prices, and prices in return determine how much of a good or service is supplied and demanded. This reciprocity means that markets tend to form an equilibrium, where supply meets demand and everyone is happy. If supplies rise or demand falls then prices fall. If demand rises or supply falls then prices rise again.
I imagine this is probably not used to most of you reading. This is interesting because economists can apply this same logic across entire nations, using aggregate figures. Aggregate supply and aggregate demand are the terms that economists use to describe the total supply of goods and services in an economy and the total consumption of those goods and services respectively. Economic growth can be achieved by increasing either of these factors, but in the long term, you need to increase both of these together to achieve stable economic prosperity.
Let me demonstrate why, say an economy creates some new manufacturing method that makes building everything much easier. That economy would then be able to produce more things which would increase aggregate supply. Increased supply, without increased demand, would mean more goods and services are consumed all with the added benefit of lower prices. But deflation, as this is known, is not sustainable for the long term. But, while on the surface falling prices might sound great, it causes issues of stagnating wages, investment, and consumption, because people have no stick at their back, prodding them to put their money to good use.
Economic growth caused by increasing demand without increasing supply is also possible, although equally unsustainable in the long term. Satan's economy gears 1400 checks to all of its citizens, which means everyone has more money and can buy more things. This increases total demand, if demand grows without an equal growth in supply, then people are going to have to compete with one another to get their hands on the goods and services that they want. This competition normally comes in the form of just paying more money. The increasing price level of goods and services in an economy is inflation and obviously, this can do serious harm as well. So, the trick is making sure that an economy achieves growth by growing supply and demand more or less in unison.
So, how is this done?
Growing supply is simple in theory, you just increase the factors of production: land, labor, and capital. You grow and train an experienced workforce or attract foreign workers to your country, you then give them the space and facilities they need to add value to the market, be that working in a factory researching new technologies, providing financial services, or anything else of value that can be supplied to the aggregate market.
Of course simple in theory, does not equal simple in practice, and forcing supply-side growth is unbelievably hard for governments to do for a few reasons. The first is that, in almost all major economies the government is not the primary supplier of goods and services. Most of that is handled by the private sector. This means that the government can't just order 100 new factories to be built to increase output. They have to somehow encourage the private sector to do it. There are some very direct ways that the government can do this, like awarding government contracts to build anything from fighter jets to bridges. This is where the direct supply side of spending fails because it doesn't normally supply the goods that consumers truly demand.
Public goods are very important and as we have seen in recent weeks there is true value in having things like fighter jets to protect your country but you can't build an economy around stuff like this. Look around your own house and try and, find anything that was built by the government rather than the private sector, it would be challenging.
So the real solution for governments is to use more indirect methods to encourage supply-side growth in their economies. This can be done through government grants to motivate research and development or, it can be done through forging mutually beneficial trade deals, or it can be as simple as making it easier for people to start a business of their own.
One other more controversial strategy is the privatization of public industries, the theory is that the private sector can produce things more efficiently than the public sector because they have market competition and a profit motive. You can probably see why this is controversial.
All I will say is that there are some industries, that are best handled by the private sector and there are others that the government best handles. Deciding where to draw that line is the hard part. Nevertheless, there are thousands of government policies in place across the world that are there to try and stimulate business activity.
Of course, all of this means nothing if the demand is not there to go with it. Businesses are ultimately profit-driven entities, so they are not going to operate unless a market exists for them to sell their goods and services. Fortunately, demand is a lot easier for governments to control, demand is a function of consumers, businesses, or government entities who are willing and able to buy a good or service. Aggregate demand is a function of all of these participants in an economy's ability and willingness to consume all the goods and services that the economy provides. Increasing demand is as simple as putting more money in people's pockets and making them willing to spend it. The more money part is easy, just cut taxes, increase welfare, or in extreme circumstances give money to people directly. Getting people to spend that money can be a little bit trickier because, of course, they could just choose to save it. This is why consumer confidence is talked about so much in the news in general. However, more money in more people's pockets will mean more people who are willing, and above all else, able to consume.
Okay, great economies grow by increasing supply and demand. It's harder for governments, to intervene in supply and it's relatively easy for governments to influence demand. But why does all of this mean that we need recessions? There are two broad classifications of economic downturns that we experience and by now you can probably hazard a guess at what those are. Demand and supply downturns.
Demand-based recessions are the ones that we are most familiar with, and they are the foundation of the cyclical business cycle. During good times, people get good jobs. They use those jobs to take out big loans. They use those loans to buy lots of things, and the companies making those things use this revenue to give people good jobs. This debt eventually needs to be paid back, which is what causes the debt cycle, if someone was making a hundred thousand dollars a year after tax, they could spend a hundred thousand dollars per year. But at some point, they might want to purchase a new car, holiday boat, holiday home, or whatever. That would mean that they are spending more than they are making.
In that year, they have two options to make this possible. The first is to forego consumption for a few years, to save up the money needed for the big purchase. To economists, this person's consumption would be below their household income level for a few years and then spike in the year they finally end up buying whatever they were looking for. Of course, no one saves for anything anymore. We just get a loan and what this does is effectively the same but in reverse. Economists will see a huge spiking in consumption for the given consumer followed by a period of consumption below their household income level as they pay back this loan in aggregate. These peaks and troughs, in household spending, are feedback off one another as we saw earlier. As soon as a few people start tightening their belts to pay back their debts, company revenues fall, and those businesses are forced to lay people off. Once those jobs are lost, those people stop taking out loans to buy new things. Once people stop buying new things, the businesses selling new things start laying off workers adding the fact that even people with jobs would be afraid of taking on new debts during a period when all their colleagues are getting laid off. You can see how this can get out of hand pretty fast.
Governments can intervene in this loop by injecting money into the system to compensate for falling household incomes and consumer confidence. Counter-cyclical monetary and fiscal policy has been used for decades now to smooth out the debt cycle and while they cannot eliminate these booms and busts they can smooth them out to make recessions less severe at the expense of making the booms less extreme at least that's the theory.
Now, the other type of economic downturn is what we call supply shocks. These are the downturns that are caused by real tangible damage done to an economy's ability to produce value. Wars, Natural disasters, trade disputes, and even things like global pandemics can all impact an economy's ability to produce goods and services. Supply shocks reduce supply which limits an economy's growth. But as we saw earlier, it's much harder for governments to stimulate supply because that isn't their domain. Even privatization as controversial as it is probably isn't the right tool for the job during a supply shock because governments are not going to get very good deals by selling off their infrastructure during an economic downturn. The thing that a lot of economists and especially politicians shy away from is, that admitting that sometimes economies will have rough patches and trying too hard to avoid these downturns entirely can push this delicate balance out of whack, causing worse issues down the road.
Inflation is the obvious problem at the moment as government stimulus has spruced demand to all-time highs while supply struggles with stagnant domestic production and disrupted global supply chains. But it's more than just that. Economic downturns caused by both demand and supply side issues play a crucial role in sustaining long-term growth in the economy, because they act as a filter to weed out poor economic practices that are only surviving, thanks to good economic times.
The easiest place to see this is in investments. During good economic times, there is a lot of money flowing around the economy and businesses will find it very easy to attract investors who are themselves more likely to invest because of the confidence that comes with an economic boom. If investors start to think that growth can continue forever, they will throw money at any business they can find. At best, this will create asset markets with unreasonably high valuations.
At worst, this will facilitate investments into bad businesses that don't make economic sense.
Investors have a very important job, they determine how an economy's capital is deployed to maximize output. If investors can endlessly count on government stimulus to prop up markets, they have no reason to take this job seriously.
Economic downturns act as an impetus for the weakest businesses in an economy to fall to the wayside and allow for businesses with better products, better management, and better systems to fill the vacuum for lack of a better way of putting it. It's survival of the fittest and unfortunately, natural selection can't take place without a bit of adversity. Be it a lion, or an economic downturn. These same downturns also create new opportunities for businesses that are robust enough to make it through. If a car manufacturer goes out of business during a downturn, they will be forced to liquidate their machinery and lay off their staff which is capital and manpower that can be utilized by a company that was able to survive this downturn. Of course, not all of these workers will be rehired which is another way that recessions can kind of do some good.
Most economists are extremely hesitant to talk about any benefit to economic downturns and even fewer want to talk about this particular perk. In the same way that recessions get rid of underperforming businesses, they are also effective in getting rid of underperforming workers. If an economy is at full employment then businesses will find it very hard to attract new employees because there is no one looking for a job. This means that attracting workers becomes more expensive because businesses need to compete with one another to offer the highest salary for a given position. It also makes getting rid of bad employees much harder, because a bad employee is often still better than no employee.
Australia once had a relatively large automotive industry having major operations in the country. These operations have closed production. One of the biggest reasons for their departure was not the expense of Australian labor, which was comparable with Germany and the United States but rather the attitude of the Australian workforce. The motor companies reported instances of up to 50 of their workforce faking sick days to extend public holidays and long weekends. The workers could get away with this because they knew that they were hard to get rid of and replace. This was not sustainable long term. Even with the Australian government paying these companies to stay in the country and today Australia has no car industry of its own.
Economists model something called the “NAIRU” or the Non-Accelerating Inflation Rate of Unemployment. This tracks the relationship between inflation and employment. The more people that are employed, the higher the inflation rate will be. As the increased cost of salaries and unproductive workers are passed along to consumers. This is compounded by the increased aggregate demand coming from the same households that will be demanding those higher wages. Economies work best when participants have to compete. Businesses have to compete against other businesses for a limited pool of customers and investors. Workers have to compete against other workers for good-paying jobs. An economy where customers have to compete for the honor of being able to purchase consumer goods and businesses have to beg workers to stick around is inevitably going to be played by higher prices and lower productivity. A surefire way of reintroducing this competition is to have a recession.
Economic downturns are painful but pain serves a very important purpose, it lets people know what's going wrong and points to areas that need to be fixed. There is nothing wrong with governments giving out painkillers to avoid the worst of this necessary evil but take too many or take them for too long and you're going to end up with some bad side effects. All while doing nothing to avoid the issues that cause the pain in the first place.