Pros And Cons Of Economic Recessions

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Recessions can be very severe, with long-term consequences. As a result, individuals and companies alike may find it difficult to recover from a downturn.

Understanding the negative and positive consequences of recessions and depressions is one of the greatest methods to survive a slump.

Negative consequences

Rising Unemployment

Both depressions and recessions are characterized by rising unemployment. As enterprises fail, they reduce their workforce to deal with lower profits. In a depression, unemployment is significantly worse than in a recession. During a recession, the unemployment rate typically rises to between 6% and 11%. In 1933, near the end of the first era of the Great Depression, the unemployment rate reached 25%.

Capital Destruction

During recessions, not only do employees lose their jobs, but vast amounts of real capital goods (processing plants, tools, buildings, and equipment) sit idle as the investments and commercial operations for which they were built fail and go out of business. Much of this invested capital can later be rescued and transformed into new meaningful uses under new owners, but some will be lost permanently due to obsolescence or physical deterioration.

Dwindling Living Standards

During a recession, labor and capital unemployment cause a drop in economic production and a drop in real per capita income. As the amount of actual goods and services produced decreases, there is less to consume. Consequently, many people are unable to maintain their quality of living. As families become more stressed, birth rates drop, and divorce rates rise.

Causing Fear

Fear is rampant during recessions and depressions. Many people lose their businesses or jobs, but those who keep them are often vulnerable and fearful about the future. Fear drives consumers to cut down on their purchasing and firms to reduce their investment, further slowing the economy.

Recession's Advantages

Recessions, despite the suffering they cause, may have some positive consequences:

Redistributing Resources

When a recession results in the failure of enterprises and the liquidation of assets whose existence is based on interest rate signals or distorted price, the discovery of these misguided investments and the redistribution of the resources allocated to them toward more productive uses under different ownership is a long-term net economic benefit, offsetting some of the pain of the temporary unemployment of employees and capital that may occur.

Investing Discipline

Marginal investors and firms who rely significantly on debt and leverage to embark on risky, speculative investing strategies or corporate ventures tend to be punished during recessions. The correction and liquidation of excessively risky investments to put their resources to more sensible use is a feature, not a defect, of recessions. It instills discipline in market players over time.

Buying Opportunities

Reallocation of real resources and assets is the inverse of mass insolvencies that can occur during a recession. When the economy is bad, there are a lot of great deals to be had. Stocks are inexpensive for newcomers to the market. Home affordability rises, allowing new homebuyers to take advantage of low costs. Land, labor, and cash may become more inexpensive for entrepreneurs looking to start a new firm. Equity markets typically reach greater highs than before the depression or recession when the downturn gives way to recovery. Contractions thus give a good chance for investors who have the patience to wait for a recovery.

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