The role of recessions


A new study by the CBI has said that the current recession will create a new era in British business, with the lessons learned from it influencing a whole generation of enterprise. In particular, the CBI says that the recession will change approaches to supply chains, finance and business ethics.

I can’t say whether those particular predictions will turn out to be true or not – no one can predict the future of entrepreneurial organizations with any real certainty – but the CBI is absolutely right to say that businesses will learn from the recession and adapt their business models for the future. That is in fact an integral part of the free market economy in general – it is a constant, dynamic process of experimentation, trial and error, and adaptation – and recessions in particular.

But I would also go further than that, and say that recessions, while clearly unpleasant for those involved in them, actually represent more than just a learning curve. Indeed, they are a necessary remedial phase in the economic cycle, in which the distortions that have built up during the boom years are unwound, bad investments are liquidated, and relative prices return to normal. In other words, recessions are a necessary step in preparing the ground for a return to economic success.

There is a real danger, however, that government will interfere with this process if their actions go beyond easing the pain of adjustment and instead represent an attempt to re-inflate the bubbles of the boom years while propping up failed business models. That is the recipe for economic stagnation, and most likely inflation too. It is also precisely what the current British government’s policies aim to do: bail out failed banks, prop up failed businesses, and pump enough money into the economy to restore the housing and financial asset bubbles, return bank lending to previous, unsustainable levels.