Reasons Recessions Are Good For The Economy

2008 April 18

by Kyle

from → Economy

We’ve already seen how recessions can be good for consumers, but recessions actually serve a much larger purpose. Capitalism, at its root, is all about the efficient allocation of scarce resources. In a free-market capitalist society, capital naturally flows wherever promises to give the highest return. If manufacturing companies are having trouble competing in the global market but software companies are thriving and making loads of profit, capital will naturally flow from the manufacturing sector to the software sector. Recessions speed this process along considerably by making it difficult for marginal operating companies to attract suitable financing.

Survival of the Fittest

During a recession, capital markets inevitably contract. Banks become reluctant to extend credit and tighten lending stands while equity investors flee to the safety of government bonds or cash. This has the effect of crowding out marginal firms and denying them critical operating capital just when they need it most. Because of lack of capital, failing firms tend to either declare bankruptcy or sell off assets to make ends meet. While bankruptcy is bad for the shareholders of that particular firm, it’s good for everybody else because it frees up capital for other, more productive purposes. Think of it as a built-in back-stop to prevent the economy from throwing good money after bad. The end result is that the economy sheds weaker companies and emerges a stronger, more dynamic and competitive entity.

Oh, and a recession also provides ample opportunity for doom-and-gloom authors to make a quick buck off the public’s fear. A quick search on Amazon.com brings up several “the sky is falling” books, all published within the last year.

The Coming Economic Collapse: How You Can Thrive When Oil Costs $200 a Barrel by Stephen Leeb
Crash Proof: How to Profit From the Coming Economic Collapse by Peter Schiff
Game Over: How the Collapsing Economy Will Sink Your Wealth by 50% or More — Unless You Know What to Do by Stephen Leeb
The Oil Factor: Protect Yourself and Profit from the Coming Energy Crisis by Stephen Leeb

Wow, this Stephen Leeb guy sure is a Debbie Downer. Here’s a good book idea, “Protect Yourself From Economic Collapse By Writing About How To Protect Yourself From Economic Collapse.” I’m offering my services to the first publishing company that offers me a $500,000 advance.