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Economies rely on a degree of overconfidence. There is a gap between present realities and future expectations without which there would be no enterprise, no investment, no credit, no commerce, and no currency.  However, at a certain point, the disconnection between reality and expectation becomes too great, and there is a need for a readjustment.   Recession is that readjustment.

 

There are two types of recession. Most recessions are “cyclical”. They come around regularly, as reactions to periods when growing confidence gets out of control. Confidence, like fear, breeds on itself – the fact that one is confident makes one more confident – until one becomes detached from all sense of proportion. Sooner or later, there must be a reality check.

Politicians may pretend they can break the “cycle of boom and bust”, but when they try, they postpone the inevitable and make things worse.

It is the same principle as paying for everything on credit. At the time, one feels prosperous. Yet the day will come when one has to repay the debts. The longer one postpones that day, the worse the debts will be and the harder they will be to repay.

A cyclical recession occurs when a whole economy effectively looks at its credit card statement and decides it needs to reduce its outstanding balances a bit.

The more serious class of recessions are “structural”. A structural recession is more than a crisis of confidence. It occurs when a deep, underlying problem in an economy can no longer be denied.

For example, for many years, British industry tolerated lax management and labour practices, in denial about the fact that the British Empire was gone, and its captive markets with it. Sooner or later, British business had to come to terms with the new reality. That realisation was the recession of the early 1980s.   Those who went through that recession remember it as a painful experience. Inefficient industries contracted or were wiped out altogether. Yet, without that wholesale demolition, the foundations could not have been laid for the viable modern economy that developed in Britain in the 1990s.

So both types of recession are sometimes inevitable, often necessary, and usually beneficial, at least in some respects.

That is, however, scant consolation to the individuals and businesses who may be suffering at the time. They do not want to hear that it might be for their own good, and that, just as the economy is overextended, so they, as individuals and as businesses, need to take in their own belts a little.   Recession may in fact be the wake-up call that forces them to take necessary measures that not only preserve them but may turn out to be the making of their fortunes.  Yet for some it comes too late, and no amount of overdue realism can save them from personal or corporate bankruptcy.

Business is Darwinian. Survival of the fittest is cruel, but ultimately it is the best way to allocate limited resources. If a business is terminally inefficient, or operating in a market of decreasing viability, it is better that the money of the investors, the labour of the employees, and the enterprise of the management be deployed elsewhere, where they can do more good.

The “redeployment” process can take years and some may be left behind by it, but, where it is unavoidable, it is best done quickly.   The problem with recession as an agent of that “redeployment” is that is it is a blunt instrument, destroying not only the terminally inefficient but also many businesses that might be viable under other circumstances.  Yet even that gives all who go under the consoling thought that they might be in the minority whose downfall was caused by recession rather than the majority whose weaknesses the recession only exposed.

About the author:-  Guy Kingston produces and presents the Mind Your Own Business podcast, offering free business advice to entrepreneurs and business owners. As well as audio podcasts there are more articles like this, compelling videos and a must-read blog. All at  http://www.myobpod.com  or you can network and join in discussions on the MYOB Facebook group ( http://www.new.facebook.com/group.php?gid=12117784275).