No, Recessions Are Not “Functional”, &
BRIEFLY NOTED: For 2022-10-29 Sa
FIRST: No, Recessions Are Not “Functional”
The extremely sharp and articulate Jason Calacanis—who will, somewhat unfairly, be best known to history for his declaration that he would "jump on a grande" for Elon Musk, he loves Elon so much:
—claims that downturns and recessions do you have a "cleansing effect" on the economy.
They are, he says, useful for society. The way you can make money in the downturn is by cutting expenses, expenses do need to be cut to keep an organization taut, and a downturn—when smart management has to focus on expenses, because there is no point of no return to focusing on growth—is when that necessary function is carried out:
In the downmarket, the best way to make money is to cut expenses. You may have problem growing your earnings, your profits. You can't grow your profits, your top line, because businesses aren't spending money. That's the headwinds. What you can do is cut expense stash. I've been doing this myself.... this is why the boom bust cycle in economies. It's a good thing because it fleshes out inefficiencies… <https://overcast.fm/+65w6slIpc>
This is a case of what we economists call a "fallacy of composition".
It is certainly true for the individual company that cutting expenses makes the organization more taut. Moreover, there are sociological advantages to cutting expenses in a downturn. Then the boss can accurately plead that it is not personal—that they are only doing this under duress, under the pressure of force majeure.
But can an organization that can only rationalize expenses during a downturn succeed in rationally cutting expenses at all?
More important, your expenses are someone else's income. From the perspective of the economy as a whole, a situation in which everyone has cut expenses is a situation in which everyone's income has gone down the drain as well. The result is that you have no idea what the underlying demand will be for what you might make when the downturn ends. Thus the entire "creation" part of creative destruction drops to zero. Thus, from the perspective of the economy as a whole, the effect of a downturn is to move a lot of people from relatively low-productivity activities into the zero-productivity activity of having no job. No constructive reallocation of economic activity takes place during a depression.
Moreover, depressions become self-sustaining vicious cycles. There is no natural and inevitable way out. There needes to be some kind of active stimulus from somewhere—an active kick to boost demand for something. Unless that active kick turns out by luck to be aligned with the long-run structural-change desirable destiny of the economy, at least the first round of constructive reallocation that take place as the economy comes out of the downturn will shift the economy in a wrong direction.
No: In total, and in sum, at the aggregate level of the economy as a whole, the destructive effects of recessions and downturns substantially outweigh any constructive or "cleansing" effects. Shifting people from low-productivity jobs to zero-productivity does none of the work of figuring out how to get people into high-productivity jobs.
So when does the “creative” part of creative destruction take place? And when should the work of making a firm more taut and efficient by focusing on expenses take place?
Let me detour for a moment:
We are going to have recessions and episodes of inflation. John Stuart Mill put his finger on why back in 1829: If there is, say, a shift in demand so that there is suddenly an excess demand for lattes and a deficient demand for yoga lessons, then we are going to have a boom in the latte-producing sector and a slump in the yoga-teaching sector. Yoga teachers will retrain as baristas. Coffee shops will expand. Managers of yoga studios won’t be searching for new teachers, and will instead focus on making their operations more efficient so that they can stay open. The economy will get more productive. The work—of creative destruction, and of pushing for firm efficiency under threat of bankruptcy—will go on, and go on without a downturn, without a recession, without a bust.
Now let us consider another situation: Suppose there is a shift in demand so there is suddenly an excess demand for money, and deficient demand for lattes and yoga lessons. Then there is a slump in the latte-producing sector. Then there is a slump in the yoga-teaching sectors.
But there is no compensatory boom in employment in producing "money"—at least, there has not been since the days "money" consisted of small silver disks, with an owl on one side and Athena on the other, made from ore dug out of the slave-worked mines in the south of Attica.
When there is an excess demand for money, the government can print some and use it to buy stuff; and the central bank can print some and manipulate the financial system to cool off the excess demand, but these processes do not take place instantaneously. And until they do take place—until the excess demand for money is satisfied—businesses cut back on their spending, which means businesses and people lose income, and that income loss forces a second-round reduction in spending
To conclude: We do not "need" recessions. Recessions are not "functional". Claims that recessions are necessary in order to spur desirable structural changes are as close to completely false as they could possibly be. During a recession, next to no businesses are profitable, and few are hiring.
It is in the boom, not in the recession, that desirable structural changes take place as people are pulled into higher productivity, sectors and businesses learn how to expand and increase efficiency.
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The peremptory cleansing effects of a recession seem most useful to the finance industry itself. Everywhere else, the requirement that one’s revenue consist of payments for *something* limits how uselessly unproductive a given company can be. Even if demand for pet rocks is inflated by cheap credit, or prices driven low by overinvestment in production, there are only so many pet rocks one person will want. Marginal demand eventually always reaches zero.
But money, there’s no limit to demand for money. Any number of elaborate Ponzi schemes fed with zero-interest lending can exist, and in fact the more the better because that makes it harder for the SEC to investigate. Zero rates mean you can promise quite ordinary returns - 5% say - which makes it much easier to string people along for years.
Of course this finance area also includes negative-profit startups. Generally those are a small part of the economy, though.
I don't see any intrinsic reason that the Fed can't do stuff (e.g. create money) as fast as firms are trying to reduce costs. Central banks should be judged against perfection. Sure they will in fact make mistakes but full employment inflation and less than full employment deflation just should not happen.