Tuesday, February 10, 2009

Why Recession Is Useful

It is indeed a hard thing to say, in the middle of so much hardship, that recession is a good thing. At least, to some extent. Let me explain this before I say any more.

The recessions are necessary for capitalism because they bring in creative destruction. That's the economist's term for getting rid of the dated, the tired and the inefficient. Karl Marx got ecstatic every time there was a recession - he thought that was capitalism's final gasp, and wrote about it. But capitalism emerged stronger and better every time. Creative destruction was what was happening then, actually the odd elements got swept away in recession and new, innovative forces, companies and ideas emerged.

Odd elements? Let's say, there are two kinds of surplus-making businesses - one that makes profit and one that earns rent. In economic terms, if you are earning a surplus because you are at the right place at the right time, or know the right people, or just get banks to lend you an unreasonable sum of money, you actually earn a rent. Yes, that's no profit - because profit, by definition, is the reward for risk taking and building an organisation.

Are rent-making businesses necessarily bad? They serve an useful economic purpose, by their entrepreneurship and brings in change in consumers' life. But these businesses add little value to the economy, and often, the gains are offset by the losses in terms of entrepreneurial spirit, the disincentive for innovation that the culture of easy money can create.

This is where recessions come in. They punish easy money, and wipe out the rent seeking businesses periodically. It is an automatic correction, where rules change overnight and the rent seekers are often left in the cold, not even knowing what happened to them.

Creative destruction, that is. As recessions destroy the rent opportunities, they provide incentives for innovation. They actually push innovation, make people work and think harder. They spawn new enterprises, from the disaffected employees of failed businesses, who have little access to capital but add new entrepreneurial energy to the system. So, capitalism lives on.

However, while we can celebrate recession actually as a positive economic force, it is actually the social costs of recession that one has to watch out for. It is easy to talk about the adjustments, but going through one personally is the painful one. As I feel now, everything I knew or counted upon has changed. The truth is that the recession hits hardest those people who have less.

This has many implications beyond personal pain. It weakens the faith in the system. Capitalism today lives on borrowed faith - it steals money from future generations to keep the social welfare, the feel-good mechanism, going. In the recession, those fault lines become apparent. The media turns gloomy, movies fail to lift our spirit and even sex becomes stale. All the things that we were told were marks of personal success suddenly appears meaningless. That's when one starts to question the wisdom of all of it.

Yes, I am saying that recessions forebear social change - that may not actually be a bad thing if you think about it.

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