Why Do Recessions Happen?

The Bureau of Labor Statistics released numbers yesterday stating that, non-farm payroll employment continued to decline in June (-467,000), and the unemployment rate was little changed at 9.5 percent. Job losses were widespread across the major industry sectors, with large declines occurring in manufacturing, professional and business services, and construction. This means that roughly 14.7 million people are currently looking for work. In addition according to the Economic Policy Institute, this is the first recession since the Great Depression that has completely wiped out all the job gains from the previous economic expansion. In sum, even though growth in unemployment is slowing, we show no signs of a turnaround any time soon.

A good question to ask at this point is why do recessions occur. Why can’t we maintain periods of growth indefinitely? Some answers commonly heard are the housing market crashed or Wall Street screwed things up. While both these statements may be true, recessions occur even when these are not the causes.

First of all recessions are a phenomenon of capitalist, market economies. Centrally planned economies such as Cuba and the Soviet Union do (did) not experience recessions. Of course, those economies are largely depressed all the time. In essence, recessions are the price we pay to have the long-term economic growth that we get with market economies.

So why do they happen? Market economies work on incentives: the incentive to produce the greatest amount of wealth in the most efficient way possible. Sometimes, however, times change — technology changes, people’s preferences change, new countries rise or fall. Recessions are an economy’s way of correcting itself. When we are no longer able to produce what is demanded in the most efficient way, an economy ceases to grow. When we don’t grow for long enoungh, we call this a recession. Companies start to fail, jobs are shed, and people are hurt.

So what do we do to get out of a recession? The simple answer is that we need to readjust to the new world. In this case, we need to adjust to a financial sector that is more risk-averse than the last 15 years, and we need to adjust to a housing sector that is no longer on fire, as tastes for housing have changed. In a healthy market, which we certainly have, this will naturally happen. Recessions always end, no one worries about that. What we worry about is 1) how long?, and 2) the people who get hurt in the downturn are not usually the same people who end up benefitting the the upswing. In the recessions of the 70s and 80s, manafacturing workers, steel workers, and the like were the ones laid off, they really never got back to work at the same level of pay. In this recession, we see that auto workers, construction workers, and financial sectors workers who really have to worry about their long term possibilities.