When times are tough, we start to question ourselves: why? Why do we deserve it? How long will it last? Will this be repeated in the future?
The last crisis was not an exception. It has ended somewhere but not elsewhere. Yet the media keeps talking about it.
Someone blames the crisis on the government, somebody is simply waiting for better times to come, but everyone is curious: why have we started to live worse, we are not working more? During the economic recession the demand for books on crisis, research and on anything that could possibly assist in managing it, increased. An interesting fact: "The Capital" by Karl Marx reached the all-time record in sales exceeding its normal demand 4 fold in 2008.
Let's try to get to the bottom of what underlies an economic crisis and draw conclusions. There are numerous studies regarding the issue but we do not aim to cover them all. However, as we will see further on, there is something common in these studies. Let us first turn to theory.
Remembering Marx
The gross domestic product of a country (GDP) - is the cost of total goods and services produced in one year by all sectors of industry within a country for consumption, export or saving. Further on, we will discuss the economy of a country, referring to its GDP.
The modern business cycle goes through the following stages in development: expansion - prosperity - recession - bottom. Expansion follows bottom and the cycle starts over. What we are interested in is how often do the stages follow one another? It is not quite clear. It happens frequently as well as seldom...
Expansions and recessions in economy have existed since the beginning of structured economy. They were fist paid attention to in the 19th century. In 1874 a British scientist, H. Clark noticed that 54 years passed between the two world "economic catastrophes" of 1793 and 1847, assuming such intervals were not accidental.
Another English scientist, V. Jevons pointed out recurring long-lasting periods of increase and decrease in a number of prices he was analyzing. However, he could not find the explanation for this phenomenon.
In the 1860's Marx developed a theory of cyclic crisises. This theory gave a push towards researching the long economic wave phenomenon by the Marxist scientists.
At the beginning of the 20th century, Joseph Kitchin, a British economist, discovered short-term economic cycles, which recur every 3-4 years. Today, the reason for such cycles is considered the change of people's preferences and the renewal of durable goods. This causes the necessity of economic changes, when some sectors become more important than others and the loads of productive capacities change. These are the cycles we most often deal with and will examine them below basing examples on cellular networks.
Clement Jouglair, a French economist, discovered mid-term economic cycles, recurring every 7-11 years. The cycles appear due to change in demand for new technology. Love new technology? - wait for a crisis. Here the reason is not the change in technology's capacity, but its replacement. For instance, in our fast-paced era of information we exchanged the abacus for electronic data processing machines and then replace those for computers. Such situation requires investments from business, causing people to be fired, trained, hired, as well as accommodating new staff, which in its turn requires time...
There also are longer cycles, which we encounter less frequently. An American economist with a Russian background, Simon Kuznets, discovered 15-25-year economic cycles in the 30's of the 20th century. Finally, Nicolay Kondratyev, a Russian scientist, discovered 40-60-year-long periodic economic cycles.
Therefore, even now we are at some stage of an economic cycle. Depending on the point of view, we might at one and the same time be at the expansion stage in a short-term cycle or recession in a long-term one. This is how it goes.
Who is to Blame?
Let's examine the reasons for expansion and recession in modern theories
The so-called "prevailing theory of business cycles" suggests the following reason for expansion and recession: the potential GDP of a country grows at a constant speed while the demand - at a variable. What does it mean? Potential GDP is the GDP that a country is able to produce at full employment. We will not dig into the definition of "full employment". Here is the more important thing to understand: what is the kind of production in the country and what is the level of consumption. If we produce more than we can purchase, the recession appears: no one needs the product, so the amounts in stocks will increase, staff will be fired. If we produce less than we can consume, inflation appears: not enough goods but everyone wants to buy. The ideal situation is to produce as much as can be consumed. But in reality no one knows how much. So, we keep guessing, is it more or less?
Keynesian theory states that the change in demand is caused by the change of investments in the country. For example, if the entrepreneurial spirit is low, business ceases to invest, which leads to firing people, decrease of income and drop in demand.
Therefore, the "prevailing business cycles theory" explains the short-term business cycles though having a disadvantage: it concentrates on the demand omitting the supply. While the supply of a product may as well cause recession. For instance, a natural disaster may cut the supply of a product, closing down enterprises, which in turn will cause recession.
The so-called "real business cycle theory" defines the main reason of economic cycles as the change in labor productivity, where the productivity is defined by the level of technology. For example, such connection was seen in research defining the connection between the USA GDP growth and labor productivity during 1960 and 2005.
The question we might ask is why does the labor productivity decrease while technologies develop? The theory states that the appearance of new technology at first causes the decrease in production, as time is required for the technology to get established. For instance, coaches were not needed anymore with the appearance of cars, but hiring and training new drivers requires time, so productivity decreased. This in turn, is followed by the productivity boom. And so it goes until a new technology has been developed. Therefore, "the real business cycle theory" explains mid-term falls and rises, which were mentioned above.
Crisis within "Mobile Technology"
We most often encounter short-term rises and falls caused by the changes of demand for an existing or new product. Let's study the example with the appearance of cellular connections.
Let's suppose that prior to the discovery of cellular connections people used to spend 40% of their income on food, 30% on non-foods and 30% on other services. Now companies offering cellular connections appear. The offer of goods and services in the country increases, the Government prints money (to avoid inflation, it should print roughly the amount to cover the cellular network services consumption). This money will be paid as salary to the cellular companies' employees and equipment purchases with part of the money becoming profit of the companies.
Here is what happens next: people in other sectors keep earning as much as they used to before the invention of cellular networks and they want to use this connection as well. Therefore, they have to choose what to deny in favor of purchasing cellular connection services. For example, if a person used to buy 5 shirts a year before the launch of cellular connection, he may now be either satisfied with 3 shirts a year or start buying cheaper shirts. The result is the so-called "structural change" in the economy. The cellular network industry starts to grow with more and more people desiring to buy a mobile phone. In such case, the production of shirts is in dire straits: the demand drops, people are being fired. That is, shirt production has a smaller market share in the country's economy while the cellular network has a larger one.
This is the way changes occur in every sector. Every day a man makes a choice changing the demand within industries. These changes do not take place evenly causing rises and falls not only within sectors but within whole economies. It is a continuous process: with the development of mankind technologies develop, the diversity of goods increase, new industries appear, certain industries decay and disappear (tape-recorders are history now, replaced by digital appliances).
At times it leads to so-called "bubbles" - when a huge amount of money is directed to a certain industry. This was the case observed in 17th century Holland during the "Tulip-mania". People were wishing to purchase tulips that certain bulbs were sold at a price compared to that of a good house. In the end, this caused the crash in tulip prices (by the end of 1637 tulip prices dropped 100 times), thousands of Dutch went broke overnight and the economy faced a crisis.
Let's ask a question: why and when should the expansion after the recession start? Today, the governments of different countries tend to "make" the economy grow. The state may, for instance, launch road-construction projects (the sectors attracting a maximum number of people are usually supported), make purchases, demand in certain sectors is stimulated, taxes are reduced, money is printed. That is, the state may do anything for the people and the business to earn more money and actively spend it thus promoting the economic growth. As we have already mentioned, as a rule, the amount of money during a crisis does not decrease, so the state aims to keep existing money out of banks (excluding reasonable savings) but to work for the growth of the economy.
As we have already mentioned, all the reasons for crisis have something in common. This common thing is the psychological component. The choice of a product, a company's decision on what to invest, to spend or to save - all these are decisions made by people. Therefore, the issue of recovery from a crisis is in many respects a matter of confidence of business and of its consumers. The support of government is necessary because people cannot gather to decide on buying and investing. The task of the government is to revive people's confidence with its actions. However, this process may flow more or less successfully and the rise or expansion depends on it in many ways.
As a conclusion let's refer to the words of Robert Zoellick, Chairman of the World Bank, who considers that international economy has a number of issues, the main being the absence of confidence.
Robert Zoellick, Chairman of the World Bank, Nov 2010 issue:
"We are struggling for it in the USA and some other countries, nevertheless, due to some regulations, rules, fear of protectionism and other issues, we lack confidence".
Fedor Sannikov, President of Oxenuk Management, LLC. Las Vegas, NV. December 2011.
Oxenuk Management, LLC operates and has active licenses of Investment Adviser in the state of Nevada and state of New York. Oxenuk Management, LLC is an expert in rendering financial advice, developing investment strategies, and delivering financial product tailored specifically to the needs of our clients.
http://www.oxenukmanagement.com
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Fedor Sannikov
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