Understanding Boom and Bust
(Introduction to Economics, Lesson 20)
Despite Economics being a subject that spans a great many different issues, there is one particular issue that almost totally dominates the economic news and which so concerns politicians and journalists that other — often far more important — economic issues are often swept aside or go unnoticed. That issue is the problem of ‘boom and bust.’
Individual economies and the world economy in general tends to go through fairly regular cycles, with periods of ‘economic growth’ interspersed with periods of recession. This is the economic cycle of ‘boom and bust’ that we’ve all become used to and which many people — in politics and in the media — appear to be rather obsessed with.
During the boom years, many businesses appear to be expanding and making decent profits. Production levels increase, unemployment tends to fall and people’s wages often go up. Then, there may come a period of recession, when lots of businesses see falling sales, some businesses go bust altogether and unemployment rises.
Read, listen to or watch the news and it always seems as if we are either struggling desperately to avoid an impending recession or struggling desperately to come out of one.
What most obsesses politicians and journalists is a single economic statistic; Gross Domestic Product — usually referred to simply as, ‘GDP.’ More specifically, it is the rate at which GDP is growing that seems to be of most concern.
In simple terms, GDP is a measure of how much ‘economic activity’ takes place in an economy (e.g. The US or the UK) in a single year. When goods are being manufactured or services are being provided, this is counted as economic activity. The greater the value of the goods and services that are being produced or provided in a year, the higher GDP will be.
If GDP is increasing by a significant amount, we call this ‘economic growth’ and members of the government pat themselves on the back for a job well done. As a rough idea, in most years, in most western countries, the government would be satisfied with growth of two percent and absolutely delighted with anything much more than that. On the other hand, any periods of zero growth or ‘negative growth’ (when GDP actually falls) are a major embarrassment.
A period when GDP is falling might be referred to as a recession, although, these days, it is usually only officially counted as a recession if there are two consecutive three-month periods when GDP falls. We don’t generally consider ourselves to have recovered from a recession until we return to a period of significant growth in GDP.
Recessions, of course, are obviously painful, especially for people who lose their jobs or whose businesses go bust. It is important to remember, however, that ‘busts’ do have an important function. Recessions are important times of change. In order to prosper and to meet our changing needs and wants, the economy needs to change and adapt.
If a business is no longer producing goods we really want or is no longer producing things efficiently, then perhaps it should go bust. When a business goes bust, its shops or industrial units become available for new businesses to start up or for other businesses to expand. Its workers may become unemployed, but this also makes them available to be employed elsewhere. The demise of one business is an opportunity for a new one to grow and expand. If we don’t allow a failing business to go bust, then it will continue to hog valuable resources and premises that could have been put to better use by someone else.
A recession is a challenging time when revenues are squeezed and firms are tested to see how robust they are. Recessions, therefore, can be an important catalyst for change — change that may, in time, bring considerable benefits. Resources that are being poorly utilized should be transferred to people or businesses that can put them to better use. People may need to be moved from where they are not being very productive to where they can be more productive.
Recessions, of course, aren’t always fair. Sometimes, businesses with a lot of potential get caught out in recessions and go bust, whilst some firms we’d be better off without manage to survive. Nevertheless, this doesn’t mean we’d be better off overall without recessions — so perhaps we shouldn’t fret quite so much when we have one occasionally. Painful as they usually are, we might end up worse off if we never had any recessions at all.
What might actually be a much bigger problem in the long run than boom and bust, however, is our obsession with boom and bust. The economic news (and, very often, political news) is dominated by the subject of economic growth. Are we staying in recession? Are we heading for recovery? As soon as we’re out of one recession, we’re scanning for signs of the next one or worrying about whether growth will be as high as predicted or hoped for.
All this talk about economic growth might be what obsesses ignorant politicians and lazy journalists. Any decent economist, however, would question whether this obsession with growth actually makes any sense. They understand perfectly well that economic growth is very far from being the be-all-and-end-all of economic success.
For a start, GDP is only a rather crude and inaccurate measure of economic activity. A lot of activities that are included in GDP statistics aren’t actually activities that make us better off. The production and sale of cigarettes, for example, contributes to GDP, but this makes us worse off, not better off.
Then there’s the well-known broken window example. If GDP is so important, then why don’t we encourage yobs to go around throwing stones and breaking windows? After all, a lot of people would have to be employed fixing those windows and the work they do would contribute towards GDP. Obviously, however, this cycle of destruction and repair wouldn’t actually be making us better off. We’d simply be working harder in order to stand still. We’d be better off if the windows didn’t get broken in the first place — but that wouldn’t boost our GDP statistics!
The importance of GDP is also lessened by the fact that a lot of important economic activity isn’t included in GDP statistics. If you pay a babysitter to look after your children, this counts towards GDP, but when Grandma does the babysitting for free, this doesn’t count, as there is no record of any transaction having taken place.
The key point overall, however, is the fact that, for a country that is already rich, there is no clear relationship between GDP and how well-off people are. GDP is a very useful statistic when looking at developing countries as they develop from subsistence economies to modern economies, but for modern, rich, western countries, it is far less useful.
In a country like the UK or the US, we’re already producing and consuming plenty enough to make ourselves very rich and very well off. Yet, politicians and journalists seem to think that we should strive to produce and consume ever more and more goods and services without end. They act as if it will be disastrous if we don’t constantly accelerate the rate at which we are producing and consuming things. But can this acceleration really continue for ever and ever? Even if it can, would we want it to? Would it actually do us any good?
Take a step back and you’ll realise that, whatever economic problems we might have, a failure to produce and consume enough things is not one of them. Of course, we still have shortages in some areas and we could do with more of certain products and services and with some goods and services being of a much higher quality, but in terms of the sheer bulk of what we produce and consume — no, there’s no shortage there!
No, this obsession with GDP makes no economic sense — and yet it continues. And this obsession itself causes many problems. Our obsession with boom and bust distracts us from what are actually far more important, underlying, economic problems and opportunities.
What about feeding the poor? What about eradicating easily-preventable diseases? What about protecting and preserving wildlife species and habitats? What about educating our populations by addressing the appalling inadequacies in our education systems? Oops — we appear to be too busy worrying about boom and bust to care about these things!
Boom and bust dominate the economics news, but there is so much more to Economics than the economics of boom and bust!
