The Cleansing Effect of Recessions

In the past, when I’ve tried to schedule our window cleaners they have always been able to come within two days. Despite the still-slow economy, the first available appointment this time is not for three weeks.

“Why?” I ask. The owner says that during the worst of the recession his firm had enough clients to survive, but barely; smaller, less efficient companies died off. Now that demand for cleaning has increased, his own customers are coming back; and the customers of the now-defunct companies are hiring him too, so he’s swamped with business. Recessions kill off inefficient firms; but at least in this case, those that survive come out stronger than before. (I can’t resist noting that some macroeconomists have referred to this phenomenon as “the cleansing effect of recessions,” especially apropos in this case!)


Brian S

Someone should give the US Fed and Government the memo on crappy businesses being allowed to fail.

Jorge

Recessions kill off inefficient firms? What a simplistic view. There are many reasons why companies go down during recessions. And likewise, there are companies that profit from bad situations without any particular skill that make them more "efficient".
The outcome of big recessions though, is often consolditation, which you seem to consider a good thing for the economy. I think there are plenty of examples on the contrary.

mctromb

I wonder if academic economists would be so cavalier about "the cleansing effects" of recessions if their own jobs weren't protected by tenure. Funny how market discipline never seems to apply to it's celebrators!

Will McKenna

We actually don't have enough information to know whether or not the inefficient firms were the ones that went out of business in this case. The firm that survived could have been charging their customers more (and making slightly higher profits despite being less efficient), but not actually be a better business than a smaller one with lower margins that simply couldn't maintain sufficient cash flow to stay in business when things slowed down. There are all kinds of inefficiencies in the markets that may have allowed a less efficient company survive over its competitors.

bcamarda

Arrgh. Economists.

There's now plenty of evidence that job loss translates into massive health problems, shorter lives, and greater human misery. More family abuse. More depression. Young people who can't get their first jobs suffer major income losses that persist for decades. Not to mention that the political system gets coarser and more intolerant.

What do economists see? The "cleansing effect."

I would like to see research done on why economists find certain things interesting and other things utterly irrelevant.

Gary

How come recessions don't seem to kill off the inefficient government programs? Instead recessions only seem to generate more of them.

This isn't a rhetorical and leads to a bigger question. Why is it that people fail to transfer the obvious lessons from the marketplace to the public sector? Why do they gladly surrender their options and choices? Just last night I watched the voters in my town change from a financial meeting format where they can debate line items in a budget to a day-long referendum on the total budget where they have less input. Now we will have less control over our taxation levels. Why do people trust something that continually fails to expand their freedom of choice?

jblog

Supply, meet Demand.

Nosybear

One of the biggest value-adds of a recession is cleaning out the corporate gene pool of non-performers. Unfortunately, those cleaned out don't tend to be the biggest losers, the megacorps who have forgotten who their customers really are and who are kept alive via socializing their losses (read government handouts). If there is a demand for the goods and services these giants provide, someone more efficient will step up to fill the void. It might take a year or three but someone will rise to the challenge. The too-big-to-fail companies should fall - the short-term pain would be great but in the long term everyone benefits from an ecosystem of smaller but more nimble companies.

Brian

Yes but the three week wait is a sign thats the market is not at equilibrium. Which means that the company should either hire more workers or wait for more competition to move in and shorten the waiting list to something closer to two days.

Abhishek

Unfortunately the inefficient firms have become bigger after the recession than before.
http://Greenworldinvestor.com

Richard Posner

Yeah, I love these academic pontifications about how losing your house, job, business, savings, investments, healthcare and dignity are 'good'.

Hey, MF! I got a great idea. You lose everything you've worked a lifetime for and -then- tell us how it's 'good' for the economy.

Screw the elite! Time for a revolution.

Torak

LOL. So If I refuse to pay my vendors, and the go out of business I am "effective" ?

You perverted loyalist. You define "ineffective businesses" as business whom are low on the plutocratic food chain.

It is an artificial economy. Money is evidence of everything but "effectiveness".

I pray that you and your kind are cast into the Fire. a pleasing aroma unto the lord !

misterb

If there is in fact a concentrating effect of a recession, then that would imply that income inequality will also increase. Now, we see why those who favor the rich are in favor of letting the recession "cleanse" the economy. They know that the already rich will get richer, while those who were just starting to emerge into higher levels of income will fall back into poverty,

Bobby G

In a truly free market, what Mr. Hammermesh is saying is valid... if there were plenty of consumer and even supplier transparency, no government intervention beyond fixing a market failure (if any).

Torak (#12), if someone survives a recession by not paying their vendors, good luck having future vendors deal with you post-recession.

Will (#4), if a firm is raising up it's prices in a free market, why is the more efficient firm failing? That doesn't make sense. Perhaps the bigger firm has economy of scale benefits that allow it to have lower prices while maintaining margin, or perhaps they can price the same but have a more solid reputation which consumers value.

Richard (#11), I'm sorry for what happened to you but the cold calculating part of me is skeptical that none of the fault of what happened falls upon you yourself. Really? You think nothing? You invested your finances in all the right areas, financed your house properly, invested in your own personal capital most efficiently? Come on man.

On the actual article I bet it's more like what Brian (#9) said... the market and likely the company itself is not yet at equilibrium, probably due to risk aversion by the window cleaning management. They probably sustained not insubstantial losses during the recession and had to cut staff, and now that there is a temporary increase in demand they may not want to jump the gun on over-expanding again. Sure the window is open for competition but I wouldn't be surprised if the competition is equally apprehensive.

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Ghooper

There is almost no doubt that during economic recessions, many companies will be forced into liquidation due to the amount of money required by Creditors outweighs the revenue gained from Debtors. Simple economics I know.

Any business can go into liquidation, or out of business, based on this premise alone.

During a recession, there is a reduced need for many services (these are usually services or products we 'want' as opposed to 'need'.) On the other hand, there is a greater need for other services, for example debt collectors. Now, an poorly managed Debt Collection agency is likely to prosper during a recession, but a well managed and highly efficient clothing company may fail.

Within an industry type that services a 'want' industry e.g. window cleaner, will be more fierce than a 'need' industry e.g. divorce lawyers. Of course, within a 'want' industry companies that aren't able to best suit their clients will be hardest hit, and price is one of many factors along with quality and availability or some other Unique Selling Point.

Recessions should be seen as clearing companies that supply our wants, not our needs. And is that such a bad thing for the West to experience?

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Dumbagent

This is the same concept Schumpeter brings up when describing Creative Destruction in economies. The less profitable and less efficient companies die out, while the more nimble, efficient and entrepreneurial ones survive and then thrive.

data mining courses

This is an interesting concept. I feel that it is true, but would have to agree with the comment above that it is not always the best for everyone. While situations such as these may seem good in this way of cleansing, does not mean that it is good for the people and community.