Understanding Recessions

A recession is a significant, widespread, and prolonged downturn in economic activity. It’s an economic cycle that involves contraction of economic activities. It is a significant decline in economic activity spread across the market, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. The declines in economic output and employment that recessions cause can become self-perpetuating. For example, declining consumer demand can prompt companies to lay off staff, which affects consumer spending power, which can further weaken consumer demand. Similarly, the bear markets that often accompany recessions can reverse the wealth effect, suddenly making people less wealthy and further trimming consumption

What Causes Recessions?

Recessions are the results of imbalance in the market, triggered by external or internal factors. It often causes big declines in asset prices. Market imbalances that cause recessions can be triggered by geopolitics, economic cycles, and many other forces. The financial sector is always involved. Most economic theories attempt to explain why and how an economy goes into recession. Some economists focus on economic changes, including structural shifts in industries, as most important. For example, a sharp, sustained surge in oil prices can raise costs across the economy, leading to recession. Some theories say financial factors cause recessions. These theories focus on credit growth and the accumulation of financial risks during good economic times, the contraction of credit and money supply when recession starts, or both. Monetarism, which says recessions are caused by insufficient growth in money supply, is a good example of this type of theory. Other theories focus on psychological factors, such as over-exuberance during economic booms and deep pessimism during downturns to explain why recessions occur and persist.

How Companies respond to recession

In the 1990s, the Asian financial crisis was caused by an imbalance where too much money had been invested in factories. In the late 1980s and early 1990s, companies in Southeast Asia invested huge sums in building factories to make products for export. This created too much capacity; factories couldn’t fully utilize the new equipment. As a result, they couldn’t service their debt. When enough companies began having serious financial difficulties, it led to a recession.

Companies respond to recession in varying degrees of readiness and health:

• Some are poised to thrive. These businesses experience relatively steady demand for high-margin products, easily attract and retain talent, and have simple supply chains. From a financial perspective, they have strong balance sheets, low leverage, and lots of cash. These companies are the lucky few.
• Another category of companies is more susceptible to a slowing economy. These companies have more complicated supply chains, smaller market share due to new competitors, and thinner margins due to inflation. These companies can resolve to reform.
• Other companies are in worse shape and will fight to survive recession. These companies have balance sheets loaded with debt, low cash reserves, and potentially high exposure to disruption.
• A fourth group is new companies that have thus far primarily focused on growth and market share rather than profitability. The challenge for these companies is to pivot to profit, as funding usually dries up in a recession.

Companies can respond by putting in place some key defensive elements, like cost cutting, price adjustment, cash preservation, and shoring up supply chains. Other measures such as

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