The downsides of an economic boom

Contando_Dinheiro_(8228640)Despite the inevitability of the economic cycle under capitalism, a great deal of time is spent by policy-makers attempting to prolong the boom and prevent or mitigate the recession. In recent history, some of them have avoided a repeat of the Great Depression of the 1930s, but the recovery has been at best sluggish and economies in the Eurozone have done especially badly, in some cases worse than during the 30s.

I have written before of the potentially ‘good’ aspects of recessions, but what of the boom? In general the latter tends to produce falling unemployment and rising wages and profits for workers and firms respectively. However, booms can often lead to an economy operating above its trend rate of growth (the long run average). While this will create jobs, if full employment is reached, then unless productivity rises at the same rate as output, this can generate inflation which while good for borrowers, is bad for lenders and savers, all else being equal, as it erodes the real value of their wealth. At high levels, inflation can also seriously disrupt the price mechanism, making it harder to achieve economic efficiency.

If a particular economy grows faster than its trading partners for a period, it may tend to import goods and services from the latter at a greater rate than those it exports in return. This can lead to a deficit on the current account of the balance of payments and requires borrowing from abroad to fund it. This can in turn force up interest rates if investors eventually find some reason to lose confidence in the faster growing economy. Higher rates will tend to reduce investment and growth, and lead to a deterioration in performance and possibly a recession.

Thus a boom often generates economic imbalances that need resolving and recession is one way that this can happen. Unemployment usually rises while inflation and wages ease, and the balance of payments should improve, although this also depends on the behaviour of the exchange rate. Of course it will be a matter of opinion and experience whether these economic outcomes are ‘good’ or ‘bad’, especially for particular individuals, households or firms, and making such a judgement for the economy as a whole may be a little pointless. Marx argued that a crisis (recession) was a way for the economy to resolve the contradictions created by a period of growth, and renew itself ready for a new upswing. The value of investment goods (eg machines) and workers would often fall, and at some point investment in new production would become profitable once more. Keynes favoured state action to mitigate the recession, seeing wage falls as reducing demand and making the recession worse. Which of these two great thinkers was right remains controversial.

An economic boom, as already mentioned, will tend to raise wages, and from there consumption. For those who do particularly well, consumption can create a culture of ‘excess’, seen from a moral point of view. Some may see this as bad and that when the subsequent bust brings this behaviour to an end, some sort of justice has been reaped. All this is highly subjective. Taking a longer term view of such cycles of behaviour may be more fruitful, and taking into account any learning and behavioural change that results from this may put a more positive spin on things.

Booms can lead to a great degree of speculation, as investors try to make money out of price fluctuations. Related to this is the possibility of business fraud, as opportunities for money-making proliferate. The Enron scandal in the US in the early 2000s is a good example.

If rapid growth degrades the environment, leads to high pollution levels, and consumes resources to the detriment of future generations, it will ultimately prove unsustainable. The cost imposed on the latter by such outcomes can be high and represents a form of inter-generational injustice. This can certainly be seen as morally wrong, but again taking into account the impact over a longer time horizon can alter such judgements.

Finally a boom can change the fortunes of governments and political parties. Incumbents can try to take some credit for it, claiming it as a result of their economic policies. If the timing is right, it can help them win re-election. If a boom has been going on for some time, with the same government at the helm, voters might consider other priorities to have risen in importance, such as social justice, the environment etc. In this case, they might vote in the opposition party, if this is not perceived to be too risky.

Thus a boom, a period of rapid economic growth, is not an unalloyed positive for individuals, households, firms or whole economies. It necessarily has good and bad aspects, depending on where the impacts are felt. A more balanced view would see different periods in the economic cycle as a mixed bag of evolving contradictions, generating both upsides and downsides in the economic, social, political and environmental spheres.

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