• Home
  • Knowledge base
  • Useful Forms
  • FAQ
Updated at 2018/07/12

The popular sentiment of financial analysts and many economists is that recessions are the inevitable result of the business cycle in a capitalist economy. The empirical evidence, at least on the surface, appears to strongly back up this theory. Recessions are highly frequent in modern economies and, more specifically, they seem to follow periods of strong growth. Unfortunately, empirical consistency can never prove inevitability. The only way to logically prove the inevitability of a business cycle outcome is through logic and reasoning, not historical evidence.

Consider the following scenario: a six-sided die is rolled 24 times, never landing on the number four. Assuming away statistical probabilities, the empirical evidence would suggest it is not possible to end on the number four. Logically, though, there is nothing preventing the 25th roll from landing on four. That possible outcome is consistent with everything known about a six-sided die. In the same way, it does not make sense to say recessions are inevitable only because history is filled with previous recessions.

Understanding Recessions

"Recession" is the title given to a an economic period marked by negative real growth, declining output, depressed prices and rising unemployment. These periods result from an unusual, simultaneous and large grouping of business errors, or malinvestments. Faced with financial loss and declining margins, businesses scale back production and reallocate resources from less valuable ends to toward more valuable ends.

Oftentimes, the malinvestments create an atmosphere of unhealthy speculation in the market. Overvalued assets attract more investors who are chasing unsustainable gains. Many assert that the tendency to speculate on unsustainable investments is the primary driving force behind recessions. They suggest these speculators are a necessary part of the capitalist market and, consequently, periodic recessions are inevitable. As John Maynard Keynes suggested, "human nature requires quick results, there is particular zest in making money quickly."

Logically, though, there are missing components to this explanation. What creates the initial malinvestment? Why do so many previously smart and successful entrepreneurs fall into the trap? And why are there periods of strong asset or sector growth that do not cause speculative bubbles?

Economics and Inevitability

There are very few certainties or axiomatic truths in economics. Economists assert that human beings interact with scarce resources to pursue purposeful ends. Economics can show that no voluntary trade takes place without both parties receiving an increase in value, subjective value, at least in the ex ante sense. Economics can even show that price controls lead to relative shortages or surpluses. However, economic logic does not show the inevitable result of aggregated individual trades leads to periods of declining real output.

Another way to look at this problem is to ask another question: "Is it possible to achieve eternal economic growth?" Conceptually, yes. It is possible, though unlikely, that technological or operational innovations occur at a rate consistent with continuous growth. It is also conceptually possible that economic actors consistently make correct entrepreneurial judgments, allocate resources effectively and maintain a level of constant or ever-increasing productivity. If it is conceptually possible to achieve permanent rates of growth, then it cannot be, by definition, inevitable for economic recessions to occur.

Did You Find it Helpful?
Related Articles