Indian Economy, 5th edition (31 page)

Business cycle

Introduction

The discussion on growth and development has shown their internal interdependence. If the quality of life in an economy is to be enhanced, there is a need of conscious public policy which can spend and invest in areas like food, nutrition, health, education, shelter, social security, etc. But for such expenditures and investments, the economy needs equitable level of income, too! The income enhancement in any economy takes place via increasing the level of production in the economy i.e. real gross national product (GNP). It means, development requires higher growth i.e. higher levels of economic activities. With the help of suitable kind of economic policies, the government of an economy keeps trying to maintain a higher level of economic activity. But, at times, economy keeps failing in this objective. And, thus economies fluctuate between the best and the worst levels of economic activities which is known in economics as
boom
and
depression
, respectively. They can be called different phases of the economic activities of the economies. In between boom and depression, there might be many other situations of the economic activities, such as—
stagnation
,
slowdown
,
recession
and
recovery
. The fluctuations in the level of economic activity between the depressions and booms has been called by the economists as
business cycle
or
trade cycle
with recession and recovery as the main intermediate stages
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. Stagnation
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and slowdown may be considered as other intermediate stages of the business cycle. We intend here to understand the actual meanings of each of the stages. The economists have pointed out that the business cycle is characterised by
four
phases or
stages
in which economies alternate:

i.
Depression

ii.
Recovery

iii.
Boom

iv.
Recession

Depression

Though depression has visited the world economy only once in 1929, economists have pin-pointed enough number of traits to recognise it. The
major
traits of depression could be as given below:

(a)
an extremely low aggregate demand in the economy causes activities to decelerate;

(b)
the inflation being comparatively lower;

(c)
the employment avenues start shrinking forcing unemployment rate to grow fast;

(d)
to keep the business going, production houses go for
forced labour-cuts
or
retrenchment
(
to cut down the production cost and be competitive in the market
) etc.

The economic situations become so chaotic in the phase of depression that the governments have almost no control over the economy. The Great Depression of 1929
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gave rise to the ideas of
strong government intervention
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in the economy, such as deficit financing, monetary management, etc.

What the governments may do if depression visits the economy? The simple answer the world has been able to find is to repeat the policy measures of 1929! The best way to avoid depression is not to let it visit. This is why every modern economy keeps extra-vigil on the major symptoms of its economy so that the prevention-measures can be taken in time and depression is avoided.

Recovery

An economy tries to come out of low production phase to survive. The low production phase might be depression, recession or slowdown with the former being the worst and rare, governments take many new fiscal and monetary measures to boost demand and production and ultimately a recovery in an economy is managed. The business cycle of recovery may show the following
major
economy traits:

(a)
an upturn in aggregate (total) demand which has to be accompanied by increase in the level of production;

(b)
production process expands and new investments become fattractive;

(c)
as demand goes upward, inflation also moves upward making borrowing cheaper for investors;

(d)
with an upturn in production, new employment avenues are created and unemployment rate starts declining; etc.

With the above symptoms, people’s income go for a certain increase which creates new demand and a cycle of demand and production (supply) starts playing hand-in-hand to recover the economy. To recover an economy, governments usually go for tax-breaks, interest cuts, an increase in salaries of its employees, etc. Assimilation of innovations by the entrepreneurs and search for new frontiers of enterprise do play a very vital role in the process of recovery provided these activities are at first incentives by the governments.

The Euro-American economies recovered out of the Great Depression with the help of the measures cited above. Such recoveries have been seen many times around the world when economies recovered from slowdown or the recessionary phases. The best example of the recent times could be cited from India of 1997 to 2002 when the economy suffered severe bouts of slowdown and recession.
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Boom

A strong upward fluctuation in the economic activities is called boom.
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As economies try to recover out of the phases of slowdown, recession and depression at times the measures taken by the governments as well as the private sector might put the economic activities as such which the economic systems fail to digest. This is the phase of the
boom.
The
major
economic traits of boom may be listed as given below:

(a)
an accelerated and prolonged increase in the demand;

(b)
demand peaks up to such a high level that it exceeds sustainable output/production levels;

(c)
the economy heats up and a demand-supply lag is visible;

(d)
the market forces mismatch (
i.e. demand and supply disequilibirium
) and tend to create a situation where inflation start going upward;

(e)
the economy might face structural problems like shortage of investible capital, lower savings, falling standard of living, creation of a sellers’ market.

The phase of recovery is considered good for the economy and it reaches the stage of boom which is considered better. But the boom has its negative side also. Boom is usually followed by price rise.
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As a boom is a strong upward fluctuation in an economy, the supply-side pattern of the economy starts lagging behind the pace of the accelerated aggregate demand.
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But the dilemma of recovery puts every economy on the path to boom—this has been the experience in the developed world during the 1990s, especially in the US economy. The same scenario developed in India after the economy recovered from the recessionary period of 1996–97 by the year 2002–03 when the rate of inflation peaked to almost 8 per cent for a few months. Majority of the experts felt that Indian economy at that time was passing through a phase of boom and we have seen how the government has been facing difficulty in containing the inflation around the 5 per cent mark. Even the Government accepted that the economy was over-heating by mid-2007.
The symptoms of overheating are as follows:
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(a)
There is a downturn in the aggregate demand on overall fall in the demand;

(b)
as demand falls, the level of production (output) in the economy also falls;

(c)
as producers cut down their production levels, new employment opportunities are not created—thus employment growth rate falls;

(d)
as demand keeps on falling, usually producers start cutting down their labour force to adjust their overhead expenditure and the cost of production (labour-cut is not ‘forced’ here but, ‘voluntary’)—resulting in increase in the unemployment rate;

(e)
if the government fails to rescue the economy from the phase of recession, the dangerous stage of
depression
remains the logical follow up;

(f)
the rate of inflation always remains at lower levels—discouraging new investments and lending.

RECESSION

This is somewhat similar to the phase of ‘depression’ – we may call it a
mild form
of depression – fatal for economies as this may lead to depression if not handled with care and in time. The financial crises which followed the US ‘sub-prime crisis’ in almost the whole Euro-American economies has basically brought in a’severe recessionary’ trends there. Major traits of recession, to a great extent, are similar to that of ‘depression’ [except the point (d) of the Depression, discussed earlier] – may be summed up as follows –

(a)
there is a general fall in demand as economic activities takes a downturn;

(b)
inflation remains lower or/and shows further signs of falling down;

(c)
emloyment rate falls/unemployment rate grows;

(d)
Industries resort to ‘price cuts’ to sustain their business.

In the financial year 1996–97, the Indian economy was taken up by the cycle of recession—basically due to a general downturn in domestic as well as foreign demands, initiated by the South East Asian Currency Crisis of mid-1990s.
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The whole plan of economic reforms in India was derailed and it was only by the end of 2001–02 that the economy was able to recover. What may a government do to rescue the economy from the phase of recession? The usual remedies are given below:

(i)
Direct and indirect taxes should be cut down, so that the consumers have higher disposable incomes (income after paying direct tax i.e. income tax) on the one hand and the goods should become cheaper on the other hand thus there is hope that the demand might pick up.

(ii)
The burden of direct tax, specially the income tax, divdend tax, interest tax are slashed to enhance the disposable income (
i.e income after direct tax payment
)—

(iii)
Salaries and wages should be revised by the government to encourage general spending by the consumers (as the Government of India implemented the recommendations of the fifth pay commission without much deliberation in 1996–97).

(iv)
Indirect taxes such as custom duty, excise duty (cenvat), sales tax, etc. should be cut down so that produced goods reach the market at cheaper prices.

(v)
The government usually goes on to follow a cheap money supply policy by slashing down the interest rates across the board and the lending procedure is also liberalised.

(vi)
Tax breaks are announced for new investments in the productive areas. etc.

All the above-given measures were taken up by the United Front Government in 1996–97 to pull the economy out of the menace of recession.
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The forthcoming Government took several other such measures by the end of 1998–99 onwards (the NDA Government). Ultimately, the measures taken up by the Governments acompanied by a general recovery in the world economy, the Indian economy started recovering recovery from the bout of recession. Many experts had already predicted a possibility of depression with a zero per cent rate of inflation.
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Although this did not happen
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.

GROWTH RECESSION

An expression coined by economists to describe an economy that is growing at such a slow pace that more jobs are being lost than are being added. The lack of job creation makes it “feel” as if the economy is in a recession, even though the economy is still advancing. Many economists believe that between 2002 and 2003, the United States’ economy was in a growth recession. In fact, at several points over the past 25 years the U.S. economy is said to have experienced a growth recession. That is, in spite of gains in real GDP, job growth was either non-existent or was being destroyed at a faster rate than new jobs were being added.

Experts have revived this term in the wake of ongoing financial cises in the Euro-American economies since 2010. The situation is better described by the term
‘double-dip recession’.

Conclusion

Business cycles are basically fluctuations in the production levels of economies above and below the trend of the equilibirium levels.
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But why do economies fluctuate? There are many factors which are said to be responsible for it, as per the experts:

(i)
Economic instability and uncertainty (due to logical or illogical expectations) may discourage investments thereby reducing growth in the long-term.

(ii)
A lack of the creative destruction (i.e. innovation) may put the economy in a slump or slowdown in its overall production.

(iii)
Anti-inflationary government policies (specially when general elections are nearing ) may direct the attraction of investors in the economy.