Economics is called the dismal science because it acknowledges that we live in a world of limited resources. This implies that we have to make trade-offs — if we want to consume more of A, we must give up some of B; we simply can’t have it all. Monetary and fiscal policy regarding short-term economic growth is similar in nature. We may make policy choices that will spur on growth in the short run — but this necessarily comes at a cost to future growth.
This is the trade-off the current administration and the Federal Reserve accepted when they opted to extend quantitative easing and maintain the tax cuts put into place over the past eight years. Given that the economy is finally starting to pull out of the doldrums, these policies are sure to keep the recovery moving ahead at a solid pace for at least the next two years.
While the recovery remained lackluster in the third and fourth quarters of 2010 with GDP growth coming in at around 2 percent, we should, however, start to see the economy begin to re-accelerate in 2011. Consumer spending this spring is expected to continue its holiday-spending momentum, as long as the increases in employment that are expected actually come into fruition. Housing should start to respond to record-low rates and exports and equipment spending are expected to remain strong. On net, real GDP is forecast to rise to around 2.5 percent in the first quarter and move back into the 3 percent range in the second quarter. As I have said more than once at recent green industry meetings, this will be a slow recovery but hopefully a smarter recovery this time around.
After the last two big recessions in the mid 1970s and early 1980s, the economy grew at close to 6 percent in the aftermath. This time around the nation has averaged less than half that rate. As a result, the unemployment rate, which is typically falling by this point in a recovery, has remained stuck near 10 percent. The sources of the weakness are primarily consumer spending and housing. This shouldn’t be a surprise since both sectors of the economy had swollen to unsustainable peaks in the bubble that preceded the crash. Regardless, the country wants growth, and it wants it now.
I can’t tell you how many folks have been asking me, “When will the next recession hit us?” But that’s not really the best question because no one knows the answer, at least in absolute terms. I would prefer folks ask me something I can help them with. I’m not just being flippant here. After all, the economics profession doesn’t necessarily have a very good track record at forecasting recessions ahead of time. Don’t get me wrong. There are some forecasters claiming to have predicted the recession. All the ones I’ve heard of, though, were predicting recession every year, good or bad, for decades. They are like the broken clock that’s right twice a day. Even doom-and-gloom economists are right once a business cycle.
So what’s the better question? How about this — “What should I do if I’m running a company and I don’t know when the next recession is coming?” Now there’s a question I can help with. The answer, of course, can be summarized by the old adage — proper prior preparation prevents poor performance. Being properly prepared will prevent owners from becoming too risk averse; a problem I see all too often in the wake of a recession. But it will also prevent managerial myopia, which is what got us into the last recession in the first place. But what does this proper preparation look like?
You first move should be to evaluate your vulnerability to a future recession. Looking at how the recent recession affected you will give you a good indication. The key, though, is to be data-driven. Before the recession, I heard plenty of folks say that their business would do better in a downturn. That didn’t exactly pan out though. I guess we really did find that even though our industry is recession resistant, we’re not recession proof.
After evaluating your own vulnerability to recession, it’s time to develop your customized early warning system. Identify the spending decisions that lead to sales. I also suggest that you monitor the economic factors that drive those purchasing decisions. So if you are dependent on discretionary consumer spending, for example, watch disposable consumer income, consumer confidence and so forth. For many businesses, an important part of the early warning system is watching sales representatives’ reports. If your sales reps are doing a good job of logging potential sales, interest, meetings, and proposals, you should be able to see a downturn coming even before your sales fall off.
So now you have evaluated your own vulnerability to recession and you have developed an early warning system. It’s time for contingency planning. Start with a single sheet of paper. You don’t want to fill a binder, you only want key ideas. Brainstorm on what actions you will take if sales turn down. By visualizing your possible actions, you prepare yourself. It’s even good to set some decision rules. If sales drop by 8 percent from a year ago, we institute a hiring freeze. If sales drop 15 percent, we’ll lay off 10 employees. You get the idea.
You’re almost done. You have evaluated your vulnerability to recession, set up an early warning system and sketched out a contingency plan. Now, manage the business to maintain the flexibility to take action as needed. Think about this with respect to employees versus contractors, real estate leases, debt versus equity capital, and long-term supply agreements. My point is that long-term business decisions may reduce a firm’s flexibility in responding strategically when opportunities arise.
In summary, get ready for the next recession by following these four steps: (1) assess your vulnerability to recession, (2) set up an early warning system, (3) sketch out a contingency plan, and (4) maintain your flexibility to implement the plan. These steps, while they seem simple, if they are followed diligently, will pay off big-time dividends in the long run.