Switzerland and Germany experienced seven economic slumps in the post-war period. Nevertheless, the prosperity of the population has increased massively since 1948. Why are we so afraid of recessions?
The costs of recessions are smaller than people often realize.
The R word is going around again. People are worried about an impending recession. This shows, for example, «Dr. Google»: In Switzerland as well as in many EU countries, the search term recession has been increasingly entered into the search engine in recent weeks.
However, the fears of the population contrast with another observation: the importance of recessions is overestimated. It is true that economic slumps attract the attention of citizens, politicians and the media. But something else is much more important for people’s prosperity, namely long-term economic growth.
Prosperity increases despite recessions
The example of Switzerland shows this. The country has experienced seven recessions since 1948, meaning phases in which economic output has contracted for at least two quarters. The first major slump of the post-war period occurred during the 1975/76 oil crisis. Marked recessions also followed from 1991 to 1993, during the financial crisis of 2008/09 and the Corona crisis in 2020 (see chart).
Despite these recessions, economic power in Switzerland has increased massively. Real gross domestic product (GDP) increased around sixfold between 1948 and 2021. The value of the goods and services produced in the country rose from CHF 125 billion to CHF 731 billion. These figures are inflation-adjusted values - so the depreciation of the currency during this period has been taken into account.
A similar picture emerges for real GDP per capita. This measure is closer to people’s prosperity because it reflects the economic power generated per inhabitant. This is important because around twice as many people live in Switzerland today as in the post-war period. Calculated per capita, the economic power has roughly tripled between 1948 and 2021 – to currently around 84,000 francs. So prosperity has increased significantly, although there have been repeated recessions.
It is not much different in Germany. Real economic output there has also multiplied despite numerous recessions.
Limited cost of economic downturns
Why is the population still afraid of economic slumps? This question has also occupied science for a long time. The analysis by Nobel laureate in economics Robert Lucas is famous, which was stated in the 1980sthat recessions hardly hurt the average American at all. They are only negligible fluctuations around a long-term growth path.
This provocative finding triggered a lively research activity. Scientists have been trying to find out how great the “welfare costs” of recessions actually are. The consensus today is that economic downturns have cost significantly more than Lucas claimed. But its consequences are indeed manageable.
“The costs of recessions are lower than is often perceived by the public,” says Reto Föllmi, Professor of Economics at the University of St. Gallen. “According to research, economic downturns only reduce overall prosperity by a few percentage points.” This is also due to the fact that central banks and politicians would usually intervene to stabilize anyway, so that recessions do not turn out to be too deep.
Unemployed most affected
Nevertheless, the public is not completely wrong in their fear of recession. In times of economic contraction there are losers. Economic slumps usually become tangible for people when they themselves or acquaintances become unemployed.
According to the research, the rising unemployment the number one reason recessions have welfare costs. With the loss of work, the income of those affected decreases. You can afford less. In addition, life satisfaction often decreases.
Potential long-term consequences
There is also an effect that researchers call “scarring”. When people are unemployed for a long time, their education and work experience lose value. Those affected may then have to accept lower-paying jobs. Your income will be reduced in the long term.
Scarring effects of this kind have been documented for the USA, for example. In Switzerland, on the other hand, they are likely to be less relevant because there have been no major problems with long-term unemployment and social decline in this country in recent decades.
In addition to the cost of unemployment, recessions have other negative consequences. For example, school graduates who enter the labor market during an economic downturn have worse career prospects than graduates who enter the workforce during a boom. As the research literature has shown, even after many years, a bad start is not yet caught up in terms of income.
Important process of renewal
However, recessions do not only result in costs. It is often hidden that they also have positive sides. Crises are phases of accelerated structural change. Economic exaggerations of the past are corrected. Companies with outdated business models are leaving the market and are being replaced by companies with better future prospects.
This cleansing effect – also known as creative destruction – may be painful in the short run, but in the long run it puts an economy on a higher growth path. Capital and labor migrate to those sectors of the economy that promise more prosperity. The system renews itself from within.
Politicians should rely on automatic stabilizers
This leads to the question of how economic policy should deal with recessions. In economics, it is undisputed that central banks and governments should ensure a certain degree of stabilization. The Cost of Recessions would be greater if nothing were done about them.
“Fiscal policy should primarily allow the automatic stabilizers to take effect,” says economics professor Föllmi. This refers to shock absorbers that support the economy without any special effort from governments and parliaments. Unemployment insurance, for example, automatically stabilizes the income of people who lose their job – and thus also aggregate consumption. The state’s tax revenues are also reduced during the crisis, leaving households and companies with more money.
On the other hand, specially designed economic programs have a dubious reputation. “They usually come too late and only take effect when the economy is starting to grow again anyway,” explains Föllmi.
Create good framework conditions for growth
Economic stimulus packages also have their pitfalls from the point of view of the citizens. Politicians like to put them on to show in crises that they are “doing something”. But when the economy is booming, many politicians no longer want anything to do with reducing the government debt that has arisen. This creates a tendency towards increasing national debt – unless effective debt brakes counteract this.
Overall, it seems misguided that politicians focus so heavily on economic slumps. Recessions aren’t as bad as they’re made out to be. Something else is decisive for the prosperity of the population, namely long-term economic growth. Politicians should therefore focus more on creating the best possible framework conditions for economic prosperity.