Why the Recession is Irrelevant

Political leaders in France, Germany and Japan are claiming that their countries are now out of recession.  While this may be a comforting thought, what does it really mean for businesses and employees?

Apart from the joyous exception of England beating the Australians at cricket, everything seems to be returning to normal – the banks are reporting enormous profits, house prices are rising and politicians are telling us that it was their policies that have saved us from a fate worse than death.

The problem I have is that I am struggling to see the so-called “green shoots of recovery” and, more to the point, I cannot see why they should exist anyway?

However, before you read on I should point out that I do not have any privileged insight into the workings of the economy – I am not an economist, a member of the Monetary Policy Committee or a senior politician, I’m just a person who has seen several of his friends get made redundant in the last few weeks due to their employers scaling back their businesses.

Before deciding whether the recession is over or not, think back to what caused it in the first place.

We were initially told that it was all due to “sub-prime lending” in the US.  It then transpired that the problem was not confined to the US – banks in the UK, Iceland and many other parts of the world had all been lending money to people who couldn’t repay their loans. In fact, levels of personal credit have been steadily rising ever since records began in 1993.  Since the growth in debt has exceeded the rate of inflation, our ability to repay that debt has been in continual decline since then also.

The painful truth therefore is that far too many of us have been living beyond our means.

So when people ask me if I think that the recession is over I answer “no”. It may be that government interventions has alleviated the worst of the problems, but the real issue is that millions of people are going to have to reduce their personal debt levels and spend less.  That in turn means that businesses will have to cut back, unemployment will rise and the bad times will persist until average household debt stabilises at a more manageable level. Technically, the economy may be emerging from recession, but that doesn’t mean that we are all going to start being better off.

So why is it that I am suggesting that the recession is irrelevant?

The reason is that the role of businesses and the role of business leaders remains unchanged – their job always was to minimise costs, maximise income and achieve the highest standards of both customer and employee satisfaction.

I mentioned this while speaking at a gathering of business leaders a few weeks ago.  While they agreed with the sentiment, they argued that the effect of recession was to change the relative priority of the four items. Their point was that in a recession the financial goals of cost and income take higher priority and driving up income is vastly more difficult and more long-term than cutting costs.

My response was that the only reason the recession has changed priorities was because they had not thought to plan for that eventuality when times were good.

For example, a friend of mine runs a successful business in the retail sector.  During the last 20 years he has grown it from nothing to a point where it provides him with a comfortable life-style.  However, at the end of each month he generally has an overdraft of around £25k.  Given the turnover of the business this is not excessive, but I cannot understand why his business has an overdraft at all.  If during the last 4 years he had taken just £500 a month less out of the business (which would have been eminently affordable) the business would now have sufficient reserves to make an overdraft unnecessary.

Not only would this have increased his profitability by significantly reducing his banking costs, it would have meant that the near catastrophic crisis he recently faced when the bank announced that it was arbitrarily halving his overdraft limit would have been avoided.

The lessons to take from this recession are therefore as follows:

  1. When times are good build your reserves.  The future is never easy to predict, but history tells us that boom times never last indefinitely.
  2. Always base your strategy on minimising cost and maximising income, customer service and employee satisfaction.  It may be tempting to spend a bit more when you can afford it, but if that spending increases your ongoing costs you may have cause to regret it later.
  3. Never ignore the fact that debt reduces your profits and increases your risks.  Only ever borrow if you are certain that you could continue to finance the debt under the worst foreseeable circumstances and if you are prepared to be beholden to the financiers.

While these simple home truths may appear to be targeted at smaller businesses, in my experience it is the larger organisations that tend to be the worst offenders.

About the Author
Alistair Schofield is Managing Director of Extensor Limited.