The R-Word and the Future of the Economy

This is a guest post by Sean D. Jasso, PhD, practitioner faculty of economics.

The entrepreneur always searches for change, responds to it, and exploits it as an opportunity.
~ Peter F. Drucker

Abraham Park, PhD The big question on the minds of most people is: What is the future of the economy?

The answer is not always found in the news—today’s journalism is often polarized, biased, or not focused on reporting the story, but rather on enhancing a perspective of the story for the benefit of a targeted audience. For example, for several months economists, journalists, and politicians alike have hesitated on how to characterize the state of the economy.

These so-called experts are afraid of saying the r-word, most often associated with recession, or, correctly defined, a contracting economy. Any astute observer can see that the economy is contracting in certain industries while also growing in many others. This ebb and flow is nothing new and since World War II, to use as a benchmark for the modern economy, every decade has experienced the natural phenomenon of growth and decline.

This article’s central objective is to elaborate on the issue of the apparent economic slowdown while providing insight on how history and theory help minimize the confusion. The answer to the big question is not simply recession, but rather, another r-word—resilience. After all, the American economy, and the world economy for that matter, is positioned better than ever to manage the natural cycles of the marketplace. To expand on this complex and imminent question of the economy and its future, let us reflect on the economy’s most enduring characteristics: capitalism, entrepreneurship, and ethics.

On Capitalism

It is appropriate and perhaps timely to identify the ‘economy’ as the world economy. No product, service, or its production is independent of worldwide commerce. This global dependence on economic progress is best defined by the concept of capitalism, a term often misunderstood and poorly defined.

Capitalism refers to how society owns, manages, and allocates resources for production. In the United States and much of the Western world, this allocation is driven by the private ownership of production. Capitalism is also rightly associated with a free marketplace where individual citizens are capable of joining the economy through their own will and where their hard work, creativity, and their competitiveness can yield wealth.

The only way for markets to provide incentives for pursuing wealth is if the rule of law supports capitalism and, most importantly, if the residual of wealth is both protected and has growing value among business, government, and society. These characteristics are most closely aligned with political economies where democracy is well-rooted, the ownership society is the norm, prices are always competitive, and slowing economies are arenas where entrepreneurs thrive.

Recalling that the rule of law plays a significant role in protecting fair play within markets, most well regulated marketplaces, including those on the global scale, have zero tolerance for price manipulations outside of the natural market forces of supply and demand.

Consequently, when we re-examine the big question of the future of the economy, capitalism alone can console the stakeholder. The market only seeks growth through prices that it can bear and through products that provide value.

To address this issue, the definition of capitalism requires one additional clarification. Markets are attributed to cycles of expansion and contraction, that is, growth and decline. These business cycles are natural forces in a capitalist economy. Indeed, most people see their wealth increase in times of growth, which is attributed to increasing demand for all aspects of capital, including knowledge, resources, land, labor, and, most importantly, entrepreneurship.

The recent housing boom is a good example of an industry that has experienced growth and decline. The entrepreneurial construction contractor with specialized skills and access to capital naturally responded to the surge in demand for housing production. Most individuals and firms associated with the booming housing industry from the construction laborer, to the mortgage lender, to the realtor, to the home furnishings supplier, to the common investor and homeowner benefited from this cycle of demand—money was made at all levels.

However, booming economies naturally reach a pinnacle where timing, asset allocation, debt management, competition, as well as public policy, play a critical role in managing what for many has been an economic crisis. Just as money was made for many, many have now lost money and assets. We have seen this economic behavior before—just ten years ago—with the growth and decline of the dot com phenomenon. Again, money was made at many levels—and for some, money was lost. As history attests, experienced and growing capitalistic economies expand—often with global reach—and, they also decline. It is in this period of decline that behavior changes and, I would argue, matures at all levels.

Prices adjust accordingly, financial markets re-evaluate their product offerings, consumers balance their short- and long-term priorities, businesses streamline their costs and compete more effectively, and government evaluates policy solutions. This concert of reactive behavior is natural, and yes, often challenging. What history also confirms is that slowing economies fortify innovation from business, government, and society. That is, when prosperity at all levels show signs of decline, the entrepreneur in all of us looks to the marketplace and says, “I’ve got an idea!”

On Entrepreneurship

It is the entrepreneur who recognizes society’s demand for progress in any given industry, who takes the leap forward, driven by vision, fueled by risk, most often with his or her own capital, and meets the challenge by producing a new gadget, resource, or idea. Markets thrive on entrepreneurs who, in the end, keep our lives filled with a sense of newness—or, simply, progress, opportunity, and innovation.

The theory of creative destruction helps explain why capitalism can meet the challenge of economic slowdowns. Attributed to Joseph Schumpeter, one our most important modern economic philosophers, creative destruction explains that the market economy (industries, firms, and households) will incessantly revitalize itself by scrapping old and failing business models and reallocating resources to become more efficient, and in essence, more productive.

Entrepreneurs are the driving force behind this creative destruction. Industries have grown and sustained their economic strength throughout the decades because of entrepreneurship and successful management, and not because of clever policies or economic speculation.

Indeed, there is evidence that the economy is slowing down, or in the case of the business cycle, is contracting. However, this phenomenon isn’t new. While growth does yield prosperity, for this benefit, there is a cost. This cost to society is most notable in the form of complacency of risk management. Essentially, we become content with the status quo.

While the status quo might have enriched our lives with wealth, progress, and efficiencies, this cycle naturally requires a correction. The growth economy, as it always has, naturally, must cool off. For example, we see markets for labor and resources adjust their prices, public policy respond with tax incentives and rebates, and firms and industries reevaluate their overall management effectiveness.

The news seems to enjoy a good slowdown story—instilling uncertainty is good for ratings. What the news doesn’t report, primarily because it happens in the minds of the capitalist, is that the entrepreneur in us all takes a clue from the economy and says, “get busy” with creative destruction. Retooling becomes imperative at all levels—individual, household, firm, industry, and nation. Creative destruction forces all aspects of the economic engine to reevaluate the sophistication and efficiencies of its productive resources—from how individuals and firms use debt, to how much education is needed to compete, to moving assets from one part of the world to another.

It is at this point of reckoning with our economic position, that capitalist economies, led by millions of entrepreneurs, begin the cycle, which is often attributed to a new era.

So, what will the second decade of the 21st Century look like? Ask the entrepreneurs.

On Ethics

Every decade since World War II has experienced the natural economic cycles of growth and contraction, although some more intense than others. Nevertheless, one trend that remains constant is that the economy and its stakeholders become better at managing risk.

We see this trend in how stock markets across the world operate more efficiently and robustly than ever before. Banks, the backbone of economic well being, are constantly innovating the circular flow of money to become more plentiful to the masses. Central banks such as the U.S. Federal Reserve and the European Central Bank more closely follow economic trends and respond decisively with monetary policy aimed at keeping the flow and cost of money at efficient and affordable rates. And of course, businesses, both small and large, continue to do what they always have done—seek profits by providing society with what it wants at the highest value and at the lowest cost.

This broad scope of actors encompasses the marketplace where entrepreneurs, managers, employees, consumers, and investors are all interconnected with one common goal—prosperity. To accomplish this important shared objective, the market requires one additional ingredient: good behavior among its players. History and theory tell us that ethics is paramount to the success of capitalist economies.

Markets prosper when the rule of law maintains its strength, codes of conduct have integrity, and capital in all aspects is protected. What this means is that markets that naturally grow, decline, and grow again do so because strangers and associates trust each other, information necessary for market decisions is transparent, and exchange results in repeat business. During the period of creative destruction, market participants will also reevaluate the condition of the morality of the marketplace.

The recent implementation of the Sarbanes Oxley Act of 2002 (SOX) is an excellent example of the federal response to corporate bad behavior. According to leading executives, SOX, though costly, has strengthened management efficiencies. Boards and CEOs have brought ethics to the forefront of their strategies and corporate cultures, yes by law, but, moreover, because good behavior is good for business. As the future endures and creates change, ethics, perhaps unlike any time in history, will be part of the dialogue of new growth.

The R-Word and The Age of Resilience

The original question presented was: What is the future of the economy? No economist can predict with precision what the future holds.

What is predictable, however, is that:

Capitalism will provide the arena for competition to flourish,
The entrepreneur will provide the marketplace with innovations, and
Ethics at all levels of business, government, and society will strengthen the integrity of the economy.

What is also predictable is that economies have natural cycles of growth and decline followed by eras of creative destruction. As we examine the world marketplace around us, pay close attention to the natural phenomenon of change and the forthcoming infusion of innovation on the horizon.

So, the answer to the economic future:

Yes, an r-word is appropriate, but not the one on the tips of everyone’s tongues. History and theory affirm that resilience best characterizes the capitalist economy of yesterday as well as the economy of tomorrow.