Think back to December 1982 and imagine a business leader with 25 years of experience. That executive had managed through five recessions. Now fast forward to December 2007 and visualize the next generation business leader. In that person's 25 years of experience, he or she had managed through only two recessions--and those were two of the mildest recessions on record.
We economists call the period from 1983 through 2007 “The Great Moderation.” It was the calmest era in all American economic history. Certainly we had political change, technological change, social change. But in terms of business cycles, that was the calmest period in American economic history.
Our current crop of leaders in business, government and non-profits learned how to be a managers in this era. Reflect on that a moment: our current leadership learned how to run organizations during the calmest era in economic history.
What’s the outlook for economic cyclicality? I am expecting a much more cyclical period in the decade to come. Let’s consider the major causes that economists identified for the Great Moderation and look at the outlook for the coming years.
- Better technology, allowing those companies that carry inventory to avoid many of the large purchasing swings of past business cycles. This one is solidly in place, and we’ll make more improvements over time, but I think that the biggest gains are behind us.
- Better monetary policy: the Federal Reserve chose a low-inflation policy during the Great Moderation, which reduced our tendency to have periodic anti-inflation recessions. That’s true, but going forward we’re headed for a roller-coaster, or you might call it a cycle-coaster. The Fed has injected a huge stimulus into the financial system. At some point in the future, the Fed will have to reverse course. To avoid setting off another business cycle, they will have to reverse themselves at exactly the right time, and in exactly the right magnitude. I’m looking for greater instability, especially in the coming five years or so.
- Financial innovation. You may be surprised to hear that financial innovation was a calming influence on the economy. I’m not talking about credit default swaps and collateralized debt obligations. Instead, think back to 1990. The savings and loan industry was going bust, and they been originating most of the residential mortgages. How would the housing industry survive? Up jumped securitization, which saved the day. Looking to the future, if one significant channel of credit gets plugged up, we will not have financial innovation unplugging it, not with the new financial reform bill that nobody understands.
- Globalization allowed us to outsource some of our more volatile sectors. However, in the past few years we’ve been outsourcing some relatively stable activity, such as call centers. I’m not expecting much of a contribution from this factor going forward.
- Good luck. Yes, economists seriously wrote in academic journals, “Maybe we were just lucky.” In fact, they may have a point. What about the future? If you’re feeling lucky, don’t bet on a calm economy; go buy a lottery ticket.
Rolling all the factors together, I forecast a more cyclical economy in the coming decade. Maybe it won’t be as bad as the 1970s, but it will definitely be worse than during The Great Moderation. Let me emphasize that when I talk about more cycles, I don’t just mean more recessions. I think the booms will be boomier, and the busts will be bustier. On average, we’ll do about as well, but there will be less time between the boom phase and the bust phase.
Now, what can you do about it? I expect the major business associations will hold a conference in about 2020 to discuss what can be done about renewed cyclicality. Let’s talk about what to do today. Nobody reading this article can change the economy, so let’s talk about how to deal with renewed cyclicality.
As a first step, we should understand that our systems became optimized for the Great Moderation. No business leader called his staff together and said, “We’re in the calm era; let’s optimize for it.” No, here’s what happened. Business leaders who were bold and fearless gained market share over those who hunkered down in fear of the next recession. Political leaders who supported spending won votes over those who favored a large rainy day fund.
Now it’s time to re-optimize for renewed cyclicality. I’ve been discussing this issue with business leaders from across the country. I’ve shared with them my ideas, and they’ve tossed out plenty of ideas themselves. Here are some hightlights that will apply to many businesses:
o Use your sales force to help identify the first signs of a change in direction. Everyone talks about this, but few companies implement it well.
o Expect the composition of your sales to switch with the business cycle. For example, in the recent recession sales of disposable diapers only declined a little, but the premium brands lost market share to the house brands. This kind of switch impacts both marketing and operations.
o Operations and logistics personnel should think about this switching of product types. And they should be prepared for smaller batch sizes.
o Smaller batch sizes may require different capital equipment.
o Human resources needs will be more variable, just as workers figure out that they should prefer more stability. It will take some work to reconcile these conflicting needs.
o Company finances should be more conservative. Businesses should hold more working capital, and operate with more equity and less debt.
Your business, non-profit or government agency should go over all areas of the enterprise to re-optimize to the new cyclicality.
For the overall economy, this cyclicality is not a good thing, but we’ll survive it. For businesses that are well run and that plan ahead, it will provide opportunity after opportunity to gain market share from weaker competitors.
Read the entire series: 11 Business Challenges in 2011