Business decisions drive the economic cycle

Bruce Kasman, chief economist at JPMorgan Chase was quoted in an article in the Financial Times last week saying that “recessions are all about shifts in business behaviour.’ The analysis piece was looking at the apparent gap between the dire warnings of recession emanating from the US financial community and the more benign view of the economic landscape coming from the leaders of bricks and mortar businesses.

What are the key business decisions that may decide the extent and duration of the downswing in the US economy in the coming months? Here are five that I can think of, there are bound to be more.

1.Whether or not to jettison workers and reduce the payroll to control labour costs – in a flexible labour market, hiring and firing workers is less costly than when employment regulations are severe. But businesses who have worked hard to recruit workers in jobs where there exist labour shortages may be reluctant to offload them at the first signs of a recession

2.Whether to postpone capital investment project – perhaps the easiest area of spending to curtail in the immediate period, but over-zealous pruning of capital spending could leave businesses short of capacity if and when demand rebounds. And weaker capital spending could have a negative effect on productivity going forward

3.The size of price discounts on offer to customers – deep discounting now is a way of maintain the volume of orders, reducing excess stocks and in generating vital cash flow but heavy price reductions bite into profit margins

4.Attempts to renegotiate agreements with suppliers and drive down the cost of inputs – although this can create problems for businesses further down the supply-chain

5.Shifting resources towards overseas markets to find fresh sources of demand – major multinationals already understand the importance of growth in overseas demand as a way of countering weakening demand in the domestic economy.

Business expectations are worsening but they are not falling off a cliff which is a cause for guarded optimism at this critical stage of the US economic cycle.

‘Students of past (economic) downturns argue that the gap between economists’ pessimism and business confidence is due to a combination of timing and psychology. First, different companies perceive recessions differently, because economic downturns and individual industries’ business cycles are not synchronised. In addition, experience suggests that as the threat of a downturn increases, corporate leaders tend to understate it, in an attempt to maintain morale among staff, customers and investors. When Bain, the management consultancy, looked at the behaviour of 377 of the largest US companies in 1981-2001, it found the same overconfident demeanour displayed by many chief executives today.’

The rest of the FT article can be read here