Sunday, November 2, 2008

Recessions Reallocate Resources

All the time, people put money into the economy to sell services and products with the hopes of making a future profit. These hopeful people lease and build commercial space, hire staff, order supplies, research and innovate, and make or order products for resale. These business people allocated time, money, capital and people to these operations to make money. Some of these ventures will be highly profitable and others will fail to achieve profitability. Those that fail to make money will close.

The closing of unprofitable business ventures occurs in good and bad economic times, but business closings accelerate in recessions. In a robust economy, in addition to the many profitable businesses, some businesses eke out just enough profitability to meet expenses but not make an adequate profit for the investment deployed. In good economic times, many economically unprofitable businesses that are just meeting their expenses will continue operations and will increase in number. These economically marginal businesses continue because their owners hope that their businesses will become profitable. These continued unprofitable operations divert capital and talent from more profitable business opportunities.

In a slowing, recessionary economy, there is an overall decline in the sale of services and products of most businesses, but the economic decline will more adversely affect marginal business operations. These marginal ventures will suffer economic losses and need additional capital investment. Many of these business owners will not want to continue to have business losses or put new funds into what appears to be a failing business venture and these unprofitable operations will not survive a recession. The closing of these marginal operations will free up resources including capital and human talent for use in other business enterprises that face greater prospects of profitability.

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