Tuesday, April 07, 2009

Remedies to overcome Recession

1. What is a recession?

1.1 According to the National Bureau of Economic Research (NBER), USA, recession is defined as "a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real gross domestic product (GDP), real income, employment, industrial production and wholesale-retail sales". More specifically, recession is defined as when businesses cease to expand, the GDP diminishes for two consecutive quarters, the rate of unemployment rises and housing prices decline.

1.2. A technical recession occurs when the level of real national output declines over two successive quarters causing a contraction in the total volume of production in the economy. But often a sharp slowdown in the rate of growth of output, spending and income can feel like a recession!

2. WHAT MIGHT CAUSE A RECESSION?

2.1 Recessions have a variety of causes and a wide range of symptoms.

2.1.1 Some causes are domestic in origin, stemming from policy mistakes on behalf of the economic authorities. For example, the central bank might allow the money supply to grow too slowly and keep interest rates above the level needed to maintain a steady rate of growth. Higher interest rates have the effect of dampening down spending by both households and businesses and can lead to plant closures and job losses.

2.1.2 External shocks can also bring about recession. For example in 1973-74 the large jump in world oil prices caused a sharp rise in cost push inflation and an acceleration in wages. Falling real purchasing power of consumers and a deflationary fiscal and monetary policy from the government sent the economy into reverse.

2.1.3 Many factors contribute to an economy's fall into a recession, but the major cause is inflation. Inflation refers to a general rise in the prices of goods and services over a period of time. The higher the rate of inflation, the smaller the percentage of goods and services that can be purchased with the same amount of money. Inflation can happen for reasons as varied as increased production costs, higher energy costs and national debt.

2.1.4 In an inflationary environment, people tend to cut out leisure spending, reduce overall spending and begin to save more. But as individuals and businesses curtail expenditures in an effort to trim costs, this causes GDP to decline. Unemployment rates rise because companies lay off workers to cut costs. It is these combined factors that cause the economy to fall into a recession.

3. SOME CHARACTERISTICS OF A RECESSION

3.1 Declining demand for output leading to higher levels of spare productive capacity

3.2 Contracting employment / rising unemployment as firms lay-off workers to control their costs

3.3 A sharp fall in business confidence & profits

3.4 A decrease in fixed capital investment spending because there is insufficient demand to justify new capital projects

3.5 De-stocking and heavy price discounting - this leads to lower inflation

3.6 Reduced inflationary pressure in the labour market as unemployment rises

3.7 Falling demand for imports

3.8 Increased government borrowing

4. Remedies to Overcome Recession or Global Financial crisis or Economic Collapse for the Government

4.1 Step 1

Encourage exports. The government should focus on this business segment because it would infuse necessary foreign currencies.

4.2 Step 2

Provide Accessible Credit for Business. Business should be encouraged by the government to compensate for unemployment. More businesses mean more jobs for the people. Or, at least, source of income for the family.

4.3 Step 3

Improve Tax Collection. Taxes can finance government expenditures such as provision of credit to businesses or budgets for social welfare.

4.4 Step 4

Set Aside Large Amount for Social Welfare. This will quell panic and riots and restore confidence in the people. Positive outlook will be developed in the process. This will also enable people to get back on their feet and start anew.

4.5 Step 5

Control Expenditures in Other Fields. Slash budgets on unnecessary expenditures in other areas - military, legislative, executive, other branches.

4.6 Step 6

Improve Tourism. Lure more tourists to the country. More tourists mean more money injected to the economy. Businesses will naturally sprout even small businesses in order to cater to the needs of these tourists.

4.7 Step 7

The main problem is the lack of funds as businesses closed and investors pull out their investments. The solution is to encourage the injection of money back to the country. Focus on the solution.

5. Islamic Solution & challenges

5.1 There were discussions on the need for regulations and prudence in the management of the financial system and at the same time, Islamic finance was gaining credibility as an alternative system. Islamic finance is fundamentally based on the principle of 'no risk, no reward. There was a huge departure from conventional finance where considerable gains could still be made on zero-risk. Islamic financial system has opened the doors to irresponsible lending where greed has been allowed to take control, citing the subprime mortgage crisis as the classic case.

5.2 The second challenge was for Muslim countries to be continuously innovative and come up with new Islamic finance products. To be competitive, they need to develop products which can set themselves apart from their conventional counterparts. We need to explore ways to create attractive financial packages. Indeed this is a daunting task but we must be confident that, with collective effort and dedication, this will not be beyond our means to do so. I urged Muslim countries to attract more young and bright practitioners to join the Islamic finance industry as they were crucial for developing the intellectual capacity to meet the above challenges.

Main Source:

HABHAJAN SINGH , WIEF: Bright future for Islamic finance http://islamicfinanceasia.blogspot.com/2009/03/wief-bright-future-for-islamic-finance.html


National Bureau of Economic Research (NBER)

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