Every few years, the economy goes through different stages. That’s why every decade or so, businesses will experience the effects of economic stagnation or downturn. These shifts in the markets affect a variety of industries. Food and agricultural supply chains might be disrupted or companies and individuals might notice the effects of inflation. In this article, we’ll share more information about stagnation. We’ll dive deeper into the causes and effects of economic stagnation and how business owners can prepare for them.
What Is Economic Stagnation
A stagnation is a period in which the gross domestic product (GDP) either shrinks or grows very little. During stagnation, businesses are at risk as the overall demand slows down. Another characteristic of economic stagnation is that unemployment levels rise and investments shrink. Usually, periods of slowdown last between 1 and 3 years. However, some recessions and economic depressions might last decades.
What Causes Economic Stagnation
There are multiple reasons why markets experience the effects of economic stagnation. If the economy is headed for a slowdown, it could be due to a single major reason or a combination of factors. Let’s examine some of the major causes of stagnation.
- Geopolitical and global factors. Wars or recessions in other countries can have a global impact and cause stagnation in many economies. Other factors that can have an impact on the state of the economy include trade tariffs and other crises that reduce demand.
- Debt and the state of the financial system. Excessive debt can cause an increase in interest rates. As borrowing becomes more expensive, businesses are prone to experience the effects of economic stagnation sooner or later. Ineffective monetary and fiscal policies can be the catalyst needed to burst the bubble and lead the economy to a recession.
- Demand slowdown and supply chain disruptions. Whether it’s due to the effects of high interest rates on businesses or another reason like political instability, demand might slow down. In a situation like this, companies might prefer to sell their products and services at lower retail and wholesale prices. This can lead to deflation in businesses and difficulties for the economy, including stagnation.
Key takeaway: During a period of recession, demand slows down and many businesses struggle. Companies can benefit from this economic condition by restructuring and diversifying. Businesses can identify strategic opportunities such as the acquisition of struggling companies.
What Are the Positive and Negative Effects of Economic Stagnation
Even though stagnation causes a lot of trouble for businesses, some companies can turn this situation to their advantage. There are no 100% recession-proof businesses. However, companies with a healthier balance sheet are likely to do better during tough times. Let’s dive a little deeper into the main impacts of an economic downturn.
Negative Effects of Economic Stagnation
- Reduced GDP and increased unemployment. A slowdown in the economy is most commonly measured with its GDP. As companies use business analytics tools and combine them with real-world data, they might postpone investments. That results in reduced job creation and increased unemployment. If the stagnation deepens, businesses might implement layoffs and other policies aimed at cutting the cost of goods sold.
- Decline in demand. Higher unemployment and reduced spending lead to a decline in demand. That’s especially true for non-essential products or services. That’s why hospitality groups and businesses in the restaurant industry are likely to suffer as these travel and dining out can be seen as not necessary. Reduction in demand can lead to deflation which can have serious consequences for the economy. That’s why governments fight recessions with policies like quantitative easing or reduced interest rates.
- Decline in assets. As investors aim for more stable assets, they might sell assets such as real estate or stocks. That leads to falling prices and financial stress for both companies and individuals. Bankruptcies and business closures are becoming much more likely during a period of recession.
Positive Effects of Economic Stagnation
- Bargaining power. As many businesses are experiencing the negative effects of economic stagnation, those with healthy balance sheets have more bargaining power. These businesses can renegotiate prices or focus on talent acquisition with recently laid-off employees.
- Optimization. Companies can use a period of economic downturn to optimize their structure and processes. That will help them maximize profits and pass through the period easily compared to businesses that don’t adapt to the situation.
- Strategic opportunities. Slowed economic growth affects many businesses poorly. That’s why a company with good cash flow and low debt can find opportunities to acquire other distressed businesses.
- Diversification. Companies should aim to diversify their products, services, and supply chains. They can focus on additional eCommerce marketing channels or find suppliers that offer better deals.
Frequently Asked Questions about the Effects of Economic Stagnation
Whether you’re expecting a potential economic recession or you wish to know more on the topic of stagnation, check out the following paragraphs. There you will find some of the commonly asked questions related to the effects of economic stagnation.
How to Prepare for the Effects of Economic Stagnation?
Recessions are a natural part of the economic cycle. That’s why companies need to be properly prepared for them. A major step in that direction is strengthening financial positions. A company with a strong balance sheet will be able to turn the negative effects of economic stagnation to its benefit.
Another important part of preparing for stagnation includes improving efficiency and cutting down costs. That can be done by streamlining processes and maximizing revenue and cash flow.
Diversification should also be strongly considered if economic slowdown is expected. That includes not only introducing new products or services but also partnering with additional suppliers. Furthermore, businesses should consider negotiating long-term commitments with customers. They can prove to be the foundation that will help the company go through hard times.
What Can Governments Do to Fight Stagnation?
Central banks and governments can introduce a variety of policies and programs in their effort to combat the effects of economic stagnation. Let’s examine some of the popular ones.
- Monetary and fiscal policies. The Fed can reduce interest rates as a way to make borrowing cheaper. As a way to fight stagnation, governments are incentivized to increase public spending on infrastructure. That helps businesses indirectly and creates new job opportunities.
- Unemployment benefits and support for small businesses. Tax cuts and direct financial aid can also be considered as a way to boost demand.
- Regulatory reforms and trade policies. Reducing bureaucratic hurdles for companies cuts their operating expenses and results in a higher ROI. Changing trade barriers as a way to boost exports is also a viable option for governments.
What’s the Difference between Stagnation and Stagflation?
The two terms are related, but stagflation is a more challenging economic condition compared to stagnation. During a period of slowdown, economic growth is either negative or at a very low rate. The decreased economic growth affects businesses as they are less likely to make investments and create jobs. Therefore, one of the effects of economic stagnation is falling prices or deflation. Central banks might integrate monetary policies like reduced interest rates or quantitative easing. The effects of low interest rates on businesses and markets are expected to kick-start the economy.
Stagflation, on the other hand, is characterized by combining the effects of economic stagnation and inflation. Therefore, certain monetary policies can’t be introduced as they might fight stagnation but additionally increase prices. This will create a devastating impact of inflation on businesses.
What Are the Most Notable Examples of Stagnation?
Throughout history, there have been many periods of stagnation. Here are some stagflation examples.
- The Great Depression. It’s considered one of the worst periods in US history. The effects of economic slowdown during the Great Depression were felt across the world too. During that period, unemployment rose and many banks and businesses failed to survive.
- The Great Recession. The bursting of the housing bubble and the global financial crisis in 2007 resulted in a period of stagnation in the US and most other countries.
- The Stagflation of the 70s. Rising oil prices and geopolitical tensions led to significant difficulties. The US and other countries experienced the effects of economic stagnation for a couple of years.