There's a 60 percent likelihood of a recession in the next four years, according to The Wall Street Journal's survey of economists. The economists pegged the odds of a recession beginning in the next 12 months at about 20 percent, an estimate with which I concur. Let's talk about why we'll likely have a recession, and what businesses can do about it now. (See also the statistical note at the bottom of the article.)
The current expansion is fairly old, as expansions go - over seven years of age compared to an historical average of just over three years. But the length of an expansion does not correlate with the probability of a recession, so age does not tell us anything.
The frequency of recessions averages one about every six years, but with wide variation - as short as 18 months from the beginning of one recession until the beginning of the next, and as long as 140 months. So an estimated probability of recession in the range of 10-20 percent puts us in normal territory.
Right now, the most likely trigger of a recession seems to be foreign economic difficulties, which could be a European financial crisis, or European recession triggered by Brexit or a significant downturn in China and the rest of east Asia. The most likely domestic triggers include political change and premature tightening by the Federal Reserve.
More importantly, what should a business do about the risk of recession? Earlier this year, I wrote a book about business management under uncertainty. The best tip for business managers considering the possibility of recession is contingency planning. The assignment I recommend to audience members in my speeches is go to the bar or coffee shop of your choice with a single sheet of paper. Identify your company's greatest risk. It could be recession, as we're discussing now, or it might be new competition, new technology, a change of social attitudes or a government regulation. Whatever the risk, sketch out what you would do if it came to pass.
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Incorporate your company's values and business strategy in your contingency plans. In The Flexible Stance, I tell the story of how Caterpillar developed a recession contingency plan that recognized most its sales came through dealers. Thus, Cat's plan to survive a recession must include its dealers also surviving. If your corporate values include never laying off employees, incorporate that into your contingency plan. If you can't, then stop talking about that corporate value.
Keep your contingency plan at the level that can be handled by one sheet of paper. If staff reductions are part of your contingency plan, don't name names, but do indicate how much of a reduction different departments would face.
For extra credit, do two additional exercises. First, look at past recessions and estimate the likely sales drop your company would see in an average recession. For stable companies, such as healthcare providers, it may be very small. For construction companies and others in highly volatile industries, it could be 50 percent or more.
The second extra credit assignment would put dollar numbers into your contingency plan, so that you can compare the recession's impact to your cost reductions. Accounting types might find it odd that this is extra credit, but I've found that getting corporate leadership to do even a simple contingency plan is such a challenge that I don't want to make the exercise too difficult. Some planning is hugely better than none.
The economics profession has a poor track record of predicting recessions, so don't expect to get much advance warning from us. Some forecasters seem to have predicted the last few recessions, but the ones I am familiar with had been predicting recession all the time, even just before the booms.
The fundamental facts that business leaders must face are:
- A recession is likely sometime in the next few years.
- Companies won’t have much advance warning.
- Thinking about recessions ahead of time can substantially mitigate the consequences of a business downturn.
Statistical note: I cannot find in The Wall Street Journal's data file that they asked about the probability of a recession in the next four years, but they did ask, as they do every month, about the probability of a recession beginning in the next 12 months. If the Journal assumes the probability will be the same 20 percent figure in the coming four years, then the probability of having at least one recession in four years is about 60 percent. If "p" is the one-year probability of a recession, then the four-year probability of at least one recession is 1-[(1-p)^4].
However, some of the economists may believe that if we get through the next year, the probability will be higher; and they may believe it will be lower. In the past five years, the one-year-ahead estimates have ranged between ten percent and 25 percent. If the Journal did extrapolate from the one-year estimate, their conclusion is on shaky ground regarding what the economists actually believe.