We are going to take Spain for example. According to resources from TradingEconomics, recession in 2008 has caused the unemployment rate to hit 11.3% in that particular year. The unemployment rate increased drastically and reached the highest unemployment rate for the last decade in year 2010 which is 19.4%. Most of the reason for the unemployment in the Spain is due to the cutting costs of firms or firms file for bankruptcy. Source: IMF, TradingEconomics.com
On the other side, the unemployment rate in Japan was increased continuously since the country experienced recession since 2008. The highest unemployment rate was at August 2009, which 5.6% of the labor force was unemployed. Although Asia countries like Japan did experience increasing unemployment during the recession period, the figures were not as high as in other European countries such as Spain.
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Recession will definitely affect the housing market in the economy. A sudden financial crisis will cause the housing bubble to burst. When the bubble bursts, it causes the high housing prices to drop immediately. During the recession time, people are poorer and therefore the demand for real estate will drop, and this will badly affect real estate proprietors. When the prices of houses drop, these firms will incur large losses and might end up being bankrupt if they are unable to pay back the interest on loans that they have borrowed from banks.
Sources from NUWIRE INVESTOR stated that Spain's house price bubble burst when the recession began in June 2008. Official figures show the average price of houses in Spain at €1,903 per sq. m. in Q3 2009; down 0.94% from the previous quarter, 8% from the same period last year, and 9.45% lower than the March 2008 peak (Bank of Spain data). In inflation-adjusted terms, house prices were 0.52% down on the quarter, 7% on the year, and 10.58% from peak. The graphs below shows the declining house prices during recession.
Source: Bank of Spain
Besides, seriously affected by the global financial crisis, falls in Japan's housing prices accelerated during the first half of 2009.The urban land price in Japan's six largest cities dropped by 7.8% (9.2% in real terms) in Q1 2009 from the previous year, according to the Japan Real Estate Institute (JREI), ending the long-anticipated recovery of Japanese property prices.
Source: The Land Institute of Japan
Recession also causes consumption to decline. As the unemployment rate increases and business earn less profit, consumer's net disposable income falls. In order to survive during the tough phase, people hold their spending power and they spent only for the unavoidable circumstances. This will further reduce the consumption of the economy, putting more pressure to the economy. Economist John Keynes identified that consumers in a recession has a tendency to grow tight-fisted, pay down their debts, and increase their savings out of their concern for their financial security. Savings is a good thing, yet a recession is not the best time for society to develop the virtue of thrift. The paradox is that, by saving instead of spending, consumers reduce demand, or at least do not contribute to the demand, thus hampering the economic recovery.
The National Statistics Institute has declared that Spain's household savings rate increased by 24.7% of disposable income in the fourth quarter of 2009, the biggest level after 2000 the consumer expenditure declined 0.40% in the same period of time, pushing savings up by 47.74 billion euros ($64.36 billion), and growth of 7.1%. The graph shows that household saving ratio rises rapidly after recession has taken place.
The graph below indicates that Japan's gross savings rate was declining for almost 2 decade since 1990. A record of lowest saving rate at the end of year 2007, however, the savings rate increased right after the financial crisis and keeps increasing until now.
Recession also causes firms to go bankrupt. During recession, aggregate demand will fall, thus leading consumer to demand less goods and services from firms. This, in a way leads to lower revenue for firms, therefore increasing the possibilities for a firm to go bankrupt. When firms do not gain any profit, they will eventually become bankrupt. These firms will have net losses instead of net profits. Thus, firms will not be able to pay off their debts, such as business loans, rental expenses, and purchase of supplies and so on.
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According to the figures revealed by the National Statistics Institute, there were 3,285 individuals and businesses filed for bankruptcy in Spain during the first half of year 2009. Out of the over 3,000 declared bankruptcies in Spain this first semester, 32.1 per cent were involved in the construction of real estate industry. The remaining bankruptcies were involved in industry and energy (24.9 per cent) and the retail business sector (17.3 per cent). A large percentage of construction firms filed for bankruptcy is due to the burst of the housing bubble when recession stroked. Even one of the biggest construction companies, Martinsa-Fadesa declared bankruptcy in July 2008. The bar chart below shows that Spain was having a high risk of bankruptcy until the year 2010.
CASES OF BANKRUPTCIES AND AMOUNT OF LIABILITIES
(Liabilities: in million yen)
( up 15.7% over 10,959 in 2007 )
( up 116.9 % over 5,491,728 in 2007 )
The same situation had happened in Japan during recession caused by the financial crisis. Cases of bankruptcies in Japan rose tremendously during year 2008 and 2009. Many big companies filed bankruptcy due to large amount of liabilities. For example, Pacific Holdings Co., a real estate manager with 163.6 billion yen ($1.7 billion) in liabilities, filed for bankruptcy protection, becoming Japan's third-biggest publicly traded company in March 2009. This was because the company failed to raise funds during the recession period. The tables below show the cases of bankruptcies with the amount of liabilities of 10 million yen or more in Japan for the year 2008 and 2009.
CASES OF BANKRUPTCIES AND AMOUNT OF LIABILITIES
(Liabilities: in million yen)
( up 4.9% over 12,681 in 2008 )
( down 42.8% 42.8% below 1,191,132 in 2008 )Source: TEIKOKU DATABANK, LTD
Recession makes a resounding impact on share markets and so it affects share prices to great extent. Generally a recession leads to lower profitability and lower dividends. Therefore, shares are less attractive and share-holders often face disappointment. Note share prices often fall in anticipation of a recession. In addition, people are having less money during this tough time as many of them are either unemployed or laid off. Therefore, they do not have additional money to make investment and also worry that they will make loss if the companies do not operate well during the recession. This causes the demand curve of shares to shift to the left. Therefore, the share prices fall during recession due to less demand of it.
The share price of Spain's biggest gas distributor, Gas Natural SDG SA kept on falling when the country experienced recession and price of natural gas fell. From the chart below, we get to know that the share price of Gas Natural SDG SA dropped since May 2008 and the reached its bottom in first quarter of 2009.
A Japanese maker of synthetic rubber, Zeon Corp. was also having a fall in its share price. The share plunged 5.5 percent to 624 yen in 2009. Kunihiko Kanno, an analyst at Credit Suisse Group AG, said in a report that the company's market share of firms used for liquid crystal display televisions fell more than expected. Below is the stock chart for Zeon Corp. for the last 5 years.
The next impact of recession is credit crunches. Credit crunch is the shortage of funds from lending or a sudden tightening of the conditions required to take a loan. During the period, unemployment rates are very high and people will be unable to pay back the loans that they have taken from the bank. Therefore, banks are afraid to give out personal loans or grants as consumers will not be able to pay back during this period of time. This crunch also happens because of high percentage of bankruptcy during recession due to a general price reduction on assets. Thus, banks will be very aware of the giving out of loans which includes education, business, personal and mortgage loans. This makes the situation worse because people will reduce their consumption further as they do not get to apply for loans as easy as before.
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After the housing bubble burst in Spain, the housing prices fell and many debtors were unable to pay back the mortgage loans. Therefore, many banks were aware of it and restricted the requirements for applying the loans. This is to make sure that the borrowers are able to pay back the loans. The graph shows the percentage reduce in lending for household mortgages since 2008 when the recession just started.
Source: Bank of Spain
But, Japanese banks did not show an obvious decline in giving out mortgage loans even during recession. It is because banks in Japan are very cautious about granting new loans and requiring the debtors to go through a strict process. Therefore, Japan has a ratio of outstanding home loans to GDP below 25%, remains one of the smallest in the developed world. As Japanese banks are used to be very strict in giving out loans, credit crunch is not a serious problem in Japan when recession happened.
Source: Japan Housing Finance Agency, MIC
Recession causes price war. Although consumers benefit from price wars, firms will ultimately have a hard time keeping up and competing in the economy. Price war is a term in the economy to indicate the competition in prices of goods and services of different companies. During recession, prices of goods and services will inevitably drop. One competitor will lower its price; therefore other companies will have to lower its prices of goods as well to attract demand of consumers. If another company reduces its price for the second time, another round of reduction of prices of goods will start. These reductions of prices will not benefit companies and will result in no profit sooner or later. This will lead to bankruptcies of firms, and fewer firms in the industry. When there are fewer firms, the market power of those remaining firms will increase automatically.
Without any surprise, price war happened in Spain. As recession cuts down the income of Spanish family, the majority of the customers are spending less. For the purpose of attracting customers and to boost up their sales, restaurants, boutiques, hotel and travel agencies were competing among their competitors by offering a very low price for their goods and services. In year 2009, Spanish could get a designer dress at 49 euros, a lunch as little as 5 euros, and even to stay a night in a five star hotels for only 40 euros. Although consumers were benefited from all these promotions, many firms were forced to close down due to the decline in profit or even loss.
Japan is very well-known for their traditional crusine, sushi. During recession, the largest sushi chain restaurants, 'kaiten-zushi' had started a price war that is making dining out more reasonable than ever before. As a result, the other restaurant chains in Japan - Kappa Sushi, Akindo Sushiro and Kura Sushi joined in the price war by reducing the cost of most platters to only Y100 (€0.90) in a bid to attract families. Many small restaurants with little modal did not be able to offer such a low price and consequently leave the market.
The figure below clearly shows that price level in both Spain and Japan fell sharply after recession hit the country.
Another effect of recession is that it causes an increase in government debt. More society are being unemployed from their jobs and they do not get income. When they do not get income, they do not pay income tax. This also applies to companies during recession, lower company profits result in lower corporation tax. On top of that, government has to provide transfer payment such as Social Security, unemployment benefits and retirement benefits to help the citizens during the hard time. This calls for bad news on the government budget. Every time government runs a budget deficit, it adds to national debts and this will result on higher taxes and higher interest payments in the near future.
After the recession, Japan's government debt has accumulated to a very high amount. In June 2010, Japan's government debt hit a record high of more than 10 trillion dollars. The total public debt stood at 904.08 trillion yen ($10.55 trillion), up 21.15 trillion yen from the end of March. The chart below shows that Japan has the highest government debt in the world and the amount is almost the double of Italy which has the second large public debt.
Spain's government had increased their borrowing when recession happened. During that time, government received less tax revenues because many people are unemployed and films were closed down. Yet, government had to increase their spending on transfer payments such as unemployment and retirement benefits. These caused the government to borrow money and accumulate a large sum of debt.