Recessions are nasty, but is it possible they are also necessary. It is a cliché, but is it not the case that medicine can be very unpleasant.

It seems there are two theories about recession. One idea sees a recession as a wasted opportunity. If the economy has the potential to expand by, say, 2 per cent a year, then if it fails to expand one year, then the economy will always be 2 per cent smaller than it would otherwise have been.

And so recession must be avoided – the cost of recession will last forever.

The truth is, however, that this idea is quite absurd.

During a boom, inefficiencies creep in. Silly ideas get adopted and magnified. Inefficient businesses thrive, some business can thrive even though the fundamental premiss upon which they were based was false.

Only a recession can put an end to these bad practices.

The last few years have seen the emergence of the buy-to-let dream. New landlords found a new easy route to riches. The nation’s would-be entrepreneurs found themselves sucked into a pyramid scheme instead. What a waste of talent.

That most dynamic of work places, the City of London, saw our finest minds, not to mention the finest minds among our immigrant population, taken up shuffling debt amongst one another, creating paper wealth, and engineering an economic miracle built on a pack of cards. What a waste of talent.

It is true that not all businesses that will fail over the next few years will be bad businesses. Some will just be victims of bad luck, and events beyond their control.

But the vacuum that will be created, will provide new opportunity.

The great Austrian economist Joseph Schumpeter calls it creative destruction. That is what we are about to witness.

Yet all this must come with a caveat. The economic turmoil will eventually create a new, more dynamic and sustainable economy, but massive hardship will occur in the interim.

Somehow, policy-makers must try and ensure that the price people pay today for creating longer-term prosperity is not too high. And that is the biggest challenge of all.

© Investment & Business News 2013