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Is Small Business Prosperity Just Around the Corner?

Posted By Scott Shane On January 24, 2011 @ 6:17 am In Research | 11 Comments

“Prosperity is just around the corner” is what Herbert Hoover told businessmen in 1932, at the depth of the Great Depression and close to a decade before prosperity returned. An optimist might say Hoover was right; it was just a very long corner.

I thought of Hoover’s famous quote when reading the spate of articles that have explained that the U.S. economy has turned the corner. That is, of course, unless you are unemployed or run a small business.

While I have written before about the non-recovery among small companies, the excessive optimism in the press has me turning to this topic again. I’ve looked at the data and they don’t show a recovery on Main Street. Moreover, I don’t think we’ll see one for a while.

Before I turn to why I don’t forecast a small company rebound anytime soon, let me first describe the current status of the small business sector. In a word, it’s not good. The National Federation of Independent Business’s (NFIB) December survey [1] of its members (who own small companies) indicates slightly lower optimism than in November, which the NFIB had said remained “ in recession territory… far below values that have typified a recovery period.” And the NFIB’s December figures on the share of small business owners planning capital investments and small business owners’ sales were lower than November’s levels, which the NFIB had said were “still historically quite low” and “not yet supportive of a widespread recovery in the small business sector,” respectively.

Discover Card’s Small Business Watch [2] – a survey of business owners with less than six people on their payroll – shows a similar lack of recovery. In December 2010, 45 percent of survey respondents reported having temporary cash flow problems, three percentage points higher than in June 2009 when the recession ended. Similarly, only one tenth of owners said they were adding employees, not many more than the nine percent hiring in June 2009. In December 2010, 62 percent of entrepreneurs said that current economic conditions were poor, an increase of three percentage points from the level at the end of the recession. Finally, in December 2010, 21 percent of small business owners surveyed planned to increase spending on business development; a number virtually the same as the 22 percent who said they planned to do so in June of 2009.

So why aren’t small businesses experiencing the economic recovery that seems to be driving the stock market higher and putting large amounts of cash in the coffers of large, multinational corporations? I think there are four reasons: First, small business owners are much more affected by the slump in housing prices than large companies. Construction and real estate have a particularly high proportion of small companies, and, of course, those industries aren’t experiencing a robust recovery.

Moreover, small business financing depends a lot on housing prices. Big public companies obtain the capital that they need by issuing bonds and stock and selling them to investors, but small businesses rely heavily on personally guaranteed and personally borrowed money from banks. Analysis I conducted with my colleague Mark Schweitzer of the Federal Reserve Bank of Cleveland [3] shows that the fall in housing prices has eliminated almost $25 billion in potential credit for small business owners.

Second, big businesses can better take advantage of the more robust economic growth occurring in other countries. Small Business Administration data [4] shows that small businesses only account for 31 percent of exports but generate more than half of non-agricultural private sector GDP. The lesser reliance of large businesses on economic conditions within the country has worked to their advantage in recent months.

Third, increase in government regulation, as seen in the financial and health care reform bills have imposed a disproportionately large burden on small businesses. In a recent paper, Nicole and Mark Crain of Lafayette University wrote that “small businesses face an annual regulatory cost … which is 36 percent higher than the regulatory cost facing large firms.”

Fourth, most government policies to combat the weak economic conditions have helped large companies more than small ones. For instance, the stimulus program, which worked in part through government contracting, favored large businesses that knew how to work the public contracting system.

Unfortunately, I don’t foresee robust growth returning to the small business sector anytime soon. Growth in home prices doesn’t appear to be on the horizon. Despite the Tea Party members elected to Congress, government regulation isn’t likely to decline. Economic growth outside the country will remain stronger than growth within the country. And no large public policies that favor small business owners are heading down the pike.


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URLs in this post:

[1] The National Federation of Independent Business’s (NFIB) December survey: http://www.nfib.com/portals/0/pdf/sbet/sbet201012.pdf

[2] Discover Card’s Small Business Watch: http://www.discovercard.com/business/watch/

[3] Analysis I conducted with my colleague Mark Schweitzer of the Federal Reserve Bank of Cleveland: http://www.clevelandfed.org/research/commentary/2010/2010-18.cfm

[4] Small Business Administration data: http://web.sba.gov/faqs/faqindex.cfm?areaID=24