Small Business Optimism Rises for New Year

Judging from the opinions of small business owners, this recession will be short. A November survey of members of the National Federation of Independent Business (NFIB) found that, net of pessimists, 30 percent of the owners expected the economy to be stronger in 6 months, the highest reading on this question since 1992 (The net percent of firms is the percent giving a favorable response minus the percent giving an unfavorable response). Plans for hiring, capital outlays and inventory investment were all up relative to the October survey. All of these indicators signal a boost to Gross Domestic Product in the months ahead.

In his December newsletter, NFIB Chief Economist William C. Dunkelberg recounts the economic events of the past two years. After nine years of expansion, by mid-2000 the U.S. economy entered what Dunkelberg calls a classic "too much stuff" slowdown. That is to say, by mid-2000 the majority of U.S. households had purchased bigger homes and SUVs and consumer electronic gadgets and all the durable goods their budgets could handle, so that demand for new stuff was waning. After a 5.6 percent growth rate in GDP in the second quarter of 2000, the third quarter growth rate fell to 1.3 percent and fourth quarter growth was 1.9 percent. Growth slowed further through mid-2001 (1.3 percent in the first quarter and 0.3 percent in the second quarter). Employment peaked in March 2001 but sales and production had peaked months earlier in 2000. We'll never know whether an outright recession would have been averted had it not been for the terrorists, but the events of September 2001 dragged down third quarter growth to -1.1 percent. The revival in small business owner optimism since then bodes well for the resumption of growth soon. Dunkelberg expects this recession profile to be a "long L", with an extended period of sub-par growth following the technical recession, similar to the "jobless recovery" period following the 1990-91 recession.

Primary risks in this forecast are twofold: 1) more terrorist attacks on either the U.S or its primary trading partners, and 2) growing economic weakness in Japan and Europe. Still, Dunkelberg notes there are many positives, including low inflation and interest rates, fiscal stimulus already working its way through the economy, no inventory buildup, a stable U.S. political environment, and cautiously optimistic consumer expectations.

Some other significant findings of the survey include the following:

• Hiring plans rose to 11 percent of all firms (net of those planning reductions), a surprisingly strong indicator in the midst of a recession, which also suggests that the downturn will be brief.

• Eighteen percent of all owners say that finding qualified labor is the most important problem facing their firm. This has been consistently cited for the past three years, and even the curtailment of hiring plans and rising layoffs in some sectors has not erased the chronic shortage of skilled workers economy-wide.

• Over twenty percent of firms reported increasing labor compensation (down from the record set last February) but still only 6 percent list rising labor costs as their top business concern. It appears that rising compensation will continue to support growth in personal income without igniting inflation fears.

• A net -4 percent of firms reported raising average selling prices, 6 points below October levels. The ten-year peak (for the most recent expansion) was 19 percent, set in June 2000. No signs of inflation here.

• Capital spending plans rose to 29 percent (percentage planning to increase minus percentage planning to decrease) of all firms in November. The record is 41 percent set in December 1998 at the height of the late 1990's optimism.

President Bush's economic policy received high marks from small business owners. Seventy three percent gave his economic policy components a "1" (excellent) or "2" rating on a five-point scale. Only one percent gave him a "5" (poor) rating. Netting the top two ratings against the poor rating produces a net 72 percentage points for his economic policy approval rating, a record high for economic policy popularity. The rationale for the rating becomes clearer in light of the small business owners' opinions about the most important problems they face. "Taxes" were the top category, receiving 25 percent of the vote. "Availability of Qualified Labor" finished second with 18 percent of the vote, followed closely by "Poor Sales," with 17 percent. Lest we suspect that small businesses always rate taxes as their primary problem, keep in mind that the historical winner in the "number one problem" category is "Inflation" which garnered as much as 42 percent of the vote in the early 1970s.