Is the small business sector underperforming the broader economy? And if so, does our economic data accurately reflect that?
Those are the questions Jan Hatzius, chief US economist at Goldman Sachs (GS), tackled in a Nov. 11 commentary (no link available). Hatzius says the recent 3.5% GDP growth estimate (annualized) for the third quarter could overstate how much the economy expanded by as much as .5 to 2 percentage points. He gets there essentially by looking at how GDP growth historically tracks to the NFIB’s Small Business Optimism Index.
From Hatzius’s note:
The National Federation of Independent Business (NFIB) reported on Tuesday that small business optimism edged up very modestly to 89.1 in October. While this is the highest level in a year, the index remains more than two standard deviations below its long-term average. The weakness of the NFIB [index] stands in stark contrast to other indicators such as the purchasing managers indexes published by the Institute for Supply Management, which have moved back to around their long-term averages, and real GDP, which grew an estimated 3.5% (annualized) in the third quarter. Small firms appear to be underperforming their larger peers, most likely because of differential access to credit.
I put together the rough chart below based on quarterly data from the NFIB’s Optimism Index. Each line charts the group’s measure of small business optimism (based on member surveys), starting in the first quarter of a recession and going through the end of that business cycle (i.e., when the next recession begins). I’ve used the NBER’s business cycle dates, and I combined the double-dip recessions of the early 1980s. Click here for full image.
The red line tracks the index from Q4 of 2007, when the current downturn officially began. Though it’s ticking up, the NFIB’s optimism measure is way below where it has been at this point in any other business cycle since the index began in 1974. Despite the rally in the stock market and other hopeful signs, this measure of the small business sector doesn’t show an incipient recovery. With small firms employing half of all private sector workers, their gloomy outlook contributes to the high unemployment rate. (In the last three months, 19% of small employers reduced headcount, compared to 8% that increased, according to the NFIB’s November survey.)
If small companies are suffering more than large ones, there could be a discrepancy if data collection for small firms, especially proprietors, lags. Here’s Hatzius’s takeaway:
Our conclusion is that if small firms aren’t captured well in the advance GDP data, the economy may be growing less quickly than suggested by the recent official data. This would not only reconcile the GDP data with the NFIB survey, but would also go some way toward explaining why the unemployment rate has so far continued to increase at a considerable clip despite official GDP estimates that imply above-trend growth. If there is an error, it may eventually be corrected via revisions, although the process could take several years.
If this analysis is accurate, it clarifies the disconnect between big business and small business. That difference was less evident earlier in the downturn. Things looked pretty dismal for businesses of all sizes a year ago. At this stage, big businesses and small busineses appear to be facing different recoveries — or lack of thereof.
Many of our readers have steered their companies through at least one downturn before. If you have, let us know — is this one different? Are you less optimistic about growth? Why? Tell us in comments below, or on Twitter.
More analysis on this from Seeking Alpha, the Curious Capitalist, and the The Pragmatic Capitalist.