Archive for the ‘Small Business’ category

Business is Aging Faster Than the Population

August 24, 2017

The U.S. economy is in a constant state of churn. New businesses are being created while existing businesses quit or fail. This dynamic process can be disruptive as new technologies, firms, and industries replace older ones, but it is not destructive, it enables increases in productivity and spurs economic growth. In a dynamic economy with lots of churning more productive firms drive out less productive ones, new entrants disrupt incumbents, and workers are better matched with firms. A dynamic economy constantly forces labor and capital to be put to better, more productive uses. Historically the dynamism of the U.S. economy is an important ingredient that distinguished our country from many slower growth (or stagnating) industrial economies. New Hampshire and the New England region have been especially dependent on economic dynamism as the region typically loses industries to regions or nations that have lower business costs once industries mature and become more standardized. High rates of new business starts fuel dynamic economies. Unfortunately in NH and in all other states the rate of new business starts is in long-term decline.

For most of the past few decades far more businesses in NH and most states were started then either quit or failed. More recently, the gap between a large number of business starts and a smaller number of quits or failures has been narrowing. Briefly, during the great recession, more businesses quit or failed in NH and the U.S. than were started.

New Firms and Exits

Except for an uptick during the “great recession,” business quits or failures have occurred at a pretty consistent rate over the past several decades. What has narrowed the gap between the number of new firms and the number of quits and failures has been a decline in the rate of new business starts in New Hampshire and the nation. The chart below shows that new firms (less than one-year old) accounted for less than 7 percent of all New Hampshire firms in 2014, down from 15 percent in 1988. A similar decline occurred in the country as a whole.

New Firms as a % of all Firms

The decline in economic dynamism implied by lower rates of business starts is contributing to our nation’s slower (by historical standards) productivity growth. Although labor force constraints are a primary culprit, lower rates of new business starts also contribute to slower employment growth, as fewer new business replace those business that quit or fail.

A recent study by Dun & Bradstreet American Express and recent data released by the U.S. Census Bureau show that larger businesses have been creating jobs at a faster rate than small businesses (less than 20 employees) in recent years, including in NH.  A very good business reporter in NH asked for my thoughts on these findings for an article he was writing.  In the article I note that the decline in entrepreneurial activity was a more important factor explaining slower job growth among smaller firms than was business size.  The age of businesses is an “intervening” variable between the apparent relationship between size of businesses and job growth, as new business typically start small. Simply comparing the percentage of jobs added by smaller and larger firms in NH would miss the job growth implications (among the small business category) of the declining rate of new business starts. New business starts account for a significant percentage of job creation in any year and a decline in business starts hurts job growth among  the category of small (under 20 employees) businesses.   The chart below shows that new firms less than one-year old accounted for about 8 percent of all private sector jobs in NH in 1984, by 2014 that percentage was down to 3 percent, a more than 60 percent decline.  From over 30,000 jobs at startups in the mid-1980s, the number of employees at startups averaged less than 18,000 between 2012 and 2014.

Jobs and % of Jobs

Today it is impossible to enter any analysis of the economy that isn’t interpreted through some ideological lens. Making it easier for entrepreneurs to start and operate a business without excessive regulatory burdens and allowing entrepreneurs to keep more of the rewards of their risk taking may seem like an ideological prescription but it just makes sense to incent more new business formations.  However, a bigger problem may be that too often regulations, laws and the political process favor older, more established technologies, businesses, and industries and look to protect and preserve the past rather than enable future technologies and industries.

Economic cycles produce temporary declines in entrepreneurial activity.  Recessions don’t make it easy to start a business but the nation’s longer-term decline in entrepreneurial activity spans economic cycles. One of the more troubling aspects of recessions is that by reducing startups and killing-off many younger firms they shrink the pool of new business from which the next generation of growth companies could emerge.  Younger firms that survive for a number of years tend to grow faster than older firms so a smaller number of new and surviving firms impede future job growth and make it harder to recover from recessions. By impeding business starts for several years (well after the recession ended) the less visible but longer-term impact of the “great recession” will be a smaller generation of the next growth companies.

Still, structural factors in the economy are more problematic for longer-term trends in business starts.  Primary among them is demographics.  There has been a lot of attention focused (often inaccurately) on the demographics of NH’s population but not enough on the demographics of its business population, even though the two are related.  Just as declining birth rates in NH’s population is the primary factor accounting for the aging of the state’s population (not the movement of young people out of the state), a decline in the rate of new business formations is rapidly aging the population of NH businesses.  In fact, the population of NH’s businesses is aging faster than is the state’s population, potentially reducing the economic dynamism that characterized the state’s vibrant economy during much of the 1980s and 1990s.  With an increasing percentage of the state’s workforce above age 50, entrepreneurial risk taking can be expected to slow and as the chart below shows, the percentage of businesses in NH that have been in business for more than 15 years rose rapidly between 2003 and 2014 (the most recent year for which data is available).

Aging of Business

Millenials are a generation that is larger than the baby boom generation and as they become established in the working world they could reverse the trend of declining entrepreneurism.  But today individuals are changing jobs at ever lower rates, suggesting a tendency to prefer security over opportunity and risk.  Millennials are also a generation that is burdened by higher debt levels when they enter the work world, that delays or eschews homebuying, marriage and having children, will they be a generation of risk takers that revive entrepreneurism in NH and the nation?  I hope so because a dynamic, high productivity U.S. and NH economy depend on it.

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“Too Big to Fail” or “Too Small to Succeed”?

March 21, 2016

Community banks’ share of the U.S. banking market has declined significantly over the past two decades but since 2010, around the time the Dodd-Frank Wall Street Reform and Consumer Protection Act was passed, community banks’ share of all U.S. banking assets has shrunk at a much faster rate.  Dodd-Frank may be offering consumers greater protections (data on that issue is not readily available and is less straightforward in any case), but the data clearly show that legislation designed to prevent another “too big to fail” financial crisis is also accelerating the declining market share of community banks, contributing to consolidation in the banking industry, and perhaps helping to create more “too big to fail” institutions.  The chart below shows how the volume of assets and loans have changed since the passage of Dodd-Frank for community banks (defined here as those with less than $1 billion in assets), banks with $1 to $10 billion in assets (some researchers consider these banks to be community banks), as well as banks with over $10 billion in assets.

assets and loans

Other than bankers and their regulators, nobody really cares about the market shares of different sized banks, but the out-sized role community banks play in lending to small businesses and the critical role community banks play in smaller communities and rural regions of the country make it an important economic issue for a large slice of the U.S. economy.  In almost one-third of the nation’s counties the only depository institutions located in the county are community banks according to a study by the U.S. General Accountability Office (GAO).  Small businesses also depend disproportionately on community banks.   The chart below shows that despite holding only 14 percent of all loans in the banking industry in 2006, community banks held 42 percent of all small business loans across the country.  The chart also shows how the rate of decline in the share of all loans held by community banks, as well as small business loans, have accelerated since 2010.

community bank shares

More troubling than the loss of market share by community banks (after all, does it matter as long as lending to small businesses increases?) is the sharp absolute decline in small business lending by community banks since the passage of Dodd-Frank.  I think it matters a lot that community banks’ share of lending is declining because of the traditional role of relationship banking and the willingness to consider “soft information” has played in community bank lending decisions and the implications for access to credit by small businesses.  As the chart below shows, as recently as 2006, community banks were the largest source of small business lending by the banking industry.  Since 2010, however, small business loans at community banks have fallen sharply.

 

small business loans

Some of this is the result of consolidation, smaller community banks being acquired by larger, non-community banks. But even that is influenced by Dodd-Frank.  Any regulatory requirement is likely to be disproportionately costly for community banks, since the fixed costs associated with compliance must be spread over a smaller base of assets.  As the GAO reports, regulators, industry participants, and Federal Reserve studies all find that consolidation is likely driven by regulatory economies of scale – larger banks are better suited to handle heightened regulatory burdens than are smaller banks, causing the average costs of community banks to be higher.

The implications for small businesses and for the economies of smaller and more rural communities are clear. As regulations require more standardized lending and reflect bigger bank processes and practices, community bank lending will be constrained and because they are a major source of small businesses loans and major source of local lending in most rural areas, small business and the economies of smaller, more rural communities will be disadvantaged.  Automobile, mortgage, and credit card loans have become increasingly standardized and data driven.  These loans are increasingly made without any personal interactions, via the internet and by less regulated institutions, or by larger banking institutions with the infrastructure to make exclusively data driven lending decisions.  Business loans are different.  Community banks have had to focus to a greater extent on small business and commercial real estate lending – products where community banks’ advantages in forming relationships with local borrowers are still important – as more types of loans have become increasingly standardized.  Community banks generally are relationship banks; their competitive advantage is a knowledge and history of their customers and a willingness to be flexible.  Community banks leverage interpersonal relationships in lieu of financial statements and data-driven models in making lending decisions, allowing them to better able to serve small businesses.  Regulatory initiatives such as Dodd-Frank are more reflective of bigger bank lending processes which are transactional, quantitative and dependent on standardization.   Understanding the financials of a business, its prospects, the local community in which it operates, or the prospects for its industry, are hard to standardize.  Community banks ability to gather “soft information” allows them to lend to borrowers that might not be able to get loans from larger institutions that lend with more standardized lending criteria.  The less “soft information” is incorporated into lending decisions, and the more costly become the regulatory requirements on banks, the more community banks will diminish and with it an important asset for small business, and small communities across the country.  It is possible that someday small business lending can be more standardized, less interpersonal, in a way similar to credit card or auto loans and in a way that does not disadvantage small businesses, but I am skeptical.

The debates surrounding financial services regulation since the “great recession” have focused on the safety and soundness of the financial system and on consumer protections, both important objectives, and to be fair, the banking industry too often  appears only self-interested in regulatory debates.  But far too little consideration has been  given to the impact of new financial services regulations on small business, communities, and rural regions of the country.

Authors Note:  I have done some studies for the banking industry in the past.  This post is not an effort to shill for their interests.  This blog is about timely topics that interest me and a place where I can write about them free of any compensated interests.  It is an outlet for my analytical interests and opinions.   I do confess, however, an affinity for community banks and the people who run them because of the strong commitment that they demonstrate to the people, businesses, and communities in which they operate.    

 

Maximizing Costs and Benefits of the Minimum Wage

April 1, 2014

Note: Links updated and some errors corrected at 6:23 pm

Lawmakers want to do the right thing on the minimum wage issue and even if some don’t, the issue is a highly symbolic indicator of one’s position on a number of important policy issues. That’s too bad because it reduces the probability that the issue will be decided entirely on its merits (benefits versus costs). With so much hyperbole on both sides of the debate it is difficult to know what the “right thing” is and raising wages for those at the bottom of the wage scale has a lot of appeal as an easier and faster way to augment income than is increasing the productivity and educational attainment of individuals.
This month the U.S. Bureau of Labor Statistics (BLS) issued a brief report on minimum wage workers. Anyone interested in the policy debates about minimum wage should at least peruse “Characteristics of Minimum Wage Workers, 2013.”  According to the BLS, about 59 percent of workers in this country are paid on an hourly basis and the percentage of that group that is working at or below the minimum wage declined to 4.3 percent last year. Thus about 2.6 percent of all workers (those paid hourly and those on salary) are paid at or below the minimum wage. Most of those workers are employed in a few industries, led by the food service industry which employs nearly one-half of all workers making at or below the minimum wage.
min wage industries

New Hampshire is immersed in its own debate over raising the state’s minimum wage. In what was largely a symbolic measure, the prior legislature repealed the minimum wage and the current legislature looks to reinstate and raise the minimum wage in the state. My analysis of data from the U.S. Census and BLS’s “Current Population Survey” (CPS) indicates that about 10,000 workers in NH earn at or below the national minimum wage of $7.25 (this number is slightly below the 11,000 estimate in the BLS report, but that report rounds the NH estimate so the discrepancy is probably less and well within the CPS’s sampling error).

number of min wage workersAnother 16,200 earn between $7.25 and the proposed new state minimum of $8.25. Thus about 26,000 hourly workers, about two-thirds of whom are mostly in the food services and retail industries, would be affected by a $8.25 minimum wage. A second proposed increase to $9.00 would affect another 13,600 workers. So all told, about 40,000 workers or about six percent of all workers in the state could be affected. I did not analyze the age composition of NH’s minimum wage workers but a 2007 study by the Federal Reserve Bank of Boston did and they conclude that younger workers comprise a larger portion of minimum wage workers in NH than in the U.S. as a whole. Almost one-half of workers at the minimum in NH are teenagers age 16-19 (chart below).

age of min wage workersWhatever the result of NH’s minimum wage debate, a lot of people earning far more than minimum are working to influence the outcome. I have no personal or professional stake in the minimum wage debate but I like the issue because it is a documentary on highly-charged policy fights, combining real and perceived forces of good and darkness: economics, emotion, populism, ideology, compassion, greed, idealism, labor versus management, as well as wealth versus want. The minimum wage debate also provides some of the clearest examples of the tradeoffs involved in public policy choices. In this case, the tradeoff is raising wages for some while reducing the employment opportunities (hours or jobs) for others. Despite what the media say, and the President’s statement that “there’s no solid evidence that a higher minimum wage costs jobs,” most economists do agree that minimum wage increases result in some economic damages (reducing employment). They don’t agree on everything about the impacts of the minimum wage, however, and a good number of reasonable economists believe that the negative employment impacts from minimum wages are offset or even outweighed by the benefits. The negative employment impacts are substantial but do not appear, to me at least, to be dramatic, which of course is a fairly insensitive view that could only be held by someone not negatively impacted by an increase in the minimum wage (who are likely to be the least skilled and with the fewest economic opportunities among us).

In any case, having some negative impacts is not, in itself, enough to reject a policy. Most people, me included, accept the fact that the tradeoff for a compassionate policy that provides a minimal cushion against the ravages of unemployment (unemployment compensation) is some increase in the rate of unemployment. There are just as many or more policies that benefit some businesses or industries but also have some negative competitive impacts or costs to consumers.

I don’t have strong feelings either way about re-establishing and raising the state’s minimum wage. Raising the state’s minimum wage will cost some businesses and/or consumers more and reduce and have some negative impact on employment and hours worked (see the Boston Fed’s study here if you don’t trust me). The chart below demonstrates (too busily) the impacts on a business of an increase in the minimum wage assuming they can’t or don’t raise prices and any increase in the minimum wage comes at the expense of profitability (that is increases is efficiencies can’t offset wage increases). Wages comprise close to 40 percent of business costs for both food service and retail businesses and the high-end of profit margin in those industries is about 5 percent so the chart also incorporates those two assumptions. Depending on what percentage of the businesses’ workforce is currently at or below the minimum wage, the chart shows how business costs increases for both the $8.25 and $9.00 increases (the red lines), as well as how profitability is affected (the blue lines). It may use simplifying assumptions but I think the chart demonstrates why businesses in affected industries are so opposed to a minimum wage increase. While expenses appear to rise modestly, profit margins can quickly erode.

business impactsMy issues with raising the minimum wage tend to be more about the distribution of the impacts than with their magnitude. Freedom from want for working Americans should be a national goal. If augmenting the income of individuals with the least earning power (because of experience, skills, education, etc.) is a national goal, it is it is hard to see why that responsibility should fall only on a few industries that employ these individuals, especially when doing so will only decrease the opportunities for employment.  That seems to be the philosophy behind the Earned Income Tax Credit.  There are other distributional impacts as well.   Those with the least opportunities bear the greatest negative employment impacts even as they also receive some benefits.   Big companies are more able to absorb higher costs and in any case are less likely to pay minimum wage, so smaller, local businesses already at a cost disadvantage can be put at even more of a competitive disadvantage.   This is especially true in rural areas. Small, rural towns have lower costs, especially for real estate, so an increase in the minimum wage gives cities and big companies competitive advantages at the expense of small and rural employers.

As is the case with most policy debates, proponents of a minimum wage increase maximize benefits and minimize costs while opponents minimize the benefits while maximizing the costs.

Small Business Optimism Improves

November 28, 2012

Small businesses fared the worst during the recent recession and hiring by small businesses has been slower to recover after this recession than it was  following past recessions.  Robust economic growth does not occur unless small businesses are confident, healthy, and hiring.  With a fragile national recovery from recession that has not quickly helped to repair the balance sheets of most small businesses, and with a number of important public policies (regulatory, tax, health care etc.) still uncertain, it is not surprising that small businesses have been less than sanguine about the prospects for the economy and reluctant to hire.   That may be changing, however, as the NFIB’s national index of small business optimism has begun to increase.  The NFIB index is a pretty good predictor of the direction of job growth in NH and its latest up-tick is consistent with last month’s increase in payroll employment in New Hampshire.


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