Where Is The Small Business Recovery?

by: Jeffrey Rosen

Introduction

Media pundits, politicians, and economists all seem to agree that small businesses are the lifeblood of the economic recovery. The idea is that large businesses tend to be more prudent in their hiring decisions. Small firms, on the other hand, are more nimble and apt to hire as soon as business starts to pick up. Thus, labor sector improvements are first felt in the small business sector while large firms lag behind.

Any hindrances, therefore, to small business conditions - such as new regulations or tighter credit - can have an outsized negative effect on the overall economic recovery.

New data from the Bureau of Labor Statistics (BLS) calls into question that adage, especially for the current recovery. Large businesses, not small, are providing the bulk of the gains in the labor sector today.

That means small businesses may still be facing difficult restrictions that are preventing the labor market recovery from accelerating at a more typical post-recessionary pace.

BLS - Experimental Employer Size Data

The BLS recently extended the Current Monthly Employment Statistics Survey - used to track payrolls, hours, and earnings - to also include changes by firm size.

The new data series was released last week, covering payroll levels by firm size from April 1990 through March 2011. Updates are expected to be released quarterly, and estimates on earnings and hours are expected in the coming months.

Firms are defined by their Employer Identification Number (EIN) reported with unemployment insurance filings. The EIN allows the BLS to identify firms across state lines.

Firms are then classified into three categories: small (1-49 employees), medium (50-499 employees), and large (500+ employees). Firm size is determined by the maximum size over the previous 12 months.

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Payrolls at large firms comprise roughly 46% of all private payrolls. The remaining employment is almost evenly split among small- and medium-sized firms.

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According to the data, almost all of the increase in payrolls from April 1990 to March 2011 came from gains in large firms. This is exemplified by the steep growth rate starting in late 1992 and culminating with the start of the 2001 recession. Since then, payrolls have trended more-or-less sideways.

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Evidence from the 1990-91 and 2001 Recessions

Small businesses led the labor recoveries following the recessions of August 1990 - March 1991 and April 2001 - November 2001, with medium- and large-sized firms lagging behind. These results follow the common thought that small businesses are leaders in the recovery.

Once the payroll levels reached their troughs, medium- and large-sized firms outperformed small business growth. Again, this result follows the common adage of a typical labor market recovery.

The results are even more pronounced when evaluating the absolute aggregate payroll changes.

The Labor Market Recovery Following the Great Recession

The labor market did not react the same way following the end of the Great Recession.

While small businesses did lead the way initially, hiring from large firms quickly caught up and outpaced small business growth.

From February 2010 to January 2011, small businesses barely added any payrolls. At the same time, large firm payrolls increased 1.8% and medium-sized firms added 1.4%.

In absolute terms, payroll growth in large firms has nearly doubled those at small-sized businesses since the end of the recession and more than tripled the gains since payroll declines reached their trough in February 2010.

A Look at the ADP Employment Data

ADP, in conjunction with Macroeconomic Advisers, has released a national employment report since 2006 - with history going back to December 2000 - which predicts changes in the BLS private payroll numbers.

The report also breaks down payroll levels based upon firm size, using different criteria than the BLS.

ADP measures a firm by establishment payrolls and not by the EIN number. That means a large parent corporation, which would be counted as one firm by the BLS, may be counted multiple times by the ADP if the firm has multiple offices/locations that provide separate payroll numbers.

For example, a local Starbucks may have 10 employees. The BLS would count those 10 workers among the thousands employed by the entire Starbucks Corporation even if hiring decisions are made at a local level based on local economic conditions.

The ADP separates those employees from the rest of the firm and labels it as a small business. Thus, a company like Starbucks may be counted as thousands of small- and medium-sized businesses instead of one giant one.

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As a result of using establishments and not EIN numbers for labeling firms, the ADP data show employees at small- and medium-sized businesses account for nearly 84% of the entire workforce. That is almost 55% larger than the BLS estimates.

Furthermore, all of the gains in employment since 2001 have been due to small business growth whereas most of the gains in the BLS data were from medium and large business.

The labor recovery following the Great Recession also looks different.

Small and medium-sized firms account for all of the growth following the recession. This follows the adage that small businesses lead the recovery. Following the trough in payrolls, large businesses only modestly recovered.

The aggregate payroll gains show an even more profound recovery in the small- and medium-sized business sectors compared to large firms.

Accounting for the Discrepancies between the BLS and ADP Data

On one hand, the ADP data show a classic labor market recovery with small-sized firms leading the way. On the other hand, the new BLS data reveal a labor recovery led by large firms.

It seems on the surface that the ADP and BLS data are revealing two different types of labor market recoveries. That, however, is really not the case.

When looking at the combined results, the recovery in the ADP and BLS data point toward large firms consisting of multiple small- and medium-sized locations as the leaders in the recovery.

The Starbucks analogy is a prime example of how that happened. Local coffeehouses are seeing a pickup in hiring. That adds payrolls to the small-sized firms in the ADP numbers and large-sized firms in the BLS data. Thus, both small- and large-sized firms can look like the main drivers of the labor market recovery.

The data are clearly not showing a typical recovery led by "mom and pop" small businesses like what happened following the 1990-91 and 2001 recessions.

Large businesses with only a few plants and/or locations have also not seen a sizable rebound in employment. This is surprising and suggests the strong employment data from the manufacturing sector may have not come from large producers. Likewise, large service providers such as law and financial firms are also dragging down large business employment growth.

Where is the Small Business Recovery?

The million dollar question is, why are typical small businesses not leaders in the current labor market recovery?

Unfortunately, there is no clear-cut answer.

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According to the January 2012 Senior Loan Officer Opinion Survey from the Federal Reserve, credit conditions have loosened since the end of the recession. However, conditions remain tight compared to how they were before the recession. Those that want funds may still be having a difficult time obtaining them.

At the same time, demand for loans from small firms has only recently turned positive. That may be due to still weak business conditions hindering growth or business being discouraged from attempting to get lending due to tight lending conditions.

In either case, growth in small business employment suffers.

New healthcare and financial regulations are also discussed as potential reasons for the lack of employment growth in small businesses. The data, however, do not support this view.

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The January 2012 Empire Manufacturing Survey asked respondents about expected hiring practices in 2012. Comments about uncertainty regarding regulations and health insurance are far down the list of problems for firms not planning on hiring this year.

By far, the most common complaint was that expected sales growth is low.

A similar report was conducted by the Philadelphia Fed in the January 2012 Business Outlook Survey. That report showed similar results with the most frequently cited reasons for not hiring being low sales growth expectations and keeping operating costs down.

Taken altogether, economic growth is the be-all end-all factor for small business gains.

Conclusion

The age-old adage of small businesses leading a labor market recovery following a recession has not happened.

Newly-published data from the BLS, combined with data from the ADP employment report, reveal that employment gains are primarily coming from large firms with multiple small- and medium-sized locations.

While the lack of growth from typical small businesses has been a headwind thus far, we expect to see a turnaround soon. As we pointed out in our February 3 report, "U.S. Economic Outlook: Growth Prospects, Full Speed Ahead," we see more upside potential than downside risk over the course of our economic outlook.

Thus, both business and credit conditions should continue to improve in the near term. That will shift small businesses from acting as a headwind into a tailwind, pushing overall employment gains higher.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.