August 12, 2011

Just like in the 1970s, today’s economy faces a stagnant stock market—the S&P 500 has not grown in over a decade, weak economic growth, weak employment growth and rising inflation risks. But not all small businesses will face the same difficulties during this weak economic environment. The appropriate strategy to managing through the weak economy varies depending upon the industry of each small business.

The slow-growth environment

Even with yesterday’s slightly positive unemployment insurance claims report (and the disproportionate response by Wall Street) the current economic recovery is tepid at best.  As such, the recovery will be unable to gain traction over the next two years—a belief the Federal Reserve appears to share given their promise to hold rates at essentially zero for the next two years. The economic environment will likely remain weak over the next two years because:

• Consumption growth will remain weak
• Investment demand will remain weak
• Government policies are wrong headed

Weak consumption growth

Consumers are currently in the process of de-leveraging and also face a high unemployment rate that shows no sign of abating, continued pressure on housing prices, falling pension wealth and looming tax increases. It is, consequently, unreasonable to expect anything but limited consumption growth over the next several years.

Weakening investment demand

The banking sector is still working off the troubled real estate loans from the recent housing bubble—which still likely has further to fall. Under these conditions, C&I loans— a key source of financing for businesses, especially small businesses—will not likely experience robust growth despite the recovery C&I loans have made from its bottom during the depths of the recession. Investment capacity will be limited under these conditions.

Rising inflation pressures

The Federal Reserve has printed an unprecedented amount of money. They have in fact more than doubled the amount of money that exists in the economy by some measures. Draining this money, when boiled down to its basics, requires the Fed to sell nearly $1.6 trillion of U.S. Treasuries and mortgage-backed securities. Unless this is flawlessly executed, continued rising price pressures (e.g. inflation) will be the likely result.

Concurrently, the dollar will continue to weaken against other currencies; and, due to the dollar’s central role, a weak U.S. dollar goes hand-in-hand with rising commodity prices including oil, gold, and other industrial commodities. Rising commodity prices, of course, creates further pressure on inflation.

Anti-growth fiscal environment

Following the financial crisis, the federal government increased spending in the U.S. economy from around the historical average of around 20 percent of GDP to 25 percent of GDP. The result—since tax revenues actually plummeted due to the recession—is the large government budget deficits we have seen since 2008. These large deficits are now a drag on the economy that will strain firms via investment crowding out and the threat of higher taxes.

Implications for small businesses

For small businesses the economic recovery implies higher costs due to rising commodity and general inflationary pressures.  Impending cost increases from the higher regulatory burdens (e.g. health care reform) will also be problematic. The result will be a higher overall cost of doing business for small businesses.

The weaker consumption and investment growth also implies continued pressure on top-line revenue growth. Weaker top-line revenue growth coupled with rising cost pressures will create significant pressure on small business profits. These profit pressures will be worse for small businesses than large businesses as small businesses are less able to diversify their operations internationally—part of the reason why large business profits are doing so well while returns for smaller businesses have been much less robust.

Industry implications

These cost and pricing pressures will need to be managed differently depending upon which industry a small business operates. Summarizing these differences for several key industries:

• The construction industry will face higher costs combined with lower demand

• The manufacturing industry will benefit from the weaker dollar, but will also face rising costs

• The retail and wholesale industry will face large top-line revenue pressures from the weak consumer

• The professional and business services industry are well-positioned to manage costs and experience revenue growth

• The health care industry faces very favorable trends both in terms of demographics and the new regulations that will lead to growth opportunities (at the cost of other areas of the economy, however)

• The private education industry will likely experience growth due to the rising employment retraining needs

• The mining industry will benefit from the rising commodity prices

Wayne Winegarden, Ph.D. is a Managing Director at Laffer Associates.  Dr. Winegarden manages Laffer Associates consulting practice that assesses the consequences of economic and policy trends for clients.  Clients vary from large corporations, small businesses, state and local governments, and policy associations.  Dr. Winegarden received his Ph.D. from George Mason University.

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Join the conversation ( 5 )

• Drewry News Network 4 months ago

  

  I am looking forward to the economy clearing up and business increasing for everyone in 2012 and for years to come :-)http://www.DrewryNewsNetwork.com

• Michael Reaves 8 months ago

  

  I would have been interested in a paragraph or two about the expectation of small business to be nimble, to take advantage of innovation, to shift market focus, for take advantage of lower employee cost. The assessment is excellent. The missing component is what astute decision makers can do to lessen the impact that this anti-growth economy. I would have like to see speculation on utilization of social media, smart phones small run manufacturing lines, outsourcing, and a host of similar non-convential potential actions. However, I do appreciate the article.

• Marsha Anderson 9 months ago

  

  So you wake one day and the hell is still in it, and the crocodile says: "I have three types of tears for sale, salty, sour, or sweet"..........

• Mark W 9 months ago

  

  It is an excellent article. I am a small business owner and fortunately we expanded to international sales 4 years ago. Today they are outpacing our sales in the States. Internally we are suffering from an anti business administration who used the rational that only the Government was big enough to fix the problem. They are the problem, and as illustrated they have only made things worse, not better.

• Scott Roen 9 months ago

  

  Interesting article Dr. Winegarden, thanks for sharing your thoughts! Good to see the differences by industry. Even with all the challenges, I still hear a lot of optimism from business owners, will be interested to see what others on OPEN Forum think...