Tuesday, January 14, 2020

Small Business Doing Its Part To Sustain Economic Growth

In August 2018 the NFIB Small Business Optimism Index hit a high of 108.8. Since then the NFIB Index has declined to 102.7 as reported in the December NFIB Small Business Optimism report today. In January 2018 though, the NFIB Index level was 101.2 and today's reading shows an improving trend. Noted in the December report was the fact "an increased number of small business owners reported better business conditions and expect higher nominal sales in the next three months. While frequency of plans to raise compensation fell 2 points, it remains one of the highest readings in the survey’s 46-year history. Small businesses continued to hire and create new jobs with actual job creation matching November’s reading, the highest since May."

Some commentary in the report are noting the three point drop in "Cost of Labor" on the NFIB's list of "single most important problem." Although the magnitude of the drop is large from a historical perspective, the absolute number is about average for this reading.

Overall the report does suggest a tight labor market remains as an important issue for small businesses. As the below panel of charts show, labor quality remains a problem (top panel) and the percentage of firms expecting to increase compensation versus decrease compensation (lower panel)  remains high at 24%.

The significance of labor cost can be seen in the below chart of average hourly earnings. When the year over year percentage increase in average hourly earnings exceeds 4%, this tends to be one variable to take into account as a potential recession indicator. A recent report from Cornerstone Macro notes, "accelerating wage gains squeeze profit margins, induce job cuts, and ultimately lead to recession."

Commensurate with the earlier chart noting the decline in "cost of labor" as a small business issue is the fact the Labor Force Participation Rate (LFPR) for workers between the age of 25-54 years old continues to increase. This reverses a decline mostly in place since the end of the recession in 2002. Importantly, the LFPR has room to trend higher to near 85% before labor supply likely becomes too tight and places upward pressure on wages.

In short, the NFIB report today is broadly a favorable one. As written in the report, "overall, the Main Street economic machine continued to push the economy forward."

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