Economic performance is largely a self-fulfilling prophecy. If business owners believe that the economy will get better in the future, they act in ways that lead to economic growth: They buy products, hire employees, expand inventories, and make investments. If they don't, well, we know what happens: Few take those actions that are crucial to growth. While everybody's optimism matters, from rank-and-file workers to Fortune 500 company executives, small business owners' outlooks are of particular importance because their businesses account for more than half of nonagricultural private economic production in the U.S., according to the Small Business Administration. Without expansion in this sector, economic growth is anemic at best. Statistical analysis confirms this view, showing that the level of small business optimism is a solid predictor of future growth.
At the moment, small business owners are very pessimistic. In September, Discover Card reported that its Small Business Watch confidence index, a measure created from its monthly survey of 750 small business owners, was at 73.8, only slightly higher than its record low the month before.The National Federation of Independent Business's most recent optimism index, a monthly measure of several hundred NFIB members' expectations about their economic future, shows they have been pessimistic for close to two and a half years, a persistence of gloominess unprecedented for this generally optimistic bunch.
The prolonged pessimism small business owners are currently expressing is in dramatic contrast to their views during 1981 and 1982—the last truly awful recession. Back then, even when unemployment jumped to 10.8 percent, the NFIB Small Business optimism index dropped below 90 for only a single quarter and then rocketed to record heights in early 1983 when the expansion began. In contrast, the index has been above 90 in only four of the past 28 months and is a mere 0.9 points above its level in June 2009, when the recent recession ended.
Problem of "Unusual Uncertainty"
While optimism triggers the self-fulfilling prophecy of economic growth, uncertainty kills optimism. Stated in plain English, it's hard to have confidence that the future will be good if you have no idea what the future will look like. Many small business owners certainly fall into this camp: They are unsure what effect the health-care law will have on their future operations. They don't know how much time they will have to spend on paperwork to adhere to new regulations or what their health-care costs will be under the new regime. Many believe that taxes are likely to increase as the government tries to bring down our massive deficits. But most business owners don't know if the increases will fall on them, or, if they do, how large a tax increase they will face.
To many in the small business sector, America appears to be entering a new era of regulation in which the government increases oversight on many aspects of business. But few, if any, can predict what all these new regulations will cover or how they will affect individual businesses. Unable to form accurate expectations about the future, small business owners can't expect the best possible outcomes. Lacking optimism, many small business owners are choosing to wait rather than hire, build inventories, expand operations, or invest in new property and equipment. Of course, the reticence of small business owners to act has led to sluggish economic growth.
A Simple Policy Recommendation
If policymakers want small businesses to participate in the economic recovery, they need to revive the business owners' optimism. That optimism won't come back as long as our economic future remains so uncertain. So my recommendation to policymakers is simple. Make a credible commitment to reduce the uncertainty facing small businesses. Promise them that their taxes won't increase and that they won't face new regulations or major changes in how they operate until after the 2012 Presidential election, at the earliest.
While reducing economic uncertainty won't guarantee a return to optimism among small business owners—the problems in the real estate sector might preclude an increase for a very long time—it's necessary if we want to encourage positive expectations. If Federal Reserve Chairman Ben Bernanke, with all the data and forecasting expertise he has access to, believes that our economic future is "unusually uncertain," how can we expect most small business owners to have enough confidence in their economic futures to hire, invest, and take other steps to expand?