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March 15, 2016
Collateral Requirements and Nonbank Online Lenders: Evidence from the 2015 Small Business Credit Survey
Businesses can secure a bank loan by offering collateral—typically a business asset such as equipment or real estate. However, the recently released 2015 Small Business Credit Survey (SBCS) Report on Employer Firms,conducted by seven regional Reserve Banks, found that 63 percent of business owners who had borrowed also used their personal assets or guarantee to secure financing. Surprisingly, the use of personal collateral was common not only among startups. Older and relatively larger small firms (see the following chart) also relied heavily on personal assets.
Source: 2015 Small Business Credit Survey
Note: "Unsure", "None", and "Other" were also options but are not shown on the chart.
Alternative lending options also exercised
Not every small business owner has sufficient hard assets, such as real estate or equipment, that can be used as collateral to secure a traditional bank loan or line of credit. For these circumstances, there are options such as credit cards and products offered by nonbank lenders (mostly operating online) that have less stringent underwriting requirements than banks. Many online nonbank lenders advertise unsecured loans or require only a general lien on business assets, without valuing those business assets.
In the 2015 SBCS, 20 percent of small firms seeking loans or lines of credit applied at nonbank online lenders. These lenders have a good reputation for quick application turnaround, and the collateral requirements can be looser than those applied by traditional lenders. But when borrowers were asked about their overall experience, only a net 15 percent of businesses approved at nonbank online lenders were satisfied (40.6 percent were satisfied and 25.3 percent were dissatisfied). In contrast, small banks received a relatively high net satisfaction score of 75 percent (see the chart).
Source: 2015 Small Business Credit Survey Report on Employer Firms
1 Satisfaction score is the share satisfied with lender minus the share dissatisfied.
2 "Online lenders" are defined as alternative and marketplace lenders, including Lending Club, OnDeck, CAN Capital, and PayPal Working Capital.
3 "Other" includes government loan funds and community development financial institutions.
The survey also showed that high interest rates were the primary reason for dissatisfaction at nonbank online lenders (see the chart).
Source: 2015 Small Business Credit Survey Report on Employer Firms
Note: Respondents could select multiple options. Select responses shown due to low observation count.
Merchant cash advances make advances
Most applicants to nonbank online lenders were seeking loans and lines of credit, but some were seeking a product that tends to be particularly expensive relative to other finance options: merchant cash advances (MCA). MCAs have been around for decades, but their popularity has risen in the wake of the financial crisis. Typically a lump-sum payment in exchange for a portion of future credit card sales, the terms of MCAs can be enticing because repayment seems easier than paying off a structured business loan that requires a fixed monthly payment. Instead, the lender is paid back as the business generates revenue, in theory making cash flow easier to manage.
One potential challenge for users of MCA products is interpreting the repayment terms. Instead of displaying an annual percentage rate (APR), MCAs are usually advertised with a "buy rate" (typically 1.2 to 1.4). For example, a buy rate of 1.3 on $100,000 would require the borrower to pay back $130,000. However, a percentage of the principal is not the same as an APR. The table below compares total interest payments made on a 1.3 MCA versus a 30 percent APR business loan repaid over 12 months and over six months. With a 12-month business loan, a 30 percent APR would equal total interest payments of roughly $17,000. With a six-month business loan, repayment would include about $9,000 in interest.
Because an MCA is structured as a commercial transaction instead of a loan, it is regulated by the Uniform Commercial Code in each state instead of by banking laws such as the Truth in Lending Act. Consequently, the provider does not have to follow all of the regulations and documentation requirements (such as displaying an APR) associated with making loans.
Converting a buy rate into an APR is not straightforward for many potential users, as was made clear in a recent online lending focus group study with small business owners conducted by the Cleveland Fed. When asked what the APR was on a $40,000 MCA that required a repayment of $52,000 (the same as a 1.3 buy rate), their answers were the following: (Product A is the MCA type of product; see the study for exactly how it was presented to respondents.)
Source: Federal Reserve Bank of Cleveland
The correct answer is that "it depends on how long it takes to pay back." For example, if the debt is repaid over six months, the APR would be 110 percent (as this calculator shows).
Nonbank online lenders can fill gaps in the borrowing needs of small business. But there may also be a role for greater clarity to ensure borrowers understand the terms they are signing up for. In a September 2015 speech, Federal Reserve Governor Lael Brainard highlights one self-policing movement already well under way:
Some have raised concerns about the high APRs associated with some online alternative lending products. Others have raised concerns about the risk that some small business borrowers may have difficulty fully understanding the terms of the various loan products or the risk of becoming trapped in layered debt that poses risks to the survival of their businesses. Some industry participants have recently proposed that online lenders follow a voluntary set of guidelines designed to standardize best practices and mitigate these risks. It is too soon to determine whether such efforts of industry participants to self-police will be sufficient. Even with these efforts, some have suggested a need for regulators to take a more active role in defining and enforcing standards that apply more broadly in this sector.
Many, but not all, nonbank online lenders have already signed the Small Business Borrower Bill of Rights. Results from the 2015 Small Business Credit Survey Report on Employer Firms can be found on our website.
February 20, 2015
Business as Usual?
Each month, we ask a large panel of firms to compare their current sales with "normal times." In our February survey, the firms in our panel reported their sales were approaching normal. Indeed, on average, larger firms (those with 100 or more employees) tell us sales levels this month were right at normal. But smaller firms, although improving, are still lagging their larger counterparts (see the chart).
These qualitative assessments suggest a continuation of the trend we've seen in our quarterly quantitative data (these data are compiled at the end of each quarter). In December, our panel of firms reported sales levels about 2.7 percent below normal—virtually identical to the Congressional Budget Office's estimate of the output gap. Here, too, our survey data show that on average, sales of the larger firms in our panel were essentially back to normal, but smaller firms were still reporting ample slack (see the chart).
Our next quantitative assessment of slack in U.S. business is due for release on March 20.
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January 15, 2015
Contrasting the Financing Needs of Different Types of Firms: Evidence From a New Small Business Survey
The National Federation of Independent Business's (NFIB) small business optimism index surpassed 100 in December, a sign that small business' outlook on the economy has now reached "normal" long-run average levels. But that doesn't mean that everything is moonlight and roses for small firms. One question from the NFIB's survey (one that is not used in its overall optimism index) concerns a firm's ability to obtain credit. The survey asks, "During the last three months, was your firm able to satisfy its borrowing needs?" The chart below shows the net percent (those responding "yes" minus those saying "no") of firms reporting improving credit access.
The chart suggests that credit access has improved significantly since the end of the recession but that conditions still appear to be tougher than typical. Given the importance of small firms to employment growth, we at the Atlanta Fed have been particularly interested in monitoring financing conditions for small businesses. For this reason, we've conducted a regular survey of small businesses in the Southeast since 2010. In the fall of 2014, we joined forces with the New York, Philadelphia, and Cleveland Feds to expand and refine the small business data collection effort. The results of that survey are now available on our website and include downloadable data tabulations by different types of firms. Specifically, data are available by criteria including states, industries, firm size (in terms of revenue), and firm development stage.
Our previous small business surveys have focused on the experiences of young firms, so I found the new survey's tabulation by firm development stage of particular interest. For example, here's a summary of the experience of startups' ability to access financing markets versus that of mature firms.
First, what constitutes a startup? For comparison purposes, we draw the line (somewhat arbitrarily) at less than five years old. For mature firms, they not only have to be at least five years old, but they also must have at least 10 employees and hold some debt. When I picture a startup, I imagine a new restaurant owner purchasing tables and chairs, or a tech company manufacturing a prototype to market to potential investors. These types of firms are unproven and risky and tend to need relatively small amounts of money. Which begs the question: where are they going to get funds they need to grow? Before answering that question, let's examine the recent business performance of startups in the survey. About half of startups operated at a loss during the previous 12 months, but only about 20 percent had shrinking revenues. Most were either increasing the size of their workforce or had the same number of employees as a year ago. The top challenge reported by these young businesses was nearly tied between "difficulty attracting customers" (reported by 27 percent of firms) and "lack of credit availability" (reported by 26 percent of firms).
So how do those behind startups fund their businesses? In 2013, nearly half relied primarily on personal savings, whereas about 18 percent primarily used retained business earnings. Without a solid revenue history to prove their creditworthiness, financing was understandably difficult to come by. Only about 38 percent of startups received at least some financing, compared with 93 percent of mature firms. Many startups assumed it would be a fruitless endeavor—about one-fifth of them assumed they would be turned down, the cost would be too high, or the search would be too time consuming. The number of people who sought financing was about equal to those who were discouraged, and most were seeking less than $250,000.
Where did they apply? Their search was much broader than used by their counterparts at mature firms. Although both types of firms sought mostly loans and lines of credit, applications for products backed by the Small Business Administration, credit cards, and equity investments were notably higher for younger firms compared to mature firms. When it came to loans and lines of credit, there were large differences not only in what types of insitutions they submitted applications to, but also where they were most successful. Startups were mostly likely to apply at large regional and large national banks, but their approval rates were higher with smaller banks and online lenders (see the table).
The differences between young firms and mature ones is only one way to look at the data. The full report details variations by firm size, industry, and state. For more on general business and finance conditions of small firms, visit the small business trends dashboard.
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May 20, 2014
Where Do Young Firms Get Financing? Evidence from the Atlanta Fed Small Business Survey
During last week's "National Small Business Week," Janet Yellen delivered a speech titled "Small Business and the Recovery," in which she outlined how the Fed's low-interest-rate policies have helped small businesses.
By putting downward pressure on interest rates, the Fed is trying to make financial conditions more accommodative—supporting asset values and lower borrowing costs for households and businesses and thus encouraging the spending that spurs job creation and a stronger recovery.
In general, I think most small businesses in search of financing would agree with the "rising tide lifts all boats" hypothesis. When times are good, strong demand for goods and services helps provide a solid cash flow, which makes small businesses more attractive to lenders. At the same time, rising equity and housing prices support collateral used to secure financing.
Reduced economic uncertainty and strong income growth can help those in search of equity financing, as investors become more willing and able to open their pocketbooks. But even when the economy is strong, there is a business segment that's had an especially difficult time getting financing. And as we've highlighted in the past, this is also the segment that has had the highest potential to contribute to job growth—namely, young businesses.
Why is it hard for young firms to find credit or financing more generally? At least two reasons come to mind: First, lenders tend to have a rearview-mirror approach for assessing commercial creditworthiness. But a young business has little track record to speak of. Moreover, lenders have good reason to be cautious about a very young firm: half of all young firms don't make it past the fifth year. The second reason is that young businesses typically ask for relatively small amounts of money. (See the survey results in the Credit Demand section under Financing Conditions.) But the fixed cost of the detailed credit analysis (underwriting) of a loan can make lenders decide that it is not worth their while to engage with these young firms.
While difficult, obtaining financing is not impossible. Over the past two years, half of small firms under six years old that participated in our survey (latest results available) were able to obtain at least some of the financing requested over all their applications. This 50-percent figure for young firms strongly contrasts with the 78 percent of more mature small firms that found at least some credit. Nonetheless, some young firms manage to find some credit.
This leads to two questions:
- What types of financing sources are young firms using?
- How are the available financing options changing?
To answer the first question, we pooled all of the financing applications submitted by small firms in our semiannual survey over the past two years and examined how likely they were to apply for financing and be approved across a variety of financing products.
Applications and approvals
While most mature firms (more than five years old) seek—and receive—financing from banks, young firms have about as many approved applications for credit cards, vendor or trade credit, or financing from friends or family as they do for bank credit.
The chart below shows that about two-thirds of applications on behalf of mature firms were for commercial loans and lines of credit at banks and about 60 percent of those applications were at least partially approved. In comparison, fewer than half of applications by young firms were for a commercial bank loan or line of credit, fewer than a third of which were approved. Further, about half of the applications by mature firms were met in full compared to less than one-fifth of applications by young firms.
In the survey, we also ask what type of bank the firm applied to (large national bank, regional bank, or community bank). It turns out this distinction matters little for the young firms in our sample—the vast majority are denied regardless of the size of the bank. However, after the five-year mark, approval is highest for firms applying at the smallest banks and lowest for large national banks. For example, firms that are 10 years or older that applied at a community bank, on average, received most of the amount requested, and those applying at large national banks received only some of the amount requested.
Half of young firms and about one-fifth of mature firms in the survey reported receiving none of the credit requested over all their applications. How are firms that don't receive credit affected? According to a 2013 New York Fed small business credit survey, 42 percent of firms that were unsuccessful at obtaining credit said it limited their business expansion, 16 percent said they were unable to complete an existing order, and 16 percent indicated that it prevented hiring.
This leads to the next couple of questions: How are the available options for young firms changing? Is the market evolving in ways that can better facilitate lending to young firms?
When thinking about the places where young firms seem to be the most successful in obtaining credit, equity investments or loans from friends and family ranked the highest according to the Atlanta Fed survey, but this source is not highly used (see the first chart). Is the low usage rate a function of having only so many "friends and family" to ask? If it is, then perhaps alternative approaches such as crowdfunding could be a viable way for young businesses seeking small amounts of funds to broaden their financing options. Interestingly, crowdfunding serves not just as a means to raise funds, but also as a way to reach more customers and potential business partners.
A variety of types of new lending sources, including crowdfunding, were featured at the New York Fed's Small Business Summit ("Filling the Gaps") last week. One major theme of the summit was that credit providers are increasingly using technology to decrease the credit search costs for the borrower and lower the underwriting costs of the lender. And when it comes to matching borrowers with lenders, there does appear to be room for improvement. The New York Fed's small business credit survey, for example, showed that small firms looking for credit spent an average of 26 hours searching during the first half of 2013. Some of the financial services presented at the summit used electronic financial records and relevant business data, including business characteristics and credit scores to better match lenders and borrowers. Another theme to come out of the summit was the importance of transparency and education about the lending process. This was considered to be especially important at a time when the small business lending landscape is changing rapidly.
The full results of the Atlanta Fed's Q1 2014 Small Business Survey are available on the website.
By Ellyn Terry, an economic policy analysis specialist in the Atlanta Fed's research department
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February 26, 2014
The Pattern of Job Creation and Destruction by Firm Age and Size
A recent Wall Street Journal blog post caught our attention. In particular, the following claim:
It’s not size that matters—at least when it comes to job creation. The age of the company is a bigger factor.
The following chart shows the average job-creation rate of expanding firms and the average job-destruction rates of shrinking firms from 1987 to 2011, broken out by various age and size categories:
In the chart, the colors represent age categories, and the sizes of the dot represent size categories. So, for example, the biggest blue dot in the far northeast quadrant shows the average rate of job creation and destruction for firms that are very young and very large. The tiny blue dot in the far east region of the chart represents the average rate of job creation and destruction for firms that are very young and very small. If an age-size dot is above the 45-degree line, then average net job creation of that firm size-age combination is positive—that is, more jobs are created than destroyed at those firms. (Note that the chart excludes firms less than one year old because, by definition in the data, they can have only job creation.)
The chart shows two things. First, the rate of job creation and destruction tends to decline with firm age. Younger firms of all sizes tend to have higher job-creation (and job-destruction) rates than their older counterparts. That is, the blue dots tend to lie above the green dots, and the green dots tend to be above the orange dots.
The second feature is that the rate of job creation at larger firms of all ages tends to exceed the rate of job destruction, whereas small firms tend to destroy more jobs than they create, on net. That is, the larger dots tend to lie above the 45-degree line, but the smaller dots are below the 45-degree line.
As pointed out in the WSJ blog post and by others (see, for example, work by the Kauffman Foundation here and here), once you control for firm size, firm age is the more important factor when measuring the rate of job creation. However, young firms are more dynamic in general, with rapid net growth balanced against a very high failure rate. (See this paper by John Haltiwanger for more on this up-or-out dynamic.) Apart from new firms, it seems that the combination of youth (between one and ten years old) and size (more than 250 employees) has tended to yield the highest rate of net job creation.
By John Robertson, a vice president and senior economist in the Atlanta Fed’s research department, and
Ellyn Terry, a senior economic analyst in the Atlanta Fed's research department
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November 15, 2013
Is Credit to Small Businesses Flowing Faster? Evidence from the Atlanta Fed Small Business Survey
The spigot of credit to small businesses appears to be turning faster. As of June 2013, outstanding amounts of small loans on the balance sheets of banks were 4 percent higher than their September 2012 levels, according to the Federal Deposit Insurance Corporation. While they are still 12 percent off 2007 levels, the recent increase is encouraging.
The turnaround in small loan portfolios is not the only sign of improved credit flows to small businesses. The Fed’s October 2013 senior loan officer survey indicates that credit terms to small firms have gradually eased since the second quarter of 2010. Approval ratings of banks and alternative lenders, as measured by Biz2Credit’s lending index, have also risen steadily over the past two years.
In addition to these positive signs, the Atlanta Fed’s third-quarter 2013 Small Business Survey has revealed signs of improvement among small business borrowers in the Southeast. The survey asked recent borrowers about their requests for credit and how successful they were at each place they applied. We also asked, “Over ALL your applications for credit, to what extent were you total financing needs met?” This measure of overall financing satisfaction showed some signs of improvement in the third quarter.
Chart 1 compares the overall financing satisfaction of small business borrowers in the first and third quarter of 2013. The portion of firms that received the full amount requested rose from 28 percent in the first quarter to 42 percent in the third quarter. Meanwhile, the portion that received none of the credit requested declined from 31 percent of the sample in the first quarter to 22 percent in the third quarter.
Further, financing satisfaction rose across a variety of dimensions. Chart 2 shows how average financing satisfaction changed for young firms and mature firms, across industries and by recent sales performance. In all cases, there were increases in the average amount of financing received from the first to the third quarter of 2013.
This broad-based increase in overall financing satisfaction is encouraging. Greater financial health of the applicant pool helped fuel the improvement in borrowing conditions. In the October survey, 52 percent of businesses reported that sales increased while 34 percent reported decreases. Sales have improved significantly from a year ago, when about as many firms reported sales increases as reported decreases. Measures of hiring and capital improvements over the year have also improved for the average firm in the survey (see chart 3).
Lending standards have been improving and small businesses have been slowly gaining momentum, but many obstacles remain. Open-ended questions in our survey revealed that small businesses are still concerned about a number of factors, including the general political and economic uncertainty, the impact of the Affordable Care Act, the higher collateral and personal guarantees required to obtain financing, and regulatory requirements that restrict lending. So while conditions on the ground seem to be improving for small businesses, there still appear to be headwinds that may be holding back a greater pace of improvement.
By Ellie Terry, an economic policy analysis specialist in the Atlanta Fed’s research department
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October 04, 2013
Certain about Uncertainty
The Bloom-Davis index of Economic Policy Uncertainty hit 162 in September, up from 102 in August and the highest level seen since December 2012. With all this uncertainty, we can be certain that the events surrounding the government shutdown are having an impact.
This notion of increased uncertainty is captured nicely in our most recent poll of small businesses in the Southeast (past results available here), which went live on September 30, the day before the government shutdown. Although the survey is still out in the field, some early results show:
- Most firms are expressing more uncertainty (see the chart),
- For a significant portion of firms, uncertainty today is having a greater impact than six months ago, and
- The government is heavily featured as a source of the uncertainty.
Of course, what we really care about is whether higher uncertainty is affecting economic activity. When asked, 45 percent of our respondents indicate that uncertainty is in fact having a greater impact on their business than six months ago, up from 37 percent in the first-quarter 2013 survey (relative to fall 2012). Further, fewer firms so far have indicated that uncertainty is having less of an impact. In the current survey, 9 percent of firms have reported less of an effect, compared with 16 percent at the close of last April's survey.
And what are the sources of uncertainty, as seen by our panel of businesses? Eighty-percent of participants have responded to our open-ended question about the primary source(s) of uncertainty. The following "word cloud" summarizes their views:
We will get more responses to the survey over the next week or so, and these may show a different picture. But we're pretty certain of one thing—the duration of the current fiscal impasse in Washington will make a difference.
By John Robertson, vice president and senior economist, and
Ellyn Terry, economic policy analysis specialist, both in the research department of the Atlanta Fed
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June 07, 2013
The Hiring Forecasts of Small Firms: Will the Pace of Employment Growth Pick Up?
The U.S. Bureau of Labor Statistics (BLS) announced today that the U.S. labor market added 175,000 payroll jobs in May, continuing a trend of steady but disappointingly slow employment growth. The employment recovery has been even slower among small firms. Will it pick up in the coming 12 months? Results from the Atlanta Fed's latest survey of small businesses in the Southeast suggest that employment growth among small firms will continue but not necessarily at a faster pace.
Since the recession began, changes in employment have been asymmetric across firm size. In contrast to large firms, employment at small and medium sized businesses began decreasing earlier, declined more, and, by last March, was a little further from its prerecession level. As of the first quarter of 2012, employment at firms with fewer than 500 employees was 5 percent below prerecession levels, compared to just 2 percent for firms with more than 500 employees. So why is employment at small firms not recovering as quickly as employment at large firms? Is it poised to accelerate and perhaps catch up?
While the Business Employment Dynamics data series from the BLS only go through first-quarter 2012 (chart 1), we can use our semi-annual survey of small business in the Southeast to find out a little more about the experiences of small firms through first-quarter 2013 as well look at their forecasts through the first quarter of 2014. Four-hundred-seventy-eight firms across the industry and age spectrum participated in the first-quarter 2013 survey, which was conducted during the first three weeks in April. Although the survey is not a random sample, the results are weighted to make them more representative of a national distribution.
When asked about changes in employment over the period Q1 2012 to Q1 2013, employer firms on net said there was almost no change. Slightly more than 40 percent of firms said they had not altered employment levels. The remainder of the responses were distributed pretty evenly between "expansion" and "contraction". As you can see in chart 2, the distribution of firms creating jobs was almost a mirror image of the distribution of firms shedding jobs in terms of the magnitude of change.
In addition to asking about changes during the past 12 months, the survey probed small firms about their expectations for the coming 12 months. Using the power of our panel data set, we can compare the expectations of firms that took the survey exactly one year ago with their actual hiring activity during that time period to determine how accurately firms predict what the future holds and whether these hiring plans are indeed good forecasts of future activity.
As it turns out, the 184 firms participating in both surveys came pretty close to meeting their hiring expectations. However, they did tend to overestimate the extent to which employment would increase (or underestimate the extent to which it would decrease), regardless of how well firms were performing at the time they made their forecast (see chart 3). For example, firms that had recently experienced reductions in their workforce expected the greatest positive change in the pace of hiring, and in fact went on to report the highest actual change during this period. Firms that had not changed their employment levels recently or had changed them by up to 10 percent expected very little growth—on average, they achieved just slightly less than expected. Regardless of how well the firm had recently performed (in terms of employment growth in the previous period), the degree to which hiring increased or downsizing decreased was less pronounced than anticipated.
Small firms are reasonably good at predicting the direction and relative magnitude of their employment growth, but on average tend to overestimate. For this reason, it might be useful to examine changes in the hiring expectations index (as opposed to changes in the pace of employment growth) when trying to understand how the forecast of firms participating in the survey might translate into actual employment growth of small firms in the Southeast.
Chart 4 shows the hiring index of firms across four broad industry groups. In the first quarter of 2013, the index for hiring in the coming 12 months was essentially unchanged from the Q3 2012 survey, and significantly below that of the Q1 2012 survey. The only industry whose employment forecast was notably positive was the construction and real estate industry. Firms in that category have been steadily increasing their hiring forecasts since the third quarter of 2011.
The fact that hiring expectations did not improve in the first-quarter survey leads to another, perhaps more important question: Why didn't they?
One contributing factor that could be having a particularly large impact on hiring expectations is rocky sales. Firms may be less willing to hire if they are uncertain about the future or if they do not expect consistent sales growth. Indeed, by looking at the experiences of firms in the past 12 months, we can tell that there is a clear correlation between rising sales and rising employment. As chart 5 shows, half of employer firms reported a recent rise in sales, and the more sales had risen, the more likely firms were to have increased their workforce.
A couple of questions that arise from chart 5 are: What about the firms that recently experienced sales growth but didn't hire? Are they planning to hire in the coming 12 months? About one-third of firms say "yes". One driving factor in that decision appears to be sustained sales growth; another is reduced uncertainty. As chart 6 makes apparent, the sales expectations of firms in this group is higher on average for the one-third of firms that say they do plan to hire in the coming 12 months than for the two-thirds who do not. All the firms in the hiring group also expect sales growth to continue, with the most common response being greater than 10 percent growth. In contrast, while 77 percent of firms in the not-hiring group anticipate sustained sales growth, the group’s most common response was lower than that of the hiring group: 1 percent to 5 percent.
Another factor that may be related to hiring is reduced uncertainty. Employer firms experiencing sales growth in the past 12 months are more likely to anticipate hiring if they perceive a decrease in uncertainty compared to six months ago. Seventy percent of firms that had a recent increase in sales and decreased uncertainty concerns relative to six months ago anticipate hiring in the coming year. In contrast, 46 percent of those who had experienced a recent increase in sales but also perceived heightened uncertainty anticipate hiring.
For now, the results suggest that uncertainty and rocky sales growth are negatively affecting the hiring plans of small firms and, unfortunately, that small firms are not likely to increase their rate of hiring in the next 12 months. However, if uncertainty eases and sales growth continues, small firms will likely revisit their hiring plans and the pace of hiring just might improve.
By Ellyn Terry, a senior economic analyst in the Atlanta Fed's research department
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February 15, 2013
Promoting Job Creation: Don't Forget the Old Guys
In a provocative article posted this week, the American Enterprise Institute's James Pethokoukis concludes that the state of entrepreneurship in the United States is, disturbingly, weaker than ever. In particular, Pethokoukis documents a decline in jobs created by establishments less than one year old, a trend that began before the 2001 recession and has continued more or less unabated since. He specifically cites the following symptoms of trouble:
- Had small business come out of the recession maintaining just the rate of start-ups generated in 2007, according to McKinsey, the U.S. economy would today have almost 2.5 million more jobs than it does.
- There were fewer new firms formed in 2010 and 2011 than during the Great Recession.
- The rate of start-up jobs during 2010 and 2011—years that were technically in full recovery—were the lowest on record, according to economist Tim Kane of the Hudson Institute.
That last point appears to be all the more ominous given this observation from Tim Kane:
"...that startups create essentially all net new jobs. Existing employers, it turns out, tend to be net job losers, averaging net losses of 1 million workers per year."
Pethokoukis makes his case with political commentary that we don't endorse and don't find particularly helpful. But we won't argue with his conclusion that more entrepreneurial start-up activity would be a good thing. Nonetheless, we get a little concerned when the conversation jumps from data on net job creation and the role of start-ups and early life-cycle firms, and moves on to policy conclusions that seem to disproportionately focus on that class of businesses specifically.
Here is the source of our concern: Though it is also tempting to lump all "existing employers” into the basket of net job destroyers, there are existing firms that create jobs, and a few are doing so on a very large scale.
Take 2006, for instance. Based on data from the Commerce Department called Business Dynamics Statistics (BDS), new firms (businesses with a payroll that existed in March 2006 but not in March 2005) had about 3.5 million employees. This is the large net job creation by new firms reported by Kane. However, over the same year, expanding firms more than 10 years old added a whopping 11 million jobs—about three times as many jobs as created by new firms. Of course, some older firms were downsizing or closing—contracting mature firms destroyed an estimated 10 million jobs. So the net number of jobs created by older established firms looks somewhat less impressive than the record of those young start-ups. But in the overall picture, were the 11 million jobs created by the expanding older businesses really less important than 3.5 million created by the newbies?
It turns out that older firms also account for a large fraction of the job creation occurring in fast-growing firms, arguably a better characterization of entrepreneurism than newness. We found some compelling evidence reported in recent research by Akbar Sadeghi, James Spletzer, and David Talan. Using data from the U.S. Bureau of Labor Statistics' Business Employment Dynamics (BED), Sadeghi, Spletzer, and Talen find that older firms (those at least 10 years old) accounted for more than 40 percent of the employment created by high-growth firms (those with at least 20 percent annual employment gains between 2008 and 2011). A similar conclusion about the role of older, fast-growing firms is found in this earlier Kauffman Foundation report based on BDS data looking at the 1 percent of fastest-growing firms in the United States.
The point is not that start-up entrepreneurial activity is unimportant. It is vitally important. But in larger terms, we should recognize that all entrepreneurial activity is important, no matter what the age of the firm in which it occurs. Atlanta Fed President Dennis Lockhart highlighted this point in a speech delivered earlier this week at Instituto de Empresas in Madrid, Spain:
My bank's experience in trying to understand the role of small businesses, small-growth businesses, young businesses, and mature-growth businesses in job creation illustrates a key point, I think. In the pursuit of economic growth and increased employment, there is no silver bullet. Rather, the policy community should be pursuing an effective mix of policy elements (with focus in areas such as new business formation, labor rules, and regulatory efficiency, to name a few) that together catalyze a virtuous circle of innovation, growth, and employment.
Certainly, entrepreneurial risk-taking, whether by large, mature businesses or start-ups aimed at becoming growth companies, is part of the solution.
When it comes to promoting job creation, forgetting to throw mature businesses into the mix with start-ups is surely not the path to finding the best policy solutions.
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February 05, 2013
2013 Business Hiring Plans: Employment, Effort, Hours, and Fiscal Uncertainty
How much is fiscal uncertainty holding back hiring? The answer seems to depend on whom you ask. Early in January, the Atlanta Fed spoke to 670 businesses in the Southeast about employment. Conditional on the respondents’ 2013 hiring plans (expand, hold steady, or contract), the following set of charts summarizes the results for how the businesses viewed activity relative to their own interpretation of “normal” along three dimensions: their current employment level, the amount of effort required from their staff per hour, and the average hours worked per employee. These questions were modeled on questions asked in the Atlanta Fed’s December 2012 Business Inflation Expectations Survey. In the following three charts, the green bars represent firms that said they planned to expand employment in 2013. The grey bars represent firms that said they did not plan to change their employment level in 2013, and the red bars represent firms that planned to reduce employment in 2013.
The first chart shows the results for current employment. Regardless of hiring plans over the next 12 months, most firms said they were currently at or below normal employment levels. Those planning on increasing employment over the next 12 months were a bit more likely to say they have already surpassed normal levels of employment than other firms, while those looking to shed employees were very likely to say their employment level is below normal employment levels.
Chart 2 shows that businesses are generally pushing hard along the effort dimension. Firms were quite likely to say that their staff’s effort per hour worked was currently at or above normal, whether or not they were planning to change employment in 2013.
Chart 3 shows that firms planning to expand were very likely to say that average hours worked were at or above normal (28 percent said hours were above normal, 60 percent about normal), whereas firms planning to contract were more likely to say that hours were at or below normal (48 percent about normal, 39 percent below normal).
Taken together, these results suggest that some firms are approaching the limit of how far they can go along the intensive margins of effort and hours before they have to hire more workers. With effort elevated, as more firms increase average hours worked to above-normal levels, one might expect more hiring to follow.
Each business was also asked how uncertainty about future fiscal policy was affecting its hiring plans. Firms planning to reduce employment tended to cite fiscal uncertainty as having a negative impact on their hiring plans. However, for those firms, hours also tended to be well below normal, so it is unlikely that removing fiscal uncertainty would move many of those firms into expansion mode (although it may help stabilize their outlook).
In contrast, fiscal uncertainty was generally viewed as having less impact by those planning to expand employment and those planning to hold employment levels steady. Presumably, reducing fiscal uncertainty would move some of the firms planning to hold steady into expansion mode, and those planning to expand would do so a bit more. To get some idea of this potential, Chart 4 shows the responses by firms who reported above-normal effort per hour and above-normal average hours worked. About 40 percent of those businesses said that fiscal uncertainty had caused them to scale back their hiring plans.
It is unclear whether eliminating fiscal uncertainty would have a big impact on the hiring plans of these firms. But these results suggest that it sure couldn’t hurt.
By John Robertson, vice president and senior economist, and
Ellyn Terry, a senior economic analyst in the Atlanta Fed's research department
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