The missing piece of hiring puzzle? Customers

Gail MarksJarvis

August 25, 2010

What’s stopping small businesses from hiring?

One popular storyline of the recession is that small businesses, which employ about half the work force, are afraid to hire because they don’t know what health care overhaul and tax changes will mean. Based on that narrative, some stock market observers have been predicting that the November election will finally be a turning point — erasing uncertainty about politics and at last freeing the stock market to climb.

But analysts who have delved into business decision-making are shooting holes in that assertion. They see a simpler truth.

Unless companies see customers showing up in greater numbers, hiring is not going to materialize, says JPMorgan Securities economist Gabriel de Kock.

“A shift in the balance of power after the November congressional elections will have a very modest sustained positive impact on economic growth and job creation, unless such a shift drives policy change that directly boosts aggregate demand,” he said. “By the same token, while risk markets could bounce after the election, any broad-based gains may be short-lived.”

To test the assertion that taxes and other political factors are weighing down employment decisions, de Kock analyzed surveys of small-business owners done by the National Federation of Independent Business over the last 37 years.

“The results are unambiguous,” de Kock said. “They overwhelmingly indicate that weak demand, rather than government policies, accounts for firms’ reluctance to expand.”

That’s been true historically and recently. As he dug into small-business sentiment since 2005, he found that taxes and regulation drove only 12 percent of the reluctance of small-business owners to expand, while weak demand accounted for 87 percent.

In other words, to use a slogan from the Clinton/Bush election, de Kock concluded: “It’s the economy, stupid! And only about a sixth is: It’s Washington, stupid.”

That leaves scant hope for a quick uptick in hiring. Although there was a slight upturn in small-business sentiment measured by the NFIB recently, economists have noted a broad slowdown in economic indicators during the last few months. Goldman Sachs economist Jan Hatzius is forecasting that real gross domestic product will grow at only a 1.5 percent annualized rate in the second half of 2010 and early 2011. He thinks the U.S. Commerce Department will announce on Friday that real GDP grew at just a 1.1 percent annualized rate in the second quarter, although 2.4 percent was previously estimated.

According to de Kock’s research, small businesses respond primarily to the economy when deciding whether to buy equipment like computers or hire new employees. And their focus is on weak sales.

Jacques Eady, a Heartland Payment Systems manager who advises restaurant owners and other small businesses, said “what stops business from hiring is sales. If they think they can move to the next level and get more business by hiring, they will do it.”

Most, he said, have been using incentives to attract customers and haven’t felt comfortable hiring yet.

Still, Ashley Bolivar, sole proprietor of Magnetic Marketing Solutions in Chicago, recently hired the first two employees for his Web development business.

“I was scared to death to hire help in this economy,” he said. “But since the business growth was there, I did it.”

Despite recent concerns about the economy, Morgan Stanley economists David Cho and Richard Berner say more companies appear to be willing to spend on new equipment than new employees. In a recent survey of analysts, the firm found that 39 percent think companies will boost fixed investment over the next three months while a quarter expect payrolls to expand.

Only 5 percent said uncertainty over health care overhaul was making companies reluctant to hire. About 20 percent said uncertainty over taxes was prompting managers to hesitate on any expansion.

Larger concerns for the businesses included stock market volatility, finding potential employees with the skills needed and fear that investors would sell the stock if companies expanded.

Cho and Berner said in a report: About a third of the companies that had announced expansions were penalized by the stock price falling — a result of investors selling shares.

“Investors want managers to be disciplined stewards of their capital and will punish undisciplined corporate behavior,” the economists said. “To the extent that these findings are representative of the broader economy, it is conceivable that firms will remain cautious until the outlook becomes more certain.”