AMERICA´S ECONOMY : AN UNCERTAIN OUTLOOK FOR MAIN STREET, USA / THE FINANCIAL TIMES MARKET ANALYSIS( A MUST READ )

September 14, 2011 8:35 pm

America’s economy: An uncertain outlook for Main Street, USA

By Hal Weitzman

Putting struggling small businesses back to work has been placed at the heart of the quest for growth – and for a president under pressure, the political stakes are as high as the economic ones, writes Hal Weitzman

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If Lee Muns does not secure a contract in the next two weeks he will be forced to close the business he started in 1989, putting himself and six employees out of work. His company, based in Beech Island, South Carolina, manufactures and installs industrial pipes. It completed its last project in November and has had no work since then.


To try to keep Muns Welding alive, he sacked 19 workers. As the months dragged on, he sold off inventory; auctioned personal items; took out a $100,000 loan from his bank, which will lend him no more; and racked up $22,000 in credit card debt. Now he fears he may no longer be able to delay the inevitable.

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The fortunes of companies such as this hold the key to understanding the sluggish US economy. Headline-grabbing corporations have been growing, hiring and racking up profits in the past year – but in the US, as in other countries, it is small and medium-sized enterprises that employ most of the workers.

“The small-business sector makes or breaks the US economy,” says Bill Dunkelberg of the National Federation of Independent Business, the main industry association.


The sector, however, is in little mood to invest and hire. Like Muns Welding, many small companies are just holding on, battered by fragile demand and weak order books. They say they are swamped by burdensome federal government regulation. Many complain of a lack of credit and skilled labour.


Nonetheless, they are now at the heart of the struggle to revive the economy. Launching the American Jobs Act in a speech to a joint session of Congress last week, President Barack Obama tied recovery to the health of small companies, proposing payroll-tax relief aimed at them and promising to speed payments to those working for the federal government.


The political stakes are as high as the economic ones. Next year’s general election seems certain to hinge on Mr Obama’s ability to get to grips with economic problems. In that sense, restoring confidence to beleaguered small businesses could be an increasingly unpopular president’s sternest test.


Mr Obama played up the dichotomy between corporations that have returned to profitability and still-struggling smaller businesses. “Should we keep tax loopholes for oil companies?” he said. “Or should we use that money to give small business owners a tax credit when they hire new workers? Because we can’t afford to do both. I’m pretty sure I know what most Americans would choose.”


This reflects frustration in Washington that big businesses are hoarding profits and not investing. “There is a significant differentiation between the largest companies, which are sitting on significant cash, and many of the smaller companies, which have faced a perfect storm in terms of more difficulty getting working capital,” according to a senior administration official.


Casting small businesses as Davids against corporate Goliaths is a gamble, particularly as many owners of small companies see their interests as more aligned with big business than with the government. Dan Danner, NFIB president, says Mr Obama’s plan “does not address the fundamental problems facing small business today” such as regulation the sector sees as excessive.


The president is right to acknowledge that the recovery is in their hands, however. Small companies – defined by the US Small Business Association, a federal agency, as those employing up to 500 workers – account for 99 per cent of all American businesses, two-thirds of private-sector em­ployment and half of economic output.


The divergence in the health of these businesses and larger companies helps to explain why the world’s biggest economy created on balance no new jobs in August. More small business are cutting jobs than hiring, according to the NFIB, although the situation has been slowly improving. Rather than hiring or firing, however, three-quarters of small companies have adopted a “wait and see” approach.


The main problem is lack of demand. The case of Muns Welding demonstrates the weakness afflicting some order books, fuelling a pessimism aggravated by general uncertainty and a diminishing faith in Washington’s ability to craft policies to get the economy back on track.


That has made many reluctant to invest. “Small and medium-sized companies were bigger risk-takers in many ways,” says Jeff Joerres, chief executive of ManpowerGroup, a global staffing agency. “In today’s environment, they’re not taking risks to the same extent – like anticipatory hiring – and it’s stifling growth.”


Weak consumer spending has hit sectors such as retailing particularly hard. Rose Corona, owner of Big Horse Feed and Mercantile store in Temecula, southern California, says that, among her middle and upper middle-class customers, “it’s now almost chic to be frugal”. The company employs 25 workers, down from 34 two years ago.


The leading concern of small and medium-sized industrial suppliers is that the big manufacturers that are their customers will cut back or go out of business altogether, according to a survey of 3,400 companies released in July by ThomasNet, a website for those researching industrial suppliers.


A second problem is the difficulty of obtaining credit. On one hand, two-thirds of NFIB members say demand is so weak they have no need of loans, while only 8 per cent cannot obtain credit. However, those that want to borrow complain of a divide in availability between companies big enough to issue public bonds, which can ext­ract better terms from banks; and others that are reliant on their bankers’ goodwill.


The Federal Reserve’s latest survey of bank loan officers, indicates that 22 per cent of lenders are loosening credit standards for companies with sales greater than $50m and none is tightening them. For companies with sales below $50m, that figure is 8 per cent.
“I hear every day from medium- to small-sized customers about problems in securing credit,” says Doug Oberhelman, chief executive of Caterpillar, the world’s biggest maker of earth-moving equipment. “In many cases, their balance sheets are still wounded, or their credit profile has changed as standards have tightened.”


Moreover, the availability of credit to new entrepreneurs is more important for job creation than its availability to existing small businesses, says Diane Swonk of Mesirow Financial, a Chicago-based financial services company. Young businesses tend to grow faster, she notes – but in their early stages, they are often funded through the founder taking on personal debt. Because credit card companies have tightened lending standards and other sources of debt – such as home equity lines of credit – have largely dried up, she says, entrepreneurship has been stifled.


While high-technology start-ups are still able to gain access to funding, most new businesses are in more traditional sectors where financing has become tighter. “We had to deleverage, but the pendulum has swung in the other direction,” Ms Swonk says. “That has hampered the spontaneous innovation that we had in the economy, with Americans starting businesses in their garages and spare bedrooms using personal credit.”
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Would-be entrepreneurs seeking to buy existing small companies are also finding it hard to secure loans. Almost half of business brokers say a lack of available financing is the crucial factor preventing such transactions, according to a survey released last month by BizBuySell, an online business brokerage. “It’s virtually impossible for a first-time business owner to get a loan from the bank,” says Mike Handelsman of BizBuySell.


Many owners who would be selling up in normal times are waiting because of low valuations, says Mr Handelsman. Owners who want to sell say potential buyers cannot secure credit. In both cases, companies remain in defensive mode, while entrepreneurs who might breathe new energy into them do not have the money to make the purchase.


Even though the SBA has made $30bn of loans available for small businesses, some start-ups have complained that banks refuse to lend to those that lack a two-year tax record.


The difficulty in gaining access to credit helps to explain a great puzzle of this economic crisis – why more people have not set up in business for themselves. A recession is often seen as the furnace for a recovery. Small companies go under but many new ones are born, as workers who lose their jobs create their own.


A string of great US companies have come out of such adversity. Procter & Gamble, IBM, General Electric, General Motors, United Technologies, Hewlett-Packard and FedEx are all the children of hard times.
That has not happened this time. In August 2008, 5.8m Americans worked for their own companies, and another 10.3m were self-employed but did not incorporate, according to the Bureau of Labor Statistics. By August 2009, that had fallen to 5.4m and 10.1m respectively. Last month the numbers had worsened to 5.2m and 9.5m.
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The NFIB’s monthly survey of business sentiment regularly shows considerable anxiety about the burden of regulation. Companies griping about taxes and red tape is nothing new, but smaller business owners say their regulatory burden is growing.


Heading the list of worries are the “Obamacare” health reforms, which from 2014 will impose financial penalties on small businesses with 50 workers or more that do not offer health coverage. Also of concern are increasing regulation from the National Labor Relations Board, including a rule issued last month requiring businesses to post notices informing workers of their rights under the National Labor Relations Act, widely seen as an example of unnecessary government meddling.


Supporters of health reform say it will extend affordable insurance coverage to small business employees. Currently, only about one-third of the smallest – with fewer than 10 employees – have a healthcare plan.


They also note that employers with fewer than 50 workers are likely to save on health costs from subsidies for the smallest businesses, for example. The Urban Institute, a Washington think-tank that backs health reform, says on balance small businesses would save 8.7 per cent of today’s premium costs.


Critics counter that the subsidies are available only to very small, low-wage companies. Small businesses with more than 80 workers that do not offer health plans will pay $2bn in penalties, while medium-sized businesses (100-1,00 workers) would face a bill of $11.8bn, according to the Urban Institute.


Ms Corona is particularly upset about the Environmental Protection Agency – one of small businesses’ least favourite regulators – which, she says, has imposed regulations in California that forced up the price of water to prohibitive levels, hurting the fruit and nut farmers in her part of the state. “This administration is just anti-small business,” she says.
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The president has acknowledged this gripe. “There are some rules and regulations that do put an unnecessary burden on businesses at a time when they can least afford it,” he admitted last week, saying his administration was reviewing all regulations.


He will need to be quick. The next election is a little over a year away – and Mr Obama will need to restore confidence among small business before he can start to turn the US economy around.


Back in Beech Island, Mr Muns is considering running for US Congress if he is forced to close shop. His local seat has recently opened up and the Tea Party Republican reckons he can put his experience as a small-business owner to good use in Washington.


“Not only does our federal government have a spending problem, it has a waste problem – it wastes a lot of what it spends,” he says. “If they’d taken the stimulus money and given $100,000 of it to every small business owner, they’d have a lot more jobs today than they do.”

STIMULUS PLAN: consensus crumbles over how to pay

When President Barack Obama travelled to Fort Hayes High School in Columbus, Ohio, this week to sell his $447bn economic stimulus plan to the American people, the plight of small business was at the top of his mind.

“It’s all well and good that big corporations have seen their profits roaring back. We want them to be able to hire people as well. But smaller companies haven’t come back,” he said. “So let’s tell Congress, instead of just talking about helping America’s job creators, let’s actually do something to help America’s job creators.”

The White House plan, announced a week ago, includes measures that are specifically designed to aid struggling small businesses in 2012, cutting payroll taxes – which fund the social security retirement scheme – in half and adding additional incentives for companies that hire new employees or lift wages for current workers.

But it is far from clear whether these proposals will see the light of day, despite the pressure Mr Obama and administration officials are expected to put on lawmakers – especially sceptical Republicans who control the House of Representatives – to adopt them.
Immediately after Mr Obama presented his new plan to Congress, Republicans were careful not to dismiss it, even though conservatives believe a different recipe of lower taxes combined with lighter regulations would be better for small businesses.

This more conciliatory position was a stark departure from the hardline stance taken by Republicans on aspects of fiscal and economic policy this year. But hopes of a political consensus in favour of the American Jobs Act appeared to wither away after the White House this week unveiled its suggestions for how to pay for the additional stimulus in order not to add to America’s debt.

Mr Obama wants to cover the cost of the plan by reducing the ability of the wealthiest Americans – households earning more than $250,000 a year – to take tax deductions on items such as mortgage interest and charitable giving over the next 10 years. In addition, he wants to curb other tax provisions that benefit oil companies, hedge fund and private equity managers. The White House has made clear that if Congress chose to use different ways to pay for the stimulus, it would be acceptable.

But Republicans fiercely attacked the provisions put forth by the administration, arguing it was no good cutting taxes on a temporary basis if they were paid for with permanent tax increases that would ultimately stifle job creation and increase the size of government.
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James Politi

Additional reporting by Robin Harding

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Copyright The Financial Times Limited 2011.