Is Economic Policy Uncertainty Affecting Small Business Growth?

Is uncertainty about the direction of federal policy hindering small businesses, causing them to hold back on expanding, hiring, and investing? This very question is at the center of a heated public debate.

According to small business owners, uncertainty and misgivings about future tax and regulatory policies is indeed hindering the recovery of their operations and adversely affecting plans they might have for expansion. Findings from the Small Business Optimism Index published by the National Federation of Independent Businesses reveal that small business owners are not only pessimistic about the economy, but that their pessimism remains at pre-recession levels. Conversely, measures of the same index for large companies exceed pre-recession levels. Leading economists attribute this parity to the reliance of small businesses on the domestic economy. Since small firms are less diversified geographically and productively, they have smaller margins for error; therefore, a weak economy at home weighs more heavily on their operations than larger firms. Furthermore, without a large in-house team of analysts to advise them of current risks, small business owners may be more alarmed by news reports regarding fiscal tightening and the debt ceiling.

Basic economic theory largely concurs with these hypotheses, underscoring the concerns currently expressed by small businesses regarding their inability to anticipate future policies coming out of Washington. As explained in a 1983 paper by Federal Reserve Board Chairman Ben Bernanke, when the future is uncertain, business owners delay costly capital investments and refrain from hiring so as to avoid discovering down the road that they made an erroneous decision. Without knowing whether or how tax and regulatory policies are going to change in the near future, business owners naturally refrain from planning to expand, hire, or invest. Stated otherwise, economic theory predicts a negative correlation between government policy uncertainty and small business plans to expand.

In the current economic milieu, small business concerns include:

  • The short-term and long-term economic security of their operations
  • Effects of tax increases on their bottom line
  • Spending cuts
  • Changes to health care benefits requirements and liabilities
  • Another fiscal blowup in Washington
  • Opening a new office
  • Hiring new employees
  • Availability of financing (i.e. getting a bank loan/qualifying for a credit line)

Adding salt to their wounds and fanning the flames of economic uncertainty, small business owners are increasingly getting turned down for bank loans, with some banks declaring them a “high risk business.” Unable to establish a credit line, some owners turn to cash-advance companies, only to be hit with exorbitant interest rates by lenders.

The facts on the ground are that the recent fiscal deal has done little to eliminate political uncertainty from small business owners. According to recent polls, 70% of small business owners do not trust Washington and do not think that now is the time to expand. Unfortunately, the consequences of their uncertainty only lead to further low economic growth. With small business owners ‘sitting on their hands’ and neither investing nor hiring, the economic outlook appears dismal indeed.

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