Wednesday, October 7, 2009

Smalll business job creation, personal income & consumption: Weak

A) More worries about small businesses: Following yesterday's post on the difficulties of external financing for small businesses and what it implies for trend growth I was pointed to a speech New York Fed President Dudley held this Monday (A Bit Better, but Very far from Best). Dudley sees three major forces restraining the pace of the recovery: The net wealth shock, the fiscal outlook and the banking system. With respect to the last point, besides the outlook for commercial real estate loans he seems especially worried about small businesses: "For small business borrowers, there are three problems. First, the fundamentals of their businesses have often deteriorated because of the length and severity of the recession—making many less creditworthy. Second, some sources of funding for small businesses—credit card borrowing and home equity loans—have dried up as banks have responded to rising credit losses in these areas by tightening credit standards. Third, small businesses have few alternative sources of funds. They are too small to borrow in the capital markets and the Small Business Administration programs are not large enough to accommodate more than a small fraction of the demand from this sector." I couldn't agree more!
Furthermore, the Atlanta Fed's macroblog as well looked into the relationship between the health of small businesses and the outlook for job growth in a post published yesterday evening (Prospects for a small business-fueled employment recovery): "During periods when national employment levels were expanding since 1992 (when this data series began), firms with less than 50 employees have made up approximately one-third of the nation's employment growth. During the employment declines associated with the 2001 recession, these firms made up only 9 percent of job losses. In the current recession, though, these very small firms have made up 45 percent of the nation's job losses. Looking ahead, it's not clear whether small businesses will continue to play their traditional role in hiring staff and helping to fuel an employment recovery. However, if the above-mentioned financial constraints are a major contributor to the disproportionately large employment contractions for very small firms, then the post-recession employment boost these firms typically provide may be less robust than in previous recoveries."
The chart below is also taken from this blog and highlights the job gains/losses by firm size.
Again to repeat: I think small businesses will continue to face a difficult financing environment which will render it more challenging to grow operations and furthermore limits business start-ups. This in turn hinders job growth to a significant degree, reduces the flexibility of the US economy and negatively impacts trend growth.

B) The evolution of personal income looks worrisome: Over the past months I highlighted several times my index of weekly nominal earnings (see for example Consumer deleveraging spiral still getting worse). This is derived from multiplying average hourly earnings with the index of aggregate weekly hours worked. Because these data are published with the monthly payroll report, they are the most timely indicator of the development of personal finances. Given that the growth in hourly earnings has been declining (+2.5% yoy in September vs. +4% yoy in December 2008) while unemployment and underemployment has been rising sharply, nominal weekly earnings growth has collapsed at an unprecedented speed (see chart).
Nominal weekly earnings are collapsing at an unprecedented speed
Source: Bloomberg, ResearchAhead

Now for the outlook for consumption growth, one key determinant usually mentioned is the development of disposable personal income (besides the savings ratio). Personal income constitutes of the compensation of employees (accounting for roughly two-thirds of income), proprietors income, receipts on assets as well as transfer payments. Deduct tax payments from personal income and you get disposable personal income. Unfortunately as shown above wage income is dropping significantly. Furthermore, also proprietors income has been falling as have receipts on assets (interest and dividend income). This leaves a poor development of disposable income less transfer receipts (see chart below, yoy %-change).
Also disposable income less transfer receipts is falling at an unprecedent post WWII speed

Source: BEA; ResearchAhead

This leaves alll the heavy lifting for the government and the increase in transfer payments as well as the reduction in taxes are the only reasons why disposable personal income so far has not fallen more.
yoy% change in disposable personal income has been supported by government support
Source: BEA, ResearchAhead

However, the outlook here is very poor. First, given the downbeat prospects for the job market not least amid the difficulties in the small business segments, nominal wage incomes are unlikely to grow meaningfully (amid ongoing job destruction and weakening wage growth). Furthermore, as rents are now falling, proprietors income does not promise to stage a rebound and should rather remain under pressure. Additionally, in the current low yield environment, dividend and interest payments are also unlikely to increase. Therefore, also for the forseeable future, growth in personal disposable income needs government assistance. However, the fiscal deficit situation does not suggest that substantial further actions to reduce tax pamyents or increase transfer entitlements - besides ever-extending unemployment benefits - are on the cards. In turn, the positive effects on disposable income growth by state actions are likely to weaken in the quarters ahead. Therefore, the growth in disposable income is very likely to drop at an even faster rate going into next year. Coupled with a rising savings ratio, as households restore their balance sheets, this promises to keep consumption growth more subdued than is currently anticipated.

The rebalancing of the real economy has only just begun and promises to be a multi-year affair which will keep real growth rates subdued and inflation pressures in check. In turn, nominal growth as the key determinant for nominal bond yields should remain at low levels for an extended period of time!


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