Signals From Small Businesses

For those interested in understanding the state of the economy, tracking the outcomes of small businesses could be particularly informative. Research has shown that businesses that are both younger and smaller are particularly sensitive to the business cycle, so signals from these businesses might provide a starker, amplified indication of the shocks hitting the economy. Other work has found that "high-growth businesses (which are disproportionately young) account for almost 50 percent of gross job creation," which has led commentators to focus on small businesses as a primary driver of jobs growth. In today's post, we parse some publicly available small-business performance indicators for potential insights into how the economy is performing.

Could small-business owners be telling us that consumer demand is more resilient than we think? One indication that business owners are sanguine on the outlook for demand is that applications to form businesses have increased substantially versus pre-COVID-19 levels. Figure 1 below plots Census Bureau data on high-propensity business applications (that is, applications to form new businesses that are likely to become employers). Most of these businesses start small and grow as they get older, rather than starting out large.

Figure 1 shows that the six-month moving average of total high-propensity business applications is up 9.3 percent over a year ago. The increase is mirrored across several industries: Health care and social assistance applications are up 12.5 percent, retail trade applications are up 42.8 percent, and accommodation and food services business applications are up 12.2 percent over last year's levels. While not every business application leads to a successful new business, the rise in applications nevertheless suggests that new entrants into the market seem particularly optimistic about their future business prospects.

When it comes to inflation, small-business data may point to price pressures remaining stubborn in early 2024. According to the National Federation of Independent Business Small Business Economic Trends survey, a net 33 percent of small-business survey respondents in January planned to raise average selling prices over the next three months, up 6 points versus six months ago and 4 points from its year-earlier reading. While not all planned price increases may ultimately be implemented, Figure 2 below shows that responses to this question have generally tended to move in line with actual inflation. However, in recent months, the survey index has generally increased while inflation has trended down.

One source of small-business employment data is the Intuit QuickBooks Small Business Index, a collaboration between Intuit QuickBooks (an accounting software firm) and a team of economists led by University of Chicago professor Ufuk Akcigit. The U.S.-based index tracks monthly employment levels and growth rates for small businesses with 1-9 employees using a sample of anonymized QuickBooks customer payroll records. A paper describing the methodology of the index shows that it closely tracks official Bureau of Labor Statistics figures on net job creation series by small establishments, with the advantage that it is available at a higher frequency.

Figure 3 below shows the most recent employment level index through January. Based on this index, employment at small businesses with 1-9 employees is currently 3.3 percent above its pre-pandemic (2015-2019) trend, suggesting small-business labor demand remains high.

However, growth in small-business labor demand appears to be slowing. Over the past three months, the Small Business Index has fallen at a 0.4 percent annualized rate. In comparison, the index rose at a 3.0 percent annual rate over the past six months and grew by 3.5 percent versus a year ago.

While the businesses underlying these data series are small, the picture they paint for the overall economy could have big implications. Economic fundamentals appear to be strong, and inflation pressure may yet linger through the coming months.

Views expressed in this article are those of the author and not necessarily those of the Federal Reserve Bank of Richmond or the Federal Reserve System.