Don’t Depend On Small Businesses To Fix Unemployment

Posted by Kim Luu in Management | 1 comment

Be careful of the rhetoric coming out of Washington about how small business will pull unemployment and the economy out of trouble. The belief of our politicians is that more liberal bank requirements will somehow result in loans trickling down to small business and thereby opening a floodgate of hiring. Our fundamental problem is bigger than that. Remember that hope is not a strategy.

Here are some points to consider.

The U.S. Department of Labor just reported July’s jobs numbers and they were as bad as expected. The national reported unemployment rate was at 9.5% percent. The real unemployment which includes those people who are looking for work, who are underemployed, or who have given up looking, is over 17%. Keep in mind that there are also people who are no longer in the system because they no longer qualified and have been out of work for over two years.

The quietly whispered number of what unemployment really is at is 24%-28%. Austan Goolsbee wrote an article in 2003 citing that the government actually “cooks” the books on unemployment rates to make things look good. Now that he’s working for the president directly as an adviser, he has no comment.

A fallacy that tends to float around is that there are millions of small businesses waiting to hire if they just get the money to do so. Let’s address some of the assumptions in Washington.

Job Losses

The unemployment losses from this recession had been steeper than the two previous ones. According to statistics provided by Speaker Nancy Pelosi’s office, in the same compared period, we lost 3.6 million jobs in 13 months ending in January 2009. This is in comparison to 1.6 million jobs in the 1990-1991 recession and 2.7 million jobs in the 2001 recession.

As I recalled, most of my small business clients did not start hiring again during the first recession until 1996. They were bitterly complaining when interest rate was raised swiftly in succession in 1996 and drove their costs sky high in three months.

In fact, the chart showed that it took several years before there was enough employment to show a net gain and recovery in job losses for both previous recessions.

According to the Department of Labor, private sector job net losses were 3.5 million in 2008 and 5.5 million in 2009.

This is a huge amount and unless there is growth for businesses, they won’t have the cash or profits to absorb this many unemployed people.

Millions of Businesses Are Looking to Hire

The Census Bureau showed approximately 28 million businesses in 2007. The technical description of a small business is less than 500 employees. There were 18,311 companies who have over 500 employees and they were responsible for employing over 61 million people. If you ran the numbers, a tiny number of companies accounted for over 50% of all jobs in the United States.

Out of the 28 million small businesses, 22 millions of those companies were single owners and did not have employees at all. These non employer companies produced only 3% of total revenue. These companies never employed people and most likely will not employ people even if they had funds.

Realistically in this economy, the small businesses that may have the financial strengths and needs to hire additional employees were those with more than 20 employees. We had 532,391 small businesses with 20-99 employees and only 88,586 businesses with 100-500 employees. These 620,977 business owners employed 38 million people which is 63% of all jobs provided by the small business sector.

Now let’s add up all the numbers. Out of 28 Million businesses, 639,288 of them were responsible for 82% of all jobs (this included big corporations which had 50%).

Washington needs to start listening to the 600,000+ small business owners who control the majority of the employment market. Please talk to the people who actually run companies and hire people.

Businesses Are Looking To Hire

I beg to differ but small businesses are just trying to survive right now. Has anyone noticed that we had a recession and spending slowed down. That translated into lack or reduction of sales. When you make fewer sales but your expenses stay the same, survival is the number one priority. Adding more expenses in the form of new employees is not top of mind.

Yes, hiring is occurring but it happens in two different ways.

1) Companies are laying off their older workers and those with long employment record. They then adjust the job position slightly and hire younger, cheaper employees. The net effect is zero or negative. One company in Los Angeles did three rounds of layoffs over 18 months and hire replacements to take over with 60% less people. This technique allows companies to earn the tax credits from the stimulus for employing new workers.

2) There are a few companies who are expanding to take advantage of the recession. However, they’re investing carefully to win market share while competitors are having problems. They’re not blindly throwing money at the employment market but picking and choosing the best candidates.

Unfortunately, the net effect is still close to zero because other businesses are laying off about the same amount of employees as those being hired.

Declining Sales

Small businesses typical depend on service and consumers purchases. Not many small companies export outside the U.S. As a result, they are highly susceptible to the decline in consumption. Much of the spending in the past several years was funded by equity created in the housing market. With the decline in the real estate market, there is not much borrowing available for consumers to use on non discretionary expenses such as spa services, big furniture purchases, etc…

In Orange County, CA, we’ve had many restaurants go out of business because of lack of sales. The owners had to buy inventory (food) and pay servers every day but there’s no guarantee that customers will come in.

Here are some industries that were heavily affected by the recession, food, service, consulting, real estate, and retail. Even sin was affected as Las Vegas and other gambling cities struggled with a large decrease in tourism. I received daily emails for the last 24 months with offers of free room and free airfare to come and visit Las Vegas.

Until spending resumes and sales increases, small businesses will not be able to hire freely. How can you hire when you have no money coming in to pay the bills. I don’t care how much tax credits or loan money I get. I can’t hire people unless there’s business to justify the work.

Real Estate Recovery Delayed For Years

Anyone who have worked through the last two recessions, which included housing crashes, knows that it takes almost a decade for the real estate cycle to recover. We still have several more years of workout before the excess inventory from the real estate downturn will be absorbed. Continuing unemployment will add more foreclosures as people become unable to pay their mortgages after losing their jobs and being out of work for an extended time period.

Much of the small business sector were dependent upon the real estate industries. According to the Small Business Administration’s annual publication, “Small Business Economy,” 99.9 percent of all employer businesses in the construction sector and 99.6 percent of all employer businesses in the real estate sector have fewer than 500 employees, the cutoff for small businesses.

The reality is that many people in the real estate industry will never get their jobs back. I am personally acquainted with three women executives in this industry who will never work there again. They were all in their 50s and were highly placed with income in the low to mid 6 figures. The companies they worked for no longer exist. By the time the industry recovers years from now, these women will be in their 60s and it will be unlikely that they will be able win high paying, management jobs in real estate when they are so close to retirement unless they are able to keep working nonstop through the cycle. At this time, all three are still unemployed two years after the layoff.

The American recently published an excellent article that discussed how declines in the real estate market affected small business owners. I agree with the analysis. The author listed the following causes:

Declining real estate value reduced the money that people have to spend on products and services that are offered by small businesses.
Small businesses were over-represented in the real estate industry.
Small businesses used their home to obtain business loans. This is a valid observation.
Banks have tightened lending standards because of bad real estate loans.
Small business customers were the primary customers of the real state loan industry.

The 2009 Gallup/NFIB survey shows that business borrowing of more than one in five small business owners is tied to the value of their homes.

Tighter loan standards and ineligibility

It’s been well documented that business loans have been more difficult to obtain. Washington keeps throwing the banks to the wolves by saying that banks’ lending standards are holding up the recovery. What the officials neglect to point out is that lending decreased dramatically due to a simple reason, borrowers no longer qualify for business loans even under the normal lax lending guidelines.

Companies have to be profitable with stable or increasing sales to qualify. A business owner need to be able to show that they are able to make loan payments with their profits and that income is stable. With the recession, very few companies meet these basic guidelines. Keep in mind that it’s the same guidelines to qualify for a Small Business Administration loan.

So the option is to relax standards and lend to companies that are losing money and going into bankruptcy or maintain the status quo. If banks take the first option, they will be shut down by bank regulators and their investors. If they take the second option, they will be vilified as holding back the economy because of greed. Frankly, right now, banks are fighting each other for the few qualified borrowers who are looking for money.

Pushing more money at the banks will not solve the qualification problem. By the way, the proposed Small Business bill that Congress and President Obama will try to re-promote in September is a failure. We’ll detailed out exactly why in an upcoming post.

Small Business Administration (SBA) going broke

Very little attention is being paid to the large losses that the SBA is going through with its existing loan guarantee portfolio. There were many actions that did not maximize recovery for the department when problems loans were being handled. As a result, the reserve is being emptied out quickly and the costs for future borrowers under the program will be quite hefty as they are required to pay into the reserve funds to replenish the coffers. If the losses continue at the same pace, the costs under the program will exceed the mandate cap that was placed by Congress years ago. This would effectively shut down the SBA loan program in the near future.

Unqualified workers

A frequent complaint by employers is that they cannot find good employees. This exists whether during good times or bad times. Even with a massive pool of prospective candidates available because of the recession, employers who are hiring still struggled with finding the right person. I recently had lunch with a hiring manager and he shared that he has been interviewing for almost four months and has no viable candidates for a job in a real estate related industry segment.

One of my clients spent nine months looking for someone to operate his digital printing press and ended up hiring from India. He had to go through massive cost and paperwork to import the worker while paying a six figure salary. Since November 2009, I myself was reviewing hundreds of applicants and finding few qualified people who would make it to the interview stage.

We have a fundamental issue with having enough educated and trained workers. The focus of the government is on low level, manual labor jobs. The reality is that we are giving away higher paying jobs within the United States because we don’t have the trained workers to handle the jobs. There are “blue collar” jobs that pay far higher salary than many white collar positions. How many people would be satisfied with getting paid $120,000/year to run a printing press. The problem is finding someone who know printing, color blend, computer programming, paper, and have good social skills to handle customers’ requests.

The government is well aware of this problem yet there are no policies to address the retraining and shifting of the American workforce to a new reality that arrived fifteen years ago. This issue was openly acknowledged on August 17, 2010 by one of the Federal Reserve Presidents, Narayana Kocherlakota.

However, the lack of vitality in the U.S. labor market can only be termed disturbing….If one digs deeper into the data, the situation seems even more troubling.

The inverse relationship between unemployment and job openings was extremely stable throughout the 2000-01 recession, the subsequent recovery, and on through the early part of this recession…

Beginning in June 2008, this stable relationship began to break down, as the unemployment rate rose much faster than could be rationalized by the fall in the job openings rate. Over the past year, the relationship has completely shattered…

What does this change in the relationship between job openings and unemployment connote? In a word, mismatch. Firms have jobs, but can’t find appropriate workers. The workers want to work, but can’t find appropriate jobs. There are many possible sources of mismatch—geography, skills, demography—and they are probably all at work. Whatever the source, though, it is hard to see how the Fed can do much to cure this problem. Monetary stimulus has provided conditions so that manufacturing plants want to hire new workers. But the Fed does not have a means to transform construction workers into manufacturing workers.

Bottom line, fiscal policies are not going to fix the fundamental problems that we face currently regarding high unemployment.

Higher Taxes

Taxes are reverting back to pre Bush years and one of the areas that will be hit hard are companies that are S Corps, LLCs, LLPs, partnerships, and sole proprietorships. These companies all claim their business income with their personal income on the 1040 tax return form. When you combine loss of sales, higher costs, and higher tax outlay, the result is usually cost cutting measures. Increasing costs by hiring new workers is not a typical option.

The companies can mitigate some of the tax burden by investing in retirement plan programs but that will involve reduction in cash flow. This action also does not improve the chances of adding new employees.

Uncertainties about new regulations

It doesn’t matter what the government may say, the new regulations are already costing businesses money that they cannot afford. The health care law alone has increased insurance premiums for group health dramatically and most of the provisions has not even hit yet. I’ve been going through insurance reviews for several companies and every one of them is experiencing substantially higher costs. Some already got hit with massive increases in July. This is not even factoring in all the penalties that will be imposed upon small businesses for compliance with the new law.

What are the decisions of the business owners so far? They will push the increased costs to their employees and some will be laying off workers just prior to 2011 in order to get below the required threshold for health care insurance requirements. This is not done because they don’t currently offer group health care but because they want to avoid the headaches and possible penalties.

In addition, there is still the fallout from the Dodd Financial Reform Law that just got enacted. Business owners can expect banking and lending costs to increase as the banks already warned that they will be passing along costs for complying with the financial reform law. Unfortunately, most small businesses cannot afford to increase the costs to their customers as they are trying to bring in sales. This means that the businesses will need to absorb the extra expenses which in turn lessens the possibility of hiring new employees.

As an example, when interest rates is lowered to almost nothing, the credits that companies received from their banks to offset their banking transactions on business accounts also gets lowered. A company can easily go from zero costs for a business account to $800/month just through a simple interest change. If the banks increase the charge per item processed, that can add up to several more thousands in expenses a year. Two small changes can equal $10,000+/year of increased expenses for an active small business that has a lot of customers.

There are more regulations and penalties that exist or are on the slate to be levied against businesses.

In 2009, President Obama signed an executive order authorizing executive agencies of the federal government to require every contractor or subcontractor on a large-scale construction project to negotiate or become a party to a Project Labor Agreement (PLA) with one or more labor organizations.

The executive order 13502 signed on Feb. 6, 2009 required project labor agreements (PLAs) to be used when the cost to the federal government exceeds $25 million. PLA’s are set up as multi-employer, multi-union, pre-existing agreements. One of the requirements meant that non union companies must pay into retirement programs for unions even though their employees are not participating and have their own retirement programs.

Nationwide about 16 percent of the nation’s private construction workforce is unionized. This means PLAs could be used to discriminate against the more than eight of out of 10 construction workers who are not part of a union, as some critics have observed.

There are many such laws and unannounced changes in the past couple of years that affect small businesses. Most business owners don’t have the time or expertise to understand what applies to them. They are dependent on their advisers to steer them through the rocks of regulations. If they have advisers who are incompetent or behind the times, the businesses tend to get hit with massive penalties for their mistakes.

Keep in mind that jobs for enforcers within the various departments such as labor, safety, and IRS have been increased by as much as 20% in order to collect penalties and fines. When the government spends money to collect fines, it does not translate to less costs for businesses.

As a small business owner myself, I know that I will be very stringent about spending money for 2011 and going forward as I need to reserve money for all the costs that are coming down the road.

Unemployed workers need to be proactive in their career and identify what they need to do in order to qualify for the jobs that exist. Waiting for a change in the employment landscape based on programs that come out of Washington is like waiting for Godot.

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