NFIB Report August 2017: Small Business Optimism Holds Its Altitude in August

Bill Dunkelberg

Surge in capital spending and high sales expectations keeps NFIB Index at near record level heading into the fall.

The percentage of small business owners planning to make capital expenditures in the next three to six months reached its highest level since 2006, according to the National Federation of Independent Business (NFIB) Index of Small Business Optimism, released today.

“This is a sign of economic health that we’ve been expecting based on the soaring optimism that began last year,” said NFIB President and CEO Juanita Duggan. “Higher optimism resulted first in higher employment activity, and now we’re seeing more small business owners making capital investments.”

The NFIB Index rose 0.1 points to 105.3. Five of the components increased, while five declined. The lofty reading keeps intact a string of historically high performances extending back to last November.

“Consumer demand is very strong, and the regulatory relief has been dramatic,” said Duggan. “Small business owners still expect progress on tax reform and healthcare, and they will be watching closely.”

According to NFIB Chief Economist Bill Dunkelberg, the August figures for capital outlays are typical of a growing economy.

“Small firms are now making long-term investments in new machines, equipment, facilities, and technology,” he said. “That’s a real sign of strength, and it will be interesting to see if the August result becomes a trend.”

Plans to make capital outlays were most common among professional services firms (46%), followed by manufacturing (38%), wholesale trades (36%), agriculture (33%), and construction (33%).

A net 27% of small business owners expected better sales in August, a five-point gain over the previous month. That matches the number of owners who said it’s a good time to expand, a four-point jump from July.

Job creation plans dipped by one point but remain historically high. Job openings slid four points, a sign that more business owners are slowly filling positions in the midst of a serious shortage of skilled labor.

“Consumer demand is driving optimism, and optimism is driving business activity,” said Duggan. “Substantial regulatory relief is also a big factor because it creates a much more hospitable business climate.”

Small business owners reported a seasonally adjusted average employment change per firm of 0.18 workers per firm over the past three months, virtually unchanged from July. Fourteen percent (up 1 point) reported increasing employment an average of 4.4 workers per firm and 12% (up 1 point) reported reducing employment an average of 2.4 workers per firm (seasonally adjusted). Fifty-nine percent reported hiring or trying to hire (down 1 point), but 52% (88% of those hiring or trying to hire) reported few or no qualified applicants for the positions they were trying to fill. Nineteen percent of owners cited the difficulty of finding qualified workers as their Single Most Important Business Problem (unchanged), second only to taxes. Labor quality is the top ranked problem in Construction (33%) and Manufacturing (25%), receiving more votes than taxes and regulatory costs. Thirty-one percent of all owners reported at least one job opening they could not fill in the current period, down 4 points but a very high reading. A seasonally adjusted net 18% of owners plan to create new jobs, off 1 point from July but historically very strong.

The net percent of all owners (seasonally adjusted) reporting higher nominal sales in the past three months compared to the prior three months was a net 3%, a 3-point improvement over July. Seasonally adjusted, the net percent of owners expecting higher real sales volumes gained 5 points, rising to a net 27% of owners, this on top of a 5-point jump in July. Stronger sales expectations are very supportive of the historically high hiring plans and strong inventory investment plans.

The net percent of owners reporting net inventory increases was unchanged at a net 1% (seasonally adjusted), reversing months of inventory stock reductions that were generated by solid consumer spending in the second quarter. The net percent of owners viewing current inventory stocks as “too low” deteriorated 3 points to a net -5%. The net percent of owners planning to add to inventory fell 3 points to a net 2%. Although lower than July’s reading, this is a positive indicator for second half growth and consistent with the improvement in real sales expectations and future business conditions.

Sixty percent reported capital outlays, up 3 points. Of those making expenditures, 42% reported spending on new equipment (up 4 points), 24% acquired vehicles (unchanged), and 16% improved or expanded facilities (down 1 point). Seven percent acquired new buildings or land for expansion (up 2 points) and 9% spent money for new fixtures and furniture (down 4 points). Solid numbers, but not enough for a significant improvement in GDP growth or productivity. The percent of owners planning capital outlays in the next 3 to 6 months increased to 32%, the strongest reading since 2006. Investment plans were most frequent in Professional Services (46%), Agriculture (33%), the Wholesale Trades (36%), Manufacturing (38% each) and Construction (33%).

The net percent of owners raising average selling prices increased 1 point, rising to a net 9%. This is the highest reading since 2014, good news for the Federal Reserve which is trying to generate more inflation. Nine percent of owners reported reducing their average selling prices in the past three months (unchanged), and 17% reported price increases (down 1 point). Seasonally adjusted, a net 20% plan price hikes.

Reports of higher worker compensation continue to be strong, consistent with the tight labor markets indicated by the job openings and complaints about labor quality. Reports of increased compensation rose 1 point to a net 28%. Plans to raise compensation fell 1 point to a net 15%, the lowest reading this year. But labor market conditions will result in many more actually raising compensation, to keep or attract the employees they need. The frequency of reports of improved profit trends declined 1 point to a net -11% reporting quarter on quarter profit improvements, historically a solid reading and one of the best readings in this expansion. Most of those reporting higher profits credit improved sales, just 14% said higher selling prices improved the bottom line.

Three percent of owners reported that all their borrowing needs were not satisfied, unchanged and historically very low. Thirty-four percent reported all credit needs met (up 3 points) and 49% explicitly said they were not interested in a loan, down 2 points. Including those who did not answer the question, 63% of owners have no interest in borrowing, down 3 points. Thirty-one percent of all owners reported borrowing on a regular basis (up 1 point). The average rate paid on short maturity loans was down 40 basis points at 5.5%, little changed even as the Federal Reserve raises rates.

“Productivity” increased 0.1% in the first quarter and 0.9% in the second quarter (annual rates). Did workers get that much better in three months? Not likely. Defined as a change in “output per hour worked,” its measurement has occupied economists for decades. Consider the productivity of an employee at a burger joint. The number of burgers served per hour measures productivity. But this varies with the economy; in good times, there are more customers and in bad time fewer. But the fundamental skills of the burger server do not change. These “skills” and the available capital equipment will determine over the long run what the worker’s productivity CAN be. What it WILL be depends on how many customers actually buy a burger. There was no amazing improvement in worker skills from the first quarter to the second, just a change in demand which resulted in more sales per hour for the existing employees.

Some argue that sluggish productivity growth can slow economic growth and prevent wages from rising much. For the burger worker, it is slow economic growth that reduces the number of burgers purchased per hour, it is not the employee’s ability to deliver burgers. Only if the demand for burgers reaches the limits of the worker to deliver them could the employee’s productivity limit growth, a “supply” problem that can be alleviated by hiring another worker or getting a machine or a reorganization of the burger production line (management skills).

Strong demand results in better utilization of capacity and creates new jobs, all of which comes about through higher wages paid to attract applicants and keep good employees. The reverse is not true. Mandating a $15 minimum wage will not increase the number of burgers served per hour by the employee to cover the higher wage cost. That will only raise costs for the business which will have to raise prices to recover those costs or fire an employee if burger demand falls due to higher prices.

One simple fact holds true: employee compensation can rise in real terms over time only if employees produce more stuff per hour e.g. productivity rises. This depends on both supply and demand factors. To make sure that the employee CAN produce more if asked, we invest in training, research, technology, improved equipment, all to increase the capacity to produce. However, demand plays an important role. The employee can’t produce more burgers per hour unless there are sufficient customers to make it happen. Thus, the need for pro-growth policies which will help finance the capital investments needed to improve long-run productivity.

Second quarter GDP growth was revised up to 3% (annual rate) revealing stronger consumer and private sector spending which raises the odds that the Federal Reserve will raise rates again. With little good news from Washington D.C., it appears that owner optimism is holding at record levels because of private sector activity on Main Street, a reason to hire and build inventories and make capital purchases. Eventually, something will happen to taxes and health care, presumably improving on the current situation, so at least the outcome will not be a negative for owners.

Bill Dunkelberg is chief economist of the National Federation of Independent Business (NFIB).

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