There’s a major recession signal everybody is missing: small businesses cutting spending as they prepare for the worst
During the pandemic, Aaron Mulherin would travel as far as 150 miles from his home in Marion, Iowa, to do jobs for his glass installation company. But with a gallon of gas in Iowa now going for $4.73, compared to $2.88 a year ago, he has had to shrink that radius to around 60 miles.
“We have been trying to be careful with a lot of things,” Mulherin, owner of AM Glass Repair, tells Fortune.
High gas prices are far from the only pain point Mulherin’s small business is feeling amid inflation reaching a 40-year-high. Costlier materials, longer waiting times for supplies, difficulties finding labor, and even pricier hotels during more distant installations is forcing Mulherin to let some potential jobs slip away, even ones his company would have jumped at a year ago.
Mulherin is far from the only small business owner to feel the sting of inflation. During the first quarter of 2022, 85% of small business owners said their business was being affected by inflation, and 67% had already been forced to raise prices, according to the U.S. Chamber of Commerce. Inflation can be catastrophic for small businesses, and many are worried about having to shut down.
“Historically when demand falls small businesses don’t have the cushion to survive. They tend to go out of business first,” David Audretsch, a developmental economist at Indiana University and co-founder and editor-in-chief of the Small Business Economics academic journal, tells Fortune.
With fears mounting that inflation will eventually give way to a recession, companies are tightening their belts, and how far small businesses like Mulherin’s go might be an early signal of whether a recession will hit, and if it does, how bad it will be.
“It can be an interesting leading indicator that people tend not to think about,” Audretsch says.
Pandemic-era winners
There’s a reason small businesses are often called the backbone of the economy.
“Small businesses are able to meet local demands and local idiosyncrasies in the markets that the larger companies just can’t meet,” Audretsch says.
Despite their more limited resources, he adds, small businesses can be more flexible and responsive to shifts in markets and in demand than their larger counterparts.
“[Small businesses] see if there’s an aspect of the demand that’s not being met by the incumbent firms. They can be quick to market, quick to offer, and quick to fill that niche,” Audretsch says.
Local businesses like Mulherin’s were able to fill that niche over the past two years, emerging from the pandemic as clear winners.
“I think the first month or two were a little bit shaky,” Mulherin says of AM Glass Repair’s business during the early days of the pandemic, but the lull didn’t last long.
“After that, once people started working from home, I would say our business doubled if not tripled,” Mulherin says.
The pandemic-era boom times for small business included a surge in entrepreneurship facilitated by the popularity of working from home, more free time, and federal stimulus checks. In 2021, there were 5.4 million applications to start new companies, according to census data, 53% more than in 2019.
“The general prognosis is that the pandemic was actually not all that bad for small businesses. Relatively speaking it was pretty good,” Audretsch says.
The surge in small business creation last year signaled the larger economy’s impressive rebound from the pandemic-induced downturn in 2020. But small businesses tend to be the first to feel the ripples of a souring economy, and recent woes may indicate that a recession is coming.
From boom to bust
High inflation means that small businesses are struggling to compete on the wage front with larger companies, and operations like Mulherin’s are finding it harder to find the right workers to meet demand.
“It is kind of hard to find people to work for a reasonable wage,” he says. “I think part of that is because we’ve got companies out here like gas stations paying $15 an hour, Costco starting their wages at $17.”
A record 51% of U.S. small businesses had vacancies last month, according to a study by the National Federation of Independent Business. Another recent report by HR software provider ADP found that 91,000 small business jobs were lost in May due to the downturn.
In addition to the labor issues, small businesses are also being hit by supply chain snags, which have created seemingly endless waits for manufacturing, production, and distribution. Lead times—the time it takes from when an order is placed and a product is delivered—have been increasing for months, and according to a recent survey by the Institute for Supply Management, the rate of backlogged orders has risen 2.7% over the past month.
“Lead times are probably close to double,” Mulherin says. “If something does go wrong, you’re out of luck. So you almost have to order extra material, hoping that if something does go wrong you have enough material to finish what you need.”
And with supply chain issues expected to last until 2023 at the earliest, the immediate outlook for the small business sector appears daunting. “Things don’t look so positive for small businesses moving ahead,” Audretsch says.
But unlike the large banks and corporations that keep talking about a coming recession, small businesses are already looking at what to do once inflation begins to subside. And even if a recession does hit, what small businesses do could be the difference between a severe recession and a mild one.
Planning for the future
While the priority for Mulherin is to maintain cash flow right now, once inflation stabilizes he intends to do what he can to grow the company.
“We want to possibly lower our prices, and try to get more aggressive to just take on more work so that we can continue to grow,” Mulherin says, adding that expanding hiring and adding new jobs will be a focus for him and the company.
“We just can’t make those [hiring] jumps as quickly as we’d like to because there’s just a lot of uncertainty right now,” he continues.
Guarded optimism about the future is shared by many small business owners who have benefited from strong consumer demand, which has been steadily rising since the pandemic’s early days. Strong spending has continued despite the gradual rise of inflation since last year, Tom Sullivan, vice president of small business policy at the U.S. Chamber of Commerce, told Fortune.
“[Small businesses] know that when inflationary pressures ease, they immediately have to hire up, and that’s what’s going on,” Sullivan says. “So there’s the sense of pragmatism to lower costs right now. But on the other hand, there’s a sense of optimism that consumer spend is still high.”
He adds, “As long as that consumer demand remains high, and it is right now, even the small businesses that are laying workers off now know that at some point they’re going to have to hire to meet that demand.”
Many, including Goldman Sachs analysts and Harvard economist Jason Furman, have touted high consumer spending as a signal that even if a recession does hit, it will likely be mild. And small businesses are watching customers continue to buy even as prices rise.
“The thing that is incredible about small businesses? You ask any of them about next year, they all say they still want to hire,” Sullivan said.
This story was originally featured on Fortune.com
