WASHINGTON, DC – November 2: Federal Reserve Chairman Jerome Powell speaks… [+] Opening remarks. (Photo by Chip Somodevilla/Getty Images)
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There are many strands of the nation’s economy. Conventional wisdom says the economy is made up of the haves and the have-nots. But this binary view of the economy misses the more important and nuanced story of the hardworking Americans who want to be the innovators and small business owners of today and tomorrow. They don’t want or need a handout, but they do need policies and economic frameworks that make it much easier to start new businesses, large and small. This demographic needs the support of a cultural, regulatory, and financial environment that fosters the growth of tomorrow’s innovators, small businesses, and more. Given the more pressing civic crises in our democracy today, writing about small business economic policy may seem like a distraction. Indeed, when you wash your hands, you wash the other hand. Here, I focus on a particular element of the economic mosaic. If that element is allowed to flourish freely, the answers to a more productive path may lie ahead.
Benefits of high interest rates:
The stock market is at an all-time high despite high interest rates, with the S&P 500 up 142% since the last serious bear market in March 2020. Despite high inflation and rising borrowing rates during that period, the largest publicly traded companies in the United States have continued to grow their earnings. Why? Partly because of rising productivity and high employment, and partly because inflation has priced out big companies. In addition, rising interest rates have allowed these big companies to earn higher interest on the cash on their balance sheets. And of course, asset-rich older people have continued to earn higher rates on their bond portfolios. Barring the decline in U.S. GDP in 2020, our nation’s economic growth has returned to a stable level of 2.5% to 3.5% per quarter, buoyed by high employment and rising prices. Admittedly, quarterly GDP growth in the most recent March quarter was 1.6%, but a single quarter does not form a trend.
This seems like a win-win for everyone. Higher interest rates benefited big business and seniors. Higher prices helped big business bottom lines. GDP stabilized again and unemployment was at normal levels. And of course it helped monetary policymakers combat dangerous levels of inflation. So why hold out and lower interest rates? Why not just keep them high for another rainy day of a system shock that might be needed to stimulate the economy again?
The hidden dangers of high interest rates and restrictive regulatory stance:
The social costs of tight monetary policy (i.e. rising interest rates) and restrictive policies (i.e. intrusive and hostile regulators) are not immediately visible in this environment. Yet the negative impacts on the American Dream are real over time and are immediately visible in the cultural zeitgeist. There is little mystery as to how big corporations continue to win and the rich get even richer. The challenge is to create an environment and cultural context that nurtures the entrepreneurs and small businesses of tomorrow. We cannot close the wealth gap among America’s underrepresented without a growing private sector that creates more innovators and small businesses, whether on Main Street, Silicon Valley, or Wall Street.
For startups and small businesses, rising interest rates are a weakness because, by definition, they are higher credit risks compared to the cash cows of larger corporations or wealthy individuals who need loans. But innovators and small businesses are the lifeblood and soul of the American economy. They account for nearly half of American corporate jobs and most of the economic value created by businesses in the United States.
Startups founded by non-white Americans continue to face lower loan approval rates compared to white-owned startups.
Startups founded by non-white Americans continue to have lower loan approval rates,… [+] White-owned start-ups.
Source: Small Business Credit Survey 2023
Borrowing rates for U.S. small businesses are currently peaking at 7.5% to 9.2%, down from historical levels of 3.5% to 4.5%.
Source: Federal Reserve Bank of Kansas SB Loan Survey. Nedco.
The hidden moral hazard of the current environment of rising borrowing costs is that it reduces the incentive to “bet” on innovators and small businesses. Moreover, the objectively restrictive regulatory stance of the past three years has quietly strangled this vulnerable economic sector with burdensome and unnecessary costs. Democracy is not only ensured by informed citizen participation, but also by a vibrant and non-hostile economic environment that encourages the creation of new small businesses.
The only silver lining is that the composition of GDP is returning to balance after the past few years of government spending overpowering other components. Simply put, GDP is made up of consumer spending, government spending, and net exports. From 2020 to 2022, government spending peaked at 47% of GDP, overpowering the primary drivers of GDP growth: consumers and the private sector. In a healthy economy, government spending cannot overpower the private sector. Now we need to focus on more normal interest rates and a less restrictive regulatory environment to make it easier for future job creators to thrive.
Conclusion:
Our economy is a complex web of factors, but if small and medium-sized businesses do not grow and thrive, three things will happen: (1) competition will become more intense as larger businesses win by consolidating market share and power; (2) new entrants will not grow, and the base of entrepreneurs and innovators on Main Street and in the tech industry will not expand; and (3) social equality will further decline as potential entrepreneurs and small business owners from underrepresented groups will have a harder time obtaining the capital they need to become self-sufficient. This situation is dangerous to our sustainable economy, culture, and ultimately, our civic life.