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Economy

How small business owners spent — and saved — early in COVID-19

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While plenty of research has examined the plight of small businesses during COVID-19, a new study is the first of its kind to look at how small business owners spent — and didn't spend — their own money in the early days of the pandemic.

Could a more coordinated, national response have helped them better weather the economic uncertainty?

"We wanted to look at how different types of shocks filter through from the business to the owner, and how a shock to the owner themselves affects the business," saidone of the study’s co-authors and a professor of finance and entrepreneurship at MIT Sloan.

Small business owners are ideal to study because they hold a lot of their wealth in their business and depend on it for their livelihood, Schoar said.

The performance of small businesses is crucial not just to business owners but to the American economy as well.

Small businesses account for two-thirds of net job growth and 44% of U.S. economic activity, according to the working paper, "Revenue Collapses and the Consumption of Small Business Owners in the Early Stages of the COVID-19 Pandemic." The paper was co-authored by MIT Sloan finance professor and Olivia Kim, a Ph.D. candidate in financial economics at MIT Sloan.

Small businesses "are really important because they are the ones that help the economy adjust more quickly to downturns but also to upturns," Schoar said.

"When there is a recession, small businesses are the first to cut down and reduce their spending and to lay off workers — that’s on the downside," Schoar said. "On the upside, they’re also the first ones to start hiring again, to grow when the business cycle turns around."

To conduct their research, the authors created a dataset using anonymous JPMorgan Chase credit card and debit card transaction information between January 2019 and May 2020 from 380,532 small businesses and their respective owners. Researchers were able to see every single transaction that businesses and owners made on their accounts, which allowed them to classify spending into categories. 

Small business owners voluntarily cut spending

The authors found that COVID-19 had an enormous impact on small businesses and their owners in the early months of the pandemic. Small business revenue and business owners’ personal consumption both dropped around 40% in March 2020 compared to a year earlier. Even owners whose businesses didn’t suffer significant revenue downturns still cut back their personal spending.

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Small business revenue and business owners’ personal consumption both dropped around 40% in March 2020 compared to a year earlier.

"Consumption drops for the person whose business is massively affected, but it also drops for the people whose business is almost not affected," Schoar said.

Even if a small business was performing well, owners were cautious of the virus and the potential impacts on their business, and still weren’t spending, "which tells us that some of, or a big fraction of, the drop in spending has to be voluntary," Schoar said.

The authors found that both businesses and business owners increased their spending on fuel and groceries in the week prior to the national emergency and that they sharply cut back spending on travel, entertainment, personal services, and food (such as restaurants and bars) immediately after the national emergency was declared.

"It’s not that people were all now so impoverished that they could not afford a restaurant meal anymore. A lot of it was that people just didn’t want to go out," Schoar said.

There was evidence that government measures such as the CARES Act and the Paycheck Protection Program (PPP) may have helped keep businesses afloat. While prior research has shown that funds were distributed unevenly and not given to the small businesses that needed them the most, the authors noted that a business owner’s median account balance in both their business and checking account declined in March 2020 but rebounded in April and May when the transfer programs began.

"Once some of the government funding kicked in, that did help some of the small businesses," Schoar said.

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By the end of May 2020, businesses and owners, respectively, had 10% and 18% higher balances in their business and personal checking accounts relative to January 2020, suggesting that the stimulus measures might be minimizing the direct impact of revenue losses on an owner’s consumption, the authors said.

Another benefit: As time went on, fewer small businesses went out of business. More businesses closed permanently in February and March than in April and May, with non-essential businesses (like restaurants and beauty salons) among the hardest hit, Schoar said.

"We know in general that small businesses are very fragile," Schoar said. "They have very little slack cash. And so, even say a couple of weeks or a month of significant slowdown seems to be enough to, in a way, kind of kill the weakest of the small businesses."

A national shock

The authors had expected to find big differences in states that shut down early versus states that did not have any shelter-in-place requirements. They were surprised, however, to find that most of the decline in business revenue and consumption was not directly related to either local infection rates or shelter-in-place orders.

"What we were really surprised about is that somehow, it looks like for the majority of small businesses, it really was a national shock that affected everyone," Schoar said. "The people who actually didn't see any income shock to their business because of COVID-19, even they have a drop of 40% in their consumption. Just the expectation that now the country is really going to go through a very dire situation might have made many small businesses cut back."

Going forward, the research suggests that small businesses would benefit from a stronger national response, as opposed to uncoordinated regional and state intervention.

Specifically, small businesses might have fared better if the government focused primarily on controlling the virus at the very beginning of the pandemic, Schoar said.

While the government stimulus may have provided a boost to small businesses, it wasn’t enough to assuage a national shock caused by "the fear of the infection and the virus spreading and therefore people endogenously deciding not to consume," Schoar said.

Indeed, economists have argued that COVID-19 had to be defeated before the economy could start going back to normal.

"We didn’t really invest in testing and contact tracing, like South Korea or Germany tried to do,” Schoar said. "I think in some sense, a lot of agony could have been better handled by treating [the pandemic] really as a first order health crisis and not so much as a, 'Oh, we need to get somehow people out to spend again,'" she said.

"You can give people lots of money, but if they don't want to leave the house, that's not going to help the economy."

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