Small Businesses in Hiring Mood? It’s Hard to Figure

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U.S. small businesses appear to be on the cusp of a mini hiring revival that may be a bit stronger than the Labor Department’s data suggests.

Three sets of private sector surveys released this month showed a pick-up in employment or hiring intentions, at odds with an official government tally that indicated a frustratingly slow pace of job creation.

There are three reasons to suspect those private surveys may be on to something that the more closely-watched Labor Department reports missed.

The Labor Department has a tough time tracking small business employment, and the model it uses to estimate the number of companies created or destroyed in a given month malfunctioned during the worst phase of the financial crisis.
The better hiring tone in the private surveys matches up with other reports showing improvement in the pace of economic growth, consumer spending, and business confidence.
The two surveys that the government uses to compile the monthly employment report gave somewhat conflicting signals for December, with the main employment growth gauge showing a paltry 113,000 gain in private-sector jobs while the other indicated 297,000 more people found work.

This does not mean the United States is experiencing a hidden hiring spree that will quickly create jobs for the 14.5 million out of work, but it does suggest the Labor Department might end up revising recent job readings slightly higher.

ADP: FALSE SIGNAL OR PRESCIENT?

Small businesses typically account for the majority of new job creation but they have been slow to hire since the end of the recession in June 2009. This is a big part of the reason job growth has been so sluggish.

A series of recent polls suggest these companies are finally in more of a hiring mood.

The ADP National Employment Report, the National Federation of Independent Business and a CEO survey by small business group Vistage all showed more small companies adding jobs or planning to do so in the coming months.

The biggest surprise came from ADP, which showed businesses added 297,000 jobs in December. (Interestingly enough — although just coincidental — that was exactly the same number as in the Labor Department’s household survey counting how many more people were employed last month.)

The smallest firms — those with fewer than 50 workers — accounted for more than a third of the jobs in ADP’s data.

Economists are wary of relying too heavily on this report because it is notorious for false signals, and there was plenty of grousing about the ADP’s poor track record when Friday’s government data showed a disappointingly small payroll gain.

But as this chart shows, ADP tended to undershoot the Labor Department’s job count for most of 2010, so its latest gigantic upside miss stands out.

ADP also proved remarkably accurate in tallying up the job losses during the darkest days of the Great Recession, and may be quicker to catch the turnaround now as hiring resumes.

In December 2008, for example, ADP reported 693,000 private-sector job cuts. Two days later, the government’s official report showed a drop of just 531,000.

But months after that, when the Labor Department examined tax receipts to get a more accurate reading on employment, it revised the December 2008 job loss count to 667,000. ADP was much closer to the mark.

In fact, ADP came closer to the final figure in three of the five months with the biggest job losses in late 2008 and early 2009. For March 2009, ADP missed by just 2,000 while the Labor Department’s initial reading was 86,000 off.

The Labor Department “survey leans toward larger companies while ADP has more smaller firms in its survey, and that could explain some of the differences,” said Jennifer Lee, an economist with BMO Capital Markets in Toronto.

WHAT’S NEW

Michelle Meyer, a senior U.S. economist with Bank of America-Merrill Lynch in New York, said the “birth-death” model that the Labor Department uses to estimate company formations and failures may once again be miscounting jobs, although nowhere near the magnitude of the miss in 2008 and 2009.

Meyer’s research shows new companies account for a large portion of small business job creation, and tight credit has made it tougher for those start-ups to launch.

Now that credit conditions are starting to ease, as evidenced by the Federal Reserve’s surveys of loan officers, she is hopeful there will be a modest pickup in monthly job gains — perhaps 175,000 to 200,000 a month, up from the 128,000 average over the past three months.

ADP may be quicker to pick up on those new companies because it draws from its own in-house payroll figures and can capture new employees when companies are just two months old, far sooner than the Labor Department can.

“If we start to see ADP consistently run ahead of nonfarm payrolls, that signals maybe we are starting to see a bit more business formation than the Labor Department is picking up,” Meyer said.

The Labor Department will release its annual benchmark revisions with January’s employment numbers next month, giving a more accurate job count based on state unemployment insurance tax records. Its preliminary estimate in October showed it overestimated employment by 366,000 in the 12 months to March 2010, a big miss but more moderate than the prior year’s.

The Labor Department will begin estimating its birth-death adjustment quarterly instead of once a year, starting with next month’s update, to try to minimize misses.

Meyer suspects next year’s recount will show there were slightly more jobs created through March 2011 than the Labor Department initially reported, and the following year’s upward revision may be even bigger.

This is because the Labor Department bases its birth-death model on data from the prior five years, and starting in 2011 it will be looking back at an unusually grim five-year period for company creation.

Many new business owners use home equity loans or pledge property as collateral, and both practices became far more difficult after the housing market began to crack in 2006.

To be sure, ADP has many detractors, and its December job shocker still looks like an outlier.

JPMorgan economist Michael Feroli issued a note to clients on Friday entitled, “Heckuva job, ADP,” a reference to former President George W. Bush’s misguided praise for the government official in charge of the government’s much-criticized emergency response after Hurricane Katrina devastated New Orleans. The official was fired shortly thereafter.

However, if ADP continues to overshoot the Labor Department’s job count, it could be telling us something.