By : Fredner Prevalus
An old adage says don’t lose sight of the forest for the trees. There’s an incredible amount of wisdom and insight in this expression. The principle is certainly applicable to the current COVID climate as it relates to small businesses. A prudent business owner/entrepreneur will have awareness of not only the daily particularities of their business and directly related affairs, but will have awareness of broader events that can have an impact on the operation of their business. In our brief discussion, we’ll provide the small business owner with some basic theoretical tools to help them understand the economic significance of the current COVID pandemic, the economic stimulus and the impact that these phenomena can have on their small business. This will be followed with some guidance on how to mitigate the effects of the pandemic and better prepare for future political and economic disruptions.
THE BIG PICTURE
To help us understand the economic and overall impact of COVID 19, a very brief and highly simplified review of short-run macro-economic theory may be helpful. The
steady state of a national economy with respect to the price level and GDP is determined by the interplay between short-run aggregate supply-SRAS-and aggregate demand-AD. Factors effecting aggregate demand includes consumption, investment, government spending and net exports. Aggregate supply represents the collective productive capacity of a nation as reflected by factors of production including capital, labor and technology. Exogenous shocks are acute events that shift either the aggregate supply or the aggregate demand curves or both. The difference between the new equilibrium position and the original steady state position is what is described as inflation/deflation or a recession/expansion depending on the nature of the impact.
APPLICATION TO COVID
Applying this theoretical framework to the current COVID pandemic, we witnessed widespread government induced businesses closures because of the lockdown. This is described as a negative short run aggregate supply shock(SRAS0=>SRAS1) which leads to a dramatic reduction in output-recession- and upward pressure on the price level-inflation. To mitigate the harmful effects, the government and the federal reserve applied expansionary fiscal and monetary policy measures through direct spending and interest rate reductions respectively. This represents a positive shift in aggregate demand(AD0=>AD1) helping to minimize the effects of the recession, but this also places further upward pressure on inflation.
THE EMPIRICAL EVIDENCE
Empirical data has largely confirmed the accuracy of the traditional macro-economic predictive models. Data from the U.S. BEA-Bureau of Economic Analysis-reveals that during the first two quarters of 2020, there was a dramatic reduction in real GDP/output. This corresponds with the widespread business closures and exogenous aggregate supply shock described in the theoretical model. In the third quarter of that year, there
was a dramatic restoration of output and more stabilized real GDP growth during successive quarters. This corresponds to the effects of the economic stimulus bill-CARES Act-passed at the end of the first quarter and represents the positive short-run aggregate demand shock described. Furthermore, the model predicted that the combined effects would lead to dramatic rates of inflation which is exactly what occurred starting in May 2020 based on data from the U.S BLS-Bureau of Labor Statistics.
SMALL BUSINESSES/ENTREPRENEURS: THE HARDEST HIT
Data from a BLS report shows that during the onset of the pandemic, 43% of businesses had temporarily closed. There was regional variation with the highest closure rates occurring in the Mid-Atlantic, New England and Pacific regions at 54%,47%,46% respectively. There was also industry variation where the highest closure rates occurred in personal services, arts & entertainment, tourism/lodging and restaurant/bar at 86%,,70%,60%, 58% respectively. In addition, there was significant variation among communities of color relative to the general population. An independent university study found that the reduction in business activity between February and April 2020 in African American owned businesses fell by 41%. This was twice the rate of the general population.
WEATHERING THE ECONOMIC STORM
The national and international events that have transpired during the past couple of years relating to the pandemic can seem dismal, daunting, and overwhelming. However, there are some strategies and resources that a small business owner can use to help their business survive. The first strategy is to take advantage of available government programs. The government has passed several economic stimulus packages since the inception of the pandemic to provide relief to small business owners which includes the PPP- Paycheck Protection Plan administered by the SBA-Small Business Administration-and other programs. Next, consider pivoting which is a way of adopting creative strategies to adapt to new challenges and demands facing your business. For instance, some companies involved in textile modified their product offerings to include face masks. A pivot can also include changes in the methods of service delivery such as expanding online operations which can also minimize costs. A small business owner should also renegotiate their contracts with their landlords, suppliers, IT providers, benefits providers, and others to secure more favorable terms or shop around for more cost-effective providers. In short, the business/economic cycle is a reality of life. Experts predict that one can expect at least one recession every five years on average. With greater concerns about the effects of climate change, social/political unrest and military conflicts, economic shocks will likely be more frequent and severe in the future. Although sometimes known pejoratively as “the dismal science” due to some of its bleak predictions, or seemingly esoteric methods, economics can still be a useful tool in the savvy businessperson/entrepreneur’s toolkit. The pandemic has taught us that seemingly irrelevant and unrelated global phenomena can have a significant impact on small businesses through their effects on the economy. Having a general understanding of the nature of these economic effects can help a small business owner better predict and most importantly better prepare for inevitable future events.
Picture Sources
https://i0.wp.com/sninews.org/wp-content/uploads/2020/04/Economic-Storm.jpg?fit=1008%2C711&ssl=1
https://www.bea.gov/system/files/gdp1q22_adv_chart-01.png
https://www.bls.gov/charts/consumer-price-index/consumer-price-index-by-category-line-chart.htm
Sources
https://www.federalreserve.gov/releases/h15/
https://www.bea.gov/data/gdp/gross-domestic-product
https://www.ncbi.nlm.nih.gov/pmc/articles/PMC7461311/
https://www.bls.gov/charts/consumer-price-index/consumer-price-index-by-category-line-chart.htm
If one were to ask which areas of law are relevant to an entrepreneur or small business owner, typical responses would likely begin with contract law, agency law or torts. Then responses would likely move on to employment law, tax law or property law-including IP/Patents. There’s a strong likelihood that anti-trust law would be near the bottom of that list if it’s even mentioned at all. Unfortunately, outside of large corporate mergers, this area of law is often neglected and overlooked, especially in small business legal discussions. It’s the Cinderella of legal academia. In our brief discussion, we’ll help dispel some common misconceptions and discuss why anti-trust law matters and how anti-trust law can potentially have an impact on small business owners and entrepreneurs.
market power and the protection of consumer welfare. A brief and highly simplified review of basic economic theory may be helpful here. Market structures exists along a continuum. A monopoly structure-single seller-occupies one extreme pole while a perfectly competitive market-many sellers- occupies the other. Ideally, with limited exceptions the perfectly competitive market structure is preferred because prices are at equilibrium-the price that buyers and sellers are willing and able to trade absent any market impediments. The equilibrium price implies that if a seller attempted to set a price above this level, they would lose sales and revenue thus becoming unprofitable. A seller in this market is a price taker. In contrast, the monopolist has market power or the ability to influence prices and set a price significantly above the competitive equilibrium thus increasing their profits. This has the deleterious effect of reducing output and creating a deadweight loss. A deadweight loss is essentially a loss in potential economic activity as a segment of buyers can no longer participate in the market.
Naturally, with the prospect of capturing significant profits, there’s a strong incentive for a business to emulate some of the features of a monopoly through contract, collusion, or co-operation with competitors, suppliers and/or others. Some of these practices by their very nature have predominantly anti-competitive effects and are condemned outright regardless of their actual effects or the size of the participants. These are called “per-se” violations and include but are not necessarily limited to price fixing, bid rigging, customer segmentation and market allocation. In addition, the first sections of the 1890 Sherman Act-the principle statutory authority on anti-trust law-suggests that even the act of making an agreement to engage in these practices is a criminal violation.
Even for practices where the circumstances and effects are taken into consideration-known as a rule of reason analysis-the disruptive and damaging toll defending a suit can have on a business may be disastrous. In order to facilitate the transmission of information for the betterment of their business, many owners and decision makers actively engage with other market participants formally or informally through meetings, correspondence and membership in trade associations. These practices are often a natural part of doing business, however it’s important for a small business owner to be mindful that the substance of some of these communications may be a potential violation. There have been a number of seminal cases where a simple email correspondence discussing prices to set between competitors was sufficient to establish an anti-trust violation.
A prevailing misconception is that anti-trust law applies only to “big” businesses. However, what constitutes “big business” can be relative and is highly contingent on how the market is being defined. In anti-trust law, a relevant market is defined in two principal ways, a product market and a geographic market. Briefly stated, a product market is determined by applying the hypothetical monopolist test. This test analyzes the consumer substitution effects of a SSNIP-Small but Significant Non-Transitory Increase in Price. If a hypothetical monopolist is not able to apply an SSNIP, then the relevant market definition must be expanded to include substitute goods/services. Moreover, the geographic market refers to the physical-or virtual-boundaries of a market. A similar hypothetical monopolist test can be used to determine the geographic market which is typically limited by transaction costs. This means that the relevant market is not necessarily national in scope but can be defined regionally or locally and the relevant product/service market can be defined so narrowly as to include a few providers. Therefore, a “small business” may very well potentially have more market power and influence then they realize. As an illustration, suppose only three restaurants in a town provided Caribbean/African cuisine. Suppose the restaurants were part of the same entity and decided to noticeably increase their menu prices. If a significant number of their customer base did not switch to alternate cuisines, then other cuisines would not be part of the same product/service market as the Caribbean/African cuisine. Also, suppose that the next nearest restaurant offering Caribbean/African cuisine was a one hour drive away. If most customers would not be willing to travel to that restaurant, then that restaurant is not part of the towns relevant geographic market for Caribbean/African cuisine.
Although market power alone does not constitute a violation, it’s a significant factor when considered in conjunction with other actions. Other potentially illegal actions include but are not limited to; predatory pricing/bidding, boycotts/refusals to deal, vertical integration-price squeezing, vertical restraints-price ceiling/floor, tying-exclusive dealing-bundled discounts. The scope of anti-trust law in regulating business conduct is broad. Anti-trust law is not exclusively limited to the mergers & acquisitions of fortune 500 companies trading shares on wall street. It can have important implications to a small business operating on main street. In fact, some of the most significant landmark cases involved businesses operating at a regional or local level (Aspen Skiing Co. v. Aspen Highlands Skiing Corp (1985)). It’s important to remember that operating one’s establishment in a way that’s unfair to competitors and/or consumers is a potentially losing strategy. It’s recommended that business owner have some familiarity with anti-trust legal principles especially as their business continues to grow. A good first step is to review the FTC’s Guide to Anti-trust Laws which can be accessed through the link below.
