Business destruction and COVID-19

In its June 2020 Monetary Policy Report, the U.S. Federal Reserve Board observed that the COVID-19 pandemic “poses acute risks to the survival of many small businesses,” adding that widespread failures among such firms “would adversely alter the economic landscape of local communities and potentially slow the economic recovery and future labor productivity growth.”[1]

In the United States small businesses are usually defined as those with fewer than 500 employees, whereas in Canada the threshold is typically set at 100 employees. The B.C. government, for its part, uses a lower threshold of 50 employees to determine whether a business is deemed to be “small.”

Small businesses as defined by American statistical agencies account for 99% of all U.S. enterprises and for approximately half of private employment.[2] U.S. central bank officials are worried about the outlook for small businesses because many of these firms are in sectors that have been disproportionately hit by pandemic-related social distancing, business closures, and dwindling consumer demand – for example, foodservices, accommodation, recreation, travel, arts and entertainment, and personal services.

Compounding the survival risks for smaller firms, they also tend to be more financially fragile than larger companies, with most having few cash reserves and very limited lines of credit. According to the JP Morgan Chase Institute, as of mid-March 2020 fully half of U.S. small businesses had cash buffers sufficient to keep them going for just 27 days in the event of a major disruption to normal business activity.[3]

The question of how the COVID-19 pandemic and the fitful economic recovery that seems likely to follow in its wake will impact small business is of great importance to British Columbia. Although B.C. has done a good job containing COVID-19, the province’s economy has been devastated by the pandemic and the measures taken to control it. For 2020, the Business Council forecasts that B.C.’s real GDP will contract by almost 8%, which is far greater than the GDP declines experienced in previous recessions. As of mid-June, B.C. is down 350,000 jobs compared to February – a catastrophic fall in employment. While the worst of the COVID-19 economic downturn may be over by the time summer arrives, the consequences of sharp declines in GDP, employment and business activity since early 2020 are expected to be felt for years to come. And there are plenty of businesses in British Columbia whose survival is in doubt.

Impact on the B.C. business community

Some idea of how the carnage associated with the COVID-19 recession may play out across the private sector can be gleaned by looking at the distribution of B.C. businesses and employment by industry. We are particularly struck by the concentration of jobs in industry sectors heavily affected by COVID-19.

The B.C. government estimates there are 517,100 “businesses” in the province. Of these, 315,000 consist of self-employed individuals with no paid staff, a group we do not consider here. That leaves about 200,000 B.C. firms that have paid employees. The vast majority of these are either “micro” businesses with 1-4 employees or “very small” firms with 5-9 employees (see Table 1). Only 8,400 B.C. firms have 50 or more staff.

Table 1: Breakdown of Small Businesses in British Columbia

Small businesses are common in all parts of our economy. Many are found in professional and business services, retail trade, finance and real estate, accommodation and foodservices, and “other services[4]” – all sectors that have been hit by a combination of full or partial business closures, the virtual cessation of travel, and falling consumer and business spending during the past few months. Other sectors with sizable numbers of small firms have also been affected – e.g., transportation; information, culture and recreation; and “non-essential” segments of health and social services.[5]Figure 1 provides a breakdown of the distribution of employment in B.C. by industry sector.

Figure 1:

The dramatic slide in consumer spending and business activity triggered by mandated closures across swathes of the economy has undoubtedly led to casualties among B.C. firms, notably in consumer-facing industries. Under the government’s staged economic re-opening plan, many formerly shuttered businesses are – or soon will be -- open again. However, in sectors like retail, restaurants and bars, leisure, recreation, and personal services, businesses are now required to maintain strict social distancing for customers and staff, to limit the number of people on-site, and to devote more resources to cleaning and sanitation. This amounts to a marked change in the operating environment for many B.C. firms. Moreover, it remains unclear how and to what extent consumer behaviour and shopping patterns may change in the post-pandemic world.

For many B.C. businesses, the “new normal” is certain to translate into less overall revenue and a rise in fixed costs per revenue dollar.[6]Some businesses may also incur higher variable costs – for example, the cost of additional personnel for security and cleaning, and for purchasing extra cleaning and sanitation supplies.

Looking ahead, we suspect that a significant number of B.C. businesses that existed when the year began will be gone by the end of 2021. Some have disappeared already, unable to survive the economic closures in place from mid-March to May. Many more will soon discover that while they are now able to do business, they cannot operate profitably in the “new normal.” The facts that international tourism has collapsed and isn’t likely to return soon, that the number of international students in B.C. is expected to shrivel in the near-term, and that the COVID-19 crisis is accelerating the rise of e-commerce and hastening the decline of traditional brick-and-mortar retail will also weigh on the survival prospects of quite a few B.C. companies. Nor should one ignore the painful consequences of the worst global economic slump since the 1930s for export-oriented B.C. companies in the natural resources, manufacturing and tradeable services sectors.

Add it all up, and it’s likely that at least 10% and perhaps as many as 15% of the 200,000 B.C. businesses with paid employees could be gone by late 2021. Some will make the difficult decision to cease operations, while others will be forced into insolvency because they are no longer able to cover their bills or service their debts.

The business support programs unveiled by governments – the temporary wage subsidy, new lending programs, tax deferrals, and assistance with commercial rent – will help some B.C. firms keep going (even if only temporarily) during an exceptionally difficult time. However, we do not believe these government initiatives will prevent a sharp jump in the number of business fatalities in 2020-21. In large part, this reflects the magnitude of the economic shock delivered by the pandemic, the global nature of the crisis, the steps that have been taken to contain the virus, and the impact of expected shifts in consumer and business behaviour.

The above estimate is a “net” figure – that is, we anticipate a significant fall in the absolute number of companies in the B.C. marketplace in the next 12-18 months. Even when times are good, the exit rate for businesses in Canada stands at around 10% per year. However, normally this is offset by a similar or larger number of new business entrants, so the universe of operating businesses slowly expands over time.[7] In the post COVID-19 context, we expect a couple of years of both rising business exits and sluggish business formation. Thus, the actual number of operating firms will decrease. The impact of a shrinking business sector will not be limited to business owners/operators. Fewer firms also mean fewer jobs for B.C. workers, less vibrant communities, and greater economic hardship for families and individuals across the province.

[1] Board of Governors of the Federal Reserve System, Monetary Policy Report, June 12, 2020, page 4.

[2] Ibid., page 24.

[3]Business Insider, “Half of small businesses only have a large enough cash buffer to allow them to stay in business for 27 days,” March 20, 2020.

[4] “Other services” includes personal and household services like hairdressers/barbers, nail salons, and household cleaning.

[5] E.g., physiotherapists, dentists, counsellors, etc.

[6] For a small consumer-facing business, fixed costs will include rent, property tax, and insurance.

[7] See Statistics Canada, “Business Dynamics Measures, by Industry,” Table 33-10-0164-01 (formerly CANSIM 527-0001).