SHOCK NUMBERS: Many Small Businesses in the Services Sector Are Unlikely to Reopen

We are getting the first hard number indications of how damaging the lockdowns have been to small service businesses.

According to a New York Federal Reserve Bank study, 35 percent of businesses that were active prior to the pandemic are still closed and that most have been inactive for twenty weeks or longer. Researchers at the bank estimate that each additional week of being closed reduces the probability that a business reopens by 2 percentage points. Moreover, an additional week of business closure lowers the share of workers that are rehired at reopening. The bank estimates imply that only about 4 percent of the workers that are still laid off from the currently closed businesses will eventually be rehired by these businesses.

Businesses that remain closed for a long time may lose firm-specific capital, for example due to depreciating entrepreneurial qualities or a deteriorating customer base, nites the researchers. Moreover, closed businesses may still have to incur fixed costs that are difficult to evade quickly (long-term rental contracts, for example). The longer a business stays closed, the more likely its net present value turns negative. 

The researchers use regression estimates to predict the fraction of the currently closed small businesses they expect to eventually reopen and the fraction of their workers they expect to be rehired. Based on our regression estimates, we expect only about 3 percent of currently closed businesses to reopen, and we expect these reopening businesses to rehire only about 35 percent of their laid-off workers over four weeks. Combining the probability of reopening and the rehiring share for each currently closed business and summing across the distribution, they estimate that only about 4 percent of the workers of the currently closed businesses will eventually be rehired.

Businesses that closed in July of 2020 are around 5 percentage points more likely to reopen than those that closed in March. One possible explanation for this finding could be that aggregate conditions hit exiting firms hardest in March, making a comeback more difficult. Moreover, time effects could play a role: closing in March implies that a business had to wait longer before aggregate demand conditions improved.

Offsetting some of the closures are new businesses now launching. However, the closures at this point far outweigh the new businesses.

As the lockdowns ease, entrepreneurs will find ways to use the existing labor and capital that is on the sidelines. Markets clear. But the Fed study shows just how devastating the lockdowns have been to so many pre-lockdown small service businesses. The personal pain and devastation that was created by the lockdowns in the "land of the free" are difficult to fathom. 

 -RW