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June 7, 2012

High Fuel Prices Hit Small Business Hard

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Oil prices are falling, but gasoline still costs about $3.60 a gallon. High pump prices drain the wallets of all consumers, particularly small-business owners. In March, a U.S. Chamber of Commerce poll of small-business executives found 24 percent citing gasoline prices as a top concern, up from just 10 percent in January.

Collectively, small businesses are America’s engine of economic growth. And that engine is fueled, quite literally, by oil. Expensive fuel drives up production costs — especially for those firms where transportation costs make up a large segment of their expense ledgers. It also puts a crimp in consumer demand.

More money spent at the pump means less disposable income and less business. Recreational activities, such as dining at restaurants and purchasing gym memberships — two of our nation’s most popular small businesses — are among of the first expenses consumers typically cut to offset soaring gas bills.

When it comes to business — be it large or small — there are unfortunately only two options for dealing with higher fuel costs. The first is to pass the costs onto consumers. In a recent poll by the Small Business & Entrepreneurship Council, 40 percent of small businesses responding said they have had to increase their prices. But that approach has a distinct downside. When consumer demand is already down, passing higher costs on to consumers suppresses demand even further, causing lower output, lower income and higher unemployment.

The second option is to absorb the costs. In an attempt to shield loyal customers from higher prices and maintain their consumer base, many businesses are absorbing the higher costs. For instance, Lorne Campbell, owner of Occasionally Cake, a Washington-area bakery, has seen supply costs increase 10 percent to 12 percent over the past year, while delivery costs have doubled. Yet Occasionally Cake has not raised costs since opening in 2009. “A small business is about personal relationships,” Mr. Campbell says. “It’s about trust.”

Yet cost absorption creates its own unfortunate rippling effect. Squeezing profit margins razon-thin prevents Mr. Campbell and other small-business owners from hiring more workers. Instead, current employees are asked to take on additional responsibilities or fewer hours.

Moreover, many small businesses — family-owned farms, for example — are price takers. Because the price is set by the market, these farmers have no choice but to absorb the costs; consequently, profits and investments shrink, and the economy suffers.

Either way, higher fuel prices tighten the economic vise and strangle job creation.When the costs become unbearable, businesses must let people go. The Heritage Foundation modeled the economic impact of an increase in the per-barrel price of crude oil of $30 over the first two quarters of the year. As a consequence of such a price-shock scenario, the Heritage Foundation estimated the U.S. economy would shrink by $20 billion and cause businesses around the country to shed 99,000 private-sector jobs.

America’s policy response to high oil prices is not as efficient as it could be, largely because our energy economy is far from being market-driven. Instead, government restrictions and regulations impede the market’s effectiveness in responding to changes in oil prices.

Alternatives to oil are extremely limited and expensive. For decades, the federal government has attempted to reduce our dependence on oil by subsidizing and mandating other transportation fuels, as well as alternative vehicle technologies. This approach has succeeded wildly in enriching politically well-connected firms and wasting billions in taxpayer money. It has, however, done little to decrease our use of oil.

Policymakers need to open access to our energy resources, reduce regulations that cost more than the benefits they deliver, and remove all energy subsidies. Freeing the energy market will help lower prices and create jobs — giving America’s economic engine a much-needed jump-start.

Nick Loris, an economist, focuses on energy, environmental and regulatory issues as the Herbert and Joyce Morgan fellow at The Heritage Foundation.

This article first appeared in the Washintgon Times.

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