Sometimes in economics, perception can become reality. If enough people develop a negative view of the future, then economic activity will begin to decline. A few weeks ago, we learned that consumer confidence soured in March. Today, we find out that small businesses owners also worry about the future. The National Federation of Independent Business (NFIB) Index of Small Business Optimism (.pdf) sunk 2.6 points last month. But this mostly reflects expectations, as actual sales don't appear to have declined much -- yet.

First, here's the chart for the optimism index:

nfib 2011-03 optimism.png

You can see that March had a pretty huge decline. The drop was the biggest since June 2010, when the recovery last hiccuped. March's decline pushed the index down to approximately its October 2010 level.

This appears to be due in large part to sales expectations:

nfib 2011-03 sales.png

This shows that just net six percent of small businesses expect sales to improve over the next three months. For some reason, however, inventory plans continue to increase. Net one percent of firms say that they'll increase inventory in the next three to six months. That might not sound like much, but it's the most since November 2007.

The outlook for general business conditions significantly worsened in March. Net 5% of firms believe that conditions will be worse six months from now. That's a huge change from February's result that net 9% thought business conditions would improve. The March outlook for business conditions was the worst since August 2010.

So we can safely conclude that small firms expect business to decline. But it hasn't yet. Actual sales don't appear to have worsened much in March. A mere 1% of additional firms reported in March that sales were worse over the first three months of 2010, compared to the last three months of 2010.

What, then, has small business so down? It may be prices. Respondents reported a big spike in prices in March:

nfib 2011-03 prices.png

Yet this increase may have failed to keep up earnings. In March, 5% more firms reported lower profits than in February, which was a pretty big drop for one month. Increased costs, which include labor, materials, financing, taxes, and regulation, may be the chief cause for weaker earnings. Nearly as many firms blamed rising costs as poor sales for their sinking profits, which is a drastic change from a year ago, when more than five times as many firms blamed sales as costs.

Although the NFIB's report doesn't detail which specific costs changed, it's pretty safe to assume that rising commodity prices played a role. From February to March, none of the other costs -- labor, financing, taxes, or regulation -- rose suddenly.

The report forecasts a sad verdict for hiring. Although the percentage of small businesses reporting job openings was flat in March compared to February, hiring plans weakened a bit. The net percent of firms planning to hire in the next three months was just 2% -- the fewest since October.

The news here is pretty discouraging. Although many conditions for small business have improved over the past several months, like sales and loan availability, new obstacles have sprung up. Costs are rising, which is likely a result of higher commodity prices. Meanwhile, small business has noticed consumer confidence falling, which will negatively impact future demand. If small businesses continue to express pessimism about the path of the economy, then the recovery will continue to trudge slowly along, with little hiring.

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