Washington Insider

Although the U.S. economy rarely fires on all cylinders simultaneously, it is bifurcated right now. This split will remain a feature rather than a bug—the perception of how the economy is doing will differ noticeably depending on whom you ask. 

Assessing a split economy solely through macro-statistics, such as gross domestic product, employment, and consumer spending, can be misleading. The data obscures the economy’s strengths, weaknesses, and vulnerabilities because the numbers can hide the real difference in how things are going in an increasingly divergent society. Low-income and high-income earners, small and large businesses, job seekers and those stably employed are experiencing very different economic realities. Recent shifts in fiscal and trade policies exacerbate the split in the economy that has been widening over the past few years

The Diverging Consumer

Pandemic concerns about a diverging household recovery have materialized, with those with lower incomes doing worse than those with higher incomes. Discretionary spending among low-income households has barely recovered from the pandemic recession, whereas high-income earners have strongly rebounded. Inflation and the accumulation of household wealth mostly explain this deviation. Since the pandemic, prices for necessities, including food and rent, have risen significantly. Because lower-income households spend a disproportionate amount of their income on these necessities, it leaves less for discretionary items. It can take several years after an inflation shock for many—particularly lower-income households—to feel financially caught up.  

This is unlikely to change any time soon because of tariffs and fiscal policy, including cuts to the federal government’s Supplemental Nutrition Assistance Program (SNAP). Lower-income households are likely to be more exposed to the impact of tariffs because they spend a disproportionate share of their income on the most-affected goods and have smaller savings buffers to withstand the hit to real incomes. The regressive One Big Beautiful Bill Act, combined with the net effect of tariffs and fiscal policy, will exacerbate the bifurcation of the consumer economy. 

Growth in consumption has become reliant on the two drivers of household wealth—the stock market and housing prices. While the accumulation of household wealth has occurred up and down the income distribution, the largest gains have been for higher-income households because a larger share of this cohort are both homeowners and stock owners. With high-income households currently contributing half of all spending, wealth has a more potent effect on consumer spending—a positive when stock and house prices are rising, but a negative if, and when, they sputter.

For context, for every $1 change in financial wealth, Oxford Economics estimates that personal spending increases by $0.14. The estimated housing wealth effect is smaller, with a $1 rise in house price increasing spending by $0.09. These differences may seem small, but they are important. Households have $48 trillion in housing wealth and $56 trillion in stock market wealth. Wealth effects have real consequences, with the wealthier consumers benefiting significantly more from both the stock and housing market increases.

Small Businesses are Under Pressure

Small businesses are under pressure from weakening sales, elevated input costs, and high interest rates. Tariffs are widening the gap between small and large businesses, as larger firms have the financial wherewithal to front-load imports and have more pricing power. Small businesses have less muscle to renegotiate contracts with foreign manufacturers, and it’s more difficult for them to pass tariffs onto the consumer.

Small businesses are the backbone of the labor market, accounting for 45% of employment, making the stress felt among them concerning. There has been an increase in small business bankruptcy filings, some of which is natural, but it needs to be watched closely. Keep in mind that there was a surge in business formations after the pandemic, and the survival rate across industries declines over time; with more births come more deaths. 

Small businesses, or firms with one to 49 employees, are the most vulnerable to policy uncertainty. An equation modeling the relationship between private payroll employment and policy uncertainty shows that a rise in uncertainty is associated with a decline in small business employment two months later. 

The negative relationship between hiring and uncertainty is the strongest for small businesses. This adds to the relative disadvantage of small businesses versus their larger counterparts, which can weather a trade shock thanks to larger financial cushions, greater pricing power, and more sophisticated supply chains.

It’s no surprise that small businesses are contributing less to total private employment growth, according to the ADP National Employment Report, and I don’t anticipate a significant change through the rest of this year and into next. I wouldn’t rule out declines in employment at small businesses because some that were born during the pandemic will begin to close as part of the natural life cycle and survival rates for businesses. 

Although business bankruptcies will rise, they will be concentrated among small firms. Stress will show up in some business metrics, including bankruptcies, but won’t be in others, such as high-yield corporate bond spreads, unless there’s a recession.

Health of Labor Market Depends on Whom You Ask

Below-average hiring and layoff rates make it more difficult for those who are unemployed or not in the labor force but want a job than for those who are employed. The median duration of unemployment is rising as an increasing number of individuals move from a single month of unemployment to multiple months. A low hiring rate is to blame because it reduces the probability of reemployment. The number of job openings has stabilized after falling significantly, but the wage premium for job switchers relative to job stayers has converged. This gives a strong incentive for those with a job to remain, reducing labor market churn and making it difficult for those who are unemployed. 

The split of the economy since the pandemic is unlikely to change soon, leaving the economy more vulnerable to geopolitical, financial, and economic shocks. The U.S. economy is, and will remain, the envy of the world because of productivity growth, and this won’t end soon. We are leading the way on many technologies, especially artificial intelligence, which promises significant productivity gains down the road. 

Unfortunately, the rising tide of the U.S. economy will not lift all boats, and perceptions of how the economy is doing will differ significantly depending on whom you ask.