A new monthly business confidence index is guaranteed to make the media headlines. It is the basis of analysts forecasting the future direction of the economy. The Financial Times defines a business confidence index as an economic indicator that measures the amount of optimism or pessimism that business managers feel about the prospects of their companies. It also provides an overview of the state of the economy. A widely quoted Australian example is the NAB’s Business Confidence Index.
How is Business Confidence Measured?
The NAB Business Confidence Index is one of the most quoted business confidence measures in Australia. The NAB Business Confidence Index is calculated based on the question: "Excluding normal seasonal changes, how do you expect business conditions facing your industry to change in the next three months?" The result is the sum of both positive and negative responses. A net balance above zero implies an improving business confidence while below zero indicates falling confidence. The average over time is about +6. It has been as high as +21 and recorded a low of -30 during the global financial crisis. The NAB business confidence index is published with a commentary on specific industries and regions. NAB also identifies what factors are driving business confidence.
How Confident should we be in Business Confidence?
It would be easy to think that the guesses from a random collection of business people would be a poor basis for economic policy. However the reason business forecasters look at confidence levels is that it is a survey where the respondents are thought to give honest opinions. When aggregated across a large number we get a roughly accurate measure of overall sentiment. When a business person is asked about their level of confidence in the economy, they will most likely answer based on their gut feeling. They make a passing comment on recent sales or recall phone conversations with clients. What they offer in response to a question about confidence is their overall expectation based on a large number of day to day experiences.
The opinions being captured in confidence questions is exactly the same micro-level information businesses rely on to keep the economy’s wheels turning smoothly. People make economic choices based on their expectation that things will work out well. From a free-market economist’s perspective this constant exploiting of micro-signals through individual micro-actions is very efficient. Our economic system relies upon each individual doing what is in their own best interest. This in turn means they act rationally on those same micro-signals of activities and opportunities that formed their answer to the confidence survey. Asking someone to answer those confidence questions is a good way to measure economic decision making.
Similarity between Business Confidence and Commercial Property Asking Price
Call centre surveys have given a good result over time. But it is not the only way to measure confidence levels. Watching commodity prices to gauge the health of the economy is not new. “Doctor Copper” and other base metal prices are often used as an indicator of economic growth. Typical would be the Fairfax newspaper’s July article that headlined “Dr Copper’s price plunge shows economy is coming down with something nasty”. Therefore looking at a commodity like commercial real estate rents in the form of Commercial Property Guide’s Asking Price Index to judge business confidence is just observing another aggregation of micro-actions to measure sentiment.
The NAB Business Confidence indicator is not without problems. It is easily spiked by tabloid headlines – Barnaby Joyce gets re-elected, the federal budget sounds good or Donald Trump gets sworn in and promises to make America great again. These events are short term and probably not basis for good long term planning.
Commercial Asking Price measures Business Confidence Accurately
Commercial real estate agents have their ear to the ground. Rather than ask them what’s going on with business, it’s much better to watch what they do. The Asking Price Index aggregates the collective action of hundreds of commercial real estate agent across the country to get a good picture of what the future holds.
This is the wisdom of the crowd. In the case of commercial real estate agents, they are a well-informed crowd whose livelihood depends on getting it right.
When we compare statistically, using a Chi-Square calculation, the Commercial Property Guide’s Asking Price Index with the NAB business confidence (with the tabloid reactions removed), we get a very close match without waiting weeks for the old-school call centre survey to be compiled.
Another benefit of using Commercial Property Asking Price Index is that there is the opportunity to drill down to individual cities and measure their local business confidence level. We know that at times such as the downturn in mining activity there was a wide variation in business confidence across the country - Sydney being very different from Perth.
The Commercial Property Asking Price Index mirrors the Business Confidence Index. When it comes to predicting where the economy is headed, gut-feel confidence matters. The good news is that we have several way of measuring business confidence to show us what the future holds. Who would have thought commercial real estate agents are one the best judges of the future?