The Economy Explained: The Small-Business Economy Finds Its Footing

At a glance

• The economy is growing again after a brief contraction in early 2025, with GDP rising at a 4.4% annual pace and the labor market holding steady at historically low 4.3% unemployment.

• Small businesses are hiring at a stable pace. Net new hires among small businesses reached +37,100 in January 2026 according to the Gusto Small Business Jobs Report, and December was revised upward to +78,500 jobs – a strong close to the year.

• Consumers keep spending despite pessimism. Consumer sentiment sits near historic lows, yet actual consumer spending continues to grow at a healthy 5.4% year-over-year pace – a widening gap between how Americans say they feel and how they actually spend.

• Inflation is mostly tamed, and the Fed is gradually cutting rates. The nation’s inflation rate has settled near 3%, and the Fed has brought the nation’s benchmark interest rate down to ~3.6% – the lowest since late 2022 – easing borrowing costs for small businesses.

• AI is reshaping work without destroying jobs in 2026. According to new Gusto research, small businesses with greater AI exposure today are likely to see higher revenue and employment after about six months, even as AI enables newer firms to operate with leaner teams from the start.

Introduction

If the small-business economy had a theme in 2025, it was resilience in the face of mixed signals. The nation’s economy is growing strongly today, following a stumble last year. Hiring has stayed positive overall, despite growing at a slower pace than in recent years. Consumers kept opening their wallets even as they told pollsters they were worried. And the Federal Reserve finally began to deliver the interest rate relief that many small business owners had been hoping for.

Now, as we head into 2026, the central question for small businesses is no longer whether the economy is growing – it clearly is – but whether they are positioned to make the most of that growth. The economy’s fundamentals are strong: GDP is rising steadily, the labor market is broadly healthy, and the Fed is cutting rates. Yet consumer confidence still remains near historic lows, and artificial intelligence is beginning to reshape which businesses thrive and which get left behind. This gap between the economy’s potential and the ability of small businesses to seize it is the main economic story in early 2026.

In this edition of The Economy Explained, we walk through what the latest data on growth, spending, inflation, and the labor market mean for small businesses – and we examine new Gusto research on how AI is creating both opportunities and challenges for Main Street.

The big picture

GDP: A strong recovery from a shaky start

The U.S. economy stumbled into 2025 with a -0.6% contraction in Q1, rattling markets and reviving recession fears. But that proved to be a temporary setback. Growth bounced back sharply in Q2 (3.8%) and accelerated further in Q3 (4.4%), as consumer spending and business investment regained momentum.

The Q1 contraction was largely driven by a surge in imports ahead of anticipated tariff changes and temporary disruptions to government spending. Once those effects washed through, the underlying strength of the U.S. economy became clear. The two-quarter average of 4.1% growth in the second half of 2025 was among the strongest stretches since the post-pandemic recovery.

Small business hiring: Steady, not spectacular

According to the Gusto Small Business Jobs Report, America’s small businesses added an estimated +37,100 net new jobs in January 2026 – slightly below the 12-month average of +52,400 but a marked improvement from January 2025, when small businesses saw a net loss of -12,100 jobs.

Beneath the headline number, January’s data revealed a striking divergence. Healthcare continued to be the standout performer (+17,100 net hires), followed by accommodation and food services (+16,200) and retail (+11,900). But professional services shed -14,000 jobs – a sector that includes many tech-adjacent firms – suggesting that white-collar small businesses may be experiencing renewed caution as AI reshapes workflows in that industry.

There was also a notable gap by company size. Larger small businesses (20-49 employees) posted exceptional gains of +52,900 net hires, while the very smallest firms (1-4 employees) experienced substantial losses of -32,700. This pattern – the smallest businesses struggling while more established ones grow – is a trend worth watching closely, particularly as new business formation remains at historically high levels.

One encouraging sign: December’s initial estimate of +47,900 jobs added by small businesses was revised sharply upward to +78,500 net hires, suggesting year-end hiring was a lot stronger than first reported.

Nonfarm payrolls: Back in positive territory

The broader labor market echoed the small-business story. The U.S. economy added 130,000 nonfarm payroll jobs in January 2026, a solid rebound from a choppy second half of 2025 that included months of net job losses in October (-140,000) and August (-70,000).

The revenue side

The key to managing any small business is a balancing act between two sides of a financial coin: driving revenue growth and keeping expenses under control. Both are shaped by the broader economic environment – and right now, that environment is sending mixed but mostly encouraging signals.

Let’s first look at the revenue side for small businesses, and today’s economic factors impacting it.  

Consumer spending: Actions speak louder than words

One of the most striking features of the current economy is the disconnect between consumer sentiment and consumer behavior. The University of Michigan Consumer Sentiment Index ended 2025 at just 52.9 – lower than during most of the 2008 financial crisis, and well below its pre-pandemic level near 100.

Yet actual consumer spending tells a different story. Personal consumption expenditures (PCE) grew 5.4% year-over-year as of November 2025, continuing a steady upward trend. Americans may be telling pollsters they’re pessimistic, but they’re continuing to spend – on dining out, travel, healthcare, and everyday goods.

What explains this disconnect? The labor market is probably the biggest factor: Most Americans remain employed, wages are still growing faster than inflation, and household balance sheets – bolstered by pandemic-era savings and rising home values – continue to support spending even as confidence wavers. In short, consumers might feel anxious about the direction of the economy, but their personal financial situations haven’t deteriorated enough to change their behavior. 

This sentiment-spending gap has now persisted for over two years, and it has important implications for small businesses. Customer-facing industries – restaurants, tourism, retail – have consistently outperformed the gloom in survey data. In fact, some of the strongest small-business hiring in January 2026 came from exactly these sectors.

Bonuses: The clearest signal of business strength

Perhaps the most direct evidence that small businesses closed 2025 on strong footing comes from year-end bonus data. Gusto payroll data show that the average year-end bonus paid to small-business employees rose to $2,789 in December 2025, up 11.5% from a year earlier – far outpacing inflation, which hovered near 3%.

Bonuses didn’t just get bigger – they also reached more workers. The share of employees receiving a year-end bonus rose to 18%, an 8% increase from 2024. Every industry we examined saw more workers receive bonuses compared with the prior year.

The gains were especially pronounced in experience-driven industries. Tourism and accommodations saw bonuses surge 52%, while entertainment and recreation posted 45% growth. Professional services (+29%) and technology (+19%) also saw strong increases – a sign that knowledge-economy firms are sharing gains with their teams, despite lingering concerns about how AI may be impacting their workforces.

This is a revealing signal. Bonuses are discretionary – employers pay them when business is good and they want to reward and retain workers. The broad-based nature of this increase, at a time when many small business owners describe themselves as “cautiously optimistic,” suggests that actual business performance may be running ahead of the broader mood.

What it means for small business

Given this picture on the revenue side – resilient consumer spending, weak sentiment, and strong year-end bonuses – what should small businesses focus on?

Watch the divergence by sector and size. January’s data revealed a widening gap: healthcare, hospitality, and retail are adding jobs, while professional services are shedding them. And larger small businesses (20-49 employees) posted strong gains while the smallest firms (1-4 employees) lost ground. Business owners should understand where their industry and size segment sit within these trends, and adjust their hiring and investment plans accordingly.

Don’t let pessimism fool you – invest in growth. The persistent gap between how consumers feel and how they spend is one of the most important economic signals right now. Customer-facing industries like restaurants, retail, and hospitality are outperforming the dour survey data, and some of the strongest small-business hiring in January came from exactly these sectors. If your business serves consumers directly, the data say this is a moment to lean in, not pull back.

Read the signals from bonus trends. Year-end bonuses rose 11.5% and reached more workers across every industry – a pattern that only happens when business owners feel genuinely good about their financial position. If your competitors are investing in retention through higher discretionary pay, sitting on the sidelines risks losing your best people. Consider whether your compensation strategy reflects the strength your business may actually be experiencing, even if the headlines feel uncertain.

The cost side

Now let’s turn to the cost side – where the news for small businesses heading into 2026 is arguably the most encouraging it has been in years.

Inflation: Settling into the new normal

The inflation shock that defined 2022 and 2023 has largely been tamed, but inflation still hasn’t returned to the Federal Reserve’s 2% target. CPI inflation stood at 3% year-over-year as of December 2025, drifting modestly higher from around 2.7% at midyear. The decline from the 9.0% peak in mid-2022 has been dramatic, but the “last mile” back to 2% is proving stubborn.

For small businesses, this means input costs are still rising faster than the pre-pandemic norm, but the pace is much more manageable. The combination of moderate inflation and solid nominal spending growth means that many small businesses are successfully passing costs through to customers – the bonus data above are consistent with this story.

The Fed: Finally delivering relief

After holding rates at over 5% for over a year, the Federal Reserve began cutting in September 2024 and has continued to ease throughout 2025. As of January 2026, the federal effective funds rate stands at about 3.6% – a huge reduction that is beginning to flow through to borrowing costs for small businesses.

Lower rates help small businesses in several ways: reduced interest on variable-rate loans and lines of credit, improved access to capital for expansion, and a more favorable environment for commercial real estate. The Fed’s recent pace of cuts – roughly 25 basis points per quarter – suggests further easing is likely in 2026, provided inflation doesn’t reaccelerate.

Compensation: Wages are moderating

The Employment Cost Index (ECI) – a comprehensive measure of compensation costs – showed total compensation growing at 3.4% year-over-year as of Q4 2025. This is down meaningfully from the 5.1% peak in mid-2022, though still above the roughly 2.8% pace that prevailed before the pandemic.

For small business owners, moderating wage growth is a double-edged sword. It eases one of their largest cost pressures. But it also reflects a labor market in which workers have less bargaining power – which, as we’ll see, may be partly related to how AI is reshaping the skills employers are looking for.

Labor market slack: The balance is shifting

The latest data on job openings vs. unemployed workers reveal a labor market that has moved decisively away from the extreme tightness of 2022. In December 2025, there were about 1.2 unemployed workers per job opening – just over one job seeker for every open position. That’s a far cry from the 0.43 ratio in mid-2022, when employers were competing fiercely for workers, but still healthier than the 3-5 levels that characterized the years after the 2008-9 financial crisis.

This normalization is significant for small businesses. The “Great Freeze” – the slowdown in both hiring and separations that has characterized the labor market since 2022 – continues today. Fewer workers are quitting, which means less need for replacement hiring. But it also means that workers who are looking for jobs face a more competitive search than they did two years ago.

What it means for small business

With inflation manageable, rates falling, and the labor market rebalancing, the cost environment is the most favorable it has been in years. Here’s how to take advantage of it.

Explore borrowing – carefully. At roughly 3.6%, the federal funds rate is at its lowest level since late 2022, and further cuts are likely later this year. For small businesses that have been deferring capital investments – new equipment, expanded locations, technology upgrades – this is a window worth evaluating. Borrowing costs won’t return to pre-pandemic lows, but they’re now at a level where growth-oriented investments can pencil out. Work with your lender or financial advisor to assess whether deferred projects now make sense at today’s rates.

Budget for stable but above-normal costs. Inflation at 3% and compensation growth at 3.4% mean that input costs are still rising faster than the pre-pandemic norm, but the pace is predictable. The era of budgeting shocks – the 9% inflation spikes and 5-6% wage surges of 2022-2023 – is behind us. Small businesses can plan their 2026 budgets with more confidence, building in moderate cost increases without the wide uncertainty bands that made planning so difficult in recent years.

Be strategic about hiring in a rebalanced labor market. With roughly 1.2 job seekers per open position, the frantic scramble for talent has given way to a more measured environment. This is a moment to focus on quality over speed – finding candidates who are strong cultural fits and who bring the skills your business needs for the year ahead, including comfort with AI tools. The Great Freeze in the labor market means fewer workers are quitting, which reduces replacement hiring pressure but also means the best candidates may need to be actively recruited rather than passively sourced.

The big AI opportunity

Over the past year, the conversation about AI and the economy has shifted from speculation to evidence. A wave of new research from the Gusto Insights team – drawing on payroll data from more than 400,000 small businesses – is beginning to reveal how AI is actually affecting Main Street. The picture that emerges is more encouraging than many predicted.

AI exposure is stable, but the effects are real

One of the most surprising findings from Gusto’s recent analysis of AI’s impact on small businesses is how little the overall landscape has changed. The average AI exposure score among U.S. small businesses – a measure of how relevant AI tools are to a company’s workforce – was 16.4% in January 2023 and 16.3% in November 2025. Despite the explosion of AI tools, the small-business economy hasn’t experienced the wholesale workforce disruption that some predicted.

But that doesn’t mean nothing is happening. When individual companies do increase their AI exposure – by shifting their workforce toward roles where AI tools are more relevant – the results are striking. Gusto’s econometric analysis finds that a one-standard-deviation increase in a firm’s AI exposure is associated with a 2.2% increase in monthly revenue after about six months. There’s no evidence of aggregate job losses; in fact, employment also edges up modestly after the same lag.

This “J-shaped” pattern – a short adjustment period followed by revenue gains – is consistent with an AI learning curve in small businesses. Firms that invest in AI-adjacent work may experience some initial disruption as they retrain workers and redesign processes, but the payoff comes within months, not years.

AI is enabling leaner startups

A related line of Gusto research is finding that AI may be changing the fundamentals of how new businesses start and grow. Companies founded in 2024 in AI-exposed industries – tech and professional services – are now operating with approximately 6% fewer employees at the 12-month mark compared with similar firms founded in 2023.

The effect is concentrated in major tech hubs – roughly 16% fewer employees in the San Francisco Bay Area, and around 10% in New York, Seattle, Austin, and Boston. Outside of tech hubs, there’s little difference.

This doesn’t mean AI is eliminating jobs. It suggests that brand new firms in innovation-dense regions are using AI tools to do more with less from the very start of their companies – a shift that may eventually allow entrepreneurs everywhere to launch and scale businesses that previously required larger teams.

AI is creating demand for skilled trades

While much of the AI conversation focuses on knowledge work, one of the most tangible economic impacts of AI in 2026 is physical: the massive build-out of data center infrastructure across the United States.

New Gusto research finds that skilled trade workers in AI data center hotspots earn about 7% more than similar workers elsewhere, with a statistically significant 5.8% premium remaining even after adjusting for cost of living and occupation mix. Plumbers and pipefitters see the largest gains at 20%, likely driven by the enormous cooling infrastructure these facilities require.

The hiring effects are even more dramatic: HVAC mechanics are being hired 41% faster in data center hotspots, and drywall installers are seeing 112% faster employment growth. These are not AI jobs in the traditional sense – they’re electricians, welders, and construction managers – but they’re jobs that exist because of AI, and they represent a tangible benefit of the AI boom for workers who may never touch an AI tool themselves.

What this means for small businesses

Taken together, these findings paint a picture of AI as a practical growth tool for small businesses – not the existential threat that dominates many headlines. The gains are real and measurable: higher revenue, modest employment growth, and leaner startups that can compete from day one.

The bottom line

Looking across the broad sweep of U.S. economic indicators heading into 2026, several clear themes emerge for small business owners and their advisors:

• The economy is on solid ground – act accordingly. GDP growth of 4.4% in the 3rd quarter of last year, a rebounding labor market, and resilient consumer spending all point to an economy that has weathered the turbulence of 2025 and emerged in good shape. Small businesses with sound fundamentals should be planning for growth, not bracing for recession.

• Take advantage of falling rates while they last. The Fed has brought rates down to around 3.6% and appears likely to continue further easing later in 2026. For small businesses that need to finance equipment, expand locations, or invest in technology, the cost of capital is moving decisively in the right direction. Businesses that position themselves to act as borrowing conditions improve will have a meaningful advantage over those that wait.

• Don’t confuse consumer pessimism with consumer behavior. The gap between historically weak sentiment and solid 5.4% spending growth has persisted for over two years. Small businesses in customer-facing industries should trust the spending data over the survey data when making investment decisions. Your customers may tell pollsters they’re worried – but they’re still showing up and opening their wallets.

• Lean into AI – and invest in the people who use it. Gusto’s research shows that small businesses increasing their AI exposure see measurable revenue gains within six months. But the data also show that AI is raising the bar for entry-level roles, shifting demand toward workers who can exercise judgment rather than just perform tasks. For small business owners, this means AI adoption and workforce development go hand in hand – the firms that invest in both will have the strongest competitive position heading in 2026.

• The cost environment favors action. Compensation cost growth has moderated to roughly 3.5-4%, inflation is holding near 3%, and the Fed has brought rates to their lowest level since late 2022. Together, these trends mean small businesses can budget with more confidence than at any point since the pandemic. Use this stability to invest strategically – whether in employee retention (in the form of bonuses), new capital projects, or the technology upgrades you’ve been putting off.

• Mind the gap between the smallest and largest small businesses. January’s data showed a striking divergence: firms with 20-49 employees posted strong hiring gains while businesses with 1-4 employees shed jobs. If you’re in that smallest category, this may be a moment to assess whether targeted investments – in marketing, hiring, or technology – could help you break through to the next stage of growth. The current economic environment, with falling rates and manageable costs, is favorable for that kind of move.