Canada’s buoyant housing market, with lots of new construction, booming renovations, and a torrid pace of transactions, has been a good news story in a year that had too few. But as underlined in a recent FP article called “The housing boom that never ends,” the news on housing has been a little too good.
Meanwhile, other business investment – in non-residential structures, machinery and equipment, and intellectual property – has languished. We ended 2020 in a troubling place: recent GDP numbers from Statistics Canada showed that private residential investment almost equaled all other types of private investment in the fourth quarter. In other words, almost half of all private non-consumption spending was on housing. That is the highest proportion ever recorded.
Looking at 2020 as a whole, residential investment was 20 per cent higher in real (inflation-adjusted) terms than it was in 2019, turbocharged by ultra-low interest rates and government transfers far bigger than the COVID-related hit to household incomes. By contrast, non-residential investment was lower across all categories: non-residential structures 11 per cent lower, machinery and equipment 16 per cent lower, and – even with COVID’s trumpeted boost to everything in the digital realm – intellectual property products four per cent lower.
Housing is good. We’re not saying it isn’t. It stimulates jobs and GDP while it’s being built, renovated and marketed, and we all want roofs over our heads. But non-residential investment also matters. Without the buildings, infrastructure, equipment, software and everything else we need to make goods and services and earn high incomes, we will end up house-rich and everything else-poor. New investment outside housing was so weak that Canada’s stock of non-residential capital actually fell in 2020. That is a major reason why forecasters, including the Bank of Canada, are marking down their projections for growth.
While 2020 was extreme, Canadians’ preference for housing over other types of investment is a trend. It shows in where our financial institutions lend. Mortgage credit has grown much faster than business credit since 2000.
Is our problem that the financial institutions that dominate the market for small and medium-size business financing in Canada extend business credit too grudgingly? Perhaps. A comparison over 2010-2017 showed a 250-basis-point spread between the interest rate charged small and medium-size businesses and that charged to large businesses – about one-fifth wider than in any other rich-world country except New Zealand.
Do these institutions extend credit to would-be homeowners too readily? Yes – in part, because of government backstops. The Canada Mortgage and Housing Corporation (CMHC) and private insurers provide lenders of insured mortgages a 100-per cent guarantee, and the government stands behind all of the CMHC’s guarantee and 90 per cent of private insurers’ guarantees. Government backstops can reduce the likelihood of, and limit the damage from, housing-market crashes. But, for good and obvious reasons, there are no similar backstops for business lending: capitalism loses its winnowing power if every business’s debt is guaranteed. But given this dichotomy, no wonder people seeking a loan for a house have had an easier time than those seeking money for a warehouse, a backhoe, or a software upgrade.
With Canadians so heavily invested in housing, and with mortgages to match, redressing this imbalance will be delicate. But it is possible. Mortgage insurance premiums charged to borrowers do not currently reflect default risk. Charging different borrowers risk-based premiums could tip the flow of credit less toward potentially overextended households and more toward businesses with viable projects.
That takes us to the second challenge: ensuring that businesses have projects they want to fund. In the early years of this century, business investment held its own against residential investment in Canada. Not only did our capital stock grow, but the gap between non-residential investment in Canada and in other countries, including the United States, narrowed. Fostering confidence in Canada as an attractive place to invest – assuring businesses that today’s massive deficits do not prefigure higher taxes in the years ahead, for example – could get investment in non-housing capital to healthier levels.
A strong housing sector provided a welcome boost when our COVID-weakened economy needed it. When housing reaches half of all business investment, however, we have too much of a good thing. House-rich is nice, but so are well-paying jobs for ourselves and our children, and to secure those we need business investment.
Published in the Financial Post
Jeremy M. Kronick is associate director of research at the C. D. Howe Institute, where William B.P. Robson is CEO.