Why a housing downturn would hurt employment
This is a topic I discuss often on this lowly blog. It’s a source of confusion for many people as most see employment as buoying house prices, not the other way around. I take a decidedly different view on this. The argument typically runs along the lines of, “house prices won’t fall until there’s a fall in unemployment”. Let me suggest that one of the problems with credit bubbles is that they mask the true employment picture, which becomes clear as day the moment the credit binge dries up.
The reality is that it is rising house prices that have created a great deal of employment gains over the past half decade. A drop in house prices and the accompanying withering of housing starts and resales will significantly pull at employment numbers in Canada. The connection between real estate prices and employment in our current economy is a significant and under-appreciated one. Rising real estate prices create jobs in several ways. Of course the flip side of that statement is also true…..falling real estate prices destroy jobs. How exactly?
1) Rising home prices create additional demand for new construction.
Rising home prices create demand for more homes, both new and existing…..oddly enough. Falling home prices and sales tend to be correlated with lower housing starts. While it would make sense that periods of falling asset prices would be met by more buying activity, Bob Farrell reminds us that few people buy as prices are depressed while most pile in close to the peak.
CMHC has calculated that the construction of 10,000 homes in Canada creates over 19,000 jobs across all sectors, with 46% being created outside the residential construction sector. With housing starts averaging 200,000 annualized over the past decade, this has been a huge driver of employment growth in Canada. The construction industry currently employs some 1.3 million Canadians and has significantly outpaced job growth in the rest of the economy.
As the US experience has shown us, when house prices and housing starts fall, employment follows.
Furthermore, MLS resales created over 200,000 additional positions in 2008 alone according to the same CMHC report. It’s hard to see how this area will not come under pressure as new mortgage rules, eroding affordability, and a dwindling buyer pool will weigh on sales.
2) Home renovations have a surprising impact on employment
The same CMHC report indicates that, “Residential renovation activity between 2006 and 2009 generated annually over 250,000 jobs in the construction industry and over 210,000 indirect jobs in other industries.” That’s not small potatoes.
In fact, home renovations (spurred on by house porn on HGTV) has risen from a long-term trend line of less than 2% of total GDP to 2.8% of GDP in 2010. This is not an insignificant rise as the correlation with construction sector job growth is very strong.
Furthermore, this can be seen in the total dollar volume of renovation expenditures, which have risen at an 11% annualized rate since 2000.
The bulk of these renovations are not for needed repairs or maintenance, but overwhelmingly to update, add value, or prepare to sell (68%).
This can further be seen in the types of renovations that are most popular:
How did most households pay for these renovations? According to a recent CAAMP report, 43% of people who have tapped into their home equity have done so to complete a major home renovation. Now this doesn’t tell us how many paid for their home renovation from savings, but it should be evident that HELOC extraction is a significant source of funding for home renovations. We know that lines of credit are the fastest growing form of debt, now accounting for 12% of total consumer debt outstanding.
Yet we also know that HELOC growth very closely parallels house price appreciation. This is the US experience. Can you find the peak in their real estate market?
On this very topic, Scotia made the following observations in a report released just today:
Looking ahead, the economic and financial landscape is becoming less conducive to continued strong expansion in renovation spending. This includes moderating home sales and prices, a leveling off in homeownership rates, high household debt loads, rising interest rates, and more stringent mortgage refinancing rules in effect since April 2010.
Indeed, should a protracted real estate slump occur, as I predict, it will have significant repercussions on home equity withdrawals and renovations, and by extension it will weigh on employment.
3) Consumer spending will slow as the wealth effect goes into reverse
The wealth effect created by rising real estate prices is well documented. In a 2006 paper, Michael R. Donihue and Andriy Avramenko described the increase in consumer spending associated with residential real estate appreciation:
“Real estate wealth is shown to have a positive effect on long-run consumption; at 6 cents per dollar, the marginal propensity to consume associated with real estate wealth is larger than the 4 cents per dollar associated with liquid stock market assets.”(p.16)
David Rosenberg, chief strategist at Toronto based Gluskin Sheff and Associates calculated that every dollar increase in Canadian housing wealth translates to 7 to 9 cents of incremental spending in the GDP accounts.
A 2008 Bank of Canada paper described the dynamics of house price wealth effect:
Movements in house prices can affect consumer spending in two ways: through a direct wealth effect…or through a collateral effect, by allowing greater access to credit. …Households perceive their houses as wealth, and base their spending decisions in part on movements in net wealth positions.
As well, if access to credit for some consumers is contingent on their housing wealth or equity, these credit-constrained households will be able to borrow and spend more, based on an increase in the collateral value of their homes.
There’s little debate that rising house prices fuel consumer spending. Depending on the measure of GDP, consumer spending accounts for between 58 and 65% of economic activity in Canada, up markedly in the past two decades. The question remains, what happens to this spending in the event of a housing market correction?
In a report earlier this year, CIBC calculated that, “Even a modest 5% additional drop in average price in 2011…will lead to a negative wealth effect of $10 bn, stripping growth in consumer spending by more than a full percentage point.”
For those more visually-oriented readers, Scotia prepared this lovely graph for us. Note the strong directional correlation between house prices, consumer spending, and employment.
The same scenario played out in the US as consumers retrenched amid falling house prices. Consumption declined, pulling employment with it:
Many economists have suggested that we will not see significant pressure on house prices until unemployment rises. I’m not so convinced. As I’ve noted before, I believe that this line of thinking has put the cart before the horse and has significantly under-appreciated the role that Canada’s credit bubble has had in buoying employment.
The question remains, what then might cause the housing market to correct. I’ve suggested several possibilities ranging from a realignment of consumer expectations to a shift in mass psychology to demographics to credit-induced deflation. The fact remains that asset bubbles pop under their own instability……they don’t necessarily need rising unemployment to cause a realignment. Indeed, if history is a guide, the unemployment better serves as a lagging rather than leading indicator of house price weakness.