Economic analysis

Why Canada's household debt problem could get worse

It’s easier to spend today when you know you don’t have to worry about saving for tomorrow

photo illustration by sarah mackinnon

Canadians set new records for household debt last year. At 163.4 per cent of after-tax income, consumer debt is the highest since the country started tracking it in 1990.

Yet judging by the experiences of other countries, Canadians could still have a long way to go when it comes to racking up their debts — although not for the reasons you might think.

Among Western economies, the two countries with the highest household debt burdens are Denmark and the Netherlands. At 223 per cent and 310 per cent respectively, their debt-to-income ratios make Canada’s look like chump change.

Both countries experienced a massive run-up in house prices, followed by sharp corrections in the aftermath of the global financial crisis. But while both have seen their house prices fall more than 20 per cent since 2007, household debt has continued to climb in Denmark while falling only slightly in the Netherlands.

A study last year by Norway’s central bank delves into some of the reasons why Danes’ debt levels have continued to far outstrip their Scandinavian neighbours. Rising incomes couldn’t account for it, the bank said, since incomes were roughly the same across the region. Nor could house prices, which have also skyrocketed in Norway and Sweden.

According to the bank, the most plausible explanation lies in Danes’ massive stores of private pension wealth. Denmark has one of the world’s most comprehensive pension systems. Along with a public pension that’s similar to Canada’s CPP and OAS, 93 per cent of Danes are also covered by generous employer-sponsored pension plans. On top of that, nearly a quarter of Danes also pay into private pensions through financial institutions. All told, Danish pension wealth is close to twice GDP and has been rising even faster than household debt. A sizeable share of soon-to-retire Danes have pensions worth as much as eight times their annual incomes.

The study doesn’t delve into why well-funded pensions would encourage consumers to take out bigger mortgages and loans, although several scenarios seem likely: One is that with so much of their earnings going toward pensions that are locked away until they retire, younger Danish workers need to take on more debt to afford the high cost of living. Another would be the psychology of a generous pension system: It’s easier to spend today when you know you don’t have to worry about saving for tomorrow. (An analysis by the Danish central bank suggests it’s the latter.)

With pensions worth 165 per cent of GDP, The Netherlands isn’t far behind Denmark. In a 2011 interview with the Wall Street Journal, Dutch Prime Minister Mark Rutte cited the country’s “huge private savings” as a reason its massive run-up household debt was no big deal. The country’s housing correction has since pushed Dutch consumers to cut back on their spending and household debt has fallen from a high of 250 per cent. But after Standard & Poor’s downgraded the country’s debt from AAA to AA+ last fall, citing sluggish GDP growth, economists blamed it on the fact that too much austerity — not debt — was harming the economy. Meanwhile, S&P pointed to the country’s considerable pension savings as a strength. Bond investors agreed, reacting to the downgrade with a collective shrug.

It may surprise some Canadians that we rank comparatively high in pension savings, both public and private. Canadians hold roughly $1.7 trillion in private pension savings, or just shy of our $1.8-trillion GDP and roughly equal to total household debt. (These figures don’t include the more than $230 billion in Canada and Quebec Pension Plan assets or the estimated $3.7 trillion in non-pension investments that many Canadians will still use to fund their retirements.)

In 2012, consulting firm Mercer ranked Canada’s pension system the sixth-best in the world. (Denmark and the Netherlands were ranked number one and two respectively.) Even stories of Canadian firms being bankrupted by their pension obligations may be exaggerated. Mercer said this year that the average Canadian pension fund is 99.9 per cent funded.

That isn’t to say that record-high Canadian household debt is nothing to worry about — or that Canadian pensions are adequate. But the correlation between a country’s pension wealth and its ability to tolerate high levels of consumer debt is something policymakers might want to consider as they push to expand public pension programs even as they fret about high levels of household debt. More generous public pension benefits, if they ever materialize, would be a good thing for Canadian families. But that may also mean household debts will continue to break new records long into the future.