U.S. economy still hog-tied by lack of small-business credit

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Economists disagree on a lot of things, but here is one that everybody pretty much knows for sure: Credit is the lifeline to an economy, and when it dries up you can count on economic growth following suit. That's why a new analysis on small-business lending in the United States is so concerning.

The report, by the Cleveland Federal Reserve, makes the blunt point that since the Great Recession, U.S. small-business lending has dropped sharply. According to its figures, the value of commercial and industrial loans of less than $1-million (U.S.) – a figure often used as a proxy for small-business loans – is now 78 per cent of its 2007 second-quarter levels. In actual numbers, there were 344,000 fewer of these loans at the end of the period, despite the fact that there were 100,000 more small businesses in the United States.

As tends to be the case, there is a lot of finger-pointing as to who is responsible for the dearth of small-business lending. Businesses say the banks are fault; after all, post-recession they are so risk-averse that it is pretty difficult for a smaller business to get a loan. The banks say that that is not the case at all, and in fact they are seeing fewer loan applications, since risk-averse small businesses are scared to take on loans in the current economic climate. And everybody blames the regulators, who have generally made borrowing and lending more difficult.

So who's at fault? According to the Fed researchers, everybody, apparently. Although the recession hurried things along, banks have been shifting away from small-business lending since the late 1990s, instead looking for more profitable ventures. Small businesses have cut back on their asks too, knowing in advance that they are not credit-worthy. Small-business owners often put up their homes as collateral – something that was easier to do in the (real estate bubble) pre-recession days than it has been more recently. Regulatory standards have gotten tighter as well.

The situation in Canada seems less concerning, though it still merits scrutiny. Data from the Canadian Bankers' Association show that although authorized credit plunged during the worst of the recession in 2008, since that time credit authorized to small and medium-sized companies has grown by 22 per cent, compared with a 19-per-cent increase in Canadian gross domestic product. Further evidence comes from a recent Industry Canada survey of small and medium-sized enterprises, which ranked obtaining financing as the least problematic external obstacle to growth.

But the shrinking of small-business credit south of the border is bad news for the U.S. economy, and, by extension, for the global economy. Although some conditions in the U.S. have gotten better, it does not look like anyone is going to jump back into the borrowing/lending pool in a big way any time soon. That's a big deal, given that in the U.S. small businesses employ about half of all workers and provide more than 40 per cent of the private sector's contribution to GDP.

As it stands, the data suggest that the fall in small-business lending may actually have been a contributing cause of the U.S. recession, as well as a factor in the weak U.S. recovery. If the United States is going to get back up to anything approaching pre-recession economic speed, a lot of things have to change – and at the moment it is not clear that any of the players want to make those changes.

Linda Nazareth is the principal of Relentless Economics Inc. and a senior fellow at the Macdonald Laurier Institute.