Canada’s housing market has seen substantial investment in recent years, but this intense focus on real estate is contributing to a broader productivity issue within the economy. Reports from the Fraser Institute and other sources highlight the challenges posed by Canada's heavy investment in housing and the subsequent underinvestment in sectors that drive productivity and economic growth.
Disproportionate Investment in Housing
From 2014 to 2021, housing investments comprised 34.1% of total investments in Canada, compared to 18.5% in the United States. This significant difference has had substantial implications for Canada's productivity. While the housing market has flourished, investments in productivity-enhancing sectors such as information technology (IT) and research and development (R&D) have lagged behind. For instance, IT investments accounted for 10.4% of total investments in Canada, compared to 16.5% in the U.S. Similarly, R&D investments represented 12.6% of total investments in Canada, significantly lower than the 27.7% seen in the U.S.
Productivity Gap and Economic Implications
This imbalance in investment has tangible impacts on productivity. As of 2022, Canada was producing only 71% of the value per hour compared to the United States. The Fraser Institute's report underscores that Canada's labor productivity has been consistently lower than that of the U.S. and other industrialized countries for decades. From 2014 to 2022, the average annual growth rate of output per hour worked in Canada was 1.35%, compared to 1.78% in the U.S.
Weak productivity growth has broader economic implications. Productivity is crucial for enhancing living standards, as it allows workers to produce more goods and services per hour, leading to higher wages and a larger economic base. The Bank of Canada has highlighted productivity as an "emergency," warning that low productivity makes the economy more susceptible to inflation and other economic shocks.
Impact on Real Estate
The heavy focus on housing investment has several significant impacts on the real estate sector:
Housing Affordability and Supply
- High levels of investment in residential real estate have driven up property prices significantly. Home prices in Canada have increased by 28% since the start of the COVID-19 pandemic, with ground-oriented single-family homes and townhouses seeing a 31% increase in prices, compared to a 17% increase for apartments.
- Despite strong demand, the supply of new housing, particularly ground-oriented homes, has not kept pace. This mismatch between supply and demand exacerbates affordability issues and leads to competitive bidding, pushing prices even higher.
Resource Allocation
- A disproportionate share of financial capital is being directed toward housing investments, reducing the availability of funds for other sectors. This crowding-out effect means less investment in business assets like machinery, equipment, and intellectual property, which are crucial for productivity growth.
- Government incentives and subsidies for residential construction, such as the Canada Housing Infrastructure Fund and apartment construction loan programs, further skew investment towards housing.
Economic Stability
- High levels of household debt, driven by significant borrowing to finance home purchases, pose a risk to economic stability. If housing prices were to decline, highly leveraged households might struggle to meet their mortgage obligations, leading to broader financial instability.
- The concentration of wealth in real estate also limits diversification in investment portfolios, potentially increasing economic vulnerability to housing market fluctuations.
Business Environment
- The high cost of housing can impact businesses by increasing the cost of living for employees, leading to higher wage demands and potentially making it harder to attract talent, especially in high-cost urban areas.
- Regulatory and policy focus on housing can detract from efforts to create a more conducive environment for business investments. For example, Canada's complex regulatory framework and relatively high tax rates on capital investment discourage business investment compared to countries like Australia.
To address these issues, the Fraser Institute suggests that Canada needs to balance its investment strategies. While there is a clear need for more housing, it is equally important to create policies that encourage domestic savings and increase business investments in sectors like R&D, AI, and IT. This could involve tax reforms to make capital investments more attractive, reducing the corporate tax burden, and improving access to credit for businesses.
Conclusion
Canada's focus on housing investment, while addressing immediate housing shortages, is contributing to a long-term productivity slump. For sustainable economic growth and improved living standards, it is crucial to strike a balance between residential investments and investments in productivity-enhancing sectors. This will require a concerted effort from policymakers to create an environment conducive to business investment and innovation.
Source: Fraser Institute
