Housing: capital may go wrong way
Long-time readers of David Bond’s column surely know the general rules of economics, of which pricing may be the best-known. In theory, the demand for a good, or how many people want it, and the supply, how much there is, intersect at what becomes the price point, resulting in the broad-based market price of a good.
Although an oversimplification, this rule generally holds true, and is the best place to start when discussing the Canadian housing market.
Dr. Mike P. Moffatt, Assistant Professor at the Ivey Business School, has gone to great lengths to demonstrate the mismatch of demand and supply in Canada’s largest cities like Toronto and Vancouver.
The GTA, for example, builds less homes as an absolute figure, not per capita, than it did back in the 1970s. Homeownership for those under 30 has plunged from 44 per cent to 36 per cent in the last decade nationwide, and the monthly mortgage payment as a percentage of median income has reached 100 per cent – a level not seen since a brief period in the 1980s.
Locally, the average sale price of a home has gone from 4.79 times median income, to 13.7 times since 2001, even as the average home has shrunk from a detached house to a condo.
This supply and demand problem, when drawn as a graph, shows a pair of sloping lines that intersect.
Imagine this as an open pair of scissors. Whether the root cause is demand-side (high population growth) or a supply-side (not enough homes being built) remains a political question, much like whether the top or bottom scissor blade cuts through a piece of paper.
The best investment for a country, in terms of long-run GDP growth, is in R&D.
This column will instead focus on the question of allocation, and whether the crisis could be warping our per-capita GDP for the worse.
Price booms can have a significant impact on capital misallocation within an economy.
As the demand for housing increases, investors are more likely to put their money into the housing market, which can result in capital being siphoned away from more productive sectors.
The central theory behind this phenomenon is that all investment chases the best return, but the best investment for a country in terms of long-run GDP growth is in research, development, and technology.
In order for an economy to grow and prosper over time, it needs to invest in innovative and productive industries that can generate more wealth with less inputs or resources.
When the housing market seems to be a safe way to generate a leveraged return, investors may be more likely to put their money into real estate, something with a poor ability to further multiply wealth.
High housing prices can make it difficult for entrepreneurs and small businesses to start and grow in certain areas.
It can be difficult for new businesses to find affordable office or retail space, which can stifle innovation and competition in the local economy.
It also discourages social mobility – with greater risk in seeking a new job in a new city.
Those locked-in to a rent-controlled apartment may turn down their dream job, or may be unable to build a family, if they’re in the wrong size of home for their stage of life.
The best and brightest immigrants, the doctors, computer scientists, and engineers that Canada needs, may choose a different country where they can spend more of their money on leisure or family, not rent.
In the end, this sort of capital misallocation could drive a Canadian iteration of “Dutch Disease,” the apparent causal relationship between the increase in the economic development of a specific sector (for example the Netherlands after the discovery of the large Groningen natural gas field) and a decline in other sectors (like the manufacturing sector or agriculture).
Building more homes carries the risk of spatial misallocation and could threaten long term growth, while reducing immigration could worsen the shortage of workers and attempts to fix Canada’s population pyramid.
It will be incumbent on policymakers to consider their options carefully.