Canada's Productivity Dilemma: Is the Housing Market to Blame?
Canada's lagging productivity, compared to the U.S., may be influenced by the housing market's disproportionate role, diverting resources from more productive sectors. Policymakers are urged to balance housing market stability with measures promoting innovation to ensure long-term economic growth and competitiveness.
In the ongoing discourse about Canada’s lagging productivity, particularly in comparison to the United States, a key factor often overlooked is the potential impact of the housing market. While various elements contribute to the nation's productivity slump, evidence suggests that the dynamics of the housing sector could be a silent but significant player in this complex puzzle.
Since the turn of the millennium, Canada’s labor productivity has fallen behind the United States by 5.6%, a concerning trend when viewed in the broader context of the global economy. This decline is more pronounced given that Canadian companies generally utilize less capital and technology and often operate on a smaller scale compared to their international counterparts. Such factors have rendered Canada less productive than the average OECD member. Research points to a noteworthy phenomenon where housing booms, particularly in the United States, have led to a reallocation of capital and labor towards firms holding real estate assets. These firms, despite their expansion driven by rising real estate values, often display lower levels of productivity than those not holding such assets. This shift not only affects individual firms but also results in a broader industry-wide decline in total factor productivity.
In Canada, housing investment stands at nearly double the OECD average, representing 8.9% of its GDP. Moreover, the ratio of mortgage claims to GDP is among the highest in the OECD. Such a significant emphasis on real estate could be having similar effects as observed in the U.S., with capital and labor being diverted towards less productive, real estate-heavy firms. This diversion could be contributing to the overall productivity slump in Canada.
To understand the full economic implications of Canada’s housing market on its productivity, it is essential to consider the opportunity costs associated with the high allocation of resources in real estate. The disproportionate investment in housing diverts capital and labor from sectors that could potentially offer higher returns in terms of productivity and innovation. This misallocation is particularly detrimental in the context of a global economy where technological advancement and efficiency are key drivers of competitiveness.
Moreover, the focus on real estate investment tends to inflate asset prices, creating a wealth effect that may discourage labor participation and entrepreneurship. This phenomenon can lead to a complacent economy, overly reliant on the housing sector, and vulnerable to market corrections. The high mortgage debt-to-GDP ratio also implies that a significant portion of household income is channeled into servicing debt, reducing disposable income and consequently, consumer spending, which is a critical component of economic growth.
Such risk of a correction is a further factor that has the possibility to harm productivity in the future. In fact, Canada ranks as the riskiest housing market in the world according to the IMF echoed by Vancouver and Toronto being ranked 12 and 7 respectively in terms of risk of real estate bubble in the world.
While housing is a vital sector of the economy, its oversized role in Canada may be a double-edged sword, boosting short-term economic indicators while undermining long-term productivity. Policymakers must therefore balance housing market stability with the need to encourage investment in more productive sectors. Strategic reforms aimed at diversifying Canada’s economic portfolio, coupled with incentives for innovation and technology adoption, could be key to reversing the productivity lag. The goal should be to create a more balanced and resilient economy, capable of sustaining growth and competitiveness in the rapidly evolving global marketplace.
Written by Antonio Brunetti