As the price of housing continues to escalate and government support for the sector continues (the Victorian government recently upped the first home owner’s grant on new houses), a valid question has arisen — is housing a productive way to spend personal (and public) money? Or should the government be doing its best to ensure a soft landing for the residential property sector?

Rismark chief and Business Spectator columnist Chris Joye certainly believes that it is, noting recently that “owning a home is a highly ‘productive’ economic activity. No sane person would dispute this”.

However, it could be argued that Joye equates an investment being “productive” with it also being “useful” to its owner. Specifically, the productivity of asset is in some way a reflective of its price — if an asset is over-priced, its benefit would be minimal compared with the capital required to be spent acquiring or creating that asset. That over-priced asset can still be useful to the owner.

Housing serves a very useful purpose of providing shelter. Further, those who own residential property as an investment asset are able to earn a commercial return (through rental income) and possibly capital growth (which is a reflection of the possibility of increased rentals in future years). In his blog, Joye pointed to several academic studies confirming the productive value of housing, such as a 2007 Federal Reserve Study which noted:

Household capital directly affects labour productivity. For example, analogous to the maintenance required to keep business capital in operating condition, workers must engage in rest, relaxation, and personal care to supply labour effectively. As a family grows, the size of its housing limits the quality of these “regeneration” activities. So, by increasing the size of its house, a household increases the productivity of its labour.

The Federal Reserve study appears to conclude that workers need shelter to be productive, apropos, housing is productive.

Housing creates economic activity in its development stage. The act of constructing a dwelling leads to employment for a large number of people (both directly in the building process, and indirectly, in creating the inputs/materials, formation of finance, sales and marketing), leading to an initial boost to economic activity (which is multiplied as those people spend the money they earn in the construction process). However, once a property is constructed, it serves the sole purpose of providing shelter, without adding to economic activity (other than for usually minor maintenance issues).

By contrast, capital invested in a business should continue to be productive to an economy even after the initial investment (although that will depend somewhat on the type of business and the cost of the investment). This is largely because economic growth (and ultimately, living standards) is spurred by two factors — population growth and technological improvement. Such technological improvement is created by businesses using capital to improve processes (efficiency gains) and developing new products and services. Think of Ford developing the production line or Cyrus McCormick’s creation of the “Reaper” which revolutionised farming practices. Not too many great technological leaps occurred while someone was sitting in their living room watching the rugby on a 50-inch plasma.

The issue is more relevant as Australians spend more money (as a proportion of their net worth) on property. Australians who live in capital cities now devote approximately six times their disposable income on property purchases — traditionally, Australians spent less than three times their income on their principal dwelling. That means that monies that would previously have been invested in real businesses are now being spent on housing.

Further, the size and luxuriousness of the housing structures have also substantially increased in recent decades — while that serves to ensure that Australians are living more “comfortably” and creates a short-term boost in living standards, it creates little additional productivity (if the goal of housing is to merely provide “shelter”, the construction of such “McMansions” leads to spending far more capital on housing than what is actually required). So even if housing could be “productive” — like investing in dot.com businesses in the late 1990s, the market has become so distorted that the marginal benefit from investment in the sector is minimal.

Adapting the theory to Australia now, the question remains — are we better off investing our scarce capital (savings) in buying larger and more expensive houses or by investing in real businesses?

When an economy invests in business, those businesses generate organic growth by devoting a portion of their capital to technological improvements. (Further, business owners are not only motivated to continually increase profits, they will also be able to compound their capital by reinvesting in the business itself). By contrast, investment in housing creates an initial burst of growth, but little other benefits after that point. The problem is exacerbated when people spend money to build a larger and more luxurious house than is necessary. (Further, the economic boost is only created for new housing — not the purchase of existing housing stock, which creates economic waste through needless transaction fees).

In 2009, an apartment was purchased in East Melbourne for almost $20 million — that money was largely collected by the developer who constructed the building. The $20 million spent will no doubt provide shelter to its occupants, but that same shelter could most likely have been purchased elsewhere for a fraction of that sum, with the monies instead being used by a business to develop new products or services.

The Australian housing bubble, led by Melbourne (which recorded price growth of almost 30% in the past 12 months) is causing investment in over-priced property to the detriment of dynamic business. This may be “productive” for real estate agents or mortgage brokers, but not for the Australian economy.

Peter Fray

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