Housing investment is not productive

Property spruikers are currently having a field day proclaiming the productivity of housing investment. These claims are fallacious. Housing investment does NOT improve productivity.

To clearly explain why this is the case we first need to define productivity. Productivity is a measure of output from a production process, per unit of input. A productive capital investment therefore enables more future goods and services to be produced per unit of input (such as labour, materials etc).

An example of a productive investment may be a machine that enables a new design of metal fasteners to be produced from less metal, and with less labour time, but is equally as strong. In this case we have a productivity gain in terms of materials and human labour time for the same output. This investment allows use to produce more fasteners in future periods even with no more inputs.

Housing does nothing of the sort. It simply houses more people and does nothing to improve the per capita productivity.

Let's use a little thought experiment to prove the point.

Imagine an island nation of 1000 people occupying 400 homes. The only production activity on the island is the making of nails from raw metals – an activity in which everyone participates. The metal is imported and the nails exported, and the income generated from the sale of nails is used to import all other goods required by the people. With present techniques each person can produce 500 nails per kilo of raw metal per week.

The people of the island breed and accept some immigration until the population reaches 1250. They begin to get cramped and decide they best build some more houses. 400 people spend a year of their time constructing the 100 new houses, and expanding the factory, before all 1250 return to the nail trade.

After all this population growth and a massive investment in housing, equivalent to 20% of the existing stock (along with a massive investment in new factory space) each person can still only produce the same number of nails per unit of labour time and per unit of raw metal. There are no productivity gains from any investment.

In fact this growth has been costly. It took 400 people out of production for a year to build the new homes and extend the factory – a loss of 10 million nails (10,000 per original occupant or 5 months of work) that cannot be recovered.

If our island nation had instead invested in better production techniques such as automation, specialising the use of labour for particular parts of the process, or even invested the time to redesign the nails to be easier to manufacture with less material, they would have had productivity gains.

Interestingly, Australia has seen no measurable productivity gains since 2004.  This, not surprisingly, coincided with a significant increase in annual housing investment.

The most popular claim by property spruiker is that housing is productive because it produces this thing called ‘somewhere to live’. Clearly there is a misunderstanding of productivity here. Tomatoes produce something to eat, as do bananas, which are equally as important as shelter.  But it doesn't mean that growing a tomato improves our productivity.

The second most overlooked issue is that even if you redefine the argument to say that productive investment is any investment in capital that enables future production, which is the case for housing because homes enable future production of occupied space, you can easily overlook the fact that there are varying degrees of productivity of an investment. Housing productivity is clearly extremely low, with net rental returns (the measure of the future production you are enabling), around 2-3% in most areas.

Of course, property spruikers will still tell you that capital growth proves their point about relative productivity, but in the current financial climate, I would say there is still time to learn about the fragility of asset prices and the disconnect between the current price and the true productive contribution of the asset.