The housing productivity myth

There is an utterly false and highly destructive economic dogma out there that for many folks is accepted wisdom. And that is the claim that investment in housing is "unproductive".

While this statement will no doubt resonate with many readers, there is not a shred of evidence to back it up. The concerning thing is that the myth that housing investment is unproductive is not just held by lay pundits. It is also sometimes advanced by lazy economists, although the more informed members of the creed will quickly acknowledge that it is hogwash.

The reason I find this falsehood frustrating is that it is often then used as one explanation to advance poor policy. A recent example is submissions to the Henry Review arguing that we should discourage home ownership because investing in housing is unproductive.

So let’s set the record straight once and for all, and hopefully in the process banish forever these silly suggestions.

Theoretical Economics Treatment of Housing

In standard economics theory, the two most basic necessities for a functioning economy and, more specifically, productive labour, are: food and shelter. We can interpret "shelter" as covering both residential property, which is the accommodation required by a functional labour force, and commercial property, which is the accommodation needed for productive businesses.

You can either be a "producer" of food and shelter by investing in, and owning, the underlying assets that supply these services/products by owning farms, homes, or commercial buildings; or, alternatively, you can just "consume" these services/products and not invest in the assets by simply buying food from the supermarket, renting a home, or leasing space in a building.

There is a final option where you can both consume and invest by living on a farm (and eating its produce), owning and occupying your home, or owning and occupying the building in which your business operates as some companies do.

As an investor in agriculture, housing, or commercial property, you derive returns as you would with any other productive asset: via a mix of both growth in the capital value of the asset and income from the sale of the products/services (ie, food, residential accommodation, and commercial accommodation).

In the case of housing, returns are measured by changes in house prices and rents. Exactly the same principle applies to commercial property. More technically put, Crone, Nakamura, and Voith (2004) remark:

“Households derive a service flow from the housing stock in which they reside. In exchange for this service flow, they pay an explicit rent, or they may own the home in which they reside, in which case their rental payment is an implicit one. What we observe are rents in the first case and housing prices in the second.”

It is instructive to read how the above relationships are described in the context of a more formal mathematical model of housing markets (Kim (2009)):