Canadians are stressed about the economy. You don’t need mountains of polling data to figure that out. But dig into the work of Canada’s pollsters and you’ll find only 14 percent of people say they are better off financially than they were a year ago and, even worse than that, many Canadians don’t see any relief on the horizon. What can we do about this? In this five-part Hub series, we’re digging deeper into the economy, identifying our country’s fiscal problems, but also offering solutions to our monetary malaise.
Part 1: Independent or not, groupthink might be the Bank of Canada’s worst enemy
Part 2: Is Canada’s real estate-driven economy dragging down growth?
Part 3: Lots of debt. Higher interest rates. Big political promises. How sustainable are Canada’s finances?
Part 4: Amid record immigration, some experts fear newcomers are ‘falling out of love with Canada’
If you believe the economist Paul Rubin’s theory of “folk economics” most of us are entirely naive about the economy, bumbling through life with only innate notions of fairness that go back thousands, maybe millions, of years to small societies of fewer than 150 people.
In that prehistoric world people focused their mental energy on monitoring their neighbours for signs of slacking off because these tiny tribes would crumble if people weren’t pulling their weight. Most transactions were exchanges of goods and, naturally, people also put a lot of emphasis on fairness.
The important elements of our modern advanced economy, like division of labour, capital investment, and economic growth weren’t relevant in small societies and so we never developed the ability to understand them intuitively.
Deep down, our brains are still trying to root out slackers at the foraging bush, scanning for anyone who might be getting more than their fair share and Rubin argued that this is why most people get things wrong when it comes to economics.
Our instinct that business tax cuts are an unfair giveaway to corporate bigwigs will usually loom larger in our minds than analysis showing they might also boost wages. We can gain economic knowledge, but it takes a conscious effort, making many basic principles of the field seem backward to most people.
“But the point is that it must be learned; it is not an innate piece of knowledge,” Rubin wrote. He concluded that economists need to think hard about educating people and, instead of assuming they are well versed in the fundamentals, start any public outreach with a remedial lesson in the fundamentals.
Rubin’s theory, backed up in recent decades with a flurry of papers and surveys, may go a long way to explaining both why we shudder when we hear the phrase “developer profits” and why Canada is suffering through one of the world’s worst housing crises.
Perhaps the most basic principle in economics is the law of supply and demand, the idea that in a competitive market, the supply of a certain good and the demand for it will always reach an equilibrium.
In fact, most of us have a pretty good understanding of that. But researchers in the United States noticed a strange phenomenon in the early days of the pandemic when house prices and used car prices started to skyrocket.
For both cars and housing, the problem came down to supply and demand. Widely reported supply chain problems in the automotive industry meant car makers couldn’t satisfy the demand, while in housing, cheap debt and consumer preferences juiced demand in a way that developers simply couldn’t match.
And in both cases, prices went way up, with used cars shooting up more than 40 percent and home prices and rents following suit.
“Yet the mass public evidently failed to see how the dynamics that play out quickly in the market for cars also affect the price of housing,” the researchers wrote, in a paper that explored the “folk economics” of housing.
About 85 percent of respondents correctly identified that supply chain issues would cause used car prices to rise, while only about a third of respondents understood the connection between the supply of homes and prices.
It’s not just that people think more houses won’t have any effect on prices, many actually believe the opposite. According to two large surveys of urban and suburban residents, the researchers found that somewhere between 30 to 40 percent of people think that a large boost to housing supply will actually cause rents and home prices to rise.
This misunderstanding runs so deep that those who said they preferred home prices to go up were actually more likely to argue for increased housing supply to make them do so.
Economists generally accept that, if nothing else changes, increasing the supply of houses puts downward pressure on home prices in the medium and long term. The U.K. government estimates, based on this research, that a one percent increase in housing supply leads to a two percent decrease in house prices, with all else being equal.
The housing researchers struggled to find an explanation for these widespread myths in the housing market, although previous research has found that when people believe a developer is poised to make a big profit on a project, they are far more inclined to oppose it. That’s backed up by a resilient finding in the study of folk economics that people evaluate economic scenarios based on the motives of the people involved, rather than their actual outcomes.
It may be that the greatest triumph of the modern economy, finding a way to make one person’s greed pay off for others, will never quite make sense to brains that are fundamentally oriented to encourage cooperation at the foraging bush.
University of Calgary professor Trevor Tombe’s day job is teaching students about economics, but he has also taken on a prominent role as an educator of the general public through op-ed columns, public speeches, and television appearances.
Most recently, he has played the part of the empirical voice of reason in the debate over Alberta’s plan to split from the Canada Pension Plan and he has long sought to clear up widespread misunderstandings about Canada’s equalization program.
Despite his reputation as a fact-checker, he’s not comfortable declaring people wrong, or ignorant, about his field of study, which is implicit in the field of folk economics.
“When I do say that some people are wrong or not, that’s probably a failing. I try not to do that. Like in the front of a classroom, what’s my job? What’s any professor’s job? As an educator, it’s not to pick on any student that raises their hand and raises a particular perspective,” said Tombe, in an interview with The Hub.
When it comes to public misunderstandings about the housing market, Tombe’s first instinct is to rack his brain for reasons people might correctly believe increased supply might juice house prices. For example, if a local government changes zoning rules in a particular neighbourhood it could make the land more valuable, simultaneously boosting supply and prices at the same time.
It’s these nuances, “the beauty of economics,” as he calls it, that makes him hesitant to declare anyone totally wrong. The world is a complicated place and economists are often aggregating millions of transactions and different behaviours in the hopes of summarizing the effect of a particular policy change.
Tombe also recognizes that politicians rarely have the luxury of embracing this kind of fair-mindedness. In these debates, he’s generally up against a political machine with a marketing budget and legions of partisan foot soldiers.
“Often, I find that political leaders are not explicitly lying in any way. Things are phrased in a much more aspirational way, phrased in a vague way, signalling what values they hold rather than hanging hats on specific numbers,” said Tombe.
“That’s tricky for an empiricist to even engage with because often, if it’s done well, it’s hard to really pin down exactly what’s being said,” said Tombe.
The trouble with housing is that changes caused by new or adjusted policies move at a glacial pace.
Policy experts are working in the medium and long term, while politicians are responding to last week’s poll numbers and, at times, the daily shudders of an election campaign.
Perhaps until very recently, the proponents of boosting Canada’s housing supply were a niche crowd, promising something that would only have a tangible effect on the housing market several years down the road. The gripes of the average not-in-my-backyard voter were immediate and concrete: unsightly construction sites; massive towers looming over their homes; and more traffic on the morning commute.
The promises made by the parties in the last federal election reflected this obsession with short-term demand-siding thinking. Prime Minister Justin Trudeau’s Liberals promised a new tax-free first home savings account and a plan to double the first-time home buyers tax credit from $5,000 to $10,000. These are policies that, while possibly helping some individual buyers, would inevitably stoke more demand and cause prices to rise.
“There’s a lot of concern at the moment that policy measures may be aimed at symptoms of the problem, which tend to be easier to address on the demand side. But what we need fundamentally is more supply,” said Aled ab Iorwerth, the deputy chief economist at the Canada Mortgage and Housing Corporation.
“There’s been a lot of attention on the demand side but we don’t think they’re very effective in the long term,” he said.
If Canadians share the mistaken ideas that Americans hold about the effects of supply-side policies in housing, it’s easy to see why political parties have been able to make counter-productive promises about housing.
We may even have some sympathy for party strategists who know full well that none of us really knows how this stuff works.
How can voters possibly evaluate the policies we’re being promised? And how can party leaders make promises when a third of the electorate thinks it will have the opposite effect and will vote accordingly?
The Canada Mortgage and Housing Corporation is aware that the economics of the housing market can be tricky for the average Canadian to understand and recent public reports by the agency reflect that.
For one, it is trying to explain the complicated chain reaction of consumer activity that happens when more housing appears in the market. In economics jargon, the “filtering” effect that makes a house more affordable over time can be throttled by a decline in construction.
“A continued stream of new construction, even if it enters in higher price brackets, is important to the success of filtering in providing low-income shelter,” reads a recent study from the University of Southern California.
The researchers noticed a sharp reversal in this filtering process when housing construction became sluggish in 2011 in the wake of the Great Recession.
“As you build new homes, they are generally going to be more expensive, and so will generally appeal to higher income households. But what will happen is that those higher income households will move into those units, vacate the units they moved from that were a little bit lower cost. But those are then becoming more affordable to people on a lower income,” ab Iorwerth.
“New supply will add to affordability.”
But it’s a slow process. And developers will always look to build houses in areas that have higher prices, so the average Canadian will be faced with pricey new homes in expensive neighbourhoods and assume that’s the effect of increased housing supply. The chain reaction of people moving through the housing market and ending up with more affordability is not discernible to the casual observer. Ab Iorwerth said that’s one of the reasons for mistaken ideas on how housing supply affects the market.
“Unfortunately, it takes time. But over the long term, this is a clear way that new supply will add to affordability,” he said.
A recent paper for the Fraser Institute by Josef Filipowicz and Steve Lafleur found that market signals are getting scrambled on both sides of the transactions in housing.
Not only is housing supply lagging behind the demands of Canadians, but the supply is mismatched with what people actually want.
The prices for “ground-oriented” homes, like detached single-family homes and townhomes, have shot up 31 percent since before the pandemic, compared to 17 percent for apartments. Filipowicz said the 2010s was the decade with the fewest ground-oriented completions since the 1960s, which is a number that doesn’t adjust for population growth. That means Canada is building homes at about the same rate as it was when the population was around 18 million people, half what it is now.
“It’s probably no surprise to many folks that governments have made it harder to build outside of cities,” said Filipowicz.
“At the same time, it’s very hard to build anything inside of the city. In fact, when you do get a building permit, it’s easier to go about building condos, for example, than some of this missing middle stuff,” he said.
We’ve found ourselves in the midst of a housing shortage where normal people don’t understand the market, developers can’t build what people want and our politicians sell us policies advertised to help affordability, but actually juice the market even more.
In almost every way, we’re talking past each other on housing.
“Governments and, in particular, the planning community, which I am a part of, has been speaking a very different language than the language of people’s aspiration,” said Filipowicz.
“So that disconnect between those two ideas of the good life is really coming to a head right now,” he said.
