Canada, we have massive construction crisis on our hands

A recent TD Economics report with the alarming title ”From Bad to Worse: Canada’s Productivity Slowdown is Everyone’s Problem” has triggered an almost panicked response from the country’s economic elite.
It is a superb, comprehensive report, to be sure.
It has also been widely misread as a productivity crisis in every nook and cranny of the economy when the construction sector alone accounts for most of the problem.
More on that later.
It’s true that Canada’s post-pandemic decline in productivity growth, or growth in GDP per capita, is disturbing.
“Without improved productivity growth, workers will face stagnating wages and government revenues will not keep pace with spending commitments, requiring higher taxes or reduced public services,” warn TD report co-authors Beata Caranci and James Marple, chief economist and senior economist at TD, respectively.
But some Canadian industrial sectors, the oft-cited report finds, have achieved productivity gains post-pandemic. They include wholesale and retail trade; information and cultural industries; and accommodation, food and real estate services.
And productivity gains in Canadian banking have outpaced those in the U.S.
By contrast, the woeful performance of the construction sector has an outsized, and growing, impact in dragging down the entire economy’s productivity.
“There is one sector in Canada that wears the Scarlet Letter more prominently than the others: construction,” says TD.
“(Construction) has accounted for the vast majority of the decline in overall Canadian productivity relative to the pre-pandemic period,” TD says.
Construction’s increasing share of the economy as Canada ramps up housing and infrastructure building threatens to constrain overall productivity growth for years to come.
Labour hours worked in construction accounted for 12.6 per cent of total hours worked in Canada in 2023, up from just eight per cent in 1997.
The $164-billion Canadian construction sector, and especially its residential component, largely operates as a cottage industry.
The sector is highly fragmented. There are more than 36,000 residential construction companies in Canada. Most of them are tiny. More than 65 per cent of them have fewer than five employees.
“In the single-detached market segments,” says Kevin Hughes, deputy chief economist at the Canada Mortgage and Housing Corp. (CMHC), “some firms will build one house a year.”
Operating locally, construction firms lack the economies of scale of regional and national enterprises.
It is not surprising, then, that the construction sector, according to TD, has achieved no productivity growth for 40 years.
As a rule, construction firms cannot afford the most modern equipment. They often have not been able to absorb the hikes in raw material costs of recent years.
Compounding the problem are today’s high interest rates.
Amid a crisis of insufficient shelter, housing starts actually fell by seven per cent last year, to 223,513 in communities of more than 10,000 people, according to the CMHC.
Compare that with the approximately 750,000 annual housing starts in several years in the 1970s.   
That was before today’s soaring land costs, rising Nimbyism and more restrictive land-use regulations, which U.S. studies cite in describing even lower U.S. rates of construction productivity growth than in Canada. 
But the negative impact on overall U.S. productivity is lower than in Canada. Construction accounts for 7.4 per cent of Canadian GDP and only 4.4 per cent of the U.S. economy.
Small-scale builders are averse to the risks in a volatile industry where demand swings are frequent. When interest rates and materials costs spike, many firms just stop building.
Large, well-capitalized firms can cope with those risks, but there are few such companies in the construction industry.
Governments can help solve the problem by streamlining lengthy approval processes for new builds.
They can reduce some of the fees and charges that account for an estimated 25 per cent of a new home’s cost in the GTA.
And they can standardize the varied building codes and zoning rules among municipalities and provinces.
That lack of harmonization discourages builders from working across jurisdictions to achieve greater economies of scale.
Modular housing promises productivity gains.
The Canadian Home Builders’ Association reports that its members who specialize in modular homes — which are entirely or partly built in a factory off-site — can reduce construction time by as much as 50 per cent compared with traditional on-site construction. 
Modular housing accounts for about 45 per cent of homes in Sweden and 15 per cent to 20 per cent of homes in Japan.
Finally, the construction industry needs to consolidate, as other major industries have done.
“Low market consolidation hinders investment in R&D and efficient recruitment, training, resource allocation and project management,” says Hughes of the CMHC.
If Canada has too many oligopolies, it has the opposite problem in construction.
The emergence of sizable firms dedicated to residential construction — encouraged and financed if need be by governments at all levels — would accelerate provision of urgently needed housing and boost productivity gains across the economy.
After all, insufficient housing is itself a drag on productivity.