Tuesday, November 18, 2014

The Skyscraper Curse in Alberta

Also available at mises.ca

The Skyscraper Index shows a correlation between the construction of large, record-setting buildings and economic busts. Of course, correlation is not causation, but it’s interesting to note how accurate this index is. Created by economist Andrew Lawrence in 1999, the index has been made famous among Austrians thanks to the work of Dr. Mark Thornton. With all the talk of a Canadian credit bubble (particularly in real estate) and the naysayers that claim that the doomsayers are hyperbolic and sensational, I thought it’d be accurate to look at Canada’s most “prosperous” economic regions and see if there were any record-setting skyscrapers under construction.

And indeed there are.

The Stantec Tower is a 62-storey building that will be the largest in Western Canada and only second to the CN Tower in Toronto. Located in Edmonton, Alberta, this region of Canada is ground zero in economic growth and bust. Alberta’s economy is considered to be in a “bitumen bubble” where all economic progress is dependent on world oil prices. If a crash in energy prices cause fewer exports, this may trigger the necessary corrections to “pop” the broader economy in real estate.

The Stantec isn’t the only tower being built to record-setting heights. When completed in 2018, the Brookfield Place tower in Calgary will stand at 247 meters and, along with the Stantec Tower in Edmonton, will dominate the skylines of these two cities. The two towers will be the largest skyscrapers in Canada outside of Toronto.

So the Canadian recession will begin in 2018? Once again, correlation is not causation but considering Canada’s economic growth is predominantly out West, and the fact that oil prices could make or break Alberta’s economy. Not to mention the ripples a crash in bitumen prices could have throughout the broader economy (thanks to the so-called “wealth effect”) – then keeping these skyscrapers in mind may help determine exactly when we can expect Canada’s housing bubble to burst.

But what gives? Why this correlation to begin with? The “skyscraper curse” is more of a skyscraper signal or an alert. When construction projects are projected to break regional records, it’s good indication that there was a reason these records weren’t broken to begin with. Distorting rates below their “natural” level increases investment and consumption, but decreases savings. Businesses tend to become more leveraged than they otherwise would have been and thus more susceptible to failure. Generally speaking, the structure of production is transformed toward longer-run and more roundabout production processes.

As Mark Thornton writes,
“With skyscrapers and related markets there is a large increase in capacity, namely, the amount of office space and related services means that expected future prices are unlikely to be achieved and therefore expected profits will not be achieved and losses will increase. Once boom has turned to bust, the existing capacity to produce new extremely-tall skyscrapers will greatly exceed demand for producing skyscrapers, and profit margins will be squeezed tight for the construction and materials firms that survive the bust.”
For more on the skyscraper curse, see this excellent interview with Dr. Mark Thornton.

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