Leading indicators is a monthly column written by RICS Chief Economist, Simon Rubinsohn. This month, how will global construction weather the economic downturn and are build back better policies finally coming into fruition?
Simon Rubinsohn, Chief Economist, RICS
15 July 2022
When we last attempted to capture sentiment in the construction industry at the end of the first quarter of the year, the feedback was generally positive. Workload growth through to the early part of 2023 was viewed as likely to remain strong. This upbeat message was provided to us despite concerns about both the sharp rise in building costs, materials and labour, and the anticipation of a further tightening in credit conditions as the year progressed.
Since then, the macro environment has markedly deteriorated. The OECD have trimmed their global growth projection down to 3% for 2022, compared with a 4.5% forecast at the beginning of the year (with a similar number in place for next year). However, this masks what is likely to be a rather more challenging environment in many of the more advanced economies; a point highlighted by the suggestion that growth in the OECD area in aggregate will struggle to beat the 1% mark.
Meanwhile, inflation indicators continue to surprise on the upside putting further pressure on central banks to take more determined steps to prevent the emergence of wage price spirals. At the same time, ongoing challenges linked to the war in Europe continue to be amplified by deep seated supply chain constraints. Against this backdrop, there is little sense that commodity prices are going to significantly retrace their steps anytime soon. Understandably, central banks are now responding in a more assertive way to this hostile environment. They are no doubt mindful that the failure to act in a bold and effective manner could see higher inflation expectations become more embedded in psychology, fuelling a wage-price spiral.
Despite this, I would not be surprised if the RICS Global Construction Monitor (GCM) Q2 survey shows workload numbers (in most parts of the world) remain generally upbeat. When the Q2 numbers are released at the beginning of August, it is likely that even the more forward-looking metrics will reflect a generally sanguine assessment of the outlook.
That may seem somewhat incongruous, but there are a number of reasons why this may be case.
One key explanation could be the heavy lifting that infrastructure, in particular, (and construction more generally) has been asked to do as part of the post-pandemic recovery platform. The phrase ‘build back better’ may have lost some of its allure. However, the policies that underpinned this message are only now coming to fruition and will support activity in the sector for some time to come. This, arguably, is more of a structural shift in demand rather than something reflecting the cyclical macro ups and downs.
However, even with the latter there is some reason for cautious optimism. There is a lot of talk about the ending of the house price boom and some early signs that prices may actually be slipping in a number of markets. But critically, it is far from clear that the demand for housing is in any sense going to wither. Supply constraints (in many cases of a regulatory nature) explain a good deal of the euphoria in a large number of top tier cities around the world. W Higher borrowing costs may temporarily puncture pricing (and activity). But the fundamental shortfall vis-a vis demand is likely to keep housing developers building even if they, for a while, slow build out rates.
On top of this, it is likely that some of the shift in commercial space usage both relating to the legacy of Covid as well as other fundamental shifts in behaviour (the move to online retail is probably the starkest) will continue to generate demand for reconfiguring buildings. Repair and maintenance has, in a number of markets, seen amongst the fastest rate of growth in the construction industry.
One key explanation could be the heavy lifting that infrastructure, in particular, (and construction more generally) has been asked to do as part of the post-pandemic recovery platform.
This isn’t to say that the sector doesn’t face significant challenges. Profitability for many businesses will be crimped by the continuing high cost of building materials and labour. Insolvencies, while still low, are beginning to creep up reflecting some of these issues. And alongside this, the pressure to address matters around sustainability in the industry are only going to intensify adding further costs to the development process. The latest round of RICS GCM surveys that I oversee have included additional questions around this issue. The survey examines sustainability from the perspective of the willingness of owners to pay more for a ‘green’ buildings. It also looks at the extent to which the industry is addressing issues around the measurement of embodied and operational carbon. I won’t prejudge the response of contributors but wouldn’t be at all surprised if the results suggest much more still needs to be done.
That said, the industry may draw some comfort from the steps being taken in some quarters to address the productivity deficit with the wider economy. Let me give some context on the scale of this. In the UK, for example, it is estimated that output per person has climbed by around 150% over the last 50 years. For the construction sector, output per person amounts to less than one-fifth of this figure – 15%. A recent insight note by WPI Economics has highlighted the importance that greater focus on offsite construction can play. Meanwhile others have pointed at more rapid adoption of new technologies and better usage of information management. The good news is that opportunities are there to be seized, and with the more treacherous macro conditions emerging, the rewards from pushing ahead with this agenda could be significant.
