The State of the Construction Industry Report

Contributors to this report are as follows:
Jacquie Cannon OBE, CFR; Jeremy Croxson, ACE; Bob Davies, DTI; Linda Gilardon, CITB; Andy Goodwin, DTI; Milan Khatri, RICS; Joe Martin, BCIS; Chris Nicholls, DTI; Thomas Parry, BSRIA; Frances Pottier, DTI; John Stewart, HBF & CC; Jim Turner, CECA & FMB; Allan Wilen, CPA

1. Economic Background

Since the start of 2001, the global economy has slowed significantly, with the terrorist attacks on September 11 further dampening confidence and expectations for 2002. According to its Pre-Budget Report, the Treasury expects growth in the major G7 economies of around 1% in 2002, before a US led recovery in 2003.

The UK is expected to perform above this average, growing by 2.25% during 2002 before recovering to above trend growth rates in 2003. Consumer spending was the main growth area during 2001, although it is predicted to slow slightly over the outlook. This, combined with an increase in government spending is likely to be the driving force behind GDP in 2002, with private investment remaining sluggish. Inflation is predicted to remain at around 2.25% in 2002.

The total volume of construction output has continued to grow steadily following a short period of decline in the middle of 2000. This is mainly due to higher growth in infrastructure work.

Figure 1.1 - Comparison of Construction Output Growth Forecasts

Source: Data provided by forecasting organisations (see key)

Figure 1.1 shows industry forecasts up to 2003 by five independent forecasters. The estimates of output growth in 2001 vary from 2.5% to 3.4%, whilst predictions for 2002 range from a fall of 1.9% to a rise of 2.3%. This is partly the result of different forecasting methods, with some of the forecasters using computer based models, and varying views on the speed of the switch in growth from private to public work. The forecasts for 2003 are closer together with the five organisations predicting growth in the range of 0.7% to 3.5%.

The forecasts vary most significantly in the extent to which output in the private sector falls in 2002. For example in the largest construction sector, private commercial work, CPA, CFR and Hewes Associates all show falls in 2002 and 2003. Although Hewes is the most gloomy at -7.2% and -5.8% respectively, whereas CPA's forecasts are -2.1% and -0.4% over the same period. There are also differences over the speed that spending on infrastructure will come through in the output figures, and whether private sector repair and maintenance will fall significantly. Forecasts for public sector R&M are more in step with one another.

2. The Impact of the Global Slowdown

The US has led the recent slowdown in the global economy, which started to cool down in 2000 following the crash in over-valued technology stock. Germany and a number of other G7 countries slowed soon after the US and this has now affected most of the world.

The US is also likely to lead the recovery of the global economy. According to the Treasury, the US economy will turn around in mid 2002, and recover strongly in 2003. The US government has taken bold steps to stimulate the economy by easing both monetary and fiscal policy (interest rates were cut from 6.3% to 1.8% during 2001). The European Central bank has also cut interest rates, though not as aggressively as the Federal Reserve.

The UK economy has been fairly resilient so far and is expected to perform well compared to other European countries with annual growth forecast to remain above 2%. This has been achieved mainly through high levels of consumer spending boosted by low interest rates, though this debt-financed consumption is not sustainable indefinitely.

There are three main impacts of the global slowdown on the UK construction industry. The first and potentially most significant, is the impact on consumer and business confidence within the UK, and associated investment in construction products. This is reflected in the slowdown in orders for new commercial construction.

The second impact is on multinational companies operating in the UK where the fall in corporate profitability may lead to reduced investment spending. Thirdly, there has been a decline in global demand for UK construction consultancy services and products.

Overall, the impact on the UK's construction industry should be relatively small, although much of this is due to the public sector spend replacing a decline in the private sector. However, product suppliers and British overseas contractors and consultants will be hit harder than most, due to their greater exposure to foreign markets.

3. Regional and Sectoral Variations

Regional
Trends in construction across the regions of Great Britain continue to vary significantly, with the South doing better overall than the North for both output and new orders.

Table 3.1: Output and New Orders by Region (first three quarters of 2001, £m current prices)

Source: DTI

The value of new work orders grew most strongly in London in the first three quarters of 2001 compared to the same period in 2000 (see table 3.1), with the capital also seeing the largest absolute increase (see figure 3.1). New orders fell most rapidly in Wales, followed by Scotland.

Figure 3.1: Actual growth in New Orders and Output by Region (first three quarters of 2001 compared to first three quarters of 2000)

Source: DTI

Sectoral
The volume of new work orders grew in most sectors during the first three quarters of 2001 compared to a year ago, with only private new housing and private industrial showing falls (see Table 3.2). Infrastructure and public new housing orders grew the fastest, with infrastructure also showing the largest actual increase (see figure 3.2). 2001 has seen fewer exceptionally large orders than in 2000, but there has still been a steady flow of significant contracts.

Table 3.2: Output and New Orders by Sector (first three quarters of 2001, £m 1995 prices).

Source: DTI

Figure 3.2: Actual Change in Output and New Orders by sector (first three quarters of 2001 compared to first three quarters of 2000)

Source: DTI

Private non-housing repair and maintenance (R&M), and infrastructure new work output were the fastest growing sectors during the first three quarters of 2001 compared to the same three quarters in 2000. This reflects the high levels of orders reported, particularly in the road and rail sectors. Three sectors showed a negative growth rate, private new housing, public housing repair and maintenance and private industrial new work.

4. Housing

Total housing completions in Great Britain fell 4% to 161,900 in 2001, the lowest level for 54 years.

Private Housing
Despite a buoyant housing market throughout most of last year, private housing starts rose by only 2% to 161,800, while NHBC private housing registrations fell 1% in 2001. The volume of private housing output in the first nine months of 2001 was 8% lower than a year earlier.

After hovering in the narrow range 146,000-153,000 between 1994 and 2000, private housing completions fell to 140,200 in 2001, the lowest since 1982. The house building industry believes the planning system has put a ceiling on private house building, so that developers are unable to raise output in response to an increase in housing demand. The industry fears that new planning rules introduced in 2000 will reduce this ceiling further.

Private housing R&M output rose by 4% in the first three quarters of 2001, more than reversing last year's slight reduction.

Public housing
Total social housing completions in 2001, at 21,500, hit a post-war low. New social housing output in the first nine months rose 2%. A 6% decline in social starts in 2001, contrasts with a 20% increase in the volume of new orders.

The fall in the Housing Corporation's Approved Development Programme to £700 million in 2000/2001 and the shift of available funds towards major regeneration programmes provide the main explanations for the declining trend in starts. Where need is greatest, in the South East, is also where the lack of available sites is most acute and cost pressures are higher than average.

Output of public housing R&M fell by 7% in the first three quarters of 2001, the fifth successive year of decline. The continuing fall is difficult to relate to the increasing number of large regeneration programmes and stock improvement work triggered by local authority stock transfers to registered social landlords.

5. Non-Residential Building

Private
The value of orders for commercial buildings in the 11 months to November 2001 was close to that for the whole of 2000, suggesting that demand has not yet run out of steam.

A strong start to the year enabled offices to hold on to their dominant role, with close to half the total value of new commercial orders in 2001. As expected, entertainment has continued to fall from the peak of 1999, while retailing shows signs of strong growth year-on-year.

Encouraging orders figures from the education sector, well up in the first eleven months of 2001 over the year earlier, suggest a rapid increase in PFI contracts and point to a fast rise in output in the future. This has been offset however by the sluggish level of health orders in 2001 due to the lag between decisions to go ahead with new PFI hospitals and the release of contracts.

Industrial construction workloads were stable during 2001, which shows a degree of resilience that was not anticipated, given the current weak state of the manufacturing sector.

Public
The increase in public funding available for schools building and refurbishment programmes goes a long way towards explaining the swiftly rising level of orders in the sector. The total for the first eleven months of 2001 exceeds that for the whole of 2000, which should lead to higher levels of output in the short term.

Health orders have likewise moved rapidly ahead of those in 2000, thus reflecting the release of the first tranche of hospital contracts included in the 2001 strategic review.

6. Infrastructure

Total infrastructure new work output grew substantially in 2001. At just over £4.9 billion at 1995 prices, output in the first three quarters was 13% higher than a year earlier. The third quarter figure of £1.7 billion, 21.7% higher than that for the third quarter 2000, is the highest quarterly total for infrastructure since the second quarter 1993.

Further increases in output may be anticipated over the next two years, given the trend in orders. Total new orders for new infrastructure in the three quarters to end-September 2001 were 9.9% higher in volume than in the first three quarters of 2000, whilst the latest four quarter figure, just over £5 billion at 1995 prices, is the highest since mid-1993.

A major influence behind this growth is the Government's Ten Year Plan for transport and the Birmingham Northern Relief Road. The Ten Year Plan has led to a significant revival in construction, improvement and structural maintenance of roads in England, while Scotland and Wales are due to announce their own schemes imminently.

The railway sector has also been buoyant. However there is concern amongst contractors that major enhancement projects are not currently being brought forward at a rate sufficient to sustain workload, in the medium term, at the level anticipated in the Plan.

On the other hand, there are indications that the dip in orders for water and sewerage works in the first three quarters of 2001 may be only a temporary phenomenon, as the five year investment plan of the English and Welsh water companies (AMP3) gathers momentum. In other segments, the grant of planning permission for a fifth terminal at London's Heathrow Airport resolves a long-standing uncertainty. This is expected to influence infrastructure orders from the start of 2003.

7. Materials & Products

Overall, after a weak start to the year, construction products sales volumes improved throughout 2001 and are ahead of the levels of a year ago according to recent surveys by the Construction Products Association. However, the improvement in sales volumes has failed to lift business confidence which has consistently remained below the levels of a year ago. CECA, HBF and FMB surveys continue to find only very low levels of concern over materials supply difficulties.

Builders merchants sales saw a sustained improvement throughout 2001, with fourth quarter sales 7% up on a year earlier. The rise over the last year has been primarily driven by higher sales of light side products and by 'mixed' sales which cover the returns from the smaller merchants. The strength of these sales reflects a buoyant private housing R&M sector with higher DIY expenditure by consumers.

Heavy side materials, however, have not fared so well, with sales volumes especially weak during the first half of 2001. Overall deliveries of bricks and concrete blocks were down by 4% and 2% respectively in the first nine months of 2001 on 2000. The Quarry Products Association recorded similar declines in road related materials, despite stronger third quarter deliveries.

Manufacturers responding to the Construction Products Association's fourth quarter survey recorded an increase in unit costs, with heavy side firms especially affected by higher fuel and wage costs, with the Climate Change Levy further adding to costs. This in turn has added to the domestic selling price of products, pushing prices up especially amongst heavy side firms.

Export selling prices and sales volumes have fallen due to the continued strength of sterling against the euro, increased competitive pressures from overseas suppliers and a general weakening of conditions in important overseas markets. Imports have also risen as attractive exchange rates and the relative strength of UK construction activity has encouraged overseas suppliers to target the UK market.

8. Consultants

Chartered surveyor workloads fell slightly in the fourth quarter of 2001, compared with the third quarter, according to the RICS construction market survey, the first decline since the beginning of 1996. Growth in private commercial workloads has come to a standstill as the slowdown in business investment continues, while the recession in manufacturing further undermined industrial construction. Housing construction activity rose at a slower pace in Q4, reflecting a sharp fall in public work, though private sector building also showed a slowdown.

Confidence among chartered surveyors for near term activity cooled significantly at the end of 2001, having been upbeat for the last two years. Rising public sector work will probably make up for some of the shortfall in the private sector in early 2002, though prospects looking towards the end of the year are viewed as more gloomy. Despite expectations for a downturn in the industry, employment is expected to hold up in early 2002, as firms are reluctant to release skilled labour amid continued concerns over skills shortages.

ACE member firms are upbeat about business prospects for the UK market, particularly in the UK where there is an expectation of further increasing workloads as the Government's plans for revitalising the nation's infrastructure are developed. However, current concerns over the skills shortage in qualified engineers and the relative low levels of fees for engineering consultancy work, may pose a question mark over the ability of UK consultants to take advantage of improving workload prospects.

Architects' new commissions rose throughout 2001. However confidence weakened significantly in the third quarter questionnaire, post 11th September, which showed a balance between practices expecting workloads to increase and those expecting them to fall (1).

9. Prices and Costs

Tender prices and labour costs continued to reflect demand pressures through 2001, while material prices moved much more in line with general inflation.

Figure 9.1 - Building Tender Prices, Material Costs and Average Earnings (annual percentage change)

Source: BCIS, DTI and ONS

Input costs rose 3% in the year to third quarter 2001. Materials prices rose 2% while average earnings in construction where up 6%. Average earnings in the whole economy rose 4.3% over the same period.

Building tender prices rose 9% (third quarter 2000 to third quarter 2001), reflecting the high demand for building work. Tender prices for civil engineering work have not shown such a significant rise despite strong growth in demand. For example the tender price index of road construction work rose 3% in the period. This may reflect the lower labour content of civil engineering work and the generally poor demand for heavy side materials reported by materials suppliers.

Tender prices generally are expected to continue rising above the rate of inflation in the economy as a whole, in response to further increases in demand for construction and labour supply remaining tight. However, there may be some shift in emphasis between buildings and civil engineering.

Output prices for all construction work rose 3% in the year to the third quarter 2001. Given that output prices reflect tender movements in the past one to two years, output price inflation is likely to rise over the next year.

10. People and Employment

Total construction employment reached the 1.5m mark in 2000 with the share of the self-employed stable at 36%. For the first three quarters of 2001, construction employment continued to increase at a moderate rate reaching 1.546m by July 2001. This was due to a rise in self-employment, which reached 600,000 or 38% of total employment, while direct employment fell slightly. Within total employment, the share of the 16-24 age group, which had increased to 14% in spring 2001, fell back to its 1998 level of 11%.

Recruitment into training has improved steadily over the past four years. According to CITB Trainee Numbers Survey, first-year students on construction courses increased from 29,000 in 1997 to 45,000 in 2000.

At degree level, the trend has been in the opposite direction. Over the past three years (between 1998/99 and 2000/01) first year intake onto construction-related degree courses has declined from 10,600 in 1998/99 to 9,440 in 2000/01. The only exception is first year intake into Architecture, which increased by approximately 200 to 2,300, according to the Higher Education Statistical Agency.

Since 1997, unemployment in the industry (2) declined faster than in the economy as a whole (see figure 10.1). From a rate of 9.7% in 1997 it reached 5.5% of the workforce by the end of 2000, while the whole economy's rate fell from 6% to 5.1% over the same period.

In the first half of 2001, the rate of construction unemployment fell below the economy's overall unemployment rate. By the end of the second quarter 2001, construction unemployment was 4.1% compared to 5.3% for the economy as a whole.

Figure 10.1 - Unemployment, 1990-2001: Construction and All Industries

Source: ONS Labour Force Survey

11. Special Focus - Construction Industry Capacity

The construction industry's capacity is cited as a possible constraint on delivering projects. In particular, it is a key concern in delivering the Government's investment pledges on time and on budget. The seeds of this situation were sown during the boom and bust of the late 1980's/early 1990's, after which many skills were permanently lost to other industries. Despite steadily rising workloads in the second half of the 1990's and early 2000's, a shortage of key trade and professional skills has emerged. Therefore, a key question is how much capacity is left in the industry to carry on increasing its output.

There are a number of ways of assessing whether the industry is operating at either high or low levels of capacity utilisation. The former is usually associated with rising tender price inflation, poor quality, and delays in completion. The latter, on the other hand, tends to prevail at times of high and rising unemployment, and when there is slow or negative growth in workloads.

Research by the DTI has produced a model for measuring capacity utilisation based on labour market data (earnings differentials, total hours worked and unemployment) and company insolvencies. Combining these data has produced a model which estimates capacity utilisation over the past 30 years. The results are shown in figure 11.1.

The discrete indicator shows periods where construction output is above trend and is most likely to cause inflationary pressures (1 is above trend, 0 is at or below trend). The continuous indicator shows the estimated extent of this capacity utilisation (positive is high, negative is low).

The figure shows four distinct periods of high capacity utilisation in the early and late 1970s, the late 1980s and mid-1990s onwards. Despite being a longer than average period of high capacity utilisation (discrete indicator), it seems from the continuous indicator however, that over the last five years the industry has been stretching its capacity less than over the previous periods.

Figure 11.1: Discrete and Continuous Capacity Utilisation Indicator

This might indicate a couple of characteristics. Firstly, the industry might be using its resources more efficiently than over previous cycles. Certainly, the lower levels of volatility would suggest that it might be able to do so, as there is more certainty of workloads and development of new forms of procurement with increasing emphasis on partnering. Secondly, it might suggest that the industry is struggling more to address its capacity shortages now, than it has done over previous periods of expansion, during which, labour could be recruited more easily than at present. Again, this seems to be plausible, as the industry continues to report shortages in recruiting the professions and skilled trades.

Figure 11.2: Construction Inflation Minus General Inflation

Both theories are plausible, but they have different implications with respect to inflationary pressures. The first is relatively benign, while the latter has an impact on inflation.

Figure 11.2 addresses this question, by showing the pattern of construction inflation over the past 30 years. It is adjusted for general inflation, so as to highlight periods of construction-specific price pressure.

This suggests that inflationary pressures are still present (favouring the second theory), but less prevalent than in the mid-1990s. Therefore it seems as though the industry has adjusted to a higher level of capacity utilisation, which has dampened some price pressures.

As a result, it is probably a bit of both theories, as most price pressure tends to comes from rapid growth of capacity utilisation, as the industry struggles to accommodate the expanding capacity; and less pressure comes from the overall level, as it has a chance to adjust over time.

Qualitative data from industry trade surveys support this view of on-site capacity, with the Contractors Confederation's quarterly survey over the last three years consistently reporting that around 50% to 65% of building contractors were working close to capacity.

In contrast, whilst the construction products industry has seen higher capacity utilisation during the second half of 2001, capacity is not expected to be a significant constraint on activity over the next year. The Construction Products Association's third quarter survey found that demand was overwhelmingly seen by manufacturers as the principal constraint on output mentioned by four-fifths of firms, compared to only 10% mentioning capacity.

Capacity constraints are recognised in the Construction Products Association's report on the ability to deliver the Government's spending plans for health, education and transport. However, it is not only dependent on the construction industry's ability to deliver, but also on the Government's ability, as a client, to spend the money allocated to the projects.

The report, Achievable Targets? Investment Realised?, highlights the scale of the proposed investment plans, as well as pointing out the gaps in data required to monitor progress towards delivery. Constraints will consist of, not only the availability of adequate construction skills, but on factors such as streamlining the PFI and Public, Private Partnership (PPP) bidding processes, and reducing planning delays and other administrative obstacles.

FOOTNOTES

1. Mira & Nacey Architects Workload Survey, January 2002

2. ILO measure

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