[ARCHIVED CONTENT] State of the Industry Report

World economic growth is estimated to have slowed to 1.6%[1] during 2002 and is forecast to recover to 2.3% during 2003. Concerns that the world�s three biggest economies might suffer as a result of deflationary spirals have unsteadied some nerves, particularly when coupled with a risk of another Gulf war. In a recent speech, Charles Bean from the Bank of England concluded that the risks of deflationary spirals in the USA, Japan and Germany were over-exaggerated. Even so, the Bank admitted there was a theoretical risk, and was setting interest rates with an eye firmly fixed on the international scene.

Fortunately, the UK�s economy looks in better shape than most other major economies, and is forecast to grow by 1.7% in 2002, and 2.1% and 2.4% in 2003 and 2004[2], respectively. There is no room for complacency though, as Britain�s open economy is vulnerable to a sustained downturn in the world economy through its trade and investment links.

Despite a slowdown in growth during 2002, UK monetary policy was tighter than would otherwise be the case, because of buoyancy in the housing market sustaining higher consumer demand. At the same time, the economy is vulnerable to a possible sharp downward price correction in the housing market.

Forecasters estimate construction growth of around 6 per cent during 2002 (see figure 1.1), with the Government�s spending programme (covering infrastructure, education, healthcare and housing projects) fuelling much of this growth. There is a difference of opinion on the industry�s prospects for the coming two years, even though all the forecasters expect growth to slow from 2002�s rate.

A surprising feature of construction�s performance during 2002 was the resilience of private commercial construction. Many forecasters have been calling the top of this market for some time, but its 11 per annual growth in the first half of 2002 has so far proved them wrong.

The new construction market is, on average, forecast to grow more rapidly during 2002 and 2003 than the repair and maintenance (R&M) market. These differences are less pronounced in 2004�s outlook.

Premiums for construction companies� employer liability insurance, and professional indemnity insurance, have risen dramatically over recent months. Some companies have seen their premiums rise to such levels that they face an uncertain future if they cannot increase prices to reflect such premium hikes.

The Construction Products Association has surveyed its members on this issue. Their members saw their average employers liability insurance premiums rise by 123% since last year, while their other insurance premiums have also outstripped inflation.

In response, the DTI is conducting research into this issue. It is examining the main reasons behind the rise in premiums; the effects on separate parts of the industry; and any measures companies can take to reduce their premiums in the future.

Trends in construction were consistent across most of the country, with strong growth in most regions. The obvious differences between North and South seen in last year�s Report are no longer quite so apparent.

New orders in the year to the third quarter of 2002 grew most strongly in the South West, North West and Wales, with the North West showing the largest absolute increase. New orders fell most rapidly in the West Midlands, although this was largely due to exceptionally strong infrastructure orders in the previous year. The only other region to experience a fall was the South East, following high commercial and industrial orders in the previous year.

Output growth in the year to the third quarter of 2002 was fastest in the East Midlands and South West, although the largest absolute change was in London. Only Scotland recorded a decline during this period, and this was very small.

Figure 3.1 shows the absolute change in both output and new orders in each region.

Table 3.1 shows absolute and percentage changes in both output and new orders for each region.

New orders in most sectors grew in the year to the third quarter of 2002, with only private industrial new work showing a fall. Public non-housing orders grew the fastest and also showed the largest actual increase.

Public non-housing new work was also the fastest growing output sector, although in absolute terms, private commercial new work showed a larger increase. Private industrial new work fell, as did public housing RMI.

Figure 3.2 shows the absolute change in both output and new orders in each sector. Table 3.2 shows absolute and percentage changes in output and orders by sector. Information about orders for R&M are not available.

House prices rose by around 25% during 2002, and quarterly property transactions are at their highest since early 1989. The number of investment buyers has been rising rapidly and, according to the HBF survey, house builders regard stocks and work in progress as well below adequate to meet anticipated demand. Yet despite booming demand and inadequate supply, private housing starts in the first ten months of 2002 were up only 1.0% on a year ago. Because �affordable housing� provision[3] is increasing, starts for sale to private owners have probably fallen in 2002. Private completions rose 5.3% in the first ten months.

In the September House Builders Federation survey, 85% of house builders identified planning delays as a major constraint on production. In the third quarter, only 16% of �major� residential planning applications (10+ units) were decided within eight weeks and 36% within 13 weeks - well short of the Government�s target of 60% within 13 weeks. Other major production constraints are labour availability (70%), land availability (62%) and land prices (61%).

The mix of private-sector new homes is changing. According to NHBC statistics, the detached house share fell from 51% in 2000 to 42% in the 12 months to September 2002 while the flat share rose from 21% to 28%.

Private housing repair, maintenance and improvement (RMI) output rose by 1.8% in the first half of 2002 compared with a year earlier, a surprisingly weak increase in view of the strength of housing transactions and consumer spending and the very low level of interest rates. It may reflect a shortage of small contractors working in this sector rather than accurately reflecting the strength of demand.

Total social housing completions in the twelve months to September 2002 numbered 20,900, another post-war low, reflecting the continuing decline in starts in the previous period. There was, however, a recovery in starts, with an additional 1,000 units getting on site. Orders displayed the same trend. The rise in the volume of output that developed in 2000 has been maintained since then, albeit at a lower rate.

Severe difficulties in increasing the level of activity in the South East are still encountered, with lack of suitable and affordable sites and cost pressures the dominant issues. These problems weaken the positive impact of Section 106, whereby a share of private housing sites in excess of a certain size has to be earmarked for social housing.

Public housing RMI output has continued to decline. The lack of a recovery in the sector does not fit in with the large number of regeneration and improvement programmes on which stock transfers and other LA measures are predicated, although slowness in concluding details of PFI or PPP contracts may partly explain the paradox.

In the twelve months to September 2002, the total value of private and public orders, excluding housing and infrastructure, exceeded that of the previous twelve by some 9%. There was a much larger increase in public than in private new work orders, with the former up 21% while the latter rose 4%. Schools and colleges made the strongest contribution to the rise in the value of orders, reflecting the impact on workloads of the government�s increased financial allocation in the public sector and the implementation of PFI contracts in the private sector.

As in the previous year, a single strong quarter helped orders for private offices hold on to their large share of commercial orders, but the value of orders slipped 4% year-on-year. Orders for entertainment and shops both showed a rise on the previous twelve months in excess of 10%.

Orders for health projects rose year-on-year in the public sector but fell in the private sector. The total is very similar to that of the previous twelve months, a weaker than anticipated outcome given the emphasis on raising the level of capital expenditure on new hospitals and other health facilities.

The volume of private commercial work rose by 11% year-on-year, exceeding most expectations, while that of public work leapt by 25%.

Industrial construction orders fell heavily in the year to September, with both warehouses and factories witnessing large declines, the inevitable effect of the manifold problems met by the manufacturing industry in the recent past.

Strong rises have been reported in the four quarters to September 2002 in the volume of public and private non-residential R&M work, of 14% in the former and 11% in the latter. Much of the increase in private work is likely to be related to R&M of the rail network, while in the public sector, work on the infrastructure and on the education stock underpins the year-on-year rise.

Infrastructure new work output is estimated to have risen by 11% in the last four quarters. Figures for output by type of work, available only at current prices, show increases under all headings apart from work at airports and for the gas and communications industries. The main gains are in work on railway infrastructure, 50% higher in value, and in road construction, up 28%. Continuing the reversal in trend evident during 2001, the increase is largely in work for public rather than private sector clients.

By region, however, the figures are highly erratic. Of an overall increase in infrastructure output of just over �1 billion, more than three quarters is accounted for by just two regions, the South West and North West of England, where the figures are higher by 80% and 75% respectively. By comparison, there are falls in the value of output in the North East, East Midlands, and Eastern regions of England, and in Wales.

Looking ahead, there has been only a modest rise over the same period in total infrastructure new orders, of a little over �200 million or 4% to �5.7 billion. Orders for both water and sewerage works are higher by more than one third, as the privatised water companies AMP3[4] investment plans are turned into orders, and there are double digit increases in orders for both road construction and work for the electricity industry. On the other hand, orders for work at ports and airports, and for the gas, communications and railway industries, are just over a fifth lower.

As with output, so with new orders, there are massive variations by region. Relatively the largest changes are a doubling of new orders to just over �800 million in the North West, an increase of 87% to �635 million in the South West, and a halving to �660 million in London. There is also a sizeable fall in the West Midlands, and a small one in the East Midlands. Orders for public sector clients are more than 40% higher, but those for private sector clients are down 15%, despite the increase in demand from the privatised water industry.

Industry sources point out that some of these large year-on-year variations in orders by type of work and by region are linked to changes in procurement. For example, the increase in the North West is mainly attributable to the letting of very large framework contracts by the region�s water and sewerage services provider. The practice of letting frameworks, or otherwise bundling together large amounts of work to be carried out over several years, is making it difficult to identify underlying trends.

The Construction Product Association (CPA) estimates that overall sales of UK products rose by around 3% to 4% last year, significantly slower than overall construction output growth. This average figure, however, disguises wide variations between heavy side manufacturers, which in many product ranges have shown little or no increase, and light side manufacturers where in a number of sectors there were significant increases in sales. The Association has identified a number of factors behind the divergence including a sharp deterioration in the overseas trade balance, changes in the nature and mix of construction workload, and the impact of the Aggregates Levy in April 2002 which has pushed costs up. Year on year aggregate sales fell, partly as a direct result of the levy. The DTI and the industry are currently investigating at greater length the factors behind the divergence in construction output growth and product sales.

Manufacturers anticipate further sales growth during 2003, although, business confidence remains fragile, reflecting the more uncertain outlook and growth remains dependent upon the realization of Government investment plans.

Builders merchants saw sales growth slow during the 2002, with sales volume for the year as a whole 3.7% up on a year earlier. The rise in sales during 2002 was primarily driven by higher 'mixed' sales, which cover the returns from the smaller merchants and are closely linked to the private housing RM&I sector and DIY expenditure by consumers. The merchants sales data points to relatively strong growth in activity early in the year, with the rise in sales volumes slackening towards the end of 2002.

Deliveries of concrete blocks have closely followed the pattern of total housing starts with both rising 3% during 2002. Brick deliveries were 1% higher during the same period.

Aggregate sales volumes since April 2002 have been general down on a year earlier according to the Quarry Products Association. Sales of ready-mixed concrete, sand & gravel and crushed rock all showed annual declines during 2002 of 3% to 4%. In contrast asphalt sales grew by 5% last year, pointing to an increase in road R&M activity.

Two-thirds of manufacturers responding to the CPA's fourth quarter survey reported that their unit costs had increased over the last year. The rise has been most widespread among heavy side firms, many of whom have seen their raw material and tax costs rise sharply following the introduction of the Aggregates Levy. The cost increases have undermined industry efforts to contain unit costs through improved productivity and on balance half of firms had increased their domestic selling prices.

Nevertheless firms remain committed to enhancing productivity further. Construction product manufacturers are set to increase their investment programmes over the next twelve months, in contrast to other parts of UK manufacturing.

Workload and profitability slowed over the past year for mechanical and electrical (M&E) consultants, however order books have lengthened especially for the larger firms. The outlook for the key office sector remains bleak, with general pessimism in the retail and leisure sectors. Optimism remains high in the public sector, the general impact of public spending in the construction industry has a reduced impact as sectors such as road and school projects tend to require fairly basic building services.

The Association of Consulting Engineers� (ACE) member firms remain generally upbeat about business prospects for the UK market. Concerns persist, however, about future workload being hampered by the skills shortage in skilled engineers and relatively low fee levels for consultancy work.

Chartered surveyors� workloads picked up towards the end of 2002, showing a firm rebound from a slowdown at the end of the previous year. Work in the public sector and private housing now accounts for an increasing share of activity. While public non-housing workloads and infrastructure activity rose at the fastest rate in the survey�s history, as investment in health, education and transport projects boosted demand in the construction industry. However, demand for commercial and industrial buildings were weak due to continued economic uncertainty, hitting private occupier demand for business property. Skills shortages jumped in the fourth quarter, with the proportion of surveyors reporting difficulties in obtaining trades people rising substantially above the average recorded since 1996.

Tender prices recovered strongly from the dip in the forth quarter 2001, which reflected the uncertainty in the market following 11th September 2001. There are also significant labour cost pressures, with nationally agreed wage awards are up 8% on average. The largest settlements have been in the services trades: plumbers have a 13% award; and heating and ventilating operatives gained a 16% increase. This compares with the settlement for building trades at 9%. Materials prices have been relatively stable over the past two years, but some recent price increases pushed the 3rd quarter�s annual rise to 2.9% (see table below).

Price movements have been very strong throughout the first nine months of 2002, as a result of robust demand. There has been a particular strong rise in the price of private domestic work, where prices have risen by over 10% for the past two years.

Construction employment has increased rapidly since 1999, and stood at over 1.6m in July 2002 � 85,000 higher than the previous year. This increase is partly due to a net influx into the industry from other industries and other countries, as the construction unemployment rate increased to 5%, up from 4.1% in 2001.

Recruitment into training has improved steadily since 1997. According to CITB Trainee Numbers Survey, the number of first-year students on construction courses increased from 29,000 in 1997 to 47,000 in 2001.

At degree level, the trend has been in the opposite direction. The first-year intake of UK residents onto construction-related degree courses declined from 7000 in 1997/98 to 6400 in 2001/02[5]. The only exception is Architecture, which increased by approximately 400 to 2,000 (see figure 10.1).

The steady decline in the number of entrants to construction related degree courses is a cause for concern, particularly because of the ageing of the workforce in the construction industry. For both manuals and non-manuals workers, the share of 16-29 year olds fell between 1990 and 2002. For non-manuals in particular, there has been a considerable increase in the proportion aged over 35.

Last year�s State of the Industry Report commented on the research undertaken by the DTI on the industry�s capacity utilisation. We continue the theme in this report, and address the question of whether the construction industry is able to deliver the expected increase in public sector projects. We also touch on some of the other reasons why some of the planned improvements have not yet been achieved.

The Construction Products Association has released a review of the Government�s delivery since the launch of the 2000 Comprehensive Spending Review, of promised investment in four key areas of the built environment: social housing; school buildings; health facilities, and roads. The report, Achievable targets? Is Government delivering?, found that whilst there is a widespread commitment across Government to deliver the planned improvements in the built environment, progress to date had been variable. The report skips over the potential capacity problems from the supply side, and focuses on the procurement angle. It finds that in many cases delivery is being hindered by:

It concludes that regular, reliable and timely information is needed to provide a clear assessment of progress, early identification of potential bottlenecks. This is also necessary to help ensure the construction industry can readily respond to the demands placed upon it.

Turning to the supply side, two main factors will determine whether the industry is able to deliver the Government�s spending commitments: firstly, the level of demand from other parts of the economy will determine how much capacity is available for public sector projects; and secondly, the labour force and whether the industry can adapt to persistent skills shortages.

The earlier sections of this report have looked at the prospects for non-public sector workloads. Overall private sector construction growth is forecast to moderate over the next two years in response to the weaker UK and world economic outlook, and in particular slower UK consumer expenditure growth.

The labour force is an area of concern, however, as key indicators already point to an overstretched industry. Industry surveys still show recruitment difficulties in key trades, and manual male[6] earnings have risen to 12 per cent above the country�s average. Although this differential is largely due to a slow down in earnings in the rest of the economy, the size of the current differential points to labour skills shortages, particularly on the manual side (see figure 11.1). A slowdown in the rest of the economy should bring some relief to the tight labour market - so long as people move into construction from other areas of the economy.

Non-manual earnings are less out of line with the rest of the economy, but all of construction�s workers are working longer hours than elsewhere in the economy (see figure 11.2). Despite recording a fall in the number of hours worked during 2002, the industry�s differential is still significantly above the rest of the economy�s typical working week.

Pressure on non-manual jobs is unlikely to improve over the coming years, however, as the number of graduates with construction related degrees is expected to continue falling.

Clearly, with such pressure in the labour market, there is limited scope for the industry to deliver significant growth in output without inflationary consequences. A move towards more productive working techniques and substituting capital for labour will help avoid spiralling labour costs. But the industry is still very labour intensive, and changes in work techniques are only starting to emerge.

In summary, the industry is in a delicate position, with skills shortages apparent in many areas of the industry. The research undertaken to date suggests that the industry is able to adapt to these conditions, and has been able to deliver non-inflationary increases in output in the past. But this adjustment period is over a number of years. The short-term effects of high capacity utilisation are, as we can see from some of the figures and tables in this report, higher costs and prices.

[1] IMF Forecast

[2] HM Treasury�s Consensus Forecasts as of 19th February 2003

[3] Planning permissions for private housing often require a proportion of �affordable� housing on a site, including social housing for rent (known as S106 agreements). Because building inspectors are sometimes unaware of the final tenure of a dwelling start, it is believed that private housing starts overstate the number of dwellings built for private buyers, while social housing starts are correspondingly understated. As the number of �affordable� housing units is almost certainly increasing, this distortion may be worsening. According to a recent Joseph Rowntree Foundation report, about 12,000 units of affordable housing per year are provided through S106 agreements.

[4] The Asset Management Plan is the Office of Water Services� plan that determines the UK water companies� infrastructure and environmental improvements

[5] Source: UCAS

[6] Comparisons are made between men only, because of the small sample sizes for women working in the construction industry

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