The global economy is in its worst ever financial crisis according to Sir Mervin King, the Governor of the Bank of England. (Elliot and Allen, 2011). The implications are highly significant for the construction industry; this essay seeks to reflect upon the historical and current impact of government economic policy and consequences for the construction industry. This essay seeks to discuss the connotations of recession on the industry; it will seek to understand the industry structure, the economic backdrop and the interaction of some of the key stakeholder groups.
Structure The construction industry is broad and difficult to define; there is obviously the direct construction and engineering trades and managements, designers, surveyors etc. There is overlap with other industries, suppliers, raw material extractors, IT personnel, financiers, plant manufacturers, tool makers, etc. who operate with varying degrees in other industries. The Standard Industrial Classification lists 20 separate direct trades. The construction industry is a vital sector and effects many different people directly and indirectly. It is highly significant to the UK economy, accounting for 7% of GDP. (Ross, 2011)
The industry can be further divided into sectors; there is new build, repairs and maintenance. Another important distinction is between the public sector which comprises government bodies and departments, local authorities and nationalised industries (though these have dwindled in the UK). In the private sector there are further sub-categories such as industrial, commercial, the energy sector, water and utilities, anything that is privately owned. The client base is diverse, and to service these client bases there is a wide range of contractors.
The Nature of Construction Projects
The construction industry is different from other industries insofar as the product is not an innovation rather a solution to client requirements, demand is bespoke. This demand is prone to fluctuation in the wider economy, a boom/ bust cycle has long existed in most sectors. Though there have been extended periods of stability and growth the industry is susceptible to economic downturns, especially in commercial sectors. Projects are diverse and can vary dramatically, the complexity of the industry, the diversity of clients, the requirements, and the nature. People employed in the industry often say two days are not the same. Construction contracts have been described as a complex web of conflicting and competing interests.
The economy and the construction industry
The construction industry reflects the ebb and flow of prevailing economic circumstances and the ideological and/or pragmatic perspective of the government in reaction. Government policy is important to the state of the construction particularly in a downturn. Historically the philosophy of government was laissez faire, based on Adam Smith’s philosophy of the hidden hand guiding the economy. In the early half of the twentieth century elements of the economy were absorbed by government. This rationale developed as a response to the last significant credit crunch that brought about the Great Depression, the socialist movement and later the requirement to reconstruct after the second World War, laissez faire economics was replaced by a more interventionist ethos, the economy became increasingly mixed.
Demand could be generated by government, fiscal policy, largely developed by John Maynard Keynes in response to the Great Depression, became the dominant philosophy. This approach advocated the intervention of government to theoretically smooth out the boom and bust cycle by generating demand in economic downturns using government investment to spur growth. Fiscal policy was eventually replaced by monetarism after the economic stagnation of the 1970s. Monetary policy is similar to fiscal policy insofar as both are tools of demand management. Monetarism is by definition less interventionist than fiscal policy as it is conducted through financial institutions. This policy involves controlling the economy through the tools of interest rates and money supply, this then is used to control inflation and theoretically stabilise the economy.
In theory, when the economy is in recession, monetary policy serves to generate growth through the expansionary instrument of interest rates to increase the flow of money. In times of unsustainable expansion, contractionary tactics of higher interest rates and less money released into the economy. Fiscal policy is still employed alongside monetary policy with varying degrees depending on the philosophy and ideological perspective of the party in power, and as a pragmatic response to generate demand, often in election years. In practise both methods are limited in their application, fluctuations in economic circumstances persist. The dominant ideological philosophy of the pursuit of continuous economic growth remains an elusive goal that leaves its proponents frustrated, the tools of demand management are limited in countering the complexities of the global economy.
The current economic situation can be linked to a combination of variables, the deregulation of the banking sector in 1998, low interest rates which were significantly lowered and maintained to counter the economic aftershock of the terrorist attacks on the World Trade Centre in 2001 and the easy availability of credit particularly in the sub-prime US housing sector. The persistent stagnation of the economy is a result of structural imbalances in the world and UK economy and the high levels of government and consumer debt, this situation is the backdrop of the current UK construction industry.
In the current recession the potential for state intervention has diminished with the general decrease in the size of the state in the 1980s and 90s and the current state of the public purse. The coalition government economic policy is the reduction of the structural deficit through a lessening of public expenditure and a reduction in the size of the public sector. The opposing Labour Party policy is to spend more to stimulate growth while also attempting to reduce the deficit. Their belief is that stimulating demand will act as a catalyst to stoke the economy, the possible danger to this approach is the potential for the downgrading of credit ratings and the threat of spiralling interest rates. Recently the Labour Government employed fiscal stimulus measures to fund capital spending during the recession of 2009.
The coalition approach is a more accelerated reduction of state expenditure which they maintain is necessary to satisfy the apprehensive bond markets and maintain low interest rates which will stimulate consumer demand. This strategy also serves to deflate the currency which they maintain will serve to stimulate demand for exports. The danger with this approach is that it can precipitate a downward spiral of reduced confidence, more cutbacks and austerity and a slump in domestic demand. This was the case through similar policies pursued in what has been defined as Japan’s lost decade.
It is a fine balance and the intricacies of global events and how they interact coupled with structural imbalances in the world economy are currently dictating policy. The dangers of abstaining from implementing austerity measures has led to stock market volatility and spiralling interest rates on borrowing requirements of certain European countries that threatens to destabilise the world economy. It is these fiscal limitations and the high levels of existing and structural debt that act as a straightjacket to any real effort to generate demand in the UK construction industry by more rigorous application of Keynesian style intervention.
Pursuing austerity may prove to be an inadequate response, the outcome of current events is uncertain, the lessons of history obscured. Employing tough stringent austerity measures to remain within European fiscal union rather than defaulting may be delaying the inevitable for heavily indebted nations. Economic policy is contested, there is no consensus and the outcome is uncertain, what is certain are the financial restrictions imposed on government for meaningful economic intervention in the UK construction industry.
The reduced demands and subsequent contraction of the construction industry is a cycle repeated during recessions. An EC Harris survey conducted in 1993 found that UK construction orders fell from 32,500 million to 21,125 million, a fall of 65%, while employment figures over the period showed a fall of 580 jobs a day over that period in the construction sector (Gunaratne, 1993). More recently output fell from 104.89 billion in the second quarter of 2007 to ï¿½91.86 Billion in the first quarter of 2009, (Ross, 2011). An inevitability of economic downturns is subsequent impact on the construction industry.
The effects of persisting stagnation on the construction industry are becoming increasingly apparent. The pressure on the public purse and the slump in private demand has resulted in supply overtaking demand. Prior to 2008 there were 15 years of sustained growth (Rawlinson, 2009).This growth was underpinned by easily available finance for speculative developers and a need to upgrade many public buildings.