The contribution of the built environment industries to output and employment are a significant component in macroeconomic stability, directly through household incomes and indirectly through aggregate demand. Recognising this, policies to increase building and construction work are a common response to slowdowns in growth during the contraction phase of the business cycle, and increased infrastructure spending is seen as an effective policy to support demand in the short run while developing assets for the future. The Australian experience managing the global financial crisis after 2007 and the end of the mining boom in 2014 are two examples of the importance of the Built Environment Sector to macroeconomic policy outcomes.
Taking a broad view of an industrial sector provides evidence of its role and significance in economic and technological development. The Industry Value Added of the sixteen built environment industries contributed 14.2 percent to Australian GDP in 2018-19, within their long-run range between 14 and 15 percent of GDP since 2006-07. The BES share of total employment fluctuated between 16.5 and 17.5 percent of total employment, reaching a high in 2011 after a major fiscal stimulus during a period of exceptionally high mining investment expenditure.
Australian Built Environment Sector: Summary Statistics.
2018-19 Employment IVA $bn
Total Australian Built Environment Sector 2,126,000 270
Total Australia Employment and GDP 12,867,000 1,801
BES Percent of Australia total 16.5% 14.2%
Sources: ABS 8155, ABS 5206, ABS 6202.
Fiscal Policy and the Global Financial Crisis
The economic stimulus used by governments during the global financial crisis that started in 2007 followed the Keynesian macroeconomic fiscal policy framework of increased government expenditure. The Australian Government’s response to the crisis included a major school building program and a home insulation scheme, as well as large and small infrastructure projects. As the following Figures show, the counter-cyclical timing and impact of the Rudd Government’s fiscal stimulus and building program is an example of the effectiveness of policies that engage the entire BES network of firms and organizations.
The figures below show how the increase in Commonwealth Government spending in 2009-10 on schools, buildings and infrastructure flowed through to the wider economy over the following years. The big increase in public sector building work was in the 2009-10 and 2010-11 budgets. With the increase in public building there was a very large increase in the IVA of the built environment industries. The BES IVA increased by 12 percent over 2009-10, at a time when nominal GDP growth was under 2 percent.
Australia was the only G20 country to avoid a recession during the global financial crisis, and one reason was the increase in Commonwealth construction expenditure. After starting to increase in 2008, in 2009-10 Public sector building work done more than doubled to over 1.5 percent of GDP. Australian Government net debt had previously peaked in 1996 at 18 percent of GDP, then fell to zero by 2006, and was back to 12.5 percent of GDP in 2013-14 after the GFC and years of large budget deficits[i].
Monetary Policy and the Transition
Rebalancing the economy after the mining boom ended in 2014 was another major macroeconomic challenge. To support aggregate demand the Reserve Bank of Australia lowered interest rates and encouraged banks to lend for mortgages and property development. During the subsequent residential boom in apartment building from 2013-18, the BES supported output across the economy as the mining boom ended and engineering construction and business investment fell from 18 percent of GDP to 8 percent. Over that period residential building rose from around 120,000 to over 200,000 commencements a year, due to an increase in high density apartment developments. In 2017-18 BES employment growth peaked around 6 percent, at the top of the residential cycle.
Australia’s mining boom started in the early 2000s, and between 2006-07 and 2013-14 Engineering construction more than doubled its share of Construction IVA, increasing from 12 to 24 percent. Over that period the share of Construction services fell from 67 to 55 percent of total Construction IVA, while Building was around 20 percent. By 2016-17 Engineering had fallen to 16 percent of Construction IVA, Building had increased to 25 percent, and Construction services were 59 percent. The shift from Engineering to Building meant BES IVA was growing around twice as much as GDP between 2003 and 2017, and the strong backward linkages between industries meant the effect on the economy was stronger compared to the mining boom because of the large amounts of imported plant, machinery and equipment included in the Engineering work statistics (included are oil and gas platforms for example).
The BES clearly has a significant role in the economy, as the examples of the effects on BES output and employment of fiscal policy in the global financial crisis and monetary policy in the transition after the mining boom show. In the first case, a very large increase in 2009-10 on Public sector building work saw an increase in BES IVA of 12 percent and employment of 6 percent. In the second case, after 2013 as engineering construction work fell from the highs of the mining boom, interest rates were lowered and the increase in residential building work supported the economy during a difficult macroeconomic transition.
Within Construction, internal dynamics saw significant changes as the IVA shares of the three component industries rose and fell with changes in the composition of Construction output: Construction services between 67 and 53 percent; Building between 20 and 27 percent; and Engineering between 12 and 24 percent of Construction IVA. While those fluctuations in output were occurring there was a shift in employment away from Construction services as Engineering increased, which was reversed after 2014 as Building work increased and Engineering fell.
Between 2007 and 2019 the Australian BES accounted for 14-15 percent of GDP and 16-17 percent of total employment. It has a significant macroeconomic role in the economy, as these examples of the effects on BES output and employment of fiscal policy in the global financial crisis and monetary policy in the transition after the mining boom show. In 2009-10 expenditure on Public sector building work led to an increase in BES IVA of 12 percent and employment of 6 percent. In 2013-14, as engineering construction work fell from the highs of the mining boom, interest rates were lowered and increasing residential building work supported the economy during a difficult macroeconomic transition over the next three years.
In the same way as Tourism, Defence and Manufacturing are not themselves an industry but collections of related industries that make up an industrial sector of the economy where firms have similarities in products and processes, industries that contribute to the construction and maintenance of the built environment can also be collected and their contribution to output and employment measured. The economic role of the BES is important and better data can contribute to economic policy decisions that, through the BES and its dense network of linkages between industries, significantly affect macroeconomic outcomes.
[i] See the Commonwealth Government’s Budget Paper No. 1, Budget Strategy and Outlook for the years 2006-07 to 2013-14 for details. The fiscal stimulus totalled over 5 percent of GDP over 2009-12.
Grattan Institute Transport Infrastructure Report
The Grattan Institute, a Melbourne based think tank for public policy, released an important report into procurement of Australian transport infrastructure projects. Their Megabucks for Megaprojects report has four chapters and makes 12 recommendations. The chapters contain a lot of carefully compiled and useful information, while the recommendations are all worthy and, despite their careful phrasing, make a strong case for greater client involvement in the design, documentation and management of large public sector projects.
Chapter 3 of the report is ‘Competition is fundamental’, addressing the issue of the dominance of tier one contractors. The chapter collects data on projects and contractors that is not readily available, with the sources and methodology detailed in the appendices. Their key point is the increase in size of projects since 2014, as shown in Figure 3.3 below.
For the last few years the quarterly value of work done on these large transport projects has been over $5 billion. In 2020 Australian governments spent a record $120 billion on road and rail transport projects.
The argument is that it is increasingly difficult for mid-tier contractors to win work on these very large projects, of the 11 projects above $3 billion 8 were ‘contracts involving multiple tier one firms’. These firms are ‘few and well-known’ in Australia and their Figure 3.10 shows how few, and how they consolidated their position through M&A over the last couple of decades.
The two sources of potential competition for the three tier one contractors are domestic rivals that might scale up sufficiently or new international entrants to the Australian market. In chapter 4 the report argues strongly for breaking up large contracts to allow greater participation from domestic firms, Recommendation 10 is: State governments should develop and use a systematic approach to determining an optimal bundling of work packages for large projects, including when to disaggregate bundles that include both complex and straightforward activities. While not a new idea it is still important because public clients do not generally do this, and often do not have the resources required to manage multiple contracts.
That leaves international entrants, which the report argues have been playing an important role since 2005: ‘International entrants add to local competition, and it’s very helpful to governments if there are a variety of market players willing and able to take on work. In particular, when tier one firms form a joint venture to bid on a large contract, the only source of genuine competition may be from international firms’. Their Figure 3.5 shows the distribution of contracts between new international entrants and firms that were already here in 2006. Of those firms, Bouygues won 4 contracts, Lang O’Rourke and Acciona 5 each.
There are barriers to entry when bidding for these contracts, on top of the high bid costs. These are the lack of transparency in the weighting given to selection criteria and the emphasis on local experience. The report’s Recommendation 8: In selecting a successful bidder, governments should not weight local experience any more heavily than is justified to provide infrastructure at the lowest long-term cost. Governments should publish weightings of the criteria used to select the winning bid for a contract. The Grattan Institute is strongly opposed to ‘market-led proposals’ from contractors, and strongly in favour of open tendering. The state with the highest transparency rating is NSW, also the state with the most contracts with new international entrants.
The report collects data on 51 projects over $1 billion in Australia since 2006. Their dataset of transport infrastructure projects includes 177 contracts worth more than $180 billion (in December 2020 dollars). That data makes this an important contribution to the debate about construction industry policy in Australia, to the limited extent that there is such a debate. A couple of decades ago this data would have been published by the Commonwealth, by the Department of Industry or similar organization, and incorporated into the procurement guides being developed by the Australian Procurement and Construction Council and related State agencies. The report concludes “these guidelines leave a great deal of room for subjectivity in the choice of contract type. Although some of the state guidelines and decision-support documents are quite detailed, none go so far as to prescribe a rigorous and systematic methodology for procurement strategy selection.”
This raises the awkward question of who the report is addressing. The fundamental problem is the politicization of the project selection process not the cost of delivery, Australian construction is not expensive by international standards. The recommendations address the problem obliquely by highlighting improvements in procedures and processes, all of which have merit, but not considering alternatives such as the role an independent authority could play or national coordination of procurement and other regulatory systems. In this it was something of a missed opportunity
State and Federal budgets have billions in unallocated funds for projects at all levels (community sports grants, local and regional infrastructure) and for major projects the Commonwealth has Snowy Hydro, the NAIF, the Murray-Darling Basin Plan etc etc. These projects, large and small, shovel money out the door with little or no accountability and there is no evidence that politicians are interested in change at this time.
Output and Income for Australian construction firms
Australian industry data is provided in the Australian Bureau of Statistics annual publication Australian Industry (ABS 8155), produced using a combination of the annual Economic Activity Survey and Business Activity Statement data provided by businesses to the Australian Taxation Office. The data includes all operating business entities and government owned or controlled Public Non-Financial Corporations. Australian Industry excludes the finance industry and public sector, but includes non-profits in industries like health and education and government businesses providing water, sewerage and drainage services. The selected industries included account for around two-thirds of GDP. Excluded are ANZSIC Subdivisions 62 Finance, 63 Insurance and superannuation funds, 64 Auxiliary finance and insurance services, 75 Public administration, and 76 Defence. The most recent issue is for 2018-19.
The analysis is based on industry value added (IVA) and industry employment. IVA is the estimate of an industry’s output and its contribution to gross domestic product (GDP), and is broadly the difference between the industry’s total income and total expenses. IVA is given in current dollars in Australian Industry. The data is presented at varying levels for industry divisions, subdivisions and classes, but unfortunately does not include the number of firms. There is, however, some firm size data. Micro firms have less than 5 employees, small firms 3-19, medium firms 20-199 and large firms more than 200 employees.
Figure 1 shows large construction firms have 15% of employment, 30% of wages and salaries and 23% of output. Medium firms have 18% of employment, 27% of wages and salaries and 21% of output, and micro and small firms account for approximately 65% of employment but only 55% of output. The labour-intensive work of small firms largely explains the lack of long-run growth of productivity in construction.
Figure 2 shows large firms have twice the level of output and income per employee compared to small and micro firms, and medium firms nearly 50% more. There is no significant difference between micro and small firms. IVA per employee is an imperfect but useful proxy for productivity, and this shows the gap between large and medium size firms is significant.
The relationship between firm size and IVA per employee is not surprising, large firms are typically better managed than small firms. Management is the most important determinant of the capacity and capability of construction firms, because managerial skills give a contractor greater flexibility. How firms utilise their capabilities differentiates them within a diverse, location-based production system. It is widely recognised there are differences between industries in the way that production is organized and new technology adopted, adapted and applied, but differences within industries generally get less attention. Important differences are the individual characteristics of firms such as their size, the effects of competitive dynamics, and how the adoption of new technology by one company in an industry influences the adoption of technology by other companies in that industry. For building and construction this is significant, not only because of the number of small and medium size firms, but because of the size and reach of the major firms.
Figures 3 and 4 show IVA and income per employee for three years respectively. The most recent 2018-19 year is representative of the industry, based on this data. Construction firms convert around a third of their income per employee into IVA per employee, however large firms have twice the income per employee. These figures identify the balance sheet effect, as firms leverage the capital on their balance sheet to maximise revenue and profits.
Construction has a large number of small firms bidding for work in local markets with little or no control over prices. There is a diminishing number of firms that can deliver large projects in a given region or have national operations, and there are a few dozen multinational corporations in construction. Construction economics has a wide range of views on the types of markets these firms operate in and their competitive behavour. There is, however, universal agreement that construction is an industry of projects, and firms operate in markets for projects of many different types.
The relationship between firm size and contract value is therefore a fundamental reality in construction, and is also the foundation of the relationship between projects and firms. A firm is a legal entity and the typical reporting period is one year. A firm’s income is the cumulative cash flow of their portfolio of projects over a year. The focus on projects and construction management in construction research obscures the role of firms as the ongoing participants in the industry.
For firms in construction markets annual revenue is the aggregated income from current work, or contracts won but not completed. Construction firms and contracts range widely in duration, size and value, but the amount of work a firm can take on must be related to the capital a firm has available. This relationship between firm size and the annual value of contracts or projects undertaken is based on the assumption that construction firms seek to maximize revenue but are constrained by their working capital. In construction the contract packages reflect the complexity of work, so there is a wide range of contract sizes. Construction contracts can, therefore, be arranged based on contract size and complexity. This is a well-known and widely agreed characteristic of the industry, with the relationship first researched in the 1980s. Competing contractors’ bids were affected by the type of project and by the value range, small firms considered both contract type and size, and large firms were more successful when bidding for large contracts. Contract size and complexity are also important because the wide range of contract sizes in the construction market is the major determinant of the number of firms. In a project-based market, defined by project size and complexity, there are many standardized projects but few companies able to undertake particularly difficult projects, those large construction firms deliver large projects and/or with a high degree of complexity.