Brickonomics

The cost to construction of false optimism

May 16th, 2013

By Brian Green

For the past five years this blog has been perceived as a purveyor of doom and gloom and sometimes criticised for being so.

I part jokingly retort that I may be gloomy, but I tend to be out-gloomed by reality. Here’s my take in 2008. There is plenty of scope I see now to have been gloomier than I was and not have been unreasonable as things have panned out.

But this post does not concern who was right or wrong about the past. That’s a dull and tedious road to travel.

This is more an observation about today and tomorrow and the dangers that lurk for those too keen to grasp at every promising-looking straw in the wind.

Five years ago we were heading into recession and, as a nation, we still generate less today in goods and services than we did then despite an increase of 3.5% in the number of people economically active.

But in newspapers yesterday and today we could read headlines pointing to economic optimism from the outgoing Governor of the Bank of England Sir Mervyn King.

Following years of downward revisions to its economic forecast, here was an inflation report that was more bullish than the previous. And how fitting that the Governor could leave his role on a sweet rather than a sour note.

It would be easy to single out the Bank of England for its poor record of forecasts. Some commentators do. But the vast majority of business consultants, banks and other independent expert forecasters have on average been greatly overoptimistic about the path of the economy.

So let’s leave carping to one side. This looks like good news.

Confidence is critical to the economy as so much rests on trust and a belief in likely outcomes. Animal spirits economists would argue are an important aspect of a functioning economy.

So pessimistic forecasts can then, justifiably, be seen as potentially having a negative effect, with bank runs being an extreme example. And I can see why my take should have attracted criticism.

However an equally important but seldom mentioned consideration is the impact of overoptimistic economic forecasts. This asymmetry seems a bit odd given the berating given to the Met Office when it promises sunshine and we are provided with rain.

What’s more interesting those who put out a pessimistic economic forecasts or analysis of likely prospects, whether their take is well founded or not, are likely to take significant flak that is seldom taken by the providers of upbeat prognostications.

So I would like to leave one thought at the door of the critics who dismiss those who challenge optimism as gloom mongers.

How many businesses have gone or are about to go to the wall in construction because they took the advice of persistent optimists suggesting things would get better soon?

Let’s look at just one aspect of how the industry works in a downturn.

Buying work. It is now commonplace in construction. It’s not sustainable long term, but it seems a not unreasonable strategy if you think things will turn around in the near future.

Now ask yourself: how widespread it is and for how long have firms been buying work in construction?

Too many and for too long is probably the most accurate assessment you can make.

So what is the consequence of this perfectly rational business approach? That is it is a perfectly rational approach is if you genuinely believe things will shortly improve.

Firstly in the short term the effects a minimal on large firms because they will still be generating cash on previously won work. Smaller firms on smaller jobs will face the pinch far quicker.

Firms with strong balance sheets can wear it for some time, those with weak balance sheets can’t wear it for long unless they have an exceptionally forgiving bank manager.

Firms that are bank financed will find after a while the cost of finance and access to finance will become tighter. Those that self-finance, as a vast proportion of firms do, will be eating into reserves or not replacing capital goods they built up in the good times.

In the end a firm can’t keep winning work and making a loss.

The brutal fact is that the construction industry has been feeding on its balance sheet fat for far too long as it has traded on the promise of recovery. Clients have received buildings at delicious prices in part because they were part funded from the industry’s balance sheet.

When I hear small family contractors saying that if they knew in 2008 what they know now they would have shut up shop, I am disturbed.

We should not be surprise if we start to see a rise in firms pulling out of the market of going bust.

We live in precarious times as an industry. There is a fine line between suicide bidding and buying work short term to keep the beast fed.

But I would lay blame at the door of those peddling an overoptimistic picture of the future. This almost inevitably will have tempted some firms into business decisions they now know they should not have made.

There is no need to be pessimistic, no need to be optimistic in ones analysis. The need is to make the best estimate you can and plan accordingly with the risks firmly in mind.

So I say welcome Sir Mervyn’s cheery forecast for the UK economy. I do. But if you are in construction take a long hard look at how soon it might be before we can expect a recovery in UK construction. Indeed whatever industry you might be in look beyond the pleasant thought of a resumption of growth in the economy.

I will leave you with one graph which is one casting of historic data and I will let you make up your own mind on what that might mean for the future of construction.

It is a scattergraph comparing growth in the economy (GDP) over three years with the corresponding growth in construction over the same three years. Each red dot is a year from 1961 to 2012.

The interesting point is that over the past 50 years or so when growth in GDP over three years has been below 7% (see the blue line) construction output growth has been at best very weak and generally output has declined, sometimes spectacularly. That 7% growth over three years equates to average annual GDP growth of more than 2%.

Even on Sir Mervyn’s more optimistic forecast it will be some while before we have a three-year growth rate in GDP of 7%.

Now that graph is taken from the past 50 years. It doesn’t necessarily follow that the future will stick to the same pattern.

The question is should construction businesses be risking their futures on the notion that things will be different this time.

Because unless firms start putting some fat back into their operations we face a very bleak period with ever more firms go to the wall. And when a weak firm goes bust it has a nasty habit of taking a few financially healthy firms with it.

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Punch drunk construction finds a prop in rich investors in London housing

May 10th, 2013

By Brian Green

Yes folks the construction industry is partying like it was 1999. Sounds like fun, but sadly it means that all the growth achieved this century has been wiped out.

And while we metaphorically vomit into the punch bowl, here’s a thought to sober us up.

If it wasn’t for rich foreign and indeed rich British investors pumping cash into London residential property the construction industry would probably be closing in on a drop of nearer to a quarter from peak instead of the 19% drop it has taken to date.

That extra drop would have had us partying like it was 1996, which doesn’t sound anywhere near as attractive.

Looking at the picture in wide angle the latest data out today shows construction continues on a downward path. And indeed on a quarterly measure the industry is doing about the same amount of work as it was in the first quarter of 1999. The peg for that awful pun earlier (sorry).

This we more or less knew from the GDP first estimate figures. The fall shown in the latest output figures of 2.4% in the first quarter was more or less in line with the -2.5% figure posted within the GDP data. But because of revisions to earlier figures the industry probably saw about £100 million or so less work in the first three months than the Office for National Statistics estimated earlier.

Overall there was little in the latest set of data to surprise. Rather it reinforces yet again the dismal demand for the industry’s wares. Well not all of them, as we shall see.

The graph which plots 12-monthly and 3-monthly average volumes of work pretty much tells the story are regards the overall pattern of business in construction. Downward.

Anyway, delve a little deeper into the data and you find some intriguing if not disturbing patterns.

Here’s one. What the aggregate figures don’t show is the impact of the boom in housing in London. The flood of foreign money and indeed investment by rich Brits is driving not just the London construction economy but has provided a major prop to the industry at a national level.

If you take out housing and infrastructure (which is distorted as it is receiving a one-off boost from CrossRail) from the capital’s construction output we see a fall in cash terms of about 5%. Adjust this for inflation and we are looking at a drop probably of about 10% or more in volumes.

Here’s a stat. From 25% of total London construction in 2007, housing new and refurbishment now accounts for 31%.

The ONS figures suggest that work on building new homes and improving and repairing existing homes in London represented about 4% of total British construction output in 2007. That proportion jumped to 6.6% in 2012.

We could take a stab and interpret this as investment by rich foreign and I suspect rich British investors in luxury London residential property is probably providing about 3% or more of GB construction.

Yes the data are estimates and should be treated with caution, but the broad picture they paint is very unsettling given the emphasis place by politicians on rebalancing the economy.

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Today’s GDP figures and why I think Government remains totally wrong on construction

April 25th, 2013

By Brian Green

The GDP data provided the Chancellor George Osborne with solace. The 0.3% quarterly rise allowed him to suggest the figures provided evidence that the economy is healing.

Had the figures shown a decline he would have been fending off a huge amount of flak. That’s politics.

But the figures mean little in the grand scheme of things unless they work some magic on the animal spirits within the economy.

The economy is probably rising very gently, but far too slowly for comfort. And there is little to guarantee that we will not see another quarterly drop in national output drop before the economy finally lifts from this depression.

It is the longest depression for more than a century. And with the full impact of austerity still to bite there remains the likelihood of a very bumpy and uncertain take off.

No one is quite clear where we should expect to see growth, especially as demand from our biggest trading partners, by and large, is also being squeezed by austerity.

For construction the GDP data seem to fit the glum background. The GDP index for construction hit 98.0, the lowest level since Q1 1999. Five years earlier it stood at 120.8.

And most pointers (though not the RICS latest construction survey) seem to be for a continued fall in output, at least this year.

The GDP first estimate figures are open for some quite big revisions, so should be taken with caution. But even taking that into account, they don’t look good for construction.

This is twisted irony. For those in construction there is a deep-seated belief that this industry should be playing the lead role in driving the economy.

Yes, it should. But it will not unless demand is there.

There are things construction firms can do to increase demand, but as the industry is structured it is in the main a passive recipient of derived demand. Someone else has to want what it provides, have the finance to cover the cost and the willingness to take risks.

That rather begs the question, why would private sector investors pump cash into the fruits of construction now?

The private housing market is dysfunctional. If it wasn’t there would be no need for unprecedented interventions by the Government.

The market for shops and offices is going through a once in a generation transformation thanks to the internet and changing pattern of work and shopping. That is before we take into account the impact of the very weak economy.

There is limited experience in financing infrastructure in the private sector outside of that which is regulated and the appetite remains a bit fitful and fanciful.

Yes there are pockets of need and opportunity that the private sector will grasp willingly. But these are limited and with better investments elsewhere it is pretty clear that a wait-and-see policy is a likely approach to be taken by prudent investors in such a risky climate.

That leaves the Government as a client or as a promoter.

I would argue when the animal spirits within the private sector are so skittish it is time for the Government to step up with a bit of backbone and lead the way. That was the lesson of the post-War era.

Well the Government probably believes it is stepping up. But it’s record to date, and this includes to a slightly lesser extent the previous administration, is to fiddle with the existing market.

The policy response has been largely focused on providing compensation from the public purse to encourage firms to do what the Government wants. This is exceedingly interventionist and not in my book very free market.

What is more it seems from the outcomes to be a classic case of the weight of unintended consequences potentially exceeding the weight of intended consequences.

From what I can deduce it has proven a very expensive way to do what appears to be not a great deal, except improve the corporate base and profits of some firms.

In fairness we will never know how bad things might have been without the interventions. But to attempt to prop up a dysfunctional marketplace for construction’s output is full of risk.

No. If you want something built, build it rather than trying to bribe someone else. This to me is far better than providing ill-directed incentives however well intentioned.

Simplistic? Maybe. Keynesian? Probably. But to me it makes complete sense for direct Government investment in construction.

The fruits of construction have an exceedingly long shelf life. They last beyond economic cycles. Impressively the value has a habit of increasing over time and the benefits of well-targeted construction pave the way for more efficiency within the rest of the economy.

The fruits of construction provide jobs.

The fruits of construction improve lives.

The fruits of construction are a totem for confidence.

The fruits of construction can be traded between the state and the private sector. We have seen a huge divestment of state assets over the past 30 years.

So why not directly invest in construction now?

The debt?

That is increasingly a ridiculous response.

The cost of debt is clearly not an issue. The Government can buy debt at less than the rate of inflation. In real terms it is being paid to take someone’s hard earned cash.

If the Government is worried about the stack of debt, why? We had huge investment post-War when the national debt was far greater than it is today.

Surely, then, the reason the Government is not investing is fear over the deficit?

This is absurd. Do we really think the gnomes of Zurich or the slick traders in London and New York would give a damn about an extra few billion quid set against tangible assets that can be sold on if necessary, especially as creating them would reduce social security spending and increase taxes.

And, if the Government is a bit squeamish on this point, it could always invests through a not-for-profit limited-life arms-length vehicle that controlled the assets built and was mandated to sell all its assets by some fixed date. This would give confidence to the markets.

No the reason would seem to be dogma.

This to me appears to be the same dogmatic attitude that the current Chancellor accuses his opposition predecessors of adopting. Doing something that is not right, but that fits with a theoretically constructed view of the world.

History would tend to suggest that state investment in construction does not crowd out the market. If anything the data suggests the reverse. Look at the peak periods of house building.

This Government talks of how Government needs to be more business-like.

Well, the Government is uniquely placed in the market to deliver construction goods at a massive discount, once it realises reduced benefits payments and increased taxes.

Any business worth its salt would not shirk at such a golden opportunity.

If as the Government says we need more houses, we need more roads, we need better infrastructure. There will seldom be a better time to invest in them than now from a national perspective.

Put aside the issue of ultimate ownership, put aside fears over picking winners, put aside dogma.

Let’s ignore issues of private or public ownership, they are fluid. Let’s invest in the future and build today what we need tomorrow. 

Frankly, in a decade’s time when hopefully the economy really as healed, the Government can choose if it wishes to rein back on its capital spending and sit smugly there knowing it invested at the right time.

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Construction forecasts shaded up, but still predict recession dragging on into 2014

April 21st, 2013

By Brian Green

The main industry forecasters have revised up their expectations for the future path of construction output.

The revisions from the previous forecast three months or so ago suggest there will be an extra one billion or so pounds worth of work flowing into construction this year than previously expected.

Part of this is statistical, as the latest Office for National Statistics data puts the fall in 2012 at less than first thought. But, even so, the forecasters have slightly shaded up the rate of growth for the coming year.

The reasons for the slightly greater optimism differ. Experian believes that recent changes in sentiment within the Government will mean the cuts to public capital expenditure will be less severe than originally planned.

The Construction Product Association and Hewes, meanwhile, believe that the Help to Buy scheme should provide a bit of a boost to private sector housing.

The Construction Products Association already had pretty bullish growth for private housing, but has raised its expectations for growth in the sector for both 2014 and 2015 by a about a percentage point.

The impact on Hewes forecast is more profound, partly because the previous forecast for private housing was pretty gloomy. The latest forecast for private housing suggests pretty robust growth (although less than the Construction Products Association expects) resulting in an expansion of about 14% over the coming three years. Within the Hewes forecast the sector positively sparkles in comparison to the gloomy prospects predicted for most other sectors.

However, before getting too excited about the upward revisions it is worth noting two things.

The risks still remain heavily on the down side and these forecasts were set before the latest release of construction output data. While no one would be silly enough to recast a forecast on the basis of one month’s data, the February figures were pretty horrible and if March’s data is equally as uninspiring then these forecasts could start to look more than a little optimistic.

Overall the forecasts are more aligned than they have been for a while. The consensus seems to put the fall this year in output at somewhere between 2% and 3%. Hewes expects output to fall again slightly in 2014, while Experian expects slight growth and the Construction Products Association is suggesting growth of near 2%.

All expect construction output to grow by 2015. This broadly suggests a turning point in activity in 2014, with Construction Products Association expecting it to be in the first half of the year and Hewes at the end.

If I am honest these forecasts were more bullish than I had expected. But that may be that I am mentally factoring in more of the downside risks.

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The answer is expect falling construction to prompt a triple dip – but what was the question?

April 15th, 2013

By Brian Green

It’s hard not to get caught up in the silly guessing game over whether the nation will tumble into a triple-dip recession or not.

Yes it is totemic. But actually measuring growth to an accuracy of 0.1% is pretty tricky and revisions over time can eliminate or even reverse growth rates.

The reality is that growth is very weak, if there is any, at the moment and that is horrible, especially for construction where its growth requires at least modest growth in GDP (see blog).

But what the heck. Let’s speculate. I’ll use as my excuse the rather disturbing latest construction data (see blog).

You already have the answer from the headline. But, importantly, how did we frame the question?

More importantly, is it meaningful?

Let’s narrow the game to guessing the March figure on the back of what we have, which is the January and February figures, and using the estimated quarterly figure as a marker for whether GDP is likely to go up or down in the coming quarter using a respected forecast for GDP as a benchmark.

Part of my prompt for this examination was a chat with Noble Francis at the Construction Products Association. We are pretty much agreed that there is a huge amount of uncertainty over where the March figure might lie. But we both seem to agree that as a whole the uncertainties are on the down side.

Bad weather events, revisions, changes to deflators, new data, workload-mix effects, the effect of the irritating lag between work happening and being recorded in the ONS data, bounce-back effects, underlying growth, variable seasonal factors such as the effect of a mobile Easter or leap years, one-off effects and many other variables can have a striking impact on assumptions made about the direction of construction activity. Gauging the effect of these is tricky. Gauging how the ONS will account for them, if and when they do, adds a further layer of trickiness.

To this list of uncertainties we need to add the behaviour of firms and local authorities in the run up to the end of the financial year. Will firms and local authorities act consistently with past behaviour or will the surge at the end of the financial year increase or decrease in our age of austerity?

The best thing to get a starting point is to see what happens if we put to one side all the above and see what would happen based on the latest figures and the historical data.

So if we start with the volume based data on table 3 of the ONS Construction Output spreadsheet we can see that on average over the past three years March workload was about 17.5% greater than the monthly average over January and February, although last year the rise was about 14.5%.

On the basis of the limited experiences over the past three years we might then expect March to come in at £8.3 billion at 2005 constant prices. Although you might fairly argue that as the industry is in decline rather than growth it would be lower. But let’s stick with the £8.3 billion.

This would put the first quarter constant price output at about £22.5 billion which is 6.5% lower than the first quarter of 2012.

Turning to table 2, the seasonally adjusted data, and reducing 2012 Q1 data by 6.5% leads to a figure of £23.5 billion for 2013 Q1. Here we are assuming no change in the effect of seasonal adjustments.

If that is where the figure comes in, we would have seen a fall from the final quarter of 2012 to the first quarter of this year of 3.4%.

Now there will be revisions to the earlier data, seasonal adjustments are mobile things, we have to assume behaviour is pretty similar to the past etc, etc, etc.

Indeed from my chat with Noble Francis we think you could make a reasonable case for a growth rate in 2013 Q1 of anything between -1% and -6%, given the huge level of uncertainty. Both of us would tend towards the lower end if pressed.

But let’s make the assumption that all other things remain equal and let’s stick to the -3.4% fall in first quarter construction output and see how this compares with the predictions made earlier last week from the well-regarded independent research organisation NIESR for first quarter growth.

NIESR estimated that GDP grew by 0.1% in the three months to March. Its latest forecast saw construction falling, on my calculations, by about 1.6% in the first quarter. This was admittedly produced before the latest and rather dismal construction output figures were released, so is not surprisingly very much at the top end of our range of expectations.

If we crudely account for the extra fall we see in construction above that currently forecast by NIESR the net effect it to lower GDP first quarter growth by about 0.12%, based on adjusting the 2009 industry weighting of 68 out of 1,000 parts of GDP.

So given that NIESR predicts 0.1% growth (and we assume that from the index it is below rather than above 0.12%) the data used in this crude fashion suggests we will be very very narrowly below zero growth. That is making the massive assumption that all the assumptions made by NIESR and all the assumptions made here are reasonable and (importantly) that reality doesn’t interfere and lead to a more positive outcome.

I would add that if anyone bothered enough to check my maths finds any glitches would they please let me know and I can adjust the headline accordingly.

Anyway, our little guessing game comes up tantalisingly close to zero, but shades on the side of a triple dip. Which we knew from the headline.

There is clearly political mileage that can be made from whether the nation is in a triple dip or not and there’s some fun to be had coming up with predictions that put GDP growth either side of the highly politically sensitive zero GDP growth mark.

But let’s be honest the real value of determining which side of zero growth falls is limited.

The truth is that growth is pitifully poor whatever assumptions we make. Tha is damaging the nation and, more parochially, pushing away hopes of a much needed revival in construction.

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The latest construction output figures are very disturbing

April 12th, 2013

By Brian Green

The graph probably says it all. The construction output figures are looking very disturbing. This will not come as a surprise to many, but the confirmation of fears provides little solace.

Yes we can blame the weather. Yes we can note that the figures bounce about a lot. Yes we can find comfort in the possibility of revisions.

But as they stand and as far as you can make out from the historic data the figures suggest that construction probably has just had its worst three months on a non-seasonally adjusted basis since 1995.

What the data are saying is very concerning. The most distressing aspect is that the largest sector, commercial building, is faltering.

Here the amount of work done over the three months to February is recorded as being 16.4% down on previous three months and 9.8% on the same period a year ago.

Meanwhile, private housing was down 17.1% on the previous three months and 7% on the same period a year ago.

We know the direction of public spending on construction. Down. The work carried out on public non-housing new construction was 23.7% less over the three months to February compared with a year ago. And other elements of the public sector are performing almost as badly.

This means the private sector will have to make up for it if the industry is not to fall sharply.

In terms of scale this means we need the private housing and commercial sectors to shine. They clearly are not, despite the Government lavishing attention and pumping in public cash and providing guarantees to help boost the housing sector.

Those who are looking to the infrastructure sector for salvation will also be distressed to see output down 14.9% in the three months to February compared with the previous three months and 7.6% down on a year ago.

It is hard to know where the recovery will come from. The orders figures have been distessing for some while. Despite this the engine of London has kept much of the industry ticking over, partly with projects coming back on stream having been shelved when the financial crisis hit.

But now the orders figures in the capital are starting to look ever shakier and the backlog of projects on hold that might be reinstated has diminished.

There is always the possibility that the statistics contain a glitch and things are not as bad as the published data suggest. To think that would be to clutch at straws, even if there are errors in the data.

The noise from the industry is increasingly the sound of discomfort. The figures could be wrong. But that does not mean things are not ugly out there in the real world of construction.

I will say it again. This is the time that the Government should be buying construction and it should be buying construction in truck loads.

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Why GDP growth is the most likely salvation for construction

April 3rd, 2013

By Brian Green

There’s constant talk of this growth policy and that growth policy centred on construction. Big-looking numbers are bandied about. Then not a lot happens.

Perhaps that’s just politics in the modern media age where it is assumed that the memory of past policies is overwritten by the latest.

Cynicism aside, while the flim flam and bluster of politics is a barrier to getting useful things done, more worrying to me is a seeming lack of understanding of scale.

Put simply if we want to do anything of note with construction to turn the tide of the economy it must be huge, really huge. What is more it has to work. It seems foolhardy to base policies on speculation and hope.

Despite the bragging of lobbyists and the wishful thinking of industry leaders, the impact of most Government interventions pale against the larger economic forces.

Yes Government interventions can be important, but ultimately what has driven the fortunes of construction over the past half a century has been GDP growth. And the strong link with GDP growth and construction growth is not limited to the UK.

To illustrate this and in the name of efficiency I shall recycle some charts from a recent presentation to CIC Economic and Policy Forum. My central point then was that the Budget measures were pretty piffling given the scale of the challenge and the economic environment and expectations.

The first graph compares GDP growth and construction output growth over three years. This seems a reasonable timescale over which to judge the two and it also dampens the noise. I have added the GDP forecast from the Office for Budget Responsibility (OBR) in a dotted line.

It is clear that construction is very procyclical. Certainly we see that when there has been little GDP growth over three years construction has dived into recession.

The second graph shows the comparison with construction new work. The relationship is far more severe.

This third graph plots the three year growth rates for GDP and construction output for the past 50 years. What we see is a pretty strong correlation. Interestingly on the five occasions when the three-year growth rate for GDP has been negative we have seen no construction growth over the same three years.

The coloured dots on the trend line are derived from the OBR forecast for GDP growth, suggesting where three-year GDP growth will be as it rises from 2013 to 2016.

Crudely put you might expect on average to need about 7% growth in GDP over three years to see construction growth over the same timeframe. Worryingly the consensus of forecasts published by the Treasury suggest GDP growth over the coming three years of about 5%.

Now there are a lot of base effects (where are we now relatively?) to take into account. But the figures don’t provide much room for optimism, particularly as private sector investment in construction (the bulk) will be in large part determined by the path of the economy.

The final graph shows the public sector proportion of the nation’s gross fixed capital formation for dwellings, other buildings and structures. It is not a perfect measure, but it does suggests that the public sector accounts for somewhere between 20% and 30% of the fruits of construction and the proportion is falling.

So for the public sector to have a meaningful direct impact on construction it would seem the scale must be large.

Alternatively the public sector could spend a bit less if it could find effective ways to lever new private sector investment. But for my money such a policy really should be based on what we know will work rather than on some speculative albeit well-meaning hope of what might work.

Recent public sector policies have focused on prompting private sector investors and businesses into building and on coaxing households to buy more new houses. In a sense seeking to prop up the collapsed market.

These were always suspect. In housing there is a market failure that predates the financial crisis. In the commercial sector there is huge structural change. In infrastructure there is the ever present level of high risk, and the economic uncertainty doesn’t make that attractive against investment elsewhere.

Furthermore dragging on all these markets has been the dead weight of negative, slow and no growth in the economy overall.

So it is little wonder that the prompts have not really been that effective, although we don’t know the counterfactual. Maybe construction activity would have been much worse without these interventions.

The other side of policy has been to point to supply-side inefficiencies, such as planning. Frankly improving the efficiency of the processes is a long-term fix and it is extremely unlikely that such policies will be effective enough to perk up construction in the short term. Rather such policies introduce the possible danger of confusing investors with uncertainty and changes to the ground rules.

All that however is a bit of a sideshow debate. The real questions are firstly, how important is it to get construction motoring? And, secondly, what actually should be done now to drive construction growth?

The first to me is simple. Build now when resources are cheap and reap the benefits over the coming decades. Trust me, it’s a good move and a wasted opportunity if you don’t.

The second question is more interesting and stewed in the politics of the day. In my view the Government should spend large and spend directly on construction. It can borrow extremely cheaply and for all its borrowing there will be an asset of most likely greater value stack against it.

We need infrastructure. We need housing. We need to transform large parts of our cities. We will need all this even more in the future when it will cost us more.

In my view we need these urgently and hoping to tease a coy private sector into action when it is quite rightly nervous seems a rather limp approach to a tough problem.

Ultimately the best hope for construction growth will be in restoring growth to the economy. But wouldn’t it be sweet if construction could be a catalyst for that.

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Why the Government must look again at the New Homes Bonus

March 27th, 2013

By Brian Green

As a critic of the New Homes Bonus, even before its inception, I had very mixed feelings reading the damning report that has emerged from the Government watchdog the National Audit Office.

I find myself battling between the ugly side craving vindication and the better side being concerned for the potential damage done and how things might be improved.

Today the devil has won.

Grant Shapps: You were told, before you launched the scheme, when you launched the scheme and as it started to take effect, that there were dangers.

It was and is unfair. It was and is ill thought through. And it didn’t and doesn’t really address the fundamental problems of getting more homes built. And even now, as the NAO points out, its effectiveness is uncertain.

Despite being a critic I was rather surprised by the intensity of the NAO report.

Such reports and subsequent comments from bodies like NAO tend to be very considered and understate what would probably be said in a pub by a huge margin.

So the words attributed to Amyas Morse, head of the National Audit Office, can be read as extremely strong.

“Some local authorities could face significant cuts in their funding as a result of the New Homes Bonus scheme. While it is too early for the scheme to have had a discernible impact on the number of new homes, the signs are not encouraging.

“The Department must now urgently carry out its proposed review of the scheme to ensure that it successfully encourages the construction of much-needed new homes.”

So how did we get here?

The New Homes Bonus – along with localism and the scrapping of the regional planning regime – was at the heart of the Conservative Parties pre-election housing strategy. It was a particular favourite of the soon to become Housing Minister Grant Shapps.

The problem was local folk saw little benefit from new homes built in their communities. The answer, as Mr Shapps saw it, was to incentivise them. The New Homes Bonus was born.

I first made comment on the notion in October 2009 after Grant Shapps presented his thoughts to the house building community at the Housing Market Intelligence conference.

My comment on the details, scant as they were then, was: “No, as I see it, this is not the way Mr Shapps. It will fail. But I have a variation that might just work – make it a lottery.”

I suggested, tongue in cheek, he should make it a true lottery to increase its chances of  success.

I was a bit surprised, but the attack did elicit this admittedly pleasant response from Mr Shapps.

Brian,

Read your lottery piece which I thought was fun. Suspect you’re right about game theorists saying it would work!

Was curious that you don’t think our incentives approach will work. It has elsewhere in the world. It’s also cost free for those hard pressed developers in the room. So nothing to lose surely.

All the best
Grant.
—

Grant Shapps MP
Shadow Housing Minister

Interestingly the NAO report points out that Mr Shapps, when in office, did not consult on the scheme with the Cabinet Office’s Behavioural Insight Team, specifically set up to support departments to apply behavioural change insights to relevant policy areas.

But it was not simply the concept that I felt was at best questionable.

The NAO’s take is: “We found little evidence from our local authority visits that the Bonus has influenced local authority planning decisions.”

But in fairness the NAO team did find evidence that the scheme was reinforcing behaviour among pro-development authorities.

For me the greater question was whether the scheme was fair. I was not convinced by Mr Shapps assertions that it was “cost free” and that there was “nothing to lose”.

As the scheme details emerged after the Coalition took office I checked out some scenarios. That led me to conclude that:

“Even if local authorities in the North do all that might reasonably be expected of them with regards to building new homes, they face losing out and losing out more heavily as and if those in the South respond to this new regime and deliver more homes.”

Some rough and ready calculations for the latest allocations rather make the point. The City of London will receive according to my crude estimations a bit more than £18 per resident for their contribution in the latest year and £55 for their contribution to date in increasing the council tax base.

Compare this with the pro-development local authority of Burnley. Its council will receive for each resident less than £3 for this year’s contribution and less than £4 for their pro-development stance to date.

But ultimately, whichever way you cut it, the pot of money is related to the total pot available to fund local councils. The average take per head is about £24 for the contribution to date. If you get more you’re a winner. If you get less you’re a loser.

So despite taking a pro-development stance Burnley folk seem to be net losers to the tune of about £20 per head.

But while it is an unfair scheme and its effectiveness is in doubt, the central problem is that it fails to recognise the central problem with delivering houses.

Planning may be a frustration, but the failure of underbuilding homes in England is not that simple.

And while nudge techniques may well have their place, the answer is not in brushing with a tickle stick those councils where you want to encourage development while you batter with baseball bats those where you don’t.

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What can you do when a radical and unashamedly ambitious housing strategy isn’t enough?

March 21st, 2013

By Brian Green

Listening to the Budget speech is often theatre, with oohs and ahhs. Reading the documents is more often a prosaic task punctuated with eh? and what?

This Budget provided no exception. Even though it failed to light fires for the construction industry, it did provide interest.

George Osborne’s Help to Buy scheme captured the imagination as he spoke. Sadly, unpicking the detail, such as it is, there is plenty of scope for both questions and concern.

The Chancellor was not subtle in trying to sell the catchline “the aspiration nation”. But it led him neatly to say “…what symbolises that more than the desire to own your own home.”

And then to: “Today I can announce Help to Buy.”

Great! For an industry desperate to see more homes built, indeed more anything built, his words offered promise. What possibly could be wrong?

A future where thousands of would-be first-time buyers and trapped first-time movers (or second steppers) have the frustration of sky-high deposits removed can’t be a bad thing?

Well let’s see.

First the quick detail.

Basically Help to Buy is a two-pronged initiative.

The first element is an extension of the FirstBuy scheme which sees the Government taking an equity loan of up to 20% with the buyer putting in at least a 5% deposit. This scheme will from April 1 be available to all home owners (not just first time buyers) who are looking to buy a new home worth up to £600,000.

The second element is a mortgage guarantee, similar in essence to NewBuy, intended to open up from January 2014 mortgages on all homes (not just new) worth up to £600,000 to buyers who can stump up 5% deposits.

Now the criticism.

The first issue the sceptic sees is the scheme means Government taking on considerably more exposure to the housing market.

It certainly appears to make the Government more prone to losses should something very nasty happen to the housing market. Its exposure, technically, runs into many billions of pounds. That problem was widely picked up in the media and, from what I heard, rather poorly answered.

Then there is concern that the initiative will raise house prices. This was picked up on twitter almost as soon as the Chancellor uttered the words “Help to Buy”. And in fairness it’s a real concern.

If you increase demand, and this scheme is intended to do just that, you can expect an increase in prices. It’s not quite that simple. But it’s fair to say that more money in the housing market will put upward pressure on prices given the supply constraints.

So already that lovely sheen on this Budget initiative looks a tad tarnished.

Then there’s the question over will it work?

I would readily understand people dismissing this initiative without consideration on the basis of the Government’s rather sorry track record. Its big promises of more house building have not materialised, hence another initiative.

But where do you go after launching a “radical and unashamedly ambitious” housing strategy that fails to lift house building?

For my money the interesting aspect of this scheme is its focus on liquidity in the housing market. I don’t know whether the Government has recognised the link between liquidity (property transactions) and private house building completions. But, whether it has or hasn’t, the historic data suggests that if you want more private sector completions you need more housing transactions in the market place overall, as the top graph shows.

So, if this policy helps to boost sales overall it should boost completions of new private sector homes.

How much of a boost is hard to judge. Intriguingly the scheme could hardly have received a more muted billing from the Office for Budget Responsibility.

It states: “The expansion of the existing schemes is likely to have a relatively small additional impact on transactions and residential investment. The details and timing of the guarantee scheme have yet to be finalised and it is therefore too early to quantify the likely impact.”

But it adds that alongside the Funding for Lending scheme we should see significant growth in property transactions and residential investment.

Ironically the announcement of the scheme seems to coincide with the OBR downgrading its forecast for residential property transactions, as the second graph shows.

If pressed I’d say I would expect to see a short-term boost in transactions and a corresponding rise in house building from pursuing these policies.

But I would be cautious about proclaiming that such a rise was a success. I have deep concerns for the long term.

Here’s my thinking.

I was no great fan of Grant Shapps as housing minister. But one thing I agreed with him about, indeed I applauded him for saying, was the need to rebalance the price of houses relative to the earnings of average folk.

There are two ways to do this. Through wage increases or through house price falls. Wage increases have for some time looked limited, while falls in house prices do carry unsettling social and economic impacts. So I expected rebalancing would be slow.

But if we do not rebalance wages against house prices we are building ourselves an ugly trap for the future.

I could go into the mathematics, but it gets boring. Basically if houses are relatively very expensive average earners are reliant on very low mortgage rates to buy one, unless they have a fat wodge of cash. Also buyers become increasingly at risk from a rise in mortgage rates.

The further worry is that sustained high house prices translate into very high land prices.

These house prices and land prices can be very sticky, with the aspirations of the sellers set by the peak prices.

Many people believe that house builders do well if house prices rise. Well short term yes they may. They have land banks that increase in value.

But any house builder with nous who’s been in the game a while knows that that party can’t last. They know strongly rising house prices mean rapidly rising land prices, which in turn mean more risk when buying in the land market.

Ultimately if we want an active private sector housing market then ordinary people must be able to buy into it and their purchases cannot be contingent on ultra low interest rates or, for that matter, ever more extensive Government guarantees.

It would seem to me that if the Government is happy to have exposure to the housing market it might consider investing directly in building homes. This would not queer the pitch for house builders. History shows that the golden eras of private sector house building have coincided with significant public sector funded building.

I have discussed before notions of how the Government could sponsor house building and build assets that it can sell, if necessary, at a later date to private buyers or to social or institutional landlords.

Given we are in a recession, the net cost to the Government of building homes would be significantly less than the asset created. And I fail to see how £20 billion or so debt well covered by an asset, which the Government seems happy enough for its citizens to buy, would distress the buyers of British debt.

The Government has in my view wasted yet another opportunity to be truly radical and ambitious.

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Is the construction industry 13% bigger than we think it is and does it matter?

March 16th, 2013

By Brian Green

Here’s an intriguing puzzle. Why would an alternative measure of construction activity suggest the industry is about 13% bigger than the official construction output figures show?

Also, why would this measure of the annual increase in capital goods resulting from construction (gross fixed capital formation) suggest the industry has fallen 20% from peak rather than the 10% the construction output figures suggest?

This has been bugging me for some time and some months ago I turned to the Office for National Statistics for advice.

It turns out that this conundrum had been puzzling the Bank of England as well and is being investigated. The investigation, which was due to be completed some while ago, was still ongoing when I last checked.

All this may seem rather esoteric. But in reality policy makers, particularly at the moment, are very concerned with the ups and downs and the size of the construction.

If the figures are saying one thing and the real world is behaving in another then the assumptions driving policy will be suspect. That makes it important.

It’s true the data for UK gross fixed capital formation (GFCF) for dwellings and for buildings and other structures is measured differently from construction output. So there will be different lags in the different data series and other technical differences.

Also there will be slight differences in what is covered, plus the regular output series covers just Great Britain not the UK. A total for UK construction output would need to include Northern Ireland’s contribution, which at peak was about £3.4 billion a year and is currently about £2.3 billion.

You wouldn’t expect the GFCF measure and output measure to produce exactly the same figures, even if they covered the same geography and exactly the same components. But in a broad sense they are much the same thing, so you would expect the trends to be fairly similar. Certainly the data series track closely from the late 1990s up to 2004. The gap between annualised GB construction output and UK GFCF was then running well within 10%.

But from being within 4% of each other at the end of 2003 the gap grew to more than 22% by early 2008.

This matters because, if the GFCF figures are actually a better reflection of the real world, it suggests construction was at peak far bigger than we gave it credit for. Discounting for Northern Ireland we’d be looking at GB construction at peak of £160 billion compared with the £130 billion in the official output figures, with the current figures at about £130 billion against £115 billion.

Interestingly the GFCF figures suggest a much harsher recession for the industry than the construction output data suggests.

For me this is fascinating, not least because I have long argued we undercounted the boom (the argument, which you can read here, relates to the measurement of foreign workers and how the construction data was put together before the change in the series when ONS began producing the statistics monthly).

Leaving curiosity over how the numbers are produced to one side, there are serious implications for policy.

That said, given the vagaries of policy making, misinformation may in practice lead to a good or bad result for the construction industry. But for my money when I am making important decisions I prefer to see the world as near as possible as it is rather than how it appears through distorted lenses.

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