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Saturday, 19 July 2014

Construction multiplier

Construction increasing steadily

In recent weeks, data from the Australian Bureau of Statistics (ABS) has revealed that the number of loans taken out for the purposes of construction has increased to the highest level in around 4 and a half years.

If we smooth the numbers out on a rolling annual basis, we can see that while an upturn is entrenched, the uptrend still remains relatively shallow at this stage, and there is much more lifting to be done here (click chart):

With dwelling prices having risen over time the total value of construction loans on a rolling annual basis is getting set to break new record highs (click chart):

Importance of this?

It's worth noting here why this is considered to be important.

Dwelling construction been extensively researched by the ABS in years gone by, and the data uncovered showed the construction industry to have a very strong multiplier effect on the economy.

One of the more depressing things about visiting Britain over the past 6 or 7 years - apart from the ongoing under-performance of the national sporting teams, that is - has been the near total lack of cranes on the horizon. 

That's rarely a sign of a thriving economy.

Things have been picking up strongly for UK construction of late, but it's been a moribund period indeed for the construction industry.

Here's the ABS on the effect of construction on the multipliers on the wider economy in terms of output and employment in Australia:

"For every $1m spent on construction output (houses, non-residential buildings, etc.) in 1996-97, a possible $2.9m in output would be generated in the economy as a whole, giving rise to 9 jobs in the construction industry (the initial employment effect), and 37 jobs in the economy as a whole from all effects.

These flow-on effects are made up as follows. The initial effect of the additional construction is $1m. The first round effect for this additional construction would be the increased value of activity of around $0.5m in those businesses manufacturing the materials needed for the additional construction, such as concrete and steel frames.

The businesses supplying and servicing the concrete and steel frame businesses, such as aggregate quarrying and raw steel production, experience an increased demand for their products and services. This industrial support effect is estimated to be an additional $0.4m.

As activity has increased in the construction industry, as well as in the suppliers to that industry and the suppliers to the suppliers, there is an increase in wages and salaries to employees in this chain. The spending of these wages and salaries induces a further round of consumption effects in other areas of the economy totaling an additional $1m".

Multiplier of 3 for construction

So, there you have it: construction in Australia has a multiplier effect of close to 3. 
That is, for every $1m invested, an additional $3m is generated in the economy as a whole.

Now let's put this in its wider context.

Below is what has happened in Aussie construction over the long run. Note the gargantuan boom in engineering construction driven by the resources building boom.

This sector is set to tail off quite nastily over the coming few years, although it's not yet entirely clear how quickly that will happen. Note how construction has become overwhelming dominated by mining and resources (click chart):

In terms of other building work done, the split between residential and non-residential building has tracked as follows (click chart):

We don't need to get bogged down too much in the headline numbers here, other than to note that if mining capital expenditure falls by 20 percent in the 2015 financial year (which forecasts suggest may well eventuate), and does something similar again in the following financial year too, this leaves a monster hole in the Australian economy to somehow be filled.

Only one shining light exists in the state economies at the moment for infrastructure and dwelling construction, that being New South Wales, which is busily tackling its infrastructure and dwelling deficit (click chart):

States which need to rebalance?

The implication of the mining and resources construction boom detailed above above is that the Aussie economy has gotten itself quite dramatically out of balance.

In the March 2014 quarter the total value of engineering construction seasonally adjusted at around $31,850m was way, way bigger than the total value of building at closer to $21,750m.

This means that some states are going to face very significant challenges when the mining construction drops away.

The quarterly engineering construction figures by state clarify which which states - Queensland and Western Australia in particular - are going to face an uphill struggle in the coming years.

Those two states have benefited greatly from the boom, so they face more of a challenge from the forthcoming downturn (click chart):

This is especially so because when you look at the uplift in building work done in this cycle only New South Wales to date has shown any real sign of thriving.

These figures are not seasonally adjusted so the next seasonal uplift will be key, but it's clear that Western Australia has hit a plateau, Victoria's house building boom was last decade's news and something is not working as it should be in Queensland in terms of building work.

South Australia and the minnow states are floundering, and in any case they aren't going to add much value in chain volume measures terms (click chart):

This something to be wary of when commentators start talking up the Brisbane property market with the usual hyperbole this year, stating that it is "due for a boom".

Look, maybe, yes, and the general consensus is that Brisbane offers relatively good bang for the buck and the outlook for the property markets over the the next few years appears bright.

But equally it always pays to be careful of the shallow property market commentary which takes little (or more typically zero) account of what is actually happening in relation to these huge structural shifts in the Aussie economy.

Yes, there is an argument for dwelling prices to rise strongly in response to low interest rates, but as a general rule people don't buy property when they don't have jobs, and there is a major rebalancing challenge lying right ahead in the Aussie economy, especially in the mining states.

You'd need rocks in your head to call a sustainable property boom while taking no account whatsoever of what the wider economy and labour markets are up to.

It's one to watch carefully.

Rates to fall lower still

The charts detailed above show quite clearly that the hole left by mining construction can't readily be filled only by building more houses and a moderate level of infrastructure.

Net exports need to increase, which they indeed have been doing, albeit in the face of lower commodity prices. Household consumption needs to increase, which it was doing quite nicely, but then appears to have stalled again post-budget.

With the economy looking likely to tread water in Q2 (the unpredictable effect of inventories left aside), futures markets are quickly getting around to realising that the next move in interest rates must be down.

To me another rate cut is looking more and more likely by the week. Pencil in a likely interest rate cut before Xmas, for my money.