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The UK Construction Industry & the Current Economic Climate

Introduction

The construction industry is very important to the UK’s, and indeed to the worlds, economy. In the UK, it accounts for more than 10% of the country’s Gross Domestic Product and employs and estimated 2.6 million people. In the last three years, an extra £33 billion has been made available to this sector to increase public services. Included in this figure are major investments in transport, health and housing. As the industry is investment driven, it is subject to the strictures of economic upturns and downturns, during the recessions of the mid 1980’s and the early 1990’s, there were significant downturns. However, in the late 1990’s, there was a marked swing in the opposite direction.

Everyone knows that downturn has hit the construction industry badly, with some sectors of the industry which have been affected more than others. Private housing, offices and industrial are badly affected by the deteriorating economics conditions and the credit crunch.

The situation is brighter for those with jobs in infrastructure and the Olympics, although neither of these will be enough to sustain industry activity.

Historically, economic conditions have led to a sharp fall in the flow of new projects in the pre-construction pipeline. Leading indicators suggest the outlook for 2009 may be worse with the UK officially having entered into a recession.

The government has had an ambitious construction-related spending programme across a number of sectors. Education and health in particular will benefit from an increase in the value of construction projects this year.

The following report outlines the current economic state of the construction industry in the UK and worldwide. We have examined how the UK has arrived at it’s current situation and how the global economy downturn has influenced out current economic situation.

All contributing factors to the current recession are examined and the most relevant are applied to the current economic state. We have also looked at the “credit crunch” and how this is playing a significant role in the current market.

It was discovered from our research that in order for the government to restore the industry to it’s former glory, financial institutions will need to release funding and begin investing in construction projects again.

The Construction industry in the Current Economic Climate

The UK economy in general has received a massive blow over the past 12-15 months. The British Chambers of Commerce said it’s survey results were awful and the worst since it began in 1989. The Bank of England has slashed interest rates from 2.0% in January 2009 to just 1.5%. VAT has been reduced from 17.5% to just 15% in December 2008 until 2010, until the economy recovers.

The construction industry in particular has been greatly affected with 2008 seeing a massive downturn. Experts outlined that more than 100,000 construction jobs have been lost in the last year, and that there is worse to come in 2009.

This has become apparent with the UK being officially labelled at being the grasp of a recession in January 2009.

The RICS is forecasting that 300,000 jobs will be lost in the construction industry over all during the recession. The worst sector to be hit with this unemployment will be the housing market, but unemployment is not exclusive to this sector of the industry.

With the UK being immersed heavily in the “Credit Crunch”, financing new projects going forward will be a key issue for government and developers alike.

So what is the credit crunch all about? A credit crunch can be defined as follows: A sudden downturn in lending precipitated by distress at financial institutions.

Many construction firms have outlined that there decision to let staff go is mainly attributed to this credit crunch. Persimmon has cut 2,000 jobs, Taylor Wimpey 1,900 jobs, Barrat 1,200, Bellway 850 and Bovis Homes 600 jobs. With limited funds available, contractors are restricted in the undertaking of new projects going forward.

According to Price Waterhouse Coopers the downturn has probably already forced more than 2,000 construction firms to go under, and without projects like the Olympics, Crossrail and initiatives on health and education, it could have been worse.

This current economic climate is not solely applicable in the UK, other once strong economies such as the USA and Japan are also suffering.

The US economy

The World may be on the brink of the “worst economic downturn since World War II” according to accountants Deloitte & Touché.

Key Factors Leading to Global Economic Downturn

The stresses in the financial markets of the United States that first emerged in the summer of 2007 transformed themselves into a full-blown global financial crisis in the fall of 2008: credit markets froze; stock markets crashed; and a sequence of insolvencies threatened the entire international financial system.

Massive liquidity injections by central banks and a variety of stopgap measures by governments proved inadequate to contain the crisis at first.

The initially hesitant policy response has become increasingly robust. The United States government introduced a $700 billion rescue package and has taken equity positions in nine major banks and several large regional banks.

Various debt and deposit guarantees have also been introduced. At the same time, European governments have announced plans for equity injections and purchases of bank assets worth some $460 billion, along with up to almost $2 trillion in guarantees of bank debt.

Virtually no country, developing or high- income, has escaped the impact of the widening crisis, although those countries with stronger fundamentals going into the crisis have been less affected.

There are many experts outlining different reasons for the current economic situation and the most relevant factors relating to the decline of the UK economy can be outlined as follows:

1. Changes in house prices.

UK house prices have been rising much faster than inflation, this has created a wealth effect and improved consumer confidence, therefore spending and AD increase. A fall in house prices, however, sees the opposite effect. E.g. when house prices fell 15% in 1992, the UK entered a recession, with negative growth of 2%.

2. Fluctuations in Stock Markets

The big fall in stock markets triggered falls in consumer confidence and can overall lead to a recession. The Wall street crash of 1929 was a primary cause of the great depression. However, the stock market crash of 1987 did not cause an economic downturn. In fact in the UK it was followed by an unprecedented economic boom. This was partly due to the way the government responded Cutting income tax and cutting interest rates.

With the collapse of Lehman brothers on Monday the 15th of September 2008 the domino effect began. At 9am, shares in HBOS, Britain’s biggest mortgage lender, crashed 34 per cent in early trading. By noon, panic had gripped the London Stock Exchange and the FTSE had shed almost 400 points. No one could believe it.

Yet worse was to come: within three days HBOS would be taken over by Lloyds, and within three weeks the FTSE would fall below 4,000, wiping billions off the value of our leading companies. We had grown used to the idea that it always stayed around the 6,000 mark. The evening news became a soap opera, or a horror movie, depending on the state of your nerves. Even the US elections were eclipsed.

Outlined below is a key example of how the key players in the worldwide market have seen a significant drop in their market values:

Ref: (BBC news channel, Wednesday 17th September 2008)

3. Global Credit Markets

The sub prime mortgage problems in the US caused many firms to go insolvent. This cause a big fall in confidence in lending money. This shortage of credit led to a restriction on new construction projects being undertaken. This caused the problems of northern rock and reduced consumer confidence.

4. Changes in Interest Rates

Interest rates are used as a tool in controlling inflation. However, they can also have an impact on consumer spending. Sometimes interest rates may have little impact, however, if they coincide with other factors they can cause a much bigger than expected fall in consumer spending. For example, in the UK, many homeowners have a variable mortgage. Therefore a small change in interest rates can have a big effect on disposable income. Although the decrease in the interest rate is beneficial to people with mortgages, the sharp decrease in the property prices has greatly depreciated the value of each home in the UK, this can cause a slowing down of house price growth and a big fall in spending.

5. Global Factors

In an era of globalisation there is an increasing interdependence of the world economies. For example, China’s boom is slowly coming to an end, and there are fears they to could be heading into uncertain times and the possibility of recession, this could cause a marked slowdown in global growth.

It used to be case the world was very dependent on the US economy. With the US economy close to recession, this can drag the rest of the world into recession. This is mainly attributed to that fact that the US is the world’s biggest consumer of imports. However, it is argued that the world is less dependent on the US economy because of the development of new economies like China and India. Nevertheless global factors are of great importance.

6. Price of Oil

An increase in the price of oil can cause economic instability, especially if it is a sudden increase like in the 1970s. Higher oil prices increase the costs of firms and cause the AS curve to shift to the left. This causes both inflation and lower growth.

However, it is worth noting that although the oil price is now nearing nearly $100 a barrel, it is not having a huge effect. The impact on economies like the UK is less than it was in the 1970s, partly because the increase in price has been more gradual. Costs of transport are still not a major problem. It would require a much bigger increase to have a really damaging impact.

Identifying & Solving the Key Problems

When we examine the current Global Economy we can clearly relate these outlined factors to the current crisis. Each one has played a significant role in the downturn, but the financial crisis has had a longing effect on the construction industry.

The financial collapse has been, I feel, the main contributor to the current economic situation in the and Global and UK economy.

With many leading financial institutions reluctant to lend money we have come to a stale mate with the banks in terms of development. With limited or no capital being obtained how do we develop our Housing, road, Rail, Commercial and other various markets? The answer is we don’t.

Despite the money that the government has pumped into financial institutions and the bailout after bailout, banks are still unwilling to lend. This is clearly evident in particular within the housing market, where people simply cannot get mortgages.

It is not only housing that is suffering, the Olympic Village, which must and will be built, is also finding it difficult to arrange and secure finance. To add to these problems, the retail and office sectors have also taken a further downturn.

Office and Retail . . . . . . . .. . . .. . . .

Some of these issues are beginning to be addressed, ie. The Mayor of London, Boris Johnson, is planning to fund frozen housing schemes to hit the 2011 target of 200,000 new homes in the capital. Mr. Johnson has also pledged a strategy to build a further 50,000 affordable houses, also to be completed by 2011. This model in my view is one which can be copied and applied to other regions in the UK.

Funding . . . . . .

The Construction industry and the Future

The construction market going forward is certainly in for some uncertain times, but all hope is not lost.

Construction on the Olympic stadium began three months early in May 2008. Work has also started on Zaha Hadid’s £300 million plus aquatic’s centre, and ISG is on site in the north of the Olympic park for the 6,000 seat Velodrome.

Developer Bovis has until the end of March to come up with half the money for the £1 Billion project. This year has also been a landmark one for the £16 billion crossrail project.

There is also a government pledge to a Regeneration programme of approximately £4 billion involving 80 major projects including Birmingham, Leeds, Liverpool, Manchester, Newcastle, Nottingham and Sheffield.

A healthcare development and renewal has also been committed to with an approximate figure of £6.1 billion being invested in a number of key projects such as:

Over 20 new hospitals

150 new walk-in healthcare centres

100 new doctors practices

Approximately £3.7 billion of restorations and repairs

In the transport and infrastructure sector we can see such projects as the widening of the M25 railway. £3 billion input for the ‘Transport Investment Programme’ in Scotland.

Education construction via the Government’s ‘Building schools for the future’ programme promises capital investment of some £45 billion to build some 3,500 state secondary schools.

The UK Government has set a target of 3 million new homes by 2020, giving an average of 240,000 new units per year.

Conclusion

Despite the factors that seem to be conspiring against it, the construction industry moves at a very fast pace and is an ever changing entity. Whilst legislation is forever altering, new techniques, technology and methods are developing to keep up. With the development of new practices, new jobs in construction are perpetually being created. In the UK, the Home Office has released figures stating that the three construction jobs that are most lacking in applicants are those for transportation and highways engineering, ground engineering and contaminated land specialists.

With the Major infrastructures and building developments that have been outlined, construction recruitment is set to soar.

Britain’s Olympic Games will have 30 venues and a budget of £2.3 billion. It also has a non-negotiable, absolute completion date. As that date draws nearer, the construction industry will find itself heavily in demand as pressure and expectation rise. 2012 promises to be an important year for this industry and many are looking upon it as a chance to showcase it’s talents.

With all this said there is still a major requirement for additional funding outside of government projects. Private developers rely heavily on this source of capital and until this again becomes a readily available resource, private development will suffer.

This unfortunately is out of our hands and we are completely at the mercy of the financial institutions. The financial market in the UK and worldwide does seem to be beginning to turn around, and some institutions have begun to lend to each other again, which is a good sign. It can only be a matter of time before this is passed onto developers and the public.

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