The Economic Framework

Introduction

One might imagine that an industry which typically consumes 50–70 per cent of public investment, contributes up to 5–10 per cent of GNP, and provides employment to a comparable proportion of the labour force would be universally well-understood and well-documented. It is unfortunate as well as surprising that, in developing countries in particular, this industry — the construction industry — is poorly documented and apparently almost unfathomable. Given that many of its activities are growth related, e.g. roads, ports, irrigation, land reclamation, this lack of knowledge and understanding can, and does, have serious repercussions.

Whilst most development plans describe the expected (or hoped for) outputs of the industry, few pay much attention to the inputs that would be required to produce these outputs. They will describe in detail the number of hospital beds, the intake of children into schools, and the lengths of road that are expected within the plan period, but this is seldom related to the implied demand that this will place on the construction industry. It is rare indeed for such plans to discuss the motivation of, and constraints affecting, the industry; and rarer still to propose practical measures to enable it to meet the demands placed on it. In general, the end products of the industry are considered in detail, and forecasts are made of the necessary output. Little or no attention is paid to the development of the means to achieve the targets so painstakingly described. The inevitable result is a frequent failure to meet planned targets, which is usually blamed on the conservatism, intransigence or plain incompetence of those involved, rather than a cool analysis of cause and effect.

In the developed countries of the world, the construction industry is generally flexible enough to be capable of meeting the fluctuating demands that are placed upon it (although the cost of the cycle of underused-to-overstrained resources is still considerable). Furthermore, these economies are not dependent upon the industry for growth. A basic infrastructure already exists, and the level of production of houses, schools and hospitals is such that a reasonable quality of life is assured. However, most developing countries do not have as yet sufficient basic infrastructure, such as ports, roads, dams, etc., to sustain an acceptable level of economic development. Furthermore, the number of houses, schools and hospitals is inadequate for social and community needs. Whilst the level of construction output that would be required to initiate and maintain economic growth is extremely high, indigenous financial resources are usually extremely limited. The share of the developing nations, comprising two-thirds of the world's population, in world construction output is of the order of 15 per cent. Further, the construction investment per capita in the developed nations is some 30–35 times greater than in the developing countries.

Besides the direct implications for development, the employment aspects of the industry are far from satisfactory. Thus, whilst the construction industry does offer the possibility of large-scale employment creation, most developing countries rely heavily on the use of equipment. (References to the industry as equipment-intensive do not imply that it is so in any absolute sense. Rather it is more equipment-biased than is justified given the labour-abundant resources endowments of most developing countries.) Very little construction equipment is manufactured in the developing countries and consequently much of the limited investment that goes to construction is spent on imports. In the industrialized countries the reliance on equipment is the natural, and logical, result of the high level of wages and the relative shortage of labour. In the developing countries the emphasis is placed on equipment in spite of the availability of a large number of workers willing to work for relatively low wages. Whilst standards of efficiency and quality certainly have to be maintained, it is paradoxical, in view of the industry's undoubted potential for employment creation, that on average the proportion of the population employed in construction is five or six times lower in the developing countries than in the developed ones.

The construction industry occupies an important place in any country's economy. It provides an appreciable share of the gross domestic product and generates a high proportion of the gross fixed capital formation. Even in the developed nations (and a fortiori in the developing ones) construction is relatively labour-intensive, in the sense that it uses a larger number of workers per unit of output than most other industries, and as such is also important as an employer.

In this chapter the industry is situated statistically in relation to the economy in general. A word of warning is apposite here. Several writers have attempted to go one stage further and suggest that the type of relationships developed in this chapter can be used to predict employment and investment changes in the industry. This can be extremely hazardous if the nature of the causal relationships are misinterpreted, and we shall return to this issue later in this chapter.

A Statistical Overview

In financial terms, the industry converts financial investment into physical assets such as industrial plant, buildings, roads and general infrastructure. This creation of fixed assets to enable other economic activities to take place is an extremely important aspect of the industry. In both developed and developing nations construction usually accounts for over 50 per cent of fixed capital formation. The market for enterprises in, or associated with, the construction industry is, therefore, largely determined by the level of investment. As an example Figure 4 shows the close correlation between gross domestic capital formation and construction output, in this case for the United Kingdom. It is not surprising that the workload of the industry in the public sector is directly affected by the level of government investment. But in the private sector, also, central government action on bank rates, credit facilities and taxation effectively controls the level of demand for the industry's services. The industry is, therefore, intrinsically very susceptible to government policy. What is more, it is used by governments as a regulator for promoting or suppressing economic growth.

The activities of the industry have long been seen by central governments as a convenient short-term means of dealing with unemployment. However, in the developing nations where high unemployment is an established and continuing fact of life, there is now a growing appreciation of the potential role of the industry in helping to alleviate the structural aspects of the problem, rather than as a short-term panacea.

The industry also has significance in the economic balance of trade. It contributes to the level of imports in three ways: by its need for plant to win raw materials and physically execute construction projects, by the direct importation of building materials and components to supplement domestic production, and as a result of the use of design and implementation expertise provided by foreign consultants and contractors. On the other hand, it contributes to exports by the sale of building products and the raw materials which constitute the basis of these products, and by the employment abroad of its own consultants and contractors. The overall balance of trade strongly favours industrialized and newly industrializing countries (NICs), while poorer nations are frequently in chronic deficit.

Various attempts have been made to correlate construction industry activity and economic growth. Graphs, prepared by the authors, relating GNP to value added in construction, value added per capita and employment are presented in Figures 1, 2 and 3. In addition, Tables 1 and 2 give a summary of an analysis of world-wide statistics for 1974 (97 countries) and 1979 (116 countries) respectively. The most striking aspect of these statistics is their variability and their range.

Value added in construction

Value added is the difference between the total revenue and the cost of bought-in raw materials, services and components. It thus measures the value that an industry has added to the bought-in materials and components by its processes of production.

The range is large, from as little as I per cent to as much as 10 per cent. It has been suggested by Turin, and repeated by others, that the percentage value added in construction increases as the GNP /capita increases. It is more accurate to state that the percentage value added in construction is generally higher in the countries with a high GNP/capita than in countries with a low GNP/capita. However, Table 2 shows that the increase is not linear. Countries with GNP /capita of less than $500 have an average value added of nearly 5 per cent, while those with GNP/capita greater than $9,000 have an average of nearly 8 percent. Regression analysis indicates that there is indeed a positive relationship between GNP/capita and percentage value added. However the increase in GNP/capita explains only some 20 per cent of the variation. Furthermore, if only the countries with a GNP /capita of more than $2,000 are analysed the relationship is much weaker. This suggests that above a certain level of GNP /capita the trend tails off to a fairly steady proportion of between 7 and 8 per cent of GNP.

Whilst the value added as a percentage of GOP usually fluctuates within a limited range, the actual value added per capita has a very wide variation. Table 2 also indicates the scale of this variation in that the least developed countries have an average value added/capita of only $13, whilst the developed countries have an average of over $400. The dramatic contrast between African and European countries is exemplified by Lesotho and Denmark, with values of $1/ capita and $1,040/capita respectively. Thus, not only do the different levels of GNP per capita lead to an imbalance in construction activity, but in the richest countries the construction industry provides a greater contribution to GNP. For example, the gross value added of 30 of the developing countries, with a total population of 1,120 million in 1974, was some $13,750 million, whilst the construction industry of France, whose total population is 53 million, contributed $12,450 million to the Gross Domestic Product.

The relationship between value added in construction per capita and GNP per capita is extremely strong and, as shown in Figure 2, linear. Regression analysis for 116 countries indicates that GNP per capita explains 90 per cent of the variation in value added per capita. This suggests that construction activity is mainly a reflection of the needs of the population rather than being strictly related to the growth of the economy.

In this context, Drewer notes that various researchers have stressed the clearly defined relationship between construction output and level of economic development. Whilst he does not dispute the validity of this relationship, he criticizes the assumption that construction is therefore an important (and independent) determinant of economic growth, and suggests that this causal relationship may have been wrongly interpreted. Estimates of the rate of change of construction output compared to the rate of change of GOP show no such clearly defined relationship, supporting the proposition that construction output is dependent upon GNP rather than vice versa.

Of course the danger in assuming that construction inspires economic growth is that governments will invest even more heavily in the industry in the hope of achieving such growth. The evidence, however, suggests that a rapid growth in construction output is associated with a disproportionate increase in the importation of construction materials, diverts scarce domestic savings from other productive sectors and imposes additional inflationary pressures on the economy.

Investment in construction

Gross Fixed Capital Formation is a measure of the additions to the stock of capital in a country. This consists of buildings, plant and machinery and includes depreciation, repairs and maintenance expenditures. Between 50 and 60 per cent of Gross Fixed Capital Formation or Investment goes to the construction sector in most countries, whether developed or developing. The percentage of the GNP in Gross Fixed Capital Formation tends to increase with the increase in GNP/capita. Thus, the percentage investment in construction also rises. However, it should be recognized that in the developed countries: (a) a larger proportion of investment will be allocated to renewing equipment as industry tends to be more capital-intensive; and (b) there is a higher proportion of repair and maintenance work. The percentage investment in entirely new construction is likely to be higher in developing countries than in the developed. Table 3 shows that in Africa less than 15 per cent of construction output was in repair and maintenance.

Per capita investment, like per capita value added, varies enormously from the developed to the developing countries, as Tables I and 2 show. Thus whilst the percentage of investment in construction is at the same level in developed and developing countries, the percentage in developing countries is of a much smaller total magnitude and has to serve a more rapidly growing population. The average investment level per capita in the most developed countries is no less than 85 times that for the least developed (Table 2), whilst the difference in GNP per capita is of the order of 30–40 times. The extremes are Norway with a GFCF in construction per capita of $2,070, and Ethiopia with $6.

The relationship between GNP per capita and investment per capita is extremely strong, 90 per cent of the variation in investment per capita being explained by changes in GNP per capita. This reflects the fairly standard percentage of investment funds that any government, rich or poor, devotes to construction. The regression analysis, however, indicates that up to $4,000 GNP per capita the relationship is very stable. Above that figure investment per capita starts to level off, presumably indicating that there is a point at which the basic major infrastructure is put in place and the need for massive investment becomes gradually less. Tables I and 2 also indicate the level of investment per workplace in construction. This reflects not only the natural tendency for developing countries to be more labour-intensive in the construction sector but also — the fairly obvious point — that the level of wages is much lower in the developing countries.

Nevertheless, it is worth noting that the range of investment per workplace is less than the range of GNP per capita (see slope of regression, Annex 1). This reinforces the argument that the industry in developing countries is over-capitalized in relation to its economic condition. That is the amount of capital available to the industry in the form of equipment is out of proportion to the level of wages and general economic condition. Unfortunately there persists the idea that rich countries become rich because they use equipment, rather than the truth which is that they use equipment because they are rich. This over-capitalization is more pronounced with the least developed countries. It reflects the general situation that the poorer the country the more inappropriate is the reliance on capital-intensive rather than labour-intensive techniques.

Employment

In all countries construction is a relatively labour-intensive industry. Moreover, it provides jobs particularly for semi-skilled and unskilled workers. The ILO has suggested that, whereas the occupational group comprising craftsmen, production process workers and labourers accounts for only 30–40 per cent of the total labour force, it accounts for 75–80 per cent of the construction labour force. In general, wages in construction in the developing countries are less than those in the manufacturing sector, and this is particularly true of the least developed countries. Workers often perceive work in the industry as a transitional stage in their migration from the rural subsistence to the urban wage-earning economy.

Whilst the amount of labour used on construction sites in developing countries tends to be greater per unit of investment, the actual level of employment per 1 ,000 population increases as one moves from the poorest to the richest countries. Table 2 shows that employment per 1,000 in countries with a GNP /capita of less than $500 is likely to be about 4. In countries with a GNP /capita of more than $2,000, the figure is in the region of 25 to 30. It is fairly clear also that employment levels off at a certain stage of economic development. Clearly several factors affect this, not least the level of mechanization and the strength of the workers' organization in the industry.