Economic Development: Strong Foundation?

Construction is good for now, but what about next year?

Bobby L. Hickman

August 28, 2008

G eorgia's non-residential construction industry has thrived despite troubles in the housing industry and a general economic slowdown. But the good times may not last much longer.

Ken Simonson, chief economist for the Associated General Contractors of America (AGC), says that aside from homebuilding, most sectors of the construction industry continue to see good demand.

"There are a lot of pockets of non-residential construction that are still strong, and will continue to do well the next couple of years," he says. At the same time, "I don't want to paint too rosy a picture," Simonson says. "Contractors generally are  busy for now, but there's a growing concern about what they'll be doing after their current projects end."

Construction statistics often are  cited as an indicator of general economic health. The industry also is  a vital component in economic development, providing factories, offices, retail buildings and infrastructure that enables companies to expand. Also, construction costs continue to rise, making it more difficult for projects to be economically feasible.

"Construction is a bigger industry than a lot of people realize," Simonson says. In Georgia, construction contributes about 4.5 percent to the state's gross domestic product and employs about 5 percent of the non-farm workforce, both comparable to national averages. The industry employed 219,000 of Georgia's 4,165,000 workers in May 2008, a decrease of 1.7 percent from May 2007. Construction also contributed $18 billion to Georgia's 2007 GDP of $397 billion.

Construction also provides a path to entrepreneurship, Simonson notes, as the industry is dominated by small businesses. Nationally, "there are a couple of million people in construction who are self-employed," he says. "Historically it has been a great way for people to start out and build up a company."


Concerns About The Future
Despite an economic slowdown, Simonson says non-residential construction demand has been high. "That's been the good news story thus far. A lot of people think commercial construction is going down, following the lag in residential. In fact, huge parts of construction have no connection with homebuilding."

For example, Georgia Power is adding generating and transmission capacity as part of a 50-year plan. A number of state universities have expansion programs driven by the demographics of record college-age populations and available capital. Hospital and military-related construction also are strong, Simonson says, citing "base realignment and closure activity around Fort Benning and other locations across Georgia."

Nevertheless, "I definitely am concerned about what's going to happen from here on out."

One area to watch is state and local governments. "They are really running into revenue shortfalls, so they'll probably cut back on some of the public spending they planned," he says. "It's easier for school districts to defer the renovation of a building than to cut teacher pay or stop buying textbooks."

In the private sector, developers are finding it harder to obtain financing. Lenders are "questioning their assumptions about how quickly they can fill up their space in shopping centers or offices. Now a lot of projects that developers thought might have gone ahead this spring are being put off until fall," or may not happen at all.

Thus far, the industry has seen little net job losses. National statistics show declines in residential construction employment. However, Simonson says those figures can be misleading, as many of those subcontractors simply have moved from homebuilding to "working on stores, schools, hospitals and office buildings. But going forward, I do expect a slowdown in hiring and job losses on the non-residential side."

Costs To Continue Rising
In late winter, AGC issued its semi-annual construction inflation alert report, which forecast uneven growth in construction spending.

"I was too optimistic when that report was prepared," Simonson recalls, "even though I warned material costs and labor costs were likely to rise faster for construction than for the overall economy. What we've seen in the past six weeks has been much more dire than what I had foreseen in mid-February."

One surprise was record steel costs through the spring and summer. Simonson expected steel costs to retreat, as happened after other large cost run-ups in recent years. "Now we've had price
increases announced for July and more are being threatened for October," he says.

What was not a surprise is that energy costs continue to be the major factor, particularly record diesel fuel prices. Contractors use a tremendous amount of diesel fuel for their own vehicles and machinery, as well as pay diesel surcharges on thousands of deliveries of equipment and materials to job sites. Other materials that incorporate oil and natural gas in their production also are costing more, such as asphalt, PVC pipes and various plastics.

Overall, contractors "are being severely walloped ­ much worse than consumers," Simonson says. From May 2007 through May 2008, the consumer price index climbed 4.2. Contractors' costs are reflected in the Producers Price Index, which was 8.4 percent during that same time. Simonson does not expect to see price relief over the next 18 months.

"A lot of the items the construction industry uses, like steel and copper, still are in strong demand worldwide," he says. "People normally are  asking whether construction costs will start going down because of the slump in homebuilding. That would be true if you were building with lumber and plywood ­ that material costs less now than at the end of 2003, when the construction prices started soaring. In fact, there's little lumber used in non-residential construction, and none in public works projects like highways and dams."

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