Economists discuss state of construction sector

There is no time like the beginning of a new year for looking ahead to forecast where we’re heading. At the outset of 2020, questions abound regarding a possible recession, political uncertainty and ongoing trade wars. But despite some potential headwinds on the horizon, the construction sector is still riding the wave of heavy demand.

To understand where the construction sector is trending, Construction & Demolition Recycling reached out to Associated Builders and Contractors (ABC) Chief Economist Anirban Basu and Associated General Contractors of America (AGC) Chief Economist Ken Simonson to get their predictions on what to expect in the year to come.

A look back

To understand where the construction industry is heading, it helps to look back on how things played out in 2019. Basu says some of the most notable shifts in the construction sector were a weakening private nonresidential sector and a strengthening public nonresidential sector.

“For several years, private nonresidential construction spending outpaced the rate of growth observed in the public sector, yet that changed in 2019,” Basu says. “As of October 2019, public nonresidential spending was up 10.4 percent year over year, while private nonresidential spending contracted 4.3 percent. Private sector weakness is largely attributable to a 16.3 percent year-over-year decrease in the commercial category. The approximately $16 billion decline in that category accounted for 82.4 percent of the decline in private spending from October 2018 to October 2019.

“Public sector growth has been fueled by rapid growth in the educational category and in infrastructure-related categories such as highway and street, transportation, sewage and waste disposal and water supply. ABC’s Construction Backlog Indicator for September 2019 showed 11.8 months of backlog for contractors in the infrastructure category, the highest reading of any segment. The increased levels of infrastructure spending stand out as one of the most significant stories of 2019.”

Simonson points to three major turnaround stories witnessed in 2019 that help paint the picture of the current state of affairs in construction.

“Single-family homebuilding tailed off sharply from early 2018 until mid-2019, then began a pickup that should carry over into 2020 thanks to the sharp decline in mortgage interest rates in the fall of 2019,” he says. “Public construction spending accelerated across both infrastructure and building categories, and though the outsized gains in early 2019 faded later in the year, public spending should be at least modestly higher again in 2020. Retail construction spending, which increased 5 percent from 2017 to 2018, collapsed in 2019 and is likely to fall still lower in 2020 in light of all-time-high store closings.”

Demand

One indisputable positive trend in the construction space is the backlog of work contractors are reporting. This portends that demand will keep companies busy in 2020.

Basu says that despite some concerning indicators surrounding employment trends and private nonresidential spending, work backlog remains lengthy for most. He points to ABC’s Construction Backlog Indicator, which showed that the average contractor had nearly nine months of overall backlog in September 2019. This was roughly the same level observed throughout the third and fourth quarters of 2018 when the industry was enjoying record growth.

Simonson agrees that while backlogs remain strong, there are other question marks surrounding employment that have contractors concerned.

“Contractors almost universally report that they are busy with backlogs that have not softened,” he says. “Based on their statements and the record number of job openings, it appears contractors expect to stay busy; their major worry is finding enough workers, not finding enough work to pay them.”

Simonson continues that although both Bureau of Labor Statistics (BLS) data on construction employment and Census Bureau figures on construction have indicated a substantial slowing in hiring and spending since early in 2019, the likelihood is that most firms may have trouble filling openings that come available.

“The worker shortage may become even more acute now that the overall unemployment rate is at a 50-year low and many industries are competing for workers,” he says.

Similarly, Basu points to ABC’s September Construction Confidence Index that showed more than 60 percent of contractors intended to increase their staffing levels during the following six months as an indicator of an ongoing hiring crunch.

“This [desire to hire] comes at a time when the U.S. construction industry reports unprecedented levels of job openings and industry unemployment hovers near an all-time low. Given healthy levels of backlog and relatively robust levels of spending, we do not anticipate the worker shortage lessening in 2020—quite the opposite,” Basu says.

Infrastructure

Although the much-discussed federal infrastructure package that was a key talking point in the first half of President Trump’s term has seemingly been put on the backburner, infrastructure spending has remained strong spurred by local and state investments.

“One of the sources of strength for the U.S. economy over the last year was the pickup in infrastructure spending,” Basu says. “While the federal government has yet to fashion a full-fledged infrastructure plan for the nation and the Highway Trust Fund is set for insolvency by 2021 absent congressional action, infrastructure-related outlays remain a good news story. So far, it has been state and local governments that have come to the rescue, supported by rising collections of income, sales and property taxes.”

He says these investments have been especially beneficial for the water/sewer, transportation, and highway and street construction segments.

Simonson says this state-specific infrastructure spending should carry over throughout the new year, particularly as it pertains to road construction.

“With 33 states having increased highway funding in the past seven years, those revenues are now growing by enough to support a significant pickup in highway construction,” he says. “In addition, there is more construction of toll roads, bridges and tunnels than there was previously. These trends should continue through 2020. Airport construction also increased sharply in recent years but may have plateaued, although it should remain at a high level. Major mass transit overhauls or expansions are underway in several metro areas. Sewer and drinking water investment have rebounded from a long collapse but are likely to increase only modestly in 2020.”

Political uncertainty

It has been said that “business likes certainty,” but questions and uncertainty in the legislative and political realm will likely abound throughout 2020 due to today’s unsteady climate.

According to Basu and Simonson, some of this uncertainty, specifically around tariffs, has begun to affect the construction sector.

“The major effect of the trade wars and tariffs has been heightened levels of uncertainty,” Basu says. “There are warning signs that this has begun to affect private construction segments. As 2020 progresses, keep a close eye on private construction spending levels and backlog. These could represent an emerging source of weakness as trade disputes persist and uncertainty mounts.”

“Some contractors were hit directly by the imposition of steep tariffs on steel and aluminum,” Simonson says. “Those were one-time impacts, that for many companies, have now reversed as a cooling U.S. and global economy has brought down many commodity prices. The real damage to construction is in projects that may have been canceled, postponed or scaled back as manufacturers, logistics and transportation companies, and ports experience higher costs on imports and retaliation for U.S. tariffs.”

Basu says that from a policymaking perspective, a lot is on the line with the upcoming 2020 presidential election regarding the future of health insurance, defense contracting, trade relations with China and other partners, taxes and regulation. He notes this uncertainty could lead to a pause in both household and government spending.

“For households, [the election could] translate into uncertainty regarding federal taxes, state and local tax deductions, incentives to purchase electric vehicles, social assistance, payments to farmers, etc.,” Basu says. “Even state and local government policymakers face growing uncertainty regarding future federal spending on infrastructure and social programs like Medicaid.”

He says that this heightened level of uncertainty could result in a “wait-and-see” approach being adopted by households, businesses and governments, which would further halt economic activity amid the already-slowing global economy. Still, Basu says an “inverted yield curve and other indicators have been flashing yellow for months even as the U.S. labor market performs brilliantly.”

Simonson says that while every election affects the construction industry differently, the fate of infrastructure spending could ultimately rest in whether or not there is one-party control of the White House and both houses of Congress. If not, he says federal funding for highways and other infrastructure projects could be tied up in disputes over party lines for years.

About that recession

Since the Great Recession, the United States has enjoyed a longer-than-normal period of growth. While this has caused some to speculate on whether a pending recession is inevitable in the near future, Basu and Simonson say the evidence doesn’t necessarily point in that direction for 2020. “I don’t try to model the economy myself, but I pay attention to surveys such as the Outlook Survey of 53 professional forecasters that the National Association for Business Economics released on Dec. 9, 2019,” Simonson says. “None of those respondents forecasted a recession in 2020, though the median forecast is for slower growth than in 2019 (which was expected to be slower than in 2018). I agree, although I expect single-family homebuilding and home sales to provide a boost to the economy.”

Basu says that as the economy enjoys reasonably healthy momentum leading into 2020, he too sees a slowdown on the horizon.

“We expect economic growth to slow as 2020 progresses and as elections approach,” Basu concludes.

Nothing is certain when it comes to predicting the future, but being able to read the tea leaves on where the construction industry is heading can help contractors ready themselves and their businesses for what’s next.

This article originally appeared in the January/February issue of Construction & Demolition Recycling magazine. The author is the editor for Construction & Demolition Recycling magazine and can be contacted at aredling@gie.net.