The Economics of the Modern Construction Sector Also by Stephen L. Gruneberg and Graham J. Ive THE ECONOMICS OF THE MODERN CONSTRUCTION FIRM Also by Stephen L. Gruneberg CONSTRUCTION ECONOMICS: An Introduction FEASIBILITY STUDIES IN CONSTRUCTION (with David H. Weight) RESPONDING TO LATHAM: The Views of the Construction Team (editor) The Economics of the Modern Construction Sector Graham J. Ive Senior Lecturer Bartlett School University College London and Stephen L. Gruneberg Lecturer Bartlett School University College London © Graham J. Ive and Stephen L. Gruneberg 2000 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, London W1P 0LP. Any person who does any unauthorised act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The authors have asserted their rights to be identified as the authors of this work in accordance with the Copyright, Designs and Patents Act 1988. First published 2000 by MACMILLAN PRESS LTD Houndmills, Basingstoke, Hampshire RG21 6XS and London Companies and representatives throughout the world ISBN 978-0-333-62662-7 ISBN 978-0-230-51091-3 (eBook) DOI 10.1057/9780230510913 A catalogue record for this book is available from the British Library. This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. 10 09 9 08 8 07 7 06 6 05 5 04 4 03 3 02 2 01 1 00 To Rose and Jan Contents List of Figures xi List of Tables xiii xv Preface xviii List of Abbreviations 1 Introduction PART I 1 2 PRODUCTION Construction and value added Introduction Defining the construction sector of production Is the construction sector really several different industries? Factors of production The structure of value added in the production of the built environment Input–output analysis and the value added by the construction sector. Gross and net profit Concluding remarks Appendix: Standard Industrial Classification, 1992 The capitalist construction industry labour market Introduction The technological and social relations of production Labour markets The supply and demand for labour Inefficient labour markets and non-clearing labour markets The dual labour market Construction labour The role of collective bargaining in construction Supply and demand in labour markets – a theory of construction wages and employment Formal and real subsumption of labour by capital vii 3 3 4 11 13 16 19 23 23 25 29 29 30 32 33 39 42 44 47 51 55 viii Contents 3 The use of labour in the construction industry Structure of the construction labour force Concluding remarks 56 58 59 Productivity and the production of profits Introduction Productivity Average net productivity Alternative estimates of level and rate of change of construction productivity Rate of increase in productivity: alternative estimates Marginal productivity theory The production function The production of profit Unit labour costs and labour and profit shares in output Division of labour in the construction industry Concluding remarks 61 61 61 65 PART II 4 66 68 71 73 74 75 76 78 ACCOUNTING FOR PRODUCTION AND ASSETS The logic of accounts Introduction The structure of national accounts The logic of national accounts statistics Income National income and the standard of living or economic welfare Output Domestic and national product ‘Output’ from real estate Accuracy and reliability of the components of the National Accounts Expenditure The structure of company accounts The production account The appropriation account The capital account The financial account National accounts again – the composition of national income National and expenditure in the corporate sector Stocks and flows of the construction industry Concluding remarks 81 81 81 85 87 90 91 92 92 95 95 96 97 98 100 101 104 105 108 111 Contents ix 5 6 Value of stock and flows of built capital at national level Introduction The valuation of property and real estate The capital stock in the National Accounts Types of fixed capital stock The valuation of fixed capital in the National Accounts Stocks of capital and flows of investment Retirements of built stock, life-spans and replacement demand Concluding remarks 113 113 113 115 118 121 123 Ownership of and investment in built stock and land Introduction The book value of assets Devalorisation Schumpeterian innovation, super-profits and revalorisation Techniques of valuation of buildings Payback period Life cycle investment appraisal models Discounting The creation of money and credit by financial institutions Landowners and capitalists in the development process Concluding remarks 129 129 129 132 PART III 126 128 134 136 137 138 139 141 141 145 THE NATURE OF THE CONSTRUCTION PROCESS 7 Actors and roles Introduction The nature of construction as a process The nature of team-working in construction Systems and their main types of actor Speculative builders and contractors Construction as a manufacturing process Other roles in the process Projects and firms Portfolio risk management costs Concluding remarks 149 149 149 150 164 166 167 167 171 176 179 8 The contracting system Introduction Fragmentation and innovation in the development process 180 180 180 x Contents The contracting system Concluding remarks Part IV 188 190 Construction and the Economy 9 Construction investment, the multiplier and the accelerator Introduction Aggregate construction demand The multiplier The accelerator Change-induced demand for buildings and works Concluding remarks 195 195 197 206 209 217 218 10 Business cycles and construction Introduction A profit-led model of private sector investment demand and of business cycles Cycles Trend and cycle Business cycles The 9-stage business cycle: a method of description of business cycles Measurement of construction demand GDP and aggregate construction demand Product cycles and the trend rate of change in aggregate construction demand Economic development and the trend in construction demand Building cycles Price fluctuations Concluding remarks 222 222 Bibliography 260 Index 269 222 226 227 229 230 237 245 250 254 255 256 258 List of Figures 1.1 2.1 2.2 2.3 3.1 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 6.1 6.2 7.1 7.2 7.3 7.4 9.1 10.1 10.2 10.3 Main sectors of production and service contributing to building production Derived demand for labour and the demand for construction (orders) Substitution effect: labour and capital Diagram of the unstable cobweb effect Manual labour and construction output, 1983–97 The logic of national and company accounting systems Time series of national income per capita, at constant factor cost Time series of GDP in current money and constant value or ‘volume’ terms, both at market prices Profit and loss account Balance sheet Cash flow statement Stock flow relationships in a world without qualitative economic change: the gross built capital stock Stock flow relationships in a world with no qualitative economic change: the net built capital stock Diagram showing consumers’ surplus, ABC Diagram showing simplified producers’ surplus and the effects on costs of product and process innovation Partially integrated construction systems Percentage distribution of firms of main contractors, by number of employees, and number and value of industrial new work contracts (payment), 1997 Contractors’ new orders, by duration and number, 1997 Contractors’ new orders, by duration and value, 1997 Effect of increase of investment on national income and savings Total net construction component of GDFCF, 1981–91, expenditure-based measures of construction demand Contractors’ orders at market prices, 1987–97 Orders and output series compared, 1957–93 xi 11 36 37 41 64 84 91 93 98 101 102 108 110 135 136 160 173 175 176 207 240 241 242 xii List of Figures 10.4 10.5 10.6 10.7 10.8 10.9 10.10 10.11 10.12 10.13 10.14 10.15 10.16 10.17 10.18 Orders lagged by one year and contractors’ output, 1987–97 Contractors’ output, 1983–97, output-based measures of construction demand New build and repair and maintenance output, 1955–97 Linear trends of contractors’ output, 1955–93 New build and repair and maintenance output, 1955–68 New build and repair and maintenance output, 1969–93 Construction output and GDP, 1971–93 Transformed construction output and GDP, 1971–93 Linear trend of construction output and GDP, 1971–93 Construction as a percentage of GDP Contractors’ output (new build), 1955–93 Contractors’ output (repair and maintenance), 1955–93 Construction output price indices, 1983–97 Price indices of construction materials, 1987–97 Smoothed tender price index for all public sector non-housebuilding contracts, 1987–97 243 244 246 246 247 248 249 249 251 251 252 253 257 258 259 List of Tables 1.1 1.2 1.3 1.4 1.A 2.1 2.2 2.3 2.4 3.1 3.2 3.3 3.4 4.1 4.2 4.3 5.1 5.2 7.1 7.2 7.3a Final demand products and sectors by activities Estimate of people engaged directly and indirectly in the production of the built environment, 1993 Value added by industry, 1939 and 1997, at current prices Value added at current basic price, by industry, 1989 and 1997 Summary of SIC 92 definition of construction and related activities Full-time male manual workers’ earnings and hours in construction and in all industries and services Full-time male non-manual workers’ earnings and hours in construction and in all industries and services (adult rates, not affected by absence) Full-time male manual and non-manual workers’ earnings and hours in construction Operatives, by craft, 1981 and 1989 Productivity index, 1975 and 1980 Level of productivity; alternative estimates, 1995 Rate of increase in productivity: method 1, 1989–97 Rate of increase in productivity: method 2, 1989–97 National income, at current factor cost, 1983–93 National Accounts, 1992, by type of income and sector of employment Financial balance of the corporate sector, 1992 Net capital stock, by sector and type of asset at current replacement cost, 1992 Percentage of fixed assets, 1982 and 1992 at current replacement cost Project types and functions of participants in the property development process The roles of participants in the process of providing the built environment Actors and roles in a private new housing project, suburban England, 1980s xiii 6 12 17 21 25 50 51 52 59 66 68 69 70 94 104 106 125 126 151 154 156 xiv List of Tables 7.3b 7.4 7.5 9.1 9.2 9.3 9.4 10.1 Actors and transactions in a private new housing project, suburban England, 1980s Actors and roles in a typical new public housing project, Inner London, 1950s/1960s Actors and roles in typical new office project, City of London, 1980s Investment in fixed and circulating capital at current market prices, 1985–94, £m Total investment and its composition, by industrial sector, at current market prices 1985–96, £m Simple model of accelerator effect Accelerator model ignoring time lags, expectations and spare capacity Schematic illustration of trend, differences and cycle relatives 158 161 162 199 200 214 216 232 Preface The Economics of the Modern Construction Sector is the companion volume of The Economics of the Modern Construction Firm, and in many ways The Economics of the Modern Construction Sector sets the context for an understanding of the operation of firms within the construction production process. As economists our particular interest is focused on the production processes of industrial activity. We are also concerned with the economic and social environment with which firms interact. This environment is comprised of the economy as a whole, its construction and other industrial sectors, government and consumers. It is also determined by the resources available for the production of particular outputs. These are the labour, materials, both natural and manufactured components, and the plant and equipment used. In turn the productivity of these resources depends on the state of technology and the methods of production adopted. Finally the behaviour of firms in the construction sector is also to a large extent determined by the behaviour of the other firms in the construction sector itself. We are therefore interested in understanding the economic roles and relationships within the construction process, in that we wish to understand how and why production takes place. We also wish to know who benefits from the system of production and how these benefits are distributed. The general economic issues raised up to this point could be applied to any industry or sector of the economy, and discussion of these and other topics can be found in all introductory economics texts. However, if the general textbook approach to economics is applied to construction several features of the construction process intervene to invalidate the conclusions. The result can be a frustration with economic theory and ultimately a rejection of economics on the grounds that it is neither realistic nor practical. In this book we attempt to provide a realistic theoretical economic framework for understanding the construction sector in particular, in a particular country, the UK, and at a particular phase of its development, at the end of the twentieth century. What may be true of the construction sector here and today, does not necessarily apply to the construction sector somewhere else and in another period. Armed with this approach, it should be possible to discuss policies related to construction and account for the behaviour of firms within the construction xv xvi Preface sector. Nevertheless, the methods of analysis and the general approach to the economic issues of the construction sector in this book should be a useful starting point for the analysis of any construction sector or construction firm working anywhere in the world. This book therefore provides the necessary background for firms operating in construction and together with the The Economics of the Modern Construction Firm, it is hoped that The Economics of the Modern Construction Sector will enable firms to improve their decision making, strategic thinking and planning effort. The four parts of The Economics of the Modern Construction Sector are entitled Production, Accounting for Production and Assets, The Nature of the Construction Process, and finally, Construction and the Economy. In the first chapter we begin by defining the production of the built environment and then move on to examine the process of adding value to inputs. The value added approach highlights the source of wages and profits. In Chapter 2 the industrial relationship between construction labour and capital is used to show the subsumption of construction labour by capital. In Chapter 3 the argument is developed to show how labour is used to raise productivity and produce profits. In Part II, we are concerned with a meaningful statistical analysis of the data surrounding construction. We show how data is used to analyse the national income, the construction industry and firms within construction. By describing the logic of accounting systems at all levels, it is possible to draw conclusions and gain insights into the operations of firms involved in the production of the built environment. The framework of all accounts is based on stocks and flows and we use this approach to understand construction in Chapter 5. Chapter 6 provides an analysis of the distribution and ownership of the property assets produced by the construction sector in the form of buildings and land. Part III describes and accounts for the economic roles of the various participants in the construction process. These roles combine in different ways depending on the nature of the project and the type of client. The complexity of the production process in construction is explained further in Chapter 8 on contracting systems. Moreover, many of the conflicts within construction between constructors and their employers can be seen in the fragmentation of the production process described in Chapter 8. In the fourth and final part of this book, we deal with the wider issues of construction and its relationship to the rest of the economy. Preface xvii In Chapter 9 we look at the economic concepts of the multiplier and the accelerator in relation to construction and construction firms. Chapter 10 deals with economic cycles and the construction sector and discusses the business cycle and the causes and effects of variations in demand on construction. Very few books can claim to be the final word on their subject, and The Economics of the Modern Construction Sector is no exception. Instead we want the reader to find the contents stimulating and thought provoking. One of the aims of this book is to act as an aid to further research. We hope therefore that many of the questions raised by the book will stimulate research into the economic processes involved in the field of construction economics. GRAHAM J. IVE STEPHEN L. GRUNEBERG List of Abbreviations ACE APTC BS CAD/CAM CFR CIBSE CIC CIRIA COP DETR DLO DOE EMS ENR EU FAME GCS GDFCF GDP GFCF GOP HA HCS ICE ICOR ISIC IT JCT LA LFS LOSC MBO MES Advanced capitalist economy Administrative, Professional, Technical, and Clerical Building Society Computer aided design and computer aided management Construction Forecasting and Research Chartered Institute of Building Services Engineers Construction Industry Council Construction Industry Research and Information Association Census of Production Department of Environment, Transport and the Regions Direct Labour Organisations Department of the Environment European Monetary System Engineering News Record European Union Financial Analysis Made Easy Gross Capital Stock Gross Domestic Fixed Capital Formation Gross Domestic Product Gross Fixed Capital Formation Gross operating profit Housing Association Housing and Construction Statistics Institution of Civil Engineers Incremental Capital Output Ratio International Standard Industrial Classification Information technology Joint Contracts Tribunal Local Authority Labour Force Survey Labour only sub-contractor Management-buy-out Minimum efficient scale xviii List of Abbreviations xix NACE (Rev1) NBER NEDO NFCF NOP NPV NWRA ONS O–O PBR PFI R&M RIBA ROCE RPI SET SIC SPC SSE SSHP SSOCP SSP TGWU UCATT VIBO WES The General Industrial Classification of Economic Activities National Bureau of Economic Research National Economic Development Office Net Fixed Capital Formation Net operating profit Net Present Value National Working Rules Agreement Office for National Statistics Owner-occupier Payment by results Private Finance Initiative Repair and maintenance Royal Institute of British Architects Return on Capital Employed Retail Price Index Selective Employment Tax The Standard Industrial Classification Special Purpose Company Social structure of the economy Social structure of housing provision Social systems of organisation of the construction process Social structure of production or provision Transport and General Workers Union Union of Construction Trades and Allied Technicians Vertically Integrated Building Owner Work to existing structures Introduction An explanation by way of introduction: the value of realism and the realism of value in economics. The search for a theory of value in economics is for a ‘unifying grand theory’ capable, in principle, of explaining the totality of economic phenomena – a search for a common unit of measurement, to be sure, but beyond that, the underlying sufficient cause of values, in the plural (i.e. prices of this and that), and the force capable of yielding a determinate set of economic outcomes from certain non-economic givens – in short, the idea that both back economics’ claims to be a science, by giving it a unifying object of study and a method, and at the same time lays it open to accusations of being no more nor less than metaphysics. For value is abstract, and not directly visible. The great arguments in the history of economics have been arguments between theories of value (Cole et al., 1991; Varoufakis, 1998). Following Cole et al. (and many others) we can call these contending theories of value the ‘subjective preference’, ‘cost-of-production’ and ‘abstract labour’ theories. Of these, the academically dominant school of thought, throughout the last century, has been based on the ‘subjective preference’ theory of value: rational, calculating, self-interested choice between given alternatives. Economic debate has got lively and deep whenever this dominance has come under challenge – and ‘economics’ has stagnated into an orthodox body of doctrine whenever that challenge has faded. To be clear: we believe, along with an increasing number of other economists critical of the orthodoxy, that economics took a profound ‘wrong turn’ when it tied itself, as a ‘reputable science’, to the subjective preference theory of value in what is known as its ‘neo-classical’ form. We believe that this mistake has led both to bad theory and a wrong agenda for xxi xxii Introduction economics – and explains especially the difficulties which arise when it is attempted to apply economic theory to the interpretation (we will not say, explanation) of the ‘real world’ of modern industry. Nor, in our view, is it simply a matter of the ‘wrong’ theory of value having been chosen, whereas the ‘right’ choice would have solved all problems. Rather, one source of the difficulty for a practical economics lies in the drive, perhaps innate in all value-theories, towards an excess of abstraction, at too great a price in terms of realism and relevance. However, statements such as those made in the previous paragraph open up such a range of arguments and issues between economists, and moreover arguments necessarily conducted in languages more or less impenetrable to non-economists, that it is certainly not our intention to develop systematically those statements or claims in the work that follows, in the sense of conducting an ‘argument’ or critique of orthodoxy – for to do so would exclude the possibility of this being a work of utility to students and practitioners in the production of the built environment. Instead, we hope the work will speak for itself, at least in respect of the range of issues our approach enables us to cover, the analytical methods we propose and the agenda of questions (for research and otherwise) which we raise. We do, however, think it both useful and necessary to give ‘fair warning’, especially to readers who have a knowledge of orthodox neo-classical economics – for such readers will not find in what follows much of what they will expect, and will find much that they will not expect. We believe that our approach, as exemplified in the chapters that follow, is sufficiently consistent and straightforward as to be reasonably clear in its application to economists and non-economists alike. However, we also feel we owe a duty to both kinds of reader to explain in this introduction just what kind of economists we are – that is, what position we take in the fundamental debates that divide economists today. The approach of many economists when they come to write ‘practical’ works on the economics of a particular sector or industry, is to start with received value theory, expound a version (to a greater or lesser degree simplified) of that theory, and then to give ‘examples’ of its application by nominally substituting apparently recognisable phenomena of that industry into the purely formal categories of that theory. An instance would be a discussion of market price for a commodity in terms of the thought-experiment that demonstrates the possibility of a set of pre-reconciled independent choices made by possessors of given productive endowments and given consumption tastes (each with perfect knowledge, and all acting in ‘analytic’ time to Introduction xxiii explore all hypothetical options fully before making actual choices) leading to an equilibrium of demand and supply; moves on to describe this imagined market as one of ‘perfect competition’; and then discusses how the idea of perfect competition can be used, to some extent or other, to describe and illuminate actual markets for grain, or fish, or stocks and shares. Our approach, by contrast, is to start by making a model of the actual processes by which economic actors arrive at their decisions – in terms which we hope will be recognised by practitioners as capturing certain (inevitably, not all) interesting or significant aspects of that process. We are in a position, since we are concerned here only with the construction industry, to develop and to prefer ‘local’ or special to general theory – to adapt our models to capture local circumstances, even at the cost of loss of ability to generalise about the economy at large. This we are happy to do. The substantive content of our theory is to an extent eclectic, formed by taking and melding together, magpie-like, whatever catches our interest from a diverse range of sources. However, just as magpies prefer that which glitters from the array open to them, so we prefer that which looks to us more ‘realistic’. Our approach often involves simply relaxing the stays of a pre-existing theoretical corset, by introducing some added degrees of realism. All of this courts the danger of over-compensating, to the extent that any and all classificatory or descriptive coherence is lost – the point where each instance becomes unique. Naturally, we hope that our readers will agree with us that we have not gone so far as that. One powerful inspiration for us, in our quest for a sufficient, minimal consistency and theoretical coherence, has been the approach to the treatment of time, uncertainty, surprise, the past and the future. Time, throughout what follows, is we hope almost always perspective not analytic time. In perspective time, decisions are made sequentially, not simultaneously, and are made using the exercise of economic imagination about possible futures – that is, under real uncertainty, where what is envisioned ex ante often differs from what is realised ex post. In this, like other economists of construction (Hillebrandt, 1985; Bon, 1989) we have been inspired by the writings of G.L.S. Shackle and other ‘Austrian’ economists – even where we disagree sharply with the political economy of much of Austrian economics. It is to Shackle, however, that we owe a particular debt – and Shackle was both an ‘Austrian’ and a post-Keynesian. The post-Keynesian economists are, of course, best known for their macroeconomics – and for insisting upon the profound theoretical xxiv Introduction implications of Keynes’ critique of macroeconomic orthodoxy, and thus resisting the absorption of the Keynesian legacy into a slightly modified orthodoxy – the so-called Keynesian neo-classical synthesis. However, there is also a very distinctive and coherent post-Keynesian microeconomics, and this has often provided us with at least a starting point or point of reference. We are also indebted to those economists who have sought to fuse elements of Keynesian and Marxian economics – the tradition beginning with Kalecki and Robinson, and carried on today by, inter alia, such inspirations for parts of our work as Bowles, Weisskopf and Marglin. Nearly twenty years ago, a book appeared whose publication in our view (and that of many) deserves to be seen as seminal to the development of a truly modern, non-orthodox economics – Nelson and Winter’s An Evolutionary Theory of Economic Change (1982). The ‘Introduction’ to that work contains an argument about the nature of the malaise afflicting orthodox microeconomic theory (what is known to economists as general equilibrium theory), and directions for its remedy, with which we wholly agree. Indeed we could wish, if academic convention and copyright law did not forbid us, to reproduce it more or less entire as our own introduction to the present work. Among the very many indications therein for positive directions for a new microeconomics let us cite at least the following: (1) theory must seek to comprehend, in stylised settings, the unfolding of economic events over (perspective) time; we must escape from the grasp of a purely ‘analytic’ time, that is really no time at all. (2) firms are motivated by profit, seek it and search for ways to increase it, but ‘firms’ actions will not be assumed to be profit-maximising over well-defined and exogenously given choice sets’ (p. 4). (3) analysis should not focus on hypothetical states of industry equilibrium, in which all unprofitable firms have left the industry and the profitable ones are at their desired size. (4) firms learn; at any given time a firm has limited capabilities, and habitually uses certain decision-rules: ‘Over time these … are modified as a result of both deliberate problem solving efforts and random events.’ Meanwhile, orthodoxy itself has been invaded by the practitioners of the so-called ‘new institutional economics’, an economics of incomplete information, bounded rationality, complex organisations and Introduction xxv transaction and organisational costs. This we welcome, and use happily where the only developed alternative is the old orthodoxy – while recognising that it too is suffering the fate of Keynesian economics – to be re-absorbed, in somewhat travestied form, into a revised orthodoxy. This, then, is the kind of economics, and the approach to the use of economics to study industry and business, that a reader will find exemplified in what follows. We hope you, the reader, will find it yields both light and fruit.