Ten years ago the credit crunch took us all unawares. But is our industry any better equipped today to respond to the deep economic currents that affect our markets?
I have a vivid memory of the start of the financial crisis. In August 2007, on my last day at work before the summer holidays, I met a global contractor refusing to accept commodity price risk - this really was the peak of the construction boom. Later that day, I found an article about the BNP hedge fund closures and read, for the first time, the words “credit crunch”. Like many people I took little notice, went on my holiday and came back to what, in retrospect, was a completely different world.
Over the next month, central banks would pump hundreds of billions of dollars into keeping financial markets afloat and by September, Northern Rock had collapsed.
The truth is that very few people in our industry really understood either how financial systems worked or the conditions of the markets in August 2007. In construction, our focus was on the pipeline of homes, schools, offices and shopping centres that would be delivered using the “wall of money” generated by hedge funds, investment banks and tax receipts.
Unfortunately, that wall of money collapsed after 9 August. However, it took 12 months for the financial crash to really hit construction, after which it finally became obvious that private sector projects were unfundable. Two years later, with government running a deficit equivalent to 11% of GDP, a government spending review hit the public investment programme and the recession really kicked in.
In 2008, construction was blindsided by the downturn. The industry made some predictable but damaging commercial calls
Reflecting on these events 10 years on, would it have been possible to foresee the full extent of the recession and, even if that were possible, would the industry have been able to act on the intelligence? Certainly since 2007, construction markets have continued to be subject to aftershocks from the financial crash and, with levels of debt remaining at close to record highs, there is little sign of a return to normal times. We must remain vigilant. With the Bank of England warning in their latest Financial Stability Report of a “spiral of complacency” relating to growing consumer debt, it would help to have a better understanding of the links between the macro-level of the economy and micro-level demand for construction - for example, the relationship between consumer spending, house purchase and investment in DIY.
The Bank of England’s analysis of the consumer lending boom highlights that the relatively benign way in which the UK economy has evolved since the credit crunch - supported by steady growth and low inflation - has encouraged lenders to become complacent. As a result, while incomes have grown by only 1.5% in the past year, outstanding loans and credit card balances have increased by 10%. It is quite possible that some of the GDP growth that has flattered the UK since Brexit is not sustainable. We need to be alert to these wider changes in the economy.
Perhaps this explains the big surprise to recently updated forecasts published by the Construction Products Association, which included a 0.5% downgrade to the growth projection for 2018, even though there is plenty of backlog demand for housing and infrastructure, and construction is on a five-year winning streak. There is a risk, however, that while we are able to respond to changes that affect our sector directly - movements in house prices, commitments to fund infrastructure, investment decisions by clients - it is much harder to understand how the deep economic currents will affect our markets and our businesses.
So, looking back to look forward, what are the three bellwether issues we should watch for? The first should be asset prices, which have soared in a low interest rate environment. High asset prices simultaneously dampen demand and provide an outlet for increased production costs, creating a long-term competitiveness challenge for the supply side. Under the cover of sky-high asset prices, construction costs have increased far faster than most other UK industry sectors. Looking forward, if asset prices are not sustainable then, as an industry, we also need to be able to deliver construction more cheaply - do we have a plan to do this?
My second issue is the absence of normal interest rates. Low borrowing costs have helped to sustain heavily indebted businesses through very challenging times. But, with construction firms being encouraged to invest in off-site and digital to compensate for low labour productivity, is the industry’s innovation path truly deliverable, or are further step changes in productivity needed to compensate for a higher long-term cost of the investment? The third and final issue is the UK’s ability to sustain investment - including the role that construction plays as an economic stabiliser - sustaining economic capacity during a downturn, for example, by delivering low-cost assets for the public good. It is easy in hindsight to see that a sustained public housebuilding programme in the 2010 to 2012 downturn would have been the right idea but virtually impossible to make the case for visionary investment in the middle of a crisis.
In 2008, construction was blindsided by the downturn. The industry made some predictable but damaging commercial calls on the basis that the recession would be short term and manageable. Now, 10 years on, the lesson from the crash is that we must understand and act on signals coming from the wider economy, reacting decisively where needed. Business planning should reflect the new normal, not the old.
Simon Rawlinson is head of strategic research and insight at Arcadis and a member of the CLC