By Dr. Bernard M. Markstein, president and chief economist of Markstein Advisors
Background on Construction and the Economy
Construction has always played a vital role in the nation’s economy despite some ups and downs. From 1999 through 2015, real (inflation-adjusted) construction investment (both residential and nonresidential) varied from 5.1 percent of real gross domestic product (GDP) in 2010 and 2011 to 9.4 percent of GDP in 1999. In 2015 and 2016, construction investment was 6.2 percent of GDP.
These numbers represent the direct impact of construction investment. However, there are additional benefits from purchases related to, but not directly included in, construction projects, such as equipment for a new factory, furniture for an office or residential property and appliances for commercial and residential units. Further, the workers employed in construction stimulate other parts of the economy as they spend their income. Based on reasonably conservative estimates, these additional purchases add at least 2 to 3 percent to the impact of construction activity on the economy.
The Bureau of Economic Analysis (BEA) produces estimates of the value added by private construction to national and state GDP. The value-added measure excludes the cost of materials used in a construction project, but does include the value of labor employed in construction. Purchased services such as communications, finance and insurance are excluded from this value-added measure, as is the value of the land on which a structure is built (which is also excluded from construction investment in the GDP accounts). Thus the value-added measure is smaller than the number used in the overall GDP accounts and for the ratios cited above.
From 1997 to 2016, the real (inflation-adjusted) value added by the private construction industry as a percentage of real GDP declined nationally from a high of 6.2 percent in 1997 and 1998 to a low of 3.7 percent in 2011. By 2016, the measure had risen to 4 percent, matching the 2009 percentage, and its highest level since 2008 when it was 4.5 percent.
Note the difference between the two measures—the contribution to the economy from construction investment and the more narrowly defined value-added number. The contribution from construction investment to the national economy is, on average, a little more than 50 percent greater than the more restrictive value-added measure of construction. The lower value-added number is used for state GDP to better capture construction-related activity within each state, since building materials and purchased services may originate in other states. For the portion of those items that do come from the same state, their value is assigned to the relevant (non-construction) industry. The value is captured in the state GDP number, but not in the state construction number.
Construction and State Economies
Although the relative impact of the value added by private construction on various state economies varies both among states in a particular year and within a state over time, every state benefits from construction activity. The increase in that activity in a particular year adds to the income and potential growth of each state. A decline in that activity acts as a drag on a state’s economic performance.
An overview of the BEA’s Regional Economic Accounts can be found on page 19 of the BEA guide Measuring the Nation’s Economy
. For a deeper dive into the methodology used in calculating state GDP and the value-added measure, see BEA’s Gross Domestic Product by State Estimation Methodology
2016 Compared to 2015
Real national GDP increased by 1.5 percent between 2015 and 2016. Among the states, 43 experienced an increase and seven experienced a decrease in their state GDP. Washington posted the largest increase, up 3.7 percent. It was followed by Oregon, up 3.3 percent. Florida, Georgia, New Hampshire and Utah were next; each rose by 3 percent.
North Dakota fell the most, down 6.5 percent, a result of the drop in energy prices and the resulting reduction in drilling and fracking activity. Also adversely affected by lower energy prices were Alaska (down 5 percent), Wyoming (down 3.6 percent) and Oklahoma (down 2.3 percent).
Meanwhile, the increase in the value added from private construction rose a more substantial 3.5 percent at the national level. A smaller, but significant, number of states (37) benefited from the rise in private construction activity in their state, while 13 states experienced a reduction in activity. However, the 3.5 percent national increase in real construction spending was a slowdown from the 4.9 percent increase in 2015. Only 18 states had a greater growth in real construction spending in 2016 compared to 2015. The growth rate for one state (Maine) was unchanged from 2015.
Top Five States for Construction Spending in 2016
The real construction spending growth rates do not depend on the size of each state’s economy. Both small states such as Idaho, whose economy ranked 42nd in 2016, and large states such as Florida, which had the fourth largest economy in 2016, had large-percentage increases in their value added from private construction.
However, the fastest growth was in the West and the South. The first state outside of those two regions in the ranking of construction growth rates is Rhode Island with the 16th largest increase (up 4.9 percent).
In 2016, the top five states for the increase in their real value added from construction in order from highest to lowest were:
1. Idaho, up 10.7 percent
2. Georgia and South Carolina (tie), up 9.4 percent
4. Florida, up 9.3 percent
5. Oregon, up 9.1 percent
Idaho had the greatest percentage contribution from construction even though state real GDP advanced a respectable, but more modest, 1.8 percent, 15th largest increase among the states (tied with Michigan). In 2015, the increase in Idaho’s construction spending was 8 percent, which was the sixth largest increase among the states, tied with Utah.
Georgia and South Carolina ranked second. For Georgia, this was down from its number-one ranking in 2015, when construction spending surged 15.1 percent. Georgia’s state GDP rose a solid 3 percent in 2016, the third highest among the states, along with Florida, New Hampshire and Utah.
South Carolina experienced a significant jump in ranking from 2015, up from 17th, with construction spending rising 5.3 percent. South Carolina’s real GDP advanced 2.1 percent in 2016, the same as Arizona and Hawaii, the ninth largest increase among the states.
Florida had the fourth largest increase in real construction spending in 2016, down from second in 2015 (up 11.1 percent). The state is in one of the areas that was engaged in significant overbuilding during the housing bubble and consequently suffered greatly when the bubble burst. From 2007 through 2009, there was a sharp deterioration in private construction spending—down 11.5 percent in 2007, down 22.5 percent in 2008 and down 23.2 percent in 2009. A slight rise in activity occurred in 2010, likely aided by stimulus from the American Recovery and Reinvestment Act (ARRA). That was followed by three years of decline (2011-13). There was finally a sharp rebound in 2014, up 13 percent.
Oregon had the fifth largest percentage increase in real construction spending, a major improvement over 33rd largest increase in 2015 (up 2.2 percent). Oregon’s 3.3 percent growth in state GDP in 2016 made it the second fastest growing state economy in the nation.
Bottom Five States for Construction Spending in 2016
In 2016, the bottom five states for growth—all of which experienced a decline in the real value added from construction from highest to lowest—were:
46. Mississippi, down 2.5 percent
47. West Virginia, down 7.5 percent
48. North Dakota, down 10.5 percent
49. Wyoming, down 11.5 percent
50. Alaska, down 13.2 percent
All of the bottom five states suffered from the effects of low energy prices.
Alaska experienced the largest drop in real private construction spending in 2016, as well as the second largest state GDP decrease in the nation, down 5 percent. The state has struggled over the last few years. In 2013 and 2014, the state’s real GDP fell 4.4 percent and 3.3 percent, respectively. In 2015, state real GDP rose a modest 0.6 percent. Meanwhile, real private construction spending has been down every year starting in 2011 with the exception of 2015 (up 0.2 percent).
Wyoming had the second largest decrease in real private construction spending in 2016. Although the state improved its relative standing—it had the largest decrease in 2015 at 6.6 percent—the 11.5 percent plunge in 2016 was an acceleration of a bad outcome. Meanwhile, the state’s real GDP fell 3.6 percent in 2016.
North Dakota had the third largest decline in its real private construction spending in 2016 and 2015, down 10.5 percent and 4.1 percent, respectively. However, the state’s growth in construction spending ranked in the top 10 from 2008 through 2014. From 2008 through 2012, the state ranked number one in construction spending growth, with growth exceeding 25 percent in 2011 and 2012. Over that same 2008 through 2014 period, North Dakota had the fastest growth in real state GDP every year except two—2009 (third fastest) and 2013 (ninth fastest). The energy boom drove the state’s economy (and construction) over those years and the drop in energy prices dragged the economy down, along with construction activity, in 2015 and 2016.
West Virginia had the fourth largest decline in its real private construction spending in 2016 and 2015, down 7.5 percent and 3.1 percent, respectively. In 2016, the state’s real GDP decreased a relatively moderate 0.9 percent. In 2015, the state eked out a modest gain in real GDP, up 0.4 percent.
Mississippi had the fifth largest decrease in its real construction spending in 2016, down 2.5 percent. Nonetheless, real GDP rose in the state by 0.8 percent. The 2016 decrease represents a slowdown in the decline in construction from 2014 and 2015, when private construction activity fell 8.6 percent and 5.6 percent, respectively. In 2014, the state had the largest drop in construction activity and in 2015, the second largest drop among the states. The deterioration in Mississippi’s energy sector (mainly natural gas) was offset by gains in areas such as manufacturing, retail trade and professional and business services.
View the complete list of 2016 state rankings
Recent Performance of the Economy and Construction
The Great Recession in the United States ended in the third quarter of 2009. From the recession’s trough in the second quarter of 2009 to the second quarter 2017, real (inflation-adjusted) GDP increased 18.6 percent, or an average of 2.2 percent per year at a compound annual growth rate.
This level of growth seems to be the new normal. A relatively strong showing in 2014, up 2.7 percent from the fourth quarter of 2013 to the fourth quarter of 2014, was followed by an acceptable, but notably weaker performance in 2015—up 2 percent from fourth quarter to fourth quarter. That dropped to 1.8 percent from fourth quarter 2015 to fourth quarter 2016.
Recent activity has continued with this type of variation, but with average growth around 2 percent. Real GDP in the first quarter of 2017 rose a disappointing 1.2 percent at an annual rate, followed by a strong rebound to 3.1 percent in the second quarter and 3 percent in the third. That still left growth at 2.3 percent from third quarter 2016 to third quarter 2017. Note that the third quarter 2017 GDP number used for these calculations is preliminary and will be revised over the next few months.
As is normal, real construction spending (residential and nonresidential) on structures, which includes improvements but not maintenance, was even more volatile. Over the same period in 2014 (fourth quarter to fourth quarter), real investment in structures surged 7.5 percent. But in the fourth quarter of 2015, it increased by a moderate 1 percent year-over-year. Further, the quarterly annualized rate of growth in the fourth quarter of 2015 fell 6.4 percent and then surged 8.5 percent in the first quarter of 2016, only to shrink 2.5 percent in the second quarter. Similarly, in the first quarter of 2017, it soared 12.7 percent, then slipped 1.3 percent in the second quarter and dropped 5.6 percent in the third quarter.
Real value added from construction—a more restrictive definition than investment in residential and nonresidential structures as previously noted—has had a different trajectory. Note that the value added from construction is for private construction. Although that captures much of construction—even government projects largely use private construction companies—it does exclude work performed by government construction workers, which may include military personnel and employees, such as the U.S. Army Corps of Engineers. Also, revisions to the value-added numbers lag behind the release of the GDP numbers.
From the fourth quarter of 2013 to the fourth quarter of 2014, real value added from private construction rose 2.4 percent. From the fourth quarter of 2014 to the fourth quarter of 2015, it was up 6.1 percent. And from the fourth quarter of 2015 to the fourth quarter of 2016, it was up 1.2 percent. On a quarterly seasonally adjusted annualized basis, it has ranged from plunging 26 percent in the first quarter of 2009 to shooting up 12.7 percent in the second quarter of 2015.
Real GDP surpassed its pre-recession peak, which occurred in the fourth quarter of 2007, in the third quarter of 2011. Meanwhile, the real construction component of GDP peaked in the first quarter of 2006. Although off its recent trough in the first quarter of 2011, it has yet to surpass its 2006 peak. As of the third quarter of 2017, it was almost 20 percent below its pre-recession peak. Similarly, real value added from private construction spending, although it peaked earlier (first quarter of 2005), was almost 20 percent below its peak as of the second quarter of 2017 (the most recent number available).
Areas of nonresidential construction that did well in 2016 included lodging, office and commercial (mainly retail). Lodging and office also performed well in 2014 and 2015.
Manufacturing construction was largely propelled by investment in energy-related projects in 2014 and 2015. However, with the downturn in the energy sector due to lower prices, investment in that sector began to fall in the second half of 2015 and throughout 2016, pulling down the overall manufacturing construction spending numbers. Concern about the general strength of the economy was an additional drag on the willingness of manufacturers to invest.
Uncertainty about the future of the Affordable Care Act (ACA) and consolidation in the health-care industry has held back investment in health-care facilities for several years. Continued uncertainty surrounds the future and form of the ACA to this day.
Construction spending on educational facilities picked up somewhat in 2015 and 2016 but has slowed to a crawl this year.
Overall inflation has remained subdued, below the Federal Reserve’s target. At the same time, construction materials prices have increased faster than general inflation. Energy prices are above their year-ago levels but remain well below their 2011 to 2014 levels. Natural gas prices, which remain low, have been less volatile and generally increased the least over the last year.
All building materials prices are subject to increases from supply disruptions such as the recent hurricanes. Energy prices are more sensitive to these disturbances than other prices, spiking higher than most other prices in the short run, but then falling back as supply comes back online. Excluding these temporary disruptions, energy prices are likely to remain around their pre-storm levels with a slight upward bias for the next year or so.
Increases in energy and building materials prices will generally be the result of improved economic activity in the United States and abroad. The positives from these increases will outweigh the negative impact from higher input prices for the construction industry as a whole.
Lower energy prices initially slowed investment in exploration and new production for oil and natural gas. This adversely affected equipment suppliers to these industries and investment in other energy-related industries. Now the industry has largely adapted to recent low prices as technology has improved to the point where many projects are now profitable at these price levels, keeping supply up and energy prices down. Investment in these and related companies has stabilized and is showing some growth.
The Consumer and Residential Construction
Lower energy prices have benefited many manufacturers and aided consumers’ budgets. Initially, consumers used the reduced spending on energy to bolster their savings. But consumers have been increasing their spending for a while now—a definite positive for the economy.
Another positive is the steady advance in employment despite some swings in the monthly numbers. For the first half of 2017, nonfarm payroll employment increased an average of 177,000 jobs per month, although more recently that has slowed to an average of around 166,000 jobs per month. Also, compensation for workers has been slowly rising recently. An improving job market also makes it easier for workers to find a higher paying job and moves the unemployed into employment.
These individuals and their families spend more, creating a virtuous cycle. The healthier job market, increased income and implicit greater job security encourages some households to move ahead with plans to purchase their first house or to move to a more expensive one. A small, but increasing percentage of these households will purchase a newly constructed house, bolstering demand for single-family residential construction.
The increase in spending on construction of new residential buildings has been strong for several years as residential construction has recovered from the deep recession after the bursting of the housing bubble. Nonetheless, the still-prevalent fear of owning a home, although diminishing to some extent, and the still relatively tight mortgage lending standards act as a drag on demand for single-family housing. Despite these impediments, housing demand has been growing slowly and the homeownership rate has risen from its recent lows.
On the supply side, many builders have also found it difficult to obtain financing (mostly small builders), have few developed lots to work with and have difficulty finding sufficient skilled labor. All of these factors limit builders’ ability to provide new homes at a price buyers are willing to pay or can afford. Nonetheless, single-family housing construction activity has been and remains strong, although working off a fairly low base, not having fully recovered from the housing recession. Overall, single-family construction is still well below the nation’s long-term, ongoing needs. One positive is that this leaves significant room for growth without creating a new national housing bubble.
Expect single-family construction to continue to increase in 2018. Single-family construction will post healthy percentage gains, but this is still from a relatively low base. Even with this increase, single-family construction will remain below the nation’s long-term needs.
The healthier job market also spurs demand for rental properties as the newly employed and those with increased income move out of shared living arrangements. This, along with normal population growth, will sustain the current level of multifamily construction even as some renters move to homeownership. Rising rents are helping keep the new multifamily projects profitable.
Multifamily construction has returned to a normal level. With the single-family market still in a slow recovery, demand for rental units will stay strong. Expect multifamily construction activity to increase more rapidly in second and third tier cities as construction activity in first tier cities levels off or even declines slightly. Occasional, localized excess supply of multifamily units arise from time to time as several projects come online simultaneously. In those cases, financing for new projects quickly dries up until the excess supply is absorbed and rents begin rising again. Expect multifamily construction activity to be somewhat lower in 2018.
Outlook for Government Infrastructure Projects
Politicians have been talking about the pressing need for investment in U.S. infrastructure for well over a year. Yet little has been done to carry out these promises to meet these needs. Opposition to raising taxes, even for badly needed infrastructure projects, remains strong among politicians, even though several surveys show the public is willing to accept higher taxes for infrastructure projects—particularly highway projects. Public-private partnerships have partially filled the gap. Despite both the president and Congress endorsing large investments in infrastructure, little has happened at the federal level. Until our politicians resolve their differences, little is likely to change.
One of the issues that continues to vex our representatives is providing funding for the Highway Trust Fund (HTF). The HTF is mainly funded by the federal gas tax, which has not been raised in more than 20 years. Occasionally Congress transfers funds to the HTF. Attempts to raise the gas tax have gone nowhere (again despite numerous surveys indicating the public would be willing to accept an increase in that tax if it meant better roads). More fuel-efficient cars have made funding the HTF through this tax more problematic.
Several states have experimented with different ways to raise money for highway construction. Ultimately, these experiments may provide the road map to solving this problem. However, it could be a long time before a solution is reached at the federal level. Recognizing that more funds are unlikely to come from the federal government, many states have devoted more funds to highway projects, though not enough to replace what came from the federal government in the past.
The nation’s infrastructure problems are not confined to highways and bridges but include everything from our power grid to water and sewer systems. Although the private sector can be expected to invest in some of this infrastructure, the outlook for significant government investment in infrastructure is bleak at this point despite major needs for maintenance, repair and upgrade. Total investment in infrastructure is headed down this year and is projected to advance in line with inflation next year.
Risks to the Forecast
The U. S. economy appears to have returned to near-normal levels of output. Employment and consumer spending are solid. There is still room for employment growth. Rising wages will attract some potential workers who have been on the sidelines and encourage employers to hire and train less-skilled workers. The construction industry continues to experience shortages for some skilled workers. However, increases in training programs are starting to pay dividends and will help alleviate some of these shortages over time. Nonetheless, the industry faces the challenge of losing a large number of older, skilled workers to retirement.
Expect the economy to move forward at its now familiar slow, but steady, pace. Nonetheless, as always, there are risks to the economic outlook. Here are the major risks to this somewhat positive economic forecast.
⦁ It is uncertain where United States trade policy is headed. Aside from withdrawing from the Trans-Pacific Partnership (TPP), which was doomed to failure regardless of who was elected president, to date little has changed in U.S. trade policy. However, any major increase in tariffs or raising of other barriers (e.g., import quotas) would slow trade, increase inflation and lead to slower growth. The construction industry in particular would feel the brunt of such actions. Abandonment of the North Atlantic Free Trade Agreement (NAFTA), which seems increasingly likely, will create major problems for several manufacturers in the U.S. as well as in Canada and Mexico, with auto producers likely to be hurt the most.
⦁ Energy prices, as always, can move sharply in either direction over a short period of time, causing disruptions in the economy. At this point, as noted above, an upward drift in prices is more likely, but volatility remains a constant threat as the impact of Hurricane Harvey demonstrated.
⦁ Brexit remains a major unknown. So far it has not had a large effect on the U.S. or world economies outside the United Kingdom. Now that the U.K. has started the Brexit process, some of the effects are appearing. So far, they have been minor, mainly confined to England and, to a small extent, the European Union. The major effects of Brexit are likely to play out over the next two years. If the effects remain largely confined to the U.K. and the EU, then there will only be minor fallout for the U.S. economy.
⦁ The Federal Reserve is expected to raise interest rates once more by year-end. Given that the markets anticipate this move, the impact on financial markets and economic activity is likely to be minor. If the economy continues to show strength, expect to see three to four more quarter point increases in the target federal funds rate next year. However, should the Fed increase rates rapidly over a relatively short period of time, as opposed to its current indication of slow, limited increases, the economy would be severely negatively affected. The probability of this outcome is low but with the administration still to fill several positions on the Federal Reserve Board of Governors, it is a clear risk.
Even facing these risks, the U.S. economy is likely to turn in an acceptable performance in 2018. The economy’s resiliency should never be underestimated, although the possibility of a large, negative shock from one of these risks or another unanticipated event could push the nation’s economy into recession with negative fallout for the construction industry. At this point, the likely result is that both the economy and the construction industry will advance at a reasonable, though not spectacular, rate next year.