Some background
Building and construction activity only accounted for less than 6% of SA’s national output and less than 4% of GDP in 2017. It is therefore a small sector; however, its impact on the economy is of critical importance as it is a fixed investment sector, i.e. an important component of SA’s fixed investment effort. Its impact is particularly important on the business cycle of the country. On the one hand, building starts or completions represent a key leading indicator of economic activity. In fact, should one consider the full building value chain, then the activity of architects and quantity surveyors (classified as business services) act as leading indicators of what is happening in the building sector, i.e. both residential and non-residential. Building plans passed typically leads the cycle in building starts by 12-18 months and building starts typically lead the overall business cycle by … months. Apart from the building industry, the construction industry – or civil engineering sector – accounts for the remainder of the overall building and construction sector. Its activity levels are mainly driven by public sector infrastructure investment (i.e. the national, provincial and municipal building of roads, dams, schools, hospitals & clinics, town development reticulation infrastructure, etc.) as well as mainly mining infrastructure developments in the private sector. The construction sector tends to lag the general business cycle (see below).
Building & construction backward linkages in the wider economy
The chart below is informative of the backward linkages the sector has in the SA economy. According to the chart, the sector acquired 38% (or more than R200 billion) of its inputs from the local manufacturing sector in 2017. Within the manufacturing sector, building materials (or non-metal mineral manufacturing) suppliers and metal manufacturers are key input sectors. The sector’s intermediate imports are virtually zero. The other important sectors supplying the construction sector are internal trade (11%), financial & business services (9%) and transport & communication (5.4%) and mining (3.4%). These intermediate inputs are combined with labour and capital, generating GDP of R165 billion, or 30.6% of total inputs (being the wages, profit and net taxes generated in production) in order to produce total output of R540 billion. The output/GDP ratio is therefore 3.3 which means that for every unit of GDP generated in the sector, additional activity of 2.3 units are stimulated in backwardly linked sectors. While this ratio is not as high as in the (higher productivity) manufacturing sector, its pivotal role in the fixed investment cycle makes it a very important sector in the economy. Generally, fixed investment spending is a key driver of the business cycle of any country and within fixed investment the investment in buildings and construction is key. A robust business cycle is typically associated with a strong building and construction cycle and vice versa.
The building & construction cycle
The focus in the current section is on the cyclical aspects of building & construction activity in SA. Whereas the sector experienced its ups and down during the 1970s and 1980s – and also the 1990s – it is clear from the above chart how activity almost exploded during the 2000s. The flat trajectory of the construction cycle during the 1980s and 1990s is explained by an equally flat overall fixed investment cycle. Whereas machinery and transport equipment investment took off following the 1994 political transition, the construction sector revival lagged due to tight fiscal policies as the authorities strived to bring SA’s fiscal matters in order. This left little room for expenditure on public sector infrastructure investment. However, as soon as the new government was able to register budget surpluses (and a much reduced debt service liability), funds were release for infrastructure development from around 2001/02. To top this explosive cycle was the infrastructure investment tied to the Fifa Soccer World Cup in 2010. In fact, this spending ensured that the construction sector by-passed the deep 2009 recession; the sector’s downturn only commenced at the end of that recession towards the end of 2009 as the SWC infrastructure projects neared completion. Between 2000 and 2010, real GDP in the sector expanded by no less than 70% – see the chart above. Following a brief downturn in 2010, the sector’s real GDP expanded by a further 15% up to 2016, where after it entered another downturn.
There is a very strong lag relationship between the construction cycle and the SA business cycle. This is depicted in the accompanying chart. The red shaded areas indicate SA’s official business cycle phases (as determined by the SARB on a regular basis) and compares it to the construction cycle downturn phases (the light blue bars). The latter was derived by using the Bry-Boschan Quarterly (BBQ) method of determining successive periods of expansion and contraction in construction real value added, after the latter was de-trended and the resulting cyclical component transformed to its natural logarithm. Only one spurious business cycle phases was removed, i.e. a brief downturn in the sector between the first quarter of 1974 and the first quarter of 1975. After eliminating this spurious business cycle phase, the blue-shaded areas resulted, depicting the construction business cycle phases. It is evident that the construction cycle lags the overall business cycle, both at lower and upper turning points of the cycle. Only during the 1997-99 economic downturn, the sector emerged from recession before the general business cycle reached a lower turning point. For the remainder, the lag is considerable, particularly at upper turning points, i.e. a median lag of 4 quarters (see the accompanying table); at lower turning points the lag is shorter, namely a median lag of 2 quarters. The un-phased nature of the construction cycle in the run-up to the 2010 SWC is evident from the chart. The sector also managed to escape the general economic downturn from the end of 2013 for a number of years, only turning down at the end of 2016, i.e. three years after the onset of the general economic downturn.
The table shows that the construction cycle is late to peak – see the 1970-72; the 2008-09 and 2013-17 economic downturns in particular when the construction upturns continued up to two years (and longer) into the respective economic downturns. The sector also exits a recession later than the general economy, albeit that this lag is appreciably shorter, i.e. typically between 6-9 months. Only the 1987-89 upturn in construction lagged the general cycle by close to two years. As noted, within the building & construction value chain, building plans passed and building completions are important leading indicators of building activity. The leads and lags referred to in the table relate to the complete building & construction sector, including civil engineering work.
