The other side of the infrastructure boom

The Australian economy has done a solid job in the transition away from the mining sector. Though mining investment has fallen to its lowest level in several years the overall investment story has been positive on the back of a tremendous upswing in infrastructure spending. 

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Over and above that trend the past year has seen a number of additional commitments, adding to the already-strong pipeline of major projects. The strength in construction activity is good news for Australia’s economy but the strong competition for labour, resources and equipment carries the risk of rising cost pressures.

"Strength in construction activity is good news… but the strong competition for labour, resources and equipment carries the risk of rising cost pressures.”

Nationwide, there is nearly $A120 billion in housing, commercial property and engineering construction (excluding mining) work in the pipeline.

The housing sector was the largest component of this for several years, driven by the boom in high-rise apartments across Sydney, Melbourne and Brisbane. More recently engineering construction has taken the mantle, supported by the many road and rail projects now under construction. To top it off the backlog of commercial property construction is now also at a record high. 

The outlook for infrastructure spending has improved further over the past year on the back of greater cooperation between various levels of government. Projects such as the Melbourne Airport rail and North East Link road (Victoria) and Badgerys Creek rail (New South Wales) will involve contributions from both state and federal level.

Further ahead, the scale of the road and rail works provides unusually clear visibility of the pipeline right through to the early 2020s.

With this strong pipeline of work, employment in the construction sector has been the second-highest job creator over the past three years, behind only healthcare. In addition, the rate of capacity utilisation in the construction sector is now at the highest levels since the financial crisis.

The Reserve Bank of Australia has noted in several recent publications the volume of work taking place is posing challenges. The RBA’s August Statement on Monetary Policy warned “capacity constraints in the building industry, especially in Sydney, are likely to constrain the pace at which this pipeline can be worked through”.

Mixed impact

This rising rate of capacity utilisation has had a mixed impact on costs to date. Wages in the construction sector remain subdued but there are several examples of rising construction costs.

Nationwide building construction costs are up 2.4 per cent year on year but the divergence across the states is noteworthy. New South Wales and Victoria are seeing the strongest growth in costs, up 3.4 per cent and 3.9 per cent respectively, in line with their strong levels of work.

This story is true across the types of construction. New South Wales and Victoria house construction costs are up 4.3 per cent and 6.2 per cent year on year while road and bridge construction costs are up 3.4 per cent and 10.6 per cent. Keep in mind these figures are coming at the same time as overall CPI inflation is running at just 2.1 per cent.

At this stage the impact of these cost and capacity increases has been fairly limited. But it is worth watching closely given the experience of the construction industry in New Zealand.

New Zealand’s construction sector has been struggling to keep up with demand in the face of capacity constraints. While there is plenty of work taking place, profitability has been getting squeezed as a result of cost pressures and delays. A BDO survey found many construction firms and sub-contractors are operating on unsustainable margins.

As a result of these pressures a growing number of companies have been forced into receivership or posted material losses. Perhaps the most noteworthy example is Fletcher Building which has lost almost $NZ1 billion over the past two years on large construction projects and posted a loss of $NZ190 million in 2017-18 – its first annual loss since the GFC.

This is not to say Australia is inevitably heading down a similar path. There are several important differences across the two countries.

Capacity utilisation began to accelerate in New Zealand much earlier, prompted by the 2011 Canterbury earthquakes, meaning spare capacity has been lower for longer than in Australia. Australia’s construction capacity was ramped up during the mining boom.

It’s likely the interstate migration of workers away from the mining sector in Queensland and Western Australia toward the housing and infrastructure sectors in Sydney and Melbourne has helped relieve pressure on labour availability. Labour availability has been a significant constraint in New Zealand.

This is reflected in wages growth which in New Zealand has seen construction wages rising faster than the all industry average for almost every period since 2011. In Australia construction wages have been below the all industry average since 2014.

In New Zealand, housing construction costs have been rising at 5.3 per cent year on year for the past five years, significantly above average inflation of just 1.1 per cent. Australian housing construction costs have also been running ahead of inflation, but the difference over the last five years (2.6 per cent vs 1.9 per cent) is much smaller.

At the national level we are not seeing much evidence of cost pressures in Australia. But the details across New South Wales and Victoria, as well as anecdotes from ANZ clients, confirm this story is worth keeping a close eye on.

Daniel Gradwell is a Senior Economist at ANZ

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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