Changing industry hints at light in the Covid recession tunnel

After two years of weirdness, it seems harder to make sense of the world around us objectively. Certainly, we might reasonably expect 2022 to be less grim than 2020 and 2021, after we put the current wave of Omicron behind us. Though it would be unwise to take that as a given.

Tough as it may be to assess the future, businesses need to plan, and forecasting is a key element. That means searching out what is likely to be in store. So, what might that be?

The appropriate place to start tends to be the economy. It hugely influences how most businesses perform. The basic measure of activity in the economy, GDP, is shown in Chart 1. Covid clearly caused a massive hit. The slump we are emerging from was far deeper than the 2008 recession. The odd thing is, for most of those who experienced both, the economic shock seemed far milder this time around and that’s not just because fear was so focused on the virus.

One important difference goes a long way to explaining that oddity. The 2008 recession was sparked by fundamental flaws in the economy which were deep lying. The cause of the recent recession did not lie within the economy, it was self-imposed as we introduced measures to contain the spread of the virus. That gives us good reason to suspect that the current recovery will be stronger than that seen after 2008. And the signs are promising.

The chart also shows a forecast for 2021 to 2025, the 2021 official figures not being in yet. The forecast is based on the average of forecasts compiled by Treasury in December for 2021 and 2022, and November for the later years. This consensus of many forecasts suggests pre-recession levels of output will be reached in about three years. It took five years to recover lost ground after the recession caused by the financial crisis. But lest we get complacent, the damage has been very unevenly distributed across the economy. Sectors like hospitality, travel, and non-digital retailing have taken much harder hits and what is unclear is how much long-term and deeper damage might be hidden beneath the top-line numbers.

The dots on the chart represent the upper and lower of the range of forecasts included by the Treasury for 2021 and 2022. They are close for 2021 but we’d expect that, as we have most of the data for last year. However, the spread in the forecasts for growth in 2022 is very wide, more than you might normally expect. The consensus in December was 4.7.%, but forecasts ranged from 3.5% to 8.1%. That difference in fortunes is huge for businesses.

Chart 2 shows how GDP tipped slightly above 2019 levels in the estimate for November 2021. The latest figures also show the construction sector has been recovering steadily and getting close to levels seen before the pandemic.

Uneven effect of multiple impacts

However, closer inspection of the numbers shows that the recovery in construction output is far from evenly spread. The upward drive has been based on the surge in infrastructure spending and the sustained increase in private housing repair maintenance and improvement. While these sectors are delivering more work than was seen in 2019, in all other sectors workloads are down. Even in private house building which has been stimulated by a stamp duty holiday and rising prices, activity over recent months has been down on 2019 levels. Meanwhile, the once mighty commercial sector has been running at about three quarters of its performance in 2019 for most of last year.

To understand where the sector might be heading, we need to look beyond broad and short-term economic data. And when we do the signals are mixed. There are multiple forces of indeterminant strength influencing the construction sector. Aside from the impacts of Covid and Brexit adjustment pains, decarbonising and digitalising the economy are having profound direct effects on the built environment and how we see its future. This is and will continue to create big changes in how we select the buildings and structures we want and how we design, construct, and alter them.

Meanwhile, complex demographic change looms large on the horizon. We are already seeing early signs of change – a greater emphasis on ‘elderly living’ for instance. But the full force is yet to hit. About 17% more baby boomers were born each year in the UK compared with the previous (Silent) generation. And they are set to live longer. But these births came in two waves. The second and bigger wave is about to break on the beach of retirement.

To grab an analogy, the tectonic plates of planet construction are shifting unusually fast. We should expect both destructive and constructive effects in the years ahead

The forces unleashed by the three Ds of decarbonisation, digitalisation and demographic change seem to have been, if anything, accelerated by Covid and Brexit, partly because change breeds change. For instance, Covid seemingly increased concerns over climate change, homeworking rapidly increased, as did online meetings, and there was a ‘race for space’ among homeowners. All have major implications for both the built and natural environments.

These forces, given the current fragile economic climate, have huge positive and huge negative potential consequences for the construction sector. What those consequences prove to be in sum is extremely unpredictable. The answer rests on so many variables and so many personal and political decisions yet to be made. That takes us close to playing a fool’s game in trying to estimate the balance with any accuracy.

The future: prediction or gambling?

This much we might know or sense. So trying to forecast the near to medium term prospects, even for experienced forecasters, feels more akin to guessing and gambling than prudent prediction. It is a task beyond tricky. There are only so many scenarios that can be presented and caveats added to any forecast before the reader gives up in despair.

Clearly forecasts have value. The commentaries of reputable forecasts lay out the risks and assess the scale of the possible effects. The numbers put to growth, however, are likely to be far less reliable and contingent on assumptions that, currently, are inevitably fragile.

Most businesses and individuals would be wise to spend more time than they might normally looking at the relative weight of major positives and major negatives and evaluating what these mean for prospects in their niche. Let’s then look at a selection of the big factors facing construction in 2022. Since psychology suggests that those passing on news prefer to lead with the good while those hearing it prefer the bad news first, let’s start with the downsides.

The lists of the bad and the good are far from comprehensive but hopefully they cover the bigger issues.

Among the bad we can clearly place the impact of energy prices and the fears over an entrenchment of inflation. Connected to the inflation fears are those of labour and materials supply chain issues made worse by the unfortunate coincidence of Covid and Brexit. Not only are products and people getting harder to secure, but also prices, reflecting effects of limited supply, are rising. This will inevitably lead to growing risks within what is already a risk-prone contractual system.

Reflecting the forces that are shifting the tectonic plates of construction, notably the desire to decarbonise both the construction sector and the built environment, the government is pushing through regulatory change. This will add to complexity and costs in the initial stages as the changes bed in and processes are refined. Some of the policy changes are driven by long-term political objectives, some by near-term issues. These can often provide real conflicts or conflicting messages within the market.

The fall-out from Grenfell will also be a challenge for the industry over the next few years. It will inevitably mean more work to be done by the industry, but it will also bring changes to the regulatory framework which the industry will need to adapt to. This highly charged and complex issue has justifiably dimmed trust in the industry, but conflicting government positioning again has not helped resolve the problems. This certainly will drag on the industry for some while.

This all comes at a time when being able to call on state resources has seldom been more useful. For instance, the provision of incentives to speed the journey to net zero and create more certainty in demand would be helpful. Sadly, years of austerity has pared the flesh of local authorities to the bone and central government is facing a hefty rise in the level of debt.

All this creates what can only be described as a fragile framework for the industry to be working over the next few years. Despite government rhetoric, its practical and political energy will be highly dissipated dealing with multiple major issues, not least managing a Brexit that seems to have satisfied a minority of the population.

But on the bright side…

Within that rather gloomy context there are many reasons to be cheerful in the wider construction sector. The advertised long-term future of construction has excitement plastered all over the billboards. The three Ds promise a radical overhaul of the built environment not seen for decades. And, more narrowly, the government ambitions of levelling up and building more homes point to a welter of work to be done. It is also keen to invest in boosting infrastructure.

In truth, much of this will boil down to what is practically and financially deliverable and not the dream. Here there remain solid reasons for positivity. The housing market remains buoyant – outside London, that is. House prices up may create long term problems over affordability, but they do act as a prompt for investment, either in new homes or in improvements.

The much talked of ‘race for space’ among homeowners may well have another lap or two in it. This should see investment in new homes and home improvements pumping more widely across the country. Increasing numbers of new retirees, many with high levels of residential property wealth, may also provide rich pickings for designers and builders of custom homes. And the collective savings pot of households has swollen over the pandemic by tens of billions and could easily top £100 billion. This is mainly in the hands of the richer households, who may choose to spend it on home improvements or the creation of a dream home.

Meanwhile, the commercial sector will need to work out what to do with its space if homeworking reduces the army of occupants. This too will bring work, as will the rapid race to adapt to digitalisation, which in turn creates a need for more server farms and high-tech warehousing and distribution hubs.

So there is plenty of opportunity for growth. There is also an unusually high level of risk. How these will balance out and how the good and bad fortune will be distributed is hard to compute. But 2022 will be an interesting time to live through.

Summing up it would be fair to say that the potential in the long term for construction looks very bright. We need to radically change the built environment and that represents a monumental struggle with lots of work and creativity. But the nearer term presents a rather different and confused picture. The situation we find ourselves in suggests that firms will need to be fleet of foot, inquisitive, and quick witted in the year ahead. Catlike perhaps.

Unfortunately, there is no year of the cat in the Chinese zodiac. Fortunately, this February marks the start of the year of the tiger. The experts on these matters suggest this is a very positive sign.