Construction Economics

This chapter defines the subject area of economics and discusses the nature of the basic economic problem. It shows that the study of economics is relevant to those interested in construction.

Many work practices and relationships in construction at the end of the twentieth century appear to be haphazard, illogical and even downright inefficient. To understand the relationships between firms in construction and the organisation of work in the building industry it is best to look at how these relationships and methods arose in the first place, and how they developed into the current situation.

To build up a picture of any industrial sector, different aspects of the industry need to be looked at separately. These aspects include the types of goods or products produced, namely the output of the sector, the types of firm producing that output, the different types of labour used, the technology and materials used in the industry, and the types of client who form the demand for the industry’s output. This chapter deals mainly with the output of the construction industry for both the public sector or the government, and firms and households in the private sector. The next chapter will deal with firms, their labour and technology.

The price of any transaction agreed between buyers and sellers reflects broad as well as specific forces at work in the economy. These economic forces must be taken into account for a proper understanding of why prices are as high or as low as they are. This chapter deals with the price mechanism, or the laws of supply and demand.

The construction sector consists of different types of specialist firm working together on temporary sites to produce buildings and civil engineering works. Once they have fulfilled their contractual undertakings, each firm moves on to other work with different firms on new sites. Apart from the main contractors, architects, engineers and surveyors, very few firms remain for the duration of a project. Temporary organisations are formed to manage projects. On completion of their contracts, the firms making up these temporary teams also disperse.

Labour is central to any production process, and construction is no exception. Without labour, production would not take place. Machinery would remain idle. Stocks of materials would not be made into products. Firms would not be managed.To understand the role of labour in the capitalist production system we need to see labour in terms of its relations with the other participants in the process — the owners of capital and land.

This chapter and Chapter 8 deal with costing within a firm. While Chapter 8 deals with the subject more from the point of view of traditional accountants, Chapter 7 tackles the subject more from the point of view of economists. Although accountants have always dealt with cash flow statements, showing money entering and leaving a firm over a period of time, in the past they were primarily concerned with auditing and producing sets of accounts such as profit and loss accounts and balance sheets. These accounts were essentially backward-looking, since they dealt with past events. Economists, on the other hand, are concerned with decision-making that concerns production in the future.

As far as marketing is concerned, compared to those selling other products and services, the construction industry and building professionals are faced with a particular set of problems. Carpenter (1982) defines these difficulties as follows:

The purchaser generally doesn’t know what he wants when he starts to buy it, no-one can actually be sure that what he requires can be produced, the production capacity to produce it doesn’t exist at the time of commissioning and there are a large number of bodies and officials whose job it is to stop you getting what you want. ... In summary the building industry and its professionals sell a production service, not buildings.

Accounting techniques are equally applicable to firms and to projects within firms. For example, cash flows concern flows of money into and out of company accounts as well as the costs and revenues associated with individual jobs.

Firms and organisations in construction are project-orientated. Unlike firms in manufacturing, construction firms rarely do the same thing in the same place from one year to the next. Firms undertake projects and allocate staff to carry out the work. Within each firm, several projects must be co-ordinated in order to make the best use of staff and resources, and to provide continuity of work and revenues. The selection of projects according to size and type of work must also be consistent with the general aims and targets of the firm. Otherwise, the firm can only respond in a haphazard way to opportunities as they become available, rather than going out to seek work of a particular type and quality.

The purpose of this chapter is to introduce the reader to feasibility studies, project appraisal, and investment analysis. Feasibility studies are an example of systems analysis. A system is a description of the relationships between the inputs of labour, machinery, materials and management procedures, both within an organisation and between an organisation and the outside world. Similarly, buildings may be seen as combinations of spaces and inputs interacting with each other and the physical, social and economic environment. Systems analysis is a set of techniques used to understand and improve methods of production. While systems analysis is usually applied to existing organisations and methods of production, feasibility studies are used to examine the practicality of proposals. In economic terms, feasibility studies are simplifying models of the real world, focusing attention on certain aspects of alternative schemes.

The previous chapter introduced the concept of feasibility studies as an example of systems analysis and economic modelling. This chapter discusses feasibility studies as an example of investment appraisal applied to construction projects. Similar techniques are used in a variety of different contexts, such as investment in new plant and equipment, or in shares in the stock market. The basic questions facing every investor are whether or not the investment will be worth more than the amount invested, and if so, by how much? Alternatively, an investor may need to know the probable rate of return on an investment to compare it to the rate of interest to be paid on loans to finance the project.

Financial and non-financial aspects of feasibility studies were discussed in the previous two chapters. This chapter is concerned with some further issues raised by and dealt with in cost-benefit analyses, including risk and uncertainty, the social rate of return and very long run implications. Finally, the chapter considers the presentation of cost-benefit analysis reports.