Lecture 2- Coconstruction economicsnstruction Economics

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CONSTRUCTION ECONOMICS

Business Economics & Finance Management - CIT

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Construction EconomicsConstruction economics is a part (branch) of general economics & studies the techniques of economics applied by construction firms, the construction business & the construction industry

Construction activity has existed ever since the days of the cave man, & exists everywhere wherever there are human settlements.

Per Capita construction costs vary widely according to the per capita income of the region, from as low as $ 5 per head per annum in Ethiopia, to $ 5000 in Japan. In India, yearly expenditure on construction activity is $ 52 per headBusiness Economics & Finance Management - CIT

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Characteristics of construction industry1. Physical nature of the final product which are durable buildings & works and therefore large bulky & expensive and are demanded over a wide geographical area.

2. There are inputs ( which are intermediate products by themselves, eg cables) which are small, or bulky (steel, cement) and are manufactured elsewhere. The inter-relation amongst these products regarding price & production (inputs) often define the nature of the construction industry.


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3. Work is discontinuous across sites. Amongst clients, Govt is one of the major ones. Construction firms, Contractors & consultants all have fixed offices out of which they cater to the work going on at the sites. The role of the Govt as employer of construction workers, is steadily diminishing, while subcontracting of labour is a steadily increasing practice, not only in India but across the World.

The quality of labour required is not highly skilled, & consequently labour contractors source labour at a cheap rates. Suppliers of inputs have to correspond with the consultant / contractors at their offices regarding tendering & supply directly at the work site.


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Demand for construction industry depends on the ultimate use of the product: whether it is a consumer good used by the end consumer (housing)Whether it is a intermediate good used as a means for further production ( factories)Whether is a social good used for the betterment of the society at large (hospitals)Whether it is an infrastructure good used for the overall development of the economy (roads)

The govt has traditionally been responsible for more than half the demand of construction goods, though its share of demand has been falling since the early nineties


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Construction Sector & the EconomyConstruction goods are capital goods, they are demanded not for their own sake but for what they can produce (exception housing)

Products of construction are expensive, their value is high wrt the income of purchasers ( people take loans to purchase them)

Construction goods have a long life, & small fluctuations in supply & demand has a big impact on prices

The govt is a major client esp for infrastructure products, more so in developing nations like India where Infrastructure development is the key to economic developmentBusiness Economics & Finance Management - CIT

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Construction Sector & the EconomyConstruction Sector works as regulator of economy Construction at any project follows a predictable pattern, slow in the beginning, picks up speed & trails off at the end.

Demand & timing for construction (for e.g a factory) depends on the demand for the final good the factory will produce, and not solely on the cost of constructing the factory.

Postponement or cancellation of any construction project produces disruptions to not only the project concerned, but can be also felt distinctly outside the direct chain, eg steel and cement suppliers will face a glut; carpenters, electricians will suddenly be out of work, etcBusiness Economics & Finance Management - CIT

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Construction Sector & the EconomyFluctuations in demand in output of construction industry, depends on the category of construction demand:

New projects A new Airport, a new Housing Building. These opportunities are large for developing countries like India

New Investments for extensions to existing units this depends upon the state of the economy

Replacement of existing units in a new form changing a tar road into a concrete road

Rehabilitation & improvement of existing units

Repair & Maintenance


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Demand for private housingData has shown that the price elasticity of demand for housing (for personal use) is inelastic in nature

Demand for private housing has increased with tax relief measures and lowered interest rates for housing loans

Income elasticity for luxury housing is elastic in nature, and demand increases during boom periodsBusiness Economics & Finance Management - CIT

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In India, the current housing shortfall is 10.8 million units.

It is estimated that Rs.1 crore in housing will generate 750 man years of employment;

A 10% increase in final expenditure in construction, increases GDP by 3%, and yields 15 lac new jobs, ie, 9% new construction jobs.

The fiscal multiplier for expenditure in construction is 5, ie, a 1 unit fiscal expenditure in construction increases GDP by 5 units


Demand for Industrial & Commercial ConstructionDemand for factories & offices is dependent not on the users of the factories of the buildings, but on the ultimate consumer of the products & services manufactured at these buildings. This is known as derived demand

The Acceleration Principle: Whenever the demand for any good increases, the capital goods required to produce the good increases in turn, which includes commercial buildings. Eg whenever the demand for steel increases, the demand for construction of steel plants increases

Since demand is derived, demand is more affected by profitability than price. Business Economics & Finance Management - CIT

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Demand for Social Construction & Infrastructure Deals with construction of hospitals, roads, schools etc, which the community (society) enjoy but are not ready to pay for directly

The public sector has traditionally been a major client for social sector construction projects, though of late private sector participation has come in through BOT, BOLT, BOOT etc

Cost benefit analysis like NPV(Net Pressure Value) and IRR(Internal Rate of Return) and welfare economics techniques are applied to gauge the demand

The demand for infrastructure often depends on the future increases in their need & is constrained by budgets & prices. Business Economics & Finance Management - CIT

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The process of the construction industryClients the initiators of the process, may by Govt or non Govt

Developers who may be Builders or the Main Contractors, - they determine the price of the construction work

They engage Sub Contractors, & Consultants in the form of principal designers, consulting civil engineers, architects, quantity surveyors, designers etc. Material Suppliers supply materials, Labour Contractors supply labourers.Business Economics & Finance Management - CIT

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Construction CostsThe costs of a construction process, are not regular, they are low at the outset of the project, rise to a peak and decline, even if we assume that the project is completed at a steady pace.

Variable costs include materials & components which comprises 50% of the total cost of construction, site labour which comprises of 33% of the total cost of construction, apart from site management costs, site plant & equipment cost (owned or hired).

The contractor needs to keep working capital for site work as low as possible, & cost of estimation as low as possible.Fixed Costs are a smaller proportion & include head office expenses, interests, etcBusiness Economics & Finance Management - CIT

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Construction77% of the global construction activity is concentrated in Developed countries & the balance 23% in developing countries.

Within the developed countries, Europe contributes for 30% of global construction output, USA for 21%, & Japan for 20%

Within the developing countries, China contributes for 6% of global construction output, & India for 1.7%

In the richer countries, where labour is expensive, machines have replaced men in many construction jobs while in poorer countries, where labour is cheaper, manual methods are usedBusiness Economics & Finance Management - CIT

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ConstructionAs far as employment goes, the developed countries employ only 26% of the total construction workforce, while the balance 74% is employed in the developing countries; thereby the developing countries employ 80 million of the total workforce in excess of 111 million construction workers

Per capita construction output in low income countries is $ 8507 compared to $79623 in richer countries


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Labor-intensive & Capital intensive

Labor-intensive: requiring a large expenditure of labor but not much capital

Capital intensiveis the term for the amount of fixed or real capital(capital)present in relation to other factors of production,(factors of production) especially labor.

At the level of either a production process or the aggregate economy, it may be estimated by the capital/labor ratioBusiness Economics & Finance Management - CIT

Capital incentive:Industry requiring large sums of investment in purchase, maintenance, and payback of capital equipment-such as automative, petroleum & steel industry.

Capital intensive industries need a high volume of production and a high margin of profit (as well as low interest rates) to be able to provide adequate RETURNS ON INVESTMENT. (As in labor intensive.)Business Economics & Finance Management - CIT

Labour intensive vs Capital intensive constructionThe use of capital intensive techniques makes economic sense in rich short-of-labour countries

Often a bias is created towards modern capital intensive techniques, by clients, consultants & lenders in construction

In countries with low wage rates & high unemployment rates, replacement of labour by capital does not make economic or social sense unless necessitated by tender specs, unless there are time over runs or quality problemsIndia doesnt need Mass Production instead India needs Production by Masses - GhandhiBusiness Economics & Finance Management - CIT

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Construction in IndiaDeveloping countries including India have witnessed a spurt of construction activity in the last 30 years, In India the construction sector, currently comprising for 5% of the GDP, is growing at 8.4% per annum.

The construction sector employs the highest number of people after agriculture & it is the most employment elastic industry in the country. It is predicted to employ 32.6 million people by 2005-06, of which just the housing sector alone will employ around 20 million workersBusiness Economics & Finance Management - CIT

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Construction in IndiaWith the cost per job created being the lowest across sectors, construction is called the employment spinning sector

The construction sector in India is a dichotomous one (In 2 ways) with a mixture modern capital intensive methods with traditional labour intensive ones

The Indian construction business is the 12th largest in the world, with a business volume of Rs.2,30,000 crores, producing1.7% of the global output at an investment of $52 per capitaBusiness Economics & Finance Management - CIT

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Construction in India16% of Indias working population depend on the construction industry, directly or indirectly

There is an increase in the use of casual labour & subcontracted labour, mostly migrant labour who move from site to site

Though paid wages higher than manual workers, a shortage in skills in workers has been observed since there is no proper training & large contractors are thinking on lines of investment on manpower training


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Indian Construction the changing faceDue to increase in outsourcing of labour through subcontractors, the role of large construction companies has gradually changed from physical construction to consultancy, management & coordination, and a step forward to finding clients & marketing of products, which are in turn produced by subcontractors.

The top firms have moved to international markets through mergers & acquisitions


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Lecture 2- Coconstruction economicsnstruction Economics

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