Build, Build, and Build: Construction GDP Growth in the 4Q and in 2017 Slipped to 2013-2014 Lows! More on Infrastructure Risks and the Path to Big Government

The economy is what actually happens, not what people think other people think Economists say is happening. Talk isn’t cheap, it’s way overvalued—Jeffrey P Snider

In the issue

Build, Build, and Build: Construction GDP Growth in the 4Q and in 2017 Slipped to 2013-2014 Lows! More on Infrastructure Risks and the Path to Big Government

-19 Months of Build, Build and Build, So Far Construction Growth Has Cascaded

-Private Sector Construction GDP Plunges to Negative in 4Q 2017 First Since 2013!

-Bank Loans, Building Permits and Construction Material Prices Reinforce Construction Slowdown

-The “Crowding Out” Effect in Motion

-More Risks from the Politics of Infrastructure Spending

-Ambitious Infrastructure, Defense and Social Expenditures: The Path to Big Government; The Collapse of UK’s Public Works Company: Carillion PLC

-Economic Opportunities in Transition

Build, Build, and Build: Construction GDP Growth in the 4Q and in 2017 Slipped to 2013-2014 Lows! More on Infrastructure Risks and the Path to Big Government

2017 have come and gone, so the popular wisdom on the state of the Philippine political economy should be tested for its validity.

More significantly, based on the Philippine government’s statistics on national accounts, to what degree has the major political initiative of “build, build and build” affected the construction industry?

19 Months of Build, Build and Build, So Far Construction Growth Has Cascaded

Let us hear it from the Philippine Statistics Authority on the 4Q Construction GDP: (bold added)

Investments in Construction grew by 2.9 percent in the fourth quarter of 2017, slower compared with the 9.3 percent growth in the previous year. Private Construction, which accounted for 74.9 percent of total construction investments, contracted by 2.9 percent compared with 6.9 percent growth in the same period in 2016. Meanwhile, Public Construction grew by 25.1 percent, faster compared with the 19.2 percent growth in 2016.

Note that the inclusion of public Build-Operate-Transfer projects in private construction investments blurs the distinction between private and public activities.

 

On a quarterly basis, the industry’s 4Q growth rate slumped to a low of 2.84%, which accounted for the lowest level since Q1 2014 (-4.2%)!

Despite the 25.1% jump in 4Q public construction investments, the scale of growth remains muted compared to the 30-50% growth rate in 2015 under the previous regime.

Remember these are government numbers which can be accessed here.

And such underachievement has hardly been an aberration or restricted to the 4Q.

The slack in 4Q growth reverberated throughout 2017. The annual real growth rate of 5.7% in 2017 accounted for only a little over a third of 2016’s real growth rate of 15.1%, and slightly above half of the 2015’s 11%.

Real public sector construction GDP grew by 13.5% in 2017 down from 28% in 2016 and 25.5% in 2015

That’s right, nineteen months into the Duterte administration, instead of a boom, construction activities have been flailing! That is, up to this point, the “golden age of infrastructure” has signified nothing more than populist hand waving!

Private Sector Construction GDP Plunges to Negative in 4Q 2017 First Since 2013!

And seen under the prism of either annual or quarterly performance, private sector construction has been in a consistent downtrend since 2012.

That’s because private construction suffered a -2.9% contraction in the 4Q, the first since 2013!

At 3.3%, private construction’s annual growth rate in 2017 signified the smallest since 2009 (-5.2%)!

Now let us move to vet on the distribution share.

Although the distribution share of public construction has been rising since 2014, it has not been enough to offset the decline in the private sector.

As noted above, the 4Q share of public construction was 25.1%. In 2017 it was slightly higher at 25.73%

So the ballyhooed “golden age of infrastructure” has yet to make a meaningful dent in the construction industry. Perhaps the groundbreaking of the 34 of the 75 ‘flagship’ projects might overhaul the economic milieu. Or, perhaps not.

Bank Loans, Building Permits and Construction Material Prices Reinforce Construction Slowdown

Many other signs reinforce the ongoing doldrums in the construction industry.

Banking loans to the construction industry have steadily been moderating since 2013. This slowdown has resonated with the construction GDP trend.

Moreover, the depressed state of construction building permits in the 2Q must have ushered the dismal 4Q construction GDP. In the meantime,3Q’s bounce was mainly about government projects which have been consistent with the industry’s 4Q % change in output

 

Real economy prices have provided significant clues

While cement prices bounced in December, the price trend remains in a contraction mode.

Why shouldn’t it? In expectation of a boom, cement producers plus importers have combined to saturate the industry. Cement production growth, according to the PSA jumped by 31.3% in November and by 31.3% in October!

Whatever demand growth generated from the government’s ambitious “build, build, and build” in the backdrop of emergency measures (historically low-interest rates, record BSP monetization of the NG liabilities and immense fiscal policy), has been offset by excess capacity issues! 

As an aside, governments have used fiscal policies as countermeasures against economic fallouts.

As example, in response to the Great Recession, the Philippine National Government launched a Php 330 billion (4.1% of GDP) package of stimulus called the Economic Resiliency Plan (ERP)*, consisting of Php 160 billion for community infrastructure projects, Php 100 billion of extra-budgetary financing of infrastructure projects and fund large infrastructure projects by GOCC (Government Owned and Controlled Corporations). Php 30 billion of new and temporary additional benefits to SSS, GSIS and PhilHealth, members and P40 billion in selective income tax cuts.

Rings a bell?

Let me further add that the though the BSP embarked on a series of interest rate cuts in 2007-9, it announced its espousal of accommodative policies only in 2009. [See Phisix: In 2009, the BSP Engineered a Crucial Pivot to a Bubble Economy April 14, 2014]

So the NG used easy money PLUS fiscal activities to cushion from a potential contagion.  I would argue that this Band-Aid policy was not required. The Philippines had little imbalances then. Having been addicted to it, the NG and the BSP has now doubled down!

*Anita Doraisami, The Global Financial Crisis: Countercyclical Fiscal Policy Issues and Challenges in Malaysia, Indonesia, the Philippines, and Singapore, ADBI Working Paper Series June 2011 ADB.org

Back to prices.

Of course, price surges in construction materials impact economic calculation or the P&L statements of the private sector. Though private sector construction activities have been lethargic, the steep price increases in wholesale prices or government spending on construction materialshave diffused to affect retail prices. (upper window) Such degree of price volatility can be seen in prices of (reinforcing and structuring) steel.

Such exemplifies distortions brought about by the combined policies.

For the private sector, unstable prices, especially unpredictable price hikes, lead to higher project costs. Or cost overruns may dissuade investors from pursuing prospective construction projects.

Since governments don’t operate on P&L, they are less sensitive to price changes compared to the private sector peers.

Such are also symptoms of “crowding out” - government activities compete with the private sector which results in the eventual “crowding out” or displacement of the latter.

The “Crowding Out” Effect in Motion

The Naia project should be a wonderful example. [Philstar.com Super consortium in NAIA bid eyes Changi as partner January 15, 2018]

The super consortium of conglomerates seeking to develop the congested Ninoy Aquino International Airport (NAIA) is planning to partner with Changi Airports International (CAI), the group behind Singapore Changi Airport, touted as one of the world’s best.

The Megawide-led group, which is also looking to develop NAIA, meanwhile, is maintaining its Bangalore-based partner, GMR Infrastructure Limited, for its NAIA bid.

Industry sources said the super consortium of mammoth conglomerates is getting Changi as its technical partner. Members of this consortium are the Aboitiz Equity Ventures, Ayala Corp., Alliance Global Inc., Lucio Tan Group, Filinvest Land Inc., JG Summit Holdings Inc. and Metro Pacific Investments Corp.

The super consortium is looking to submit its unsolicited proposal within the first quarter, sources said. The group is seeking to develop NAIA into a world-class airport that is at par with the world’s best gateways.

Should the super consortium, which consists of the companies owned by the elites, obtain the contract for the development of the NAIA airport, the budget, and resources allocated for this grand project would be withdrawn from their respective private sector endeavors.

The good news is that the diversion of resources would diminish the “race-to-build supply” in the bubble sectors

On the other hand, the bad news is that with more resources channeled to politically-directed economic activities, such would come at cost of the private sector

Actually, regardless of who wins, such infrastructure project entails the transferring of resources from the private to the public sector.

The “crowding out” dynamic would not only affect the other sectors but also the construction industry.

The process of picking winners and losers translates to a selective distribution of benefits. The key beneficiaries from such dynamic will be firms of the politically connected and of the elites and their subcontractors.

Smaller competitors will lose out and likely uprooted out of existence.

Industries benefiting from political patronage and privileges will absorb most of the economic reallocation coming at the expense of the others.

Given the nature of selective distribution of benefits, the misallocation of a significant amount of resources to the few privileged entities would translate to concentration risks.

Since “investments” require financing, such privileged companies are likely to be funded by credit. Thus credit flows required to finance these invisible transfers to politically privileged entities would likewise redound to amplified concentration risks in credit. 

Free lunch doesn’t exist even in public works or infrastructure projects

More Risks from the Politics of Infrastructure Spending

Infrastructure projects require government spending depending on the type of arrangement

For “available payment partnerships” where government designed projects are subcontracted to the private sector, the government pays the private partner regardless of whether the infrastructure is publicly consumed or not

Thus, real economy price hikes caused by the HB 10963 or TRAIN essentially serve to subsidize or transfer resources and or finances these elites. It’s a reverse Robin Hood.

As the philosopher, the late Tibor Machan once wrote**

Investing in public works is a complete illusion--most of such spending by government is directed politically; it’s nearly always graft, and what else could it be since government officials haven’t the faintest clue as to what the money they have extorted from the citizenry should be spent on. So the spending will be a response to the pleas of lobbyists and others who can be of help in reelecting the politicians.

Of course, balanced budgets are very rarely implemented. Politicians do not want their hands tied.

The citizens who taxes are extorted could, of course, spend their own funds or invest them or place them in banks that can lend them out all of which would end up employing people for purposes that actually fulfilled what the public wants. Indeed, it is only such spending that amounts to support for public works since the so called public works are nothing but made up projects that serve the agendas of the politicians and bureaucrats. 

**Dr. Tibor R. Machan Lessons in Freedom: The Keynesian Non-Answer Weblogbahamas.com August 15, 2011

For “demand risk partnerships” or commonly known as Build-Operate-Transfers, subsidies are indirect. Since the infrastructure operator functions as a monopoly, it would charge monopoly prices to compensate for the project costs and to incorporate profit margin.

With no competition, consumers will have to bear the burden of higher prices for the use of these edifices.  Prices or fees will thus be regulated by a “captured” government.

The advantage of demand risks partnerships is that the private sector assumes part of the P&L risk in contrast to available payment partnerships***

***Randal O’Toole The Good and the Bad of Public-Private Partnerships Cato Institute Blog January 10, 2018

Moreover, government projects will incur expenditures in these projects, though the scale of spending vary depends on the arrangement of infrastructure projects.

Enlarge fiscal deficits from these political projects translates to bigger debt (higher future taxes) or debt monetization by central banks (thus, magnified currency risks) or increase in present taxes.

That’s what HB 10963 has all been about.

Another risk might be that liabilities acquired by private sector PPP partners could be guaranteed by the government. With government backing, moral hazard may come into the picture. Private sector partners may take advantage of these setting to acquire as much liabilities at the risks of taxpayers. (see the collapse of UK’s Carillion below)

Ambitious Infrastructure, Defense and Social Expenditures: The Path to Big Government; The Collapse of UK’s Public Works Company: Carillion PLC

Lastly, a magnification of political projects, such as grandiose infrastructure projects, substantial increases in military, welfare and bureaucratic spending, will not only siphon resources and finances away from the private sector, but this will expand government control over the economy.

The larger the government, the smaller the private sector. (Watch how the government spends! Tax cuts are a farce under record deficits!)

And an expansive government should lead to the undermining of private property rights, thus, economic freedom will diminish

Business will evolve from servicing consumers through the marketplace to servicing of expediencies of political leaders and the bureaucracy.

Further, with the entrenchment of economy politically directed allocations, economic maladjustments will intensify.

Most importantly, this evolution will entail increasing constraints on individual liberties.

As the great Ayn Rand wrote in her classic Atlas Shrugged

Money is the barometer of a society’s virtue. When you see that trading is done, not by consent, but by compulsion–when you see that in order to produce, you need to obtain permission from men who produce nothing–when you see that money is flowing to those who deal, not in goods, but in favors–when you see that men get richer by graft and by pull than by work, and your laws don’t protect you against them, but protect them against you–when you see corruption being rewarded and honesty becoming a self-sacrifice–you may know that your society is doomed. Money is so noble a medium that does not compete with guns and it does not make terms with brutality. It will not permit a country to survive as half-property, half-loot

And if you have come to believe that private sector firms engaged in public works are inviolable, the collapse of UK’s Carillion Plc should serve as a wakeup call.

From Bloomberg: [Carillion Collapses After U.K. Government Refuses Bailout January 15, 2018]

Carillion Plc, a U.K. construction company with government contracts in everything from hospitals to the HS2 high-speed rail project, filed for compulsory liquidation after failing in a last-ditch effort to shore up finances and get a government bailout.

The company employs 43,000 people worldwide, almost 20,000 of them in the U.K., and has as much as 1.5 billion pounds ($2.1 billion) in outstanding borrowings. It held talks with the government Sunday to ask for the 300 million pounds it needed by the end of the month to stay afloat, the Mail on Sunday reported.

Debt, moral hazard, misallocations, arrogance, waste and incompetence drove the company to the gutters.

From Simon Jenkins [I’m not surprised by Carillion’s failure – companies like this shouldn’t exist, theGuardian.com January 15, 2018]

What the Carillion saga demonstrates is the rampant indiscipline in the contracts themselves. The company’s demise is attributable tofavouritism, cost escalation, excessive risk, obscene remuneration and reckless indebtedness. Carillion and its bankers clearly thought it too big to fail. Whitehall behaved accordingly. It was like a pre-2008 bank.

Economic Opportunities in Transition

Oh, I was recently asked about possible “economic opportunities” under the prevailing political-economic environment.

The answer in a word is GOVERNMENT.

We are seeing and will see a vastly bigger government.

This expansion will intensify once an economic downturn or a slowdown surfaces. Thus, the business or economic prospects is that which is anchored upon them. One can get supply contract/s with them. That’s if you have the right connections or networks. Or one can become a subcontractor to a private sector direct government contractor/supplier. Or, one can get employed by them.

One can also look at external options.  In the meantime, one can buy the USD Php.