Capacity for a substantial rise in public construction - Capital Economics
UK Economics

Capacity for a substantial rise in public construction

UK Economics Update
Written by Andrew Wishart

We think that the construction sector has the capacity to deliver an increase in public sector investment of around £50bn over the next five years if it is phased in gradually. Unless capacity increases significantly, the government’s manifesto plan to spend £100bn would struggle to be realised in practice.

  • We think that the construction sector has the capacity to deliver an increase in public sector investment of around £50bn over the next five years if it is phased in gradually. Unless capacity increases significantly, the government’s manifesto plan to spend £100bn would struggle to be realised in practice.
  • We expect the Budget on 11th March to reveal a significant loosening in fiscal policy. (See here.) We’ve pencilled in £55bn of additional public investment over the next five years which would raise public investment from 2.3% of GDP to 2.7% by 2022/23. That would be the highest share since the 1970s (aside from during the financial crisis) but it is well within the realms of possibility. After all, government investment in the UK is low by G7 standards. And we think the government could easily raise the required capital without any significant rise in borrowing costs.
  • Spending, rather than raising, the money could prove to be a larger stumbling block. One issue is whether the construction sector has the means to deliver more large infrastructure projects.
  • The good news is that there is currently some slack in the sector. At 2%, annual pay growth in the sector is below its long-run average of 3%, annual growth in construction output of 2.5% in Q4 is also below its post-crisis average (also of 3%), and the proportion of construction firms reporting that a shortage of labour or materials is holding back production has fallen back to historical norms.
  • History suggests that when construction output grows faster than about 6% a year, such as in 2014 and 2017, shortages of materials and labour emerge. (See Chart 1.) And the circled areas on Chart 2 show that these shortages caused construction output to fall short of some indicators of demand. So annual growth of 6% may be the point at which capacity constraints bite.
  • If our forecast that public investment will be £55bn higher than currently planned over the next five years was phased in gradually it would push up annual construction output growth by just under 3 percentage points (ppts). Assuming underlying output grows in line with its post-crisis average of 3% a year, that would leave output growth just below 6% and therefore appears plausible.
  • But we think that the government would struggle to get more ambitious investment plans out of the door without crowding out some private sector activity. For example, under the same assumptions as before, the government manifesto plan to increase public investment by £100bn would result in total construction output growing by over 7% a year. £70bn might see construction output grow by about 6.5%.
  • Of course, if the government lays out clear plans for a boom in infrastructure spending then capacity may rise. Existing firms can expand, new firms can be created, and construction workers can be attracted from overseas. But all of this takes time and the latter may conflict with the government’s new migration policy.
  • Overall, there appears to be room for a sizeable rise in public investment to boost construction output and the economy. But without a big increase in capacity, there is a limit on how quickly and effectively projects can be completed and a risk that it could crowd out some private sector construction activity.

Chart 1: Construction Output & Shortages (3m Averages)

Chart 2: Reported Demand & Construction Output

Sources: Refinitiv, Capital Economics

Sources: Refinitiv, Capital Economics


Andrew Wishart, UK Economist, +44 20 7808 4062, andrew.wishart@capitaleconomics.com