by Adrian Hart, Associate Director, BIS Oxford Economics
“Flattening the curve” is important for beating COVID-19, but the global policy response and eventual recovery will likely drive further cycles in the economy and the infrastructure construction market.
In the previous issue of Infrastructure, against the backdrop of the devastating bushfires, I outlined BIS Oxford Economics’ “Top 5” trends for economic infrastructure (or engineering) construction activity, covering transport, utilities and mining.
As every economist should, I did manage to slip in one caveat, “while there may yet be more surprises in store”, when outlining these trends.
COVID-19, and the massive policy response in dealing with the health crisis, have turned out to be an exceptional “surprise”, however. And not a pleasant one.
Indeed, the economy is now in the midst of an unprecedented shock, with economic growth anticipated to fall at a double digit pace in the June quarter, and a range of scenarios emerging beyond this depending on how deep the downturn goes, how effectively businesses can be sustained by supportive fiscal and monetary policy, how many people are detached from work, how long restrictive social distancing policies are retained, and how they are eventually relaxed.
Even with an improvement from the September quarter, it is now likely the Australian economy will contract between 6-8 per cent through 2020 as a whole.
In growth terms, a recovery may look “V-shaped” in 2021 but it will be coming from a decimated base. In activity terms, it will take much longer for the economy to recover to a “new normal”.
Depending on the length of the downturn and how we adjust to it, this “new normal” will likely be governed by new behaviours.
Consequently, some industries will take a much longer time to recover – some may not recover at all – but new industries may be created.
Top 5 COVID-19 impacts on the market
However, despite the onset of COVID-19 – and the unprecedented policy response – the broad trends identified for economic infrastructure in 2020 remain intact.
While the June and September quarters are likely to be bumpy to say the least, we still expect engineering construction activity to move higher through 2020 compared to 2019.
Transport and resources projects remain the key growth drivers for the market. Activity in Western Australia and Queensland is still expected to grow faster than New South Wales and Victoria over the next three years.
And there remains considerable short-run and long-run challenges to the infrastructure industry in terms of dealing with the increasing cyclicality of work as crises play out and achieving industry sustainability over the medium to longer term.
But there are also important differences emerging in the infrastructure outlook due to COVID-19. So, for the record, here are my Top 5 COVID-19 impacts on the infrastructure market (recognising there may be yet even more surprises):
1. Infrastructure building facing greater COVID-19 risks
In terms of the total construction industry impact, the infrastructure building market is expected to be far more negatively impacted by COVID-19 than engineering construction.
This is due to building markets – particularly across accommodation, aged care, education, retail, offices, entertainment and recreation – being directly impacted by the demand shock associated with lower “people flows”, with privately-funded projects most at risk of delay or cancellation.
By contrast, engineering construction projects have, in the main, not seen the same immediate demand shock, with the public sector remaining committed to a large portfolio of projects across transport and the private sector also continuing to invest in existing mining projects and necessary utilities work.
Building projects are also more susceptible to supply chain risks for materials (e.g. fit-out items, parts for fixtures and fittings or external cladding) and productivity risks, particularly on vertical sites where social distancing increases the time required for workforce access.
However, while infrastructure building faces a crunch in the near term, there could also be a recovery later on once social distancing and isolation policies are relaxed.
2. Weaker population growth to impact on subdivisions demand
The sharp contraction in net overseas migration – coupled with social distancing policies impacting housing sales and commitments – is expected to drive a sharp contraction in subdivision and residential building activity in the June quarter which could extend to the September quarter.
Apart from residential buildings, subdivision infrastructure including roads, pavements and utilities will also be negatively impacted.
Again, however, a recovery may occur later on once migration restrictions are relaxed, although the timing for this remains uncertain.
3. Differences to emerge between private and public funded economic infrastructure works
In the short term at least, the economic infrastructure market remains supported by large projects across the public and private sectors.
At BIS Oxford Economics, we were already anticipating a further upward shift in transport infrastructure construction as a further wave of large rail and road projects rolled out.
While there are delays to some of these projects, the Australian and state governments have broadly committed to maintaining their infrastructure pipelines – at least in the near term.
Meanwhile, privately-funded engineering construction is dominated by mining, utilities and roads. Mining activity is rising now, but any risk to a sustained global economic recovery in 2021 could put this at risk.
Meanwhile, very low oil prices threaten the next round of large gas projects in Australia. Another key risk for privately-funded works is in roads, where the expected pullback in housing will impact subdivision works.
Privately-owned airports may also reassess timing of runways and aprons work, along with landside road infrastructure.
By contrast, the big private sector “winner” from COVID-19 (if it can be called that) is telecommunications, with strong demand for services leading asset owners to accelerate investment in 5G and other infrastructure.
4. Renewed focus on smaller projects and maintenance
While much of the infrastructure pipeline focuses on the megaprojects, it is expected that a COVID-19 response from governments that (i) sustains the construction industry initially and (ii) provides a broader economic stimulus later on, will require a deeper focus on smaller projects and maintenance.
Already, several state governments have announced increases to maintenance spending for roads and other public assets such as social housing.
There are several very good reasons for doing this. Smaller projects can be mobilised and rolled out quickly, programs can be spread more widely geographically and are, in many cases, more sensible than large single projects from a cost-benefit perspective.
But more importantly, smaller projects are the lifeblood of smaller contractors and material and plant suppliers that form the backbone of the infrastructure industry.
In recent years, there has been a shortage of small to medium sized infrastructure projects in the pipeline, and backlogs in maintenance for public assets such as roads are well documented.
5. Longer term reforms to the way we choose, fund and deliver infrastructure
This is perhaps more hope than prediction, but the economic shock associated with COVID-19 and associated large increase in public sector debt will inevitably place additional pressure on our ability to sustainably fund, procure and deliver infrastructure.
In the spirit of “never waste a good crisis” COVID-19 could act as a catalyst to spur significant, meaningful reform.
At the top of the list should be a substantial, across the board rethink on tax and spend policies so governments will be in a stronger position to sustainably fund infrastructure and pay down higher levels of debt.
Dusting off the 2010 Henry Tax Review would be a good place to start.
This may mean halting promised tax cuts, possibly introducing new taxes that replace existing, inefficient or inequitable taxes, or seeking greater private sector engagement in infrastructure ownership, funding and delivery.
Coupled with this, there needs to be a rethink on the kind of infrastructure we really need – particularly in light of any changed behaviours from COVID-19 – and what we are prepared to fund.
Finally, we will need to reform the way we procure infrastructure delivery, as this is the single biggest reason driving high infrastructure costs and stagnant industry productivity.
Doing proper groundwork to identify risks before tender, getting the risk allocation right in the contract, choosing the best procurement model for the project, and working together to deliver projects successfully may require a substantial shift in culture, but will give the greatest bang for the buck for every infrastructure dollar spent.
This will be vital in a cost- constrained, post-COVID-19 world.
Just as the recent bushfires reignited interest in climate change action, so too could COVID-19 act as a catalyst for an “infrastructure revolution”. As one revolutionary once said:
“There are decades where nothing happens; and there are weeks where decades happen.”
The challenges facing infrastructure funding, procurement and delivery have been with us for decades, but risk is being exacerbated by a large COVID-driven economic and construction cycle. Its time to change.