by Thomas Westrup, Economist, BIS Oxford Economics

Fiscal stimulus remains an important chapter in the economic playbook. Governments worldwide have set their sights firmly on public infrastructure investment as a means to spark demand and employment following the coronavirus-induced economic downturn.

The benefits of infrastructure investment are underpinned by the key assumption that projects can be delivered on time, on budget and on scope. But what if the avalanche of project announcements and growing pipeline of work is too great for local or global supply chains to keep up with?

As supercharged infrastructure construction demand is set to push total construction market activity beyond previous peaks, there is no guarantee that supply will be able to rise to the occasion.

In Australia, this has been highlighted by Infrastructure Australia in its recent Market Capacity Report, wherein a near doubling in public infrastructure investment over the next three years will drive exceptional increases in demand for labour, plant, equipment and materials.

In the case of construction, it isn’t often apparent if there is spare capacity in the supply of materials, plant or labour until after the contract has been signed or the build commences, with risks of project delays or higher prices often borne by the contractor.

Capacity issues have been further exacerbated by the unique challenges of the coronavirus outbreak – varying levels of movement restrictions on internal and overseas migration have limited key sources of skilled labour over the past two years.

These constraints can be amplified in regional areas – where supply chains are generally geared to cater for a particular, usually mild, level of demand. Other international factors are already straining capacity and raising resource costs – the rebound in demand for energy commodities following the global easing of lockdowns, coupled with sanctions on Russian oil and gas has already driven prices to record high levels.

The potential for more extensive sanctions and the ongoing disruptions to international supply chains has only magnified uncertainty regarding the future supply of energy. Rising energy costs impact other key construction resources, including the price of Chinese steel, which has barely budged from the price peak in late 2021.

Risks if supply chains fail to meet demand

In Australia, the upcoming rise in private investment and the expansive program of public infrastructure investment will further tighten domestic resource markets, which in combination with existing international capacity challenges, may work to deliver a sustained period of high escalation rates across the entire industry.

This challenge has been faced before – in Australia, periods of supranormal growth in construction during the mining boom drove large increases in wages and other local inputcosts. In tandem, exceptional strength in global oil and steelprices drove construction cost growth well above inflation,peaking at over ten per cent in the late 2000s.

There are substantial consequences of failure if supplychains fail to meet the demand challenge, beyond the financial health of the supplying firms themselves and the sustainabilit of the construction industry.

Sustained periods of high-cost escalation and growing backlogs among domestic material suppliers will increase the prevalence of delays, cost overruns, or project failures. This isn’t isolated to new builds; the operations and maintenance of existing infrastructure will exceed budgeted expectations due to overlapping inputs.

Severe delays and project overruns will distort the ability of federal and state governments to accurately time public infrastructure investment. Stimulus measures may not provide the economic support in the period in which it is needed, and instead, may further enlarge an already ‘overheating’ economy.

The taxpayer is the eventual loser as resource price rises erode the value for money delivery of infrastructure and increased spending flows through to higher costs rather than higher real activity.

The increasing saturation of global construction markets in an industry with historically poor productivity growth globally – noting that multifactor productivity in the Australian construction industry is now lower than it was in 1990 – suggests that governments should place greater emphasis on ensuring either that capacity can rise to meet forthcoming demand or that infrastructure is procured or delivered more productively to ensure that scarce inputs are put to effective use.

Taking a long-term view

Developing a highly visible, sustained long-term funded pipeline of infrastructure would help shift the sector away from the steep peaks and troughs that hamper industry confidence and productivity.

A sustained pipeline of works, particularly in regional and remote areas, provides the security for businesses to invest in their own capacity and allows skilled labour to be more easily attracted and retained over time.

Governments can also play a transformative role in raising productivity, including procurement reforms, productivityenhancing technologies, enhanced flexibility and coordination in delivery.

Beyond this, governments could consider more direct intervention in the market – identifying risks and potential supply ‘pinch points’ by developing comprehensive assessments of capacity across construction resources and regions.

This may include audits on domestic material production capacity, workforce capability modelling for skilled roles, and further research on the quality, price, strategic and security resource risks for imported resources.

Capacity assessments, in combination with a richer understanding of future resource requirements, allow for targeted investment and policy shifts to alleviate specific supply bottlenecks.

In the context of an upcoming global boom in construction activity predicated on large-scale public infrastructure investment, accomplishing the above will be difficult. Political factors, including election cycles, reduce the incentives for long-term planning.

The focus can easily shift to short-term wins through targeted investments in marginal electorates or a change in government disrupting long-term plans.

Meanwhile, with challenges in securing essential skills consistently rated by industry as the greatest supply side risk to infrastructure delivery, it may be time to focus once more on the longer term competitive efficiency and productivity benefits that flow from investment in ‘well-chosen’ infrastructure, rather than the number of jobs it will create during construction itself.

Ultimately, this requires a shift in mindset. As major economies navigate towards sustainable economic recovery and growth, attention will need to divert from using infrastructure to boost demand and employment to making productivity and supply the ‘new sexy’.

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