Q&A May/June 2009 – Climate Change: Stimulus Economics
Kenneth D. Simonson, chief economist of the Associated General Contractors of America, has more than 30 years of experience in the field of economics, fiscal matters and market analysis. He is a former senior economic advisor with the U.S. Small Business Administration and has worked with the President’s Commission on Industrial Competitiveness, the U.S. Chamber of Commerce and the Federal Home Loan bank system. Simonson contributes to several business and professional publications, appears frequently as a speaker at industry conferences and has been interviewed by national print and television media outlets, including CNBC, USA Today and Business Week. Simonson spoke with Correctional News via telephone about institutional and public safety construction, the economic downturn, the state of the market and the federal stimulus package.
Q: Many people were caught off-guard by the sharpness and severity of the economic downturn as work on the boards masked the recession in the institutional sector until 2008. Looking at the recession retrospectively, what strikes you most about the last 12 to 18 months?
A: The so-called official pronouncement of the recession, issued by the National Bureau of Economic Research, dated it to December 2007. For the construction industry, there are a couple of ways of looking at it: you can go with employment data, which peaked at 7.7 million in January 2007. By February this year, residential and nonresidential construction employment had fallen to 6.6 million, so basically one in seven construction jobs disappeared in last the two years.
Although the nonresidential sector kept growing pretty strongly until August 2008, in mid-September the industry was slammed by the shutdown of credit for developers and the inability of states to float tax-exempt bonds. That certainly affected the direction of the institutional sector and construction activity in corrections, and the credit markets have barely opened up since then. Meanwhile, the financial condition of so many state and local governments has deteriorated to the point they are forced to scale back nonessential and essential spending, which is having a major impact on construction activity.
Q: Looking at the economy in a broader sense, when can we expect the downturn to reverse?
A: It will likely happen in stages. A lot of things have imploded at more or less the same time, so the recovery will be far from simultaneous. I do think the stimulus legislation is going to help: It should boost gross domestic product in the second quarter, and personal consumption spending and government spending will likely rebound enough to offset declines in business investment and net exports. I think we’ll see a rather gradual and very uneven recovery of the economy with a lot of differences among states and across sectors.
Q: What regions are likely to fare best and worst?
A: Places like Florida and Nevada that depend on tourism and recreation and business conventions and that don’t have significant industries beyond those activities, are going to continue to struggle longer than states, such Texas or California, which have a more balanced economy or robust base. For the time being, there will likely be only a few pockets of strength — areas that are continuing to see population growth or have pretty reliable sources of employment — such as energy production and power plants or through the U.S military with base-realignment work. There are still a lot of construction projects out there, particularly in the energy sector, both traditional and alternative. There is also a considerable amount of funds available for energy efficiency retrofit and weatherization initiatives, and for renewables, such as wind farms and solar installations, and a portion of that could find its way into public safety.
Q: In terms of the general economic situation, what is your outlook for the next 12 to 24 months?
A: I think we’ll see GDP move up in the second quarter of 2009, but it’s not going to be a rapid rebound and as a result it’s likely we’ll see nonresidential construction continue to shrink for the next several quarters. First we’ll see some revival in home building in different parts of the country, probably in the fourth quarter of this year, followed by selective growth in retail construction. But most other types of nonresidential construction, private-, state- and locally funded could be wallowing in the economic bog for a year or two.
Q: What impact will the stimulus have on the institutional sector and public safety construction, and how soon will that funding make its way into the industry?
A: First of all, the scale of stimulus — AGC estimates that the Recovery Act contains about $135 billion worth of construction related spending — and the amount of federal funds for construction is very hefty compared to total value of nonresidential construction in 2008, which was about $711 billion.
The Census Bureau data on value of construction put in place in 2008 breaks out figures for correctional structures, with total spending of $6.2 billion, which was made up of $4.4 billion for detention construction and $1.8 billion for police and sheriffs. So $800 million just for federal prisons represents a hefty input in the context of annual spending.
Of course the funds won’t all go to contractors, and some of the spending will be at the discretion of governors. Although some of the funding may show up as design and site preparation, most of the stimulus money will be committed by Sept. 30th, 2010. That’s a pretty short timetable to make decisions about where to spend some $130 billion, but we are seeing good faith efforts by state and federal agencies to commit stimulus funds to specific projects.
Q: Do you foresee any impediments that could slow or stop stimulus funding making its way into the institutional sector and public safety segment?
A: Not really. There is huge underutilized capacity in the construction industry right now; we’ve already talked about the 1.1 million jobs lost during the past two years.
Where public projects might have trouble attracting two to three bidders in the past, now you might have 25 or 30 companies bidding, which is good from an owner’s perspective. In addition, after jumping much more than people had foreseen for four to five years, materials costs are dropping in many cases.
I’ve had many public agencies tell me that bids they’ve opened recently are as much as 20 percent below what they had expected. This is an ideal time for public entities to take on construction projects because it’s like a limited-time sale. Materials costs are coming down now, but they could jump back again at any time and there are plenty of skilled contractors eager to bid on jobs. A year from now, however, those conditions could change significantly and some of those contractors may not be available or may even have gone under.
Q: Could factors, such as frozen credit markets, low investor interest in bond issues or more stringent lending/surety criteria, inhibit the ability of public agencies to fund shovel-ready projects or source matching funds to take advantage of federal monies?
A: Frozen credit markets and states’ ability to get project funding remain a concern. Based on its credit rating, California would be exhibit A for states that should get a frosty reception on the bond markets, and yet investors were snapping up recent issues.
I would not expect the willingness of lenders to be the constraint. Certainly, state and local governments are facing dire revenue forecasts and that will restrict the amount of construction spending they undertake. The need for states to balance budgets every year is more of a problem than the bad condition of the credit markets. Credit markets remain a concern for contractors, particularly for private construction, and of course state and local revenue streams are impacted greatly by the broader economic conditions, by business activity, productive output, employment and consumer spending.
Q: Will balanced-budget requirements or spending obligations in other areas make governments think twice about construction projects or could we see a use-it-or-lose-it mindset on stimulus funding?
A: We hear reports of states and localities juggling budgets and pulling back spending in some areas, so they can replace that with federal money. There’s a story in today’s San Francisco Chronicle about lawmakers changing laws to make sure the state receives the greatest amount of federal funding possible for sanitation and water projects. That’s happening in many places and although a few governors are saying they don’t want stimulus money, because once it runs out they won’t be able to afford to continue spending at those levels or afford the payments, the more typical story is how states are maneuvering to get the maximum amount of money possible.
Q: What are the greatest challenges for construction contractors and industry professionals in the current economic climate?
A: The weak credit markets and the huge overhang of vacant or underutilized facilities we now have are definitely the twin bogeymen for the construction sector. Developers or construction companies that want to move ahead with a project are likely paying much higher interest rates than they did even one year ago. Beyond that, there are so many office buildings, hotels and factories way below capacity that construction will be very weak in those areas for some time.
Q: What other challenges are emerging for contractors in the current economic climate?
A: Contractors that historically have focused on public safety work are facing the added threat of competition from contractors that, in the past, worked only in the private sector or other institutional sectors and public/civic projects. Even contractors who have long been successful doing large government jobs are concerned that firms inexperienced in the market are gravitating to the public safety sector because that’s where they see the action, activity, spending and profits. It’s often these inexperienced firms that are more likely or willing to bid a job below cost. However, on the flip side, you may win one job by bidding low, but that doesn’t mean you’ll be around afterward or for the next project.
Q: Are surety conditions more stringent for contractors? Is bonding out more difficult now than say two years ago?
A: In my experience, the surety companies are generally looking for proof that a contractor is viable, but if the contractor isn’t viable, then it’s got bigger problems than obtaining surety, so I don’t think surety is the hang up at this stage.
With less work out there for contractors, the slowdown also has the effect of making surety companies a little hungrier for business, which may offset their reluctance to back any one contractor. There will always be tension between due diligence and wanting to win a contract or make a sale.
Many contractors appear prepared to sacrifice profit in order to be competitive, win a job, secure a project and keep key employees busy, which is helping owners as much as, or more than, the decline in materials costs. I certainly hear that talked about a lot and I’m sure we’re going to hear about a lot more companies either going under or making much smaller profits this year.
Q: Are there any upsides to the current economic environment that could spur project activity?
A: Again, flat or declining materials costs have given many contractors some breathing room on projects that are already under way. Whether this would be a factor in inducing owners to speed up or commit to work they are unsure about is hard to predict because the impact of prices on the overall cost of a project is so project-specific in terms of the materials mix. Having said that, I firmly believe this is a great time to take advantage of low materials costs, available contractors and federal funding.
Q: What economic indicators in the broader economy should public safety stakeholders look to for a sign that the turnaround is gathering pace?
A: There really isn’t one market indicator to which you can look. Some people put their faith in the Architectural Billings Index, but you really need to look at the subindexes there. This month the ABI moved up a little overall, but each of the subindexes, which reflect a three-month moving average, were flat or down in the commercial, industrial, institutional and mixed practice sectors.
I keep an eye on architectural and engineering employment as a more comprehensive measure, which has been dropping rather sharply for the last few months. Once that ticks up, then it’s generally a good sign that people are getting project designs they intend to build. Additionally, retail sales and industrial production are indicators there may be demand in some regions and industrial sectors for retail and factory construction, which speaks to a turnaround in the broader economy.
In terms of the public safety segment and institutional sector, you want to see that state revenues are growing sharply. You also want to see that they aren’t running budget deficits, but I wouldn’t expect that to happen until maybe two years from now.
The stimulus package will be very helpful in offsetting the decline in state and local construction overall and it looks as though justice and corrections construction is getting a sizable chunk of the federal funding package. In addition, areas such as water and wastewater systems, and energy retrofit and weatherization are seeing a large percentage-change increase in spending, and some parts of public sector construction will benefit greatly from that stimulus component.
Q: Are there elements of the stimulus you would have liked to include or expand upon?
A: It made a lot of sense to put money into construction because it can put people to work right away and it creates assets that will add to the nation’s productivity in the long term. Nonresidential construction is going to drop sharply this year. Last year, nonresidential construction spending was up 12 percent. For 2009, I would expect a decline of 3 percent to 9 percent.
The stimulus will offset some of that decline but it will not be enough to make up for all of the contraction, particularly on the private side. From that perspective, I would like to have seen even more investment in construction, but I don’t want to be ungrateful for a bill that delivers more money in a short time than the construction industry has ever seen from Congress.