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Sustained GDP Growth Returns

The economy's rising tide will lift nonresidential construction's boat

By Jim Haughey, Reed Business Economist

December 1, 2003

Building Design and Construction

Recent reports show surprisingly bright signs that the economy is picking up steam much more rapidly than many expected it would only a few short weeks ago. Construction numbers for September were very strong and were revised up from there. This sets the stage for a significant positive upswing in the nonresidential market for 2004.

GDP growth was up a surprising 8.2% in the summer quarter. During this same period, productivity rose at an 8% annual rate and durable manufacturing rose 15%. Labor costs in manufactured products also decreased. Layoffs in October decreased by 50,000. These events help keep the lid on inflation and credit costs, which in turn keeps the price of equipment and manufactured items down.

A year ago the initial phase of the economic recovery was put on hold for seven months as cautious investors awaited the outcome of the Iraq conflict. The recovery restarted last May, this time with more strength than in 2002. This was because of a second round of tax cuts, further credit cost reduction, and the fact that U.S. export customers had time to work through their own recessions.

The interruption in the recovery also provided extra time for the U.S. to shed excess inventory, depreciate the dollar, and downsize business and government so that there is now less residual restraint from the recession than there was during the initial 2001-02 recovery.

The economy's growth is well positioned to be more sustainable than a year ago. The economy has an abundance of idle building, machinery, and labor resources that will permit above-average economic growth for an extended period without a significant increase in inflation or widespread supply problems.

The staying power of the recovery depends on the economy's sustainable noninflationary growth rate. At the extreme low estimate of 2.5% per year, the expected 4.2% growth rate in 2004 could extend into the middle of 2005. At the 3.0% estimate generally assumed in Washington, D.C., economic growth could continue at that pace until the spring of 2006. This estimate assumes only 2% annual improvement in labor productivity. Recently it has been much higher — nearly 7% in the middle of 2002 and over 4.5% this year.

With the economy likely in the early stage of a multiyear period of above average growth, nonresidential construction will be pulled along, although with the usual lag.

Gross Domestic Product
Annual % change

	Q1	Q2	Q3	Q4	Year
1999	3.7	2.0	5.2	7.1	4.0
2000	2.6	4.8	0.6	1.1	3.8
2001	-0.6	-1.6	-0.3	2.7	0.3
2002	5.0	1.3	4.0	1.4	2.4
2003	1.4	3.3	8.2	4.1(f)	3.1(f)
2004(f)	3.9	4.3	4.0	4.2	4.5
Source: U.S. Department of Commerce; Forecast (f): Reed Research Group

Supply environment remains bright for 2004

The supply/cost environment has been favorable for nonresidential building construction for the last several years when demand was weakening and will remain favorable through next year during the initial expansion of demand.

But construction loan rates should be steady until midyear and then increase about 0.5% by the end of the year. Construction loan rates are typically a markup from the prime bank rate, which in turn is a markup from the Federal funds rates closely controlled by the Federal Reserve Board as its principal monetary policy instrument.

Similarly, commercial mortgage rates should inch up only about 0.5% next year.

Construction labor should be readily available next year without any need for premium wages, although the pool of available labor will shrink steadily when net hiring begins in late 2003. Nonresidential contractors have laid off 6% of their employees over the last year.

The market will also have enough slack to keep inflation for construction material prices near 1% for another year. Raw commodities are already experiencing rising inflation, but productivity gains in processing and assembly industries are keeping inflation for intermediate and finished goods nearly steady. Most of the slack will be used up in 15-18 months, so supply conditions will be clearly tightening beginning in mid-2005.