Macmillan Building and Surveying Series Series Editor: Ivor H. Seeley

Emeritus Professor; Nottingham Trent University

Accounting and Finance for Building and Surveying A. R. Jennings Advanced Building Measurement, second edition Ivor H Seeley Advanced Valuation Diane Butler and David Richmond Applied Valuation, second edition Diane Butler Asset Valuation Michael Rayner Building Economics, fourth edition Ivor H Seeley Building Maintenance, second edition Ivor H Seeley Building Maintenance Technology Lee How Son and George C. S. Yuen Building Procurement, second edition Alan Turner Building Project Appraisal Keith Hutchinson Building Quantities Explained, fourth edition Ivor H Seeley Building Surveys, Reports and Dilapidations Ivor HSeeley Building Technology, fifth edition Ivor H Seeley Civil Engineering Contract Administration and Control, second edition Ivor H Seeley Civil Engineering Quantities, fifth edition Ivor H Seeley Civil Engineering Specification, second edition Ivor H Seeley Commercial Lease Renewals Philip Freedman and Eric F. Shapiro Computers and Quantity Surveyors A. J. Smith Conflicts in Construction: Avoiding, Managing, Resolving Jeff Whitfield Constructability in Building and Engineering Projects Alan Griffith and Tony Sidwell Construction Contract Claims RegThomas Construction Economics: An Introduction Stephen L. Gruneberg Construction Law Michael F. James Contract Planning and Contract Procedures, third edition B. Cooke Contract Planning Case Studies B. Cooke Cost Estimation of Structures in Commercial Buildings Surinder Singh Design-Build Explained D. E. L. Janssens Development Site Evaluation N. P. Taylor Economics and Construction Andrew J. Cooke Environment Management in Construction Alan Griffith Environmental Science in Building, third edition R. McMullan Estimating, Tendering and Bidding for Construction Adrian J. Smith European Construction - Procedures and Techniques B. Cooke and G. Walker Facilities Management: An Explanation Alan Park Greener Buildings: Environmental Impact of Property Stuart Johnson Housing Associations Helen Cope Housing Management: Changing Practice Christine Davies (Editor) Information and Technology Applications in Commercial Property Rosemary Feenan

and Tim Dixon (Editors) Introduction to Building Services, second edition Eric F. Curd and

Christopher A. Howard Introduction to Valuation, third edition D. Richmond Marketing and Property People Owen Bevan Principles of Property Investment and Pricing, second edition W. D. Fraser Project Management and Control D. W. 1. Day

Property Development: Appraisal and Finance David Isaac Property Finance David Isaac Property Valuation Techniques David Isaac and Terry Steley Public Works Engineering Ivor H. Seeley Quality Assurance in Building Alan Griffith Quantity Surveying Practice Ivor H. Seeley Recreation Planning and Development Neil Ravenscroft Resource Management for Construction M.R. Canter Small Building Works Management Alan Griffith Structural Detailing, second edition P. Newton Sub-Contracting under the JCT Standard Forms of Building Contract Jennie Price Urban Land Economics and Public Policy, fifth edition Paul N. Balchin, Jeffrey L. Kieve

and Gregory H. Bull Urban Renewal: Theory and Practice Chris Couch Value Management in Construction: A Practical Guide Brian R. Norton and

William C. MCElligott 1980 JCT Standard Form of Building Contract, second edition R. F. Fellows

Macmillan Building and Surveying Series Series Standing Order ISBN 978-0-333-69333-9

You can receive future titles in this series as they are published by placing a standing order. Please contact your bookseller or, in the case of difficulty, write to us at the address below with your name and address, the title of the series and the ISBN quoted above.

Customer Services Department, Macmillan Distribution Ltd Houndmills, Basingstoke, Hampshire, RG21 6XS, England.

Construction Economics

An Introduction

Stephen L. Gruneberg Lecturer in Economics

School of Construction

South Bank University

London

--MACMILlAN

© Stephen L. Gruneberg 1997

All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission.

No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, London W1 P 9HE

Any person who does any unauthorised act in relation to this publication may be liable to criminal prosecution and civil claims for damages.

The author has asserted his right to be identified as the author of this work in accordance with the Copyright, Designs and Patents Act 1988.

First published 1997 by MACMILLAN PRESS LTD Houndmills, Basingstoke, Hampshire RG21 6XS and London Companies and representatives throughout the world

ISBN 978-0-333-65541-2 ISBN 978-1-349-13998-9 (eBook) DOI 10.1007/978-1-349-13998-9

A catalogue record for this book is available from the British Library.

This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources.

10 9 8 7 6 5 4 3 2 1 06 05 04 03 02 01 00 99 98 97

Copy-edited and typeset by Povey-Edmondson Tavistock and Rochdale, England

To my mother

Contents

Preface xiii

Acknowledgements xv

1 Introduction to the economics of construction

Introduction The basic economic problem Money and the real economy The subject matter of economics Economic constraints facing construction professionals The economic approach to design problem-solving The nature of choice in the construction industry

1

1 2 2 4 7 8

12

PART 1 THE CONSTRUCTION SECTOR

2 The construction industry in a historical context 17

Introduction 17 Construction before 1800 - an account of the guild system 17 Construction during the 1800s 18

The emergence of the architecture and surveying professions 19

Construction during the 1900s 21 Changes in the construction industry labour force 21 Demand for construction in the 1900s 23 Construction industry cycles 24 Developments in materials, technology and methods of

construction 29 Professional, trade and public-sector organisations in

construction 32

vii

viii Contents

3 Construction and the economy 37

Introduction 37 The output of the construction industry 37

Economic data of the construction sector 38 Regional variations 41 Exports 43

The economic role of construction 45 Economic sectors 51 Value added 52

The multiplier effect 54 The accelerator principle 57 Construction as a tool of government

economic policy 59 The Keynesians versus the monetarists 61 Government policies 64

4 Supply and demand in construction 68

Introduction 68 Effective demand 69

Derived demand 69 The price 70 Interest rates 70 The prices of other products 72 Income 73 Size of the population 76 Taste 77 Government policy 78 Expectations 78 Shifts of the demand curve 78 Elasticity of demand 79

Supply 83 Price and fees 84 Shifts of supply 85 Products in competitive supply 85 The factors of production 86 Aims and objectives 87 Technology 88 Exogenous factors, government policies, and nature 89 Price elasticity of supply 90

Inflation and the use of index numbers 93

5 Economic structure of the construction industry

Introduction Construction firms Tendering Procurement methods Construction markets Labour markets Unemployment Plant hire market Materials Land Social and political issues Surplus

6 Construction labour economics

Introduction Industrial relations in construction Wage-forms Training and skill shortages Productivity The law of diminishing returns Health and safety issues in construction

PART 2 THE ECONOMICS OF THE FIRM

7 Costs, revenues and pricing

Introduction Factors of production

Rent Profit

Costs Economies and diseconomies of scale Marginal cost Other costs

Revenues Marginal revenue

Profit maximisation Marginal cost pricing Cost plus pricing Forecasting

Contents ix

98

98 99

101 102 105 109 113 115 117 118 120 123

126

126 127 128 130 133 136 137

143

143 144 145 146 148 152 154 156 157 159 160 162 163 163

x Contents

8 Markets 167

Introduction 167 Perfect competition 167 Imperfect competition 169 Monopoly 170 Oligopoly 171 Contestable markets 172 Alternative approaches to understanding markets 173

Transaction costs 175

9 Basic accounting concepts 177

Introduction 177 Book-keeping 178

The trial balance 179 The profit and loss account 180 The balance sheet 182 The sources and application of funds 187

Working capital 187 Ratio analysis 188

The acid test or quick ratio 188 Performance ratios 190 Gearing ratios 192

Cash flow tables 193

10 Planning and control of firms and projects 195

Introduction 195 Business objectives 196 The business plan 196 Corporate strategy 197 The financial management of projects 198 Fast track 200 The use of computers and information technology 201

Computer-aided architectural design/draughting 202 Computerised costing of projects 203 Computerised project management 204 Using computers for administration 205 Using computers for networking communications 205

Contents xi

PART 3 PROJECT APPRAISAL

11 Introduction to feasibility studies 209 Introduction 209 Financial viability versus economic viability 210 Legal and planning constraints 212 Value for money and cost effectiveness 213 Life-cycle costing 214 Economic considerations 214 Social costs and benefits 216 Tangible and intangible costs and benefits 217

Note on double counting 218 Weighting intangibles using money 219 Valuation of human life in economic terms 222

Importance ratings 224

12 Financial appraisal 229 Introduction 229 The principle of discounting 229

Net discounted present value 231 The internal rate of return 233 Annual equivalence and capital values 235 The cost benefit ratio 236 Payback periods 237 Analysis of cost effectiveness 238

Gross development value 240 Tax 244 Regional variations 246 Inflation 246

Residual valuation 248 Conclusion 251

13 Cost-benefit analysis 252 Introduction 252 Life-cycle of projects 252 Balanced economic arguments 253

Environmental issues 254 Social rate of return 255 Terminal values 256 The continuation principle 256

Risk and uncertainty 256

xii Contents

Establishing true values Incremental analysis Comparison of two options The general layout of cost-benefit studies Conclusion

Bibliography

Index

258 258 259 260 264

265

269

Preface

The aim of this book is to introduce students and practitioners of construc­tion and property to economics, with a view to preparing them for a profes­sional life in which they will inevitably discuss the topics raised here with clients as well as professionals from the financial world. It is essential that the comments and contributions of the planner, developer, architect, engineer, builder and surveyor are well informed and expressed in the vocabulary of colleagues in the other professions. The study of economics will also give them the ability and the confidence to communicate with professionals from other disciplines.

The theoretical tools of economics can be used by members of the con­struction and property professions and others to enable them to become imaginative and productive providers of the built environment. The study of economics provides an approach to, and an understanding of, the implica­tions of design and construction, not only in an economic but also in a social context.

The study of economics suggests several general principles. It may be worthwhile, even at this stage, to list some of these. This list is not in any order of priority.

1. A correct decision for an individual is not necessarily a correct decision if everybody decides to do the same thing.

2. Decisions are often taken in terms of a little more or a little less. 3. Let bygones be bygones. 4. What matters is the real world; money only matters in so far as it affects

the real world. S. Always shop around before making a decision - consider the options. 6. From a firm's point of view, it is more important to be profitable than

efficient. 7. There is no one way of doing anything - the best way depends on the

objectives. 8. Nothing in economics is good or bad - it all depends on whose interests

you are considering. 9. Everything has a cost; not all costs can be measured in terms of money.

10. Exchange can make people better off, even when no more is produced.

It is well known that economists rarely agree (partly because of the eighth principle), and it is unlikely that there would be universal agreement on this

xiii

xiv Preface

list, gleaned from a study of the subject. There might not even be agreement about the list itself. Nevertheless, it is to be hoped this book will clarify some of these statements. As it is, the book ranges over a wide variety of subjects in order to provide a bird's-eye view of economics in the context of the produc­tion of the built environment. It is also hoped that readers will be encouraged by this book to read further and deeper.

After an initial introduction to economics in the first chapter, the book is divided into three parts: the construction sector, the economics of the firm, and project appraisal.

Chapter 1 is concerned with the subject of economics itself and the economy as a whole. It aims to show that the study of economics and the economy as a whole have important lessons for the management of con­struction projects and property.

Part 1 deals with the economic context of the construction and property sector, providing a brief summary of its development, the range of built out­put, the types of firm, and their working practices and arrangements. Chapter 2 shows that the current arrangements of the construction industry have largely emerged from historical precedents and traditionally demarcated functions. Chapter 3 examines the role of the construction industry in the economy as a whole, showing the theoretical economic links between con­struction and its customers in both the private and public sectors.

Chapter 4 deals with these links in more detail, showing how construction markets are conventionally described in terms of supply and demand. Chap­ter 5 then extends the concept of markets in a construction context to describe the variety of markets that exist there and to show how markets operate within the sector. Finally, the construction labour market is discussed in more detail in Chapter 6. This completes the first part of the book.

In Part 2 the perspective is seen from a firm's point of view. A firm can range in size and type from a professional practice or small contractor employing as few as one or two people to a large contractor employing many hundreds. Chapter 7 looks at the economics of costs and revenues. This equips the reader for the discussion of the conventional theory of market types in Chapter 8. In Chapter 9 revenues, costs and profits are introduced in terms of balance sheets and profit and loss accounts. Chapter 10 concludes Part 2, with a discussion of business planning and project management.

In Part 3, Chapter 11 introduces the general concepts and principles of feasibility studies, while Chapter 12 describes the discounting techniques which lie at the heart of financial investment appraisal. Chapter 13 looks at the wider economic and social issues raised by cost-benefit analysis.

STEPHEN L. GRUNEBERG

Acknowledgements

I should like to thank the many people who have given me their help, advice and comments, all of which have been invaluable to me in the writing of this

book. I am therefore very grateful to my friends and colleagues, includingjohn Adriaanse, Michael Ball, Derek Beck, Linda Clarke, jeff Denton, janet Druker,

Graham Ive, Farzad Khosrowshahi, julia Lemessany, Keith Povey, james Semple, Malcolm Stewart and Frank Woods, all of whom have given me sound advice and the benefit of their knowledge. I am also very grateful to Norman Allen, of the Plant Hire Association, and Peter Gill, of the Builders Merchants Federation, for their time and help. Above all, my long-suffering wife, jan, who has supported me throughout, deserves a special thank you.

Crown copyright material is reproduced with the permission of the Controller of HMSo.

xv