House of Commons - Business and Enterprise

Select Committee on Business and Enterprise Ninth Report

3 Increasing capacity

79. Since the end of the recession in the 1990s the sector has had near continuous growth in capacity, due in part to the ability to respond to demand and its openness to migrant labour. In this chapter we look at the recent expansion of the construction industry, and estimates for its future growth. We then look at the ways in which the industry's capacity has expanded in recent years, its ability to continue doing so, and the implications of any constraints for construction price inflation. Finally, we consider what role government can play as client to the sector to help it plan to meet future demands.

Recent and predicted growth

80. Since 1995, the industry has expanded in every year bar one. It has grown by 20% in the last five years alone—a performance the Construction Confederation described as "unparalleled".[103] This move away from the shorter-term boom and bust cycles that characterised the sector in previous decades has been underpinned by a combination of continuous growth in the private sector and large increases in public sector capital investment. Overall, new publicly-funded construction work, including Private Finance Initiative projects, has risen by around 50% since 1999.[104]

81. At the time we launched our inquiry, many commentators were predicting the construction sector would maintain its recent growth in the years ahead. The expectation was that any drop in public sector construction output would be offset by continued growth in the private sector.[105] However, in the wake of the US sub-prime mortgage market crisis, this looks too hopeful. The Royal Institution of Chartered Surveyors recently recorded a slowdown in reported workloads, particularly in the home-building sector.[106] Similarly, the latest government statistics show a 1% fall in new private housing work in 2007, compared to 2006. This was, however, offset by increases in output in other areas of the construction industry with, for example, private commercial work 13% higher than in 2006. This meant that overall, the sector's output grew by 2% in 2007, and its total employment was also up by 5%.[107]

82. It is difficult to predict how the construction sector will fare in 2008 and 2009. The latest Construction Skills Network report forecasts a decline or little change in activity for much of the private sector. However, it anticipates this will be partly offset by growth in public sector and infrastructure output.[108] Non-housing public expenditure on construction fell in recent years, though it is now expected to increase by 3.7% per annum up to 2012, due largely to the Government's Building Schools for the Future programme. Public sector housing output is also set to grow by 2.9% per annum as the Housing Corporation works towards its target to produce 45,000 social housing units annually by 2010-11.[109]

83. Expenditure on infrastructure is expected to outpace the rest of the industry with annual growth of 5.7% in the period up to 2012. Whilst the Olympics is perhaps the most high-profile construction project in the short to medium term (but still accounting only for 5% of construction work in the South East during this period), there are also a number of other anticipated infrastructure projects.[110] These include the East London Line and Docklands Light Railway extensions; railway station redevelopment at London Victoria, Reading and Birmingham; the M25 widening; Heathrow Terminal East; Crossrail; and the Thames Gateway regeneration scheme. Nor is this growth in activity confined to the South. Infrastructure work in Scotland is expected to expand by 6% a year between now and 2011, whilst a new programme of investment in Northern Ireland will see expenditure of £14.4 billion in the next seven years.[111]

84. The construction industry has enjoyed a period of sustained growth for over a decade, in sharp contrast to the cycles typical of much of the post-war era. Construction output in parts of the industry, particularly house-building, is experiencing a sharp downturn in the wake of the fall-out from the sub-prime mortgage market crisis. While public sector expenditure is always subject to a degree of political uncertainty, in the coming years the industry currently expects to benefit from rising infrastructure investment and greater spending in areas such as social housing and education.

Sources of capacity growth

85. The industry has increased its capacity in several different ways. The Construction Products Association told us its members had augmented their manufacturing capacity by 10% in the past two years, and were expecting to add the same again in the next couple of years.[112] Capacity and productivity have also been increased through improved construction methods such as greater use of IT, offsite manufacture, prefabrication, and automation.[113] This has resulted in some increase in capacity, but has been limited by the industry's traditional aversion to new techniques. We explore the issue of innovation fully in Chapter 7. Innovation aside, the most important determinants of the industry's capacity to respond to demand in recent years have been the supply of skilled labour and the planning system.

LABOUR SUPPLY

86. It seems likely that labour force growth will continue to provide one of the main means of capacity growth in the short to medium term.[114] Construction employment has risen by just under 500,000 in the past decade, although the rate of recruitment has remained relatively flat, suggesting that the duration of employment in the sector has increased over this period.[115] The Construction Skills Network estimates that to meet the expected expansion in construction output in the coming years, even taking account of a possible slowdown, the sector will need to recruit an average of 88,400 new recruits in each of the years up to 2012. This figure covers a range of skills and disciplines, including almost 10,000 extra workers in the electrical trades and installation sector every year, more than 12,000 construction professionals and technical staff, and 6,350 construction managers.[116] Within this, there will be considerable regional variation. Double-digit employment growth is anticipated in Wales, Northern Ireland and the East of England. In absolute terms, though, the largest sources of demand will be London and the South East, requiring over 28,000 new entrants in each of the next five years.

87. The new recruits needed in construction are expected to come from a range of sources, including school-leavers and other domestic new entrants.[117] We talk about increasing domestic capacity in Chapter 5, but for the industry to provide capacity in the short term, migration must also play an important part in meeting the future demand for new workers. The UK's ability to attract foreign labour explained why many organisations we spoke to, such as ConstructionSkills and CABE, were confident that the industry would achieve the increase in recruits it needed in the coming years, although there were likely to be shortages for some specific skills and disciplines.[118]

88. The Department for Work and Pensions (DWP) told us migration has "long made a small, but nevertheless important, contribution" to the UK's employment needs and that this is likely to continue in the future.[119] For construction in particular its current estimate of the number of migrants is around 144,000 out of 1.8 million manual workers in the sector (although this does not take account of illegal workers).[120] The extent to which the industry depends on migrant labour depends on its location. In most of the UK the proportion of migrant workers in construction is lower than in the wider working population. However, the proportion of the construction workforce that is migrant labour has risen from 4.6% in 2001 to 7.7% in 2006, and in London its share of employment has risen from 21.5% to almost 42% during the same period.[121]

89. Although the UK has traditionally drawn migrant workers from countries such as Ireland, the majority of those entering the sector in recent years have come from Eastern Europe.[122] Poland has been the chief source, followed by other countries that joined the EU in 2004. Several organisations, including ConstructionSkills, emphasised that migrant labour in construction is generally highly skilled and so mitigated the effects of domestic skills shortages.[123] A recent survey of construction firms by the Confederation of British Industry (CBI) found 41% expected to hire skilled migrants while only 29% expected to hire unskilled labour.[124] Evidence from DWP suggested the influx of Eastern European labour had had no discernable effect on claimant count unemployment, suggesting almost all of those that have entered the UK in recent years have done so to work. As ARUP told us: "Without these workers, our capacity to deliver major projects would be severely reduced".[125]

90. The increased use of migrant labour in the UK's construction industry was not welcomed by everyone. Unite—the union told us the UK was "over reliant on an imported off the peg skilled workforce".[126] While it accepted the benefits that imported labour had brought, the Construction Confederation considered that the current dependence on cheap foreign labour reduced the incentives for firms to invest in more modern methods of construction, and so was concerned that migration was a possible barrier to innovation.[127] The Minister did not accept this, and cited the fact that wage growth in construction has outstripped that of the rest of the economy as evidence that firms have not been able to artificially depress earnings by using migrant workers.[128] We are not convinced by this argument. The fact that earnings in construction have outpaced the rest of the economy might simply mean they would have been even higher if firms had not had access to an external source of labour.

91. While the possible effects of migration on construction innovation are largely anecdotal, there was a consensus that long-term reliance on migrant labour is not sustainable. ConstructionSkills told us it believed East European migrant workers came to the UK with the intention of accumulating savings for two to three years, before returning to their home country.[129] The recent decline in the value of sterling and increasing construction wages in Poland are likely to draw workers back. The Minister too stated "we may not be able to benefit from as many migrant workers in the future as we have done in the past".[130] Reports suggest this process has already begun. There was a 10% fall in East European migrants approved for work in the UK in 2007, compared to 2006.[131] The Institute for Public Policy Research also estimates that half of the one million migrant workers who entered the UK since 2004 have now returned.[132]

92. One of the main sources of capacity growth in the construction industry in recent years has been the availability of skilled migrant workers, predominantly from Eastern Europe. This imported labour has helped mitigate the effect of skills shortages and facilitated the continued expansion of the industry. However, it will not provide a long-term solution to the construction industry's skills needs since, over time, most foreign workers will return to their home countries. This means there is an ongoing need for the UK to invest in its own construction skills base—an issue we return to in Chapter 5.

THE PLANNING SYSTEM

93. The planning system is another crucial determinant of construction industry capacity. The Home Builders Federation (HBF) told us that unlike skills availability, construction methods, or materials, planning is different because it is largely outside the industry's control.[133] It referred to the supply of land through the planning process as the industry's "lifeblood".[134] Various parts of the construction sector have concerns about the planning process. For example, the Quarry Products Association told us that quarry operation and restoration plans that create environments attractive to birds are now potentially subject to planning objections from aviation authorities because of their policy to create 'bird-strike safeguarding zones' for a 13 km radius around airfields.[135]

94. In the housing sector the HBF told us that it currently requires on average 15 and a half months for a residential planning application to be approved and that the amount of land coming through the system actually fell by 7% between 1997 and 2003.[136] The Federation saw this as the biggest single constraint on the Government's ability to increase the rate of housing new build in the UK.[137] In the infrastructure sector too, there have been many high profile examples of large-scale projects that were delayed significantly by the planning system, including the newly opened Heathrow Terminal 5 and Sizewell B nuclear power station.[138]

95. Although largely outside the scope of our inquiry, the planning system fundamentally determines the capacity of the construction industry through the supply of land, which can be developed and the uses to which that land can be put. This constraint affects all parts of the sector, from quarry products, through house-building, to infrastructure. The Committee looks forward to engaging further on this issue in the next Session, when it will be scrutinising the National Policy Statement for energy.

Construction price inflation

96. For some time construction prices have been increasing at well above the overall rate of inflation, which suggests that the industry's capacity is now constrained.[139] The Building Cost Information Service's (BCIS) current forecast of tender price inflation is 4.8% for 2008, with a rate of 6.5% in London.[140] There are several underlying causes of these inflationary pressures. First is the sustained increase in construction demand in recent years. Second is the shortage of skilled labour. Although, this has been partly offset by the influx of migrant workers, nonetheless, wages in construction have continued to grow faster than in the wider economy. Finally, shortages of key materials such as steel, copper and timber have also raised input costs significantly as has the rapidly rising cost of energy. Raw material costs have increased because of demand from other parts of the world, including China and the Middle East.[141]

97. The City of London Corporation told us pressure from the Olympics was likely to lead to a higher level of tender price inflation in the capital, although the Games were not expected to result in prohibitively high price levels in the City.[142] The Government's own estimates are for the Olympics to add 0.2% per annum to tender prices between 2006 and 2010.[143] The more worrying issue is the impact of inflationary uncertainty on construction contractors in long-term fixed price contracts. The Chartered Institute of Building suggested this may have the effect of firms being unwilling to enter into contracts without significant risk premiums being built into their bids.[144] This could impact on projects such as the Olympics, Crossrail and Heathrow East, all of which have long-term delivery schedules.

98. Despite the offsetting factors of recent migration and the current economic slowdown, a combination of high demand, skills shortages and rising input prices has led to construction price inflation running at above the overall rate of inflation. However, we cannot predict what the effect of the current industry downturn will be. Construction price inflation poses a cost risk to construction firms on long-term contracts. It also reduces the cost certainty for public sector clients of long-term projects such as the Olympics.

Helping the industry plan for additional capacity

99. The project-based nature of much construction activity means that the industry often takes a short-term attitude when making decisions about capacity investment, and fails to invest in areas such as training, new technologies, innovative ways of working or client relations, all of which could raise productive capacity in the long run.[145] For example, an apprentice would usually gain experience through working on several projects over time. However, a small contractor may not be able to offer sufficient employment security for them to be able to complete their training. Ultimately, the client suffers the consequences of this short-termism through higher tender prices and an end-product delivered through traditional construction methods, rather than using practices designed to give them best value.[146]

100. As the largest client to the construction industry, the public sector could potentially structure its work to give the sector's supply chains the security to invest in their capacity. The Construction Confederation told us the industry has "a great capacity to deliver when it gets engaged early".[147] Buildoffsite said that engaging as early as possible with suppliers helps to ensure that the optimum construction techniques are identified and gives them time to plan for greater investment in manufacturing capacity and the required skilled resources.[148] Indeed, this view was echoed by most of the industry's main representative bodies.[149] In evidence, the Minister himself also agreed that there is "huge potential […] for the public sector in its procurement activity to be helpful to the industry, and indeed to promote improvement".[150]

101. While the public sector provides the most stable part of the industry's work in one sense, at the programme and project level it has often been characterised by volatility and poorly co-ordinated demand. This partly reflects the political context in which the public sector operates. That said, ARUP told us other countries, for example France, generally have a greater capacity than the UK for the delivery of large infrastructure projects on time and to budget because of their use of longer-term investment planning.[151] In recent years, there has been a growing acknowledgement in the UK of the importance of early engagement with the construction sector to help ensure it can deliver the Government's investment pledges. For example, the spending review system provides an indication of spending on public sector construction anticipated in the following three years, as do longer-term planned programmes of expenditure such as Building Schools for the Future. Elsewhere, Ofwat is setting out long-term investment plans for the water industry and the Department for Transport is developing a 30-year national rail strategy. However, such intentions are inevitably subject to the perennial uncertainty over longer-term public spending plans. Statements of policy, such as the commitment for all new homes to be 'zero carbon' by 2016, also provide information to the construction sector on the direction of travel of the Building Regulations and where it should focus its capacity investment.

102. In the area of planning, the Government is currently introducing a new single system for major infrastructure. The reforms will include the establishment of National Policy Statements to inform planning decisions on major projects. They have the potential to make the consent system for infrastructure projects more predictable, which could allow the construction industry to plan more effectively for their delivery, although, as the Institution of Civil Engineers told us, this would have to be "accompanied by increased cross-government planning of construction work flow".[152] Another change in planning policy, this time at a local level, has been the introduction of Planning Policy Statement 3 on Housing, which entered into force in April 2007. This requires local authorities to identify a rolling five-year forward supply of developable land sufficient to meet their agreed housing requirements. This information should help developers to plan for the longer-term, but house building rates will still depend on the strength of the housing market.[153]

103. Despite these improvements in the Government's approach, the construction industry believes it could still do better. The Construction Products Association (CPA) told us that while details of government spending plans were useful for the sector, firms would find it more helpful if these were set out, for example, in terms of number of schools to be built rather than overall expenditure levels. The CPA said it is "output targets, not input spend, which interests us".[154] In addition, whereas some parts of the public sector have improved information flow to the construction industry, there are many other areas where there is still uncertainty and confusion because the Government either does not collect information on progress towards a particular target, or does not communicate well when programmes have been delayed or changed.[155]

104. The CPA produces an annual report which monitors and assesses the delivery of the Government's plans for investment in the built environment.[156] It covers six areas of activity—social housing, schools, the NHS estate, roads, the rail network, and water—on which it scores the Government's performance against its targets and makes recommendations. In its most recent report the CPA gave three stars out of a potential five for the public sector's new build work, but only two stars for its efforts with the existing building stock. The CBI also highlighted its concern about public sector procurement delays.[157] It found on average delays in the procurement process on health Private Finance Initiative schemes amounted to £2.45 million on each deal. It also cited findings from the Major Contractors' Group of average delays of just under eight months for health projects and seven and a half months for schools. The CBI argued that such procurement delays are "costly to bidders and the taxpayer and seriously undermine the drive for value for money and efficiency in public services".[158] More generally, the Construction Confederation told us the public sector needed to be more realistic about the delays that tended to blight major construction programmes.[159] What is important is the flow of information to the industry when such delays or cut-backs are anticipated.

105. Not only is it important for the Government to establish long-term programmes and communicate progress and changes to planned delivery, it also needs to have adequate phasing of projects to ensure a steady flow of work to the industry. This too will help its supply chains keep together experienced teams that can move from project to project.[160] This is also important where the timescales for major infrastructure projects overlap. For instance, the Royal Institution of Chartered Surveyors noted the general belief by those in the industry that the Olympics, Crossrail and the M25 expansion would collectively need careful co-ordination to avoid spikes in construction price inflation and delays to delivery schedules.[161] Yet the Institution of Civil Engineers told us at present "there is little evidence of serious co-ordination".[162] In a recent report it argued that the Government needed to provide greater client leadership to the construction industry on the demand for infrastructure work. It called for the setting up of an independent national commission for strategic infrastructure planning whose role would be to co-ordinate spending programmes across the public sector and "bring an end to unpredictable, stop-start procurement".[163]

106. In recent years the public sector has responded to calls for greater co-ordination of construction activity. A review by Sir Christopher Kelly in 2003 made recommendations on the importance of engaging suppliers at an early stage and ways in which sharing supply and demand information can enable better planning in the construction industry.[164] This work is now being led by the Public Sector Construction Clients' Forum (PSCCF). In 2006 the PSCCF produced a report on construction demand and capacity. One of its key findings was that, assuming there would be no restrictions on the use of migrant labour, the UK would not face any significant general labour capacity constraints between now and 2012, although there would be shortages in some specific areas such as project management and design.[165] The study also produced an econometric model to help government analyse the impact of different scenarios and therefore inform investment decisions. The Minister told us he thought the Forum "does give us the opportunity to improve the flow of information to the industry […] about what is coming up".[166] These developments, combined with the current work of ConstructionSkills to forecast future skills needs, have the potential to enhance the construction industry's long-term capacity planning. However, they are still dependent on the provision of reliable and timely information on construction demand from the rest of the public sector.

107. If the construction industry is to have an incentive to improve its capacity to deliver in the long run by investing in training and new ways of working, it requires the security of a long-term flow of work. The public sector is beginning to acknowledge the role it can play in engaging early with the construction supply chain. It is setting longer-term investment programmes for public services, introducing a new approach to planning, and has clearly committed to 'zero-carbon' homes by 2016. However, it could still do more to improve the flow of information to the construction industry, particularly when programmes are delayed, amended, or abandoned. We believe that there is scope for greater co-ordination of major construction projects to mitigate the effects on construction price inflation and to ensure a steady workflow for the industry, although the industry must recognise that its health is only one of the factors the public sector has to take into account. Like any other client, different parts of the public sector will expect to arrange their construction projects to meet their own needs.

108. One of the responsibilities of the Chief Construction Officer should be leading the Public Sector Construction Clients' Forum's work on capacity planning. The post-holder should work with departments both to improve the flow of information on construction programmes, and to advise on their co-ordination. As the industry's largest single client, the public sector ultimately benefits from such early engagement.

103 Qq 140 (ConstructionSkills) and 586 (BERR); Ev 208, para 4 (Construction Confederation, Construction Industry Council and Construction Products Association) Back

104 Ev 208, para 5 (Construction Confederation, Construction Industry Council and Construction Products Association) Back

105 Unite-the union, Sustainable Solutions for the Long-Term Supply of Skilled Operatives to the UK Construction Industry, 2007 Back

106 BBC News Online, Housing decline hits construction, 31 March 2008 Back

107 National Statistics, Output and employment in the construction industry 4^th quarter 2007, 7 March 2008 Back

108 Construction Skills Network, Blueprint for UK Construction Skills 2008 to 2012, March 2008 Back

109 Ibid. Back

110 Ev 272, para 2.1 (Institution of Civil Engineers) Back

111 Unite-the union, Sustainable Solutions for the Long-Term Supply of Skilled Operatives to the UK Construction Industry, 2007 Back

112 Q 10 (Construction Products Association) Back

113 Ev 226, para 33 (Constructing Excellence) Back

114 Ev 243, para 1.4.6 (Davis Langdon) Back