Area Economy

Construction has varying impact on state economies

March 27, 2015
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State economies are affected differently depending on the level of construction activity relative to their overall economic activity. The bubble in residential construction in the first part of the 2000s is a prime example.

The so called “sand states” (Arizona, California, Florida and Nevada) were most heavily affected due to the concentration of overbuilding. The impact from the downturn in residential construction spread out from those states to the rest of the country as demand for inputs to construction fell. However, it ultimately was the fallout from substandard lending and financing practices for residential mortgages that sharply curtailed construction activity and sent the U.S. economy into a sharp recession.

The relative impact of the construction industry on each state’s economy can vary dramatically. It has ranged from a high of 14.8 percent of state GDP in Nevada in 1997 to a low of 2.8 percent in Delaware in 2012.

This variation can be seen within a state over time. Nevada’s peak of 14.8 percent, in a period when the joke was that the state bird was the (construction) crane, fell to a low of 4.4 percent in 2012. For Delaware, the impact of the construction industry was as high as 5.8 percent in 1997. Even in the District of Columbia, the range has been from a high of 1.7 percent (2002 and 2003) to a low of 1 percent (2008-10).

In 2013, the top five states for construction as a percentage of state GDP were Mississippi, Hawaii, Louisiana, North Dakota and Montana. The boom in the energy field benefited all but Hawaii from construction related to fracking (especially in North Dakota and Montana) to refineries and ports (Mississippi and Louisiana). Louisiana benefited from significant industrial construction in 2013. The resurgence in tourism following the recession and sharp increase in lodging construction benefited Hawaii and, to a lesser degree, Louisiana. The inflow of money from defense spending benefited Hawaii and Mississippi. Residential construction also rebounded strongly in Hawaii in 2013.

The bottom five states in 2013 for GDP were Delaware, Michigan, Connecticut, Oregon and Ohio. The construction industry represents about 3 percent of state GDP for all five states, which is not that far below the 3.7 percent for the United States as a whole. Delaware and Connecticut tend over time to be less dependent on the construction industry. Michigan and Ohio are still recovering from the effects of the recession and are more dependent on manufacturing.

2015 promises continued improvement for the U.S. economy and construction. The year is likely to produce significant changes for some industries. The likelihood of continued low oil prices for much of the year (and possibly beyond) will slow investment in exploration and new production. This will adversely affect equipment suppliers to the oil industry. At the same time, it will increase the availability for construction of skilled workers, many of whom have been employed in the energy sector.

Meanwhile, lower energy prices are benefiting many manufacturers and are putting money back in consumers’ pockets. It’s a slow process, but increased consumer spending will ripple through the economy. The demand for more consumer goods and services will mean increased need for facilities to produce those goods and deliver those services (e.g., office space, lodging, health care facilities).

Increased hiring to meet those needs will raise income among those who return to the workforce, those who move from part-time work to full-time work, and those who move to a better paying job or receive an increase in pay above the inflation rate. They, in turn, will spend more, continuing the virtuous cycle. For some, the increased income will spur the purchase of their first house or a move to a more expensive house. Some will purchase a newly constructed house, increasing demand for construction. Another beneficiary of the improving job market will be demand for rental properties as newly hired workers move out of shared living arrangements. Rising rents will keep multifamily projects moving forward.

Construction of single-family structures will remain below the long-term needs of the nation, but will increase over last year. Construction of multifamily structures, which are already close to the long-term needs of the nation, will increase moderately. Any evidence of overbuilding in a particular locale will be quickly reined in by lenders. In most markets, this means an adjustment period of two to three months as the oversupply of rental units is absorbed and demand puts upward pressure on rents. Thus, expect overall residential construction activity to advance somewhat faster in 2015 than in 2014.

One of the big unknowns is what government spending on infrastructure projects will be this year. A number of politicians on both sides of the aisle have touted the importance of infrastructure to the U.S. economy and indicated a willingness to fund such projects. At the same time, there is little agreement on how to fund them.

There are risks to this modestly optimistic economic forecast. The complete fallout from the significant drop in energy prices may play out in unexpected ways, though we believe that, on net, the effects will be positive for the U.S. economy. At some point (most likely in the third quarter of this year), the Federal Reserve will begin a process of raising interest rates. The increases in 2015 should not have a significant impact on economic activity. Other, positive forces should more than offset the negative impact of higher rates. The Fed also will be cautious in its moves to raise rates for fear of undermining the expansion, but the risk of too fast an increase remains.

Another risk is the recession in Europe, which is already hurting U.S. exports to Europe. On the other hand, lower energy prices greatly benefit European economies and should help limit their downturn. Although we expect the negative impact on the U.S. economy to be fairly modest, the risk for greater fallout exists.

The biggest risk from Europe to the forecast is from what happens to the euro and how that ripples through the financial markets. The impact of the exit of a nation from the euro (voluntary or otherwise) is unknown.

Although these risks to the forecast are real, we believe most of the risks will be avoided or the negative effects from them will be limited. We expect the U.S. economy to perform somewhat better this year than last and for the construction industry to benefit from that improvement.

Bernard Markstein is an economist with Associated Builders and Contractors.

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