Can Tracking Construction Help Predict Economic Decline?

It's been a while since we here at Don't Quit Your Day Job have collaborated with another site to give you some original epic pieces. Today, we rectify that by teaming up with the inimitable ADP at American Debt Project. ADP is one of the good ones - a debt blogger who is actually seeing declining debt. And isn't that the way the debt genre is supposed to work? (And almost never does?). Follow her progress as she does what so few others do.

ADP came to us with a curious question: Can we use building statistics to see when economies become overheated? Basically, she wanted to know if watching building trends and construction would provide any clues to where an economy is headed. Evidence is slim, but let's take a look at the numbers and see what we can figure out!

China, Japan, and the United States

We chose to bust out the microscopes on three countries - China (the newest media growth darling), Japan (the last media growth darling) and the United States (US, at least for ADP and yours truly). We decided to start our examination in 1953 - as you recall from your intensive studies of history, the United States occupied post war Japan through 1952... so statistics before that aren't very worthwhile.

On the Japan side, GDP reached pre-war levels in 1955, and they experienced an 'Economic Miracle' through at least the early 70s. GPD growth slowed for a bit, only to boom again right aroung 1980. In 1991, prices collapse, leading to what has been called a 'lost decade'. Of course, that decade became a score of years and they've now seen 20 years of sub-par growth.

China is a bit of a different story. Even today, with shades of past socialism, China likes to think in "five year plans", where the massive power of state investment will concentrate on identified problems. The first five year plan from 1953 to 1957 led to booming heavy industry and agriculture, but the "Great Leap Forward" from 1958 to 1960 led to millions of deaths and a massive economic contraction. China had two more periods of growth under socialism - from 70-74, and again in the years before 1978. 1978 was when they started to liberalize economically, ditching some of the socialist control and unleashing growth of the free market. Especially since 1982 (the first few years were known as the "Period of Readjustment") China has reported massive growth in GDP, with only a minor hitch during the Asian financial Crisis (1997). Setting aside the fact that China's statistics aren't the most trustworthy statistics coming from a foreign government (to be fair, neither were Japan's, at least before 2007), they've undoubtedly had quite a run since their free market reforms.

The United States has a well-known history to most of the readers here. The NBER publishes exact beginning and ending dates for US Recessions, recognizing 10 since 1953 (with two being adjacent, namely 1980-1982). The biggest recession in that time, of course, was the so-called "Great Recession" which ended officially in the second quarter of 2009 (but the after effects continue). 1990-1991 also saw a real estate led recession, while the oil crisis and stagflation of the recession in 73-75 also depressed construction.

How does that map to our chart of Construction as a percentage of GDP? (Sources below)

The Correlation is Strong With This One...

Due to our unreliable statistics (that are oh-so-hard to find online for two of the three!), it's unsafe to say that we can predict recession when the construction sector gets overheated. However, the chart is incredibly interesting, especially when it comes to Japan and the United States. Japan shows perfectly the decline due the the Lost (two) Decade(s), with a minor inflection coming at the end of the 1970s (only to run up again in the 1980s!). The United States clearly shows the effects of stagflation, the early 90s, and the Great Recession.

China? A different story. Construction as a percentage of GDP growth is at an all time high according to the statistics we found, and while rumors of the Chinese economic collapse abound, evidence is still ambiguous (but mounting).

One thing we can say is that construction is incredibly volatile. Note that the chart shown is construction as a percentage of GDP, not construction in total. That means every fall means other sectors take up more of GDP than construction previously had. That means that we can safely say that construction heats up faster than the rest of the economy in many booms, and falls faster in many recessions - so even if it doesn't hold predictive power, construction as a percentage of GDP is an interesting metric, nonetheless.

Here's what ADP had to say about this data:

We’re lucky that this collaboration included PK doing most of the heavy lifting. Thanks to his innate skill at showing us the hard numbers, I’d like to point out some interesting anecdotal evidence related to real estate and construction. What jumps out about construction spending as a percentage of GDP is its correlation to other economic factors and its own volatility. Construction, like PK mentioned, is incredibly volatile in both its upward and downward trajectories. When we consider the housing markets in the US that crashed the hardest, such as Phoenix, Miami, Las Vegas, inland cities of Southern California and smaller cities in these regions, these were the same areas where mega-developments and thousands of condo developments mushroomed like an unrestrained fungal growth. Overly ambitious, aspirational developments tend to come at the tail-end of a construction growth spurt, like the $8.5 billion CityCenter in Las Vegas (including the Harmon Tower, which will most likely be demolished after being revised to half its original size and never completed due to construction defects). So the next time you see a huge development being built in an area with little else to sustain economic growth, it may be time to review construction spending statistics again.

As to the question of whether China is headed for a similar economic collapse with construction growth being just one indicator, it becomes useful to consider some cultural differences. The US and China have differed greatly in household savings rates: while the US has rarely hit a 10% savings rate in the last 30 years (hovering around 1% in the boom of 2005-06 and currently sitting at 4.4%), China continues to post household savings rates of about 29%. The entire nation is saving nearly one-third of their income on a regular basis?! Chinese consumers are simply not the consumers of the West and although many Western companies are successfully importing a consumer culture into China, Chinese consumers tend to show more caution and will continue to save a significant portion of their income. An impressive savings rate may not ward off an economic downturn, especially when China needs greater consumer spending to continue its growth, but the people still seem better off if they continue to exercise caution as they experience growth in personal income.

For a more depth piece on construction by ADP, visit her companion piece.

Conclusions?

Even though the data isn't specific enough to make awe inspiring conclusions (perhaps weekly or monthly data could do that?), it is certainly interesting to see how the three economies did in terms of construction since World War II. China, if stats are the be believed, is now the leader of the bunch (and with the cheapest labor, that would translate to many more projects than Japan and the US, as a percentage of GDP). So, while we can't quite predict recessions from construction data, we do know one thing - China has had an epic amount of growth since the 1980s.

However, before you lament the downfall of the US remember that the US had a GDP of $15.1 trillion in 2011 compared to a GDP of $7.3 trillion in China. We do have stats on 2011 in China and the US - and 6.79% of 7.3 is still less than 3.45% of 15.1. However, it's getting too close for comfort!

What do you think about the data presented? Are you worried about China's construction sector surpassing the United States, perhaps even this year? Did you worry about Japan in the 1980s eclipsing US GDP? Have you bookmarked and subscribed to American Debt Project yet? Have you read ADP's follow up article?