Recession – Yes or No?
Thomas C Schleifer, Ph.D.
As the Fed uses interest rates to joust with inflation, everyone wants to know if we’re headed into a recession. The dreaded R word is on everybody’s mind. Do I think we’re in for an immediate recession? How severe will it be? How long will it last? These are the topics that dominate almost every conversation I’m having with construction industry leaders.
The R Word
After giving it careful thought, my answer is: It depends on what you mean by recession.
Recession has become an economic buzz word. Everyone has a different definition.
- A common definition is – two consecutive quarters of decline in GDP (Gross Domestic Product).
- Others believe that is too narrow a definition. They think that a recession just needs to be a contraction of the economy, featuring shrinking production and consumption, higher unemployment, and (sometimes) lower price levels.
- The National Bureau of Economic Research (NBER), a leading economic think tank founded in 1920, is the generally recognized authority in the United States when it comes to declaring a recession. It calls a recession “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”
- Contractors tend to be a little less academic. Most see recession simply as a “shrinking” of contracts available both in government work and the private sector. In other words, recession means less work; fewer contracts; and more competition for scant projects. Construction recessions depress revenues. It’s about the top line.
Because construction services are conceived, designed, funded, and contracted for long before actual work begins and money changes hands, construction lags far behind declines in GDP. Contractors are still busy completing long term contracts well after economies have taken a downward turn into economic recession. In fact, if recessions are brief, the construction industry sometimes doesn’t even notice. Right now, contractors are busy completing existing projects and aggressively signing new contracts that will keep them busy for another 12 to 18 months. At the same time, the Fed is trying to push the economy into recession by bumping rates in three quarter point increments; the most aggressive interest rate increases since Paul Volcker gave inflation a thumping back in the 80s. There is little doubt the economy will drift into a technical recession. The primary issue for contractors is – how long will it last and will they (hopefully) be too busy to notice?
Because the consumer economy does not have an immediate effect on construction revenues, classic definitions and discussions about technical recessions caused by the Fed’s fight against inflation are not good indicators of the construction market. What is critical in construction, and worthy of notice, is the impact rampant cost inflation has on construction profits.
Here’s my answer to the recession question: The construction industry is already entering a “bottom-line recession” caused by an inflation spiral in wages and the cost of materials that cannot be easily passed on to the consumer of construction services because our industry fixes its selling price by contract. The energy industry, the food industry, and the automobile industry are all enjoying record profitability during this inflationary spiral simply because they can easily mark up and pass on cost inflation to their consumers. The construction industry does not enjoy that luxury, so for us, inflation is recession. That’s my message to contractors. We are already entering, if not in, a bottom-line recession.
When it comes to the question of the battle against inflation leading to recession, the construction industry is almost an economic counterweight to the economy at large. While the Fed wants to cure inflation with mild recession, the construction industry needs to cure bottom-line recession with selling-price inflation. During periods of rampant cost inflation, contractors need to reverse fields and change the way we traditionally do business:
- By carefully passing on cost inflation to consumers of construction services.
- By reevaluating the philosophy of competing for work by submitting the lowest bid.
- By retooling estimating programs to take continued cost inflation rates into account.
- By being satisfied with less work during inflationary periods knowing that the difficulty of passing on inflated costs to consumers portends “bottom-line” recession for the construction industry. (More “cheap work” in not the answer. Think “profit” not volume.)
Recession – Yes or No?
So, when I’m asked whether we’re about to enter a recessionary period and how deep and long it might be, my answer is – Recession? – Yes – Because in the construction industry the selling price always lags cost inflation thus creating “bottom-line” recession.
Next week: Project selection in a recessionary environment.
For a deeper look into the recession, its effect on the construction industry, and strategies and mitigation factors, read more here: RECESSION
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