How did the construction sector get it so wrong?

Some headlines from SA’s popular financial media just this morning paints a bleak picture of the state of, and future for, the country’s construction firms.

• Mismanagement stuns Sanyati – profits down 60%+ for 6 months ended August, company hinges fortunes on increase of public spending.
• Construction: From darling to dust? – prominent analyst says “If you didn’t own building and construction shares you just looked absolutely stupid up until a year or so ago, and you have looked very clever since then.”
• Construction wobblies – “Construction giants WBHO and Group Five express their concern as work disappears.”

The list goes on, but we’re all familiar with the realities. But more importantly, it begs the question: How did this group of entrepreneurs – particularly in the construction sector – manage to get it so wrong? How did they all make such a massive mistake in anticipating the future state of the economy, and hence, lead them to expand business to deal with this fountain of demand? And to top it, they all floundered at exactly the same time? Many of the local construction companies went as far as Dubai to partake and expand business. Now the future is not as it seemed, and these firms are having to rely on the government to provide work for them.

Well, for those who care to listen, the reasons are in fact really simple . The business cycle is caused by the increase in the supply of money and credit in the economy, which has a tendency to reduce the market rate of interest. Freeman explained the SARB’s tools and methods of doing this in recent posts. As the SARB forcefully lowers the rate of interest below levels that would prevail in a free market, entrepreneurs take it as a signal that capital goods and savings are sufficiently available in the economy with which it can firstly expand on productive activities, and that once the projects are completed, there are available savings that would validate the investments. Increasing savings and capital accumulation go hand in hand with wealth creation, and a higher level of savings and capital in an economy is accompanied by a lower level of the market rate of interest. But when the market rate of interest is lowered through credit and money creation, additional wealth has not yet been created. The wealth effect is, in fact, merely an illusion brought about by a short-term rise in the levels of credit and money. The problem is that entrepreneurs cannot distinguish between this real wealth and phony wealth, and once the reality dawns, it is in fact already too late. The majority of these capital intensive investments accompanying the credit-induced boom are malinvestments. They should never have happened in the first place. The economy, as a whole, is impoverished as resources were withdrawn from uses deemed by the consumer to be more productive to uses less productive – hence the impoverishment.

Hard as the SARB may try to reinflate the bubble in the short-term, the fundamentals of the SA construction sector remain weak, and it is highly unlikely that the size of the population and the growth in real wealth will see a turnaround here soon. Historically, a boom-bust industry has seldom – if ever – led the way for a sustainable economic recovery. We reckon SA will be no exception.