The economics of construction price inflation: measurement, output and productivity

This thesis evaluates the UK construction price and cost indices and their use in measuring inflation, construction output and productivity. It proposes theoretically grounded and econometrically sound models for construction demand and supply. This study reviews the compilation methods of the published tender price indices (TPIs) in the UK and finds that they have distinct advantages. However, some components (M&E trades), some procurement methods (design and build), and some sub-sectors (private commercial and housing) are disproportionally under-represented or absent from the sampling of projects that underpins the TPIs. The TPIs are found to be very likely biased upwards. The review of the construction cost indices in the UK, measures of the input prices facing contractors, finds that the measure of labour cost is based on increasingly unrepresentative national wage agreements, and appears to be biased upwards. The construction new orders series published by ONS are reviewed as a possible measure of demand and predictor of quantity of construction output, and are shown to be unfit for either purpose. Grounded on a simple demand-and-supply theoretical model, the method proposed by Haynes and Stone (1985) is applied to estimate a system of demand-and-supply equations for new construction work in the UK, which is tested against and supported by the results of the data-driven vector autoregressive model. Findings from EU-KLEMS show that the rate of productivity growth of the construction sector is lower than that of the whole economy. Applying Baumol’s two sector unbalanced growth model, econometric studies are undertaken for the UK and other European countries. Results confirm the proposition that the relative rate of growth of labour productivity of the construction sector determines the long-run relative price movement of its outputs. The positive productivity growth in UK construction industry explains the differential between its (higher) input price growth and (lower) output price growth.