Building a firm foundation

ECONOMICS:The housebuilding industry is in freefall. There are other ways of describing it, but they all amount to the same thing. In the latest three months for which data are available (June through August), housing starts were running at an annual rate of just 45,000 - less than half the rate of a year earlier.

The trend indicates that they were still decelerating at that stage; the likelihood is therefore that they have farther to fall before they bottom out.

From the point of view of overall activity, employment, housing supply and contribution to the exchequer's coffers, house completions matter rather more than starts.

To date, the trend in completions has not been so steeply downward. In the first seven months of the year, they were running just 6 per cent off their pace of the corresponding 2006 period.

But starts are a leading indicator of completions. According to Davy Stockbrokers, which has published some good research in this area, the lead time is about nine months. What this means is that the low rate of starts this summer will convert into a correspondingly low rate of completions next spring.

That's assuming the relationship between starts and completions that has been observed in recent years, when demand was brisk and market conditions were strong, is maintained. But, in current market conditions, that relationship may break down and builders may be much slower to complete the work on houses they've started. What this means is that the very low rate of housing starts may presage an even lower rate of completion next spring.

Okay, let's do the maths. Assume that the steep deceleration in housing starts has come to an end and they stabilise at their June to August rate through the first quarter of next year. Assume also that the nine-month lead time between starts and completions estimated by Davy continues to hold. Taking account of the 54,000 annual rate of starts in the second quarter of this year, this would mean completions in 2008 would be about 48,000 - almost 30,000 or 35 per cent below this year's projected outturn, enough to knock at least three percentage points off the GNP growth rate, and close to the 45,000 figure that the Construction Industry Federation (CIF) recently put in play - which some commentators were quick to dismiss as a doomsday scenario contrived for lobbying purposes.

Of course, all of this is subject to considerable uncertainty. On the downside, the decelerating trend in starts could continue and the lead time between starts and completions could lengthen for the reasons touched on above.

On the other hand, the true picture may not be as bad as the published data suggest because housing starts during the summer months may have been artificially depressed by unseasonably poor weather and/or because once-off housebuilding activity, which is not reflected in the published data, may not be contracting as quickly as activity in multi-unit schemes.

The point is that, unless one strains very hard to be optimistic, one must conclude that a very sharp fall in housing output is on the cards for 2008. My guess is that it will be a good deal sharper than the decline (from 78,000 to 65,000 completions) projected by the ESRI in its latest Quarterly Economic Commentary, a decline incorporated in its forecast of 2.9 per cent GNP growth for next year, possibly by a margin sufficient to reduce that GNP forecast to the 1-1.5 per cent range all else being equal.

On the face of it, this is all thoroughly bad news and is apt to produce weeping, gnashing of teeth and wringing of hands on a grand scale as well as demands for all sorts of remedial action by Government. Granted, the slowdown under way will have painful consequences, including redundancies in the construction industry and financial distress for some building firms (especially smaller ones). It will also result in the evaporation of a large chunk of exchequer tax receipts with obvious implications for budget 2008.

On the other hand, far too great a proportion of the economy's resources has been pre-empted by housebuilding in recent years and the boom in the industry has crowded out other sectors of the economy that offer a much sounder platform for long-term sustainable growth of output and living standards. In this much at least, the ESRI is right when it says that the adjustment taking place at the moment is "part of a process of returning the economy to a sustainable growth path". To that extent, it is necessary and desirable.

Given that, it would seem perverse to consider measures that would seek to arrest or reverse the process. What are needed instead are measures that would boost the competitiveness of the economy's internationally trading sectors. Of course, that might include accelerating the National Development Plan.

* Beware the housing lags, Davy Research, 21 June 2007

Jim O'Leary is a senior fellow of the department of economics at NUI Maynooth. He can be contacted at jim.oleary@nuim.ie