William Baumol's insights into the construction productivity puzzle explain why my old house would not be built the same way today
Have we forgotten how to build houses efficiently? Or are important economic ideas missing from the construction productivity debate?
The above photo is of my house in Brisbane. It was built in the early 1880s.
The original portion of the home is 46 square meters (460 square feet) internally, with a small front and rear verandah. It sat on twenty timber posts dug into the earth and secured by ramming in the dirt around them. It had four doors (two external, two internal) and eight windows. It did not have a single electrical wire, light, or power plug. It had only water piped into external taps and an outside toilet.1
Now?
This same home has six lockable doors and twelve windows with flyscreens, and sits on steel posts on a concrete slab, with earthworks undertaken and retaining walls built to manage stormwater. It has a complete internal kitchen and bathroom, insulation, electric wiring, lights and air-conditioning, a driveway, a garden with edging, a laundry, and a fibre-optic connection. The home has also grown to double its original size due to various renovations over the years.
What’s my point?
A house today is not the same as a house historically. We made our houses better because we are richer now and housing is a great thing to invest in with extra wealth and income.
These radical changes in the very idea of what constitutes a house are a key issue when it comes to the concept of construction productivity, which seems to worry so many.
Don’t get me wrong. I want more productivity in every sector, not less. But I think we are being tricked by the way we interpret some of the data and we miss the fact that the construction sector, even the residential sector, is so vast as to be its own macroeconomy. It hence contains the same economic compositional effects as we see in the macroeconomy more broadly—changes that William Baumol explained size decades ago.
Let me explain.
Troubling construction productivity declines
It’s not impossible to get worse at producing something. History is littered with examples of societies forgetting how to make things. We still debate today how ancient mega structures were built because we collectively forgot. Knowledge only persists if it is used and embedded in our activities.
But as anyone who watches the terrific B1M YouTube channel can attest, we seem to be building more and more seemingly impossible construction projects all the time.
So what is it that concerns us?
Measured construction productivity has remained flat while other sectors have grown, or outright declined, in Australia, the United States, Canada and elsewhere over the past four decades.
It is a worry for many. After all, it sure sounds bad!
So what exactly are we dealing with here?
Construction productivity is simply a metric that comes from dividing two numbers—a measure of construction sector outputs and a measure of construction sector inputs.
Typically output is measured by value, so if a construction contract to build a home is worth $400,000, that is the output measure. It doesn’t care about WHAT is in that $400,000—whether a garden shed or a luxury apartment—just that it is a measure of the market value of the output.
The inputs are what exactly?
Well, they can’t be a value. If they are a value of inputs of labour time and materials, then productivity change is just a measure of the change in margins and declining productivity would indicate an increasingly cost-competitive construction sector.
For example, if decades ago your $400,000 construction contract required $300,000 of inputs, providing a 33% margin on cost, but it now requires $350,000 of inputs, then margins have compressed to 14%. But that doesn’t tell us about productivity.
We need to divide a quantity by a quantity, not a price by a price, to get something more meaningful.
The most common construction productivity metric, called labour productivity, gets us halfway there. It asks “How many on-site work hours did it take to produce $400,000 of construction value?”
It still uses value as an output metric, but a quantity of the important labour input as the input metric.
But please note that some analysis of construction productivity relies on a metric called total-factor (or multi-factor) productivity which merely adds to the measurement issues at play by trying to count the input quantity of labour and every other input such as capital (equipment usage) and materials. The layers of measurement issues make this total-factor productivity metric a very bad way to understand construction.2
Sometimes in housing debates people will measure dwelling production per worker, or total dwelling square meters built per worker, focussing more narrowly on housing and on quantities or output and inputs.
So keep an eye out for what exactly is being talked about when you read about declining construction productivity.
The puzzle for many is that labour productivity in manufacturing and many other sectors keeps increasing—we get more cars per car factory worker, more bottles of soft drink per Coca-Cola worker, and more agricultural produce per farm worker—but in construction, we get the same output value per on-site construction worker.
Why?
I want to focus on two things in this article—1) measurement issues and 2) the economics that helps us interpret those measurements.
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Measurement: Inputs and outputs
The measurement of productivity faces some challenges. The table below shows the breakdown of construction costs for a typical detached home in the United States in 2022.
My question is this.
Are these itemised components the same as the components of a typical new detached home before the decline in measured construction productivity in the 1960s?
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