Hong Kong’s Construction Industry: Diagnosis and Prognosis

(This essay was published in Hong Kong Economic Journal on 6 March 2013)

 

Hong Kong’s economic transformation from manufacturing to producer services can be understood as a response to the explosive regional economic growth that started some 30 years ago with China, and is now spreading to the rest of Asia. Regional demand for skilled professional services, including those in the building and construction industry, is growing and local professional services are striving increasingly to serve markets beyond Hong Kong.

 

Hong Kong companies have earned a reputation for the rapid and timely construction of quality high-rise residential and commercial buildings and their expertise is in demand overseas, particularly in Asia with the Chinese mainland taking the lead. Many professionals involved in the building and construction industry, notably architects, surveyors and engineers, are also exporting their high value-added skills and services.

 

However, alongside this rise in construction service exports, there has been sluggishness in the local market and, conversely, growing concerns about a labor shortage due to short-term demand from public infrastructure projects. Although these activities seem contradictory – not enough activity on one hand and too much on the other – they both have a similar root problem. While the rest of Hong Kong’s economy has advanced, labor productivity in the construction sector has stagnated and lags behind that of other cities.

 

The Decline of Domestic Construction

 

Less skilled local workers are much less able to take advantage of regional development opportunities. As a result they are more affected by changes in the local market. Local construction activity has slowed down over the past 15 years or so due to the adverse macroeconomic environment, the maturing of the city into a service economy, the ageing of the population, and the difficulties of urban renewal.

 

This is in sharp contrast to the situation from the mid-1980s to mid-1990s when Hong Kong’s economic transformation brought prosperity and fuelled a long housing and construction boom from the mid-1980s to the mid-1990s, until it ended with the Asian Financial Crisis in 1997. Since then building and construction have continued to be a slow growing sector. The city’s local expenditures on new constructions have been shrinking relative to the size of the economy, while the number of new constructions in Hong Kong has been on a downward trend since the late 1990s.  The economic recovery after 2003 did not lead to rapid growth in building and construction.

 

In a bid to chart a new course for Hong Kong’s future, the Chief Executive’s Policy Address in October 2007 announced ten major infrastructure projects. The pace of such a strategy took on increasing urgency with the onset of the Financial Tsunami in late 2008. As a consequence, public investment is being fast-tracked to forestall an economic slowdown, although it is doubtful whether this can reverse the longer term trend of moving to a slower growth trajectory within the construction industry.

 

Output, Employment and Productivity in Construction

 

 

 

The contribution of Hong Kong’s construction industry to total GDP by factor cost has declined from 5.6% of total GDP on average in the 1980s to 5.2% in the 1990s and 3.4% in the 2000s (see Table 1).  The decline since the late 1990s has been especially rapid. Given that public sector work accounted for 32.7% of gross construction work value in 2011 (which totaled HK$128.5 billion), compared to a historical average of 29.3% over the period 1983-2011, this trend is likely to continue after the ten major infrastructure projects have been completed.

 

Nonetheless there is growing worry that a labor shortage is likely to hold up progress of projects in both the public and private ones. How can there be such a problem in a declining industry? An answer can be found by looking at labor productivity.

 

The contribution of Hong Kong’s construction industry to total employment has remained quite stable, i.e., 8.01% of total employment on average in the 1980s, 8.45% in the 1990s, and 8.11% in the 2000s (see Table 1). This is actually a rather high figure for a major financial and service center. The combination of this stable employment share and a secular decline of the construction industry’s share of GDP means that industry’s labor productivity has fallen over time.

 

Good measures of changes in labor productivity over time are not easy to obtain as the available data do not allow for direct measurement of many price indices used in the sector.

However, in Chart 1 we have constructed two approximate measures. One is based on taking the ratio of construction industry output to total hours worked.  The other is the ratio of constant dollars of gross value of construction works performed by main contractors to total hours worked. The evidence suggests that labor productivity has been declining since the mid-1990s, even though the overall labor productivity of the economy has risen over the same period.  The construction industry has become a drag on the overall growth in productivity of the Hong Kong economy.

 

Employment Comparisons with Major International Cities

 

The construction industry in Hong Kong accounts for a far larger share of employment than other mature financial and service centers. While the share was 8.11% of total employment on average in Hong Kong in the 2000s, it is much higher than three of the other mature financial and service centers in the world.

In London it was 5.28%, in New York City it was 3.22%, and in Tokyo it was 7.56% (see Table 2). Tokyo’s relatively high share must be understood in terms of its own economic situation. Beginning in 1992 Japan plunged into one of the longest post-war recessions in a major industrial economy. Massive expansionary fiscal stimulus measures have been adopted to boost the economy through spending on physical infrastructure. The fiscal investments probably significantly slowed down the decline of the construction industry.

 

In Shanghai the employment share of the construction industry was also much lower than Hong Kong’s in the 2000s, at 5.66%, although there may be an element of understatement because many construction workers in the floating population might have been omitted in the official estimates. Shanghai’s share has risen rapidly in recent years to 8.8% in 2011, putting it at a similar level to Hong Kong. But Shanghai is a young rapidly developing city with a constant influx of people. The recent growth in construction activities is also partly a result of the World Expo project.

 

When the share of employment is compared with the share of GDP, the problem of labor productivity in the construction industry becomes even more apparent. Construction’s labor productivity is likely to be lower compared to the rest of the economy if its employment share exceeds its GDP share. If the difference in the shares grows over time, then it is a sign that construction labor productivity is declining. Table 2 shows the percentage contribution of construction to total employment versus that of GDP for five cities. In Hong Kong, Shanghai and Tokyo, construction total employment shares are larger than GDP shares. The difference does not appear to have grown very much over time in either Shanghai or Tokyo. But in Hong Kong, the difference has grown very significantly. Construction’s total employment share in Hong Kong exceeded its GDP share by 2.4% in the 1980s, by 3.3% in the 1990s, and by 4.6% in the 2000s. This is a cause of considerable concern.

 

With reference to other major financial and service centers, both London and New York have construction total employment shares that are about the same as their GDP shares. There is no evidence that the differences between these two shares have increased or decreased over time with any detectable trend. Construction labor productivity in London and New York has probably been stable over time (see Table 2). Note that detailed components of GDP by industry are not available for New York City so instead we have used construction shares in GDP based on figures from New York State. The New York figures are therefore rough estimates.

 

The trends in Hong Kong’s construction industry are highly suggestive of falling labor productivity in the domestic construction industry since the mid-1990s.  The inability of older workers to move out of the sector is a proximate cause for why the employment share has remained stable despite declining demand for its services. The industry has also failed to attract new young workers domestically. Few young men and women aspire to work in construction today.

 

The result of all this is that Hong Kong’s construction industry is over-sized in terms of its stable employment share relative to its declining contribution to GDP.  And because Hong Kong has not been able to raise the labor productivity of workers in the construction industry through exit into other industries that could use similar skill sets, and because there has not been adequate employment opportunities in the region that could offer compensation commensurate to that in Hong Kong, the situation is unlikely to change. Employment share will necessarily remain high here in comparison with London and New York City, and even Shanghai and Tokyo, because of the low labor productivity.

 

There is reason to be immediately concerned about this. Some of the heaviest construction works for the ten major infrastructure projects will be in full progress this year. A labor shortage due to the low productivity of local construction workers will create a major bottleneck for satisfactory progress in these works. This will add to the burden of completing planned housing construction in future as announced in the Chief Executive’s Policy Address last month.  Unless the importation of construction workers is planned to help keep these current and past ambitious projects on deadline, they are unlikely to be completed successfully on time.