Investment Construction and Economic Growth in Australia

The economic importance of investment and construction

Investment drives economic growth, but in recent years, the Australian economy has been dependent on growth in public investment while growth in private investment has flatlined. Over the second half of the 2020s, this trend is expected to reverse, with rising private investment stirring stronger economic outcomes, but also driving changes in the pattern and volume of construction activity. Those states with the strongest investment drivers will be economic winners over the remainder of this decade. 

I was fortunate at high school (or unfortunate, depending on your view of economists) to have an economics teacher who was passionate about the subject and taught it in memorable ways.  

Mr Brown liked a diagram. Why express ideas in many words when something visual takes less time and has more impact? So, we high school students would learn to pepper our economics essays with all kinds of flow charts and other visualisations. 

One of the first we learned was the I-P-E diagram: i.e. business (I)nvestment drives increases in (P)production, which in turn drives increases in household incomes and (E)xpenditure. In turn, rising expenditure on goods and services can trigger further increases in business investment and so on. 

Figure 1: A Simple Investment, Production and Expenditure Circular Flow 

A lot is missing from this diagram to be sure, but visualisations like these got me hooked on economics as a way of describing a story (I am easily impressed) and are just part of the more well-known circular flow of income diagrams, which all economists learn. (The RBA has great education resources which cover this as well as other topics discussed in this blog. And, for the engineers, there is also an amazing working physical model of the economy built in New Zealand in the 1940s using water, pipes, valves and a marker pen – the awesomely named MONIAC. 

Why is construction important?

The story gets more interesting when recognising that construction typically makes up 55-60% of public and private investment (the main other category of investment spending being purchases of plant and equipment) and construction itself has high economic multipliers given its use of local labour and materials. 

By this, we mean that every dollar spent on construction activity has a much bigger impact on the overall economy. As construction industry supply chains gear up to service higher levels of construction activity (e.g. manufacturers of cement and concrete increase their production to meet rising demand), this creates added “indirect” economic benefits. Subsequent growth in incomes in supply chain sectors (manufacturing, transport and others) is then spent on goods and services in other sectors, which creates further “induced” economic benefits. 

Overall, analysis by Oxford Economics Australia reveals that every dollar spent on construction activity boosts the broader economy by almost three dollars when indirect and induced effects are included. Construction activity turns out to be a very strong economic accelerant. 

Well-chosen investment adds to long run productive capacity of the economy – or what we term generally as aggregate supply. Boosting supply means the economy has more wiggle room to manage variations and growth in demand. Combined with productivity improvements, it means we can achieve stronger economic growth before capacity constraints (and inflation) kick in. 

Tracking investment and economic cycles

Investment is also interesting to economic forecasters because of its high volatility which in turn can drive sharp cycles in economic growth. Economic booms usually correspond to periods of sharply increasing investment, whereas troughs (including recessions) tend to occur when investment is in reverse. 

Figure 2: Private Investment and Economic Growth, Australia 

While private consumption represents the largest share of expenditure in the economy, private investment is much more volatile and so tends to pack a bigger punch on economic growth. Private investment has experienced six bouts of high double-digit growth over the past 40 years, each corresponding with a boom or high growth phase for the economy. Similarly, private investment has fallen at a double-digit rate twice over the past 40 years, and, on both occasions, it resulted in a recession (the early 1990s commercial property bust and another mild recession in the early 2000s following the introduction of the GST).  

The Covid recession during 2020-2021 was unusual in that it was driven mainly by a sharp fall in household spending, although private investment, too, fell around 3-4% and was a contributing factor. (Australia avoided recession in the period following the resources investment boom thanks to strong growth in resulting mining production and exports.) 

Implications

So what does all this mean? 

For economists, a better understanding of investment – its drivers and growth outlook – gives insights into what we can expect for the direction of production, expenditure and economic growth, as well as picking turning points in the cycle. Currently, growth in private investment – and hence the broader economy – is sluggish, but the next five years should see a shift as the private sector reasserts its role as the dominant driver of investment growth.  

For businesses, the key implication is that the shift in investment drivers will see significant changes in construction activity. And not just changes in the type of assets being built, but also where assets are being built, with implications for state economic performance. 

In particular: 

• Growth in road and rail civil construction (which is traditionally public sector funded) is slowing sharply and being replaced by strong growth in (increasingly private sector funded) utilities and elements of non-residential building (e.g. data centres, health, manufacturing and airports) 

• With the energy transition investment boom already upon us, the next major upward leg in construction work will be driven by rising private housing investment… but it will still take time to materialise 

• For businesses and government, the change in investment drivers will mean securing very different skillsets, using different materials, working with different clients and supply chains and different methods of procurement and contracting 

• Some states look set to buck the trend and see growth in both public and private investment, fuelling a surge in construction and broader regional economic activity, but also triggering capacity risks and potentially driving up construction costs 

Which Australian states and territories will see stronger growth in the coming years? The answers, in our next blog, may surprise you. 

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Australia Construction Economy Outlook

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