Articles and Updates
Economic Impacts of Homebuilding on Arizona's Economy
November, 2008
By Marshall J. Vest
This analysis was first presented as part of the background report for the 93rd Arizona Town Hall, November 2-5, 2008, Grand Canyon, Arizona.
Introduction
When one thinks of the housing industry, the first image that pops into mind is of construction workers pouring concrete slabs, assembling “stick-built” houses with skill saws and nail guns, and installing cabinets, plumbing and electrical fixtures into rows and rows of houses that are part of a large subdivision of new homes.
This activity, along with remodeling of existing homes and provision of public infrastructure (in the form of water and sewer treatment facilities, streets, parks, etc.) and coupled with commercial construction (of shopping centers, offices and industrial buildings) comprises a large portion of the economy. Since Arizona is a rapidly growing state, a higher portion of total economic activity is accounted for by such activity than is found in most other states.
The portion devoted to construction activity varies significantly over the business cycle. In 2006 during the recent boom, construction employment represented 9.1% of total nonfarm jobs in Arizona. During recessions, that proportion falls significantly. For example, it fell to 5.4% during the 1990-91 recession and to 5.6% during the 1974-75 recessions. Exhibit 1.
Exhibit 1: Construction is the Most Volatile Industry
The point here is that the construction industry is different than most other industries as it represents the investment component of economic activity. In a growing economy, a large portion of resources are required to build needed infrastructure to accommodate new residents and workers. But when the economy slows, while growth in retailing and services also slows, construction activity has to shrink! If the economy stops growing entirely, the need for construction workers drops dramatically.
Therefore, the construction industry has an accelerator effect on growth – it adds significantly to growth and makes the peaks higher during expansions while subtracting from growth and making the bottoms lower during recessions. During 2005, the construction industry accounted for 22% of all newly-created jobs. During 2007, it lost nearly 16,000 jobs while total nonfarm jobs increased by only 38,000. Arizona’s construction activity is volatile because growth varies significantly over the business cycle. In turn, swings in construction activity account for a major portion of the economy’s volatility.
The construction industry is only part of the story, however. Other industries also are related to and support the area’s growth. These include mortgage lending, title agencies, appraisal, brokerage (both residential and commercial), landscaping, architecture, home improvement centers, material suppliers, etc. If these components are included, we find that in a typical year close to 20% of the economy in Arizona is tied to growth (Exhibit 2).
Exhibit 2: Development-Related Employment (Construction + Suppliers), AZ, 2007
| Industry | Jobs |
| NAICS 2361 Residential building construction | 26,109 |
| NAICS 2362 Nonresidential building construction | 16,544 |
| NAICS 237 Heavy and civil engineering construction | 27,970 |
| NAICS 238 Specialty trade contractors | 153,729 |
| NAICS 321 Wood product manufacturing | 7,660 |
| NAICS 32412 Asphalt paving and roofing materials mfg. | 166 |
| NAICS 3255 Paint, coating, and adhesive manufacturing | 227 |
| NAICS 326191 Plastics plumbing fixture manufacturing | 467 |
| NAICS 32712 Clay building material and refractories mfg. | 607 |
| NAICS 3272 Glass and glass product manufacturing | 702 |
| NAICS 3273 Cement and concrete product manufacturing | 7,451 |
| NAICS 327991 Cut stone and stone product manufacturing | 464 |
| NAICS 3323 Architectural and structural metals mfg. | 8,236 |
| NAICS 33312 Construction machinery manufacturing | 267 |
| NAICS 3334 HVAC and commercial refrigeration equipment | 1,410 |
| NAICS 3351 Electric lighting equipment manufacturing | 396 |
| NAICS 3352 Household appliance manufacturing | 390 |
| NAICS 337 Furniture and related product manufacturing | 8,887 |
| NAICS 4233 Lumber and const. supply merchant wholesalers | 7,061 |
| NAICS 4236 Electric goods merchant wholesalers | 13,238 |
| NAICS 4237 Hardware and plumbing merchant wholesalers | 6,113 |
| NAICS 42381 Construction equipment merchant wholesalers | 1,630 |
| NAICS 442 Furniture and home furnishings stores | 14,670 |
| NAICS 443 Electronics and appliance stores | 12,358 |
| NAICS 444 Building material and garden supply stores | 27,587 |
| NAICS 2211 Power generation and supply | 9,148 |
| NAICS 22131 Water supply and irrigation systems | 2,151 |
| NAICS 522292 Real estate credit | 12,494 |
| NAICS 52231 Mortgage and nonmortgage loan brokers | 4,824 |
| NAICS 524126 Direct property and casualty insurers | 8,354 |
| NAICS 524127 Direct title insurance carriers | 3,113 |
| NAICS 5311 Lessors of real estate | 9,493 |
| NAICS 5312 Offices of real estate agents and brokers | 11,079 |
| NAICS 53131 Real estate property managers | 11,856 |
| NAICS 53132 Offices of real estate appraisers | 1,252 |
| NAICS 53139 Other activities related to real estate | 1,230 |
| NAICS 541191 Title abstract and settlement offices | 835 |
| NAICS 5413 Architectural and engineering services | 32,585 |
| NAICS 54141 Interior design services | 1,043 |
| NAICS 54142 Industrial design services | 119 |
 |
|
| Total, Development Related | 453,915 |
| Total, all industries | 2,247,684 |
| Development Related as a % of Total | 20.2% |
Source: Quarterly Census of Employment and Wages
Is Development Activity a Driver of Growth?
Contrary to popular opinion, construction activity is not a driver of growth – at least not normally. Rather, it’s a by-product from expansion of basic economic activity. It’s the consequence of expanded economic activity – not the source. As such it is nonsensical to calculate multipliers for construction activity. It’s a hard pill for some to swallow, but construction activity is part of someone else’s multiplier.
The theory of regional economic development states that a local economy is driven by economic activities that import money into the local area through the sales of goods and services to customers who do not live in the area. These are referred to as “basic” or “export” activities. Mining, most types of manufacturing, most agriculture, and tourism are classic examples of basic activities. In the modern economy, many services also have a basic component.
Within manufacturing, computers, semiconductors, and electronic components along with missiles are the largest export-related components. Soft drink bottlers and cement plants are mostly used by locals and are not export related.
The accommodations industry, along with golf courses, and eating and drinking places have a large export-based component as they support tourism. (Tourism doesn’t export anything, but the result is the same -- tourists come here to enjoy themselves and leave behind their dollars).
Many economic activities primarily serve local residents. Retail trade, health care, finance, and newspaper publishing are examples of activities that serve primarily local residents. Similarly, most new construction is purchased by local residents and businesses. These activities do not directly bring much new money into the community and thus are not drivers for the local economy. For these activities, dollars changing hands are simply being respent over and over– they are not newly imported dollars.
Some construction activity could be considered export-related such as development of retirement communities that sell to non-Arizona retirees (who pay for the home with dollars earned in their home state), but the numbers are small. This also pertains to construction of a new export-based manufacturing plant.
Aspects of the Current Building Cycle
Regional growth theory holds most of the time, but there are occasions when new development does temporarily become a driver, such as the recent bubble in housing from 2004-2006. Asset bubbles follow three stages (manias, panics and crashes) and unfortunately always end badly. For a time-honored description and history of this phenomenon see the classic book on financial crises by Kindleberger.
Low interest rates and a massive expansion of credit were both important contributors to the period of easy money. First, low interest rates boosted conventional measures of housing affordability to all-time highs, which sparked home sales and started prices moving upward. Then innovative mortgage products (such as alt-A and sub-prime loans) provided "easy to qualify" credit, which fueled the fire. As prices surged (eventually doubling in some markets) affordability dropped to the lowest levels seen in decades.
During the mania phase, money poured into Arizona from all corners of the world, driving construction activity and suppliers to their limits. People camped overnight to be first in line for the Saturday morning lottery drawing to see if they’d be allowed to buy a house. Bus loads of out-of-state buyers went from project to project, putting down deposits on houses in each. Others pulled equity out of their homes and bought half a dozen others with little/no money down and exotic mortgages. It was common to hear such utterances as “we need to get on board before the train leaves the station.” All these are classic signs that a bubble is forming.
As with all asset bubbles, prices eventually stop increasing and investors begin cashing in their profits. Once prices start moving down, panic sets in and more houses come on the market, driving prices down even faster. With prices falling, real buyers become spectators, waiting for the price to fall even further. As prices decline, many new homeowners discover that they owe more on their house than what it is worth. Foreclosures skyrocket, and these houses are offered at fire-sale prices, which drives market prices even lower.
By mid-2008, housing prices had declined by 30% in the metro Phoenix area, according to the Standard and Poor’s Case-Shiller home price index. Additional declines are expected as some 50-60,000 homes remain vacant, according to economists at Arizona Public Service Company, who base their estimates on electrical usage of individual houses. Building activity collapsed sending the number of houses under construction down by more than 70% from peak levels. This is typical of the crash stage.
Just as housing drives the economy upward during the mania stage, so too does it drive the economy into recession during the crash. These episodes are thankfully infrequent, occurring only once or twice in a generation. The last time Arizona experienced an asset bubble in single family housing was in the late 1970s. The real estate bubble during the 1980s was primarily in commercial markets and apartments, rather than single family housing.
Policy Considerations
Arizona is one of the nation’s most cyclically sensitive states because it is a growth state. People want to live here. A large portion of resources and economic activity is devoted to supporting that growth. From a policy perspective, efforts to make Arizona less reliant on construction by developing other industries are largely counter-productive at best since creating new jobs in say, high tech manufacturing, will simply boost the number of people moving here. Diversifying the economy is always a good idea – but it won’t lessen Arizona’s reliance on construction activity. As long as Arizona continues to be a destination of choice for retirees, job seekers, and those looking for low-cost housing, its economy will remain one of the most volatile of aFor additional information, please contact us.
