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Shard building
Work continues on the Shard at London Bridge. GDP growth of 0.8% in the last quarter was driven by the construction sector. Photograph: Anthony Devlin/PA
Work continues on the Shard at London Bridge. GDP growth of 0.8% in the last quarter was driven by the construction sector. Photograph: Anthony Devlin/PA

Construction gives UK economic recovery an unstable foundation

This article is more than 13 years old
George Osborne says the economy is growing strongly, but how much of that is down to a construction rally that is already petering out?

The Shard of Glass is just the kind of totemic confidence booster the country needs. Sandwiched between London Bridge station and Guy's hospital on the south bank of the Thames, it will be the tallest building in Europe when the first tenants cross the threshold in 2012. It will also charge the highest commercial rents outside New York and Tokyo.

The Renzo Piano-designed Shard could become a symbol of London's renewed vigour following the worst banking crash since 1929. It could also become the opposite, according to analysts who fear that Britain will fall back on its old allies of construction and financial services to boost recovery.

This week the construction sector was found to be one of the main props holding up the UK's growth in national income. Commercial property and spending on infrastructure projects spurred a jump of 4% in overall bricks-and-mortar spending in the third quarter, the Office for National Statistics revealed, after a 9% rise in the previous quarter. Once the figures were fed into the ONS mincer, construction made up almost a third of growth in gross domestic product (GDP).

The chancellor, George Osborne, was elated. Appearing before TV cameras, he focused on the headline figure that showed the UK grew by 0.8% in the three months to September, which was twice the City's more gloomy estimate.

Osborne said the economy was growing strongly and was on track to meet forecasts for growth set by the Office for Budget Responsibility. Several investment banks provided helpful charts showing the UK recovering more strongly than in previous recessions.

To most people, it seemed the prospect of massive public spending cuts was having little impact on the economy. But many analysts say we should ignore the headline figure and examine which sectors that are propelling the economy and how they are likely to fare.

In the construction sector, a rally that began last year is expected to peter out. "Everyone is wondering where growth is coming from," says Mel Budd, a construction forecaster at the analyst Leading Edge.

Kelly Forrest, a construction economist at the Construction Products Association, says the commercial market's strength was probably the biggest surprise. "The private sector has bounced back quite strongly but from a low base. There has been some recovery, but there are question marks as to whether it can be sustained."

Developers in London especially have started projects recently as City rents rise and forecasters predict a shortage of office space. The Pinnacle tower, or Helter Skelter, in Bishopsgate is now above street level. Land Securities and Songbird, owner of Canary Wharf, have started work on the Walkie Talkie on Fenchurch Street, and British Land is restarting its Cheesegrater on Leadenhall Street.

The last two are unlikely to have fed into the third-quarter figures but the Shard, which is in its most costly phase as its glass cladding is fitted, will have.

Two other factors have boosted construction this year. Housebuilders saw a brief recovery early this year, with the industry's top names talking of hiring 10,000 people. That will have affected recent output levels.

The previous government's stimulus efforts on public housing and schools construction will also have boosted numbers, according to Forrest. "Public-sector construction output continued to rise in the third quarter. We expect that to fall away from early next year," Forrest says.

The best guide to what will happen in construction is the government's new orders data, and it tells a grim story.

Housing orders are down sharply, especially as the government's decision to give more power back to local councils starts to bite and they reject planning applications after the relaxation of regional housebuilding targets. Few have confidence in the government's claims that it will build more homes than its predecessor, at least not in the short term.

But perhaps the biggest question remains the health of the commercial sector (offices, retail and industrial), which makes up almost a quarter of construction activity in the good times. New orders of commercial buildings rose towards the end of 2009, but then fell back 7% in the second quarter of this year. The sector will also need to rise strongly to offset falls in public-sector building.

Forrest says: "The outlook is a lot less optimistic than the figures for the second and third quarters suggest."

Without construction to lift growth, the economy will fall back on its old favourite: financial services. Banking, insurance, legal and accountancy services dropped like a stone after the Lehman Brothers crash of 2008. Since then they have recovered strongly and not only made up a significant slice of UK growth, but also propped up exports.

Manufacturing has regained some of the losses from the crisis, but has yet to show signs of a renaissance.

It was with this in mind that the eminent economic historian Robert Skidelsky argued on BBC radio that Osborne was "economically illiterate". Why, he asked, was the chancellor relying on figures showing the economy was growing when these were obviously retrospective? Spending cuts would lay waste to vital parts of industry, force up unemployment and shatter regional economies reliant on public investment.

Skidelsky warns of a double-dip recession. A devout Keynesian, he derides the government's reliance on monetarist remedies, including the prospect of quantitative easing by the Bank of England.

He is not certain the economy is on a crash course but like many commentators he fears Osborne's refusal to consider alternatives if austerity erodes confidence and kills growth. He stresses that the comprehensive spending review, which cut all important investment as well as current expenditure, raises the risk of this.

Chris Williamson, chief economist at Markit, which monitors sentiment in the economy, agrees. He fears that the coalition's determination to withdraw support for the economy at such a delicate stage will bring about a double dip.

"With construction still the main driver of the stronger-than-expected GDP figure, and a deteriorating outlook for that sector and lower public spending, there is still a chance that the economy may need a further shot of stimulus in the near future," he says. "At the moment the only medicine available seems to be additional quantitative easing by the Bank of England."

Simon Kirby, an economist at the National Institute of Economic and Social Research, warns that the effects of quantitative easing are unknown.

"They could be beneficial or they could be costly and long-lasting. It's for this reason we think the government should adopt a less stringent fiscal policy in the short term. It would allow the economy to establish a growth pattern before fiscal tightening takes effect," he says.

John Philpott, chief economist at the Chartered Institute of Personnel and Development, is even more strident. He says: "QE2 [a second round of quantitative easing] is the ultimate escape route for fiscal masochists who reckon the chancellor doesn't need a plan B if public spending cuts and tax measures drive the economy back into recession. But what they overlook is that macho monetarism only works to stimulate demand, investment and jobs under certain conditions – and early post-recession Britain doesn't fit the bill."

No amount of skyscrapers will propel the UK out of recession, he adds. "Not only is the usual mechanism for transmitting extra money to businesses and households screwed up as the banks put their financial safety above the national interest but business and consumer confidence is anyway weak against a backdrop of economic uncertainty both at home and abroad.

"This is precisely the situation Keynes warned about in the 1930s when describing the impotence of monetary policy in a depressed economy. Simplistic reliance on QE2 could prove to be our own version of what Keynes called the futility of 'pushing on a string'.

"If George Osborne really wants to avoid a double-dip recession he should abandon the 'carry on regardless' school of fiscal policy and take a much more cautious approach to cutting the deficit. He can't assume QE2 will help him out."

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