The unquantifiable cost of construction to our society | Lino Briguglio

As any accountant will tell you, the value of a company is measured by its ‘assets versus liabilities’. But Prof. LINO BRIGUGLIO, of the University of Malta’s Economics Department, argues that a different model is used when calculating value of the construction sector: one which disregards all the ‘hidden costs’

Lino Briguglio (photo: James Bianchi/MaltaToday)
Lino Briguglio (photo: James Bianchi/MaltaToday)

Recently, Finance Minister Clyde Caruana indicated that he wanted to steer Malta’s economic model away from its dependence on the construction industry. What do you think brought about this realisation? And how reliant is our economy, in real terms, on construction to begin with?

Let’s start by talking about how much construction actually contributes to our GDP. We’ve heard a lot of different estimates over the years – the industry itself claims anywhere between 6 and 8%, for instance. However, it works out at around 4.2%.

Now: that is not a small amount. Our total GDP is around €12 billion…  and half a billion of that is produced directly by construction.

However, a country’s GDP is only measured by the income that is generated in that country through the production of goods and services. It does not include imports: even though you sometimes still hear people arguing that it does. Our GDP is what we add on imports and from what we add, we earn our wages and profits. So the contribution of construction to GDP does not include imported products such as cement. However, the transformation of cement into concrete is value added by the construction sector and contributes to GDP.

So the construction sector directly adds about 5% of our GDP. There is also an indirect contribution in that the sector generates demand from other industries: like quarrying, for instance; or tiling; or plumbing; or installation of doors and windows… and many, many more. That all counts as ‘indirect’ contribution. So if the direct contribution is just under 5%: including all those other industries, it becomes closer to 10%. In other words, €1 billion.

So we are not talking about a ‘small’ industry, by any means. At the same time, however: it’s not as ‘big’ as, say, the Malta Development Association claims. Thus the main contribution of the sector is that it generates directly about a billion euros.

But one has to juxtapose the cost, against this benefit.  We do not normally factor the costs into this equation: even if everybody knows what they are… because they complain about them, all the time.

Let us start with the effect of construction on our quality of life…

In fact, Minister Caruana seemed to acknowledge that: when he said that ‘people are fed up of all the noise and dust, etc’. Are you suggesting, however, that those factors should also be considered, when calculating the value of the construction industry to the Maltese economy?

In a nutshell: yes. And so, I think, was Clyde Caruana. After all, he is a former student of mine: so I know he understands – because I taught him myself - that economics is not just about the ‘quantifiable’. It is also about giving value to things which are intrinsically hard to quantify. So even if he didn’t specify what ‘valuation techniques’ mean, he himself may have used the concept of valuation techniques, to arrive at the conclusion that the disadvantages associated with construction, are a cost for the country.

And he’s right. Those factors he mentioned are having a direct impact on our quality of life.

Dust is already a well-known contributor to air-pollution: but the industry also uses old, polluting vehicles that should really have been scrapped years ago. Not to mention the damage caused by construction itself – the broken pavements, pot-holes, and so on – that later have to be fixed… at a cost.

Then there’s also the disruption caused by blocked roads. Because when a construction site occupies a space… it occupies all the space around it, too.  It takes up all the surrounding pavements; and often forces pedestrian to walk in the middle of the street… without a care in the world. And all too often, without a permit from the local council, either.

All of that, too, has to be factored into the question of how much construction really contributes to the economy…

But… how? Can such a cost even be quantified at all, in terms of money?

Some of the damage caused by construction is actually quite easy to quantify. How much does it cost to fix a pavement? How much more petrol does your car consume, because of all the detours you’ve had to take? And so on…

But others are, admittedly, much harder. Certainly, however, the final bill would have to include all the medical expenses, when people get ill… because a lot of people die from asthma, and other respiratory diseases, in Malta: due to the fine particles emitted during construction, and the diesel fumes from old vehicles. People have also died as a direct result of construction itself: and as we all saw last week – when an injured construction worker was dumped in the middle of the road in Selmun – there are accidents, injuries, and God-knows what else happening, that we don’t even know about. Obviously life has a price, even though it is difficult to quantify.  How much is all that worth, in the end? Half a billion?

I would say that, if you added it all up together… it would come to a lot more than that. I can’t prove it, naturally; but I suspect that just the quantifiable parts alone – all the direct expenses to fix those pavements; all the health costs; all the petrol and work hours wasted on traffic, etc. – is likely toamount to a hefty sum of money.

But add to it also the unquantifiable parts: the cost of our quality of life, our peace of mind, our blocked views, our uglified skyline…  my guess is that the costs, including those that are easily quantifiable and those that are not, would be more than the 1 billion generated by the construction industry: meaning that the industry would be operating at a loss.

All the same, it would be interesting to have an actual value. You mentioned that there are ‘cost-evaluation techniques’: what sort of techniques would apply to this scenario?

If you don’t mind a quick digression to explain: a former student of mine has undertaken a valuation project applied to Pretty Bay in Birzebbugia. The idea was to try and quantify the value of the bay itself: not the combined value of the surrounding property; but rather, how much of the surroundings themselves - the beach, the view, etc. – contributed to that value.

Let’s say, for example, that a seafront apartment, with a nice view, will sell on the market for 1 million euros. Naturally, the view will have contributed to that value; and one simple way to find out how much, would be to find a similar property without the same view, and compare the difference.

If it’s, for argument’s sake, half a million… then you can value the view of Pretty Bay at approximately E500,000. But I stress ‘approximately’, because it can never really be 100% accurate.

The project also featured a survey asking people of that locality – and also visitors – how much they would be willing to pay for access, if the beach were to be privatised. And there were a lot of other such measurements used.

In any case: on that basis, there is the possibility that if the beach were to be degraded and lose its appeal,  Malta would lose as much value as if the Freeport were to close down…

If I’m understanding correctly: a similar exercise could be carried out to quantify how much the the construction industry COSTS the Maltese economy… rather than how much money it pumps into it…

Yes, it could. And again, some of the expenses are already known. For example, each time a new apartment block, or high-rise building, goes up, anywhere on the island… it will most probably be blocking such a view for many other properties in that area, and reducing their value.

These are costs which affect property owners directly. And yet we never factor in that loss – the quantifiable drop in price of these properties – when it comes to evaluating how much construction really contributes.

Besides: there are other good reasons to want to diversify away from the construction industry, as an economic motor. Another aspect that we don’t talk about enough is the risk of an oversupply: which, if it happens, would result in dramatic losses, in terms of property value, across the board…

Excuse me for interrupting, but there has been talk of the ‘property bubble bursting’ for years now: but every time the issue has been raised, we are always assured (mostly by property negotiators) that ‘it will never happen’…

It hasn’t happened yet, true; but that doesn’t mean it can’t happen at all. It has already happened in other countries like Ireland, Spain…  and if we carry on the rate we’re going, I see no reason why it can’t happen here. In fact, there may even be indications that it has already started…

One thing to bear in mind, however is that the housing sector is quite exceptional, in some respects. If, for instance, there is an oversupply of perishable items – like fish, fruit and veg, and so on – the price will automatically drop the next day. Non-perishable things like construction, on the other hand, don’t have that effect. The price will not plummet from one day to the next; the market will continue to operate, with prices affected by demand and supply l… but at a slower rhythm and it may take years, even decades, for the effect of oversupply to be felt.

But when it happens, we will not be able to cry over spilt milk. We have to start preparing for that eventuality, from now…

You mention ‘indications’ that the bubble may already be bursting: like what?

As an economist, I cannot but attach a lot of weight to the possibility – possibility, please note - that we might have an oversupply. I can’t say when it will happen; but I can say is that certain indicators are already in place. First of all, the sheer number of development projects in the pipeline: including all the new ones that are being approved now; and the ones being submitted for approval as we speak.

But there is also the concern – yet another ‘cost’ to be added to the list – with money-laundering. Today, with all the heightened scrutiny of Malta’s financial sector… many people are realising that it it may be better to have ‘empty buildings’, than to have lots of cash-in-hand. To ‘invest in stone’, so to speak. So it’s perfectly possible that a developer would invest his profits in more buildings… rather than depositing them in the bank: and, in a nutshell, ‘uncovering his ass’…

Construction is, in fact, often regarded as simply another ‘storage for wealth’; and I assume that this is another reason the Finance Minister might be keen on diversifying.

Then, there’s the issue of the banks.  It is not exactly a secret that some contractors are up to their eyeballs in debt. As is well known,  many IMF reports on Malta say that ‘Malta’s banking sector is at risk’. Why? Because it has too much debt tied in with the construction sector.

Although measures have been taken to reduce this major risk - which is big enough to sound international warnings -  the bank’s dependence on the sector is still high, even though it sector itself generates its own funds.  Fortunately the banks themselves are now doing everything in their power, to diversify away from property. But for the present, they are still exposed to those risks.  And that is a factor that has to also be included in the calculation…

And lastly, there is also the issue of… let’s call it, ‘bad behaviour’.

You mean it gets worse? That there’s more ‘bad behaviour’ than what you’ve already mentioned: money laundering, banks exposed to risk, etc?

To be fair, I’ve mentioned most of it already. It’s the same ‘social cost’ Minister Caruana alluded to in that statement – the dust, the noise, etc. But it goes beyond all the arrogance of blocking roads, and simply inconveniencing everyone.

Because let’s face it: the construction industry has a very bad reputation. So bad, in fact that… let’s just say, nobody really trusts the system anymore. When the PA dishes out permits, there is always suspicion of foul play… and let’s be clear about this. It is not for nothing. Recently we even heard a well-known developer telling us that he ‘consults with ministers’… and another complaining about political parties ‘running after him for donations’.  We all know what the situation really is.

Meanwhile, if you ever try to complain to any contractors or developers, they get angry… they get threatening… you end up too scared to talk to them…

There is, let’s be honest, an aura of ‘untouchability’ around this sector. They can do whatever they like, and no one can do anything about it.

And now, we are coming to the second generation. There is a new breed of younger contractors rising through the ranks… and already, it looks as though they are going to be no different from their fathers. So this arrogance, this ‘untouchability’, is being inherited, from generation to generation…

Now: admittedly, this part of the ‘cost’ is very difficult to quantify. But it is a cost all the same: and it is measured by its impact on the rule of law.

Because when one contractor sees another breaking the law with impunity… he is going to reason that he can do the same himself. And this is precisely what is happening: a culture has set in, that it is possible to inflict damage on the rest of society… real damage… and keep getting away with it, every time.

In brief, construction has a large, let’s say social and environmental cost; and that expense has to be included in the net contribution of the construction sector as a whole. And something tells me that, if it were to be actually quantified… we may discover that construction actually costs this country a lot more than it contributes.