There comes a time in an economic cycle when things can go either way. The second half of 2002 may just be one of those times for construction. The pessimists have plenty of bad economic news to make their case, including a string of business scandals, a shaky stock market and rising oil prices, spurred even higher by the threat of war with Iraq. Yet the economy is hanging together and economists say the recovery is under way.

"The recovery is coming along, although it will be the slowest first year of expansion in history," says David Wyss, chief economist for Standard & Poor's. The financial information services firm, like ENR part of the McGraw-Hill Cos., predicts that gross domestic product will grow at an annual rate of 3.5% during the second half of this year and then inch up to a 4% annual rate during the first half of 2003. "The recovery still faces plenty of risks but most of those are coming from the Middle East," he says.

The mild economic recovery does not seem to have enough strength to pull construction up with it. In 2002, construction increasingly became two distinct markets. Housing and public construction continued their long expansion, but many of the private building markets are close to, if not in, recession. Through July, construction saw year-to-date declines of 44% for office buildings, 29% for hotels, 25% for commercial buildings and 17% for the already depressed industrial market, according to the U.S. Dept. of Commerce. During the same period, public markets experienced year-to-date increases of 24% for hospitals and 16% for schools, while highway, water and sewer work remained strong. In addition, low interest rates continued to keep the housing market growing.

The following uncertainties still face the construction industry: Will the economy recover fast enough to snap the private nonresidential building market out of its funk? Or, will growing federal and state budget deficits finally pull the plug on the public sector? Lastly, will a poor job market and falling consumer confidence overcome the lure of low interest rates and end the housing market's remarkable run?

Source: Bureau of Labor Statistics

Construction's new split personality is reflected in the cost trends reported in ENR's Third Quarterly Cost Report. Prices are falling for materials trapped on the depressed side of the industry. For example, prices for fabricated structural steel used for buildings have fallen 2.4% below last year's level, according to the Bureau of Labor Statistics' producer price index for July. Materials with a high end-use in public works or housing are showing some price strength. However, of these, only gypsum wallboard and asphalt paving report price gains in the double digits. Paving asphalt prices are being driven by rising prices for crude oil, while wallboard prices are rebounding from last year's depressed levels.

Of the 29 construction material and equipment price indexes tracked by BLS, 11 show increases of between 1% and 5% over a year ago. Ten indexes show declines between 1% and 5%, while six show relatively stable price levels. Outside this group, prices are up 14% for gypsum wallboard and down 7% for aluminum sheet.

Labor costs continued to be the main inflation driver during the third quarter. However, both union and nonunion sectors seem to have taken into account weaker market conditions and growing unemployment in this year's wage negotiations. In August, the unemployment rate for both blue and white collar construction workers rose to 9.5%, according to BLS. Up from a low of 6.4% two years ago, it is now at the highest level since 1994.

Open-shop contractors say that because of weaker market conditions, they only expect to increase wages for their workers by 4.2%, according to a survey conducted by Personnel Administration Services, Saline, Mich. This would be down from a 4.8% wage increase that the same group of contractors awarded last year and a 5.3% wage increase reported by PAS in 2000.

The union sector also reeled in wage hikes this year, says a survey of 165 settlements by the Construction Labor Research Council, Washington, D.C. Wage and benefit settlements reported to CLRC so far in 2002 have resulted in an average first-year increase of $1.40, or a 4.2% annual wage hike. In 2001, union wages showed a 4.6% annual increase for the same period.

Labor costs also are getting a kick from higher workers' compensation rates. This year, the average premium per $100 of payroll increased 9% for structural ironworkers; 7% for bricklayers and 2% for carpenters, according to an annual survey compiled for ENR by the New York City-based insurance broker Marsh USA Inc.

These rate increases may just be the first tremor in a major upheaval in workers' compensation rates expected to hit the market by next year. Industry sources interviewed by ENR for its Third Quarterly Cost Report expect to see double-digit rate increases in 2003.

The slump in the nonresidential building market is putting a severe squeeze on contractor margins, according to an analysis of general building and selling cost indexes published in this report. Ten general building indexes, which measure input costs, registered annual inflation of 2.5%. This is about the same rate of inflation tracked by this group of indexes in the third quarter of 2001.

By contrast, three selling price indexes compiled by contractors show annual inflation rates falling from 2.5% a year ago to 0.8% this quarter. The gap between the contractors "selling price" and input costs is an indication of how hard margins are being squeezed in today's market.

Another gap exists between ENR's construction and building cost indexes. In September, the CCI was up 3.1% for the year, while the BCI showed only a 1.6% annual increase. The labor component accounts for 80% of the CCI, and it is up 4.5% for the year. The BCI's labor component is up only 4% for the year. In addition, labor accounts for only 64% of the BCI, making it more vulnerable to declines in lumber and steel prices.

The full impact of the U.S. tariffs on steel imports became clear in the third quarter. Last March, President Bush placed a 30% tariff on most imported flat products, which includes plate. The so-called long products, which include structural steel and reinforcing bars, were excluded. By August, prices for flat products had increased 41%, while those for long products rose just 3%, according to composite prices compiled by the forecasting firm DRI-WEFA, Washington, D.C.

Other factors coincided with the implementation of tarrifs to drive up prices, including a weaker dollar and a surge in inventory purchases. But tariffs have worked as intended to give large domestic integrated steel mills temporary protection from cheap imports that had driven prices below costs.

The tariffs offer three years of price protection. They fall to 24% next March and to 18% a year later. In the meantime, domestic producers are looking to consolidate and reduce worldwide capacity to keep prices in line. But they may not have three years to fix the steel crisis, which has driven 34 steel companies into bankruptcy. Two large mills are bringing new capacity on line, which should drive prices back down. DRI-WEFA predicts prices will start to fall by next quarter.

Click below to view other articles from Third Quarterly Cost Report >>

ASPHALT: Fear of war between the U.S. and Iraq fuels higher prices

STEEL: New tariffs spark 41% price increase for flat products

INSURANCE: Workers' comp rates under severe upward pressure

WALLBOARD: Prices start long climb back after 2001's collapse

LABOR: Wages reflect tough times as increases fall short of last year

INDEXES: Competition cuts into contractors' selling price