Economists and Construction Sector

The ‘high’ and ‘low’ road to development in the Italian construction sector: reflections from the point of view of the economist

Autor: PhD Cesare Benzi, Phd Andrea Kalajzic (CRIEL – Research Center on the Internationalization of Local Economies, University of Insubria, Economics Department)

During the last 25 years the Italian construction sector has been affected by significant changes related to the instability of the macroeconomic and sectoral conjuncture, the increased attention to issues concerning the environmental, economic and social sustainability, and the progressive affirmation, fostered by the introduction of BIM (Buiding Information Modeling), of digital models for the design/implementation and programming/management of building processes.
These changes have led to consider construction as a complex system in which the participating actors have to deal not only with reduced revenue and profit margins and with relevant technological innovations, but also with a growing and deep fragmentation of the process of designing and realizing of buildings that now involves a myriad of technicians, professionals, craftsmen and companies.

Basically, the increased complexity of the dynamics affecting the Italian construction sector has given rise to two types of responses. On the one hand, there are the actors who have reacted to change by taking a ‘low’ road to development based solely on cost and price competition. On the other hand, there are instead the actors who have faced change by taking a ‘high’ road to development, characterized not only by the now essential ability to control costs and the search for management efficiency, but also, and sometimes above all, by enhancing new skills linked to the technological innovation of materials and plant engineering and the digitalization of the building process. The ‘high’ road to development therefore leads to the adoption of organizational and management models that are both efficient and oriented towards the achievement of environmental (clean energy and energy-saving, fight against climate change, respect for life on earth), economic (sustainable growth, creation of decent jobs), and social (health and well-being, creation of cities and communities ensuring a high quality of life for all) sustainability goals.
A building possessing features of sustainability and adaptation to environmental changes guarantees a higher quality than that offered by ‘traditional’ buildings: in economic terms, this higher quality translates into a reduction of the overall costs incurred by those who use the building throughout its existence. However, this cost reduction is only evident if the two construction methods are compared over the long term.

Sustainable building is characterized by relatively higher construction costs, but very low operating costs, while the ‘traditional’ building is characterized by lower construction costs and much higher operating costs.

The problem catching the economist’s eye is that the differences between an approach to construction based on cost compression and a construction approach instead based on the enhancement of a wide variety of environmental, economic and social factors appears perfectly clear to the actors participating in the building process, but not to the subjects making up the market demand since, generally, the latter do not have the technical skills to fully understand if a construction project can guarantee the long-term sustainability of the building.
The Covid-19 pandemic and the consequent economic policy responses to the crisis thus raise, even more urgently than in the recent past, the question of the reasons preventing the large-scale affirmation of approaches to the design and construction of innovative, efficient and sustainable buildings to the advantage of the survival of more ‘traditional’ approaches marked by the exclusive compression of costs.

In this regard, economic literature can offer an answer through the strand known under the name of ‘information economics’ and, in particular, through a seminal contribution by George Akerlof published in 1970 analyzing the working mechanisms of the market for used cars (an article thanks to which Akerlof would be later awarded the Nobel Prize for economics in 2001).
The analysis of the dynamics of the market for used cars has led Akerlof to conclude that, in a market characterized by the presence of heterogeneous goods and asymmetrical distribution of information (because the buyer is unable to fully distinguish the quality/price ratio of the goods offered on the market) it is possible that, in the end, phenomena of ‘adverse selection’ may occur that favor the prevalence of producers offering goods with a lower quality/price ratio.

With reference to the construction sector, we can illustrate these conclusions through the following example, which reproduces in a simplified form the example used by Akerlof in his article published in 1970.

Suppose that the potential buyer is aware of the fact that on the construction market half of the newly built buildings respond to long-term sustainability characteristics, while the other half of the buildings were built according to ‘traditional’ criteria. Let us also assume that buildings with a low quality/price ratio are offered at a price of 100,000 € and that buildings with a high quality/price ratio are instead offered at a price of 200,000 €, but that the potential buyer is not able to fully evaluate the qualitative features of the buildings offered for sale. Based on the (incomplete) information available, the potential buyer will then be willing to pay for a new building:

P = (200,000€ x 0.5) + (100,000€ x 0.5) = 150,000€

However, at this price, only the sellers of ‘traditional’ buildings are willing to sell their buildings (realizing an extra profit of 50,000 €). On the other hand, the sellers of sustainable buildings would face a loss of 50,000 € and are thus destined to be pushed out of the market.
This form of ‘market failure’ raises the question of identifying tools allowing the achievement of an equilibrium characterized by the efficient allocation of resources. In general, this objective is pursued by trying to ‘extend’ the time horizon to which the buyer refers when deciding which building to buy.

Financial instruments to support price differentiation

A price differentiation policy can serve to inform potential buyers of the costs they will incur in the long run if they choose a low-quality building. Potential buyers can then refer to prices to obtain the information necessary to select the seller (or offer) that best meets their needs in relation to their budget constraints. But as we have seen above, in the presence of an asymmetrical distribution of information, price differentials may not be sufficient to correctly indicate the quality of the product offered. The price differentiation policy can thus be usefully supported by the offer of financial instruments (leasing, mortgages with credit companies or other financial intermediaries specialized in the green building sector, very-long term mortgages, etc.) guaranteeing the long-term financial sustainability of the investment to the potential buyer.

Signaling policies other than price differentiation

Signaling the high quality/price ratio of the product offered to the potential buyer can also take place through a certification policy or the issue of guarantees that cover the long-term functionality of the building, or through the stipulation of insurance contracts by which the builder guarantees to the buyer the reimbursement of the damages that the building could possibly incur in the long-term. The effectiveness of signaling policies crucially depends on the ability of the tool used to foster the identification of a separation equilibrium, namely an equilibrium allowing the potential buyer to ‘separate’ the lower from the higher-level quality/price combinations.

Actions in support of reputation

Reputation derives from the iteration of behaviors ensuring the supply of high-quality products. The acquisition of an individual reputation (through the construction of a brand) is a very expensive process and, in the context of the increasingly fragmented supply chains characterizing the construction sector, it could also be completely or partially ineffective. Therefore, it is often preferred to pursue the goal of consolidating a collective reputation linked to specific territories (think, for example, of the DOC, DOCG, IGT brands) or to particular associations (for example Klimahaus or Casa Clima Network Lombardia). In this second case, the construction of buildings in common between different associates can be very important for consolidating the collective reputation.

Bio:
Andrea Kalajzic, Milan 26/2/1966, degree in “Economics and Commerce” and PhD in “Economics of Production and Development” from the University of Insubria.
Researcher at CRIEL (Research Center for the internationalization of local economies), Department of Economics, University of Insubria.
Mobile: 348/7253928
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Cesare Benzi, Acqui Terme (AL) 22/10/1963, degree in “Economics and Commerce” in Pavia, master in “Development Economics” at the Université Pierre Mendés France in Grenoble. I worked for the Universities of Pavia and Insubria like as consultant, as well as for numerous public entities. Currently I carry out research activities at the CRIEL (Research Center for the internationalization of local economies), Department of Economics, University of Insubria.
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