Economic turbulence
Graham Robinson, Global Business Consultant, and Neal Morris, Partner, Head of Construction Advisory and Disputes, Pinsent Masons
STORM clouds have gathered across the global construction market as inflationary pressures during a post-COVID recovery surge in demand, the war in Ukraine and other regional problems continue to cause cost pressures and supply chain disruption.
But, inflation is easing and with China’s zero COVID policy lifted there appears to be the conditions for some positive growth in 2024.
Against a turbulent global backdrop, construction disputes continue to rise in value, complexity and in scope – but around familiar issues, as well as some new ones. Across our global construction practice, perennial issues such as ground conditions, fitness for purpose obligations, force majeure and hardship, terminations, and the extinguishment of rights continue to cause disputes.
We can also expect more disputes to emerge from the greater focus on the zero carbon agenda, industrialising construction and modern methods of construction.
A challenging economic picture
A combination of rapid rate rises and ‘quantitative tightening’ to combat runaway inflation by the Federal Reserve in the US has strengthened the US dollar considerably. US CPI inflation was 6.5% in December 2022 while construction inflation has been considerable.
According to the IMF, in 2020, the world experienced the largest one-year debt surge since the second world war, with global debt rising to US$266 trillion.
The Russia-Ukraine war and other geopolitical tensions have also increased speculation about deglobalisation and are adding significant pressures to construction supply chains.The Russia-Ukraine war and other geopolitical tensions have also increased speculation about deglobalisation and are adding significant pressures to construction supply chains. The construction industry is scrambling to build resilience into its supply chains in response.
Exporters face a deteriorating outlook, with many of the world’s largest economies anticipated to move into recession by early 2023. At the same time, a global correction in house prices is in the process of unfolding. House prices in the US, China, Canada, and some other countries have risen by very high rates of growth and are in the process of cooling considerably.
China remains attractive as an investment location, and foreign direct investment from China into Asia in 2021 has been close to previous peaks. However, the recent shift of manufacturing output from China to the likes of Vietnam and Indonesia should be expected to continue given cost increases as the country moves up the value chain and diversification of supply chains.
Chinese President Xi Jinping addressed the 20th National Congress of the ruling Communist Party in Beijing amid an economic slump and debt crises in the home-building sector that has seen growth fall to below half of the official 5.5% annual rate in growth. With the lifting of China’s zero COVID policy growth across the Chinese economy is expected to pick up momentum and a potential turnaround with growth engines driving growth in 2024.
The retrenchment of the real estate sector is set to continue with developer defaults remaining a significant risk – although a market collapse remains unlikely if ultimately the new 20th Central Committee of the CCP considers it too big to fail.
Globally
These events really matter to global construction. China has the largest construction market in the world. It accounts for around a quarter of world demand – more if purchasing power parity measures are used. The construction market in China also consumes vast quantities of natural resources, which it imports from countries such as Australia and Indonesia. The Chinese construction market is expected to grow over the next decade with China increasing its share of the global construction market.
These events really matter to global construction. China has the largest construction market in the world. It accounts for around a quarter of world demand – more if purchasing power parity measures are used.Elsewhere in Asia inflationary pressures and materials shortages have been a cause of slowdown across construction markets with labour shortages and supply chain disruption causing issues across infrastructure and real estate sectors.
Emerging Asia will continue to be the fastest-growing region globally for construction. Population growth in both India and Indonesia will continue to underpin growth in construction output into the longer term to 2050 and eventually see India surpass the US as the secondlargest global construction market.
In Singapore, a weak manufacturing sector has been offset by strong pharmaceutical exports and overall economic growth has been strong with reopening post-COVID boosting services and construction. CPI inflation in Singapore was 6.5% over the 12 months to December 2022.
Domestic tourism and reopening of borders to international travel in Japan should support growth for construction but, longer term, the construction market in Japan is expected to be the weakest of all major markets because of negative population and demographic trends.
The outlook for the construction sector in South Africa remains weak with load-shedding and power blackouts continuing to disrupt the economy. More broadly, subSaharan Africa will be one of the world’s fastest-growing regions for construction as population and urbanisation of populations is expected to explode.
The risk of ‘stagflation’ for the eurozone is increasing which adds to risk of a deeper recession. The continuing uncertain energy outlook and the Russia-Ukraine war combined with policymakers hitting the brakes to deal with inflation risks being undermined by large fiscal policy responses, which add to inflationary pressures. Annual construction inflation in the EU as a whole reached 11.4% in September 2022 according to Eurostat, compared to CPI inflation for the eurozone at 9.2% in December 2022.
In the UK, the construction market faces cutbacks in capital spending as the government looks to stabilise financial markets in the wake of the recent ‘mini budget’.In the UK, a slowing up of spending on infrastructure projects to ease inflationary pressures should be expected. CPI inflation in the UK rose by 10.5% in the 12 months to December 2022, down from 10.7% in November. Inflation in the construction sector in the UK is expected to be more persistent with cost escalation of around 5% expected in the medium term.
The Office of National Statistics’ (ONS) reported building materials index rose by 10.1% in September 2022 down from an earlier peak which was much higher. This global outlook for construction provides the conditions that will lead to a rise in disputes.
Impact on dispute resolution
These turbulent global forces impact on construction disputes in practice. To take just one simple metric, the trend towards ‘big money/high value’ disputes continues: the upward trend in values identified in, for example, Arcadis’ 2022 Global Disputes report in the summer, has continued, with only a 3% value reduction after 2021’s big increase.
Across our global network of 18 offices, we are increasingly seeing construction disputes being resolved through a variety of ‘fast track’ alternative dispute resolution (ADR) procedures. This will continue to go from strength to strength – as will online hearing procedures, which we will look at in more depth in the coming weeks.
According to the Arcadis survey, adjudication has now overtaken mediation as the second most common form of ADR in construction. This embracing by global markets of adjudication is borne out by our teams in Australia, South Africa, Singapore and, of course, the UK.
We are increasingly seeing construction disputes being resolved through a variety of ‘fast track’ alternative dispute resolution (ADR) procedures.We are also seeing a big increase in dispute resolution boards (DRBs) to try to resolve disputes early – although these often end up as a ‘dress rehearsal’ for the arbitration, given the sums typically at issue. International arbitration continues to grow as a means of dispute resolution in construction globally – with ‘regional’ bodies growing their offerings to provide this service.
Use of expedited proceedings and conservatory/interim measures is becoming much more common – such as for example ‘emergency arbitrators’ in relation to performance bonds.
Inflation and change driving disputes
Unsurprisingly, inflation is the big global issue for businesses operating in the construction sector. The rise in prices of materials, labour and energy costs for construction projects – against contractual frameworks that are often ‘fixed price’ or make inadequate allowance for the huge increases actually being suffered – provides huge stress on projects and is leading to many disputes.
Disputes over the value of change, the cost of delays and the interpretation of price escalation clauses are becoming commonplace all over our global network.
These factors are also leading to disputes involving concepts such as force majeure and other legal concepts underpinning the broader concept of ‘economic hardship’.
We can expect unprecedented cost pressures and turbulent macro-economic conditions to continue to drive disputes, but we will see other factors at play too.
The zero carbon agenda is now hugely shifting the dial in construction projects, both in the number of zero carbon projects being planned and constructed and in changes to how the industry delivers its projects.The zero carbon agenda is now hugely shifting the dial in construction projects, both in the number of zero carbon projects being planned and constructed and in changes to how the industry delivers its projects – an essential development given that, according to the UN Global Alliance for Buildings and Construction, the building and construction sector is responsible for up to 37% of all energyrelated carbon emissions.
This agenda is being felt in practice, driving environmental, social and governance (ESG) considerations through the procurement of infrastructure projects and furthermore in practical decarbonisation steps.
These changes are creating additional pressures on delivery in an already challenging environment – and will, in our experience of similar conditions during 30 years of resolving construction disputes, lead to an increase in disputes, unless careful and early risk management and dispute avoidance steps are taken.
New types of project – including innovative renewable energy projects – bring with them new and complex areas of potential dispute. A similar picture arises in respect of the developing fields of industrialised construction and modern methods of construction.
The propensity for this untested innovation, new players and new contracting frameworks to cause disputes is being tackled by those with foresight – see, for example, the UK’s Construction Innovation Hub’s construction product manufacturing guide to de-risk industrialised construction – however, unless these ‘smart’ approaches are taken up widely by the industry, we can expect new types of construction disputes in their wake.
To be forewarned is to be forearmed – and our forthcoming series of practical construction dispute guides will enable you to get there.
Graham Robinson, Global Business Consultant and Neal Morris, Partner, Head of Construction Advisory & Disputes, Pinsent Masons
graham.robinson@pinsentmasons.com
Additional research by Charlie Chetwood, Pinsent Masons