Academic journal article IUP Journal of Applied Economics

The Construction-Development Curve: Evidence from a New International Dataset

Academic journal article IUP Journal of Applied Economics

The Construction-Development Curve: Evidence from a New International Dataset

Article excerpt

Introduction

In a seminal paper in construction economics, Bon (1992) proposed an inverted U-shaped pattern for the relation between construction and economic development. The share of construction in GDP tends to increase during the initial stages of economic growth, to stabilize in middle-income countries and to decline in advanced economies. This pattern is often referred to as the 'Bon curve'.

Providing an empirical framework to explain the level of construction activity in a country, Bon curve could help forecast construction sector dynamics and assess whether the size of the construction industry is in line with its long-run pattern or short-run factors (for example a property bubble) are influencing it in a relevant way. No less importantly, its implication that the construction sector is able to persistently 'outgrow' the rest of the economy in developing countries is relevant for the debate about whether or not construction should be actively supported as a driving force of growth by policy makers in those countries.

Empirical studies investigating Bon's model yielded mixed results. The most recent of these studies (Choy, 2011) argued that Bon curve does not hold across countries. In this paper, to the contrary, we will provide evidence that Bon curve does indeed explain a relevant fraction of cross-country variation in the share of construction in GDP. With respect to previous studies we employ a new dataset, which allows us to measure construction activity through gross investment instead of value added (the latter being employed in most previous works). Furthermore, we control for three sources of distortion that may have affected previous studies, namely, non-stationarity, omitted-variables bias and outliers.

Besides this, we refine the model proposed by Bon from two points of view. First, we show that the curve is asymmetric with respect to its maximum. This implies that the share of construction in GDP decreases at a slower pace after industrialization, approaching some kind of 'plateau' in mature economies. Moreover, we take into account a broader definition of economic development by replacing GDP per capita with alternative indicators.

In order to be useful for forecasting and drawing more precise policy implications the model would need to be enriched with an assessment of the other structural factors that influence the share of construction in output. This is one of the tasks that we deal with here. We show that population density, demographic growth and credit expansion carry no explicative power, while there is weak evidence that a better (i.e., less concentrated) income distribution is associated with a bigger relative size of the construction sector. This appears to suggest that, on a microeconomic level, demand for housing exhibits a positive and decreasing income elasticity.

The paper is organized as follows: it briefly reviews the literature on the long-run relation between construction and development, followed by the description of the data and preliminary tests used in the study. Subsequently, it discusses the results, and finally, offers the conclusion.

Literature Review

There are three main strands in the literature on the economic role of construction. The first one studies the relationship between construction and development. The second tries to assess whether construction investment leads GDP growth (De Long and Summers, 1991; Ball and Wood, 1996; and Chang and Nieh, 2004). The third one employs input-output tables to study the role of construction in a national economy (Bon and Pietroforte, 1990; and Pietroforte and Gregori, 2003). This paper is concerned with the first strand.

Early seminal papers investigating the role of construction in economic development are the ones by Strassmann (1970), Turin (1974), Drewer (1980), Wells (1985) and Bon (1992). They tried to assess whether "the construction sector, like agriculture or manufacturing, follows a pattern of change that reflects a country's level of development", as Strassmann (1970) put it. …

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