Gareth Kiernan says the Mainzeal failure could hurt Q1 GDP by 0.14% but calling for direct government intervention is 'one of the worst reactions I've seen'

By Gareth Kiernan*

The rise and fall of firms is part of a changing and dynamic economy, with labour and capital shifting to industries and areas where it can be most usefully, efficiently, and profitably employed.

So the collapse of construction company Mainzeal is something that happens on a daily basis, albeit usually on a much smaller scale.

The worst thing about Mainzeal’s collapse is the disorderly fashion in which it has occurred.

A gradual reduction in staff numbers and productive capability would give workers time to adjust, retrain if necessary, and find new employment. It wouldn’t be a painless transition – change is never comfortable – but it would arguably be preferable to the situation we’re confronted with now.

If we assume that Mainzeal’s projects represent 10% of non-residential construction in New Zealand, and there’s no work done on these sites between the Waitangi Day receivership and Easter, the direct effect could be about a 3% hit to nationwide construction activity and a 0.14% knock to GDP.

Projects such as the new Manukau Institute of Technology Campus ($95m), the Campus Hub at Victoria University ($62m), and the Coastlands Aquatic Centre in Kapiti ($21m) are in limbo.

It has been suggested that receivers will be keen to get these projects finished to recoup some value for creditors, but organising that will be a slow process, taking weeks or months rather than days.

The lumpy nature of construction work, particularly non-residential construction, represents a significant difference between the industry and many other parts of the economy.

From the customers’ points of view, the receivership of Feltex in 2006 mostly resulted in demand for carpet simply shifting to other manufacturers and suppliers, with limited disruption. It’s not as easy to take a partially completed building project and get someone else to come in and finish the job.

We’ve also got presumably profitable subcontracting firms likely not to be paid for work they’ve completed, a sudden hole in their pipeline of work with nothing happening on Mainzeal’s building sites, and even a lack of immediate access to their tools that could prevent them from moving on to other projects.

This recipe could see some smaller firms go to the wall as well.

Dialogue is all that's needed from the Government

One of the worst reactions I’ve seen is the assertion from Colin Espiner that the government must get involved.

He almost implies that this nasty situation with Mainzeal should be mitigated in any possible way.

Perhaps the government could buy all affected subcontractors a plane ticket to Christchurch, throw a bag of new tools in their luggage, and provide them with a month’s accommodation to do some earthquake repair and rebuilding work.

Or maybe the government could buy out Mainzeal’s partially completed contracts so that everybody can get back on site by next Monday.

There are some important differences between the government’s decision to backstop the banking sector in 2008/09 and the current Mainzeal situation.

• The potential failure of one of the banks during the global financial crisis would have resulted in other banks failing, as scared investors withdrew their money. But Mainzeal’s failure is not going to adversely affect the ability of Fletcher Building or Hawkins Construction to keep trading.

• The banks are a vital intermediary in the modern economy, and their collapse would have massive flow-on effects beyond their direct share of the economy. In contrast, Mainzeal operates in a highly competitive industry with limited implications for the economy outside the construction sector.

• The causes of the potential banking crisis were mostly offshore, and the fact that other governments were taking similar action left us with little alternative but to act.

At most, the government needs to be in dialogue with banks to try and ensure that subcontracting firms affected by non-payment and suffering cash-flow problems have appropriate access to credit over the next six months and are being dealt with sympathetically.

There has clearly been overcapacity in the building industry since activity was hit by the finance company collapses and the global financial crisis in 2007 and 2008. Colin Espiner wonders “how a company in the construction sector managed to find itself in this position in the middle of what is supposed to be a boom in the industry”, but there is definitely no boom in the construction industry at the moment.

Nationwide construction activity fell by 33% between the end of 2007 and its low point in September 2011.

The collapse of Mainzeal will ultimately help restore profit margins in the industry, which have reportedly been very thin over the last few years thanks to fierce competition for contracts.

It may also help divert more construction labour resources to meet demand down in Christchurch, which is set to increase substantially over the next two years – the promise of the boom that is yet to properly materialise.

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By Gareth Kiernan is the managing director at Infometrics, an economic consultancy and forecasting service, and he manages the forecasting team. You can contact him here »

(Corrected. Short introduction from home page referred to a 1.4% hit to GDP. The correct figure of 0.14% was in the headline and the full article. The introduction has been corrected)