Imperfect competition in the construction sector

While a steeper cost development in Sweden than in comparison countries could be indicative of weaker competition in some segments of the construction sector, and perhaps especially in the case of building materials, we should point out that this cannot be inferred from differences in cost trends alone but depends on underlying causes.

The construction sector includes a very heterogeneous group of actors supplying a wide array of products and services. Market structure varies considerably, from a segment with an abundance of small builders and firms, providing various services such as carpentry, plumbing or electric installations, to industrialized segments such as the production of building materials, where there are significant economies of scale and where consolidation has been strong. Accordingly, market concentration is very low for the former types of services while it is very high for building materials such as dry wall or cement.⁷²

Market concentration is one determinant of competitive conditions, but other factors such as openness to trade, barriers to entry, and contractual and commercial practices, also matter and affect market performance. Market structure can affect firms’ ability to extract supra-normal prices either because the market structure affects firms’ unilateral price setting in a way that softens competition, or because it facilitates coordinated behaviour, such as tacit or explicit collusion. In the former case, market concentration essentially makes the demand a firm faces less sensitive to the price it sets. This is captured by the Lerner condition, which says that the optimal markup for a firm is the inverse of the price elasticity of demand.

Specifically, the Lerner condition is

L=^P_P^−c =¹_e

where the left-hand side is the Lerner index,Pis price,cmarginal cost andeis elasticity of demand. The relationship between market structure and market power, as measured by the Lerner-condition, is mediated by a number of factors and is not a simple function of the number of firms in the market. A highly concentrated industry could be quite competitive if products are homogeneous and barriers to entry are low. Conversely, competition could be weak in a market with many firms if customers face high switching costsex post. However, for given market conditions, increased concentration tends to weaken competition.

If we examine competition through the lens of the Lerner condition, we could look for clues on either side of the equality sign. For instance, we could focus on the left-hand side and look for segments in the construction sector where firms seem to have exceptionally high margins, in comparison to similar firms in other markets or firms facing similar market circumstances and risks. This can be indicative of weak competition and low firm-level demand elasticities. Alternatively, evidence on price elasticities for different inputs could be informative about the competitive

conditions on different input markets. Unfortunately, there is not very much direct

72. See e.g., SOU (2015) for a more in detail discussion of the construction sector.

information available on margins or elasticities.

There are, however, price indices for different inputs. Rising prices may of course have various causes, such as rising world market prices or reduced competition.

While we lack cost information, which could be helpful in discriminating between various explanatory factors, the price developments at least show to what extent different product categories contribute to the increase in the index for building materials. Market concentration can also be an indicator, depending on the mode of competition. For example, if firms were competing in a Cournot fashion there would under some assumptions exist a link between the market concentration as measured by the Herfindal-Hirshman index⁷³(HHI) and the average markup:L=HHI/e. Taken together these observations suggest that concentrated markets where prices have increased substantially might be worth a closer look. Since we are looking at the development of prices over time, markets where the concentration has also increased could be particularly interesting.

As discussed above (see Figure 6a), there are indications that the cost of building materials has increased more in Sweden than in comparable countries. Factor price indices for the housing sector, as reported by Statistics Sweden, offer more details.

Building materials is the factor with the highest price growth within the sector, as illustrated in Figure 7.⁷⁴

Figure 7Factor price indices for new residential building in Sweden

Materials – multi-family Labour – multi-family FPI – multi-family Materials – single-family Labour – single-family FPI – single-family CPI

2004 2006 2008 2010 2012 2014 2016 2018

90 100 110 120 130 140 150 160 170 180

Note:Annual prices for 2016–2019 calculated by the authors as average of monthly prices. Labour – multi-family and Labour – single-family follow closely, consequently the curves coincide.

Source:SCB, Factor price indices for new dwellings, excluding VAT.

73. Defined as the sum of the squared market shares, typically measured in percent.

74. Statistics Sweden currently reports price indices for 17 factors for multi-family dwellings. The highest price growth over the five most recent years is for white-collar salaries, followed by three indices for different types of materials.

Back-of-the-envelope calculations show that if materials account for two thirds of the cost of new single-family homes, as reported in a government inquiry (SOU 2015), then increasing materials costs can explain all of the real price increase for such dwellings. Statistics Sweden (2020) estimates that materials account for only one third forall types of housing. This suggests that increasing materials costs can explain only about a quarter of the real price increase of all new dwellings in Sweden.

However, cost increases for materials do not necessarily contribute to the construction cost difference between countries. They may instead reflect rising commodity prices, for example for metals. In Figure 8 we present price developments for some building materials, indexed to 100 in 1984, together with the CPI and an index series for imported commercial steel. The figure shows that while the domestic price index for steel rebars closely tracked the import prices for commercial steel between 1984 and 1995, domestic prices have increased by more than 400 percent since 1995, while import prices increased by less than 50 percent.

Figure 8 also shows that price increases will not necessarily be large in a highly concentrated industry such as the cement industry. Over the period, cement prices have actually increased less than the CPI. One should also note that the price of installation equipment has increased by more than a factor eight and cables and conductions have increased by a factor of twenty, while the CPI only increased by a little more than 130 percent.

Figure 8Nominal price increases for some building materials in Sweden, 1984–2019

Cement Steel rebars

Cables – conduction Installation equipment

CPI Commercial steel – import price index

1984 1989 1994 1999 2004 2009 2014 2019

0 200 400 600 800 1000 1200 1400 1600 1800 2000 2200

Note:Import price index for commercial steel 1984–1995. For the 1990–2019 period, a price index was generated by the authors as the average of the index values for four steel products. Old and new price series for building materials were linked by assuming that the price increase in 2011 is equal to the average of the price increases in 2010 and 2012.

Sources:CPI and import prices from Statistics Sweden. Materials prices from Swedish Construction Federation.