The Decline in Construction Employment, Infrastructure Investment and the Davis Bacon Act

Reihan Salam has a smart piece in National Review Online and provides some good insights about how the construction sector is changing and why construction employment has not rebounded as it has in prior recoveries.  He notes that modular construction and technological change is likely to change the labor intensity of construction projects.  So even when construction activity rebounds, construction employment may never regain the share of total employment it reached during the housing boom of a decade ago.  Salam is correct; trends in construction employment may begin to look a bit more like manufacturing.  In U.S. manufacturing it has been quite common to see output increase despite stagnant or even declining employment because of technological change.

Salam writes that construction projects in the U.S are often inefficient and I agree, especially when it comes to infrastructure investments.  The federal regulations make public sector projects far too expensive to taxpayers even at a time when a record downturn in construction employment should mean much lower costs.  The federal government has not taken enough advantage of the considerable slack in construction employment to build and repair infrastructure.

By law, federal government projects must pay the prevailing wages of construction workers, and these wages are often union scale.  This regulation, known as the Davis Bacon Act, has artificially inflated the price of construction labor on public sector projects.  Even in states and counties  where construction employment has been depressed for the past five years, government contractors are sometimes required to pay wages in construction trades that exceed the average in the area by at least $10 per hour.

Davis Bacon wages do not rely on carefully designed samples of workers, such as the Bureau of Labor Statistics (BLS) Occupation Employment Statistics (OES) Survey to determine the wage distribution in construction trades in a local area.  Instead, Davis Bacon wages are determined in the Labor Department’s Wage and Hour Division which over-samples unions and obtains much higher construction wage estimates.  Only 6.6% of private sector workers are union members so the special treatment of unions in Wage and Hour Division surveys leads to unrepresentative prevailing wage estimates.

As an example consider Riverside County, California where the unemployment rate in July was 11.1%.  The most recent OES survey reports that the average wage for a carpenter is $27.25 per hour and 75% of carpenters earn $36.39 per hour or less in Riverside.  Yet the Davis Bacon Act mandates that federal contractors pay at least $48.43 per hour to carpenters in Riverside, in wages plus fringe benefits, on government construction projects.  The Davis Bacon prevailing wage for carpenters is $37.35 per hour and prevailing fringe benefits are $11.08 per hour.  (The BLS National Compensation Survey reports that the average cost of fringe benefits is $10.52 per hour nationwide.)  Similarly inflated compensation is required for brick masons, electricians, plumbers and equipment operators.

Although reasonable economists can disagree about the level of public spending on infrastructure, ideally we should make more public investments in infrastructure during a downturn when opportunity costs are lower.  The Davis Bacon Act interferes with such a common sense policy.  Conservatives should have proposed a repeal of Davis Bacon in the waning months of the Bush Administration or early in the Obama Administration as a way to more efficiently utilize slack resources during the recession.

Requiring taxpayers to pay inflated prices to construction labor makes as much sense as paying inflated interest rates to government bondholders even though market interest rates have declined.  The federal government currently pays lower interest rates on government debt because it pays market rates on new debt issues.  Fortunately there is no equivalent to the Davis Bacon Act requiring that the federal government pay inflated non-market interest rates to protect retirees and pension funds that hold government bonds.  It is time to change the law so that taxpayers can also pay market wages on construction projects.

Political Pork and (Davis) Bacon

President Obama, while campaigning in Iowa, announced $170 million in Federal meat purchases, including $100 million of pork, to help offset the expected decline in prices caused by this summer’s drought.  Ranchers have been slaughtering more animals rather than paying higher prices for feed this summer.  The shift in supply is driving meat prices down.  The President explained that the government plans to purchase more meat now at lower prices and freeze the meat  for later use, adding  “we’ve got a lot of freezers.”

The government should take advantage of lower prices for the commodities it buys because it reduces the cost of government.  It would be nice if these policies could be extended to construction labor hired for government projects.  Unfortunately the Davis Bacon Act keeps the cost of construction labor artificially high even as millions of construction workers remain unemployed or under-employed due to the collapse of the residential housing market.  For example, Federal law mandates a wage of at least $75 per hour for electricians and $71 per hour for plumbers in the city of Philadelphia for government construction projects.  Surely there are underemployed construction workers in Philadelphia who are willing and able to work on infrastructure projects for only $50 per hour.

The argument that the Federal government should intervene in commodity markets in order to dampen price fluctuations is dubious.  First, low prices are generally bad news for producers but good news for consumers.  Any government attempt to manipulate prices won’t benefit both buyers and sellers simultaneously.  (Price controls can however harm both producers and consumers).

Second, commodity producers can easily hedge against price declines by participating in futures markets (and taking a short position).  Purchasers can hedge against price increases by taking the opposite (long) position in the futures market.  For example, Southwest Airlines benefited from hedging against airplane fuel price increases when fuel prices were increasing, but lost out on their “insurance” when fuel prices fell.  The Federal government should not attempt to manipulate commodity price fluctuations when market participants could have hedged their positions in organized (and regulated) futures markets.  Nor should there be government intervention to limit the financial impact on companies from fluctuations in interest rates and the value of foreign currencies.  Companies can hedge against this volatility if such “insurance” is worth the expected cost.

Finally, if the goal is simply to lower the price of livestock feed there are better policy changes to consider.  First, as noted by the Washington Examiner, Federal energy policy now diverts billions of bushels of corn (representing 40 percent of domestic production) to the production of ethanol.  Second, our policy to tax imported sugar diverts hundreds of millions of bushels of corn per year to the production of high fructose corn syrup, a sugar substitute.  The Federal government should pursue smarter energy policies and eliminate sugar tariffs that protect sugar beet producers from foreign competition.  These policy changes would lower the artificially high price of corn and provide welcome relief to ranchers facing even higher feed prices due to the drought.

Should President Obama Suspend the Davis Bacon Act?

Professor Robert Frank argues for more government spending on infrastructure in an opinion piece in the New York Times.  Frank writes that both Mitt Romney and President Obama should be “willing to take the one politically feasible step that could help mend the economy quickly: an accelerated program of infrastructure repairs.”  Frank’s column is quite similar to one written in October 2011 by informal Obama advisor Richard Thaler, who wrote that infrastructure investments are “on sale” because of low interest rates.  Frank seconds this argument by writing “many skilled people who can do these jobs are unemployed today. If we wait, we’ll have to bid them away from other useful work. And with much of the world still in a downturn, the required materials are cheap.”

The problem, as I noted in an earlier blog post, is that labor costs for government construction projects are dictated by the Davis Bacon Act and not by competitive labor market conditions.  The Davis Bacon Act states:

every contract in excess of $2,000, to which the Federal Government or the District of Columbia is a party, for construction, alteration, or repair, including painting and decorating, of public buildings and public works … and which requires or involves the employment of mechanics or laborers shall contain a provision stating the minimum wages to be paid various classes of laborers and mechanics.

minimum wages shall be based on the wages the Secretary of Labor determines to be prevailing for the corresponding classes of laborers and mechanics employed on projects of a character similar to the contract work in the civil subdivision of the State in which the work is to be performed . . .

The prevailing wages set by the Secretary of Labor are generally substantially higher than the median wage in BLS surveys, even in areas where the construction industry has been decimated by the recession.  The following chart shows the change in construction employment in four counties especially hard hit by the recession.

One would expect that construction workers would be willing and able to work on infrastructure projects for relatively low rates of pay in these counties.  In Clark County, Nevada, for example. construction employment fell by more than one half.  Unfortunately the prevailing wages set by the Secretary of Labor for heavy construction projects in Clark County do not reflect the slack in the labor market:

• Flagperson                                                      $41.44 per hour
• Carpenter                                                        $45.11 per hour
• Structural Ironworker                                   $56.74 per hour
• Crane Operator                                               $66.75 per hour

These hourly wages are, on average, about 12.8% higher than they were in 2007 when the construction sector in Las Vegas and Clark County was booming.  The prevailing wages in Riverside, Maricopa and Miami-Dade counties are similarly high and have also increased over the past few years even though the demand for construction labor has plummeted.

Government infrastructure projects are expensive because prevailing wages are above the market wages measured by the Bureau of Labor Statistics.  High labor costs make infrastructure projects much less of a bargain than Professors Thaler and Frank have argued.

What can President Obama do? He can suspend the Davis Bacon Act until the economy, especially the housing market and construction sector, has recovered.  Suspension of the Davis Bacon Act is not without precedent in the case of a national emergency.  President George W. Bush suspended Davis-Bacon in Alabama, Florida, Louisiana and Mississippi in the fall of 2005 as the region recovered from Hurricane Katrina.

Mr. President, we face an emergency in the construction sector.  Housing prices have not recovered from the recession and employment in the construction sector is far below its pre-recession levels.  Professors Frank and Thaler are correct – it makes sense to invest in infrastructure projects when they are “on sale.”  The Davis Bacon Act stands in the way of getting important construction projects completed at a reasonable cost to taxpayers.  In addition, a bold move like suspending Davis Bacon could encourage Republicans in Congress to support other job initiatives that you favor.

Infrastructure Spending and the Davis-Bacon Act

It’s been three years since the American Recovery and Reinvestment Act was signed into law.  Only 7% of the $840 billion in stimulus funds were allocated to transportation and infrastructure projects.  White House Budget Chief of Staff Jack Lew  recently said that a “crumbling infrastructure is not the way to build an economy that can last.”  The Obama Administration  has proposed spending hundreds of billions of additional dollars on roads, bridges and schools.  Common sense says that the Federal government should undertake those infrastructure projects where the benefits exceed the costs.  Unfortunately the Davis-Bacon Act inflates costs by requiring Federal contractors to pay the prevailing wage (plus fringe benefits) on construction projects.

Government infrastructure spending makes sense because borrowing costs are low; the 10 year Treasury bond rate is about 2%.  This argument would be bolstered if labor costs were also relatively low.  The Davis-Bacon Act, however, forces government contractors to pay artificially high wages and benefits.  This means that fewer projects will be completed for each billion dollars budgeted for infrastructure.

If the wages paid on government construction projects could freely adjust to market conditions, labor costs would be much lower in many parts of the U.S.  The following figure shows construction employment in three states particularly hard hit by the 2008 recession: Florida, Michigan, and Nevada.  Construction employment is down 40% to 62% from its pre-recession peak in these states.

The large demand reductions in the Florida, Michigan and Nevada construction industries put downward pressure on construction wages.  Davis-Bacon prevents this from lowering labor costs for Federal projects.  The U.S. Department of Labor sets the prevailing wage in each area based on surveys of unions and employers that are administered by its Wage and Hours Division (not the Bureau of Labor Statistics).

The 2012 prevailing wage in Las Vegas (Clark County) is about $50 per hour for carpenters and $60 per hour for electricians and power equipment operators.  I presume there are thousands of unemployed and underemployed construction workers in Las Vegas who would be willing to work for less than $50 per hour.

Prevailing wages that are unresponsive to current labor market conditions are not limited to Las Vegas.  The following figures show prevailing wages for plumbers and elevator mechanics in Wayne County, Michigan (Detroit) and Broward County, Florida in 2004 and 2012.  Since 2004, the prevailing wages of elevator mechanics increased by about 80% in Wayne County and by 90% in Broward County.  Over the past 8 years, plumbers’ wages increased by 40% in Broward County and by 67% in Wayne County.  These substantial increases occurred despite the collapse of the construction industries in Michigan and South Florida in the past decade.

The Works Progress Administration (WPA) had a much different approach for infrastructure projects from 1935 to 1943.  WPA wages were twice welfare benefits, but far less than the union pay scale, so that more workers could be employed.  The WPA also used excessively labor intensive methods to increase employment per project.

Inflated infrastructure costs are undesirable whether they are due to artificially high wages or an inefficient production process.  Ultra-Keynesians, like Paul Krugman, may advocate infrastructure spending as a stimulus even if production is inefficient or labor costs are inflated.  After all, Krugman recently argued that government spending for protection from imaginary space aliens would be beneficial.

The Federal government should undertake infrastructure projects where benefits exceed costs, allocate resources efficiently, and pay market wages.  The projected benefits of infrastructure projects should be based on the merits of each project not supposed stimulus effects.  Project costs should reflect market conditions.  Requiring contractors to pay their employees inflated prevailing wages produces no more stimulus than would a requirement that domestic bondholders receive 5% rather than 2% interest.  Davis-Bacon prevailing wage requirements were suspended in the aftermath of Hurricane Katrina.  The Obama Administration should consider suspending Davis-Bacon again so that contractor wages reflect market conditions, more unemployed construction workers can be hired and more worthwhile infrastructure projects can be funded.