Small businesses are making building homes more expensive, CEDA report warns

Australian housing costs have surged, due in part to a shortage of homes relative to a rapidly increasing population.
But what if you could build 12 per cent more homes each year than we are currently with no extra workers?
Both the federal government's Productivity Commission and the Committee for Economic Development in Australia (CEDA) believe that is possible by improving efficiency in the construction sector.
"The Productivity Commission has found that, even when adjusting for size and quality improvements, construction labour productivity per hour worked has declined by around 12 per cent since 1994, and still significantly underperformed the wider economy, which experienced labour productivity growth of around 49 per cent over the same period," noted CEDA economists Melissa Wilson and James Brooks.
In a report released by CEDA today, the two economists argued that the commonly blamed suspects of industrial relations and workplace conditions in the building sector are not among the key drivers of this productivity decline.
They argue the key culprits include complex and slow building approvals processes, a lack of innovation, skills shortages and a lack of scale. It is the latter issue they focused on in their report.
"There are currently 410,602 construction firms in Australia, of which 98.5 per cent are small businesses with fewer than 20 employees," they observed.
"Ninety-one per cent of construction firms are microbusinesses with fewer than five employees, up significantly from 43 per cent in 1988/89."
This makes construction one of the least concentrated industries in Australia, with these micro and small firms accounting for more than half of the money spent on building work in Australia.
Yet they achieve far less output than the small number of larger construction firms.
"We found that Australian construction firms with 200 or more employees generate 86 per cent more revenue per worker than Australian construction firms with five to 19 employees," CEDA's economists noted.
"If firms in the Australian construction industry matched the size distribution of firms in the manufacturing industry, the construction industry would produce 12 per cent, or $54 billion, more revenue per year without requiring any additional labour.
"This is equivalent to gaining an extra 150,000 construction workers."
Not that all experts agree that smaller building firms are inherently less efficient than large operators.
"I do not agree with the conclusion that big is the answer," wrote former NSW building commissioner David Chandler on LinkedIn in response to the report.
"The Tier1 contractors in Australia are mostly foreign owned and amongst the most risk adverse and expensive players."
However, in their paper, Ms Wilson and Mr Brooks noted that overseas research has produced similar findings about the overall productivity benefits of larger firms.
"Researchers have found a strong connection between firm size and productivity in US residential construction, where firms with 500 or more employees produce six times as many units per employee than firms with fewer than 20 employees, and firms with 100 to 499 employees are twice as productive," they wrote.
So why are smaller construction firms so much less efficient than larger ones?
Ms Wilson and Mr Brooks concluded that smaller firms are less able to achieve economies of scale.
"Consultation with CEDA members and other industry experts has confirmed that the construction industry tends to be fragmented, insular and lacking incentives to adopt new ways of doing things," they argued.
"They have less capacity to innovate, to invest in equipment and technology, and to devote to training and capability building, which are all important drivers of productivity growth."
The economists said the boom-bust cycles prevalent in construction seemed to have accelerated the trend towards using subcontractors, and therefore the dominance of smaller firms and independent contractors.
"As subcontracting fragments the industry, this has likely increased the time and effort spent on procurement, contract negotiations, supervision and regulation, and dispute resolution," they noted.
"Our consultation has identified reworks and disputes as a major source of inefficiency in the sector."
So, if smaller operations are so much less efficient than larger ones, why have they proliferated?
The authors say perverse incentives in the federal tax system are a major suspect.
"Being self-employed can result in paying less tax than a salaried employee earning the same pre-tax income," they observed.
"Our analysis of HILDA income data for people working at least 30 hours per week shows around 8.5 per cent of independent contractors in the construction sector disclose income under the tax-free threshold of $18,200, and therefore pay no tax, compared with just 2 per cent of salaried construction workers.
"A high-income construction worker earning $148,000 per year would pay 26 per cent tax as a salaried worker. As a contractor, they could structure their income with a discretionary trust and a 'bucket' company and pay just 18 per cent tax — a difference of $12,400 in annual-take home pay after tax.
"Additionally, in trust structures, a high-income individual can distribute income across household members, who may pay even lower tax rates. Or, in rare cases, contractors can simply misrepresent their income and avoid tax altogether."
Not to mention that small businesses have been able to access an instant asset write-off that further cuts their taxes, when they buy things like tools or utes.
Independent economist Saul Eslake said the "excellent report" identified some of the costs of what he labels "small business fetishism".
"Small business fetishism refers to the widespread (and bi-partisan) belief that there is something inherently more noble about running a small business than working for a big one, a government or a not-for-profit, and that therefore small business operators should pay less tax on any given amount of income, and enjoy preferential treatment in many other respects, than people earning wages or salaries, large businesses, and others less 'noble'," he wrote on his LinkedIn page.
Aside from income tax minimisation, the authors also identified complex and localised building approvals processes, state-based trades licensing, and the lack of a stable workflow due to the demise of the public housing sector as factors preventing the growth of more large construction firms.
"To encourage scale, governments should:
They also noted that reduced planning regulation appeared to be correlated with an increase in construction productivity in Auckland.

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