High construction costs: Do price controls on cement help?

An intervention-eager state neglects its regulatory role

The president of Sri Lanka’s Chamber of Construction Industry has complained that construction costs in Sri Lanka are higher than in the region. Players in the tourism industry have claimed that high construction costs inhibit capacity expansion in the tourism industry. Why are construction costs so high? The government imposes price controls on cement, an important factor in construction, supposedly to keep costs low; but is this working?

Price controls distort markets, causing shortages and creating black markets. But, these obvious market distortions are not visible in cement. This may be because of industry involvement in setting prices, which are based on cost estimates provided by manufacturers. This seems likely, given that cement prices in Sri Lanka are higher than in the region. According to the JUBM & Arcadis Construction Cost Handbook (2017), the cost of ordinary Portland cement in Malaysia is between RM19 and RM20 per 50kg bag, which is about Rs715-750. The cost in Indonesia is around Rs845. The regulated price in Sri Lanka is Rs870-930 per bag.

Naturally, producers would be quite happy to supply a product if the price was set high enough and no shortages would occur.

Promoting competition and allowing markets to work properly are the best ways to lower prices, but in 2013, the government imposed a new restriction that curtails competition. The number of cement plants that may be operated in a port was limited to one per port. If a new factory is to be set up, priority has to be given to existing operators in the port. This limits new investment and competition, and prevents prices from falling.

If price controls were removed, the price of cement would probably fall, as it would give cheaper imports the opportunity to compete on price. Would this affect quality?

If price controls were removed, the price of cement would probably fall, as it would give cheaper imports the opportunity to compete on price

QUALITY
The local cement industry has complained of low-quality (and low-cost) cement imports in the past. This is a problem because consumers cannot detect poor quality. Substandard cement on construction work is a serious matter, as the consequences may manifest after construction is completed.

This issue needs to be addressed through a comprehensive building code, which is lacking. A proper code is needed for consumer protection and public safety. Although old regulations such as the Factories Ordinance exist, these are not up-to-date and enforcement is weak. A standard Code of Practice to regulate and enforce design, construction and compliance requirements is necessary.

While a uniform code is absent, a multiplicity of approvals exists: at provincial, district, pradesheeyasabaha, urban and municipal level. These become even more complex given several central agencies such as the Urban Development Authority (UDA), the Sri Lanka Land Reclamation and Development Corporation, and the Department of Agrarian Development. This leads to overlaps of authority, conflicts of instructions, contradictory regulations and compliance loopholes.

There is a lot of red tape, but it does not improve safety or ensure quality. The government needs to replace these old regulations with a single comprehensive code, legally enforceable, covering all classes of buildings and including safety, structural stability and accessibility.

Along with a code, building contractors and architects should be licensed and carry professional indemnity insurance. The objective of licensing is to ensure that work is done by people who are conversant with the standard (which should carry statutory force), and conduct their duties competently and professionally.

In the event of any failure in buildings, they may lose their license to practice. This is apart from any action taken in courts. The insurance ensures that consumers can receive compensation for shoddy work. The code is self-enforcing; if there is a failure, they will not be able to practice, which gives the incentive to ensure quality.

Specialist licenses should be necessary for more complex work, including the following:
(a) Piling work
(b) Ground support and stabilization work
(c) Site investigation work
(d) Structural steel work
(e) Pre-cast concrete work
(f ) In-situ post-tensioning work

OVERALL CONSTRUCTION COSTS
Cement is only one part of the construction cost; policy with regard to other construction materials significantly increases costs.

The government imposes high taxes on many imported construction materials to protect domestic industries. These include steel bars and rods (taxed at 89.66%), ceramic tiles (107.6%), and sanitarywear (72.4%). Aluminium extrusions, granite, electrical fittings, furniture and carpets are also heavily taxed. This results in high overall construction costs.

For example, steel costs around $723/mt in Sri Lanka, but only $500/mt in Thailand and $470/mt in China. By some estimates, the construction cost of an average (non-luxury) high-rise apartment block in Sri Lanka may be as much as 60% above that of Thailand or Malaysia due to these protective taxes, despite Sri Lanka’s lower labour costs.

The policy is a muddle of ad-hoc interventions. Contrast this with the UK government, which in partnership with the industry has developed a strategy to improve the performance of the construction sector by 2025. Objectives include lowering costs: a 33% reduction in the initial construction of a new building and the whole life cost of built assets, a 50% reduction in the overall time from inception to completion of a construction, and a 50% reduction in greenhouse gases. The UK industry is focused on reducing costs through efficiency, better methodology, technology and innovation.

Apart from protective taxes, the lack of scale among contractors, low labour productivity, outmoded methods and long delays in approvals also contribute to high overall costs

The focus is on overall cost reduction, and not trying to protect local producers of construction material.

Apart from protective taxes, the lack of scale among contractors, low labour productivity, outmoded methods and long delays in approvals also contribute to high overall costs.

Improvements in these areas will also reduce costs. Ordinary citizens are unable to afford housing, while the government intervenes to protect the industry.According to a report by Jones Lang LaSalle (2014): “High project development costs, coupled with the high borrowing costs for housing loans, have breached affordable limits and restricted home buying prospects for Sri Lanka.

Based on our understanding from the affordability assessment, only the top income-earning resident Sri Lankans can buy homes in Colombo. Residents with limited income are forced to opt for properties that are at least 20-25km away from city limits.”

CONCLUSION
Price controls for cement are clearly not helping to reduce construction costs. Restrictions on competition deter investment and contribute to raise, rather than lower, cement prices. Other interventions to protect the local industry have resulted in raising overall construction costs.

While the State is eager to intervene in unnecessary areas, it has neglected its role as a regulator. Although in most circumstances the best protection is the common sense of an individual consumer, in instances where technical knowledge is needed to detect poor quality, there is a case for regulation, particularly if public safety is involved.

The government should stop controlling the price of cement, and focus on drawing up and enforcing a proper building code. To lower costs, taxes on construction materials must be reduced and competition facilitated