The absence of a predictable pattern of cyclical changes

10.5.1 In their behavioural approach to the firm, Cyert and March (1992, p. 119) argue that the business environment is “unpredictably unstable” and that firms are constantly engaged in a process of reacting to it. At different points in the business cycle the degree of slack within any given firm varies. They describe slack as the excess resources used by the firm over and above that necessary for it to maintain production. Slack is a kind of economic rent which management and the coalition of groups within the firm are in a position to acquire for themselves in order to relieve themselves of pressures, stress and strain, or to make

themselves more comfortable, add status or increase rewards and bonuses.

10.5.2 Cyert and March (1992, p. 189) state that success tends to breed slack, with the result that there is a muting of the problems of scarcity. They imply that as a company’s

profitability increases there is a softening in the firm’s approach to cost control and

investment. They argue that subunit (such as project) demands for additional resources are more likely to be met as they come into less conflict with other demands for funding. It therefore follows that internal conflict within firms increases at different phases of the business cycle. The major problem with such a behavioural approach to firms is obtaining a suitable measurement of conflict in relation to slack over the business cycle. As a

consequence the argument remains descriptive and largely intuitive rather than providing a predictive model. Nevertheless it does illustrate that the behaviour and strategies of firms are likely to vary over the business cycle.

10.5.3 The absence of a predictable pattern of cyclical changes can be seen in Figure 10.4, which shows the annual changes in aggregate real wages of member firms of the HVCA, and annual changes in heating and ventilating output, construction output and GDP between 1956 and 1996. (Figure 10.5 omits GDP and is inserted for the purpose of clarity only). Provided the percentage increases remained positive, the output of the heating and ventilating industry and the construction industry expanded. Thus, if in year t\ there is a 5 per cent expansion followed by a 2 per cent increase in year t%, the output of the industry would have increased by 7.1 per cent since the beginning of year t%. Figures 10.4 and 10.5 would illustrate this by indicating a decline in the rate of growth. Hence, although there was a downward trend in the rate of growth from 1961 to 1968, in that period aggregate wage returns almost doubled (see Figure 11.2).

10.5.4 In Figure 10.5 changes in construction output and aggregate wages in the heating and ventilating industry appear to be co-incident variables throughout the period of study.

Simultaneous high and low rates of growth particularly in 1967, 1974, 1978, and 1991 with similar patterns of decline and recovery from 1965 to 1979 support the view that there is no visual evidence of a time lag between the two variables before 1979. However, since 1988 in spite of the co-incident lower turning points in the two variables in 1991, the earlier pattern of co-variance between the two growth rates appears to have broken down. In the mid 1970s for example, the decline and recovery of construction and wage returns occurred

simultaneously. In contrast, in 1987 the peak in growth rates in construction output was only followed 3 years later by a peak in the rate of growth of the wage return data.

10.5.5 Looking at changes in the rate of change (acceleration) in Figure 10.4, in the 37 years of continuous data available in only 3 periods (1965-6, 1974, and 1989-90) did heating and ventilating accelerate while both construction and GDP slowed down. On the other hand in 5 years (1959,1964,1975,1987 and 1994) heating and ventilating decelerated while the construction industry and the GDP both accelerated. In all other 27 years heating and ventilating, construction and GDP all increased or decreased together.

10.5.6 Looking at the annual changes in GDP, construction output, heating and ventilating output and wage returns in Figure 10.4, in the 29 years between 1959 and 1996 (excluding

1980 to 1987 because of missing wage return data) the annual changes in all 4 variables can be compared. There were only 2 years when the rate of growth of all four increased (1976,

1978), and only 3 years (1962, 1979, 1991 and 1992), in which they all decreased. In only 15 years did both wage returns and heating and ventilating output either accelerate or decelerate together. They accelerated together in 6 years (1961, 1976, 1978,1989, 1990, and 1995), and in 9 years, they both decelerated, namely 1959, 1962-4, 1973, 1979,1991, 1992 and 1996. It is therefore difficult to predict changes in annual wage returns on the basis of changes in heating and ventilating output.

10.5.7 In the 41 years of GCPI deflated wage data, by and large, periods of growth tended to last either one or two years as did periods of deceleration. However, between 1961 and 1974 the general trend was one of a declining rate of increase in aggregate annual wage returns, with aggregate wage returns actually declining by over 10 per cent in 1974. The recession in the early 1990s caused growth rates of the construction industry variables to decline in 1991 and 1992. In 3 periods (in 1969, from 1972 to 1975, and from 1991 to 1994) does Figure

10.4 show negative growth in aggregate wage returns. To summarise these findings, as far as the heating and ventilating industry is concerned, no fixed period short run business cycle can reasonably be discerned from the wage return data.

10.5.8 The GDP appears to follow a much more predictable and far less volatile pattern than wage returns. In only 3 periods does GDP actually show a decline, namely; 1974 to 1975,

1980 to 1981 and 1991 to 1992. For the rest of the period between 1949 and 1996 the economy appeared to grow at up to 5 per cent per annum, but more usually in the 2 to 3 per cent range. In comparison, the trend in the rate of growth of aggregate wages was

downwards between 1956 and 1974, declining to a growth rate of approximately -11 per cent in 1974 alone. Although relatively volatile, the long run average annual growth rate of wage returns remained above the long run annual growth rate of the GDP from 1956 to 1996. This implies that although some productivity improvement was enabling employers to control their real total annual wage bills over the long run, they were still able to pay their workforce a higher real income. However, taking only the short run period between 1988 and 1996, no such trend can be seen.

Figure 10.4 Annual percentage changes in GDP from 1949, HVCA wage returns from 1956, heating and ventilating output from 1958, ___________________________________ and construction output from 1956 to 1996_____________________________________

Q) O) C CD § 0) O) (0 CD 3 C C < -1 5 -20 CO CD Ui 00 O CD 8 S g § g i § CD O CD ~ v l N3 CD CD N O) CD -vj 00 CD 00 O g

I

Sources; HVCA declared wage returns ledgers

GDP, Table 1.3 ONS, Economic Trends Annual Supplement 1997 edition N o 23, HMSO

GDP deflated using GDP implied deflator at market prices, Tablel .l Prices, Economic Trends Annual Supplement 1997 edition No 23, ONS, p.7 Construction industry series deflated using GCPI,

Figure 10.5 Annual percentage change in

construction output, heating and ventilating output and wage returns 1956-1996

-Aggregate wage returns

Year

•Heating and ventilating industry •Construction industry

Sources: HVCA declared wage returns ledgers; Economic Trends Annual Supplement 1997, N o 23, HMSO Note: Construction industry series deflated using GCPI.

10.5.9 Figures 10.4 and 10.5 show the annual real rates of growth of construction output, heating and ventilating output and wage returns. The annual rates of growth of heating and ventilating and construction follow a volatile but generally long run declining trend from

1956 to 1973 without any subsequent clear upward trend in annual growth rates since 1974. The depression of 1973 to 1977 can be clearly seen, as can the disruption caused by the recession of the early 1990s. Nevertheless, the data shows little predictability' between the variables except perhaps between construction output and wage returns as shown in Figure

10.6.

Figure 10.6 Annual percentage changes inin construction output and HVCA wage returns 1956-1996

cn o> c -10 -15 (O CD CD CD CD IS CD S

i

Aggregate wage returns Construction industry output

Sources: HVCA declared wage returns ledgers; HCS, DETR Construction industry series deflated using GCPI.

10.6 Concluding remarks

10.6.1 One of the conclusions that may be drawn from the nutcracker theory is that pressure on profits may be most acute at the upper turning point in the business cycle. As a result firms require liquid resources to ensure they have sufficient funds to avoid a cash flow problem, though in construction retention monies and late payments may continue to support firms after decline in demand has become apparent. At the lower turning point in the cycle, firms’ cash flows are likely to be positive as demand and prices rise before costs, especially labour wage rates. The risk facing heating and ventilating contractors at this point in the cycle is over-rapid expansion, which exhausts working capital and leads to cash flow difficulties. It follows then that appropriate strategies may differ at different points in the cycle.

10.6.2 Many, indeed most, firms do survive any one recession. Recent building cycles, for example, from 1973 to 1979, from 1979 to 1990 and from 1990 to 1996 and beyond have tended to be relatively long and far more volatile compared to earlier short 4 year cycles. Market exit may be expected more in long lasting downturns than if cycles were short and expected to be short. Depending on its liquidity and capital reserves, a firm’s ability to survive recessions and take advantage of booms may be the major factor in determining its survival and growth. Many heating and ventilating firms survive by adopting and adapting new methods, technologies and products. Larger firms with larger cash reserves are in a stronger position to do this than smaller firms. This appears to be the case in the heating and ventilating market. New technologies are continually being adopted as a consequence of merger activity.

10.6.3 This fits in to the needs of smaller rapidly expanding firms. They either wish to sell to capitalise on the early development of an innovation, or require the additional marketing and financial strengths of a larger firm to exploit the specific competitive advantage of the small firm before others have time to imitate it. There are also opportunities for large firms during recessions as merger or being taken over by another company is an option for a fundamentally sound firm, which may be in financial difficulties in a declining market, as in the Schumpeterian ‘creative destruction’ model. The business cycle is therefore central to understanding changes in the population of firms in the heating and ventilating industry. 10.6.4 This chapter has argued in favour of the following propositions;

• There is no one correct way to conduct business because what may be prudent in one set of conditions may not be prudent in another.

• As far as heating and ventilating firms are concerned the business cycle affects demand for their services as exogenous, discrete and irregular shocks.

• There is no predictable pattern of annual expansion and contraction in the heating and ventilating industry in relation to the construction industry or the economy at large. • However, the relationship between annual changes in aggregate wages in the heating and

ventilating industry and total construction output is closer than heating and ventilating wages and heating and ventilating output.

• If the recession of the early 1990s was typical, during periods of recession in the

the heating and ventilating rather than heating and ventilating contractors diversifying out of their own specialism.

10.6.5 Many of the propositions of this chapter can be examined by studying the time series of gross domestic product, construction output, heating and ventilating output and annual wage returns. These are therefore examined in detail in the chapters which follow. The next chapter discusses the use of aggregate annual wage returns as a proxy for heating and

ventilating industry output and firms’ annual wage returns as a proxy for their turnover, which is one of the conventional measures of size of firm.

Chapter 11 The use of wage returns as a proxy for output