Construction sector of Latvia faces overheating, experts warn

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Most of the nearly two billion euros that Latvia will receive within the EU Recovery and Resilience facility will be invested in infrastructure. Other European funds are expected to be invested in construction at the same time, and experts are warning about the risk of overheating the construction sector, Latvian Television reported July 12.

The recovery facility of €1.82 billion will flow into Latvia over the next five years. Investment plans show that more than half will go into infrastructure, which means a large part is related to construction. For comparison, it is planned to invest only a tenth of the funds in human capital and even less in research, development, and innovation.

A panel of 16 people, comprising economists, financial professionals and entrepreneurs, concluded that the plan provides too little for research and human capital because these are the areas that provide a more sustainable impact on economic development than the construction of new sites.

Member of the Fiscal Discipline Council, Jānis Plato, said: “I think it is such a traditional orientation for us that we invest more in concrete, but not maybe in human. Though that concrete is the first thing that people seem to miss most at first sight."

Also  agrees: “This, if we have more good quality roads to some destination, or different houses where public authorities will work, or new schools, or different types of digital solutions, do not mean that people will want to use them if they do not have a job at that moment or if they do not want to live in Latvia at all."

Relatively easier administration of infrastructure projects – in her opinion, this is one possible reason why the focus is placed on this area when planning public funds. At the same time, there is no doubt that infrastructure investment is necessary, experts say. Excellent infrastructure is one of the prerequisites for increasing productivity and competitiveness. The question is only about the balance of investment and the expected return.

Citadele Bank economist Mārtiņš Āboliņš explains that there are projects (such as insulating buildings) where the return will be seen – “lower imports for energy resources, more money remains in the Latvian economy”.

Another important factor is the impact of infrastructure investments on the health status of the construction sector. Last year, the sector accumulated a total of €2.4 billion in Latvia. Construction has not been affected by the Covid crisis but is greatly affected by the flow of public and municipal orders.

The majority, more than 60 percent, of the total construction volumes is financed by public funds. The sector's internal discussions also discuss the expected return of recovery money. “The next five, six years look very hopeful in terms of the flow of funding in the construction sector. What is already worrying, first of all, how it will be distributed over the next five years or how smooth it will be. And the second thing, the big thing that worries, is what will happen in 2027, 2028, when the funding will dwindle,” said Mārtiņš Dunskis, executive vice president of the construction industry union.

Under this scenario, the situation in the construction sector will be significantly affected by government action. For example, planning for the sale of Liepaja prison or any other ambitious project would have a positive impact at a time when the tide of European money is receding. Otherwise, the construction sector is likely to suffer a sharp fall.

Dunskis said: “The crazy thing is when the industry is building up muscles, such as recruiting 70,000 employees, the industry has already got people who can work, who have the training, who have experience and who could make the same amount or even higher next year, because skills are growing. At that moment when the order is falling sharply, there is no need for these 70,000 employees, consequently, they are dismissed, they seek work in other countries in the same sector or in other sectors.”

Experts predict that in the coming years, the construction industry will face strong pressure on wages in the fight over the workforce. Together with the rise in prices of construction materials, which has already seen a sharp rise this summer, it can significantly increase offer of construction services. This poses a far-reaching risk to the overall state economy, adversely affecting Latvia's competitiveness and may also apply directly to the execution of the construction projects envisaged in the Recovery Plan.

“This means that the current potential plan for costs can be incorrect. It may prove that this investment project is more expensive in the end than we had planned. That means we can come to a situation that we can't complete [the project] at all. Or create a significantly smaller volume,” the dean of the LU Faculty of Economics and Management said.

Experts warn of the risk of overheating in the construction industry.

Inna Šteinbuka, chair of the Fiscal Discipline Council, believes that the risk of overheating is fundamental: “And now that we are talking about inflation and we see prices already rising for a variety of reasons - fuel prices, but food prices are also rising gradually. And if we add more to the construction of overheating risks, then we can count on inflation to rise by more than 2%.”

Šteinbuka believes that cooling measures in the construction sector, such as postponing project deadlines to avoid overlaps, are already largely overdue: “Of course, these measures will heat the economy extremely strongly. It's hard for me to say right now, but for me the inner feeling is that our economy could be quite hot for the next couple of years. Hot because we have the deferred demand created during the pandemic.”

As the lead researcher for Providus, Iveta Kažoka, summarizes, the Recovery Plan is essentially a vision of our top officials and the political elite for Latvia's development, which includes several clear elements:

“As the structuring element number one – almost everyone wants to build something. Structuring element number two – that everyone sees the need to boost business and competitiveness, almost no one sees the need to get serious about reducing social inequality. Number three is that, yes, the government is trying to keep their overall view on things, but at the same time, that common view, independent of the ministries' own special visions, sectorial visions, lacks power.”

The first part of recovery money – €237 million – is expected to be available to Latvia already in July.

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