This paper studies the factors behind pro-cyclical but widely varying construction shares (as a percent of GDP) across countries, with a strong focus on European countries. Using a dataset covering 48 countries (including advanced and emerging economies within and outside Europe) for 1990-2011, we find that country’s geography, demographics, and economic conditions are the key determinants of a norm around which actual construction shares revolve in a simple AR(1) and error-correction process. The empirical results show that in many European countries, construction shares overshoot relative to their norms before the recent global crisis, but they have fallen significantly since the crisis. Nevertheless, there is still room for further adjustment in construction shares in some countries which may weigh on economic recovery.

For many European countries, construction shares (in percent of GDP) have varied greatly before and during the recent economic crisis. Construction shares increased, some to very high levels, during the boom period. For example, during 2000-08 the real estate boom in Ireland, Spain, and Cyprus was synonymous with a construction boom, which boosted growth. In emerging Europe, similar overheating also took place in the Baltic countries, and to a lesser extent, Croatia. The process has largely reversed itself in these countries since the crisis. For most countries, the deep recession has been accompanied by a collapse in construction activities and a sharp decline in construction shares. Over the medium-term, construction shares are likely to recover in many European countries, but some may see further declines ahead. When economic conditions normalize over the medium term, Greece, Iceland, and Ireland in advanced Europe, and Latvia, Lithuania, Hungary, and Ukraine in emerging Europe may see a recovery in their construction shares. But construction shares could decline further in Spain, the United Kingdom, Romania, and the Slovak Republic. The improvement in construction shares, or lack of it, will have serious implications for the speed of recovery in economic activity and for employment.