Economics

Business or Economic Cycles
Economic cycles are natural phenomenon that occurs between periods of expansion and contraction in an economy. These cycles of growth and recession arise due to fluctuations in the economic activity levels. Investopedia defines Economic Cycles as

An economy is deemed to be in the expansion stage of the economic cycle when gross domestic product (GDP) is rapidly increasing. During times of expansion, investors seek to purchase companies in technology, capital goods and basic energy. During times of contraction, investors will look to purchase companies such asutilities, financials and healthcare.

A debate exists as to why business cycles take place, and if there is some way to minimize the intensity of these cycles. Many economists are of the view that potential depressions can be offset by adequate policy measures (Stephen, 2009).

As a result of increased policy controls and governments role in the economies, the fluctuations have indeed gone down and the duration of business cycles increased.  Researchers have also suggested that shift towards service based economy is also one of the reason behind dampening of business cycles. On the other hand, developments such as deregulation and increased globalization of financial institutions have conflicting and unclear effects on the cycles.

Characteristics of Business Cycles
A business cycle is an alternating expansion and contraction in business activity of an economy. Business cycles are characterized by

Periodic in Nature
Business cycles are periodic and recurrent in nature. However, they occur at irregular intervals. They might occur in 30-40 years and may vary from 7 to 10 years. (Stephen, 2009)

Wave Movement
Business cycles are comprised of crests and troughs. Crests are characterized by expansion and growth in economy. In this period, GDP of the economy grows with an upward trend more investors seek to enter the economy and generally more investments are done in the areas of technology and capital intensive industries. In the period of Trough, the economy starts to slow down with employment opportunities thinning down and overall productivity of the economy slumping down as well. During the times of recession, investments are directed towards sectors like health, finance and utilities.

Presence of Crisis
Generally, economies start to decline as a result of some crisis. Crisis in one major sector of economy effects many other sectors which results in a trickle -down effect. An excellent example would be the Global Financial Crisis that devastated many economies of the world. This crisis also started as a result of Subprime Mortgage Crisis. (Stephen, 2009)

Self - Reinforcing and Cumulative Process
Business cycles are cumulative in nature. That is to say that when upward movement starts, the upward trend is seen in all the sectors and a cumulative movement towards growth begins. Similarly, a downward trend is also cumulative when many sectors combine to move the economy to a slump.

Phases of Business Cycle
Business cycle fluctuations occur in aggregate variables like national income, employment level, and price levels etc. however, the intensity and the duration of all the variables differ. These ups and downs of economic activity can be generally divided into following 4 phases

Prosperity This phase of business cycle is characterized by rapid growth in business activity. Real income, real output, industrial activity are rising rapidly. Optimism is there among the businessmen and investments are going up. Financial institutions easily extend credit to individuals and businesses that result in expansion of the industries. Unemployment remains low as new business and job opportunities keep coming in the economy. At the same time, more investments are directed towards capital- intensive businesses. (Stephen, 2009)

Recession In recession phase, consumers buying pattern changes due to shrinking income levels. More focus is on buying basic, functional products. Business activities mirror these changes by reducing their levels of output, postponing expansion plans etc. aggregate demand in the economy goes down which results in piling up of unsold inventory. Laying -off of employees becomes the common practice.

Depression Depression is a long recession. If the economy fails to recover from its recessionary phase, the economy enters depression. In recession, the economy is at its trough with negative growth of income levels and GDP. Unemployment is ubiquitous in depression. Great Depression of 1929 is a prime example.

Recovery In the recovery phase, economy starts to pick up pace. New businesses start to emerge however, the profits rise very slowly. Banks start to expand credit again but the credit expansion is very prudent this time.

Factors Shaping Business Cycles
Business cycles have been a topic of interest for economists for centuries. Earlier, many theorists considered recessions as a disease that needed to be cured. However, after 19th century, the perception changed as economists then realized that economies are cyclical by their very nature. They then directed all their effort in determining the factors affecting business cycles and the ways to maneuver those factors to dampen the adverse affects of recessions. Below are discussed some factors that corporate executives and economists suggest causes changes in business cycles

Volatility of Investment Spending
Investment spending is one of the most volatile components of aggregate demand. Empirical studies have revealed that volatility of investment component is an important factor in explaining changes in business cycle. According to these studies, investment growth spurs a growth in aggregate demand that leads to an overall expansion of the economy. The Great Depression of 1929 was also a result of investment spending collapse as a result of stock exchange crash in 1929 in USA.

Acceleration Principle also tries to explain the linkage between aggregate demand and investment spending. As the sales increase mirroring the increase in demand, output has to be increased which requires plant expansion and thus investments. This, in turns accelerates the economy in upward direction. Thus once the expansion starts the pace of investments also increases in a magnified amount. (Oleg and Stanislav, 2004)

Technological Advancements
Technological advancements in the fields of communications, transportations, manufacturing, and operations have had a ripple effect on the whole industry. Technological innovations in production or production processes have led to increased productivity and efficiency. However, researches have shown that technological innovations and consequent increases in investments take place at irregular intervals. Fluctuating investments, thus, result in fluctuations in the business cycles as well. Economists consider that technological innovations do not have a systematic pattern, and this irregularity is a cause of fluctuations in the economy.

Variations in Government Spending
Government spending are another big factor affecting macro economic conditions of a country.  It is one of the major policy factors that can help in stabilizing an economy. Greater the level of government spending, greater will be the economic activity and vice versa. Recently, US and many European countries are trying to give a boost to their economies by increasing government spending and injecting money in the system. (Friedman et al. 2003)

Politically Generated Business Cycles
It has been hypothesized by economists that politicians also sometimes motivated macro -economic policies for their self -interest.

Monetary Policy
Monetary policy involves controlling the money supply and interest rates in the economy. Central banks use this powerful tool to influence the macro economic conditions and stabilize the economy. Interest rates are lowered when government wants to motivate people to consume more and increase aggregate demand. Conversely, interest rates are set high to induce savings and investments. (Oleg and Stanislav, 2004)

Fluctuations in Exports and Imports
The difference between imports and exports, known as net exports, is a main component of aggregate demand. As GDP grows, peoples demands for imported items grow. Growth in demand for goods for other countries results in increase in exports. (Friedman et al. 2003)

Policy Actions Used to Control Macro Economy
As discussed earlier, economic cycles are cyclical by nature. But economists have devised ways to dampen the adverse effects the fluctuations might have on the economy. These ways include certain policy measures like

Fiscal Policy
Fiscal policy has been the topic of debate in the developed nations like US, Europe and Japan. In US, the role of fiscal policy as a tool to stabilize business cycles has been questioned. In Europe, single currency has also raised concerns whether fiscal policy can substitute for monetary policy and whether supranational fiscal federation should be created for this purpose. In Japan, government has had used expansionary fiscal policy repeatedly to boost the economy but there is no consensus on whether it had any significant impact on the economy or not.

Keynesian cross model states that automatic changes in government revenue in response to output fluctuations help smoothing business cycles through demand multiplier. In this model smoothing effect of taxes on disposable income is the stabilizing factor. By fiscal policy measures, government can control its spending its revenues in terms of taxes and thus control the business cycles. (Oleg and Stanislav, 2004)

Monetary Policy
Of all the hypotheses proposed in economic, the one that has been most widely tested is the relation between money growth and inflation. Disagreements occur in terms of how soon, or how much will always occur, but there are a very few economists who would argue that monetary aggregate has no subsequent bearing on inflation rate. According to Beryl Sprinkle, monetary policy decisions are sometimes influenced by the political factors too. According to him, there is a fairly consistent lead-lag relationship between monetary change and the business cycle.

Friedman and Schwartz (1962), in their famous book, postulated a link between monetary policy and real economic activity. The effect of monetary policy on business cycle has been studied through various empirical and theoretical studies.

Central banks use monetary policy tools-money supply and interest rate- to influence the market powers and to stabilize the economy. Central banks respond to deviations in inflation and desired output levels.  Consensus is that monetary policy does not have a deep -rooted impact on the cyclical fluctuations. Some authors, though, disagree. In most countries, the primary goal of Monetary Policy is price stability. However, other objectives are also in the mandate of central banks. These objectives include full employment, domestic financial stability, and normal operations of foreign payments. Changes in monetary policy are triggered by domestic and external shocks that endanger the attainment of policy objectives. Central bank keeps an eye over the macro- economic variables and changes the policy instruments to offset any imbalances.

The transmission mechanism of monetary policy affects several different variables in the economy at different intensities and speeds. The transmission mechanism involves channels through which monetary policy objectives are achieved. The first channel is the interest rate channel which is regarded as the main channel of monetary policy transmission. An expansionary policy, for instance, leads to a decrease in long term interest rates, which in turn effects investment environment. The corresponding shift in aggregate demand becomes the driving force behind increased output.

The exchange rate channel works through both aggregate demand and aggregate supply. Monetary policy expansion brings about the depreciation of local currency, which leads to higher net exports and thus higher aggregate demand. There is another channel, identified by economists, known as expectations channel. This channel implies that many variables are determined using a forward- looking approach. Thus expectations also play an integral role in transmitting monetary policy objectives to the economy.

Researchers have shown that monetary policy changes are transmitted more quickly in the economy if it is a well -diversified one in terms of financial products. Second, consumption and investment decisions by households are more responsive to monetary policy changes if they are not financially constrained.

What is the Global Financial Crisis
Global Financial Crisis is the biggest financial crisis that western world has seen after the great depression of 1929- 30. The crisis that started off as a sub- prime mortgage crisis enveloped in it all the major sectors of the economies. In this part, I would like to discuss the impact of crisis on the construction industry of UK as a whole as well as its impact and future implications on the growth and profitability of Balfour Beatty Plc, on e of the largest construction companies of the UK. The reason of selecting this particular company is that it has operations in other countries as well and thus would help in understanding macro economic variables well. (Thomas et al, 2002)

Financial Crisis and Construction Industry
Financial crisis of 2007-08 devastated many economies and industries. Millions of people were left unemployed and hundreds of businesses went bankrupt. Construction industry also was deeply affected by this global crunch. However, a recent survey report by KPMG on Global Construction Survey reveals that construction industry is surprisingly positive despite recession. Almost 64 of the respondents in the survey expected increased profitability or at least same level of profitability by mid 2010. (Beryl, 2006)

According to Fiona McDermott, UK head of building and construction,
Given the intensity of the economic crisis, the construction industry so far appears to have weathered the economic storm, with around half of respondents reporting order books and profit rates at similar or greater levels than a year ago.

Survey has shown that work force realization has been limited, with most construction companies keeping their best people with them only. Moreover, only 12 of the global survey respondents were of the view that government stimulus packages will bring a significant increase in opportunities. (Norman and Klaus, 2002)

Introduction to the Firm
Balfour Beatty Plc is a construction company that specializes in engineering and construction, professional and support services and investments. The company works in five major segments namely building and building management services, civil and specialist engineering and services, rail engineering and services, investments and corporate.

The company operates along with its subsidiaries and affiliates across the UK. The US, Asia-Pacific, Middle East, Europe, and Central and South America.(Beryl, 2006)

Overview of Business Activity (2009)
According to Half -year report by Balfour Beatty, profitability remained high even in the face of recessionary pressures on the economy. This growth in profitability can be attributed to the expansion of Groups business to US, which now provides 30 of the total revenue. Below are some highlights from the report that depict the financial position of the firm (Friedman et al. 2003)

Revenue including joint ventures and associates was up 17 at 5,072m from previous position of 4,332m in 2008.

Profit from operations in the building sector gone up by 39, in the engineering sector by 5 and in the investments sector by 86, while profits in the rail sector showed a decrease by 2m.
Pre-tax profit increased by 14 at 108m (2008 95m).

Adjusted earnings per ordinary share were up 6 at 17.2p (200816.2p).
Basic earnings per ordinary share were 10.9p (2008 24.1p).
Period-end net cash stood at 394m (2008 333m), before taking account of the consolidation of 190m of non-recourse net debt held in PPP subsidiaries (2008 91m).
Cash generated from operations was good at 78m (2008 84m) despite a very strong cash inflow at the end of 2008.
The Board has declared an interim dividend up 8 at 5.5p per ordinary share (2008 5.1p).
Macroeconomic Variables and Balfour Beatty
GDP

UKs GDP is expected to fall by 4.75 and a modest GDP growth of 0.75 is projected for 2010. This slow growth in output is likely to affect consumer spending as well. The squeeze in consumer spending is mostly due to the factors like high debt levels, tighter credit conditions, rising levels of unemployment and decreasing disposable incomes. This has had an effect on all the sectors of the economy. When we talk about construction sector, the economic variables show that house building will remain low considering the market conditions. However, the worst part is over now and future expectations are good.

Balfour Beatty is the UKs largest construction company and it has shown positive results even in the face of recession. Thus we can say that 2010 will again be a good year for Balfour Beatty as it is expanding operations in US as well.

Interest Rate
Interest rates are likely to remain low till mid 2010.This monetary policy measure has been taken to influence consumer spending. The economic outlook report of UK states that, in medium term risk of inflation might pick up. Housing market has started to show signs of recovery.

Inflation
Inflation is likely to gain momentum by second half of 2010. In the short term however it is going to be volatile. By the end of 2010, it is going to be below the expectations majorly due to excess capacity in the economy. Economists believe that still there are uncertainties and risks involved relating to the path of global commodity prices, domestic demand and sterling.

With an increase in government expenditure, there is likely to be a boost in construction activity as well.

Employment
Unemployment is going to peak at 3 million in the second half of 2010, according to the reports. Companies are trying to retain their best employees. The unemployment rate rose from 5.2 in 2008 to 7.8 in the second quarter of 2009. This is also going to impact the company as well. Company will strive to retain excellent talent only.

Exchange rate of Sterling
There is a downward pressure on the sterling. Monetary policy adjustment for medium term might be required to boost the value of sterling. According to UK Economic Outlook, November 2009
The exchange rate may nonetheless be more volatile due to investor sentiment swinging between the attractions of higher short-term interest rates and the longer term downsides of higher public debt levels. Greater volatility in sterling and probably also higher and more variable interest rates would tend to produce a less favorable environment for UK investment and exports.

From the view point of Balfour Beatty, the exchange rate matters very much as it has operations in other countries as well. Most important would be the exchange rate of Pound Sterling against that of US Dollar. US dollar is itself depreciating due to similar economic conditions as of UK.

Conclusion
Third quarter saw a contraction in the economic output of UK, but there are increasing signs of stabilization as found out in the surveys. Risks of economic growth are fairly balanced now as compared to early 2009. Businesses, including construction businesses like Balfour Beatty should stress test their plans against a prolonged recession scenario though. According to reports and surveys, it is not the most likely scenario, but still its possibility cannot be ruled out at this point in time.

According to the half -year report of Balfour Beatty, the group has shown positive results even in the face of slowing business activity. Business presence has been made in US, as well as other contracts have been signed with Asian countries like Hong Kong too.