After decades of trending downward, public sector capital investment as a share of state and local government spending rebounded in the past two years. U.S. Treasury data show this measure decreased to 14% by 2020 from 24% in 1970, before rising 1.6% from 2020-2022, the largest increase since the late 1970s. State and local government consumption expenditures and gross investment have increased since 2013, with a spike of 14.4% since 2021 (chart 1); measured on a seasonally adjusted basis, state and local government gross investment grew almost 32% since 2020 (chart 2).
It's no surprise that inflationary construction costs increases have eroded the impact of federal infrastructure investment. Of course, we won't know by how much until the spending is completed. Using the IIJA as an example, the Congressional Budget Office has estimated the projected loss of purchasing power (the difference between nominal and inflation-adjusted outlay amounts) will grow to 16.5% at the end of fiscal 2026, the final year of the IIJA, and to 24.3% by the end of fiscal 2031 (the final year of a five-year reauthorization)--and this assumes construction cost inflation of only 2.6%. Some estimates indicate that the IIJA has seen almost one-fifth of its spending power reduced by inflation. And, to the extent the growth in project funding is not matched by a proportional increase in construction market capacity, it could exacerbate inflation and skilled labor shortages.
As we noted in "Construction Cost Inflation Weighs On U.S. Public Infrastructure Investment,", April 14, 2022,in general, public sector project sponsors will continue to see historically high bids from contractors, the need for larger contingencies in new contracts along with wider cost escalation ranges for materials, and a shift away from fixed-price contracts. Public project sponsors could also receive claims for equitable adjustment for compensation by contractors on existing projects or experience higher bids for follow-on work to recoup previous losses. Many issuers manage higher-than-previously forecast construction costs by slowing debt issuance and deferring project elements until they can start with better materials and supply availability; or potentially more favorable market conditions arrive. Assuming all other key credit fundamentals are unchanged, we believe issuers can maintain credit quality if higher debt burdens can be supported by commensurate and sustainable revenue enhancements.
We expect the availability of skilled labor will remain a problem during 2024 for E&C companies, pushing up wages and construction costs. According to the Bureau of Labor Statistics, U.S. hourly earnings were up 5.1% in 2023 and 4.8% in the past three months as of April 2024 for construction jobs, compared with 4.3% and 4.2%, respectively, for all jobs. On a weekly earnings basis, the gap was wider by 220 basis points (bp) at year end and widened to 700 bps in the last three months as of April this year. We expect this gap will widen in 2024, given labor shortages and increased competition for labor in light of the ramp-up of new projects across the U.S.
Although the pace of projects funded through the BIL/IIJA remains somewhat uncertain, E&C issuers have started to see those opportunities coming to market. Backlogs across E&C issuers rated by S&P Global Ratings are historically high, spurred by strong sector tailwinds, and we expect incremental dollars from the BIL/IIJA will further boost activity in the coming years. We expect revenue from these projects will start flowing through issuers' revenue in 2025 and beyond as backlogs burn. Still, we do not expect this will result in outsize growth in one given year, but will provide long-term sound fundamentals. We estimate revenue growth in the mid-to-high single digits over the next two years.
Rated E&C issuers have become more selective about the projects they bid for, particularly for low-margin work, and in some cases have strategically limited or reduced their exposure to public-sponsored projects. As a result, the competitive landscape has evolved, with generally less competition for large complex projects. To some extent, this is also pushing the industry to move away from traditional fixed-price contracts. E&C companies seek more flexible contract types including the use of progressive design-build. We've seen some evidence that the early alignment between the design and construction phase reduces the risk for change orders and delays, resulting in substantially higher margins.
Infrastructure projects are typically awarded under fixed-price contracts. In previous years, cost overruns were usually spurred by project delays and change orders, but in the past few years, materials and wage inflation further heightened this risk and resulted in project losses. As a result, E&C issuers with high exposure to these contracts saw their profit margins compress. Protecting profit margins is a key strategic priority among rated E&C issuers and companies are now including more conservative provisions and escalations for cost overruns, which ultimately increases the bidding price. Based on the higher margin profile in issuers' backlogs as companies account for higher provisions and include escalation clauses, we expect S&P Global Ratings' adjusted EBITDA margins will gradually increase over the next 12-24 months.
On top of reworking program scopes or finding additional funding sources to offset higher construction costs, many recipients of federal grants or other funding programs face other hurdles imposed by the Build America Buy America Act, passed as part of the BIL/IIJA. The act requires that federal financial assistance for infrastructure cannot be expended unless all the iron, steel, manufactured products, and construction materials used in the project are produced in the U.S. Although the requirements can be waived based on domestic nonavailability, unreasonable cost, and public interest, navigating that process is time consuming with no guarantee of success. In addition, in February 2022, President Biden mandated project labor agreements for federal construction contracts of more than $35 million effective Jan. 22, 2024.
The impacts associated with construction cost increases on public sector project sponsors and E&C companies include the following examples.
After four years of pandemic-induced increases in construction cost spurred by commodity and labor shortages, we anticipate the overall inflation rate for projects will moderate in 2024 even as some higher component costs look to be permanent. Specifically, construction input costs have stabilized at levels 35%-40% higher than pre-pandemic rates while many market participants see labor costs still rising at a 4% annual pace. Although price volatility seems to be under control, there's little likelihood that prices will revert to early 2020 levels any time soon.
The most referenced signal of inflationary pressures is the Producer Price Index (PPI), which is a collection of indexes measuring the average change over time in selling prices received by U.S. producers of goods and services. PPI measures price changes from the perspective of the seller as compared with the Consumer Price Index, which measures price change from the purchaser's perspective. Differences between the two are often due to government subsidies, sales and excise taxes, and distribution costs.
Positively, some construction cost inputs have largely come down from 2022 levels (table 1) with overall building materials and supplies measures showing a welcome decrease from pandemic peaks, but they are still elevated relative to historical levels (chart 5). For example, some estimates have concrete material prices falling 1%-2% annually through 2025, while other inputs like wood, plastics, composites, plaster, gypsum, and thermal protection could average increases of up to 6.5% per year.
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