Confluence of Factors at Work
After years of security and growth fueled by pandemic era stimuli and the largest infrastructure package in American history (2021), the outlook for highway construction has shifted from something approaching unfettered optimism to mounting concern. Multiple factors are at work, and much of what has transpired was unforeseeable or at least unlikely.
Like much of the U.S. economy, the impacts of lingering inflation have become deeply problematic. In 2021, when inflation raged for the first time in decades, America’s central bank, the Federal Reserve, effectively yawned, declaring those price pressures to be transitory. The logic was that once supply chains normalized post-pandemic, inflation would simply abate to the Federal Reserve’s target level of 2% per annum without their intervention.
They were wrong. Inflation remained sticky, failing to peak until the summer of 2022. The Federal Reserve eventually saw fit to raise the short-term rates it directly controls by 5.25 percentage points (the upper limit on the Federal Funds rate rose from 0.25% to 5.5%).
With supply chains steadily normalizing after the heightened instability that characterized 2020-22, interest rates taking some bite out of the economy, and pandemic era stimulus waning, inflation declined throughout 2023 and 2024.
By late-2024, the Federal Reserve had begun to cut interest rates. From September to December of last year, the Federal Reserve took a full percentage off those short-term policy rates. As 2024 wound toward a close, the expectation among many economists, investors, and other stakeholders was that 2025 would be associated with even less inflation and even sharper declines in borrowing costs.
Alas, it was not meant to be. A new administration in Washington, D.C. — in a push to reduce America’s trade deficit with the balance of the world while restoring at least some of the industrial muscle that had disappeared over the course of decades as manufacturing activities were broadly offshored — initiated a trade war. That trade war has been wrapped in patriotism, with particularly sizable tariffs announced by the Trump Administration on Liberation Day (April 2), which though not a national holiday, was still a day to remember.
Based on what many economists deemed to be a flawed formula, the administration announced 46% tariffs on Vietnamese imports on that day, 26% on India, 24% on Japan, 20% on Europe, 25% on South Korea, and so on. Even nations with which America runs a trade surplus faced a new 10% tariff, which remains in place for all nations.
Roughly a week later, those elevated “reciprocal” tariffs would be paused for three months, but tariffs on Canada, Mexico, steel and aluminum (effective March 12), and China persisted. Suddenly, the outlook is for higher inflation and loftier interest rates for longer than anticipated.
One might think that highway construction would be relatively insulated from the impact of higher interest rates. After all, unlike many construction activities, highway and street related construction is largely publicly financed, and a considerable amount of federal investment has already been authorized.
But it is often the case that construction projects involve federal funding working in conjunction with state and local government efforts. Higher prices for steel, aluminum, concrete, and other critical materials have decision-makers at various state and local departments of transportation wondering whether or not this is a propitious moment to green light projects, or whether this is a time to post flashing yellows and pause. Debt service shows up on state/local operating budgets, and with public financial pressures building (discussed later) in some states and localities, public infrastructure funding may soon be increasingly facing red lights.
Of course, many projects continue to move ahead, but even this can be problematic for contractors. These are often large and desirable contracts. Competition to win them is fierce, which means that margins can be highly constrained if many bidders step forward. These are often fixed price contracts, which implies that contractors often bear the bulk of risk when construction service delivery costs unexpectedly rise. That risk is in force now. Shifting immigration policies may also be driving certain costs higher, which adds to an increasingly murky picture from contractor perspectives.
To put the magnitude of some of these cost increases into context, since mid-summer 2024, steel price increases exceeding 20% have become commonplace. According to producer price index data produced by the federal government, steel mill product prices rose more than 7% in March alone. There was also a nearly 6% increase in the price of fabricated structural metal products.
According to the U.S. Department of Commerce, America imports approximately 40% of its aluminum and 25% of its steel from Canada, and yet another 12% of its steel from Mexico. One can perhaps look back at a similar episode in 2018 when the Trump administration imposed a 25% tariff of imported steel and a 10% tariff on aluminum. While domestic steel production increased by 6 million tons when comparing 2017 to 2019 and aluminum output expanded by 350,000 tons, the construction industry still faced higher input costs and slower growth as a consequence, according to a 2019 Federal Reserve study.1 The tariff rates of today are often higher and are associated with far fewer exemptions.
State & Local Finances Deteriorate
Beyond tariffs, worker shortages, attendant inflation, and upward pressures on interest rates, there is the fact that fiscal conditions in several states and localities have been deteriorating. With pandemic-era federal monies having largely been spent and many governments overspending as their economies have softened, budgetary shortfalls have emerged.
According to a recent Pew analysis, “State budget stresses are more widespread than they have been at any time since at least 2020.” Several states have projected substantial shortfalls in their general funds, including Maine, Colorado, Arizona, California, and Maryland. In Illinois, “Chicago-area transit agencies face a $730 million shortfall for FY2026.” Even mighty Florida is not exempt from such forces. A three-year forecast released last September indicates that absent corrective actions, that state will face a deficit in FY2027 that will expand to nearly $7 billion in FY2028.2
Those growing financial stresses imply that infrastructure funding will be facing stiffer competition for dollars with other social priorities, including education, health care, and public safety (e.g., fighting wildfires). With so many hurricanes and other catastrophes impacting much of the nation in recent years, including recent wildfires in both California and New Jersey, insurance payouts have expanded. That, in turn, has raised insurance costs for state and local governments, just one of many factors that have recently dimmed the infrastructure construction outlook.
Looking Ahead
While the economic outlook has become increasingly pessimistic as 2025 has progressed, circumstances can quickly change. Indications by the president that the trade war is ending would likely result in rapid increases in stock prices, consumer, and business confidence. Subsequently stronger consumer spending and labor market dynamics would bolster sales, income, and corporate tax receipts, restoring confidence among budgeteers, including those that fashion capital budgets.
But as long as the trade wars continue, including the particularly intense one with China, a major supplier of both construction materials and equipment, the outlook for infrastructure spending will continue to blur. Meanwhile, the national debt is screaming towards $37 trillion, which will likely negatively impact public spending on infrastructure at some point during the not-so-distant future.
Endnotes
- construction.com/blog/how-will-tariffs-impact-the-construction-industry-in-2025.
- pewtrusts.org/en/research-and-analysis/articles/2025/01/13/lawmakers-face-budget-crunches-tough-decisions-to-close-expected-shortfalls.