EC-686
In many communities across America local officials and leaders wrestle with the role of providing enough local jobs and income to maintain the economic viability of their communities. National and international events and trends can have a major impact on the rate and type of income and employment growth communities can achieve. But communities that take an active role in attracting and retaining jobs have an advantage over those communities that allow external events to exclusively dictate the pace of local economic growth. To make good economic development decisions, communities must use whatever information and tools are available.
One important tool that is widely used to evaluate economic development impacts is the economic impact analysis. Economic impact analyses measure the potential impact of economic decisions by business, government, and consumers on an economy. Decisions that affect the employment base, such as expansion by an existing firm, the establishment of a new firm, public investments in infrastructure, or the closing of a government facility such as a military base, all impact the local economy. Economic impact analyses estimate the impact of economic decisions on the output of goods and services in an economy and on employment and personal income. If prepared and used properly, an economic impact analysis can allow for an objective evaluation of the economic impact of a particular action on the local economy. Such information can be used to help communities influence the decision process or reduce the negative aspects of a particular action.
The purpose of this publication is to familiarize local leaders and decision-makers with the principles used in the development of economic impact analyses. Local governments typically seek advice on these matters from consultants, universities, and government agencies. While the results of such analyses are fairly straightforward, proper care and attention to detail are critical to developing accurate estimates. Without such care precious economic development resources may be misdirected or wasted, with the result being poorly conceived economic development efforts. Armed with a basic knowledge of the principles used to construct economic analyses, local decision-makers will be better equipped to determine whether a particular impact analysis was performed properly.
The publication is divided into four sections. The first section discusses the flow of spending in an economy, i.e., how spending in one portion of the economy affects spending and employment in another. The second section provides discussions of some of the key principles used in the creation of economic impact analyses, of multipliers and the multiplier effect, and of some common errors in the use of multipliers. The third section presents a brief discussion of input-output models, which are a means of estimating multiplier effects, and presents the multipliers for major industries in Indiana by labor market area. The concluding section discusses some of the implications that economic impact analyses can have for communities.
A useful way of explaining how goods and payments flow through an economy is by dividing all goods and services into two broad groups, or sectors, basic and nonbasic. The basic sector is made up of firms that sell goods and services to businesses and consumers outside the local economy. Sales of these goods and services bring new income into the local economy. This new spending by businesses and consumers from outside the local economy provides the base on which an economy can grow. The basic sector also includes certain kinds of payments from businesses, individuals, and governments outside the local economy. These payments may be in the form of: social security and other government assistance programs; retirement and pension income; interest, rents, and dividends from outside investments; and grants from higher levels of government.
The nonbasic sector is made up of firms that sell goods and services to local businesses and consumers. Spending in the nonbasic sector causes dollars to remain in the local economy, which creates jobs and income locally rather than elsewhere. Although it is primarily new spending by businesses and consumers from outside the local economy that generates new local income, a well-developed nonbasic sector serves to keep economic activity, and jobs and income, in the local economy.
A simple way to understand an economy and the flow of spending is to picture a leaky bucket, with the water level in the bucket representing the prosperity of the community (Figure 1). The basic sector represents the flow of income into the economy from outside, just as if water were being poured into a bucket. Inflows include the sale, or export, of goods and services to outside entities, investment income from external sources, and payments received from outside entities. The latter includes government transfer payments to individuals, such as social security, and grants from higher levels of government.
Leakage out of the holes of the bucket represents spending by consumers and business on: imported goods and services; tax payments to non-local levels of government; investments in enterprises outside the local economy; payments to individuals outside the local economy; and individuals, businesses, and governments that hold underutilized assets or resources, which is waste due to inefficiency.
An economy can remain prosperous with a large amount of leakage if the inflow, or basic sector, remains strong. However, if the basic sector weakens, causing a decline in output and employment, the level of water in the bucket will decline, implying a lower level of prosperity. Likewise, an economy that has only small leakages, reflecting a well-developed nonbasic sector, can prosper even with a small basic sector. Small holes in the bucket reflect a slower outflow of dollars, causing the water level in the bucket to remain high, which represents greater economic prosperity.
An economic impact analysis is based on the concept of the multiplier. The multiplier is the relationship between some change in an economy and the succeeding economic activity that occurs as a result of that change. Consider the location of a new automobile parts manufacturer. Initial projections of the impact of the firm would likely include estimates of the number of new jobs and the income earned by the new workers. This is called the direct effect, which is an initial change in the economy.
But there are other effects as well. It is likely that the new plant will require inputs of goods and services from other local businesses. These purchases generate new jobs and income in those allied industries. These spinoff activities are referred to as indirect effects. In addition, the new workers in the parts plant and the employees in the supporting industries spend a portion of their income locally to meet household needs, and this spending creates new jobs and income. The jobs and spending created as a result of these activities are called the induced effect.
The sum of the direct, indirect, and induced effects is the total effect. The process of job creation and income generation continues so long as some portion of spending remains local. The multiplier is an estimate of how much additional economic activity will result from some new investment in an economy. "Multiplier" is an apt term, because the original investment is "multiplied" by the multiplier to obtain the total economic impact.
There are many different types of multipliers. Most multipliers reflect the ratio of the total effect to a direct effect in the following manner:
total effect multiplier = ------------- direct effect
There are three multipliers of particular importance in assessing the impact of change on the economic development of a community or region: output, employment, and income multipliers.
Output multipliers reflect the change in total output of an economy with regard to some direct change in the production of all goods and services. For example, as the parts plant expands production, the output of other industries also increase, such as a trucking firm that transports the finished product to the automotive assembly plant.
Employment and income multipliers are perhaps more relevant in assessing impacts on the community. The employment multiplier reflects a change in the total number of people employed given a direct change in employment or output, such as the trucking firm hiring additional drivers. The employment multiplier is also useful in estimating the change in total employment in the economy that would occur if an existing firm announced that they were expanding production, and planned to hire additional workers. The income multiplier measures the change in income generated per dollar of new income earned. For the auto parts firm, this would refer to income such as that earned by the newly hired auto parts workers and truckers.
Multipliers vary in magnitude from place to place primarily because larger and/or more urbanized locations have more economic interactions and therefore larger multipliers. For example, the larger the county, the farther one needs to travel, on average, to conduct business outside the county, and distance creates an incentive to conduct business locally. In urban areas there is less need to travel far to conduct business because more goods and services are available locally.
Multipliers vary from firm to firm because of differences in the relationship between inputs and output. For example, an automotive assembly plant that purchases all of its inputs from suppliers outside the local economy will have a smaller multiplier than one that purchases its inputs locally. For the same reason, multipliers can vary from industry to industry. For example, an automobile repair shop that services local customers would likely have a higher multiplier than a consulting firm that conducts much of its business outside the local economy. Multipliers also vary in magnitude because of differences in the way businesses operate. For example, in a labor- intensive industry such as primary education, the employment multiplier is likely to be larger than in an industry that is less labor-intensive, such as an automated assembly plant, even though the income and output multipliers may be similar.
Multipliers and multiplier effects should be evaluated cautiously for a variety of reasons. First, the size of the multiplier is fixed. For small changes this may not matter. But large changes, such as the establishment of a large manufacturing firm, may cause a restructuring of the economy. Over time, the demand for inputs may draw new firms into the area to provide these inputs. As a result, instead of purchasing inputs from outside the local economy, the firm may purchase inputs locally, which reduces leakages, implying a larger multiplier. Thus for large initial changes, the estimates of the multipliers may be significantly under- or overstated.
For changes that are short lived, such as a golf tournament or festival that draws people from surrounding areas, the multipliers listed here may be too large, because they include induced effects. Induced effects result from added population and/or additional permanent jobs created. It is likely that a short-term event will not have these impacts, and so it may be necessary to exclude the induced effects.
Double counting may also be a problem. For example, an employment multiplier of 1.9 means that for every new job created a total of 1.9 jobs will result. Since the total effect includes the original 1.0 jobs, the spin-off is only 0.9 jobs. Hence, if you want to look only at the secondary effects, be sure to use 0.9 rather than 1.9.
Pyramiding is a form of double counting that occurs when a multiplier is applied to a change in the automotive industry, for example, and a separate multiplier is applied to the firms that supply inputs, such as brake parts. Including a separate multiplier for the brake parts supplier would inflate the estimated total impact because the effects of the brake parts firm are captured in the indirect effect of the automotive industry. It is also important to not confuse the multiplier with turnover. Turnover refers to the number of rounds of spending generated by a direct change before it has all leaked out of the economy.
Multiplier effects can be estimated with an input-output model. An input-output model is a set of equations describing the relationships that link the output of one industry with all other industries in an economy. These models are able to estimate impacts within each industry in the model and thereby provide much more information than simple total economic impacts on income, output, and employment. The U.S. Forest Service has developed a comprehensive input-output model called IMPLAN which characterizes an economy into 528 separate industries. IMPLAN includes data at the county level for all counties in the United States, and these counties can be combined to form economic regions in any manner desired.
Labor Market Areas (LMAs) are multi-county areas with a minimum population of 100,000. Counties are combined to form LMAs based on commuting patterns. LMAs were used instead of counties because in many cases individual counties are too small to capture all of the local economic interactions.
For this publication counties were combined into LMAs for Indiana. Spillover effects on neighboring counties can be large, and these in tum can have spillover effects back to the original county. Hence, limiting the analysis to a specific county would understate the total effect. Figure 2 shows how the counties in Indiana are divided into LMAs.
The multipliers provided in this publication were generated by IMPLAN. For the sake of brevity similar industries were combined into nine primary industries. The output multipliers for the 17 LMAs in Indiana are shown in Table 1 of the Appendix, the income multipliers in Table 2, and the employment multipliers in Table 3. To find a multiplier for a particular county, simply determine from Figure 2 in which LMA the county is located. Choose the table corresponding to the multiplier you want to identify, then choose the row corresponding to the major industry group, and read across to the LMA column.
For example, the employment multiplier for manufacturing in LMA 7, 1.8404, appears in Table 3, under column heading "LMA 7" and row heading "Manufacturing."
The multipliers in this report are provided for general information only and may be compared with multipliers generated elsewhere. It is not advisable to use multipliers in all but the most simple of applications because they are unable to capture the full complexity of an economy. An input-output analysis can provide much better estimates of multiplier impacts than can simple multipliers. However, an understanding of the use of multipliers in economic impact estimates and the multiplier figures in Tables 1-3 will be of real help in evaluating the usefulness of impact analyses in particular communities.
If used properly, estimates of multiplier effects using input-output models are a valuable tool for assessing the merits of economic development proposals and estimating economic impacts. Input- output analyses can be used to estimate impacts of a wide variety of economic changes, including firm relocation, expansion of output and employment at existing firms, public projects such as park development and new roads, and one-time events such as festivals and tournaments. Multipliers are equally useful in those situations in which negative economic events occur, such as a plant shutdown or a reduction in tourism.
It is common to hear or read of multipliers that differ substantially from those presented here. Such estimates should be viewed with skepticism for two reasons. First, as the above discussion maintains, there are many ways in which the analyst can be led astray. It takes skill and attention to detail to develop accurate estimates. And second, there is often an incentive to report multipliers that are artificially high. In the case of a firm considering relocating to a particular community, the larger the potential economic impacts are, the more the community has to gain. This creates an incentive for supporters of such a relocation to use large multipliers that overestimate the positive impacts. Likewise there is an incentive to use small multipliers for negative economic events, such as a military base shutdown, in hopes of reducing opposition to such actions. Only accurate, unbiased estimates of economic impacts should be used in decision of this nature.
Overeliance on economic impact estimates in evaluating economic development proposals can present problems as well. All multipliers are estimates, and therefore caution should be used in making inference regarding impacts on economic activity. It is also not advisable to rely solely on multiplier impacts when evaluating the merits of a particular economic development proposal. An analysis of the impact on local government revenues and expenditures should be considered as well. Perhaps new public facilities such as parks will be required, or an increase in road traffic will cause congestion and/or require increased expenditures for roadways.
Attention should also be paid to the types of jobs being created. If wages paid to workers are low it could have an adverse impact on the community. It should also be determined if the jobs and income created are for current residents, or whether the new employees will commute from surrounding areas or relocate from outside the local community. Finally, it should be determined whether a particular economic development activity will be compatible with current land uses, whether it will generate excessive environment impacts, and whether it will alter the general character of the community.
Many communities in Indiana are constantly looking at ways to improve local economic conditions. Those communities that fail to take an active role in shaping their economic future are more apt to lose control and to be subject to the mercy of decisions thrust upon them by others. Those that take an active role are more likely to create good jobs and the type of economic development that improves the quality of life. Objective evaluation of local economic impacts, in conjunction with other types of analyses, is one way that decision-makers can make more informed decisions, the kinds of decisions that are more likely to lead to improvements in the community and to economic prosperity.
Sector LMA 1 LMA 2 LMA 3 LMA 4 LMA 5 LMA 6 ------------------------------------------------------------------------------------------ Agriculture, Forestry & Fisheries 1.8007 1.6986 1.7779 1.7153 1.7700 1.7510 Mining 1.1336 1.1221 1.2352 1.2324 1.2928 1.1881 Construction 1.6506 1.5629 1.6030 1.5811 1.5179 1.6427 Manufacturing 1.3640 1.4709 1.4429 1.4352 1.3715 1.4417 Transportation, Communication & Utilities 1.4637 1.3773 1.4466 1.4366 1.4422 1.4223 Wholesale & Retail Trade 2.0310 1.7944 1.8433 1.9270 1.9348 2.0884 Finance, Insurance & Real Estate 1.4077 1.3894 1.4156 1.3588 1.3886 1.3862 Services 1.8635 1.8024 1.8118 1.8087 1.7875 1.9444 Government 1.9072 1.7262 1.7648 1.7083 1.7202 1.8564 ------------------------------------------------------------------------------------------- Sector LMA 7 LMA 8 LMA 9 LMA 10 LMA 11 LMA 12 -------------------------------------------------------------------------------------------- Agriculture, Forestry & Fisheries 1.6085 1.7611 1.8248 1.6933 1.7092 1.6734 Mining 1.2870 1.2586 1.2131 1.2006 1.1927 1.2423 Construction 1.4765 1.5564 1.6348 1.4913 1.5557 1.4880 Manufacturing 1.4294 1.4021 1.4743 1.2937 1.4254 1.3914 Transportation, Communication & Utilities 1.3497 1.4010 1.4936 1.3560 1.4191 1.4048 Wholesale & Retail Trade 1.9077 1.9557 1.7890 1.7482 1.9102 1.8167 Finance, Insurance & Real Estate 1.2874 1.3622 1.4627 1.2687 1.3569 1.3537 Services 1.7775 1.8961 1.8058 1.6656 1.8143 1.8991 Government 1.8410 1.8310 1.6822 1.6390 1.6301 1.7095 -------------------------------------------------------------------------------------------- Sector LMA 13 LMA 14 LMA 15 LMA 16 LMA 17 -------------------------------------------------------------------------------------------- Agriculture, Forestry & Fisheries 1.8884 1.5612 1.6847 1.7041 1.7293 Mining 1.2760 1.2229 1.2639 1.2077 1.2122 Construction 1.5803 1.4174 1.6594 1.3855 1.5889 Manufacturing n.a. 1.3123 1.5169 1.3586 1.3905 Transportation, Communication & Utilities 1.3970 1.2862 1.4755 1.2850 1.4299 Wholesale & Retail Trade 2.2878 1.6550 1.8966 1.8923 1.9451 Finance, Insurance & Real Estate 1.3650 1.3248 1.4246 1.2901 1.3349 Services 2.1095 1.5629 1.8473 1.7065 1.9943 Government 2.0633 1.5730 1.7782 1.6228 1.8166 ------------------------------------------------------------------------------------------
Sector LMA 1 LMA 2 LMA 3 LMA 4 LMA 5 LMA 6 ------------------------------------------------------------------------------------------ Agriculture, Forestry & Fisheries 2.2290 2.2248 2.3853 2.2283 2.2591 2.3121 Mining 1.1401 1.1350 1.2452 1.2197 1.2718 1.1957 Construction 1.8040 1.7658 1.8760 1.8637 1.7584 1.9628 Manufacturing 1.5483 1.6513 1.5791 1.5894 1.5791 1.5299 Transportation, Communication & Utilities 1.4333 1.3949 1.4525 1.4371 1.4489 1.4970 Wholesale & Retail Trade 1.8411 1.6476 1.7246 1.8092 1.8184 1.9427 Finance, Insurance & Real Estate 1.4110 1.3625 1.3863 1.3375 1.3541 1.3541 Services 1.8411 1.8001 1.8183 1.7731 1.7968 1.9747 Government 1.5371 1.4349 1.4842 1.4278 1.4439 1.5153 ------------------------------------------------------------------------------------------ Sector LMA 7 LMA 8 LMA 9 LMA 10 LMA 11 LMA 12 ------------------------------------------------------------------------------------------ Agriculture, Forestry & Fisheries 1.9458 2.1405 2.3662 2.0787 2.1912 2.0872 Mining 1.2655 1.2355 1.2352 1.1843 1.2024 1.2241 Construction 1.8489 1.7699 1.9141 1.7339 1.8028 1.7155 Manufacturing 1.5306 1.5180 1.6476 1.3898 1.6499 1.5067 Transportation, Communication & Utilities 1.3516 1.4155 1.4895 1.3575 1.4175 1.4049 Wholesale & Retail Trade 1.7879 1.7673 1.6576 1.6226 1.7877 1.7042 Finance, Insurance & Real Estate 1.2545 1.3855 1.4594 1.3053 1.3327 1.3292 Services 1.8068 1.9079 1.7791 1.6455 1.8256 1.9638 Government 1.4724 1.4716 1.4306 1.4204 1.3713 1.4421 ------------------------------------------------------------------------------------------ Sector LMA 13 LMA 14 LMA 15 LMA 16 LMA 17 ------------------------------------------------------------------------------------------ Agriculture, Forestry & Fisheries 2.4267 1.9317 2.1323 2.0763 2.2234 Mining 1.2425 1.2247 1.2422 1.1944 1.2058 Construction 1.8289 1.6806 1.8417 1.5876 1.8523 Manufacturing n.a. 1.4674 1.7869 1.4548 1.4706 Transportation, Communication & Utilities 1.4127 1.3402 1.4914 1.3924 1.4680 Wholesale & Retail Trade 2.0473 1.5899 1.7132 1.8260 1.7591 Finance, Insurance & Real Estate 1.3590 1.3109 1.3978 1.2704 1.3655 Services 2.2846 1.5536 1.8160 1.6913 1.9974 Government 1.5949 1.3661 1.4691 1.4305 1.4405 ------------------------------------------------------------------------------------------
Sector LMA 1 LMA 2 LMA 3 LMA 4 LMA 5 LMA 6 -------------------------------------------------------------------------------------------- Agriculture, Forestry & Fisheries 1.9415 1.8087 1.8643 1.8625 1.8834 2.0280 Mining 2.2141 1.8829 1.6846 1.5662 1.5937 1.8829 Construction 1.9588 1.7948 1.8701 1.8724 1.7959 2.0033 Manufacturing 2.2388 1.9552 2.0050 2.0462 2.1984 2.0834 Transportation. Communication & Utilities 1.9699 1.6889 1.8198 1.8573 1.8333 1.8545 Wholesale & Retail Trade 1.5193 1.4229 1.4532 1.4714 1.4618 1.5859 Finance. Insurance & Real Estate 1.9426 1.8393 1.8334 1.8921 1.8617 2.0416 Services 1.6726 1.5960 1.6172 1.6086 1.6179 1.7435 Government 1.5064 1.4078 1.4366 1.4587 1.4595 1.5760 -------------------------------------------------------------------------------------------- Sector LMA 7 LMA 8 LMA 9 LMA 10 LMA 11 LMA 12 -------------------------------------------------------------------------------------------- Agriculture, Forestry & Fisheries 1.9154 2.0341 1.8310 1.8547 1.9014 1.8603 Mining 1.5003 1.6710 1.9950 1.5273 1.9254 1.5820 Construction 1.6828 1.8928 1.8338 1.7637 1.8922 1.7640 Manufacturing 1.8404 2.0136 2.1292 1.8586 2.0465 1.9697 Transportation, Communication & Utilities 1.7823 2.0231 1.8428 1.7034 1.8266 1.7946 Wholesale & Retail Trade 1.4709 1.5408 1.4366 1.4300 1.4699 1.4525 Finance, Insurance & Real Estate 1.8056 1.9035 1.8817 1.6902 1.9451 1.8481 Services 1.5595 1.6540 1.6079 1.5506 1.5951 1.5459 Government 1.4343 1.5202 1.4146 1.4642 1.4737 1.4603 -------------------------------------------------------------------------------------------- Sector LMA 13 LMA 14 LMA 15 LMA 16 LMA 17 ------------------------------------------------------------------------------------------ Agriculture, Forestry & Fisheries 2.2024 1.8151 1.8245 1.8736 2.0005 Mining 1.7628 1.4602 1.6089 1.5533 1.8120 Construction 1.9733 1.7070 1.9222 1.6839 1.9619 Manufacturing n.a. 1.7649 2.2098 1.7098 2.0197 Transportation, Communication & Utilities 2.2247 1.6874 2.0115 1.8408 1.9145 Wholesale & Retail Trade 1.7199 1.3774 1.4654 1.4698 1.5610 Finance Insurance & Real Estate 2.0925 1.6793 1.8437 1.7460 1.9288 Services 1.8237 1.4841 1.6138 1.5382 1.6746 Government 1.7178 1.3721 1.4745 1.5072 1.5264 ------------------------------------------------------------------------------------------
New 11/93
Cooperative Extension work in Agriculture and Home Economics, State of Indiana, Purdue University and U.S. Department of Agriculture cooperating: H.A. Wadsworth, Director, West Lafayette, IN. Issued in furtherance of the acts of May 8 and June 30, 1914. The Cooperative Extension Service of Purdue University is an equal opportunity/equal access institution.