Economic Impact Assessment

Economic Impact Assessment

Economic impact assessments are a specific form of analysis technique which calculate (1) direct, (2) indirect and (3) induced benefits from projects.

Key to economic impact assessment is the consideration of multiplier effects borne out of projects, especially relating to employment and expenditure. Economic impact assessments assume that employment will increase as an outcome of a project, without any wage or price effects. This is considered possible as it is argued previously unused or underused resources will become employed, as is found in the assumptions of input-output models.

Limitations

Importantly economic impact assessments often ignore certain costs involved in projects, including construction costs, time costs etc. This type of analysis technique also often underestimates environmental costs.

Importantly they do not explore the counterfactual i.e. what would have happened without the intervention you are evaluating. Further work is required – as part of a wider evaluation - to identify the impacts that occur in addition to those that would happen anyway (deadweight).

This is about converting the gross impacts (jobs and output) from an EIA to net impacts accounting for:

Persistence: a consideration of how long impacts are likely to last – the ‘durability of impacts’. Persistence is often expressed in terms of number of years (usually based on assumptions developed in the literature). Future impacts over this period need to be appropriately discounted.

Deadweight and additionality: consideration of how far the impacts would have been achieved without the intervention (deadweight). A key objective of further evaluation following an initial economic impact assessment is to identify the counter-factual i.e. what would have happened in the absence of the intervention.

Displacement: an assessment of the effect of the intervention on the structure of local factor and final goods markets (e.g. one factor moves from one firm to another, such as a new firm expanding due to an intervention and taking market share from another firm, with the labour factor of production moving from that firm – rather than new employment being created in the area). For example, tourists who would have normally travelled to the UK in 2012 may have travelled to London for the Olympic Games displacing tourist revenue from other parts of the country e.g. Devon and Cornwall.

Substitution: where the intervention causes an employed factor to be replaced by a currently unemployed factor (e.g. a firm recruits from the unemployed through a government scheme, but sacks – or ‘substitutes’ its current employees).

Input-Output Analysis

Input-output analysis is a well-known technique for exploring the interdependencies which exist between industries and upon which their total production depends. It was invented by Wassily Leontief (1966).

For example, the output of the steel industry includes, as one of its inputs, part of the output of the coal industry. Similarly, the output of the coal industry includes as part of its inputs, part of the output of a variety of other industries, including steel (tools for example). Thus a network of interdependencies exists between industries in the production of their outputs. Click here to view an extended example (external link).

Input-output analysis is based on the representation of these interdependencies in the form of a coefficients table which shows the proportions of each industry's gross output which are attributable to inputs from other industries. Importantly, input-output analysis can be performed at the local level as well as industry level, by adapting coefficients using local employment data, allowing application to economic impact assessment. This is necessary as the results of the national model would overstate the multiplier effects on local economic activity. This is because a number of the outputs generated by a change in the local economy will take place outside of the local economy i.e. the local economy of the East Midlands would need to import intermediate inputs from the rest of the UK.

Multiplier Effects

Some demand is generated by income from existing production. Specifically, consumption will change as a result of changes in household post-tax income. This results in a ‘multiplier effect’ i.e. a change in final demand will cause a greater change in production, as a result of knock-on effects caused by the reactions of consumers.

Coefficients enable us to quantify the effects of an increase in an industry’s output on all of its suppliers. Disturbances to demand and production in particular industries will therefore have consequences for their suppliers. But any changes will have further repercussions. For example, to produce output to satisfy the demands of the steel industry, the coal industry would purchase output from other industries. Any change in the output of a particular industry will therefore necessarily result in changes in the output of many other industries. This multiplier effect extends beyond the immediate suppliers of the initial industry.

The classic multiplier effect is applied in the context of (1) spending/sales, (2) income, and (3) employment effects (Kasimati, 2003; Crompton, 1995). Each is in turn comprised of three aspects:

1. Direct e.g. X construction jobs created e.g. a construction company funded to build a new housing estate would experience the direct impacts in terms of increased turnover and jobs.

2. Indirect e.g. Y jobs created to produce construction inputs. These are the inter-industry purchases as they respond to new demands from directly affected industries. Sometimes referred to as supply chain linkage effects.

3. Induced e.g. Z jobs emerging in other industries from money spent in other areas of economy. e.g. workers increase production as a result of an intervention, earn extra income, leading to extra expenditure further down the supply chain (multiplier effects usually focus on measurement of the positive effects of an intervention).

The indirect and induced impacts are often referred to as secondary impact (Crompton, 1995). Over-estimating the direct benefit may thus result in over-estimation of the indirect and induced benefits.

Multiplier effects can provide a number of benefits to an area including the potential to significantly reduce levels of unemployment, and make use of other unused resources (other than labour) such as empty buildings. This utilization has very low associated opportunity costs, as these resources were idle, but have the potential to create significant surplus from the employment of unemployed workers and other resources.

Problems in the calculation and use of Multiplier Effects

Multiplier effects can be included as project benefits, but caution should be shown when considering this for a number of reasons (Boardman et al, 2008, 124-5).

(1) Firstly, many potential multiplier effects simply represent transfers or displacement effects as noted above. For example, increased spending in one tourist resort due to a new investment in leisure facilities will simply displace spending (reduce it) in another resort which does not receive any investment.

(2) Second, wider benefits for example enjoyment and utility gained from attending a sporting event, does not all remain in one locale. Some of these benefits will be enjoyed by visitors who will then leave an area, so cannot be included in calculated project benefits (if considering effects on one area or locale). This is often referred to as ‘leakage’, and may be expressed in terms of a % of total impacts - with the % of leakage drawn from the literature or, in some cases, from primary research.

(3) Thirdly, some of the benefits for business of increased demand, may result in costs for residents in an area. As consumers residents may face more competition for goods and increased prices. However, it should be noted in this case that increased demand may result in businesses being able to take advantage of economies of scale, reducing production costs, and further benefiting the local area (and providing further potential project benefits).

(4) Finally, when considering the effect on a local area multiplier effects are likely to be relatively small as many businesses may be owned by non-residents (chain stores for example), so some of the benefits accrued will actually be outside the local area.

Controversy over Multiplier Effects

The use of multiplier effects to estimate the benefits accrued from a project is not without debate.

It has been suggested that ‘economic impact studies based on multipliers are quite clearly an improper tool for legislative decision-making’ (Hunter, 1988, p. 16). In contrast, Crompton (1995, 34) suggested that although use of multiplier effects has limitations, this technique can be valuable ‘if it is implemented knowledgeably and with integrity’.

(Thanks to Chris Lawton (ESRB, Nottingham Trent University) and Bob Jones (formerly of Nottingham Trent University), for contributing to the material on this page).