This post is largely directed to any of this blog’s readers who perform economic impact analysis. Too many years ago, my Honours research paper was a study of the economic impact that the Christchurch Arts Festival had on Christchurch. The festival had asked for someone in the Department to undertake the analysis, but they weren’t prepared to pay anything, and so my supervisor Ken Henry (now Australian Secretary of the Treasury) agree to take it on as an Honours research topic.
I followed the usual methods employed for these kinds of studies: I circulated questionnaires at various concert venues asking patrons to answer some questions designed to find out if they were locals or visitors, if the latter, whether they came to Christchurch because of the festival, what their festival-caused expenditures were, etc. and then threw the results into input-output tables to calculate the usual multipliers.
While I did present the results following the standard Keynesian template, my base numbers were more reasonable. I assumed that additional spending by local residents would mostly have crowded out other spending rather than savings (in effect, being true to the fixed coefficients assumption of input-output analysis), and further presented results in which it was assumed that there was no Keynesian deficiency of demand that wasn’t being addressed by monetary policy. Needless to say, the festival chose never to release the report that Ken and I wrote for them!
But even fully stripped of the Keynesian assumptions, there was still the results arising from what was called the export-base model. This was the impact on Christchurch that arose from the “export” money being brought into the city by visitors from outside whose presence here was caused by the existence of the festival. This made me uncomfortable at the time, but I never was able to fully articulate in my mind whether export-base modelling made sense or not.
I have recently had cause to think about this kind of analysis again, and I don’t feel any the wiser. Let’s say someone does an economic impact report and concludes that a particular activity generates $10m of economic activity in a region, not due to any Keynesian effect in which idle resources are brought into productive use through stimulating aggregate demand, but due to bringing expenditure into a region. What is the question to which $10m is the answer? I can see that it is probably an ordinal measure of something, so that if $10m of economic activity is a good, $20m is probably better, and if $10m is a bad, $20m probably worse. But what does $10m mean as a cardinal number? Is it a benefit that can be compared to a cost in a Kaldor-Hicks cost-benefit framework, so that, say, one could conclude that public expenditure funded of up to $10m would be justified in order to secure the activity? This can’t be right, as it ignores the opportunity cost of the resources that produced the goods and services sold for $10m.
For there to be any case for public expenditure to secure the $10m of economic impact, it seems that economic impact studies of this kind must be implicitly appealing to either some notion of a public intermediate good or second-best analysis, but it is never clear to me just what the assumed failure is in these analyses. And in any event, even with such market failures, the net benefit of the public expenditure would not be $10m.
So here are two questions for those of you who do economic impact studies. First, when you calculate a number for an economic impact, do you assume that there is any underlying market failures such that the “impact” is, in fact, a benefit. And second, what exactly is the question to which the reported dollar number of impact is the answer?