« The US may need a financial hegemon. But the US is not the world. | Main | Why does liquidity matter so much? »

Comments

Feed You can follow this conversation by subscribing to the comment feed for this post.

I have a lot of experience with Economic Impact studies (they are very popular in the consulting world). It is hard to take the estimates produced with multipliers at face value given the lack of constraints.I also don't like the lack of dynamics in EIA which is why I like to also use an error-correction model with GDP anchored to trend (plus other dynamics) and then use the AR(1) term to estimate the propagation of shocks.

Thanks for sharing your thoughts on this. EIA's are something that those of us in gov't who deal with infrastructure (maybe I should only speak for myself) struggle with. On one hand, as Brendon states, they are popular in the consulting world and can be quickly done. A consulting firm with a local/provincial input-output model can crank out a report in less than a week. On the other hand, the robustness of the analysis can be called into question.

Perhaps it's best that all this is kept as simple as possible. Not every government analyst who is employed as an economist has a grad degree in economics let alone an undergrad in economics. Your average analyst doing the work-up on a project for a Minister will have difficulty interpreting the complexities of a CGE model. Doing a thorough CBA takes time and expertise.

Brendon, Adam: thanks for the replies. You two have a lot more experience in producing and using EIAs than I have. A couple of questions:

1. The I-O models: are they looking at the structure of production (how much steel will be used in the building, and how much labout, iron ore, and fuel to produce the steel, etc.), or do they also look at the impact on consumer demand (marginal propensities to consume, import, etc)?

2. What do governments actually use these EIAs for?

In current circumstances, I would think that the most interesting question to ask would be: which particular resources will be used in the project, and are those resources currently unemployed (or underemployed) or fully employed? The standard Keynesian multiplier stuff seems sort of irrelevant. There's little reason to think that workers employed in one local project will consume a different vector of goods than workers employed in another project (except for obvious local effects in the demand for immobile services).

Put it another way: The Department of Finance presumably wants/needs to know about the details of this particular project which might differ from other projects. The I-O analysis might do that, but the Keynesian mpc/mpi/multiplier analysis won't.

Hey Nick,

Isn't this your idea only in a different form?

Take care,

Don

"March 17 (Bloomberg) -- Chairman Ben S. Bernanke and Federal Reserve policy makers may have to ramp up their purchases of mortgage securities and other assets after the economy and job market deteriorated further since they last met.

The Federal Open Market Committee, gathering today and tomorrow in Washington, needs to redouble its efforts after the central bank’s balance sheet shrank 17 percent from a $2.3 trillion December peak, Fed watchers said. The retreat came even as Bernanke acknowledged the chance that the unemployment rate will exceed 10 percent for the first time in a quarter century.

“It takes massive balance-sheet expansion to generate significant easing in financial conditions,” said Andrew Tilton, an economist at Goldman Sachs Group Inc. in New York who used to work at the Treasury. “More needs to be done.”

This week’s FOMC meeting could mark a shift toward more aggressive monetary expansion to fight deflation after demand waned for many of the Fed’s existing programs. One top consideration is an increase in the pace and size of a $600 billion program to buy bonds issued and backed by U.S. housing agencies such as Fannie Mae, analysts said.

Other measures could include everything from purchases of Treasuries to corporate bonds, Tilton said. The Fed has already agreed to work with the Treasury on implementing a program to revive consumer and business loans, which the Obama administration has said could reach $1 trillion. "

Nick, You have the spirit of Economic Impact summarized in paragraph 1. It can actually be useful to answer specific questions, if one exploits the industrial, commodity or geographic detail that some input-output models provide. Tax incidence is one example.

EIA should usually be relabelled Political Impact Assessment. They are the favourite rhetorical weapon of self-obsessed special interest groups. They appeal to people with no or just a minimal, faulty understanding of welfare economics and measurement theory.

Social wealth is an appropriate criteria; total cost accounting benefit-cost analysis is one of way of getting at that criteria.

The big problem with Economic Impact Assessment is that it provides incentives for bad management. Take a popular table fish like west coast Pacific halibut. Recreational harvesters require a relatively large and powerful boat to pursue them, sometimes several nautical miles offshore. Mismanage these fish so our pluck sport fishermen have to travel farther distances in order to find good numbers of halibut and the economic impact increases. This example illustrates why this type of analysis is sometimes referred to as the "Broken Window Theory of Economic Value".

Open version input-output models generate GDP multipliers whose values are less than one (< 1). To get around this apparent problem, special interests do several things. For one they generate gross output multiplier values that exceed one and involve considerable double-counting or n-counting. For two, they use Closed version input-out models that include induced effects from respending and generate enormous values akin to those of naive Keynesian-Hicksian macroeconomic models.

In the worst case, I saw recently in a consultant's report comparing economic impacts of commercial and recreational sectors in the Skeena River of nothern British Columbia, the consultant used gross output multipliers in a closed-version input-output model.

A number of years ago, the Input-Output division of Statistics Canada discontinued the closed version model precisely because of chronic special-interest abuse. At the time, we advised British Columbia statistics that of the short-comings of this model. That advise fell on deaf ears.

Before concluding, it behooves me to point out that the multiplier and impact magnitudes from an I-O model are highly sensitive to direct and indirect subsidies. The danger of relying on the faulty use of EIA in policy analysis is that it encourages a vicious circle of public subsidies (or reduced net taxes if you prefer).

Input output models are like stiff narcotics. For the right application, at the right time, they can be incredibly useful. Otherwise, they can wreak all kinds of social damage.

- Erik Poole, White Rock, BC

Don: yes, that looks like quantitative easing.

Westslope: Very informative comment. I just want to clarify the difference between open and closed version input-output models.

Open versions ignore the effects of increased consumer spending. Closed (as in "closed-loop"?) versions include the effects of increased consumer spending, in a feedback loop. Both versions assume unemployed resources (no resource constraints). Employment is determined by demand for labour (and other inputs). Is that correct?

My principal problem with EIA is that the size of the multipliers are not sensitive to business cycle conditions (a particular problem for EIA in BC for construction projects).

As for what they are used for by government - propaganda largely - either to secure government funding or public opinion.

I have never been asked for a specific structure of production or specific impacts on consumption - just the output - GDP, Jobs (always the most important for bureaucrats) and taxes.

I think the difference is indeed a "fallacy of decomposition", except that, for a single decision maker on a single project, it is not a fallacy.

If I'm a mayor deciding whether to spend $10 million, the impact on interest rates, wages, money supply etc of my project really is tiny. Of course, if we added up all the $10 million projects of all the mayors in the country, that would not be true. But I am not in the position to make a decision on all those projects - therefore I should not take their effects into account in measuring the impact of my project.

The appropriate counterfactual in my decision is where my project doesn't go ahead, but all the others do. Thus in my personal cost-benefit analysis, the inflationary impact of all those projects is not relevant, and the marginal cost (to me) of my project is just the tiny extra price impact that I cause. The rest of my costs are an externality borne by all the other cities. On the other hand, my benefit is the demand effect of just my project, most of which I capture myself.

It's the same phenomenon as the tragedy of the commons. No matter what decision I make personally, I have to bearing all the externality costs of everyone else's independent decisions. My rational choice is to graze my sheep and screw the rest of the village.

Only a larger-scale coordination mechanism can change the overall rationality of this decision, by internalising the externality and making me bear the real cost of my own expenditure.

Nick wrote above:

Westslope: Very informative comment. I just want to clarify the difference between open and closed version input-output models.

Open versions ignore the effects of increased consumer spending. Closed (as in "closed-loop"?) versions include the effects of increased consumer spending, in a feedback loop. Both versions assume unemployed resources (no resource constraints). Employment is determined by demand for labour (and other inputs). Is that correct?

--------------------------------------

Nick: Yes. You are correct on all accounts.

To elaborate further, the common closed version I-O model is actually a partially closed model. Only consumer spending of generated labour income occurs; taxation, investment revenue and other factor incomes are ignored.

Full closing an input-output model and thus making it a full macreconomic model would mean completing the relationship between supply and demand by introducing realistic resource constraints.

Nevertheless, as Michel Truchon once pointed out to me, Statistics Canada's rectangular input-output models provide an empirically accurate and useful short-term snap-shot of the overall economy. (Some refer to this as the 'mesa economy' to avoid the potentially misleading term 'macro economy'.)

Leigh: Your reference to the Tragedy of the Commons with respect to how these numbers are potentially abused in social policy decision-making is spot on. Hence my plea for total cost accouting benefit-cost analysis to borrow terminology introduced to me by west coast ecological activist Pete Broomhall.

-Erik

Nick: you posed these questions earlier.

1. The I-O models: are they looking at the structure of production (how much steel will be used in the building, and how much labout, iron ore, and fuel to produce the steel, etc.), or do they also look at the impact on consumer demand (marginal propensities to consume, import, etc)?

2. What do governments actually use these EIAs for?

The one's that I have reveiwed do not get into the structure of production nor consumer demand in the way you've enquired about. All I usually see are figures representing the impact on various sectors (both public & private including households) and person-year equivalents for the number of jobs created. And then those results are categorized as direct, indirect, or induced impacts and a multiplier is calculated. That's all we usually get.

Wwhat do governments do with EIA's? In a word, communications. As others have stated above, if one actually paid attention to funding announcements, you'd see language to the effect of "this funding will contribute $X million to the economy and create Y jobs."

Nick, Because money is fungible, wouldn't universities have an incentive to claim the money was used for a project that looked good to those doling out the funds, even if it was a project they were going to do anyway, and the money was just being diverted in higher faculty salaries?

Also have to remember that the person commissioning the EIA is not the only one looking at it (most likely). There are different groups within the bureaucracy, and some of them have the job of promoting projects and others have the job of killing them. Most people with the job of killing them absolutely recognise all these limitations. They will have seen thousands of these things, and recognise that most of them aren't worth the paper they're written on. In some cases, they are worth the paper they're written on but only because of the general hilarity they create around the bureaucracy.

And a second to Adam's point that they're used for communications/sales jobs.

But you still have to do it if you want the $. Question is whether you want to use your academic reputation to help get the $.

I have no experience with EIA's, but my guess is that projects that relieve or improve bottlenecks would have a very high multiplier effect, but not one you could calculate from an I-O analysis. You'd have to do a more general kind of impact analysis.

An example would be the bridge built across the Lachine canal 10 years ago in Montreal to replace the Atwater Tunnel. The tunnel was a bottleneck because modern trucks coul;d not fit through it. The bridge should have been built 30 years earlier. In the meantime, Canada's oldest industrial area collapsed because trucks could not easily reach the factories. This sort of impact cannot be measured by I-O analysis or simple-minded IEA's.

Leigh: yes, if I am a mayor, looking at the impact on my city, then feedback effects of national variables (exchange rates, interest rates, etc.) on my city are very small. But if I am a minister of the nation, evaluating the mayor's project, looking at the impact on the nation, those feedback effects are the same order of magnitude as the direct effects of the mayor's project on the nation. Both are small, but the feedback effects are not small relative to the direct effects. I think we agree.

Brendon's approach of doing a VAR seems to be reasonable, but I am wondering if this provides any "local", or project-specific information. Presumably any expenditure of the same $ value would have the same effects, according to the VAR model.

The sort of example that Anonymous gives (the bridge over the Lachine canal) seems to be exactly the sort of project-specific "local" information that would be VERY useful to know. It's not just dollars spent, and it's not just ordinary macro analysis of fiscal policy (which the national authority could do just as well or better than the local authority). But I agree, that this sort of very relevant information, which the local authorities would have but the national one's wouldn't, is unlikely to come out of any standard EIA. It's a supply-side multiplier.

Scott: yes. But my own gut-sense of university resource-allocation decisions, seen from the inside, is that there's a fairly large flypaper effect. Not sure why.

Christine (and thanks for my morning laugh!) seems to be summing up my general sense of dissatisfaction with EIAs. They seem like a large waste of resources (as currently done). Some sort of reform seems to be required. This is how I think it should be approached:

1. Decide who the audience/reader is for an IEA.

2. What decisions will that audience take on the basis of an EIA?

3. What information for that audience would be:
a, Useful
b, non-obvious
c, where the writer of the EIA has a comparative advantage over the audience in collecting and providing that information (e.g. local, project-specific information).

By the way, the EIA we needed for the university project just wanted 16 numbers: a 2x2x2x2 matrix.
The 4 dimenions were:

1. dollars spent vs jobs created (divide by $100,000?). Waste of time.

2. before vs after a certain date. Useful, given current economic circumstance.

3. "Direct" vs "Indirect" (No "induced" category). This presumably means we have to divide expenditures according to whether it is for value added by the primary contractor ("direct") vs inputs purchased by the primary contractor (indirect")? I can't see the point of this division.

4. Within province vs within Canada. Probably useful, since we want to see whether fiscal stimulus may be spread across the country according to where it's needed?

Nick,

I don't know if you saw this:

#

By Nick Rowe on Mar 18, 2009 | Reply

That’s interesting. We get the same story told in Canada. It’s not that the banks have stopped lending, but the non-bank (or direct market) source of loans is the one that has dried up, and banks are struggling to fill the gap.
#

By Don the libertarian Democrat on Mar 18, 2009 | Reply

John or Nick,

Could you take a look at E2.6 and tell me what’s going on between the large, small, and foreign banks?

Take care,

Don
#

By Darren Larson on Mar 18, 2009 | Reply

Don, I also noticed the difference between bank sizes. The rates are dramtically higher, the fixed period of rate is longer and the time since the commitment was made is shorter the smaller the bank. One would guess that commitments made by large banks 10.7 months ago (avg) are a lot different than those being made today. We shall see if the numbers change over time. Namely, large banks could start using different indexes, margins or installing floor rates.

On the other hand, the small bank numbers show that the commitment is 6.3 months on average. Plus, anything that contains a rate with a repricing interval greater than one year has a rate of 5.94% and these were less than a month ago in commitment time. These loans are also 97% secured and less than 8% are based on prime. In essense, prime is a useless index right now.

I would assume that large banks are attempting to swap out those rates or packaging the loans out, as making a profit at 3% interest has to be incredibly difficult. For the most part, small banks portfolio their loans, thus they need a profitable interest rate.

Nick wrote:
3. "Direct" vs "Indirect" (No "induced" category). This presumably means we have to divide expenditures according to whether it is for value added by the primary contractor ("direct") vs inputs purchased by the primary contractor (indirect")? I can't see the point of this division.

------------------------

Somebody is likely assuming that you will use an open-version input-output model to derive these direct and upstream numbers. Presumably you feed in a gross expenditure/output number and out pops direct GDP impact and indirect GDP impact. Or you get fancy, decompose the project by commodity-level entry and feed that in. Likely not worth the bother....

To add to your repertoire of uses, these impact studies were popular with senior defence brass who had a minimal understanding of economics but were seeking additional political support for budgets. Instead of seeking to rationalize defence expenditures and more specifically procurement, senior defence officers have decided to play ball with regional benefit-oriented politicians and support Industrial Benefits and politically directed domestic procurement contracts that ultimately contribute to less effective Canadian Armed forces.

I have quite a bit of experience with EIAs, and as far as I can tell, they are used mostly so governments can get a rough idea of the tax revenues that flow from a project. The consultants drafting them know they are BS, as do the people reviewing them. But, certain non-economic folks love to be able to state that some amount of expenditure will create some amount of jobs, dollars, etc.

If you've ever read Confessions of an Economic Hitman, you'll be able to relate what Perkins did for his firm to the discipline of EIAs. He'd pump up the multipliers and the numbers for some hydroelectric project and exaggerate the heck out of its impact on national growth. Governments lapped that stuff up, because it made it easier to sell the people, especially when the full costs wre not considered.

I'd say companies use EIAs for projects in order to sell it to the shareholders, then to governments, who get the next biggest cut of the economic pie. With all the huge dollar figures floating around in the debates, the public is left confused, but for the most part accepts it. (A billion dollars is better than nothing).

The comments to this entry are closed.

Search this site

  • Google

    WWW
    worthwhile.typepad.com
Blog powered by Typepad