Calculating economic impact

Economists are often asked to calculate the economic effect of a new business activity, such as the opening of a manufacturing plant or the building of a residential development. NC State University economist Mike Walden explains what goes into these computations.

“Several factors go in. What we economists try to do, number one, is obviously account for the spending and employment at the particular company that may be added, like the manufacturing plant or subdivision, etc. We call that the direct effect.

“But then there are going to be indirect effects. That is to say, if you build a new manufacturing plant, that plant is likely going to buy supplies and inputs from other companies, so there is going to be a supply-chain effect there. Also the workers at that plant are going to go out and spend money on retail items, so there is going to be a retail effect there. So we try to account for that. And what this means is that there is going to be this multiplicative effect as you follow the spending patterns down the line in the economy.

“Now where one mistake is often made, however, is that these calculations sometimes ignore the element called leakage. That is to say, if I buy an automobile from a dealer in North Carolina, I may spend $20,000. Most of that money is going to immediately leave North Carolina, because it is going to go to wherever that car was assembled.

“A mistake would be made if you took that $20,000 and followed it through and said it was going to turn over many, many times in North Carolina. It may be that only $3,000 or $4,000 is left in North Carolina to turn over. So you have to be very careful in subtracting these leakage effects.”