by Jurgen Brauer, February 2006
Copyright: J. Brauer. No reproduction without permission.

The other day I received a phone call from a senior officer at a sizeable Augusta employer. She had a simple question: would I – as an economist – be able to give her an idea of the economic impact of her company on the local economy. After all, she reasoned, when the company's employees spend their income, somebody else in Augusta benefits. All she wanted to know was just how much of an economic splash her company was making.

I took a deep breath, sighed, and fumbled for words. How to nicely explain to the lady on the phone that her company's "economic impact" was zero?

I took a deep breath, sighed, and fumbled for words. How to nicely explain to the lady on the phone that her company's "economic impact" was zero?

Suppose an Augusta company has a payroll of 1,000 employees, each with a $50,000 annual income. That's a $50 million annual payroll. Further suppose that each employee spends his or her entire $50,000 income locally, so that there are no "leakages" outside of Augusta. From this it follows that each dollar thus spent generates exactly one dollar of income for somebody else locally and therefore creates local jobs. For simplicity's sake, let's say another 1,000 jobs are created in this way, so that on this reasoning the "economic impact" of the original company is 2. Total employment is 2 x 1,000, or 2,000 total jobs, and the annual payroll is 2 x $50 million which equals $100 million.

That's what the lady on the phone wanted to know. But now suppose that I receive a phone call from another employer. That employer wants to know what his company's economic impact is. By the above reasoning, the impact should be 2 as well. So, too, for a third and a fourth and a fifth employer. All of them come to believe that their own company's impact on the economy is 2. However, when all of Augusta's employers have called me – each believing that the impact of their company on the economy is 2 – Augusta would be twice as large as it is!

Evidently that cannot be the case. So, what's wrong? What's wrong is that people completely, thoroughly, utterly, entirely, wholly, and deeply misunderstand the concept of economic impact, or "the multiplier" as economists call it.

The mistake that the lady who called made is to believe that only her company's employees spend money to benefit someone else in the local economy. She altogether neglected to consider that the only reason her company is in business is because other people spend money to make it possible for her company to have employees in the first place.

The economic impact of the lady's firm is just the value of the payroll itself – not a penny less, and not a penny more. Sorry.

Whence, then, all the talk about economic impact? How come high-priced consultants are running around the country selling their services as suppliers of economic impact studies when we know that the "impact" must be zero? Put the unethical riffraff to one side – those who are selling economic snake-oil to the unsuspecting or the gullible – and honest consulting firms will tell you that an economic impact study revolves around estimating the effect of the addition (or removal) of economic activity, not around existing activity. So, if the lady on the phone had told me that her company plans to add an extra 100 employees at $50,000/year each, and thereby generate an extra payroll of $5 million annually, then the impact would indeed be about an extra 2 x $5 million of spending power in the Augusta community. Likewise, if she had told me that her company was going to lay off 100 people – the removal of economic activity – then there would result a multiplied adverse economic effect to the community at large.

Suppose a man sits in his bathtub. If another man enters the same bathtub, the water level rises, as might their temper! Likewise, when the first man gets out, the water level falls, as might their temper. But if a man sits in his bathtub and nobody else enters and nobody leaves either, then the water levels stay put. And so it is with the economy: an impact occurs if, and only if, there are additions to or withdrawals from the existing environment.

Suppose a man sits in his bathtub. If another man enters the same bathtub, you can imagine the impact: the water level rises, as might their temper! Likewise, when the first man gets out, the water level falls, as might their temper. But if a man sits in his bathtub and nobody else enters and nobody leaves either, then the water levels stay put. And so it is with the economy: an impact occurs if, and only if, there are additions to or withdrawals from the existing environment.

Therefore, my own institution – Augusta State University – has a zero "economic impact" on the local economy, except that an educated workforce attracts new economic activity to locate in Augusta. It is by the new employers coming here, or by the existing employers expanding their operations here, that ASU would properly measure its economic impact on Augusta, not by the size of its current payroll. And the same is true of the lady's employer.

And what about the upcoming Masters' golf tournament week? Sorry to say it but the impact will be zero because the Masters' has been around for many decades. It is not new economic activity, only seasonal activity. If we were to have a second Masters', or a two-week long Masters', or a field of players double in size, then we would have new economic activity and there would be an impact for a short time. Even then, the impact might be small because as more people rent out their homes (money flowing in, an "injection") they also spend it on a week in the Bahamas (money flowing out, a "leakage") so that the net effect of this new economic activity on Augusta would perhaps be rather small.

I will measure the impact of this column by the number of phone calls I get about "economic impact" studies: the fewer the phone calls, the more of you learned the lesson.