Erie Chamber Blog
Wednesday May 8,  2019
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Direct, Indirect, and Induced Effects

Economic impact reports have long been used by economists to quantify the impact a business or organization, new or existing policy, or other event has on an economy. An economy can be anything from a designated local neighborhood to entire countries to the global economy. 

The Erie Regional Chamber and Growth Partnership recently published an economic impact report on Wabtec. The purpose of the report is to illustrate the depths of a company’s impact on a community. Communities can use economic impact studies to evaluate and understand the role that organizations have on their region, from major employers to small businesses to local universities. As such, it’s important to answer the question – what is an economic impact report?

What is an Economic Impact Report?
An economic impact report (or study) examines the effects of change within the local economy of a specified area, ranging in size from a neighborhood to the world. It measures and analyzes the change in business revenue, profits, wages, and jobs. Often times, economic impact reports are useful when a proposed project is in question, a new policy is in play, or a company is relocating into or out of an area.
Economic impact studies are frequently used to compare different hypothetical scenarios and outcomes.

For example, let’s say a new tax policy is being considered. An economic impact study may be conducted to help quantify various costs and benefits of the policy on individuals, businesses, and the broader community. Whatever the case, the goal of an economic impact study is to demonstrate and quantify the ripple effects of a potential economic change on a specific region.

What are the Types of Economic Impact Studies?
There are five common types of economic impact studies. Each analysis provides a different depth of information pertinent to understanding economic implications of various actions and changes within the local economy. The five common types of impact reports include:

  • output impact
  • value-added impact
  • labor income impact
  • employment impact
  • property value impact

For the purposes of the recent economic impact report on Wabtec, it’s important to understand the basic concepts of an output impact study, a value-added impact study, and a labor income impact study.

An output impact study focuses on business sales revenue as a way to measure the impact of the business using some of its revenue to purchase goods and services outside the specified region. A value-added impact study determines effects of an increase or decrease in a region’s gross regional product (much like how gross domestic product is discussed at a national level). A labor income impact study focuses on the wages paid to local employees with an intent to measure how employees are projected to spend their wages in the local economy.

Additionally, there are three core economic sources to measure – direct, indirect, and induced effects.

Direct Effects: the money spent by businesses within a specific region, including, but not limited to, salary, materials, and operating costs.

Indirect Effects: transactions between primary businesses and secondary businesses that are a direct result of the money spent by the primary businesses within the study. This cycle often continues down the supply chain.

Induced effects: the increase in personal spending by the primary and secondary businesses’ employees at local establishments within the specific region.

An Economic Impact Report Example Scenario
Let’s review a simplified example to illustrate the economic sources and types of impact analyses.

Company ABC wins a new contract for $100 million. As a result, they hire 75 new employees, they increase the wages within two departments responsible for the bulk of the work order, and they engage ten local businesses within their supply chain. These are a direct effect of the economic injection into the primary business.

Those ten businesses hire an additional 40 employees and engage three additional local businesses to assist with their portion of the project. The cycle continues down the supply chain. This economic activity is an indirect effect of the primary business’s activity.

The combined labor pool of 115 new employees all increase their spending at local establishments —they join a gym, eat out more, purchase a home or a vehicle, or enroll their children in various after-school activities within the defined region of economic study. This is the induced effect of the primary business’s activity, or the increase in household spending based on the economic injection of increased wages, etc.

The above information would allow an economic impact study to determine how much additional revenue will be pumped into a local economy over a period of time. It creates an understanding of how one industry impacts other industries within a defined region. It also gives parameters to determine the implications of job loss or creation and how those changes will impact a community— something called a multiplier effect.

What is the Multiplier Effect?
The multiplier effect is a common economic development formula that determines how the change in income relates to the permanent change in the flow of spending. In other words, the multiplier effect refers to how an increase (or decrease) in jobs and wages impacts the money spent within the local economy. The higher the multiplier, the higher the potential impact. It acts as a continuous chain following an injection of money into an economy where one business’s spending is another business’s income.

Consider the following simplified example to illustrate the multiplier effect. John Smith works for a company headquartered in Erie. John recently received a salary increase during his annual review, along with the 100 of his coworkers. The multiplier effect measures the increased spending from John and his coworkers within the local economy.

This same scenario can apply to business revenue. Let’s assume there’s an injection of $100 million in capital investment from a local company to build a new plant. More than likely, this injection of funds will be the catalyst for additional spending in expenditures from the company at other local businesses. It’s essentially the flow of direct, indirect, and induced effects and is an important economic model to understand the flow of money within a local economy.

Economic impact reports allow a community to visualize the impact local businesses and industry have on their daily quality of life. These types of reports and studies make tangible assumptions on how a change in operation goes beyond the confines of the company and flows out into the community at large. Economic impact reports are also a useful tool to understand how new policies could impact a community based on whether or not they pass and are implemented. This basic overview of economic impact reports can provide greater context to changes in local business structure and economy.

Do you own a business in Erie? Do you know your economic impact on the local economy? Contact the Chamber to learn more about economic impact reports and how to understand your business’s impact on the region: (814) 454 – 7191 x 141.

  • impact
  • economic impact
  • multiplier effect

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