Policy Position

Economic Impact Studies

in Budget, Taxation, and the Economy

Introduction

Whether it’s to support a new highway project, special tax breaks for solar energy, the building of a civic center or sports complex, or to promote subsidies for Hollywood film producers, you can find an economic impact study touting how great the project will be for the state or local economy.

The formula is simple. A special-interest group that stands to benefit from the project funds an economic impact study that purports to provide hard numbers on the number of jobs, the increase in wages, and the additional output that will be generated by the project or subsidy, and it will do this on an industry-by-industry basis. It makes grandiose claims about how much overall economic growth will be enhanced for the state or region generally. Once the report is completed, the special-interest group that paid for the study will tout these results in press releases that will be picked up by the largely uncritical media establishment, ensuring that the political decision-makers and others who determine the fate of the project receive political cover.

These studies all have several things in common. First, they typically use proprietary, off-the-shelf models with acronym names like IMPLAN (Impact Analysis for Planning), CUM (Capacity Utilization Model), or REMI (Regional Economic Model, Inc.). Rights to use the models are purchased by professional consulting firms who are hired by the interest groups to conduct the studies. Furthermore, seldom do those who perform the studies have formal training in economics. Instead, their expertise is in using one or more of the proprietary models. And finally, all of these studies ignore basic principles of economics and, as a result, do not meaningfully measure what they claim to be measuring, namely the economic impact of the public policies and projects that they are assessing.

Key Facts

  • To properly assess the impact of any economic activity, it must first be understood that the project will yield directly observable activities that one can reasonably expect to occur and there will be economic activities that don’t occur but otherwise would. These are called “opportunity costs.” Opportunity costs exist because the project assessed uses revenues and resources, including labor, that would have been used elsewhere in the economy if the project that is the subject of the study were not pursued.
  • In a normal economy, what these studies typically describe as job creation is actually labor diversion. In an otherwise full-employment economy, like we are currently experiencing, workers that will be employed by the project being considered are likely being bid away from other areas of employment where they are working. These labor shifts are part of the opportunity costs that need to be considered but never are.
  • Any economic impact study that does not attempt to assess opportunity costs cannot legitimately be called economic analysis. None of the studies using the commercial models mentioned above even attempts to make these assessments.
  • These studies claim to be measuring impacts on variables like job creation and gross domestic product. Because they ignore opportunity costs, they, in fact, are not.
  • Because alternative resource uses are not being considered in these studies, the economic impact of any project assessed will automatically be positive. A negative result, i.e., a result that shows a negative economic impact, is ruled out by the nature of the study.
  • The impact numbers typically generated by these studies should not be viewed as social benefits but as a measurement of the extent to which the project being considered is drawing resources away from other uses.

Recommendations

  1. Before using any economic impact studies to inform public policy decisions, elected officials and agency leaders should have the study assessed by an independent team of economists to ensure that estimates of opportunity costs are included in the analysis.
  2. If policymakers are going to commission studies that provide quantitative economic analysis to inform their decision-making, they should insist that it be based on cost-benefit analysis, not “economic impact” analysis, and be performed by qualified economists. No government, government agency, or advisory committee should commission an economic impact study using the above-mentioned models.

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