Introduction

Headlines like these recent real-life examples are prized by project promoters and business boosters. They often appear when advocates for private sector projects are seeking public support. The dollar figures featured in the stories are large, even "huge". They signal to readers both economic importance and political significance.

An economic multiplier lies behind nearly all such headlines. Multipliers are typically used to turn large dollar impacts into even larger ones. They do this because they translate project-specific effects into economy-wide impacts.

The local spending impacts associated directly with a specific project or economic activity are the starting point of any impact analysis. Known or planned facility construction and operating expenditures are a typical example. Called "direct effects", they are nearly always the most important data to estimate well in any impact analysis. To estimate economy-wide impacts, numbers known as multipliers are literally multiplied by the direct effects.

Citizens, elected officials, journalists, planning commissioners, neighborhood organizers, business persons and many others concerned with economic growth and development can benefit from a basic understanding of multipliers and their uses and abuses. Those who understand will be better prepared to separate the useful wheat from the promotional chaff of economic impact study reports. They should be better prepared to ask the questions that will help them go behind the "gee whiz" headlines.

Economic Multipliers

An economic multiplier is a number used to estimate economy-wide impacts of industry-specific economic changes. Multipliers are generated from numerical or statistical models of a national or regional economy. Using models, multipliers can be calculated for every business or industry sector in the economy. A multiplier is always greater than one because it is a ratio that is calculated by dividing a) the estimated total effect resulting from a given economic "shock" to the economy by b) a necessarily smaller partial effect, namely the direct project- or activity-specific effect.

Each multiplier can be thought of as an empirical, quantified measurement of the strength of the economic linkages between a given industry or economic sector and the rest of the regional economy. The greater the extent of the linkages, the greater the size of the multiplier. The greater the multiplier, the greater the economy-wide dollar or employment impact of any given stimulus to one industry or sector of the economy.

Final Demand Changes, Multiplier Rounds, and Leakage

There are at least three key concepts that must be understood to understand what lies behind the use of most multipliers. The first is the concept of an economic stimulus through a change in final demand. The second is the notion of a chain of spending and respending that is set into motion by an initial economic stimulus. The third is the notion of "leakage" from a local economy.

"Final demand" refers to the sales of economic goods and services to purchasers who are the ultimate users or consumers of these products. The demand is "final" as opposed to "intermediate". In other words, the goods and services are valued in and of themselves rather than for their usefulness in the economic production of new goods and services.

When final demand increases, a kind of chain reaction of economic events is triggered. The initial stimulus of new spending sets into motion a series of additional spending and respending activities. Most multipliers are used with the presumption that, in a precise mirror image of an increase, any decrease in existing final demand sets into motion a whole series of spending contractions. The best way to explain this may be to give an example (using a spending increase).
Assume the overall final demand for locally made ice cream increases significantly, say boosting sales by $100,000 because of a successful non-local advertising campaign. The local ice-cream manufacturer's receipts then increase, but that is not the end of the money trail. In order to meet the increased demand, the manufacturer will typically respond by increasing production. To do this, the firm will use some portion of the $100,000 to buy more inputs in the form of additional goods and services. The additional inputs for new ice cream production will include ingredients like cream, sugar, fruits, and chocolate; paper and ink for more containers; more electricity and water; more labor; perhaps even new equipment; and so on. But again, this is not the end of the money trail. Each of the ice-cream manufacturer's suppliers will respond in similar fashion. As demand for their products increase, so they too will increase their purchases of all the inputs they require for their production processes. Ultimately, the chain of input purchases is likely to reach far beyond the sectors of the economy that are most obviously linked to ice cream production.

Increased purchases of inputs by business firms are not the only way in which the economic stimulus of increased final demand diffuses throughout the economy. People also benefit from increased demand as workers or business owners earn more. They are very unlikely to stash all of their increased revenues unproductively in a cookie jar. More likely, they will spend some or all of that money on a wide variety of new consumer goods and services, not to mention new investments. Depending on their income classes, purchasers of new consumer goods will likely spend across the full spectrum from cookies to cars to piano lessons. Next, as the grocery stores, car dealers, and piano teachers respond to this increased demand, they will in turn increase their own purchases of inputs to their businesses. Moreover, any owners and employees in these businesses will have additional income or profit to spend on still other goods and services.
At first glance, this cycle of spending and respending seems like it might continue without end. However, this is not the case. The reason can be summarized in the term "leakage". Leakage represents the dollars that are withdrawn from the respending cycle.

Insofar as they are not respent, the withdrawn dollars cannot stimulate further purchases. Starting right at the very first round of spending associated with an increase in final demand, and continuing in all subsequent rounds, a certain portion of the dollars will "leak" out of the economy.

Because of leakage, at each round of spending and respending, the dollar amount re-spent diminishes. The amount that it diminishes is usually averaged across the entire process and summarized in percentage terms.

A small amount of leakage may indeed end up in a cookie jar or under someone's mattress. However, leakage more importantly is associated with other sources including:

• other forms of long term saving and nonlocal investment
• increased tax payments
• spending on goods and services that are not produced locally, (e.g. domestic and foreign imports)

While it is true that some of what is termed leakage here may eventually be re-spent locally, this is not likely to be immediate or automatic. If such spending does occur, it would generally be considered a new increase in final demand.

A single city or county, especially in a rural area, is much more likely to experience high levels of leakage. This is because, compared to a state or nation, most "small" economies are more dependent on the need to buy many goods and services produced outside its boundaries. For this reason, it is nearly always but not necessarily true that multipliers for small geographic areas are smaller than for larger ones.

In fact, a couple of the more likely errors behind exaggerated economic impact reports pertain to misunderstandings of the role of geographic boundaries. One is the misapplication of a large area multiplier (state and national multipliers are usually easier to acquire at low cost) to a small area like a county. Another is the failure to account for the fact that new consumer spending that is associated with one new project in a regional economy (a retail mall, for example) may be partly or even fully counterbalanced by reduced consumer spending at existing, competitive facilities within the same region.

Figure 1 illustrates the rounds of spending and leakage that are associated with a $100,000 change in final demand. A multiplier of 2.5 and 40% leakage are assumed.

Many Kinds of Multipliers

One of the reasons references to multipliers can be confusing is that there are a number of different kinds of multipliers that can be calculated. Multipliers often vary in their unit of measurement or denominator (e.g. output, jobs, income). I-O multipliers also vary in the assumptions they make about the relationship between increased worker and investor incomes and subsequent consumer spending behavior.

An employment multiplier summarizes the number of total jobs in the economy that will be created for each new job created directly by a given increase in final demand. An output multiplier represents the total value of new sales that will be stimulated in the economy for each dollar increase in final demand. And the income multiplier indicates the total amount of new income that will be generated for each dollar of income earned by workers in the industry directly affected by the increased final demand.

Any one of these multipliers is as valid to use as any others. The choice of which to use depends upon what issues are being studied and what kinds of measures are of greatest salience to the intended audience. These three kinds of multipliers are often calculated before others because they tend to have high political salience.

*For a longer version of this article or further information on multipliers or impact analyses in New York and Pennsylvania, and for contacts in other states, please contact David Kay (dlk2@cornell.edu) or Dr. Martin Shields - Penn State University (mshields@psu.edu).