With each new subsidy, tax incentive, or project, we’re told some number of jobs follows. No doubt you’ve seen the headlines. The Trans Mountain Pipeline can create 3,300 permanent jobs and Energy East can create over 4,250. Bombardier, which is actively seeking government financial support, claims responsibility for 64,800.
The numbers aren’t pulled from nothing, they are available from what exactly are called economic impact studies. They are used in marketing campaigns and often are even mandated by governments. The application process for Alberta’s new subsidy for petrochemical plants, for example, requires them.
Unfortunately, such studies are simple to misinterpret, rarely explained, and can make bad public policy look good. Let’s explore their limitations.
What’s truly the net effect of a new petrochemical plant on overall employment? Roughly zero.
Suppose you spent $1 million on beer. This spending would use a brewer or two, but it doesn’t stop there. Breweries must also buy inputs – grains, fuel, and so on. Suppliers then employ more workers, and themselves buy more inputs. The cycle proceeds and on.
Statistics Canada will the math in what is known as an “Input-Output Model.” For breweries, $1 million in additional sales will “create” over $1.8 million in total sales and 4.6 jobs throughout the economy. These are called the direct plus indirect effects.
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Next, workers are paid income, which they’ll spend, spurring another round of sales, hiring, and input purchases. These are known as the induced effects. For breweries, it adds another 1.4 jobs. Overall, that’s approximately six jobs per $1 million in new brewery sales.
Unfortunately, these research has serious problems.
First, why consider only worker incomes when calculating induced effects? How about business owners? Won’t they also spend additional incomes? When we account for this, something interesting happens. The greater business income that will get recycled as spending, the greater the induced effects.
And there is no limit. Under some tweaks to the model, an additional $1 in spending can imply millions C heck, billions C of recent jobs! If both workers and corporations spend all of any additional income, the “induced” effects become infinite!
Obviously, this is silly. While students learn this startling result, the substitute nature of induced effects is not widely appreciated.
This brings us to the next problem: The models assume workers are in limitless supply. Accumulate all the direct, indirect and induced jobs within the Canadian economy using Statistics Canada’s standard numbers and also you get about 36 million jobs. No matter that there are only 18 million workers to go around, the model doesn’t care.
In reality, total employment is basically pinned down because when many workers you will find. More jobs in one part of the economy mean fewer jobs in another. Demand for labour is important, of course, but same with supply.
So what’s truly the net effect of the new petrochemical plant on overall employment? Roughly zero. Workers, with few exceptions, would certainly happen to be employed elsewhere. The plant doesn’t increase employment, it shifts employment.
This leads us to a final point: The models take into account benefits, but not costs. Desire a subsidy? Point to the concentrated and visible gains. Desire a larger subsidy? Point to large spillover gains from indirect and induced effects.
The costs, however, are less visible C though they are no less real. Once we saw, workers that shift into one activity aren’t available to work in another. Money to provide subsidies must also originate from somewhere. Typically, the funds are raised through distortionary taxes that lower business activities. Income tax lower employment, and corporate taxes lower investment. These cost is absent from typical economic impact studies.
So how can we improve? Better models are available. Instead of simple “input-output” models, we are able to use what are known as “general equilibrium” ones. They’ve many benefits, including recognizing that workers are in limited supply.
We can also put more weight on income and productivity, and less on job creation claims. Producing electricity with a fleet of stationary bicycles, in the end, would employ a military of workers but is hardly sensible policy.
Finally, we should push back against those making dodgy claims. Is a result of economic impact studies, particularly those regarding induced effects, aren’t what they are cracked up to be.
Trevor Tombe is definitely an Assistant Professor of Economics in the University of Calgary.
