Economic impact assessment

What Is Economic Impact Assessment?

Economic impact assessment is a systematic process used to identify, quantify, and evaluate the economic effects of a particular event, project, or policy on a defined geographic region or industry sector. This analytical tool falls under the broader umbrella of public finance and policy analysis, providing crucial insights for decision-makers in both the public sector and private sector. It aims to illustrate the "ripple effect" of an economic change, showing how an initial action can generate subsequent rounds of economic activity, ultimately affecting measures such as employment, wages, and gross domestic product.³²,³¹,³⁰

History and Origin

The roots of formal economic impact assessment can be traced, in part, to the rise of environmental policy in the mid-22nd century. A significant legislative milestone was the National Environmental Policy Act (NEPA) of 1969 in the United States, which mandated federal agencies to assess the environmental, social, and economic effects of their proposed actions prior to making decisions.²⁹,²⁸ This pioneering act required agencies to prepare detailed statements on potential impacts, alternatives, and resource commitments, laying a foundational framework for integrated impact studies.²⁷,²⁶ Over time, the methodologies evolved, with the adoption of tools like Input-Output (I-O) models, which gained prominence after economist Wassily Leontief's work in the mid-20th century.²⁵ These models helped to systematically analyze inter-industry relationships, allowing for more comprehensive economic evaluations beyond just direct effects.²⁴

Key Takeaways

• Economic impact assessment quantifies the direct, indirect, and induced economic effects of projects, policies, or events.
• It is a vital tool for policymakers, businesses, and stakeholders to understand potential outcomes and inform investment decisions.
• Key metrics typically include changes in employment, labor income, output (sales), and value added to the economy.
• The methodology often relies on input-output models and other economic modeling techniques.
• Economic impact assessments face criticisms related to potential overstatement of benefits and neglecting opportunity cost.

Interpreting the Economic Impact Assessment

Interpreting an economic impact assessment requires an understanding of its distinct components: direct, indirect, and induced impacts. Direct impacts are the immediate effects of an activity, such as the jobs created directly by a new factory or the spending on construction materials for infrastructure projects. Indirect impacts result from the spending by directly affected businesses on their suppliers. For instance, the factory's material purchases create economic activity for its suppliers. Induced impacts arise from the spending of wages by employees in both directly and indirectly affected businesses on local goods and services, creating further economic activity throughout the local economy.²³,²²

Analysts often use economic multiplier effects to estimate these flow-on effects, translating initial spending into a broader economic footprint.²¹,²⁰ A robust assessment considers the defined geographic boundaries, the baseline economic conditions, and the time horizon of the impacts. The results are typically presented in terms of jobs, labor income, and gross regional product (GRP), which is the regional economics equivalent of gross domestic product.¹⁹

Hypothetical Example

Consider a hypothetical scenario where a major company decides to build a new manufacturing plant in a specific county. An economic impact assessment would begin by quantifying the direct impacts:

1. Direct Jobs: The new plant directly hires 500 employees.
2. Direct Spending: The company spends $20 million annually on local utilities, maintenance, and supplies for the plant's operation.

Next, the assessment would calculate the indirect impacts. The local suppliers of utilities, maintenance services, and raw materials for the plant now experience increased demand. This increased demand leads them to hire more employees and purchase more inputs, creating new jobs and spending within their supply chain. For example, the utility company might hire 10 new staff, and the maintenance firm might purchase more equipment.

Finally, the induced impacts are calculated. The 500 direct employees and the 10 indirect employees earn wages, which they spend on housing, food, retail, and entertainment within the county. This spending supports jobs and generates revenue in local restaurants, grocery stores, and other retail establishments, further stimulating the local economic growth.

The assessment would aggregate these direct, indirect, and induced effects to provide a comprehensive picture of the total new jobs, labor income, and economic output generated by the new manufacturing plant over a specified period.

Practical Applications

Economic impact assessment is a widely used tool across various sectors to inform strategic decisions and communicate potential benefits. Governments frequently commission these assessments for proposed fiscal policy changes, major public works, or environmental regulations to understand their effects on local, regional, or national economies.,¹⁸ For example, a local government might use an economic impact assessment to evaluate the projected benefits of a new sports stadium, quantifying the jobs created during construction and operation, the increased tourist spending, and the additional tax revenues.¹⁷ Similarly, private businesses use these analyses to justify major capital expenditures, assess the economic footprint of their operations, or support applications for grants and tax incentives.,¹⁶ International organizations also utilize forms of economic impact analysis to evaluate the macroeconomic effects of global financial turmoil or policy recommendations on member countries.¹⁵ The OECD, for instance, provides guidelines for multinational enterprises that include considering economic impacts as part of responsible business conduct.¹⁴,¹³,¹²

Limitations and Criticisms

Despite its widespread use, economic impact assessment faces several significant limitations and criticisms. One common critique is the potential for overstatement of positive impacts. Many studies focus on gross economic activity rather than net impacts, failing to adequately account for "deadweight" (activity that would have occurred anyway) or displacement effects, where new economic activity merely shifts from one part of the economy to another.¹¹ Critics argue that these studies often overlook opportunity cost, which is the value of the next best alternative use of resources. If a project requires resources that would have been used elsewhere, the overall net economic benefit might be exaggerated if the alternative use is not considered.¹⁰

Another challenge stems from methodological inconsistencies and the reliance on proprietary models, which can lead to results that are difficult to compare or verify.⁹,⁸ Some analyses are criticized for being commissioned to legitimize a predetermined political position rather than to seek an objective economic truth, leading to potentially misleading communication of results.⁷ The assumption that all new spending represents new money in the economy can also be flawed, as it often ignores that every dollar flowing into a project is a dollar diverted from elsewhere.⁶

Economic Impact Assessment vs. Cost-Benefit Analysis

While both economic impact assessment and cost-benefit analysis (CBA) are analytical tools used to evaluate projects or policies, they serve distinct purposes and focus on different aspects of economic consequences.

Economic impact assessment quantifies how a project affects overall economic activity, focusing on changes in activity levels. In contrast, cost-benefit analysis evaluates the efficiency of a project by comparing all its costs and benefits, often expressing them in monetary terms to determine whether the project adds net value to society.⁵,⁴

FAQs

What are the three types of economic impacts?

The three types of economic impacts typically measured in an economic impact assessment are direct, indirect, and induced impacts. Direct impacts are the immediate effects from the activity itself. Indirect impacts arise from the supply chain responses to the direct activity. Induced impacts result from the spending of new income by those directly and indirectly employed.³

Is economic impact assessment the same as a feasibility study?

No, an economic impact assessment is not the same as a feasibility study. A feasibility study evaluates the practicality of a project, considering its technical, economic, legal, operational, and scheduling viability. An economic impact assessment, however, specifically quantifies the economic benefits and costs a project might have on a regional economy.

Who conducts economic impact assessments?

Economic impact assessments are conducted by various professionals, including economists, financial analysts, and specialized consulting firms. Government agencies, academic institutions, and non-profit organizations also perform or commission these studies to inform their planning and policy decisions. Organizations like the U.S. Bureau of Economic Analysis (BEA) provide data and methodologies that underpin many such assessments.²,¹