Employment multiplier

What Is Employment Multiplier?

The employment multiplier is an economic indicator used in macroeconomics to quantify the total number of jobs created within an economy as a result of an initial increase in direct employment in a particular industry or sector. It measures the ripple effect of new job creation, encompassing not only the direct jobs but also the indirect and induced jobs that stem from the initial employment growth³⁰, ³¹. This concept is crucial for understanding the broader economic impact of new businesses, industries, or specific policy initiatives on a regional economy.

The employment multiplier illustrates how an initial investment or policy action can lead to a magnified effect on overall employment. Direct jobs are those immediately created by a new project or industry. Indirect jobs are those generated within the supply chain that supports the directly affected industry. Induced jobs arise from the increased consumer spending by individuals holding both direct and indirect jobs within the community²⁸, ²⁹.

History and Origin

The concept of the employment multiplier has its roots in the early 20th century, emerging from a broader inquiry into economic multipliers. The specific idea of the employment multiplier was introduced by British economist Richard F. Kahn in his 1931 article, "The Relation of Home Investment to Unemployment," published in The Economic Journal²⁷. Kahn's work focused on how an increase in primary employment, such as that generated by public spending on infrastructure, could lead to a larger total increase in employment throughout the economy.

John Maynard Keynes later built upon Kahn's multiplier concept, integrating it into his seminal 1936 work, The General Theory of Employment, Interest, and Money, where he formalized the investment multiplier. While Keynes primarily focused on the relationship between investment and national income, his framework underscored the broader principle that an initial injection of spending could create a magnified effect on economic activity and, consequently, on employment levels²⁶. This laid the groundwork for the modern application and study of the employment multiplier in assessing economic interventions.

Key Takeaways

• The employment multiplier quantifies the total jobs (direct, indirect, and induced) generated by an initial direct job creation.
• It is a key economic indicator used by policymakers and economists to assess the broader ripple effects of new industries or projects.
• Direct jobs are those created within the specific industry, indirect jobs support that industry's supply chain, and induced jobs result from worker spending.
• Industries with higher employment multipliers are generally considered more beneficial for economic growth due to their wider job-creating capacity.
• The value of an employment multiplier can vary significantly based on industry type, regional economic characteristics, and factors like the marginal propensity to consume.

Formula and Calculation

The employment multiplier is typically calculated by dividing the total employment created (including direct, indirect, and induced jobs) by the initial direct employment²⁵.

The formula can be expressed as:

Where:

• DE: Direct jobs created within the specific industry or project.
• IE: Indirect jobs created through the supply chain and supporting industries.
• Induced E: Induced jobs created by the spending of direct and indirect employees within the local economy.

For example, if an initial investment creates 100 direct jobs, and this leads to 50 indirect jobs in supplier industries and 200 induced jobs from worker spending, the employment multiplier would be:

This means that for every one direct job created, an additional 2.5 jobs are generated indirectly and through induced spending, totaling 3.5 jobs in the economy.

Interpreting the Employment Multiplier

Interpreting the employment multiplier involves understanding its numerical value as an indicator of an industry's or project's broader impact on the labor market. A higher employment multiplier suggests that a given initial employment increase will result in a significantly larger total number of jobs across the economy. Conversely, a lower multiplier indicates a more contained job creation effect.

For instance, an employment multiplier of 2.0 means that for every direct job created, one additional job is generated indirectly or through induced spending. An industry with a multiplier of 4.0, however, would indicate that three additional jobs are created for every single direct job. Understanding this metric allows economists and policymakers to compare the job-creating potential of different sectors or public spending initiatives²⁴. Industries with deep backward and forward linkages within the economy, meaning they rely on many local suppliers and their employees spend a significant portion of their income locally, tend to have higher multipliers²³.

Hypothetical Example

Consider a hypothetical scenario where a new automobile manufacturing plant is established in a town. This plant directly employs 1,000 workers.

1. Direct Employment (DE): The 1,000 jobs created directly at the automobile manufacturing plant.
2. Indirect Employment (IE): The plant requires various inputs, such as steel, plastic components, and electronics. This demand leads to increased production at local steel mills, plastics factories, and technology firms, which, in turn, hire more workers. Let's assume this results in 1,500 indirect jobs. These jobs are generated in industries that form the plant's supply chain.
3. Induced Employment (IE): The 2,500 direct and indirect employees (1,000 + 1,500) earn wages and salaries, which they then spend on goods and services in the local community. They buy groceries, eat at restaurants, visit doctors, and utilize various other services. This increased consumer spending stimulates demand, leading to job creation in sectors like retail, healthcare, and food services. Let's assume this spending generates an additional 2,000 induced jobs.

Using the employment multiplier formula:

In this hypothetical example, the employment multiplier for the new automobile plant is 4.5. This means that for every direct job created at the plant, an additional 3.5 jobs are generated elsewhere in the regional economy, leading to a total of 4,500 new jobs from the initial 1,000.

Practical Applications

The employment multiplier is a vital tool for policymakers, economists, and regional planners to assess and forecast the job creation potential of various economic activities.

• Economic Development Policy: Governments often use employment multipliers to evaluate proposed investment projects or industry expansions. By understanding which sectors have higher multipliers, policymakers can prioritize initiatives that offer the broadest economic impact and job creation for their communities²¹, ²². For example, the Economic Policy Institute publishes updated employment multipliers for various U.S. industries, providing data that can inform policy decisions²⁰.
• Infrastructure Projects: Large-scale infrastructure projects, such as building new roads or public transportation systems, are often justified based on their potential to stimulate job growth. The employment multiplier helps estimate not just the construction jobs (direct) but also jobs in material supply (indirect) and service industries catering to the workers (induced).
• Industry Analysis: Businesses and analysts use multipliers to understand the full employment contribution of a particular industry. This can inform decisions about industry incentives, workforce development programs, and long-term economic planning. Industries like manufacturing and information technology often exhibit higher multipliers due to their extensive supply chains and high-wage jobs that lead to significant respending¹⁸, ¹⁹.
• Recession Recovery: During economic downturns, policymakers may implement fiscal policy measures, such as government stimulus packages, with the goal of increasing aggregate demand and generating jobs. The employment multiplier helps forecast the total job gains from such interventions.

Limitations and Criticisms

Despite its utility, the employment multiplier, like other economic models, has several limitations and criticisms that must be considered.

One significant criticism is the assumption of readily available resources and excess capacity in the economy. If an economy is already operating near full employment or has limited available labor, new investment might not create many new jobs but instead divert workers from other sectors, potentially leading to increased wages and inflation rather than significant job growth¹⁶, ¹⁷.

Another limitation pertains to "leakages" from the income stream. The multiplier effect assumes that a substantial portion of the newly earned income is respent within the local economy, creating further demand and jobs. However, money can "leak" out of the system through various channels, such as savings, taxes, or imports¹⁴, ¹⁵. If workers save a large portion of their income or spend it on goods and services produced outside the local region, the induced job creation will be diminished, thereby reducing the actual employment multiplier¹³.

Furthermore, the calculation of employment multipliers often relies on input-output models, which assume fixed production relationships between industries¹². This can oversimplify complex economic dynamics and may not accurately reflect real-world adjustments. Research from institutions like the W.E. Upjohn Institute for Employment Research suggests that job multipliers touted by policymakers can often be overstated because they may not fully account for cost feedbacks like increased land prices and labor costs that accompany regional growth¹¹. Time lags between the initial investment and the realization of its full multiplier effect also pose a challenge, as economic conditions can change significantly over time¹⁰.

Employment Multiplier vs. Fiscal Multiplier

The employment multiplier and the fiscal multiplier are related but distinct concepts within economic theory. Both describe how an initial change can lead to a larger overall impact within the economy, but they focus on different outcomes.

The employment multiplier specifically measures the total change in jobs (direct, indirect, and induced) resulting from an initial change in direct employment within a sector or due to a specific project. Its primary focus is on job creation and its cascading effects throughout the labor market.

The fiscal multiplier, often associated with Keynesian economics, measures the ratio of the total change in gross domestic product (GDP) or national income to an initial change in government spending or taxation. This multiplier quantifies the overall economic output generated by public spending or tax policy, recognizing that initial government expenditure can lead to further rounds of spending and income generation across the economy⁹. While increased GDP often correlates with increased employment, the fiscal multiplier directly measures output, whereas the employment multiplier directly measures jobs.

FAQs

How is direct employment different from indirect and induced employment?

Direct employment refers to jobs directly created by a new project or industry. Indirect employment encompasses jobs generated in industries that supply goods and services to the directly affected industry (the supply chain). Induced employment arises from the spending of wages by both direct and indirect employees on consumer goods and services within the local community⁷, ⁸.

Why is the employment multiplier important for policymakers?

The employment multiplier is important for policymakers because it helps them understand the broader economic impact of different investments or policy decisions. By comparing multipliers across industries, they can prioritize initiatives that are likely to generate the most jobs and foster greater economic growth in their regions⁵, ⁶.

Can an employment multiplier be less than 1?

In theory, an employment multiplier is typically expected to be greater than 1, meaning that initial job creation leads to additional jobs. However, if a project displaces existing jobs, or if there are significant "leakages" where money leaves the local economy (e.g., through high imports or savings), the net effect on local employment might be minimal, or in extreme cases, could theoretically approach a value indicating no net gain in jobs if not properly managed⁴. Realistic multipliers often factor in these leakages and cost feedbacks³.

What factors can influence the size of an employment multiplier?

Several factors can influence the size of an employment multiplier, including the industry sector (e.g., high-tech industries often have larger multipliers), the local labor market conditions, the marginal propensity to consume of the newly employed workers, and the extent of reliance on local suppliers¹, ². Regions with diverse and robust local economies tend to exhibit higher multipliers.