Input-output has not been used to its maximum potential in economic development. Often it is merely a political tool that helps to justify incentives for recruiting and retaining specific companies in a region. By running impact scenarios and estimating multipliers, an IO model will tell you approximately how much one employer is “worth” to the regional economy.
But IO has far more potential to help economic development efforts, because of its ability to capture and analyze the structure of a regional economy, which is invaluable for measuring the economy’s health and potential. IO can identify the region’s most important industries (not just those with a lot of jobs), regional industry clusters, and gaps in the regional supply chain, to name a few applications.
Much of the thought and investment that is going into current issues like green jobs (which are at this point primarily middle- to low-skill construction-related occupations) and energy efficiency really are not thought of as “basic” industries, or those industries that bring money into the region. So, before any of these development projects take place, and a lot of money is spent on systems or structures that need a lot of maintenance, it is vital for regions to understand which development projects could compliment the current base of the economy. Development professionals also need to make sure that investments make sense and are actually feasible for the region. If this is not done, projects with positive short term impacts might actually have a negative long term impacts (e.g. increased taxes, increase maintenance, lack of economic structure to support and utilize the improvements).
An important summary of economic structure is an economic base analysis. By taking into account key industries and their multiplier effects, rather than simply total jobs by industry, you can get a much clearer picture of the importance of various sectors in your economy. We cannot stress how important it is for you to know and understand these foundations of your regional economy before development decisions are made. Lately our nation has experienced many shifts in many well established industry sectors. For instance, manufacturing, which has historically been the backbone of many regional economies across the Unites States, has experienced radical employment decline due to globalization and technology. As a result, many local economies, particularly in places like Michigan and Ohio, have shaky foundations and risk losing the jobs and earnings that drive regional prosperity. Again, these manufacturing industries have very high multipliers—meaning that for every 1 job lost in this sector there could actually be as many as 5-10 other jobs in the region that are threatened. Regional planners should first understand what industries drive the local economy and understand how to incorporate this factor into broader development plans.
After structure is identified, you can begin to look for “gaps” and opportunities to strengthen the linkages among your region’s industries, which can lead to a short list of important industries you should try to attract into the area.
A. Analyzing Economic Base
Introduction: Basic vs. Non-Basic Industries
Discussion of economic base hinges on the difference between “basic” and “non-basic” industries, since the economic base is made up of contributions from basic industries only. Basic industries are those which export products/services, generating income from outside the region which they bring into the region. Non-basic industries are those which generally support or sell to residents and businesses that are already in the region. Economic development theory indicates that basic industries first take root in a region, followed by non-basic industries. For example, the California gold rush started with a basic industry—gold mining—but generated a lot of non-basic industries to supply the gold miners with food, clothing, tools, housing, entertainment, and so on. As time goes on, original basic industries may go into decline and be replaced by others. Economic development theory thus emphasizes the importance of basic industries as the “pillars” of a region’s economy that support non-basic industries. Basic industries are often natural resources or manufacturing based. However, basic industries can also be more intangible, like information services, financial services, tourism, and even government (e.g., in a university town or state capitol).
Going back to our original water-tank illustration, basic industries are like tanks with big inflow pipes that bring water directly into the room (the region). But the majority of pipes going into non-basic industries are coming from other tanks in the room—they mostly handle water that has already been brought in.
Note that many industries are partially basic and partially non-basic. A manufacturer that sells 10% of its products locally and 90% non-locally is one example. A restaurant that serves 80% locals and 20% visitors/tourists can also be considered partially basic and partially non-basic, because it is bringing in some outside income.
Using IO Data to Generate Economic Base Analysis
There are many ways of determining economic base, including
(1) simple assumption (assuming certain industries are always basic to some degree—like agriculture, mining, or manufacturing),
(2) location quotients* (LQs significantly higher than 1.0 indicate basic industries), and
(3) using input-output models to see the multiplier effects of industries’ export sales. EMSI recommends and uses the IO method for economic base analysis.
* A location quotient measures the relative size of an industry in a region, compared to the relative size of the same industry in a larger area (such as the whole nation). If the LQ is greater than 1, it means that the industry has an above-average presence, or concentration, in the region’s economy. This usually also indicates that the industry has an export orientation.
Any economic base analysis should show which broad sectors, industries, and other sources are ultimately responsible for bringing income to the region. Industries generally do this by exporting products and services to non-regional purchasers, but there are other ways that a region can bring in money: for example, the income of out-commuters in a bedroom community, or residents’ Social Security payments from the federal government. (Where these “other” sources are significant, they should be identified as part of the region’s economic base.) To create our Economic Base report, EMSI’s EI model estimates how much of each industry’s jobs and earnings rely on its out-of-region exports and other outside income, then uses multiplier effects to attribute jobs and earnings from other industries to the original “basic” industry. Additional data is used to calculate non-industry sources of income.
So, an EMSI economic base report might show that the Manufacturing sector is “responsible” for 40% of the jobs and 37% of the earnings in your region. Note that this includes ripple effects: the 40% of jobs that Manufacturing supports are more than the jobs on the payroll of manufacturing establishments. This is because manufacturing workers take their pay home from factories and buy food, clothes, housing, entertainment, etc., which supports jobs in the industries that provide those goods and services. Those jobs are thus included in the Manufacturing sector of the region’s economic base because Manufacturing is “responsible” for those jobs through its jobs multiplier.
So, if all regional Manufacturing industries suddenly went out of business, 40% of the jobs and 37% of the earnings in your economy would be lost. This is because there would be less of nearly all goods and services (e.g., food, clothing, housing, entertainment, etc.) bought, and so layoffs would occur in those areas as well. Notice that the Manufacturing sector in our example supports slightly lower-than-average paying jobs—it drives 40% of the jobs but only 37% of the earnings in your region.
Moreover, note that the “Services” sector tends to play a smaller role in a region’s economic base than it does in terms of total jobs. Service industries may hold 30% of the region’s actual jobs, but only account for 10% of jobs in the region’s economic base. This is because service industries tend to be non-basic to a region’s economy—that is, they serve local residents and circulate money that was already brought into the region by another industry. For example, a large restaurant may be next door to a custom software development firm. Though both are in the “services” industry (food services and custom programming services), the consulting firm brings in large amounts of income from clients outside the region while the restaurant mostly serves residents of the region. This means that the software firm contributes to the region’s economic base while the restaurant does not, and the closure of the software firm would have a much more negative impact than the closure of the restaurant. In a tourism-heavy region, however, most of a restaurant’s sales may be to non-residents, which would make the restaurant contribute to the region’s economic base.
Defining Economic Base Sectors
When analyzing economic base, we need to create different categories or sectors of economic activity to represent basic activities. These major groups of industries are called economic base sectors—not to be confused with industry sectors (NAICS* definitions) or industry clusters. Economic base sectors are merely groupings of broadly related industries with no claims made about their inter-dependence; in contrast, NAICS sectors are grouped by similar products and production processes, and industry cluster definitions assume a much tighter supply chain and/or labor market inter-dependence. Economic base sectors are created for convenience to describe any broad type of activity that brings money into a region, for example, “Manufacturing,” or “Visitors.” As such, they are somewhat arbitrary and can be redefined using local knowledge: a town might even allocate an economic base sector to a single large employer. In addition, some of them are not “industries” at all, but various non-industrial sources of outside regional income.
* North American Industry Classification System. All recent federal statistics use this system to categorize businesses.
In EMSI’s default economic base report, we use the following top-level economic sectors. Most of them are collections of NAICS industries.
- Agriculture, Mining, Manufacturing, Construction, Communications, Services, Finance, and Government: These super-sectors are familiar and fairly self-explanatory, since they closely match top-level NAICS categories. Note that the size of each of these sectors depends more on each one’s export orientation than on each one’s total employment.
- Residents’ Outside Income: This sector includes various sources of income from outside the region, which residents in turn spend in the regional economy. Examples of outside income include outside earnings (e.g., income of residents who commute or telecommute to an employer outside the region), capital or property income (investment dividends, royalties, rents), and transfer payments (unemployment benefits, welfare, Social Security payments, etc.)
- Exogenous Investment: Capital investments in the region from sources outside the region; e.g., federal transportation projects, new factory or plant, or a state government office complex.
- Visitors: Non-residents are an important source of income for many regions, and this sector helps quantify the jobs and earnings attributable to visitors in the region. Note that a region need not be centered on tourism to profit from visitors. For example, cities frequently draws visitors from surrounding towns and rural areas because they need to use the cities’ unique amenities, or “central functions” (shopping centers, airport, county courthouse, and so on).
- All Other: All other industries or other sources of money entering the region not included in other sectors.
Note again that these are somewhat arbitrary categories that can be rearranged to suit the area being analyzed. If, for example, we drill down in “manufacturing” and discover that one industry in that sector (Aluminum sheet, plate, and foil manufacturing) is responsible for 10% of the region’s economic base. Furthermore, we know that there is only one local employer in this industry (ACME Aluminum). We could then create a new economic base sector and call it “ACME Aluminum” to better inform community stakeholders about the area’s economic base—it means more to say that “ACME Aluminum is ultimately responsible for 10% of our jobs; the rest of our manufacturing accounts for 25%” than just to say “Manufacturing as a whole is responsible for 35% of our jobs.” To take another example, suppose a small town has a large public university. A researcher could estimate how much of each default sector’s jobs and earnings could be attributed to that single entity (e.g., the university may be responsible for 75% of the jobs currently assigned to the generic sector “Government”). The researcher could then create a new economic base sector called “The University,” and even subdivide it further into “University-related visitors,” “University-related real estate activity,” “Tech transfer spinoffs,” and so on. This can make analysis and presentation of data more customized and meaningful to the area.
Interpreting and Acting on Economic Base Analysis
Once broad sectors are identified, the region needs to make sure its broad economic development strategy and government policies are designed to support, retain, and recruit industries that make up and/or complement its economic base structure. Recent and projected job growth or decline in key industries should be monitored closely to detect potentially disastrous declines in basic industries. Emerging basic industries should also be identified as those having relatively fewer jobs but a relatively high share of economic base.
Finally, most of this discussion has focused on “region-building” industries, or industries that make up the economic base. Also important are “region-filling” industries, which support basic industries and residents’ needs. While the former are absolutely necessary for economic growth, the latter also play an important role. Region-filling industries can form a supplier network for basic industries, thus making them more competitive. They can also create higher quality of life for residents, by providing goods and services that they demand. If for some reason there are obstacles to region-filling industries, it can harm the region-building industries. So to that extent, region-filling industries can also be considered as targets for economic development efforts.
B. Using IO to Conduct Industry Gap Analysis
Because IO models capture inter-industry purchasing relationships, they can identify overall supply/demand gaps in a given region. For example, many regional industries might require commercial printing services, but the model may indicate that existing commercial printing services in the region do not have nearly enough output to satisfy the demand, so the other industries purchase these services elsewhere. If it is feasible and cost-effective to increase the in-region availability of commercial printing services, then more money would remain in the region rather than “leaking” out, contributing to economic growth.
Such information not only helps to identify the gap, but also provides additional persuasion when courting prospective employers to the region. The ability to say “there is $20 million in unmet demand for your services in our region” gives your economic develop-ment team an edge.
Scans like this can look at the requirements (demand) of the whole economy, or of one particular industry in particular. EMSI’s EI model interface has made some key innovations in this area, offering “push-button” reports that use its IO model to scan for gaps in regional industry requirements.
Remember: because IO models include many mathematically-generated estimates, it is always a good idea to confirm important parts of the data with some primary research.
Here are some issues you might run into:
- The size of input gaps depends on assumptions about how much of their inputs that industries will buy in-region versus outside the region. Cost of the inputs is the biggest factor.
- It may not be cost-effective or even feasible for a certain gap-filling industry to locate in the region. For example, key raw materials may not be located close by, or regional labor with the relevant skill sets may be too expensive, or lack of economies of scale may not make the venture profitable.
- Some firms may have specialized input needs not captured by the model, which uses average data for the whole industry.
- Because of these issues, it is advisable to use the data as a starting point for further survey-based investigation.