San José State University
Department of Economics
The economic base model is commonly used for estimating the short-term impacts of a particular project on employment. It has also been used occasionally for projections, although there is a great deal of controversy among economists over the assumptions it makes and the methods it uses to determine the components of the model. Also, it has one limitation which is particularly important for local governments to understand: it is most appropriate for estimating the change in employment in an economic region. Using this method, it is much more difficult to estimate what share of the indirect and induced employment a particular city or county will receive. This is not so great a problem in single-county economic regions, but in the Los Angeles or San Francisco areas, employees of a new project may commute substantial distances, thus spreading the effects of employment over a number of cities and counties.
The economic base model divides employment into two major categories: 1) export or basic industries which produce and sell goods that bring in new income from outside the area; and, 2) service or residentiary industries which produce and sell goods that simply circulate existing income in the area. The export industries in a region make up the economic base.
Hereafter basic employment may sometimes be denoted as BE and employment serving the local market may be denoted as LMSE. Total employment TE is just the sum of BE and LMSE.
Employment in the export sector creates a multiplier effect by providing additional employment from the new income it brings in. The service industries develop largely to serve the local needs of the existing population. Thus, the economic base model can be used for projecting employment if it is assumed that a ratio of service to export employment can be measured and that the ratio will remain sufficiently stable so that forecasts of export employment can be used to determine future total employment. The total number of jobs resulting from one export job is the employment multiplier.
|Ratio of LMSE|
|Ratio of TE|
The model is most commonly used, however, as a rule-of-thumb to estimate the effect of specific projects or policies on employment. For example, if a new industrial plant proposes to locate in a region, the impact on employment may be estimated for: (1) a direct impact from the jobs provided by the business itself; (2) an indirect impact if the business buys production materials and services locally; and (3) an induced impact or multiplier effect from the flow of wages spent by new employees, which may provide new jobs in other businesses and in turn the spending of those wages--and on and on.
|Increas in permanent jobs |
(provided by a particular industry)
on other basic employment
(from industries supplying the above industry)
|Induced impact multiplier||1.7|
|Total employment increase||1,539|
Assuming that the multiplier also works in the reverse, this process may in turn be used to estimate the total unemployment caused by an industry leaving a city or cutting back employment.
Multipliers take information on employment and income for one part of the economy and use it to estimates employment and income in several parts of the economy or all of it. In trying to apply income and employment multipliers, the analyst needs to keep in mind one cardinal fact: the components of the calculations require information that is just not available and the final result is all too often based upon a host of assumptions. Therefore, though convenient to use, multipliers often rely upon poor data and unverified assumptions. When faced with the need to use a multiplier, the best practice is to trust local experience, testing it against as many examples as can be found of multipliers used in comparable jurisdictions. Next, it is always wise to consult with experts who work in this field, for they can provide sound advice and help the novice (and even the experienced) to avoid pitfalls.
Finally, the analyst must choose the components of the multiplier carefully. For example, if the project includes manufacturing and warehousing activities in a new industrial park, applying an export-derived multiplier to employment (e.g. one that includes all base industries) would count the warehouse twice because it moves goods between industries.
Many economists have written about income and employment multipliers. The following examples give empirical values of the multipliers for various regions. Frequently, these studies have computed multipliers for a variety of sectors, but only a respresentative example appears in the tables. The references cited in the tables include some of the more important articles available in the economic journals. Unfortunately, many of the papers which estimate regional multipliers are difficult to acquire because they are the working papers of economic research organizations.
In order to explain the employment multiplier, it is necessary to understand the concept of the income multiplier. The income multiplier measures the change in local income that results from a change in local production stimulated by outside, independent demand:
Let Y denote local income, which is made up of the direct, indirect and induced effect. Indirect effects are the effects on other local industries of a one particular industry. Induced effects come through the spending of local households.
where the symbol Δ stands for change in a quantity and DD stands for direct demand.
The use of k as a symbol for the income multiplier may be puzzling to noneconomists. The k probably stands for the British economist John Maynard Keynes; y is often used to symbolize income because i represents other variables.
Suppose the local income multiplier is 1.5.
If the demand for electronics products increases by $32,000,000, then:
The value of k depends upon the increased demand generated per unit increase in local production. This ratio will be denoted as m. For example m might be 1/3 as used in the calculation below. This ratio measures the extent to which demand feeds back into the local economy. The value of m can be used to derive the value of ky
Thus if m=1/3 then ky = 1/(2/3) = 3/2 = 1.5.
For the U.S. economy, m is approximately 0.6. Therefore, the income multiplier for the U.S. is:
The increase in demand for local production for each increase in local production, m=(Δdemand for local production)/(Δlocal production), can be represented as the product of four factors:
|f1 =||(Δlocal incomes)|
|f2 =||(Δspending of residents)|
|f3 =||(Δlocal spending of residents)|
|(Δspending of residents)|
|f4 =||(Δdemand for local production)|
|(Δlocal spending of residents)|
The following combines an example drawn from information about San Francisco with an explanation of the ratio m. The first factor measures the change in income of local households that results from a change in local production:
Of the employees working in San Francisco, 60.2% live in the city according to the Journey to Work Survey of the U.S. Census. There is no readily available source of statistics on the proportion of property income in San Francisco that goes to residents. The owernship of business property by national corporations would tend to take property income out of San Francisco.
Purchasing power which gets diverted to residents of other regions or to state and federal government does not necessarily induce any spending in the local economy. Payments to local government, however, generally lead to spending in the local economy.
Nationwide, about two-thirds (.67) of any additional production becomes disposable income for households. The share of local income going to households in San Francisco is not very different from the national average - that is, 0.67. About one-fourth (.25) of additional income goes for taxes, while corporations retain one-twelf th (.083) as earnings. Although they are rough, the national ratios give an idea of relative magnitude.
The second factor determining m is the marginal propensity to spend:
Nationally, this figure stands at 90%. The ratio for San Francisco residents also is probably not much different.
The third factor determining m is the share of spending done in the local economy:
This may involve a sum of terms because of the way income is divided between residents and nonresidents and their spending habits.
For purposes of this example, the distribution of property income between residents and nonresidents is the same as the distrubiton of jobs: 60% to residents and 40% to nonresidents. If 60% of the income from San Francisco's economy goes to San Francisco residents who do 95% of their buying in San Francisco and 40% of the income goes to non-residents who do 30% of their spending in San Francisco, the increase in spending in San Francisco would be:
The final factor determining m is the change in demand for the local economy's products compared to the change in the demand for goods and services in the economy:
Consumers want various goods and services. The extent to which the local economy satisfies their wants depends on the diversity of the local economy. The precise ratio that is involved is the value added to the sales in the local economy. Value added may be created by producing goods locally or by wholesaling or retailing imported goods.
The share of local sales which is locally produced is difficult to establish. It may differ significantly for goods and services. Locally purchased services have to be locally produced. Locally purchased goods are, of course, not necessarily produced locally. According to the 1964 Census of Manufacturers, 42% of the value of sales in San Francisco derived from value added by the local manufacturing sector.
The final factor determining m is a weighted average of 100% local production figure for services and 42% local production figure for goods. The weights represent the share of services and goods in local spending. These shares are not available for San Francisco, but in 1972 for the U.S. as a whole, 38% of consumer purchases went for services. Using this share, the final factor is:
The value of m for San Francisco based upon the four factors previously computed is:
The values of m and ky for the U.S. economy, where consumers spend virtually all of their money for U.S. goods and services, are:
The difference between the multipliers for the U.S. and San Francisco economies is due solely to the dispersion of income out of the San Francisco economy and the lower share of local purchases accounted for by local production.
Economic studies often make use of the concept of the employment multiplier kE.
This quantity is defined as:
The employment multipler, kE may be derived from the income multipler, ky , through the folrolwing relationship:
The following tables give a few income and employment multipliers. Some of these come from studies that presented a variety of multipliers. These studies are listed at the end of the table.
Suppose a region has an income multiplier, ky , of 1.6, the ratio of the wage shares of industries serving the local market to the industry with directly generated employment (aI/aD) is 1.00 and the ratio of wage rates for direct jobs to induced jobs (WD/WI) is equal to 1.3.
The employment multiplier for this region will be:
Therefore, total employment from 100 new direct employment jobs would be 178, including induced employment of 78.
|Regional Income Multipliers|
|Utah||1947||1.81||Input-Output||Direct and Indirect Demand||Moore and|
|St. Louis||1955||2.16||Input-Output||Direct Demand||Hirsch3|
|Los Angeles||1959-1970||2.43||Econometric||Private Export||Hall and Licari4|
|Washington State||1963||3.07||Input-Output||Private Export||Bourqe5|
|Washington State||1963||2.75||Econometric||Private Export||Garnick6|
|Boulder, Colorado||1963||1.2||Input-Output||Speace Program|
|Regional Employment Multipliers|
|New York-Philadelphia||1947||2.14||Input-Output||Steel Employment||Isard and Kuenne1|
|Portsmouth, N.H.||1955-1964||1.80||Econometric||Private Export||Weiss and Gooding4|
|California||1960||2.76||Input-Output||Private Export||Hansen and Tiebout5|
|1960||2.13||Input-Output||Private Export||Hansen and Tiebout5|
|San Francisco-Oakland||1960||2.06||Input-Output||Private Export||Hansen and Tiebout5|
|Washington State||1966||2.749||Special||Basic Export||Garnick6|
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