“How can $1 of spending support more than $1 in the local economy?”

We get questions like this about economic impact analyses all the time. The answer is very straightforward. The results of an input-output (I-O) analysis are broken down into direct, indirect, and induced effects. The combination of these overarching economic effects often total greater than the initial economic input. Each level of effects captures a different portion of the complete economic portrait. In order to understand the totality of an impact, you must conceptualize how each value is defined and what they represent.  

What are the Types of Economic Effects?

Direct Effects

Direct effects are the set of expenditures applied to the I-O multipliers for an impact analysis. It is one or more production changes or expenditures made by producers/consumers as a result of an activity or policy. Direct effects can be positive or negative.

These initial changes are determined by an analyst and demonstrate the result of an activity or policy being analyzed. Applying these initial changes to the multipliers in IMPLAN will then display how a region will respond economically to them.

Indirect Effects

Indirect effects are the business to business purchases in the supply chain taking place in the region that stem from the initial industry input purchases. As the industry specified spends their money in the region with their suppliers, this spending is shown through the indirect effect. 

Induced Effects

Induced effects are the values stemming from household spending of Labor Income, after removal of taxes, savings, and commuter income. The induced effects are generated by the spending of the employees within the business’ supply chain.

How Do You Interpret Economic Effects? 

Each type of effect relates to economic indicators differently. The size of each value and what it is representative of is determined by the type of analysis run. A base knowledge of interpreting what the direct, indirect, and induced effects demonstrate is crucial to understanding the outcomes of any economic impact study. 

The easiest way to illustrate this is through an Industry Output Event example. For this example, let’s take a look at the results of an analysis of $1.5M in output for a distillery (IMPLAN Industry 108) in North Carolina.

North Carolina Distillery Impact

Employment

A total of 4.3 jobs is supported by the $1.5M of output by this distillery. This total job number is a combination of direct, indirect, and induced effects. Each level represents something a little bit different.

Direct Employment

The 0.95 direct employment shows that with $1.5M in direct output, almost 1 job is supported within the distillery. Jobs are an annual average of employment that accounts for full-time, part-time, and seasonal employment. This figure is the direct number of job years associated with the output.  

Indirect Employment

In order to operate a distillery, you need to buy supplies like corn and yeast. Since some of these intermediate inputs are made within the region, the distillery’s spending supports 1.19 jobs amongst suppliers within the supply chain. This figure represents the number of jobs that are supported by the business to business transactions in the scenario.

Induced Employment

The employees of both the distillery and their suppliers earn wages for their work, and spend much of their take-home pay locally on things like groceries, housing, and utilities. This spending supports 2.16 jobs in industries like real estate, health care, and food service. This figure represents the number of jobs supported by the household spending generated by the business’ activity. 

Labor Income

There is a total of $471,346.76 in labor income that is supported by the distilleries output. Labor income represents the total value of all forms of employment income and encompasses employee compensation and proprietor income.

Direct Labor Income

The direct labor income generated by the distillery is $292,511.77, and this includes wages, benefits, and payroll taxes. The direct labor income is fairly large for a single employee, but it does also include proprietor income. 

Indirect Labor Income

The distillery’s activity supports $83,289.03 worth of indirect labor income for the employees of suppliers to the distillery. This figure represents the amount of compensation that is supported by the business to business transactions from the distillery to other connected businesses.

Induced Labor Income

The employees of both the distillery and their suppliers take their wages and spend them on their own household needs. This spending supports $95,545.96 of labor income for employees in industries including grocery stores, health care, etc. This figure represents the employee compensation and proprietor income that comes from the household spending of the employees connected to the business and supply chain. 

Value Added

In this study, the distillery’s activity generates a total of $1,354,482.62 value added to the state’s economy, which is then broken down into the aforementioned levels. Value added is the difference between an industry's or establishment's total output and the cost of its intermediate inputs. It is a measure of the contribution to GDP. This measure encompasses Labor Income, Other Property Income (OPI), and Taxes on Production and Imports (TOPI).

Direct Value Added

Value added is akin to Gross Domestic Product (GDP). The distillery’s operations generate $1,047,588.95 in direct value added. Remember, this includes the $292,511.77 in Labor Income, plus TOPI plus OPI.

Indirect Value Added

Through the business-to-business transactions, the company contributes $131,416.71 to value added. Again, this includes the $83,289.03 in indirect Labor Income plus TOPI, plus OPI. This is the specific value added that is generated by business to business transactions as a result of the economic activity generated by the distillery.

Induced Value Added

Because of the spending of employees working at the distillery and the supply chain companies, $175,476.96 of value added is supported. This includes the $95,545.96 of induced Labor Income, plus TOPI, plus OPI. This is the specific value added that is generated from household spending as a result of the business’ activity.

Output

The total output generated by the distillery’s direct $1.5M output is $2,048,930.87. Output is the total value of a business’ production and is the measure of the value added plus intermediate expenditures. Output is the basis for all calculations within IMPLAN. For Industries that do not hold inventory, output equals revenues (sales). For Industries that do hold inventory, output equals revenues less any net change in inventory (additions to inventory less sales out of inventory).

Direct Output

The direct output was the starting point for this analysis. To arrive at the $1.5M output value, you need to calculate the output of an industry. A distillery could hold inventory, however for the purposes of this example, we assumed that all the products produced by the distillery were produced within the year and sold within the year. With this being the case, the $1.5M direct output is equivalent to the revenue for our business for the year.

Indirect Output

Because of the business to business transactions resulting from local input purchases by the distillery, $244,801.18 in output is supported. Indirect output represents all of the output generated because of the direct business to business spending. This figure includes the $131,416.71 in indirect value added; and that value added then includes the $83,289.03 in indirect labor income.  

Induced Output

Finally, $304,129.70 of induced output is supported when the employees working at the distillery and their suppliers (and the suppliers of their suppliers) spend their money throughout the economy. Induced output is the total value that all industries take in as a result of household spending. This figure includes the $175,476.96 in induced value added; and that value added then includes the $95,545.96 in induced labor income. 

The Takeaway

The impact of any activity within the economy has wide-ranging effects. The activity from any business creates ripples across multiple industries, engages supplier businesses, and generates household spending. Understanding how to interpret each type of effect demonstrated by an IMPLAN economic impact study ensures that you are able to present a complete economic portrait.

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