Commissioned by Alabama Coalition for Capital …capcofacts.com/resources/AL-CAPCO-Study.pdffor the Alabama Coalition for Capital February 2007 by Center for Business and Economic

Commissioned by Alabama Coalition for Capital

February 2007

Center for Business and Economic Research Culverhouse College of Commerce and Business Administration

for the

Alabama Coalition for Capital

February 2007

by

Center for Business and Economic Research Culverhouse College of Commerce and Business Administration

The University of Alabama Box 870221, Tuscaloosa, AL 35487-0221

Tel: (205) 348-6191 Fax: (205) 348-2951

Samuel Addy, Ph.D. Ahmad Ijaz Director &Associate Research Economist Economic Analyst

Acknowledgments

Completion of this project was due to the timely contributions of many people. We are very grateful

to the officers and staff of the four certified private venture capital companies—Advantage Capital

Alabama Partners I, LP; Enhanced Alabama Issuer, LLC; Stonehenge Capital Fund Alabama, LLC; and

Waveland NCP Alabama Ventures—who directly provided us with key data or were involved in the

data gathering effort. Many thanks also to our colleagues and graduate research assistants at the

Center for Business and Economic Research for their help on various phases of this research project.

Contents

Executive Summary i

Introduction 1

Economic and Fiscal Impacts 4

Conclusions 7

Appendix 8 Methodology – Economic Impact Analysis 8

Economic Impacts of CAPCOs on Alabama UA/CBER i

Executive Summary

This report uses the economic and fiscal impacts of certified private venture capital companies (CAPCOs) on the State of Alabama to present an economic assessment of the Alabama CAPCO program to date. Specifically, the impacts of companies that CAPCOs have invested in (called portfolio companies) are estimated and used for the assessment.*

CAPCOs pool investment funds provided by insurance companies (called certified investors)

and provide these funds to qualified start-up or expansion-stage portfolio companies with significant growth potential. Certified investors claim a credit against their state insurance premium liability equal to the amount of the investment over a period of eight years (beginning in the second calendar year after the investment year) at a rate that does not exceed 12.5 percent of the earned credit in any taxable year.

Beginning in 2004, a total of $37.2 million had been invested in portfolio companies by the

end of 2006. Portfolio companies’ employment rose from about 250 to nearly 1,200, with combined payroll rising from $15.2 million to $56.6 million. Most portfolio companies belong to the high-wage professional, scientific, and technical services industry.

The economic and fiscal impacts of Alabama CAPCO portfolio companies on the state have

been growing at a very fast rate. Statewide 2004 economic impacts were 563 direct and indirect jobs, $26.7 million in earnings to Alabama households, and $78.3 million in output. Output refers to contributions to the gross state product (GSP), the value of goods and services on a value-added basis. In 2005 the impacts rose to 2,048 jobs, $56.8 million in earnings, and $175.6 million in output. The impacts reached 3,284 jobs, $107.2 million in earnings, and $336.1 million in output in 2006. Fiscal impacts totaled $2.2 million for 2004, with $1.5 million going to the state, and were $4.8 million ($3.2 million for the state) and $9.1 million ($6.1 million to state coffers), respectively, for 2005 and 2006.

The impacts presented in this report are conservative because data on 75 percent of the total

allocations to CAPCOs was used. Also, other taxes and fees (e.g., utility taxes, car tags and fees, and other personal property taxes) were not included.

The fiscal impacts of the CAPCO portfolio companies on the state show that from 2004 to

2006, the Alabama CAPCO program resulted in a cumulative net revenue inflow of $3.7 million. It is likely that the state CAPCO program will never yield negative cumulative net revenue from a complete statewide perspective (i.e., when both state and local tax receipts are considered). If state only tax receipts are considered, there will be a few years when cumulative revenue turns negative as certified investors claim credits, but cumulative revenue will turn positive and grow because of future revenue inflows that continue to grow long after the credits have been claimed.

* The Regional Input-Output software, RIMS II, developed by the U.S. Department of Commerce’s Bureau of Economic

Analysis, is used to estimate the impacts.

Economic Impacts of CAPCOs on Alabama UA/CBER 1

Economic Impacts of CAPCOs on Alabama

Introduction

This report presents the economic and fiscal impacts of certified private venture capital companies

(CAPCOs) on the State of Alabama. CAPCOs pool investment funds provided by insurance

companies (certified investors) and provide these funds to qualified start-up or expansion-stage

companies (called portfolio companies) with significant growth potential. For their contribution to

CAPCOs, certified investors get to claim a credit against their state insurance premium liability equal

to the amount of the investment. This credit is claimed over a period of eight years (beginning in the

second calendar year after the investment year) at a rate that does not exceed 12.5 percent of the

earned credit in any taxable year.

By funding their portfolio companies, CAPCOs spur business development and consequently create

jobs and generate tax revenues. The insurance premium tax credit may be considered as an investment

by the state that will yield revenue inflows in later years. Spreading the credit over eight years reduces

the cost of the CAPCO program for the state; for example, a $100 million program actually costs

$77.8 million at a 4 percent discount rate or $73.3 million at 5 percent. CAPCO investment in

portfolio companies leverages non-CAPCO investment in these companies that are attracted to the

growth potential. In essence, CAPCOs do the ground work for non-CAPCO investors by identifying

prime investment opportunities. In this way, CAPCOs encourage and raise the level of investment in

the state for small to medium size businesses and contribute to development in general. CAPCOs can

therefore be considered an economic development tool.

Some of the funds managed by CAPCOs are invested into low-risk securities such as Treasury Notes to

minimize risk for the certified investors. CAPCOs often have to guarantee the certified investors a

fixed rate of return. CAPCOs receive an annual management fee to cover costs. They typically do not

earn profits until their investments or portfolio companies mature and have a liquidity event. For

instance, one of the portfolio companies, Emageon, received CAPCO funds in 2004 and went public

in 2005. Proceeds from such events are put back into the venture fund and recycled.

Table 1 shows some information about Alabama CAPCOs and their portfolio companies. The four

CAPCOs that provided data for this study are listed together with 20 companies they have invested in

to date and the industries to which these portfolio companies belong. Knowing the industries that

portfolio companies belong to is essential in determining their economic and fiscal impacts. The four

CAPCOs began investing in portfolio companies in 2004 and by the end of 2006 had invested $37.2

million. Portfolio companies’ employment has risen from about 250 in 2004 to nearly 1,200 in 2006.


Table 1. Alabama CAPCOs and Their Portfolio Companies CAPCOs Advantage Capital Alabama Partners, LP Enhanced Alabama Issuer, LLC Stonehenge Capital Fund Alabama, LLC Waveland NCP Alabama Ventures Portfolio Company Industry Actek Professional, scientific, and technical services American Rotor Company, LLC Electrical equipment and appliance manufacturing Atherotech Professional, scientific, and technical services Awarix, Inc. Professional, scientific, and technical services Bridgeville Trailers, Inc. Motor vehicles, body, trailer, and parts manufacturingComlet Technologies, LLC Professional, scientific, and technical services DailyAccess Corporation Professional, scientific, and technical services Digium Professional, scientific, and technical services Emageon Professional, scientific, and technical services Hospiscript Services, LLC Professional, scientific, and technical services Lexim Mortgage Real Estate Mobile Storage, LLC Professional, scientific, and technical services ProSoft, Inc. Professional, scientific, and technical services Proxsys Professional, scientific, and technical services Rx Advantage, Inc. Professional, scientific, and technical services Source Medical Professional, scientific, and technical services Southeastern Plateworks Fabricated metal product manufacturing Southern Cable Services, LLC Professional, scientific, and technical services Valley Rubber Plastics and rubber products manufacturing WPL Group (a.k.a. Wedding Points) Professional, scientific, and technical services Total investment in portfolio companies through 2006 = $37,248,666 2004 2005 2006Employment by portfolio companies 251 693 1,197 Payroll of portfolio companies $15,214,458 $30,367,376 $56,550,710Average earnings per employee $60,615 $43,820 $47,244

Note: Payroll expenditures cover just salaries and wages, not benefits. The information in this table accounts for 89 percent of investment allocations to CAPCOs.

Source: Advantage Capital Alabama Partners, LP; Enhanced Alabama Issuer, LLC; Stonehenge Capital Fund Alabama, LLC; Waveland NCP Alabama Ventures; U.S. Department of Commerce, Bureau of Economic Analysis; Labor Market Information Division, Alabama Department of Industrial Relations; and Center for Business and Economic Research, The University of Alabama.


Combined payroll for the portfolio companies was determined using company-provided salary data

together with average industry salary data from federal and state government sources. For companies

where average employee salaries were not provided, the federal and state average industry wages and

salaries were used. A 4 percent annual wage increase was assumed for 2005 and 2006 if wage and salary

data were provided only for prior years. The companies’ combined payroll rose from $15.2 million in

2004, through $30.4 million in 2005, to $56.6 million in 2006. Average employee earnings fell from

$60,615 in 2004 to $43,820 in 2005, and then rose to $47,244 in 2006. Most of the portfolio

companies belong to the high-wage professional, scientific, and technical services industry.

Spending by portfolio company workers and the companies themselves provides jobs and stimulates

business activity in various sectors of the Alabama economy. The cash infusions have impacts on state

output and generate earnings and employment beyond those of the companies. Output refers to the

gross product (the value of goods and services) on a value-added basis for the region of focus, the State

of Alabama in this case. The spending also generates significant taxes for the state and other taxing

jurisdictions.

To assess how Alabama CAPCOs have performed to date, this study estimated the economic and fiscal

impacts of CAPCO portfolio companies on the state for calendar years 2004 through 2006. The

economic impacts focused on output, earnings, and employment. The fiscal impacts presented

comprise income, sales, and property taxes derived from the earnings impacts. The impacts indicate

the influence that the CAPCO portfolio companies have on the state economy.

It is important to note the impacts presented only cover 75 percent of the total allocations given to all

the CAPCOs. Data for the remaining allocation had not been received at the time of the analysis.

Thus, the impact of CAPCOs on the state that is presented here is conservative. The economic and

fiscal impacts are presented first and are followed by a revenue flow analysis. The impact methodology

is detailed in the Appendix.


Economic and Fiscal Impacts

To calculate the total economic and fiscal impacts, we focus first on household impacts, which deals

with the economic and fiscal impacts of the spending behavior of CAPCO portfolio company workers

and determine employment and earnings impacts. Direct effect multipliers are used to estimate the

household impacts. Final demand multipliers are then used to derive output impacts, which involve

spending by both the companies and their workers. Fiscal impacts are derived from the earnings

impacts. The Regional Input-Output software, RIMS II, developed by the U.S. Department of

Commerce’s Bureau of Economic Analysis, is used to estimate the impacts. RIMS II multipliers for

the six industries the portfolio companies belong to are used to determine the impacts.

The economic and fiscal impacts on Alabama are shown in Table 2. The 2004 statewide economic

impacts were 563 direct and indirect jobs, $26.7 million in earnings to Alabama households, and $78.3

million in output (0.06 percent of the $141.4 billion Alabama GSP). In 2005 the impacts rose to 2,048

jobs, $56.8 million in earnings, and $175.6 million in output (0.12 percent of Alabama GSP). The

impacts grew again in 2006 as CAPCOs increased investment in more portfolio companies to 3,284

jobs, $107.2 million in earnings, and $336.1 million in output.

The earnings impacts generate tax revenues. Not all of the earnings impact is taxable; expenditures on

sales taxable items constitute 42.4 percent of total household earnings and state taxable income is

about 80 percent of earnings. The state income tax rate is 5.0 percent on net income. The first $500

and next $2,500 are taxed at 2.0 percent and 4.0 percent, respectively, for single persons, head of

family, and married persons filing separately. For married persons filing joint returns the first $1,000

and the next $5,000 are taxed at 2.0 percent and 4.0 percent, respectively. Excess net income is taxed

at the 5.0 percent rate. Corporations pay at a 6.5 percent rate. Sales tax rates used are 4.0 percent for

the state and 5.0 percent for local (combined county and city) jurisdictions. Local sales tax rates vary

among Alabama counties, but are most frequently at

5.0 percent.

State and local property taxes for the counties are estimated using millage rates derived from data

published by the Alabama Department of Revenue (ADOR) and from average home values for specific

income ranges from the U.S. Bureau of the Census. The statewide home property tax rate is 6.5 mills

(0.65 percent), and the effective average local property tax rate is 41.0 mills. U.S. Census Bureau data

on housing tenure by income of householder provide home ownership rates and values. For example,

85.7 percent of households in the $50,000-74,999 income range are homeowners and the 2000 average

home value was $117,400. To get current home values, an annual net appreciation rate of 3.0 percent

was applied to the year 2000 census home values.


Table 2. Alabama CAPCO Portfolio Companies’ Economic and Fiscal Impacts on the State

ECONOMIC IMPACTS 2004 2005 2006Direct employment (Jobs) 251 693 1,197 Indirect employment (Jobs) 312 1,355 2,087 Employment Impact (Jobs) 563 2,048 3,284 Direct earnings (wages and salaries) $15,214,458 $30,367,376 $56,550,710Indirect earnings (wages and salaries) $11,469,354 $26,476,520 $50,655,824Earnings Impact $26,683,812 $56,843,896 $107,206,535 Output Impact $78,346,144 $175,560,220 $336,130,737Alabama GSP (Millions) $141,366 $151,610 Share of Alabama GSP 0.06% 0.12%

FISCAL IMPACTS 2004 2005 2006State income tax $1,053,467 $2,244,176 $4,232,474State sales tax $429,930 $915,869 $1,727,312State property tax $30,092 $72,855 $136,792State tax total $1,513,489 $3,232,899 $6,096,577 Local (county and city) sales tax $537,412 $1,144,836 $2,159,140Local (county and city) property tax $189,593 $459,013 $861,839Local tax total $727,005 $1,603,849 $3,020,978 Total state and local tax receipts $2,240,493 $4,836,749 $9,117,555

Note: Rounding errors may be present.

Source: U.S. Department of Commerce, Bureau of Economic Analysis; Alabama Department of Revenue; and Center for Business and Economic Research, The University of Alabama.

Fiscal impacts for 2004 totaled $2.2 million with $1.5 million going to the state. Similarly, 2005 and

2006 fiscal impacts were $4.8 million ($3.2 million for the state) and $9.1 million ($6.1 million to state

coffers), respectively. CAPCO income and sales taxes make up the major part of tax receipts generated

by the portfolio companies. Local jurisdictions generally receive about half of what the state receives.

It is important to note that the fiscal impacts reported here are conservative because other taxes and

fees (e.g., utility taxes, car tags and fees, and other personal property taxes) were not included in these

estimates.

Clearly, tax revenues generated by CAPCOs portfolio companies’ activity are growing at a fast rate.

Assuming the same efficiency in investment and return, tax revenues generated should exceed the

insurance premium capital credit claims. For example, a doubling of the investment in portfolio


companies under this assumption would result in about $12.2 million in state tax receipts and $6.0

million local tax receipts annually.

Table 3 shows revenue flows related to CAPCO activity. The insurance premium tax credit is first

being claimed in 2006. The $12.5 million credit claimed suggests that the Alabama CAPCO program

must be at least $100 million. Considering state only tax receipts, the program has resulted in a

cumulative net revenue outflow of $1.7 million through 2006. As noted earlier, revenue outflows are

expected in the early years of the program as certified investors claim credits, but they will be offset by

revenue inflows that continue and grow long after the credits have been claimed.

Table 3. CAPCO Activity Revenue Flows

2004 2005 2006Receipts State only tax receipts $1,513,489 $3,232,899 $6,096,577 Local (county and city) tax receipts $727,005 $1,603,849 $3,020,978 Total state and local tax receipts $2,240,493 $4,836,749 $9,117,555 Credits Claimed Premium Tax Credit Claimed $12,500,000 Net Fiscal Position (State only receipts) $1,513,489 $3,232,899 ($6,403,423)Cumulative Flows (State only receipts) $1,513,489 $4,746,388 ($1,657,035)Net Fiscal Position (State and local receipts) $2,240,493 $4,836,749 ($3,382,445)Cumulative Flows (State and local receipts) $2,240,493 $7,077,242 $3,694,798

Note: Rounding errors may be present.

Source: U.S. Department of Commerce, Bureau of Economic Analysis; Alabama Department of Revenue; and Center for Business and Economic Research, The University of Alabama.

Using state only tax receipts paints an incomplete picture in assessing such a program. Because taxes

are used to provide services statewide, it is necessary to take a statewide perspective in the program

assessment and include the local fiscal impacts of CAPCO portfolio companies as well. Table 3 shows

a cumulative net revenue inflow of $3.7 million through 2006. A 38 percent or $14 million increase in

CAPCO investment will generate enough state and local tax receipts to offset the $12.5 million annual

tax credits claimed, if the same investment efficiency and portfolio company performance is achieved.

If this target is achieved by 2008, it is possible that the state CAPCO program will never result in

negative cumulative net revenue.


Conclusions

The economic and fiscal impacts of Alabama CAPCO portfolio companies on the state have been

growing at a very fast rate. Their 2004 statewide economic impacts were 563 direct and indirect jobs,

$26.7 million in earnings to Alabama households, and $78.3 million in output. In 2005 the impacts

rose to 2,048 jobs, $56.8 million in earnings, and $175.6 million in output. As CAPCOs increased

investment in more portfolio companies, the impacts grew again to 3,284 jobs, $107.2 million in

earnings, and $336.1 million in output for 2006. These economic impacts were accompanied by fiscal

impacts totaling $2.2 million for 2004, with $1.5 million going to the state. Fiscal impacts for 2005

and 2006 were $4.8 million ($3.2 million for the state) and $9.1 million ($6.1 million to state coffers),

respectively.

The impacts presented in this report are conservative because data on 75 percent of the total

allocations to CAPCOs was used. Also, other taxes and fees (e.g., utility taxes, car tags and fees, and

other personal property taxes) were not included. The Input-Output (I-O) modeling framework used

to estimate the impacts was the Regional Input-Output Modeling System (RIMS II) software developed

by the U.S. Department of Commerce, Bureau of Economic Analysis. This technique traces

interindustry transactions in the economy represented as matrices that show all the inputs used and

purchases made by a specific industry from all other industries, thereby enabling tracking of

expenditure effects for any industry. The multipliers generated by the I-O technique are for industries,

not firms, and are larger the more value addition involved in the industry or firm’s product or service.

This evaluation of the Alabama CAPCO program shows that from 2004 to 2006 the program has

resulted in a cumulative net revenue inflow of $3.7 million. The CAPCOs have invested in companies

that provide skilled and high-paying jobs and generate business for their suppliers as well as significant

taxes for state and local jurisdictions. It is likely that the state CAPCO program will never yield

negative cumulative net revenue.


APPENDIX

Methodology - Economic Impact Analysis

Economic impact analysis measures the effects of a specific economic activity or event on a specified

geographic area. Examples include the economic impact on a state or county of a proposed industrial

plant, an existing industry, or closing a military installation. In some cases, federal laws, as well as state

and local regulations, require economic impact studies prior to the implementation of a particular

policy (relocation of an economic activity, changes in zoning ordinance, etc.). No matter what the

justification, impact studies are designed to provide information for instituting policies to facilitate

positive economic impacts and/or mitigate potential negative impacts. Economic impact analysis is

therefore an important tool that can enhance the quality of decisions made, as well as the decision

making process in both public and private sectors.

The analysis typically focuses on one or more of the major economic indicators: output, employment,

and income. The purpose of an impact study usually determines which socioeconomic variable(s)

should be monitored. In this study, the primary focus is on all three major indicators and the

consequent changes in tax revenues: income, sales, and property taxes.

Economic impacts comprise direct and indirect types. Direct impacts are those that are most obvious

and include the wages and salaries of the employees who work directly for a firm or industry, as well as

all other expenditures of the firm or industry, including taxes and distributed profits. Indirect

economic impacts, often referred to as the “ripple” or “multiplier” effects, occur because of the

additional demands arising from new income and expenditures for inputs and products related to the

activity under study. New income creates demand for consumer products and services and their

associated indirect impacts are often called induced impacts. Indirect and induced impacts may spark

demand for more output of the firm or industry under study. For example, CAPCO portfolio

companies create an indirect impact on multiple industries (e.g. health care and wholesale and retail

industries) through purchases of supplies and spending by their employees. These industries can then

turn around and require more services and products from the CAPCO portfolio companies. The total

economic impacts of the entity being studied are the combined direct, indirect, and induced impacts.

The ratio of the total economic impact to the direct impact is the multiplier that can be used to

summarize the economic effects of the organization on the region(s) or area(s) of focus, the State of

Alabama in this study.

Economic relationships do not obey strict geographic boundaries; workers and their incomes and

industry purchases flow across these boundaries enabled by transportation and communication. Thus


a portion of the indirect effects of purchases or expenditures may occur beyond the boundaries of the

specified region. Such occurrences are called leakages, as opposed to linkages (supplier-purchaser

relationships) within the region. In general a small geographic area will have a small absolute economic

impact due to a high likelihood of leakage. A large region will have a larger absolute economic impact,

but a smaller relative economic impact of an individual firm or industry on that area. The closure of

one plant within a state, for example, may have only a small relative impact even if the plant employs

thousands of workers; the absolute impact could be very large. The important point is that the effect

or size of the economic impact is influenced by the size of the study area. If the area is too broadly

defined, the relative impact will be small. If narrowly defined, the relative impact will be large.

Determining the Multiplier Several methodological approaches are used in estimating economic impacts. These include the

construction of econometric, economic base, computable general equilibrium (CGE), and input-

output (I-O) models. Econometric and CGE models can be very costly and time-consuming to build.

Economic base models require a very detailed set of information that is sometimes not available. The

other methodological approaches generate slightly smaller multipliers than I-O models because of

assumptions on factors such as input substitution and optimization behavior by economic agents.

The I-O modeling framework is used in this study. The technique generates multipliers for the

economic activity of interest by focusing on economic interactions among all industries and all other

economic transactions in the specified region. Interindustry relationships exist in both a backward

direction (suppliers and other upstream linkages and leakages), and a forward direction (distributors,

retailers, customers, and other downstream linkages and leakages). The number and strength of these

backward and forward linkages and leakages determines the multiplier effects of the industry. In

general, products that require a small number of inputs and little additional processing (little value

addition) will have smaller multiplier effects than complex products that require lots of inputs and

extensive processing.

The three main types of multipliers–output, income or earnings, and employment–are defined as

follows. Output multipliers represent the total dollar change in all industries that results from a $1

change in output delivered to final demand (final consumption) by the industry under study. Earnings

multipliers represent the total dollar change in earnings of households employed by all industries for

each dollar of payroll expenditure or each dollar of output delivered to final demand by the industry

whose economic impact is being estimated. Employment multipliers represent the total change in the

number of jobs in all industries for each direct job or for each million dollars of output delivered to

final demand by the industry whose economic impact is being estimated.


The nature of the product and technology largely determine the degree of interindustry linkages and

leakages (and thus the overall impact), and the specific impact on a region depends upon the degree to

which these interindustry relationships are localized. Technology determines inputs and economics

determines the geographic source of supply. Inputs purchased outside the economic impact study area

constitute a leakage of potential impact. Leakage represents activities of local firms that have no

economic impact on the local economy; it provides opportunities for “localizing” such impact.

Identifying leakage can provide valuable planning information to local economic development

authorities for commercial or industrial development. An activity’s maximum impact on a specific

area is obtained when all interindustry linkages occur within the area. A systemwide view is required

because different firms have different linkages. The I-O technique permits the incorporation of such

systemwide perspectives.

To estimate the economic impact of CAPCO portfolio companies on the Alabama economy, linkages

between them or the industries they belong to and the rest of the state economy must be traced. This

task is greatly facilitated by the Regional Input-Output Modeling System (RIMS II), an input-output

model developed and maintained by the U.S. Department of Commerce’s Bureau of Economic

Analysis. The model is available for every state in the nation and also for many counties. This study

uses RIMS II for Alabama. As part of the analysis, another I-O software package called IMPLAN is

used to check the RIMS II multipliers.

The RIMS II I-O model consists of nearly 500 industries. Data on each industry reflects the value of

inputs used per dollar of output in the production of that industry’s output. For example, data for the

professional, scientific, and technical services industry show the value of each input per dollar of

service provided. Since the rows (outputs) are produced by specific industries, they are also columns

(inputs). Demand for a particular input will cause supply from the industry that produces it. This

then creates demand for the inputs that are used to produce the particular product, and so on; the

round-by-round impacts converge. The I-O model captures the total effect of these rounds of

spending as the multiplier effect. RIMS II multipliers for an economy account for all linkages within

and leakages from that economy. I-O models are based on a table of transaction balances, which

ensures economy-wide accounting consistency. Total payments equal total receipts for each sector.

Aggregate final demand equals aggregate value added.

Multipliers are determined mathematically from I-O tables that are constructed from observed and

reported data for the economic area of interest. The economy is divided into a number of producing

industries or sectors that sell and purchase goods and services to and from each other (interindustry or

intersectoral flows). These interindustry flows are key data. Sector goods and services are purchased by

domestic consumers (households), international customers (exports), governments (federal, state, and


local), and for private investment purposes. These external to production purchases are for direct use

and termed final demand. Assume an economy with n sectors and let Xi represent total output for

sector i, Yi represent final demand for sector i products, zij represent interindustry flows. Then for each

sector we can write

YzX i

n

jiji += ∑

=1 (1)

If we let aij represent the I-O technical coefficients where aij = zij / Xj so that sectors use inputs in fixed

proportions (the constant returns to scale Leontief production function) then the above equation

becomes

YXaX ii

n

iiji += ∑

=1 (2)

The standard formulation of the basic I-O model and its application, in matrix notation is:

Transactions balance: X = AX + Y (3)

Solving for X: X = (I - A)-1Y (4)

For a change in Y: ∆X = (I - A)-1∆Y (5)

where X is the gross output column vector, A is the matrix of fixed I-O coefficients, Y is the final

demand column vector, and I is the identity matrix. With this basic model, the resulting output is

computed given changes in final demand levels (consumption, investment, government, or exports).

The Leontief inverse, (I - A)-1, is the source of multipliers for determining impacts in the I-O

methodology. The elements of the matrix are really very useful and important. Each captures in a

single number an entire series of direct and indirect effects. Gross output requirements are translatable

into employment coefficients in a diagonal matrix that is used together with the Leontief inverse to

generate employment impacts. Similar manipulations generate income or earnings multipliers.

Documents

Commissioned by Alabama Coalition for Capital …capcofacts.com/resources/AL-CAPCO-Study.pdffor the Alabama Coalition for Capital February 2007 by Center for Business and Economic