Local & Regional Economics Regional and Local Economics (RALE) 2010 – Lecture 2a 1 Lecture 2a Multipliers & output models

Local & Regional Economics

Regional and Local Economics (RALE) 2010 – Lecture 2a

1

Lecture 2a Multipliers & output models



2

RALE - Lecture 2aLast week: Introduction and profiling the local economy

This week: part a) Multipliers & output models

and part b) econometric models & input-output analysis

Aim To understand how all or some of the economic activity in

a local economy is measured.

Objective To be able to understand the multiplier concept To be familiar with applications of multiplier analysis, its

strengths and weaknesses To be aware of more sophisticated models of income

determination



3

The Multiplier Concept Based on the idea that the CUMULATIVE EFFECT of an injection is greater than the INITIAL IMPACT. There are 4 Main effects when a new business starts up

3. Induced effect –via the household spending locally by staff of the new plant

3

2. Indirect effect - via goods &

services directly purchased by the new company

Buys goods & services from

other companies

2

New Business starts up

1. Direct effect - Jobs & output from the new plant

Pays wages to staff

1

4. Feedback loop - as companies in the supply chain to the new business and recipients of household expenditures restock and take on more staff

4



4

Export base multiplier Very simplistic early model, domestic sector assumed to service the export sector

T = X + D D = dX where d is a positive constant fraction T = X + dX or T = (1+d)X 1+d is the multiplier and gives a figure greater than 1 If exports increase by 2 then T output change = 2+(0.25*2) = 2.5

Basic (Exporting) 8

Non-basic

Domestic 2

Multiplier 1.25

Problems – Does not include external non-export income (wages from abroad) Sectors are not homogeneous (Production methods are different) Trying to define what is “export” & what is “domestic” production Increased output can be met in a variety of ways. (>productivity)



5

Keynesian Income Expenditure approachBased on national income/expenditure accounting framework

Y = C + I0 + G0 + X0- M (Income, consumption and imports are regionally determined)

C = C0 + cDY (Consumption partially dependent on regional disposable income)

M = M0 + mDY (Imports dependent on regional disposable income & prop to import)

DY = Y – tY (Regional disposable income determined by the regional tax rate)

Y = k(C0+I0+G0+X0-M0) mct

k

11

1

The most important feature of the model is the marginal propensity to consume locally produced goods (c-m)

Problems – Size of region – Industry Mix - Location

See Armstrong and Taylor (2000) pp 8- 15



6

Multiplier process an exampleNaval Base and

Operational Staff

6,100 jobs

B+C

Portsmouth Based Ships 7,300 crew

B+C

Visiting Warships

18,500 crew

B

Other Training Bases inc. Flagship

6,850 jobs

A+B+C

Base Prime & Day Contractors 3,550 jobs

A+B+C

Base Heritage Area250 jobs + 335,000

visitors

A+B+C

APurchases from local

defence industrial base & other suppliers

£70.0m

BVisitor & tourist spending

in the local economy£40.9m

CWages spent as household purchases in the local area

£215.7m

LeakagesMainly household purchases

out of the local area +

expenditure taxes

£110.5m

+ £178m Multiplier effect from Local Economy Forecasting Model

£326m - Expenditure into local economy

MoD Support Agencies

2,350 jobs

A+B+C

Maritime Defence Inner Core Maritime Defence Outer Core

Local Expenditures net of Tax & NI

£437.1m

Source CLREA 2005

1. The Portsmouth Naval Base directly employs in excess of 26,000 people, (70% live within 20 miles of the base).

2. The value to the local economy is around £500million p.a. and supports 38,000 jobs overall.

3. The additional multiplier impact is 12,000 additional jobs

Output multiplier of

1.54



7

The multiplicand Importance of 1st round

leakages - may be large Examples: Dounreay and

Torness + Portsmouth NB

Y

t c m gC I G X M

1

1 1 0 0 0 0 0

Use of Keynesian Model – Archibald (FES) Bleaney (examined different groups mpc) Extending the basic model making allowance for transfer payments

Initial injectionincreasing expenditure

into the region

Governm ent Subsidies on

additional Expenditure

Leakage 1.Im ports into regiontaxes on additional

expenditure

Increase in gross regional product (GRP): Wages, salaries,

profits, rent, interest & dividends

Leakage 2.Taxes on additional

incom e, national insurance contributions, retained

earnings of firm s, loss ofunem ployment benefit

(from increased em ploym ent)

Indirect & inducedexpenditure in the

region

Increase in regionaldisposable incom e (RDI)

Adapted from Armstrong and Taylor (2000) pp 14



8

Sinclair and Sutcliff (1984) effects of tourist expenditure in Malaga (Spain).

Armstrong (1988) multipliers resulting from local economic development initiatives for different companies in local authority areas.

Work by Luger and Goldstein (1996) the forward and backward linkages of Universities.

University

Hum an capitalGraduates

Skill level of local workforceNew firm form ation

KnowledgeR&D

Joint ventures

Attractiveness of local econom yInward m igration of capital

Inward m igration of labour (skilled)

Local householdsIncrease in household

Incom e & spending

Local Governm entServices & revenues

Im proved revenue baseAdditional dem and

Congestion problem s

Local businessDem and for servicesDisplacem ent effects

Inputs backw ard linkages (short-run multiplier effects

Outputs forward linkages (long-run effects on econom ic developm ent of region)

Applications of regional multiplier analysis




9

Strengths & Weakness of Regional Multiplier AnalysisStrengths They demonstrate that injections are a process rather than an

event They identify the linkages between sectors

Weaknesses They do not take capacity constraints into account They fail to allow for interregional feedback effects Time is assumed discrete rather than continuous. They provide a very aggregated picture of the impact of

expenditure injections The ability of the indigenous firms to supply inputs to

expanding firms The role of money



10

A simple multi-regional model of income determination

Weakness of single-region model - it does not account for interregional feedback.

One region's imports are another's exports - therefore income changes are transmitted inter-regionally.

Model features Two regions (north and south) no supply constraints, output determined by demand for

products and services. Level of output dependant - demand own region, export

demand and change in (Y) of other region).

snyy ns

yy



11

ys

yn

snyy

a

sy

ny*

Two region model with BT function

sy*

nsyy

ny

A

0BT

ny

sy

ny

B

C



12

Consequence of prolonged regional BoT Deficit Although flows of goods and payments are not recorded,

they exist and this has severe effects in the real economy.

If region has a persistent BOT deficit this must be paid for by one or a combination of the following:

Net income transfer into the region by Govt. Residents running down savings. Borrowing from the banking system Selling assets to residents in other regions Long or short-term inward investment to reduce

dependence on imports



13

Assumptions Positive response to

external shocks. Labour supply elastic

at current wage rates. Spare capacity - output

increased without increasing price

Regions are price takers (wages are set nationally)

Supply of output

Regional employment

Demand for region’s output

World income Other regions

Weakness of the model it Ignores the fact that an increase in demand is likely to affect the price of factor inputs

More Sophisticated ModelsDemand-based model of income and employment

Demand for labour

Regional income External Demand




14

Demand-based model

with supply-side

World demand

Demand for region’s goods

Region’s employment Unemployment

Regional income

Price of region’s goods

Wage rate Participation rate

Net inward migration

Supply of labour

Competitiveness of region

1. Supply side is endogenous as demand affects the labour market and the supply of output to meet regional and world demand.

2. Wage rate is determined within the region as labour market tightens

3. Increased regional wage rates induces further supply of labour (participation and migration)

4. Increased regional wage rates reduce competitiveness (production costs )




15

Summary Cumulative effect on a regional economy is always greater

than initial injection but Impact reduces in subsequent rounds

Multiplier combination of Direct, Indirect and Induced effects, there is also a feedback loop.

Keynesian Income Expenditure model is useful for deriving overall regional multipliers. Importance of MPC – size, industry mix, location – can be extended.

Importance of 1st round injections – applications, universities, tourism, defence etc.

But there are clear weaknesses in the approach. Multi-regional model shows the inter-connection between

regions, further developments have looked at the feedback effect and the supply-side.

Next econometric models & input-output analysis

Documents

Local & Regional Economics Regional and Local Economics (RALE) 2010 – Lecture 2a 1 Lecture 2a Multipliers & output models