Especially during crises.
Economic multipliers
are shrinking
Economists often use input-output modelling to measure the
broader economic impacts of a single event. If, for example, a major $100 million
construction project is announced, we can insert that $100m into the model, and
it tells us how the effect of that construction activity would spread to the
rest of the economy.
The difference between this broader impact and the initial
construction injection is called the ‘multiplier’.
But in recent years, the assumed multiplier in input-output
modelling has been falling, meaning that individual investments by industry
and/or government are having smaller and smaller knock-on effects on the
broader economy. Why?
Well one explanation lies within globalisation –
specifically the globalisation of supply chains. Businesses no longer source
all their inputs locally. They can buy machinery from Germany, parts from Bangladesh,
technical expertise from the US, even one’s workforce can be sourced from
interstate or overseas (just look at Australia’s mining and resources boom,
where most of WA’s labour shortfalls were met with international labour,
not labour from other states).
Consequently, even when money is invested in one area, it
‘leaks’, resulting in smaller and smaller general impacts in the location in
which the investment was initially made.
Example – Geraldton
Western Australian regional city, Greater Geraldton, for
example, suffers from significant economic ‘leakage’. A project Geografia undertook last
year calculated total business ‘leakage’ alone of $1.24b, much of which was from
the Manufacturing sector, but also Construction, Mining, Transport, postal and
warehousing, and Rental, hiring and real estate services (Figure 1). Returning
to our construction project above, $100m here would result in only a $31m direct economic impact and a $65m flow-on impact ($96m total – still smaller than the
initial injection). Many of the benefits would be felt elsewhere. Consequently,
the broader economic impact was only larger than the initial injection when you
include the positive impacts outside Greater Geraldton.
Figure 1: Expenditure Leakage by
Source, Greater Geraldton
Source: Geografia, 2016
Example – Casey
Outer metropolitan municipalities offer a variation on this
theme. They are notorious for highly mobile labour forces and therefore, out-commuting.
And as residents leave every day to work closer to the city centre, they
spend a considerable proportion of their income outside of their home
municipality.
Let’s take Casey in outer metropolitan Melbourne. With a
population of 300,000 at the 2016 Census, Geografia used bank transaction data in
their Spendmapp product to see they spent upwards of $250 million outside their own
municipality just in the month of December 2016 (Figure 2). In addition to
out-commuting, this may also be due to a lack of appropriate offerings within
Casey. As per our construction example above, just $84m in total would be
captured locally if the $100m project occurred in Casey.
Figure 2: Resident Expenditure Leakage,
Casey
Source: Spendmapp, 2017
This kind of leakage has significant implications for the
economic viability of investment projects. A local government is going to have
a harder time justifying a project if they can’t demonstrate through
input-output modelling that a large proportion of the benefits from such a
project will remain in the local area.
There are also implications for economic recovery after
crises. The standard Keynesian approach says that during a recession, fiscal
multipliers are especially high and therefore, particularly effective at reviving
a lagging economy. In the US, those multipliers have indeed been strong in
recent years, justifying a stronger fiscal policy response to an economy that
was, until recently, underperforming. But the US is an enormous economy, so
their domestic supply chains are well-established and diverse, resulting in
minimal economic ‘leakage’ and strong fiscal multipliers. But for smaller,
internationally open economies such as Australia, fiscal policy may be less and
less effective at kick-starting a slumping economy.
And this brings me to the solution – self-sustainability vs.
cooperation.
Self-sustainability
In the case of Greater Geraldton, a significant amount of their
‘leakage’ could actually be clawed back (Geografia estimated about $259m of the
$1.24b in business leakage). This can be done by identifying industries where
the volume of leakage is so high, it demonstrates a large local market that
could be used to entice (and support) a new business to invest locally. ‘Buy
local’ policies could be used to support these businesses. Equally, population
growth will help meet more of the local workforce needs. This increased
self-sufficiency would help contain a much larger share of any investment
directed at Greater Geraldton. Leakage would be minimised, and multipliers would be
higher.
Entire nations have even greater potential to contain
leakage by diversifying into more industries along their supply chains, thereby
reducing reliance on imported inputs. Investment in education and training can
also reduce reliance on foreign skilled labour.
Of course, this kind of self-sustainability is not always
possible or advisable. Capital City CBDs for example, are major financial and
business hubs – and should remain so. Trying to stimulate their economies by
increasing the local resident population, thereby reducing the need to import
labour from the rest of the city, will likely detract from its commercial
advantages. Yes, it may retain more of its local resident expenditure, but this
will reduce floorspace available for commercial use.
And even nationally, it is often not advisable for an economy
to try to specialise in everything. Firstly, in a developed country such as
Australia, where the private sector hasn’t already developed such activity,
this would require the government to ‘pick winners’ – this ‘infant industry argument’
has been successful in the past (sometimes), but it’s a risky option.
Furthermore, often it is just better to import things that
other countries are better at doing (like labour-intensive manufacturing from Bangladesh),
rather than dedicating resources to an industry in which we will probably never
reclaim our competitive advantage (and potentially taking resources away from
our real advantages).
Cooperation
Consequently, if self-sufficiency is not possible or
advisable, cooperation is needed. If Greater Geraldton needs an economic boost
but ‘leakage’ is a concern, fiscal support from the State government is
justified. This way, Geraldton benefits from added assistance, Perth will
benefit, given many of Geraldton’s inputs would be sourced from Perth, and, in
a lovely positive feedback loop, Perth would potentially buy more goods and
services from Geraldton. So when a small area is susceptible to leakage, the
broader area that benefits from this leakage should also assist.
Nationally, this requires global cooperation. During the
post-GFC slump in the developed world, efforts by individual countries to
stimulate their economies fiscally (if they existed) would have leaked
somewhat, having less impact locally. But through international cooperation,
nations could have coordinated their fiscal policy programs, with all nations
benefitting from the leakage of other nations, via the modern world’s
globalised supply chains.
The verdict
The solution, as is often the case, will require a balance. Places,
big and small, should not become so overly specialised that they are vulnerable
to external shocks, and virtually unaffected by local fiscal stimulus. But at
the same time, the benefits of globalisation should not be unwound by attempting
to become completely self-sufficient in areas of competitive/comparative
disadvantage.
A global economy requires global cooperation.
