I saw an advertisement in the paper touting the economic benefits of a new pipeline. While the ad was for TransCanada Pipelines (TRP) the problem I have with it is not with TRP (or their independent consultant) but more broadly with people calling economic impacts economic benefits.

They are not the same thing. Benefits are a measure of worth; impacts are measure of activity. (Net) benefits are a decision-making criterion. Impacts are a marketing tool.

The ad says that the proposed $12 billion pipeline will add billions in GDP and thousands of jobs, … yada yada, yada.

Economic impact analysis generates jobs and income for consultants and marketing copy for the proposed project but tells you nothing much more than the size of the project.

A Dirty Economic Impact Analysis Secret

TRP commissioned Deloitte & Touche LLP to do the study. In the print version of the ad they say this as if this gives it some independence. But, all economic impact analysis in Canada use the same Statistics Canada Input-Output model. So it matters not who does the analysis. TRP could have saved some money and done it themselves.

The same is true in other countries, the models are national accounting based. You sum up all the inputs from an industry or sector and all of the outputs. The numbers (called multipliers) than come out are used by economic analysts to determine how much is generated in all sectors of the economy from a $1 spent in one sector. The models also give the same type of result for jobs and taxes.

So the models are all the same. Which is not a bad thing. It takes away a lot of the discretion in the analysis. All the “independent” consulting firm has to do is decide how much is being spent where – something like, how many dollars are going to the steel fabricating industry, how many to the restaurant and catering service and so on. Then it is just a turn of the crank and out pops the answer.

Impacts are as Easy to Generate as Lorem Ipsum

Project sponsors love impact analyses. Because they are completely no risk. Nothing bad comes from impacts. Every study produces a “good” result. You see, Gross Domestic Product (GDP), jobs, and taxes all scale with dollars spent. As long as you spend money you will generate income, output, jobs and tax revenue.

In fact the more you spend the bigger the impacts. If your project spends billions, you will employ thousands and generate billions in GDP and taxes.

And marketing copy is further pumped up by the addition of spin-off “benefits”: indirect and induced impacts! As direct project spending works its way through the economy, supplier industries output goes up and so indirect GDP and jobs pump up the impacts. Induced impacts add yet again to the economic activity of the project by taking into account increased spending due to increased incomes of consumers and businesses. So project promoters tout the direct, indirect and induced output and jobs with all the enthusiasm of a “new and improved formula”.

Beware Job Creation and Income Created!

As is widely recognized, income and output, or GDP are not good measures of welfare. Production may produce income and be generally positive but there are many examples of less than desirable activities that may have negative effects that are not captured.

While GDP and welfare are probably positively correlated, they need not always be. For example, economic growth, as measured by GDP, only captures market transactions. If carbon emissions are not taxed or regulated, there is no accounting for its consequences in economic accounts. These non-market or unintended consequences are called externalities. Externalities can be positive such as road users benefiting from traffic congestion relief offered by a new transit line or negative such as pollution resulting from energy production.

In addition to external values that are not captured, the cost of not doing something is also omitted from GDP accounting. Digging holes and filling them in again may put people to work and increase GDP but there may be better uses for these resources. This is a concept called opportunity cost, the fact that by pursuing one project, another cannot be done because resources are used up.

A simple example is that if TRP hires skilled workers to build its pipeline by hiring them from other jobs (a likely scenario) then there are no jobs created. In fact all that has happened is that wages have been bid up to lure workers away from existing jobs.

Real Net Benefits Please Not Impacts

A nice summary of uneconomic growth comes from Herman Daly:

• The economy is a subset of the ecosystem, and the ecosystem cannot grow beyond its current limits (i.e., planet earth); therefore, the ecosystem represents the physical limit to economic growth.
• GDP is a measurement of economic activity that includes both helpful and harmful activities and is therefore not a suitable metric for sustainability (or ecological economic) analyses.
• Growth of the economy can be economic growth (producing net benefit) or uneconomic growth (depleting natural capital and producing net detriment).

“I think in fact that growth in the United States now, aggregate growth, is uneconomic because it’s increasing costs faster than it’s increasing benefits. Do I mean by that that there’s no way we can improve welfare in the United States? No, of course not. There are plenty of things that should grow and plenty of things that should decline. The problem is aggregate GDP. If you want to talk about those things which should grow you have to get away from the aggregate and talk about the parts, you have to get away from macroeconomics back to microeconomics and identify those individual things for which marginal benefits are still greater than marginal costs.”¹

When the last dollar of benefits exceeds the cost, a project is valuable, it adds to welfare. Society is better off. While such an analysis requires a bit more thought than simply turning the crank on an input-output model, the results are useful. Impacts are only (slightly) informative when used with calculation of net benefits.

Economic impact analysis generates jobs and income for consultants and marketing copy for the proposed project but tells you nothing much more than the size of the project.

1Herman E. Daly “uneconomic growth in theory and in fact” – The First Annual Feasta Lecture 1 Trinity College, Dublin 26th April, 1999 – FEASTA review http://www.feasta.org/documents/feastareview/daly.htm and http://www.feasta.org/documents/feastareview/daly1.pdf downloaded February 19^th 2013