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Mathemagical Multipliers: Believe Them Not

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“I don’t know IMPLAN, other than the thing that people love to hate.” – Mike Munger, Duke University.

“You were right to focus on the opportunity cost aspect. The program completely ignores that.” – David Henderson, Hoover Institution.

“IMPLAN is an economic hoax and a mathematical fraud. You can quote me on that.” – Robert Malt, Malt & Company.

“If you were trying to persuade a city council or a legislative chamber to bankroll your venture, it’s what you’d be inclined to use.” – Jon Sanders, John Locke Foundation.

“Our argument is that its results produce nothing that is useful for determining the desirability of public policy.” – Roy Cordato, John Locke Foundation.

At their last meeting, the Buncombe County Commissioners approved the issue of $4.25 million in bonds for Plasticard-Locktech. The loan came by way of the Buncombe County Industrial Facilities and Pollution Control Financing Authority, with the approval of the NC Department of Commerce. The public hearing was simply a formality required by IRS codes.

The commissioners wanted the public to understand taxpayers would incur no obligation. County Attorney Mike Frue explained, “The Industrial Facilities Authority will issue the bonds, or sign on the dotted line. And what they do is find a private placement, usually GE Capital Credits, so they would buy it, and they’re sort of like the bank, and any defaulting would not be an obligation of the taxpayers.”

In other words, the county is directing business from competing conventional lenders into the hands of GE, that great corporation that just received $15.7 million from Buncombe County as well as a sweet real estate setup, $600,000 from Durham and Durham County, $900,000 from Wilmington, and $1.2 million from Ashe County for the infamous Project X. In the absence of cozy relationship-building, it makes no sense for the multinational giant to need government to direct business to its financial arm when that lending arm isn’t good enough for GE’s own projects. The corporation merely chooses taxpayer financing.

After the brief meeting, the commissioners went into closed session to discuss another “economic development matter.” Subsidizing corporate expansion the market isn’t supporting with taxes from the working poor is one of very few issues with bipartisan support. “This is how we like to do business in North Carolina,” remarked Governor Pat McCrory when Linamar received its last grant from the county. To receive economic development grants, companies must affirm they would pretty much up and relocate to another state “but for” the taxpayers’ incentives.

About three weeks ago, the commissioners approved giving Linamar $9 million from the public treasury. In return, the public was told the company would invest $190 million in capital improvements. In so doing, it would create 400, 317, and 264 direct, indirect, and induced jobs, respectively, and generate $30 million plus $27 million plus $15 million in direct, indirect, and induced local dollars. At the same meeting, Polylinks received $25,000 to invest $2.3 million; create 12 plus 3.9 plus 3.6 jobs, and generate $429,600 plus $151,365 plus $130,475 for the economy.

In these and other situations, county leadership will flash PowerPoint slides showing the fantastic values for direct, indirect, and induced quantities. The innumerate public is supposed to ooh and ah because an expert has done something with scary numbers. More likely, they’re laughing at the outrageously high returns calculated to the nearest dollar with laser precision.

IMPLAN’s Sordid Past –

The graphs are prepared with IMPLAN. Originally developed by the USDA Forest Service, the software is an attempt to model with formidable amounts of economic data from numerous agencies. It is based on input-output analysis, a concept developed by Wassily Leontief, who won a Nobel Prize for developing it.

According to Wikipedia, this Marxist approach to economic analysis was designed to show interrelationships between departments. The online encyclopedia states, “The input-output model is one of the major conceptual models for a socialist planned economy. This model involves the direct determination of physical quantities to be produced in each industry, which is used to formulate a consistent economic plan of resource allocation.”

Fundamentally, input-output analysis consists in assembling a table with industries listed in both rows and columns. The columns represent inputs; the rows, outputs. The numbers in the table represent how much each industry on the left contributes to those running across the top of the table. The technique is deemed useful for immediate, short-term calculations, but it has been criticized almost from the outset.

In a 1955 paper, Carl Christ of Johns Hopkins faults the model because it assumes supply equals demand, and thus operates only for market-clearing values, which are constantly in flux. “It does not present a theoretically complete picture of either the supply or the demand side of the economy, in that it does not envision optimizing behavior on the part of economic organisms faced with alternative courses of action.” Christ later cautioned about the implications treating humans as automatons would have on a free society.

Christ argued, “The problems are legion: whether to use producers’ values or purchasers’ values; how to approximate a commodity basis for defining industries when most of the available data are on an establishment basis; how to treat secondary products; how to handle imports of goods that are also domestically produced; where to charge transport costs; how to handle scrap; and so on and on. And there is the ever-present problem of where to get more basic information.”

IMPLAN’s algorithms are proprietary, but literature published by the Minnesota IMPLAN Group indicates some inconvenient assumptions must still be endured. For example, the program assumes resources are infinite. It neither allows for substitutions of input materials nor technological transitions. Furthermore, if an industry produces two products, it assumes it will always produce the two in the same proportion.

On the bright-side, IMPLAN does allow the operator to choose whether he will allow imports and exports of resources, labor, and products. It can apportion inputs and outputs to, say, account for commuters from outside the region of interest and portions of income from national chains that stay in the community. It also performs iterative functions to handle problems of, for example, a growing milk factory that has to hire more employees who drink milk, etc. Thanks to computers, IMPLAN is capable of accurately processing matrices for 528 industries.

The developers at IMPLAN recognize these shortcomings, and so they advise users to appeal to reason. The literature on input-output analysis is replete with instructions to use the model as a first approximation and make adjustments. Unfortunately, the presentations made before legislators are often not prepared by economists.

Humorous on the MIG website is the disclaimer, “The direct impacts do not include household savings and payments to federal, state, and local taxes, as these payments do not circulate through the economy.” Regardless, another Nobelist, Milton Friedman, said of input-output analysis, “I would myself prefer, on many grounds, to rely primarily on the price system . . .”

A question that was not addressed in a somewhat extensive literature search was how converting a model designed to manage resource allocation into a predictive tool was justified. Mathematically, the inverse of the input-output matrix is taken, but no attempt to reconcile the math with the real world was uncovered. Visions of production rising unfettered to meet demand, or at least the analogy of pushing a rope, come to mind.

The “Super Multiplier” –

Why IMPLAN should be viewed with suspicion in the first place are the seemingly outrageous numbers presented at the commissioners’ meeting and elsewhere. According to the charts, the Linamar subsidy would have a ROI greater than 10, but Polylinks’ would be over 30. Meanwhile, IMPLAN developers say 1.8 would be pushing it for a multiplier effect. Economics guru Paul Krugman, and Christina Romer, who grossly overestimated the returns from federal stimulus, say multipliers around 1.5-1.6 are reasonable.

Jon Sanders wrote an article for the Carolina Journal entitled, “Iron Man? No, the Real Hero is the Super Multiplier.” In it, he scoffed at IMPLAN predicting North Carolina film incentives for “Iron Man 3” would have a multiplier effect of 8.99. “Though to be fair,” he added, “it’s not quite half the multiplier claimed by the renewable energy industry in North Carolina, which was – don’t laugh – 19.3.”

One reason for the ginormous ROI’s is it is easy to play fast and loose with unparameterized numbers. The county is acting as if its contribution is the whole cause of all the benefits, ignoring any private investment, including that of the subsidy recipient. When the city, county, and state announce the ROI’s of their investment in the same project, they all claim the same benefit in the numerator, but they divide only by their own contribution.

When the presentation gets into indirect and induced multipliers, the pitcher credits the corporation to be subsidized with the creation of jobs in other industries, even though those employees will be payrolled by somebody else. Worse, IMPLAN’s literature describes an “event” for a housing development as “the total household incomes of the households that buy or rent the homes.” Well, what if an IMPLAN study was performed on the new factory that was going to justify the housing development? It could claim those householders as direct jobs created and chalk the income they spend up to inducements from the corporation.

IMPLAN is often faulted for double-counting. The MIG website’s message board displays a handful of requests for help because the program is double-counting. The concerns are all happily resolved in subsequent replies, but that doesn’t mean the non-engineers who are pitching projects to legislators are aware of what’s happening.

Sanders explained the phenomenal numbers as the result of robbing Peter to pay Paul, and then recording Paul’s boon with single-entry accounting. A critique of the magnificent multipliers used to pitch clean energy in North Carolina, prepared by the Beacon Hill Institute, described the wild multipliers as “akin to having your cake and eating the entire bakery, too.”

What’s missing is opportunity costs. If government gives money to an industry, it must first take the money out of the economy. If government taxes, taxpayers no longer have funds to invest elsewhere. Private investment and purchases also multiply, but IMPLAN has no accounting for subtractive elements.

The concept was made famous by Frederic Bastiat in the 1800s. He facetiously argued we could all become rich by breaking windows, because that would make jobs for glaziers, who could, in turn, have money to spend in other places in the community. “What is not seen,” is what the person with a broken window would have bought if he did not have to repair his window, and the multipliers of that.

In a report for the Heritage Foundation during the last wave of federal stimulus, Brian Riedl explained why legislators swallow the multiplicative power of subsidy. He said Keynesians believe (1) “government spending adds money to the economy, taxes remove money from the economy, and so the increase in the budget deficit represents net new dollars injected,” and (2) “consumption spending adds to immediate economic growth while savings do not.”

By way of review, government gets its money by taxing, printing, or borrowing. Opportunity costs are obvious with taxation. Even though the pain is spread, each dollar sucked in is a dollar not spent in the economy. If government borrows, it does so with principal and interest due to taxpayers and their progeny. If it prints, supply and demand dictates the value of the dollar will decrease, and so running the government printing press is referred to as a “hidden tax.”

Addressing the second item, Riedl quips, “By this reasoning, unemployment benefits, food stamps, and low-income tax rebates are among the most effective stimulus policies because of their likelihood to be consumed rather than saved.” As for savings not contributing to economic growth, he informs those unfamiliar with the purpose of financial institutions that they collect money so they may lend it out. Savings accounts and investment, then, goes to finance tractors or lumber for somebody else. The only way the second assumption would be true is if the masses were “socking money away in mattresses.”

Economic development incentives are not injections of cash to stimulate the economy. They are transfers of wealth. A desert island would remain primitive if all tribesmen did was trade beads. If, instead, they started converting the islands’ resources into devices so useful fellow-tribesmen would part with their beads to have one; their standard of living would improve. As it turns out, the private sector, with its profit motive, is usually more strategic about how it spends. According to Riedl, “Mountains of academic studies show that government spending typically reduces long-term economic growth.”

The Beacon Hill group astutely observed, “The baseline assumption any reasonable economic analysis should make is that private firms maximize profit. If it were the case that cost-savings of this magnitude were available, then private energy firms would have been leaving hundreds of millions of dollars on the table – that is, definitely not maximizing profit – for no apparent reason. If the authors believe they have overturned the fundamental basis for microeconomic theory, they should specify why.”

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