Public investment and the scourge of big numbers

Anybody who hung around downtown Saint Paul during the 2008 Republican National Convention knows that it was a dud for most local businesses. It wasn’t surprising; analysis of other conventions showed somewhat similar results. What sounds like a big infusion of cash barely makes a ripple. But local officials put out a post-mortem assessment saying the convention had dropped a pile of cash on the city anyway, requiring people to ignore their own lying eyes.

Politicians and civic boosters are again tossing around big numbers now that Minneapolis has made its pitch to lure the 2018 Super Bowl to the ZygiDome. It would have a $500 million impact, according to Gov. Dayton, although MPR’s Tim Nelson points out that economists find that figure somewhat preposterous.

This is the world of economic impact analysis, which is highly questionable math that guides public policy.

How so?

Take the Canadian energy firm, Kinder Morgan, which has recently submitted a 15,000 page application to expand an oil pipeline, pointing out that although oil spills might be a problem, they result in economic development because of the money they bring into a community. (h/t: Press Progress)

The example “should lead us to re-examine what we accept as proof of the economic benefits of projects in general,” an energy professor, Andrew Leach, writes on Maclean’s this week.

There are, basically, two issues with this method, and both are wonderfully illustrated by the oil spill example. First, the method is agnostic as to what the money is spent on, so money spent cleaning up an oil spill looks remarkably similar to money spent building a new hospital or school in terms of economic impact. Second, the technique generally does not account for where the money comes from, or how it would otherwise have been spent. Money spent on a hockey arena in Edmonton might otherwise have been spent on light rail or tax reductions, both of which would also have economic impacts. In the case of an oil spill cleanup, the costs are likely to be directly incurred by an insurance company, but the premiums paid for that insurance come at the expense of the value of the oil transportation service—the higher the expected clean-up costs from oil spills, the higher insurance premiums will be, and this will mean higher pipeline tolls, which in turn implies lower profits, taxes, and royalties on the products shipped. Simply-put, there’s no free lunch.

Economic impact analysis leads to what economists have known for decades as the broken windows fallacy—the idea that rebuilding existing things creates economic growth by requiring people to spend money. The oil spill is a perfect example of this fallacy, but of course it’s one in which we all know intuitively that oil spills are bad, so it seems ridiculous to talk about the benefits of cleaning them up. The fact that the technique we use to evaluate the benefits of spending in general only makes sense when we know the spending is beneficial should raise more than a few flags.Economic impact analysis is a wonderful tool for confirming your pre-existing biases and for justifying anything. For this reason, it’s a terrible tool for analyzing economic benefits because it never yields negative numbers—all spending is good spending as far as an economic impact analysis is concerned. All spending creates jobs. The trick, it seems, is to only listen to the results when it’s a project you like.

Leach says there likely isn’t an economic impact technique “both more universally loathed by academic experts in the field and at the same time widely used in public policy than economic impact analysis.” It’s an indication,
Leach says, that we’re “doing project evaluation wrong.”

Whether it’s a pipeline, a stadium, or the proposed PolyMet mine, the better method, Leach says, is whether a social return on investment outweighs the resources used.

Some of these same issues also arise when it comes to valuing a “job”—a salary paid to someone is not a gift, but a payment for services, and a worker employed on this project may or may not have been employed elsewhere in its absence. So, how would a cost-benefit analysis value a job? Supposing that the salaries are paid by Canadians to Canadians, you’d be close to zero-sum as long as the labour market is at or close to full employment. It would be reasonable to assume, in that case, that the workers employed building a pipeline would be otherwise employed building something else in the absence of the pipeline project, and so the impact on their well-being is limited. Similarly, from the employer’s perspective, they pay the wages, but also receive the value of the labour, and in a tight labour market those two should be close to equal at the margin.