I am regularly asked the question, “What will be the economic impact of (fill in the blank)?” It could be construction of a new housing development, extending a line of fiber optic broadband cable or shutting down a paper mill.

The underlying implication of such questions is that economic analysis is like rocket science – the thoughtful consideration of the effects of known laws of nature that can lead to an accurate prediction of the outcome tomorrow of certain actions taken today.

To a certain extent, particularly regarding investment decisions, this analogy can be useful. Construction of a new housing development puts money in the hands of architects, engineers, tradespeople and building supply stores. Tracing known patterns of vendor supply-chain and consumer spending behavior can indeed specify far-flung impacts flowing from initial investment activity.

But the further out into the future one presses the analysis, the more speculative it becomes. This is not because the interrelations of the actors are more or less complicated, but because past behavior – no matter how detailed or long the observation – is not always an accurate prediction of future action.

Imagine rocket scientists dealing with celestial bodies possessed of internal motivation. “Gosh, I thought Mars would be passing by here about now. It’s been following an orbit around here for millions of years. Wonder what changed its mind today!”

Those were the exclamations we heard from Alan Greenspan, Robert Rubin and the other architects of the Great Recession-generating housing bubble of the last decade that have given pause to the economic forecasting wizards who compare their activities to rocket science.

“I guess,” they have had to admit, “assuming that people will always make their mortgage payments isn’t as certain as assuming that Mars will continue the same orbit around the Sun.”

So what becomes of economic impact analysis? Do we throw it in the dustbin of history?

I don’t think so. The answer, I think, is to focus not on a specific accurate prediction but on the approaching planets whose collective “decisions” will determine an outcome. Much of successful economic development is the result not of ironclad agreements committed to in advance, but serendipitous synergies imagined by interested observers only after the first steps taken by some unrelated parties.

A city or town improves a dock or boat landing, a museum adds a new gallery, a new restaurant opens, tourist visitation arises, a developer decides to build a new hotel, etc. etc.

Are these events logically linked? Probably yes. Could they have been predicted? Perhaps. Could any one be accurately claimed as the economic impact of any of the others? Almost certainly not. Or, to be even more precise, for any one investment to claim another as its necessary outcome is to claim too much. Yet to ignore the outcome of their collective impact is to say too little.

This is where the task of economic impact analysis becomes both less precise and more important – in highlighting possible “mights” rather than projecting specific “wills.” Would an improved dock alone have brought more visitors to the town? Perhaps, but almost certainly not as many more as did come if it had not been accompanied by the museum expansion, the new restaurant and the new hotel. The success of the whole flowed from the mutually reinforcing but not inevitably necessary synergies of a series of independent investment and operational decisions.

The value of impact analysis for investors and policy makers, therefore, is in highlighting the areas where such synergies “may” occur and quantifying both the levels of demand each successive investor is likely to require for her or his investment to succeed and the degree to which hitting those sales targets are made more likely by each successive addition to the synergistic solar system.

In one sense, this process is “in your dreams” blue-sky thinking. But in another, it is only by giving imagination free rein and clearly thinking through the full range of “what ifs” that the reasons for supporting or opposing a particular investment can be evaluated.

Practitioners of impact analysis are often criticized for providing whatever number their employer wants. Well of course! If the impact number isn’t what the employer wants, the analysis won’t see the light of day. But in spite of what the employer wants (and opponents don’t want), the value of impact analysis lies not in any “final” number. In fact too much attention to any number simply distracts attention from the important issues.

The real value of impact analysis lies in the articulation of the events that will be required to produce that number. The task of the investors and policy makers charged with making and approving investment decisions is not to say, “OK, we’ve got a number; let’s go home.”

It is, rather, to evaluate the likelihood of achieving this number. This isn’t rocket science, but it does require rigorous thinking.

Charles Lawton is chief economist for Planning Decisions, Inc. He can be contacted at:

clawton@planningdecisions.com

Copy the Story Link