Far and away the most common mistake most people make when trying to understand the economy comes from ignoring that part of the economy they cannot directly observe.
The 19th century economist Frederic Bastiat summed it up best when he said: “There is only one difference between a bad economist and a good one: The bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be unseen.”
A little primer on how this “unseen” economy works might get us better economic decision making in government.
Maybe the best example of this comes in the form of local economic development. We are all delighted to hear about some new business coming to our county or town, bringing with it jobs and investment. This is the “seen” part of the economy.
Oftentimes a consultant or accounting firm will compile the impacts of these jobs, and maybe even run them through some sort of economic model in a computer spreadsheet. These models try to give part of the ‘unseen’ effects of the new business, by estimating the amount of new local businesses that might spring up and new taxes paid.
These types of studies are relatively straightforward. But, what is unseen makes all the difference. For example, a new business coming to town also uses some local inputs; people and land mostly. If the firm sells its products locally, it also will absorb some of the local demand. The number of local people they hire and how much existing sales they displace dramatically affect the impact.
If the new firm pays good wages and the community is attractive it will surely attract new families to move the region. If the business pays only average wages it will usually draw workers from other businesses, not really changing local employment.
However, if the job pays well, but the community has poor schools and undesirable neighborhoods, most workers, especially the better paid ones, will live elsewhere and simply commute to the jobs. In this case, all the economic impacts simply commute to another town.
A consequence of this is that the local economic impact of any new business attraction effort is almost wholly dependent only on how desirable the community is. This is one of the most obvious truths in economic impact analysis, but in 20 years I have yet to read a consulting report that noted that issue. There is more to the story.
Oftentimes, the largest “unseen” part of the economy isn’t what the new business does in terms of employment and taxes. Rather, the “unseen” effect is often related to the costly efforts to lure the new company to town. Over the past quarter century, fewer than one out of 50 new jobs in are due to businesses relocating to Indiana. So, most, but not all, economic development efforts involving tax incentives or use of public funds simply raise taxes on the existing businesses who create the other 49 out of 50 new jobs in the state.
Worse still, dollars spent on speculative buildings, single-use infrastructure and tax abatements are resources not used to make a community more attractive to potential residents. While there are lots of good ways for government to help boost economic activity, including the tax code, ignoring that “unseen” portion of the economy is today the broadest and most persistent failure in economic development policy in Indiana.
Michael J. Hicks is the director of the Center for Business and Economic Research and an associate professor of economics in the Miller College of Business at Ball State University. Send comments to firstname.lastname@example.org.