Economic spin-off from events is wildly miscalculated

30 November 2017

The crass use of multiplier analysis to boost forecast benefits of public and private sector projects needs to be sharply reined in, argues Tim Hazledine.

There used to be a big sign on the side of the road leading in to Auckland airport advertising real estate in the airport precinct. It read: "Over one quarter of Auckland's GDP is generated here. Be part of it!"

There should have been another big sign a few metres further down the road saying something like: "If you are silly enough to have believed the first sign, then dial this number to invest in a fool-proof scheme guaranteed to double your money every three years!"

Of course anyone making such claims would immediately be prosecuted for fraud, or at least for misleading advertising. But why didn't the real estate company get into trouble for the even more outlandish claim? (The correct number for the airport precinct in 2011 was about 3% of Auckland's GDP — it is likely to be a bit more now.)

Probably no great harm done; commercial property investors can look after themselves. Perhaps prospective donors to the University of Auckland can also look after themselves, and not be misguided by the claim that our excellent University "generates" about $8 billion in "economic benefits" annually — that would be close to 3% of New Zealand's entire GDP.

The study that supported this similarly implausible number was carried out by the New Zealand Institute of Economic Research using a multiplier model that it has now, correctly, renounced, but it is still on the University’s website.

It is actually hard to even formulate a meaningful question about the economic contribution of an ongoing entity such as an airport or a university – what is the counterfactual, the "what if?" The numbers can be taken as propaganda; cheap talk.

More meaningful, and much more serious – because real money is involved – is the answer to a question like: "What is the likely economic impact of a one-off special event such as hosting the America’s Cup, and what taxpayer contribution therefore should be made to this event?"

Here the counterfactual is pretty clear: the alternative to holding the Cup in Auckland is holding it somewhere else, probably out of New Zealand. It is possible to estimate the likely economic impact of the Cup, but unfortunately it hasn't yet been done properly.

Instead, the Ministry of Business, Innovation and Employment has commissioned a report from the same consulting company responsible for the Auckland Airport impact numbers cited above.

Using the same "multiplier analysis" that NZIER and other independent economic consultancies have now renounced, the report produced quite spectacular numbers for the impact of the Cup: up to $1billion injected into the New Zealand economy, thousands of jobs created, and a return of more than seven dollars on every dollar invested in new wharf facilities.

Take the last number first. Reality check: a return on investment of over $7 per dollar invested is loosely equivalent to the "double your money in three years" promise on my hypothetical hoarding on the airport road.

As for the value-added injection and the jobs created: to a first-order approximation, the net number of new jobs created in Auckland, with its already stretched construction and tourism industries, will be about zero. The workers needed will be bid away from other jobs, or imported as new immigrants. As a result, there will be no significant real output increases. The extra spending will be soaked up in higher prices.

Higher prices are harmful for this country’s customers and for travellers but beneficial to the bottom lines of New Zealand and foreign-owned businesses. It is a trade-off. My expectation is that, overall, there will be net economic benefits from holding the Cup in Auckland but that they will be quite small — below the costs to which national and local government are being asked to contribute.

So, does that mean we shouldn't support the Cup? I hope not, because personally I am looking forward to the 2021 regatta. Now that they can make the boats fly, the racing is really exciting. But ministers and mayors should not try to palm off taxpayer and ratepayer subsidies as "investments".

More generally, the crass use of multiplier analysis to boost forecast benefits of public and private sector projects needs to be sharply reined in. I expect that Treasury economists would agree with what I have written here, which indeed is fully consistent with their own Guide to Social Cost Benefit.

Treasury, with cross-party support, should be much more diligent and energetic in setting out clear guidelines for consultants and interested parties, so that we don't need to go through this muddled and costly process time and time again.

Read the published article:

Tim Hazledine

Tim Hazledine is a Professor of Economics at the University of Auckland Business School.

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