Leakage Analysis

Description

By Michael H. Shuman & Doug Hoffer:

1.

"A growing body of evidence suggests that the best way to strengthen a community economy is by expanding locally owned businesses serving local markets. By studying leaks of dollars – that is, goods and services being imported that could be produced locally – a community can identify the most promising markets for new or expanded local businesses, and the best private initiatives and public policies to support this kind of economic development." (https://mvcommission.org/sites/default/files/docs/leakagestudy.pdf)

2. Multiplier vs leakage:

"Every purchase triggers purchases by others within a community. For instance, a dollar spent on rent might be spent again by the property owners at the local grocer, who in turn pays an employee, who then buys a movie ticket. This phenomenon is what economists call “the multiplier.” The more times a dollar circulates within a defined geographic area and the faster it circulates without leaving that area, the more income, wealth, and jobs it creates. This basic concept in community economics highlights the importance of maximizing the numbers of dollars being spent locally and minimizing their “leakage.”

Discussion

The importance of import-substitution for local prosperity

"Import substitution matters for economic prosperity as well. Every time a community imports a good or service that it could cost-effectively produce for itself, it “leaks” dollars and loses the critically important economic multipliers associated with them. Unnecessary imports – of foreign oil, for example – also subject a community to risks of major price hikes and disruptions outside local control. And they deny a community a diversified base of businesses and skills that are needed to take advantage of unknown (and unknowable) future opportunities in the global economy.

“Localization” turns out to be an important strategy for promoting the expansion of highwage, “high road” jobs. More traditional strategies for attracting these jobs from nonlocal enterprises have had disappointing results, because many of the promised jobs do not materialize or turn out to be temporary. Moreover, because nonlocal businesses spent less money locally than local businesses, they have lower multipliers and fail to raise wages in other sectors of the local economy. A recent study in San Francisco found, for example, that a 10 percent shift of residential spending on retail from nonlocal business would add to the city’s economy nearly 1,300 more jobs, $72 million more in wages, and $192 million more in annual output.

(A similar shift in spending the other way, from local to chain, would eliminate 1,300 jobs, shrink wages by $72 million, and reduce output by $192 million.)

Two clarifications about LOIS are important:

First, import-substitution does not mean cutting off a community from the global economy. To the contrary, as the late Jane Jacobs argued, an economic strategy of promoting import-substituting businesses turns out to be an effective way to develop export-oriented businesses. But instead of putting all of the community’s eggs in one export-oriented basket, this strategy aims to develop myriad small businesses, all grounded (initially at least) in local markets with many then becoming exporters.

Second, this perspective does not carry a moral judgment about non-LOIS businesses being bad or unproductive. To the contrary, many global, export-led companies are terrific at creating wealth and jobs. But dollar for dollar of sales, the typical LOIS business produces more benefits for a given region than the typical non-LOIS business, in part because local ownership anchors the business to the community and in part because of the multiplier effects.

LOIS businesses actually constitute the majority of the U.S. economy. According to the Small Business Administration, about half of the private sector’s output and jobs comes from small business. Add nonprofits and governmental sectors, and the “place-based economy” accounts for 58% of gross domestic product (GDP). This number is significantly higher in rural communities. The businesses in the place-based sectors, moreover, produce far more jobs, patents, and innovation than equivalent sized nonlocal businesses.

The main doubt economists express about LOIS concerns competitiveness. Are we not in an era when bigger businesses can better achieve economies of scale? In fact, in all but seven of the thousand-plus sectors of the North American Industrial Classification System (NAICS), there are more examples of competitive small-scale enterprise in each sector than large-scale enterprise. Put another way, the U.S. economy is full of models of small-scale success that can inform entrepreneurship activities in even very small communities. What’s missing is an economic-development strategy that these communities can use to identify, create, and nurture theses enterprises. Enter leakage analysis."

More information

• Related concept: Locally Owned, Import-Substituting Businesses

By Michael H. Shuman & Doug Hoffer:

"Locally owned, import-substituting (LOIS) businesses. Discerning opportunities for LOIS requires an analysis both of dollar leakages (that is, where residents are spending money outside the local economy) and of opportunities for plugging leaks." (https://mvcommission.org/sites/default/files/docs/leakagestudy.pdf)

* Report: By Michael H. Shuman & Doug Hoffer. Leakage Analysis of the Martha's Vineyard Economy: Increasing Prosperity through Greater Self-Reliance. Martha’s Vineyard Commission, August 2007

URL = https://mvcommission.org/sites/default/files/docs/leakagestudy.pdf