VANCOUVER – With cities accounting for more than 70 percent of GDP globally, they are considered the engines of economic growth. However, all too often, cities fall short of their potential. This is because they fail to take into consideration the economic forces that are at play. Local economies can be affected by economic change in a variety of ways, including through national level trends, industry specific trends, the entry and exit of businesses and even changes in policy. Urban economics offers an important vantage point for understanding how economic change affects a community. Moreover, its tools can provide communities with a means of anticipating shocks and leveraging opportunities to better position themselves for the future.
Urban economics is the examination of urban areas by using the tools of economic analysis. It helps to explain the factors that give cities their competitive advantage; namely, proximity and density. In doing so, it demonstrates how a higher concentration of activity in a smaller area – the precursor for density – creates a more functional urban form. This makes cities more cost effective when it comes to supplying infrastructure. It also creates fertile ground for the exchange of knowledge (knowledge spillover), the sharing of assets (technology transfer) and a more efficient pairing of skills (job matching). When synergies occur within a single industry, urban economists refer to this as agglomeration economies, however, when it occurs across multiple industries/geographies it is referred to as urbanization economies. Knowledge of urban economics can equip local administrations with the tools that are needed to take advantage of agglomeration and urbanization economies helping them to promote a more optimized urban form and a more robust local economy.
"Basic industries form the backbone or economic base of the local economy, while non-basic industries exist as a result of them."
Perhaps one of the most useful applications of economics for the analysis of urban areas is that of Economic Base Analysis. Economic Base Analysis provides important information on the state of the economy, which can reveal useful insights when compared to other geographical areas or across different periods in time. Economic Base Analysis posits that the economy of a city or region can be divided into two categories: basic and non-basic industries. Basic industries are those industries which sell the majority of their goods and services outside of the local community. These are considered industries in which the city is specialized in and are thus considered exporting industries. Examples of basic industries include aerospace manufacturing in Montreal, automobile manufacturing in Detroit and the tech sector in Silicon Valley. Non-basic industries, on the other hand, are those industries that supply goods and services locally; meaning that most of what they produce is for local consumption. These could be anything from restaurants to hairdressers to small suppliers. Basic industries, therefore, form the backbone or economic base of the local economy, while non-basic industries exist as a result of them. Another important distinction is that basic industries bring external capital into a community, while non-basic industries recirculate existing capital; the former of which is associated with greater economic prosperity. The importance of an Economic Base Analysis is in its ability to identify basic industries that will export their surpluses and bring further growth to the region. This will then have spillover effects that benefit the non-basic industry.
"Economic Base Analysis and the Shift-Share Analysis offer useful techniques for assessing economic change at the local level."
Related to the Economic Base Analysis is the concept of Employment Multipliers. An employment multiplier is a measure used to determine the impact that investment in a certain industry or industries will have on additional employment in the region. In the case of an Economic Base Analysis, it is usually reflected as the ratio of basic sector employment to non-basic sector employment in a given year, providing an indication of the impact that a job (or dollar value of investment) created in the basic sector will have on additional jobs in the non-basic sector. If the employment multiplier is 4, this would suggest that for every 1 job created in the basic sector, 3 additional jobs would be created in the non-basic sector. The hidden value of the employment multiplier can be seen in its predictive capabilities. When a community attracts new employment or investment opportunities in the basic sector, for example, a planner can utilize the employment multiplier to make a general prediction as to the number of additional jobs that will be created in the non-basic sector. The same can be applied to job losses.
An extension of the Economic Base Analysis is the Shift-Share Analysis. The Shift-Share Analysis is an approach for examining the competitiveness of an industry relative to the same industry at the national level. In doing so, it determines whether a local economy is experiencing growth (or decline) at a faster rate than the national economy. An important aspect of this is determining why a local industry is growing. The Shift-Share Analysis has the ability to determine whether this is due to a national growth effect, an industrial mix effect, or a competitive effect. The national growth effect refers to the share of local employment growth that is a result of changes associated with the national economy; this suggests that if the national economy is growing it will have a positive impact on employment growth at the local level. The industrial mix effect refers to the share of employment that is the result of industry specific trends at the national level; meaning that some industries at the national level are growing faster than others and could potentially equate to faster growth in the same industries at the local level. Finally, the competitive effect refers to trends that are occurring at the local level that may be different than those at the national level; this suggests that there may be comparative advantages in a specific industry at the local level that makes it grow faster than at the national level. The value of the Shift-Share Analysis is that it provides a means for analyzing growth effects at the local level and identifying the primary factors that are influencing it. This can be useful for local administrations looking to assess their competitiveness and develop strategies to build more robust and resilient economies.
Economic Base Analysis and the Shift-Share Analysis offer useful techniques for assessing economic change at the local level. For those who are interested in learning more about these tools, please reach out to us directly.
Kyle Farrell is Managing Partner and Chief Urban Economist at Economic Pulse Analytics. He works closely with local governments to provide them with population, housing and employment forecasts to make more informed decisions about their future. He holds a PhD with specialized knowledge in Urban Economics and regularly consults for the United Nations.
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