Economic Base Theory

"Information about an area's future population is incomplete without a parallel understanding of the local economy that largely shapes its future." (Klosterman, p. 113) The above quote from Klosterman helps to illustrate the importance of coupling local population estimates or forecasts to an in-depth knowledge of the local economy. Whereas population projections function to estimate the number of persons in an area, these projections do not provide any insight into the most important factor in local growth and decline: the local economy. If the local economy is strong, as it has been in the Seattle Metropolitan Area for the past several years, population growth is usually brisk. In times of economic trouble, though, an area often will experience a loss in population- a direct result of a stagnant economy. Knowledge of the local economy usually results via analysis using a variety ofeconomic base analytical techniques. Klosterman notes that the economic base technique "is the oldest, simplest and most widely used technique for regional economic analysis." (p. 113) It is an analytical method that illustrates many fundamental techniques used by local and regional planners, including areal comparisons, local versus regional/national conditions, and standardizing values. The Economic Sectors The economic base technique is grounded in the assumption that the local economy can be divided into two very general sectors: 1) a basic (or non-local) sector or 2) anon-basic (or local) sector.

Basic Sector: This sector is made up of local businesses (firms) that are entirely dependent upon external factors. For example, Boeing builds and sells large airplanes to companies and countries located throughout the world. Their business is dependent almost entirely upon non-local firms. Boeing does not sell planes to families or households locally, so their business is very much dependent upon exporting their goods. Manufacturing and local resource-oriented firms (like logging or mining) are usually considered to be basic sector firms because their fortunes depend largely upon non-local factors, they usuallyexport their goods. Non-basic Sector: The non-basic sector, in contrast, is composed of those firms that depend largely upon local business conditions. For example, a local grocery store sells its goods to local households, businesses, and individuals. Its clientele is locally based and, therefore, its products are consumed locally. Almost all local services (like drycleaners, restaurants, and drug stores) are identified as non-basic because they depend almost entirely on local factors.

Economic Base Theory assumes that all local economic activities can be identified as basic or non-basic. Firms that sell to both local and an export market must, therefore, be assigned to one of these sectors or some means of apportioning their employment to each sector must be employed. Means of assigning firms to basic and non-basic sectors will be discussed in the various techniques outlined below. The Importance of the Economic Base Why is the basic/non-basic distinction important? Economic Base Theory asserts that the means of strengthening and growing the local economy is to develop and enhance the basic sector. The basic sector is therefore identified as the "engine" of the local economy.

"The economic base technique is based on a simple causal model that assumes that the basic sector is the prime cause of local economic growth, that it is the economic base of the local economy." (Klosterman, p. 115) Economic Base Theory also posits that the local economy is strongest when it develops those economic sectors that are not closely tied to the local economy. By developing firms that rely primarily on external markets, the local economy can better insulate itself from economic downturns because, it is hoped, these external markets will remain strong even if the local economy experiences problems. In contrast, a local economy wholly dependent upon local factors will have great trouble responding to economic slumps. The Base Multiplier The method for estimating the impact of the basic sector upon the local economy is the Base Multiplier. The base multiplier is calculated via the following ratio: Base Multiplier =Total Employment Year i Basic Employment Year i Simply stated, the Base Multiplier can provide insight as to how many non-basic jobs are created by one base job. An example below: Base Multiplier =Total Employment Year i Basic Employment Year i =15,000 =7,900 =1.90

In this example, locality X has a Base Multiplier of 1.90. This multiplier estimates that for every one Basic Sector job created, 0.90 Non-basic Sector jobs are created (or for every 10 basic sector jobs we would expect 9 non-basic sector jobs). The non-basic jobs are usually in the form of personal/business services or related-goods employment. A Local Example: Some estimates have placed Boeing's impact (a firm which provides predominately basic sector employment) at over 4 non-basic jobs for every 1 Boeing job. Their Base Multiplier would be something on the order of 4.3. How can this be? For every Boeing job created to help build airplanes, a job may be created in another manufacturing sector (for airplane parts not made by Boeing, for example), a job may be created in office services that have Boeing as a client (a human resources agency, for example), and perhaps two jobs in personal services (a restaurant job and a job at a local drug store, for example). Now these jobs are not directly tied to that one specific Boeing job in that if that Boeing job is phased out one day the other jobs will not exist the next day. But, ultimately, Boeing's employment is a major factor in the number of business and personal services offered in the area. If Boeing cuts its workforce by several thousand, the local economy will likely lose a far greater number of jobs, on the order of four for every one of Boeing's. Economic Base Analysis can be performed by way of several different techniques. However, each of these techniques is based upon general Economic Base concepts like the assignment of firms to basic or non-basic sectors and the calculation of a base multiplier (or multipliers).

Other Important Considerations Prior to introducing the different economic base analysis techniques, a few other general points should be mentioned. Klosterman identifies two key decisions that need to be made at the beginning of this analytical process. 1) Identify your study area: It is important to note that the "local economy" means different things to different people. As a planner for the city of Redmond, for example, the local economy may mean your city's economy as compared to the regions. In contrast, if you were working for the Puget Sound Regional Council, you would likely be comparing the metropolitan economy to that of the West or even the Nation as a whole. What this suggests to planners is that one should be sure to identify the boundaries of the local economy versus the external world. It is also important to note that this will have a significant impact upon your results as the economic base model is grounded upon the distinction between the local and the external economies. 2) Select Your Measurement Units: Economic base analysis usually is undertaken using Employment data. This unit of analysis, the number of jobs, is most common because employment data is available from the Census Bureau. However, these same techniques can be used on other economic units like Payroll and Sales and Value Added. Lastly, a brief mention of data availability is necessary. Most economic data for use in economic base analysis is taken from the US Census Bureau's County Business Patterns. This data is collected annually and it provides employment and payroll information for counties and cities throughout the United States. To organize this employment and payroll data, a Standard Industrial Classification was developed by the U.S. Office and Management and Budget. For more information on this classification, go to the SIC Code page. Gathering and using this data, the analyst can utilize the various economic base techniques to determine the strengths, weaknesses, and overall form of the local economy. Economic Base Analysis Techniques There are any number of ways to analyze the strengths/weaknesses, specializations, and overall diversity of the local economy. The three techniques below offer planners a set of simple, but popular tools to perform such analyses. These techniques also illustrate core principles underlying the quantitative analysis of data by the planning profession. I. Assumption Technique: The Assumption Technique is by far the simplest economic analysis tool available to planners. This method estimates local Basic sector employment by using a fundamental set of assumptions about the local economy. II. Location Quotient Technique: A step up in complexity, the Location Quotient Technique determines the level of Basic sector employment by comparing the local economy to the economy of a larger geographic unit like the State or the entire United States.

III. Minimum Requirements Technique:Lastly, the Minimum Requirements Technique is the most complex economic base analysis method. This method compares the local economy with the economies of a sample of similarly sized regions. Economic Base Projection Techniques Once the local economy has come to be understood in more depth, often a planner's attention turns toward the future. What projections can be made about the local economy? To address this question, techniques related to the above methods have been developed. Again, these techniques are not solely related to economic base analysis, but, rather, illustrate some of the guiding principles when making projections of any kind. I. Constant-Share Projection Technique: This technique assumes a local share of region's activity for individual industries will remain constant into the future. Like the Location Quotient technique above, a larger reference region is used, in this case, to project future economic conditions. II. Shift-Share Projection Technique: This technique adds some complexity to the Constant Share Projection Technique. The Shift-Share method adds a "shift" factor to the equation to attempt to account for the movement of jobs into or out of the local economy due to factors affecting the local economy. Key Concepts

Basic versus Non-basic sectors: Exports versus Imports Why the Basic Sector is considered more important to the local economy The Base Multiplier: Interpretation, Calculation Local Conditions/Examples Defining your geographic and measurement units Data sources/SIC Codes

Lessons to be Learned

The Urban Planning profession is intimately tied to both population and economic considerations (and many others, of course). Counting persons and households is essential to understanding the future and prospects for an area. Equally important is an understanding of the strengths, weaknesses, and changes within the local economy. Economic Base Theory provides a framework for understanding the local economy and points towards several techniques for analyzing the local economy. The techniques that have developed from this theory attempt to translate general principles concerning the local economy into calculable and tangible evidence about that economy. It is essential to understand the power and the limitations of this translation. In summary, then, Economic Base Theory provides an overall framework to understand and specific tools to analyze the local economy. However, these methods should only be used with a clear understanding of what information is generated through an application of these techniques and what information isnot provided through an application of these techniques.