One way to measure the impact of economic growth or decline in one industry on the entire regional economy is with a tool known as economic base modeling. Economic base analysis was developed in 1928 when Robert Haig was working on a plan for the regional economic development of New York. An economic base analysis divides regional economic activity into two categories: basic economic activities and non-basic activities. Basic economic activities are a form of regional competitive advantage in which the regional output exceeds the regional needs. Thus, basic activities are a source of economic exports for the area. Non-basic activities, on the other hand, are sources of support for the region’s basic economic industries.
Economic base analysis is useful in a real estate market analysis because it provides a data-driven picture of a region’s economic activity. By comparing the size and impact of a particular industry in relation to the state or national level, it is possible to predict how industry-level trends will impact a particular market. The goal of economic base analysis is not only to understand the direct impact of growth or decline on a market but also the overflow into support industries in a market. These tools are essential to performing a thorough market analysis capable of generating realistic proforma cash flow statements.
The Economic Base Model
The first step in creating an economic base analysis is determining which industries make the regional economic base and which industries are non-basic, or support, industries. To accomplish this, we can use the Location Quotient (LQ). The Location Quotient is a way of quantifying how concentrated an industry is within an area compared to the country as a whole.
What does the location quotient mean? Industries with a Location Quotient greater than one can be considered a region’s base industries. Those industries with a Location Quotient less than one can be considered support industries.
The next step is to estimate how employment changes in the economic base industries can influence the support industries as well as the overall regional economic outlook.
The economic base analysis considers that total employment (T) is a function of base employment (B) and support employment (S).
Total employment = Base employment + Support employment
T = B + S
Support employment is proportional to base employment by a constant factor (c).
S = c x T
Re-writing the equation in terms of the base industry,
T = k x B
Where k is the employment multiplier that is defined as:
k = 1 / (1-c).
In other words, the employment multiplier can be defined by calculating the ratio total number of new jobs created to the number of basic industry jobs created during a given time period. Multiplying this ratio by the total number of basic jobs expected to be added to the regional economy results in the total expected number of new jobs created in the region. So, if a company announces that it expects to bring 500 new jobs into an area, the economic base analysis estimates the total new jobs this brings as new support jobs are added as well. This analysis is important in forecasting the future demand for real estate and government services.
Where to Find Data for an Economic Base Analysis
The data needed to create an economic base analysis is easily accessible online through a variety of federal and state government offices. In particular, the U.S. Bureau of Labor Statistics reports annual average employment by major industry. The Covered Employment data series also breaks this information down by the state, county, and major metropolitan MSA sub-categories. Although data may be available down to census tracts and smaller areas, the general availability of and access to such data can be limited. Practically, the subject market area for an economic base analysis is the smallest area for which data is available. The region you analyze as the local economy should, however, represent a reasonable market area for a particular piece of real estate since potential tenants will be drawn from the market in that region. As a result, the local region may be a larger metropolitan area, county, or entire state.
Economic Base Analysis Example
Download the Covered Employment data from the U.S. Bureau of Labor Statistics for the entire United States and the county or metropolitan area of choice. This example uses the Orlando-Kissimmee, Florida MSA. This example uses data on annual average employment by industry. Choose the most recent year for which data is available. This is an example of the raw data collected for the year 2016.
Next, you’ll need to calculate the Location Quotient for the major industries in the region. This figure shows the major industries for private (non-government) employment in the Orlando-Kissimmee, FL MSA. A Location Quotient greater than one indicates a base industry or net exporter of economic activity. So, the base industries in the Orlando-Kissimmee MSA are construction, financial activities, professional and business services, and leisure and hospitality. It is not surprising that this region has a Location Quotient nearly equal to two since the area is known to be a massively popular tourist destination.
| Industry | Location Quotient |
|---|---|
| Goods-producing | 0.664674599 |
| Natural resources and mining | 0.330605357 |
| Construction | 1.213038593 |
| Manufacturing | 0.41740123 |
| Service-providing | 1.143132811 |
| Trade, transportation, and utilities | 0.99493952 |
| Information | 0.983670576 |
| Financial activities | 1.092321103 |
| Professional and business services | 1.153196509 |
| Education and health services | 0.819187622 |
| Leisure and hospitality | 1.952753058 |
| Other services | 0.993404995 |
| Unclassified | 0.13973717 |
The final step is to calculate the regional employment multiplier. This example estimates the employment multiplier using the change in employment between the years 2015 and 2016. In practice, it is best to get an average employment multiplier using employment changes over multiple years.
| Industry | Annual Average Employment | Change Employment 2015-2016 |
|---|---|---|
| Total, all industries | 1,042,526 | 43,773 |
| Goods-producing | 113,104 | 7,874 |
| Natural resources and mining | 5,052 | -324 |
| Construction | 66,175 | 6,884 |
| Manufacturing | 41,878 | 1,314 |
| Service-providing | 929,422 | 35,899 |
| Trade, transportation, and utilities | 219,205 | 7,049 |
| Information | 22,448 | -292 |
| Financial activities | 70,887 | 1,340 |
| Professional and business services | 188,416 | 10,818 |
| Education and health services | 144,734 | 5,111 |
| Leisure and hospitality | 247,860 | 9,333 |
| Other services | 35,563 | 2,808 |
| Unclassified | 310 | -266 |
The employment multiplier is the market’s ratio of total new jobs divided by the total new jobs in base industries. Private employment in the Orlando-Kissimmee metropolitan area grew by 43,773 between 2015 and 2016. Base industries created 28,375 jobs during that time period. Therefore, the employment multiplier is 43,73/28,375, or about 1.5. The economic base analysis helps to predict the impact of base industry growth or decline on the overall regional economy. For example, if a base industry brings 100 new jobs into the Orlando-Kissimmee area, the overall impact would be around 150 total new jobs. Similarly, a decline in economic activity that results in the loss of 100 base industry jobs would create an estimated loss of 150 jobs across the Orlando-Kissimmee area.
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Conclusion
Economic base models focus on the demand side of regional economic growth and often result in a short-run view of urban development. Focusing too much on the immediate growth potential can lead to a lack of development in industries that may take more time and investment to develop in the area. In addition, economic base analysis does not factor into the equation the quality of employment being generated in the market. For example, the overall economic impact of low-skilled or minimum wage jobs is significantly different from the economic impact of highly skilled and paid jobs. Still, economic base analysis is a useful component in a real estate market analysis because it helps to determine future demand for real estate to meet both the needs of growing base industries as well as the support industries. This can include planning to develop adequate office or warehouse space in addition to retail and residential real estate. Economic base analysis is also helpful when forecasting population growth, rental rate growth, and vacancy rates.