EIA modelling

Methodology

The following section gives an overview of the methodology used to conduct an Economic Impact Assessment, with a focus on the inputs required, and interpretation and communication of the outputs produced by the assessment. The methodology is common for undertaking either I-O or CGE modelling. Links to further reading with more detailed technical information on the methodology are also provided.

Inputs required

The key input to conduct an EIA is the level of direct economic contribution (Government spending/investment) in each year considered by the assessment, relative to the ‘Base Case’. The Base Case for the EIA is the ACT economy without the project occurring (i.e. where none of the economic contribution linked to the project occurs). The Base Case for the EIA should align to the Base Case assumed in the Economic Appraisal conducted as part of the Business Case for the project.

The Project Team should clearly document the assumed direct economic contribution relating to the project in each year of the assessment, relative to the Base Case. The Project Team should derive these inputs (primarily the project’s direct benefits and direct costs) from the Financial Analysis Guidelines and Economic Appraisal Guidelines. If the Project Team uses an alternative source to develop these inputs, the Project Team should clearly document this source and the rationale for its use.

For a more appropriate estimate of the overall economic activity and employment impact of a project, the Project Team should allocate cost items to the most relevant industry to which they relate. This approach generally produces more accurate results as it means using industry-specific assumptions around the flow-on impacts of an initial investment, rather than broader economy-wide assumptions.

Conducting the assessment

In the I-O technique, the I-O table is converted into a model of inter-industry response through the manipulation of the I-O database. Specifically, the values in the I-O table are converted to fixed shares which through the process of matrix manipulation can be used to derive estimates of the total response of the economy as a result of the project.

I-O analysis involves the use of multipliers to calculate the overall economic impact of a project or policy change. Two types of multipliers are commonly used:

  • multipliers that measure the industrial response to the change
  • multipliers that measure in addition to the industrial response the consumption-induced response.

In the majority of CGE models used in Australia, firms or producers are assumed to maximise profits. In addition, product and factor markets are assumed to be competitive. Profit maximisation dictates that firms act to minimise costs and factors are generally responsive to price changes. Households are assumed to maximise utility in their consumption decisions, responding to price differences across goods and services. Finally, prices adjust in goods, services, and factor markets to equate demand and supply.

CGE models can be commonly separated into two broad categories, comparative static and recursive-dynamic. Like the I-O model, the comparative static CGE model does not contain any explicit time dimension. A recursive-dynamic CGE model can be linked to a macro-econometric model to produce a ‘business-as-usual’ forecast. The CGE model can then be used to trace out a specific time path of the economy following the introduction of the project. The economic adjustment can then be determined by the difference between the two alternative time paths.

Information on I-O modelling is available from other sources, including the ABS⁠ (Footnote: Australian Bureau of Statistics, 2020: Australian National Accounts: Input-Output Tables ) and New South Wales Treasury.⁠ (Footnote: New South Wales Treasury, 2009: Employment support estimates – methodological framework ) Infrastructure Australia’s guidance on estimating employment impacts also provides more detail and worked examples of a similar methodology.⁠ (Footnote: Infrastructure Australia, 2021: Developing a business case: Stage 3 of the Assessment Framework) Information on CGE modelling is available from other sources, including Australian Transport Assessment and Planning (ATAP).⁠ (Footnote: ATAPA, 2022,Computable General Equilibrium Models in Transport Appraisal)

Outputs

I-O and CGE modelling produces information on two key types of project impacts – often called ‘direct’ and ‘flow-on’. The figure below illustrates how direct investment by Government can generate direct and flow-on impacts in terms of economic activity and supporting employment.

Direct and flow-on impacts

Direct Impacts are when an initial (direct) investment is made by government to proceed with the project, which supports particular sectors of the economy (e.g. a government funds the construction of an infrastructure project, which primarily supports the construction industry).

Examples of the kinds of outputs and measures on which the Project Team could report on a direct and flow-on basis include the following:

  • Economic output: the level of overall economic activity supported by the project, estimated through the total transaction for goods and services. The Project Team should report output in dollar terms, usually on an annual basis during the project’s construction and operation.
  • Value add: the value of outputs produced less the cost of the inputs sourced (i.e. the value that supports incomes and business profits). As with output, the Project Team should report value add in dollar terms, usually on an annual basis.
  • Employment: the number of jobs (as an average over the project life cycle, at its peak or at different stages - noting they are not additive across years) and/or the value of the wages supported to service increased demand.

More guidance on interpreting and communicating the results of the assessment is provided in the Interpreting and communicating results section below.

Benchmark ratios

Infrastructure Australia discusses benchmark conversion factors at Attachment A of Stage 3 of its Developing a Business Case Assessment Framework. These are industry averages for the number of direct jobs (as full-time equivalents or FTE) supported per million dollars of output in 2018-19. These benchmark ratios were published across a broad range of industry sectors for the Australian economy and the Project Team may use them to validate and sense-check the direct employment impacts calculated through the EIA.

Interpreting and communicating results

The Project Team can use the results of the EIA in a number of settings to provide information on how the project is expected to affect economic activity and employment. The sample sentences below provide a guide to the Project Team on the types of information that the assessment can provide. The values in these sentences are illustrative only:

  • In 2030 in the ACT, it is estimated that the project will contribute $10 million of value to the ACT economy.
  • Across the project’s five-year construction phase, it is estimated that the project will contribute $40m to economic output.
  • The project is estimated to support a total of 80 FTE job-years between the commencement of construction and 2035.
  • The project is estimated to support a peak of 40 FTE jobs in 2030, with 25 of these directly related to the project and the remaining 15 relating to the flow-on impacts of the investment on other parts of the economy.
  • Once operational, it is estimated that the project will support around 20 FTE jobs each year on an ongoing basis.

The Project Team should use caution when interpreting and communicating the results of the Economic Impact Assessment. Misinterpretation of this type of analysis by readers is relatively common, due to the differences between the assessment and the Economic Appraisal, as well as the limitations set out in Limitation of Input-Output modelling Section below.

When communicating and reporting the results of the Economic Impact Assessment, the Project Team should:

  • Avoid using language that implies additionality, such as ‘creation of’, ‘increase in’ or ‘addition of’ jobs, or ‘adding to’ the economy. Wording such as ‘supports’ or ‘contributes’ more accurately convey the nature of the analysis
  • State the period for which the results apply; e.g. “in 2036” or “every year” etc.
  • Use caution in the language employed to describe impacts over multiple years (particularly in relation to employment impacts, where the FTE measure should be used to avoid confusion relating to jobs over a number of years)
  • Avoid averaging results where possible as the results of the EIA are applicable to a specific location and may be materially different across different locations

Report assumptions and limitations

The Project Team should detail the assumptions that underpin the EIA when presenting the results. The purpose and limitations of this type of assessment (as detailed in the section below) should be noted, together with its difference from an Economic Appraisal.

Limitations of Input-Output modelling

The EIA is a useful tool to estimate the effect that a project will have on the structure of an economy. However, before undertaking I-O modelling, the Project Team should ensure that it understands the limitations of the methodology. These limitations have been detailed more fully by the ABS⁠ (Footnote: Australian Bureau of Statistics, 2020: Australian National Accounts: Input-Output Tables. ) , but in summary include the following:

  • Lack of additionality: the assessment does not account for displacement or reductions in economic activity in other parts of the economy that offset the project’s impacts (some of which would be from within the ACT)
  • Lack of supply-side constraints: the assessment assumes that the availability of labour and other supply-side inputs is unconstrained
  • Fixed prices: prices for inputs, such as labour, are assumed to be fixed and do not respond to additional demand generated by the project
  • Static economy: the assessment is built on a static picture of the economy that does not consider how the economy may change over time, nor dynamic adjustments that occur over time or as a result of a project
  • Fixed ratios for inputs and production: economies or diseconomies of scale⁠ (Footnote: Economies of scale occur when the average cost of production per unit falls as the scale of production becomes larger. By contrast, diseconomies of scale occur when the average cost per unit increases as output increases. ) are not captured

CGE modelling mitigates many of these limitations as CGE modelling assumes a dynamic economy and imposes limits on the supply of labour and other inputs to production.

Supplementary guidelines

Infrastructure Australia has published a high-level reference guide which provides a consistent methodology to estimate the employment impacts of an infrastructure investment over the asset’s life (see Attachment A of this guide).

The Project Team may wish to refer to Infrastructure Australia’s guide to inform their Economic Impact Assessment.

Footnotes: