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13 January 2009


Nolan Love

A regular reader of RR, this is my first comment, posted with the caveat that I have no background in economic theory other than a casual layman's interest and the occasional Wikipedia article. However, something about the logic of this post set off some warning bells, and I wanted to ask for some clarification and to posit my own theory of the potential benefit of an imported dollar.

To begin with, a challenge to the thesis of the output multiplier via reductio ad absurdum: Imagine a dollar imported to a micro-economy of baseball collectors via the sale of a baseball card. Then picture the same dollar being spent for an indefinite period of time among collectors to buy $1 cards from each other (for the sake of perpetual variety in each collection, let's say). Using the above logic, the multiplier approaches infinity (1/(1-r)) as r approaches 1.0, meaning the economic benefit to the community is immeasurable. But the dollar entered the economy at the same time as a one-dollar card left the economy, so there was no change in value of the overall system, only a conversion of one baseball card into currency, and a lot of transaction. For this reason, I don't think the metric is sophisticated enough on its own to measure economic benefit.

It seems then that the multiplier is a measure of the number of dollar-valued transactions a given dollar is likely to engage in during its tenure in an economy. This, however, is not a guarantee of economic benefit because it is not a guarantee of value creation. The true metric that makes the multiplier valuable is the degree to which spending locally stimulates value-creating activity within the local economy. Buying baseball cards from other members of the economy is economic activity, but it does not make the overall system more valuable. If however, a member of the community carves a walking stick and sells it for the aforementioned dollar, the overall system has increased in value by one walking stick.

The other question that needs to be addressed is what value left the system when the dollar was imported. Each economy has value in the form of property (e.g., land) and potential (e.g. the ability to create net value or wealth from raw materials or by performing services). If an economy imports dollars by exporting/selling non-renewable resources such as oil, or real-estate, or even personal property such as diamond necklaces, the net value of the economy does not change (given a stable currency). If, however, the citizens of the economy trade value that they themselves have created for dollars (e.g. by teaching kickboxing or by sculpting clay), they increase the value of the overall economy through their own voluntary industry which is itself renewable.

The next piece of my somewhat simplified puzzle (which does not address appreciation and depreciation among other things) is the question of how an exported dollar is spent. This dollar can be spent in one of two ways: either it increases the net value of the economy through the purchase of something that increases the overall property or potential (e.g. a tractor or a math lesson), or it decreases the net value because the dollar has not economically edified the community -- e.g. the purchase of entertainment.

Finally, getting back to the original subject of the output multiplier, we have to ask this key question: How much is the spending of each dollar within an economy likely to spur wealth creation therein? The simple, almost tautological answer seems to be "only as much as each citizen demands via his purchasing power something that requires creation anew within the system". This means that buying baseball cards and cars within Nevada County, even if done with great frequency (http://en.wikipedia.org/wiki/Velocity_of_money) will not increase the value to the overall economy. What is needed is the purchase of kickboxing lessons and locally made clay pots while there, the selling of locally created goods and services to those from outside, and the purchase of "economically edifying" property and skills from those outside of the system.

In conclusion, I believe that the output multiplier must be itself multiplied by the percentage of local transactions which are "value-creating" in order to get a sense of the economic benefit of an imported dollar.

George Rebane

Good points Nolan. The presumed use of these multipliers in promoting the building of economies is that, indeed, the succession of trades involves something more than the same type of baseball cards. However, your critique is equally valid to how GDP is computed by the government where each such transaction, no matter what kind of 'value' is produced or not, adds to the quoted total.

Steve Frisch

Nolan Love just hit on the reason why "Buy Local" and "Think Local" are not the same thing.

Buying local only creates wealth if value is created: if the item purchased is imported, if its local and the external costs are higher than the multiplier, or the dollar immediately leaves the community, the new wealth created is insignificant.

To create new wealth by "Thinking Local", (which includes encouraging diversity in local products and services, local manufacture, renewable resource management, local investment, local philanthropy and building local intellectual or physical capacity) is to leave lasting value in the community, which will then multiply.

George Rebane

Appreciably, the notions introduced by Nolan Love and Steve Frisch go beyond the mere definition of output multiplier which is fairly straightforward as seen in my explication. We all understand that each money transaction serves at least one of two major functions – creation of wealth (capital) and supporting consumption. The claimed benefit from the imported dollar, before it leaks out of the economy, is made up of both parts, but most certainly the dollar must support consumption with or without increasing local capital.

Before going on, I want to restrict my discussion to only sane types of economic behavior which will exclude most kinds of repeated exchanges of, say, baseball cards for money. In such exchanges the imported dollar will quickly evaporate from the community, and its departure as such will be captured in the value of the multiplier (M).

Both Nolan and Steve are correct in identifying that some imported money will (should?) be used in local transactions that build retained capital (recall, capital is anything that can be used to create wealth – cash, labor, machinery, land, intellectual property, …). But it is easy to see that there exist plenty of communities, mostly with low M values, that use the imported dollar only for consumption and little or no capital creation, save through the relative scarcity or increase in demand (an exogenous factor) for their very location and/or its resources.

When we consider the entire ‘buy/think locally’ issue, we are really talking about the attempt to make a community, a piece of land more self-sufficient economically. In modern times there are great economic forces arrayed against such insularity. Given facile means of communications and transportation, and the absence of government diktats – directly by checkpoints and barriers, and indirectly by taxes and tariffs – the modern world has on the whole increased our quality of life (QoL) by promoting the exact opposite of such aims and behavior.

Economics and human propensities have long made specialization and the economies of scale the basis for developing and delivering excellence in goods and services. The downside (if any) of such national and international progress has been the requirement of stable and mutually supportive civilizations which understand and teach the benefits of such behavior. For increasing the overall QoL around the world, the arguments for continuing in this direction are legion.

Multiple times on these pages (here) and elsewhere (here) I am on record for supporting more than less specialization in communities and countries. I am still not sure where the boundaries of self-sufficiency and insularity lie – they most certainly depend on the perceived goodwill of one’s partners and peers in such efforts as globalization – but I am fairly certain that expending the resources of a small economy, such as western Nevada County, to achieve a ‘balanced community’ in modern America is a counter-productive fool’s errand. Of course, as always, I invite reasoned argument to counter these beliefs.


Ricardo showed that trade created more real wealth because of "comparative advantage". Having people engage in economic behavior which is comparatively disadvantageous simply because of a misplaced reliance on the multiplier effect is foolish.

George Rebane

Excellent point Stan and agreed. My piece is an explication of the multiplier itself and not an endorsement of one kind of trade policy vs another in order to maximize the creation of wealth in a given economy. To the extent that most small communities have little or no comparative advantage to offer, their ability to sustain themselves as a distinct community (for objectives other than maximizing wealth) mostly depends on the multiplier effect. In our own little community of western Nevada County, the only comparative advantage that we have is a desirable living environment for the retired (cash importers) and tourism drawn by our natural environment and cultural events. Nevertheless, this is not a widely held view, and therefore we continue to promote local policies that are designed to force/maintain a 'balanced community'.

Cy Englert

I appreciate all the information here and I am still struggling to find 'ball park' multipliers for different size communities. Does anyone know of a source of such estimations? For example, I'm wondering if multipliers are larger for remote, rural communitities since they must be by design more self-sufficient. Anyway, I'm building an ROI model incorporating benefits of microfinancing. The output multiplier is an important benefit in estimating the benefit to local communities.

George Rebane

Couple of points Cy -
1. The multiplier would be higher for larger remote communities that provide a large variety of goods/services. Small remote communities would suffer higher leakage especially as abetted by ecommerce.
2. The spreadsheet should let you develop usable bounds for the multiplier.

I think RR readers would be interested in your ROI work (especially incorporating micro-financing), if you care to share it.

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