EC 6313, Regional Economics

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EC 6313, Regional Economics

• Week Three of Ed. Leadership presentations.

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Topic 1, Basics of State and Local Finance,
Revenue Forecasting, Cost-Benefit Analysis, and
Fiscal Impact Analysis

• The Growth of State and Local Governments
• TAXATION CONCEPTS and Tax Incidence
• Revenue Forecasting

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BACKGROUND

• fiscal year 2000 was the peak and therefore close
  to the end of a near record economic expansion.
• At the end of that fiscal year, the combined
  states had a year-end balance equal to 10.4
  percent of their budget.
• This was one of the highest year-end balances in
  20 years.
• In a fairly predictable response, 42 states
  lowered taxes by a total of about 5.2 billion
  dollars.

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An Introduction to State and Local Public Finance

• Thomas A. Garrett and John C. Leatherman

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• However, the euphoria of 2000 was followed by a
  sobering 2001. During fiscal year 2001, there
  was a precipitous decline in revenue growth.
  Revenues increased by a modest 4.5 percent the
  slowest growth experienced since 1993 in
  nominal terms(Honey, Jean, Spring, 2002. The
  States Reactions A Comparative Analysis
  Business Pespectives, pp. 28-33).
• This amounted to a real (adjusted for inflation)
  increase of just over 2 percent.

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Significant Budget Short-Falls because of

• increasing unemployment rolls
• Lower sales tax revenues
• Lower income tax revenues
• a 14 percent increase in the overall costs of
  health care

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Since then

• 44 states have failed to reach their expected
  levels of revenues,
• 19 have spent more than their budget allowed and
• 36 have experienced some sort of shortfalls
• According to the NASBO, report state revenues
  have been shrinking across the nation as
  pressures on spending have increased (National
  Association of State Budget Officers (NASBO),
  2002. The Fiscal Survey of States (Washington
  D.C.National Governors Association), November.)

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The largest budgetary items for state governments

• elementary and secondary education (22.2 percent)
  
• Medicaid (19.6 percent)
• higher education (11.3 percent)
• transportation (8.9 percent)
• corrections (3.7 percent)
• public assistance (2.2 percent)
• other expenditures (32.1 percent)

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The largest budgetary items for state governments
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Nationwide, general fund spending (as enacted in
state budgets) for fiscal year 2003 were the
smallest increases in state general fund spending
since 1983 did not even keep pace with inflation.

• Since the recession of the early 1990s, states
  have worked to build their rainy day fund
  balances and ending balances to safeguard against
  disruption of services should economic growth
  slow. The fiscal downturn during those years and
  during a similar period in the early 1980s caused
  state balances to fall rapidly. During the
  one-year period from 1980 to 1981, for example,
  balances plunged from 9 percent of expenditures
  to 4.4 percent, forcing states to cut budgets and
  raise taxes. During the early 1990s, states
  found themselves lacking balances adequate to
  manage a fiscal slowdown once again. Before the
  economy slowed in 1989, state balances equaled
  4.8 percent of expenditures. Within two years,
  balances hit bottom, totaling only 1.1 percent of
  expenditures in 1991. NASBO (2002), p.13.

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• Given the repetitiveness of the pattern, it is
  thus apparent that budget crises following
  periods of expansion should be no surprise.

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Treasurer of Mississippi when times were good.

• Certainly the time to consider tax relief is
  now, during flush economic times. Elected
  officials and those seeking elected office and
  citizens should educate themselves to that tax
  relief which is most affordable, effective and
  does not jeopardize the provision of needed
  services and quality of life. Bennett, Marshall,
  (1999)

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When Times are Bad

•       Mississippi has weathered wilting revenue
  growth for three fiscal years and is positioned
  for a fourth straight year of under-performance
  in the economy. Revenue for fiscal year 2002,
  which ended June 30, actually fell below estimate
  by 268,000,000, and short of the previous year
  by 72.9 million or (-2.1). While sales tax
  collections grew by almost 2, individual income
  tax collections were (-3.82) below the previous
  year, and corporate income tax collections posted
  a (-7.10) decline. Budget safeguards enacted
  throughout the year, including reductions to
  estimates and budgets, tapping the rainy day
  fund, and transferring monies from the Health
  Care Trust Fund, allowed Mississippi to end the
  year with a balanced budget. However, our budget
  safeguards were designed to offset two to four
  years of lagging revenue, and a buoyant economic
  recovery is not expected in 2003. We must be
  pragmatic in our approach and conservative in our
  budgeting and forecasting this year to avoid deep
  and painful budget cuts next Spring. Bennett,
  Marshall, (2002)

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TAXATION CONCEPTS
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generally accepted principles of taxes

• efficient and not interfere in the market
  process, unless such interference is the reason
  for the tax.
• simple and easily administered
• contribute to the stability of revenue flows
• provide adequate revenues for the planned uses of
  those revenues
• transparent, meaning that it should be clearly
  apparent that the payment is a tax and the amount
  of the tax should be readily discernible by
  taxpayers. In other words, there should be no
  hidden taxes.
• Finally, the tax should be fair.

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contradictions

• The first contradiction is between stability and
  fairness. The most progressive taxes are income
  taxes while sales taxes tend to be more
  regressive, yet sales taxes tend be fairly stable
  during economic downturns. On the other hand
  progressive income taxes tend to fluctuate with
  general economic activity (Fox, William F. and
  Charles A. Campbell, 1984. "Stability of the
  State Sales Tax Variability of the Income
  Elasticity" National Tax Journal, June. )

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contradictions

• A second apparent contradiction is the very
  concept of fairness. Fairness is often in the
  eye of the beholder.

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Fairness consists of two principles

• the benefits principle
• ability to pay principle.

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benefits principle

• taxpayers should pay in proportion to the
  benefits derived from the use of those taxes.
• For example, those who drive should pay gasoline
  taxes, which go toward the building and
  maintenance of roads.
• This principle is often the reason for such
  taxation schemes as user fees and is seen by some
  as a reason for taxes, which ignore the level of
  income of the taxpayer.

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ability to pay principle

• those with greater ability to pay should pay the
  most
• derived from a basic economic principle called
  the declining marginal utility of money.
• for those who have a great deal of money, an
  additional dollar is of little meaning or
  importance, whereas, for those with very little
  money, an additional dollar is very important.

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Five Types of Taxes to Raise State and Local
Revenues

• general sales tax
• the personal income tax
• the corporate income tax
• the property tax and
• excise taxes (taxes such as alcohol and tobacco
  taxes and the motor fuels tax)

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Tax Basics

• Tax BaseThe item or the activity that is to be
  taxed
• Tax Rate StructureThe relationship between the
  amount that is to be paid in tax and the tax base
  for a given accounting period
• Marginal Tax RateThe amount by which the tax
  increases when the tax base increases.
• Average Tax RateThe total amount of tax divided
  by the total amount of the tax base.
• Tax bracketThe range of the tax base in which
  the marginal rate is constant

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Tax Rate Structure

• Progressive Tax has a structure where the
  marginal tax rate is increasing and greater than
  the average tax rate
• Proportional Tax has a structure where the
  marginal tax rate is constant and equal to the
  average tax rate
• Regressive Tax has a structure where the marginal
  tax rate is decreasing and less than the average
  tax rate

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trends of Mississippi tax revenues over the
period 1998-2001

• 1) Mississippi is becoming harder pressed
  for revenues because of general economic
  conditions and programs which benefit the poor
  are often the first targets of expenditure cuts
• 2) The continued need to build both physical and
  social infrastructure for future economic growth.
  
• 3) the new federalism

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New Federalism or Devolution

• a general transfer of many traditional federal
  responsibilities to state and local governments
• much of this without the commensurate shifting of
  revenues to state and local authorities
• A significant amount of the new federalism
  revolves around the changing welfare system,
  including how the new welfare rules and the
  resulting system have affected the poor.

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Devolution
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• Tanenwald (1997) examined the fiscal comfort of
  each state as a function of their tax bases and
  their spending needs. Figure 1, indicates his
  findings, including that the least fiscally
  comfortable state is Mississippi.

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Tannenwald, Robert, Fall 1997. DevolutionHow
will New England fare? Regional Review. (Federal
Reserve Bank of Boston) 7 (4).

• Devolution is the term commonly used to
  describe the process by which the
  responsibilities of government are being shifted
  from federal to state and state to local
  governments. Much attention has been paid to the
  impact this shift may have on the services
  government provides. But, if state and local
  governments are to continue to provide the
  services they have in the past, and provide the
  new high quality services that the public
  demands, the discussion will inevitably turn to
  taxes (Ettlinger, Michael P., John OHare, Robert
  S. McIntyre, Julia King, Elizabet A. Fray, and
  Nail Miransky, June, 1996. Who Pays A
  Distributional Analysis of the Tax Systems of all
  50 States. (Washington DC, Citizens for Tax
  Justice and the Institute on Taxation and
  Economic Policy)

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general sales tax

• among the most regressive of taxes
• States that rely heavily on the general sales tax
  tend to have more regressive tax systems

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The 12 Most Regressive General Sale Taxes (sales
taxes as shares of income by family income group,
2002.
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Ettlinger et al (1996)

• found that most state tax systems take
  proportionally more income from middle and lower
  income families than from the wealthy
• In other words, most state and local tax systems
  are income regressive.
• The Ettlinger study was updated in 2003 by
  McIntyre et al. and published as Who Pays (2nd
  ed.).
• Both studies indicate the characteristics that
  make a state tax system regressive include a
  reliance on sales and excise taxes rather than
  income taxes and the use of flat rather than
  progressive income taxes.

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• Sales taxes are generally a fixed percentage of
  some broad range of goods and sometimes services.
  
• The exact base for taxable sales varies
  substantially from state to state with some
  states exempting food and or drugs from sales
  taxes and some allowing additions to the base
  rate for local usage.
• Since sales taxes are imposed on the amount of
  expenditure, and because consumption generally
  decreases as a percentage of income as income
  grows, these taxes are income regressive.

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• Excise taxes are usually confined to a relatively
  small group of goods and are taxes upon the
  quantity of goods rather than the expenditure on
  such goods.
• Wealthy tax payers who are able to afford higher
  priced goods, actually pay the same amount of tax
  as poorer people who are only able to afford
  cheaper varieties.
• Excise taxes comprise a lower percentage of the
  price as the price of the good increases.
• Those who are wealthiest tend to buy the most
  expensive items.
• In this respect, excise taxes are even more
  income regressive than sales taxes and are
  generally characterized as the single most income
  regressive type of tax.

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• Most local tax revenues emanate from property
  taxes.
• Such taxes are on personal property of
  individuals and businesses, the major portion of
  which tends to be on real estate.
• Such a tax is generally income regressive, but
  less regressive than sales and excise taxes.
• The real estate held by wealthy individuals tends
  to be less as a share of their total income than
  is real estate held by families that are less
  well off. Generally such taxes are a flat
  percentage of a proportion of assessed valuation.
  
• Because the poor tend to pay a much higher share
  of their total income as rent than do the
  wealthy, the portion of the property tax passed
  on to renters also tends to be regressive.

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Trickle down and Regressivity

• It has been argued by some proponents of
  consumption taxes, that progressive taxes such as
  income taxes tend to reduce economic growth
  because higher income individuals have less money
  to invest. From such reasoning (trickle down
  theory) it is argued that regressive taxes are
  better for economic growth.

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• There is simply no correlation between the
  regressivity of a states tax system and a
  states income levels or income growth.
• Both the ten most regressive states and the ten
  least regressive have about the same average
  per-capita person income,
• and both had about the same average per capita
  personal income growth rates over the past seven
  years.
• Indeed, each of these groups was, on average,
  about the same in both categories as states in
  the middle of the pack (Ettlinger, et al (1996).

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Regressivity in Mississippi
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(No Transcript)
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The Personal Income Tax

• States have increased their reliance on the
  personal income tax as a source of revenue more
  than any other tax.
• tax revenues accounted for less than 10 percent
  of state tax revenues in 1960
• more than 30 percent of state tax revenues in
  1996
• As of 1999, seven states with no personal income
  tax on earnings were Alaska, Florida, Nevada,
  South Dakota, Texas, Washington and Wyoming.
• Two states, New Hampshire and Tennessee, only tax
  dividend and interest income.

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Source U.S. Census Bureau State Government
Finances, various years, and (Holcombe and Sobel,
1997, 36)

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The Corporate Income Tax

• Corporate income taxes are another possible
  source of revenue for the state.
• Mississippi has already become a pioneer in
  solving the passive investment corporation
  loophole (Mazerov, Michael. April 9, 2002.
  Closing Three Common Corporate Income Tax
  Loopholes Could Raise Additional Revenue for Many
  States. Center on Budget and Policy Priorities.
  http//www.cbpp.org/4-9-02sfp.htm.)
• Nationally, revenues from state corporate income
  taxes have been dropping even when federal
  corporate income taxes were increasing.
• In Mississippi, if revenues from corporate taxes
  were making up the same portion of total revenues
  going to the Tax Commission as in 1998 (that is,
  6.89 rather than 5.65), coporations would have
  paid an additional 65,290,759 in corporate
  income taxes.

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marginal tax rate (MTR)

• measures the additional tax liability for every
  additional dollar in income.
• Marginal tax rates are adjusted by state and
  local officials (as well as federal officials for
  the federal personal income tax) to influence
  personal income tax revenues.
• the dramatic increase in personal income tax
  revenues generated by states is a result of
  increases in marginal tax rates over time.

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tax incidence

• who bears the final burden of a specific tax or
  group of taxes
• regressive tax is one for which the tax burden
  (defined as the share of income going to the tax)
  decreases as income increases.
• proportional when the tax burden is relatively
  constant across income groups.
• progressive when the tax burden increases as
  income increases

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Tax Incidence in Mississippi

• Total taxes paid by those in the lowest income
  bracket (less than 11,000) were a total of 10
  percent of family income.
• This rose for the second 20 percent (from 11,000
  to 19,000) to 11.5 percent of family income.
• After that, as income rises the percentage of
  family income going to taxes decreases steadily.
  
• The top 1 percent of the income distribution
  (228,000 or more) pays only 5.3 percent of their
  income as taxes.
• It is clear that overall, Mississippi has
  regressive taxes and this is primarily due to
  highly regressive sales taxes.
• It is also clear that while the income taxes are
  progressive, they are only very mildly
  progressive.
• The property tax would be much more regressive
  except for the homestead exemption.

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State Local Taxes in 2002, Shares of Family
Income for Non-Elderly Taxpayers
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Tax Incidence Comparison
State Local Taxes in 2002, Shares of Family
Income for Non-Elderly Taxpayers
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Other Revenue Sources

• intergovernmental revenues-funds exchanged
  between levels of government
• User fees are payments for the use of a publicly
  provided service, such as state parks, sewage and
  water services and toll roads.

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Mississippi State Tax Commission, General Fund
Receipts as a Percent of Total Revenues, Fiscal
Years Ending June 30.
Receipts as a Percent of Total Revenues, Fiscal
Years Ending June 30.
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A Unit Tax on Sellers
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A Unit Tax on Buyers
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The Burden of the Tax

• the burden on sellers is really a burden on
  individuals rather than a physical business
  entity.
• A burden on sellers may result in lower profits,
  lower employee wages, etc.
• although we say the burden of taxation falls on
  sellers, the reader should realize that the
  burden really falls on all individuals associated
  with the taxed business.
• The economic impact of the tax is the same
  regardless of which group is initially taxed.

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A General Rule of Tax Incidence

• those individuals less likely to change their
  behavior will ultimately bear a greater burden of
  the tax.
• The price elasticity characterizes willingness to
  change behavior.

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The Case of Inelastic Supply

• In Figure 2a, the price elasticity of supply is
  less than the price elasticity of demand
• This is determined by examining the slope of the
  supply and demand curves - a change in price has
  a smaller impact on the quantity supplied than it
  does on the quantity demanded.
• Because suppliers change their behavior less than
  consumers, suppliers bear a larger portion of the
  final tax burden.

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The Case of Elastic Supply

• Figure 2b considers the case where demand is more
  inelastic than supply.
• That is, consumers are less responsive to changes
  in price than suppliers.
• Because demand is less responsive to price
  changes than is supply, consumers will bear a
  greater portion of the overall tax burden.

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Efficiency is said to occur when

• the marginal social benefits of consuming a good
  are equal to or are greater than the marginal
  social costs of producing that good, or similarly
• any additional consumption or production of a
  good is not possible without making another party
  worse off.

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Market Efficiency

• The supply curve for a commodity can be equated
  to the marginal social costs (MSC) of production
• As we are also assuming no spill-over costs to
  other parties, the marginal cost of production is
  equal to the marginal social costs of production.

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Externalities (one source of market failure)

• negative (or sometimes positive) unintended
  spill-over effects to third parties.
• producers of a negative externality, do not
  consider the external costs of steel production
  (the pollution) when determining its production
  decisions.
• As a result, the market provides an amount of
  steel production that is greater than the
  efficient amount because the external costs of
  steel production are not considered.
• A tax equal to the external costs of production
  (pollution) will decrease the supply curve for
  producers and restore efficiency conditions at
  MSB MSC

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Efficiency Loss From A Unit Tax

• The excess burden is triangle ABC
• The excess burden of taxation is dependent upon
  the price elasticity of demand and the tax rate
• there will also be an impact on other markets as
  consumers change their consumption of other
  commodities.

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The Efficiency/Equity Tradeoff

• most taxes create inefficiencies
• tax revenues are used in the production of social
  goods, such as education and public welfare
• Without taxes, markets would function more
  efficiently.
• Production levels would be higher, consumers
  would have more goods available to them, prices
  would be lower and mean incomes would be higher,
  although there would be a greater variance in
  incomes across individuals.
• With greater efficiency there will exist greater
  societal inequality because there are no revenues
  to be allocated from one portion of society to
  another.

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models of optimal taxation

• Ramsey Rule. This model assumes that governments
  attempt to minimize the excess burden (efficiency
  loss) of taxation subject to given revenue
  requirements. The optimal tax rate under the
  Ramsey rule is the rate that minimizes the excess
  burden of taxation while still generating the
  required revenues.
• The Laffer curve This model assumes that
  governments will attempt to generate as much
  revenue as possible without any regard to the
  efficiency losses caused by taxation. Only
  constitutional constraints and other legislation
  can limit the governments desire for increased
  revenue

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The Laffer Curve
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The Forecasting Process
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Guajardo and Miranda (2000) seven step process
step 1

• The first step involves selecting a time period
  over which revenue data is examined. The length
  of time depends on the availability and quality
  of data, the type of revenue to be forecasted,
  and the degree of accuracy sought.

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Guajardo and Miranda (2000) seven step process
step 2

• In the second step, the data is examined to
  determine any patterns, rates of change, or
  trends that may be evident. Patterns may suggest
  that the rates of change are relatively stable or
  changing exponentially. Once the trend is
  identified, the forecaster needs to decide to
  what degree the revenue is predictable. This is
  done by examining the underlying characteristics
  of the revenue, such as the rate structures used
  to collect the revenue, changes in demand, or
  seasonal or cyclical variation.

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Guajardo and Miranda (2000) seven step
process-step 3

• Forecasters next need to understand the
  underlying assumptions associated with the
  revenue source.
• They need to consider to what degree the revenue
  is affected by economic conditions, changing
  citizen demand, and changes in government
  policies.
• These assumptions help determine which
  forecasting method is most appropriate.

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Guajardo and Miranda (2000) seven step process
step 4

• The next step is to actually project revenue
  collections in future years.
• The method selected to perform the projection
  depends on the nature and type of revenue.
• Revenue sources with a high degree of
  uncertainty, such as new revenues and grants or
  asset sales, may employ a qualitative forecasting
  method, such as consensus or expert forecasting.
• Revenues that are generally predictable will
  typically be forecast using a quantitative
  method, such as a trend analysis or regression
  analysis.

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Guajardo and Miranda (2000) seven step process
step 5

• After the projections have been made, the
  estimates need to be evaluated for their
  reliability and validity.
• To evaluate the validity of the estimates, the
  assumptions associated with the revenue source
  are re-examined.
• If the assumptions associated with existing
  economic, administrative, and political
  environment are sound, the projections are
  assumed valid.
• Reliability is assessed by conducting a
  sensitivity analysis. This involves varying key
  parameters used to create the estimates.
• If large changes in the estimates result, the
  projection is assumed to have a low degree of
  reliability.

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Guajardo and Miranda (2000) seven step process
step 6

• In the sixth step, actual revenue collections are
  monitored and compared against the estimates.
• Monitoring serves both to assess the accuracy of
  the projections and to determine whether there is
  likely to be any budget shortfall or surplus

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Guajardo and Miranda (2000) seven step process
step 7

• Finally, as conditions affecting revenue
  generation change, the forecast will need
  updating.
• Fluctuations in collections may be caused by
  unexpected changes in economic conditions, policy
  and administrative adjustments, or in patterns of
  consumer demand.

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Forecasting Methods

• wide range of forecasting techniques available
• range from relatively informal qualitative
  techniques to highly sophisticated quantitative
  techniques
• In revenue forecasting, more sophisticated does
  not necessarily mean more accurate

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Forecasting Topics

• The importance of forecasting
• Component factors of the time-series model
• Smoothing of annual time series
• Moving averages
• Exponential smoothing
• Least square trend fitting and forecasting
• Linear, quadratic and exponential models

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Chapter Topics
(continued)

• Autoregressive models
• Choosing appropriate forecasting models
• Time series forecasting of monthly or quarterly
  data
• Pitfalls concerning time-series analysis

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The Importance of Forecasting

• Government needs to forecast unemployment,
  interest rates, expected revenues from income
  taxes to formulate policies
• College administrators need to forecast
  enrollments to plan for facilities and for
  faculty recruitment

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Time-Series

• Numerical data obtained at regular time intervals
• The time intervals can be annually, quarterly,
  daily, hourly, etc.
• Example
• Year 1994 1995 1996 1997 1998
• Sales 75.3 74.2 78.5 79.7 80.2

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Time-Series Components
Cyclical
Trend
Time-Series
Random
Seasonal
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Trend Component

• Overall upward or downward movement
• Data taken over a period of years

Upward trend
Sales
Time
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Cyclical Component

• Upward or downward swings
• May vary in length
• Usually lasts 2 - 10 years

1 Cycle
Sales
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Seasonal Component

• Upward or downward swings
• Regular patterns
• Observed within 1 year

Sales
Summer
Winter
Spring
Fall
Time (Monthly or Quarterly)
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Random or Irregular Component

• Erratic, nonsystematic, random, residual
  fluctuations
• Due to random variations of
• Nature
• Accidents
• Short duration and non-repeating

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e.g. Quarterly Retail Sales with Seasonal
Components
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e.g. Quarterly Retail Sales with Seasonal
Components Removed
82
Multiplicative Time-Series Model

• Used primarily for forecasting
• Observed value in time series is the product of
  components
• For annual data
• For quarterly or monthly data

Ti Trend Ci Cyclical Ii Irregular Si
Seasonal
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Moving Averages

• Used for smoothing
• Series of arithmetic means over time
• Result dependent upon choice of L (length of
  period for computing means)
• To smooth out cyclical component, L should be
  multiple of the estimated average length of the
  cycle
• For annual time-series, L should be odd

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Moving Averages
(continued)

• Example Three-year moving average
• First average
• Second average

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Moving Average Example
John is a building contractor who has constructed
24 single-family homes over a six-year period.
Provide John with a three-year Moving Average
Graph.
Year Units Moving Ave 1994 2
NA 1995 5 3 1996
2 3 1997 2 3.67 1998
7 5 1999 6 NA
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Moving Average Example Solution
Year Response Moving Ave 1994
2 NA 1995 5 3 1996
2 3 1997 2
3.67 1998 7 5 1999
6 NA
Sales
L 3
8 6 4 2 0
94 95 96 97 98 99
No MA for the first and last (L-1)/2 years
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e.g. 5-point Moving Averages of Quarterly Retail
Sales
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Exponential Smoothing

• Weighted moving average
• Weights decline exponentially
• Most recent observation weighted most
• Used for smoothing and short term forecasting
• Weights are
• Subjectively chosen
• Ranges from 0 to 1
• Close to 0 for smoothing out unwanted cyclical
  and irregular components
• Close to 1 for forecasting

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Exponential Weight Example
Year Response Smoothing Value
Forecast (W .2, (1-W).8) 1994 2
2 NA 1995 5
(.2)(5) (.8)(2) 2.6 2 1996
2 (.2)(2) (.8)(2.6) 2.48
2.6 1997 2 (.2)(2)
(.8)(2.48) 2.384 2.48 1998 7
(.2)(7) (.8)(2.384) 3.307 2.384 1999
6 (.2)(6) (.8)(3.307)
3.846 3.307
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Exponential Weight Example Graph
Sales
8 6 4 2 0
Data
Smoothed
94 95 96 97
98 99
Year
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The Least Squares Linear Trend Model
Year Coded X Sales (Y) 95 0
2 96 1 5 97 2
2 98 3 2 99 4
7 00 5 6
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The Least Squares Linear Trend Model
(continued)
Excel Output
Projected to year 2001
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The Quadratic Trend Model
Year Coded X Sales (Y) 95 0
2 96 1 5 97 2
2 98 3 2 99 4
7 00 5 6
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The Quadratic Trend Model
(continued)
Excel Output
Projected to year 2001
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The Exponential Trend Model
or
Year Coded X Sales (Y) 95 0
2 96 1 5 97 2
2 98 3 2 99 4
7 00 5 6
Excel Output of Values in logs
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Model Selection Using Differences

• Use a linear trend model if the first differences
  are more or less constant
• Use a quadratic trend model if the second
  differences are more or less constant

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Model Selection Using Differences
(continued)

• Use an exponential trend model if the percentage
  differences are more or less constant

98
Autoregressive Modeling

• Used for forecasting
• Takes advantage of autocorrelation
• 1st order - correlation between consecutive
  values
• 2nd order - correlation between values 2 periods
  apart
• Autoregressive model for p- th order

Random Error
99
Autoregressive Model Example
The Office Concept Corp. has acquired a number of
office units (in thousands of square feet) over
the last eight years. Develop the second order
Autoregressive model.
Year Units 93 4 94 3 95
2 96 3 97 2 98 2 99
4 00 6
100
Autoregressive Model Example Solution
Year Yi Yi-1 Yi-2 93 4 ---
--- 94 3 4 --- 95
2 3 4 96 3 2
3 97 2 3 2 98 2
2 3 99 4 2
2 00 6 4 2
Develop the 2nd order table Use Excel to estimate
a regression model
Excel Output
101
Autoregressive Model Example Forecasting
Use the second order model to forecast number of
units for 200x
102
Autoregressive Modeling Steps

• 1. Choose p note that df n - 2p - 1
• 2. Form a series of lag predictor variables
• Yi-1 , Yi-2 , ,Yi-p
• 3. Use excel to run regression model using all p
  variables
• 4. Test significance of Ap
• If null hypothesis rejected, this model is
  selected
• If null hypothesis not rejected, decrease p by 1
  and repeat

103
Selecting A Forecasting Model

• Perform a residual analysis
• Look for pattern or direction
• Measure sum of square error - SSE (residual
  errors)
• Measure residual error using MAD
• Use simplest model
• Principle of parsimony

104
Residual Analysis
e
e
0
0
T
T
Random errors
Cyclical effects not accounted for
e
e
0
0
T
T
Trend not accounted for
Seasonal effects not accounted for
105
Measuring Errors

• Choose a model that gives the smallest measuring
  errors
• Sum square error (SSE)
• Sensitive to outliers

106
Measuring Errors
(continued)

• Mean Absolute Deviation (MAD)
• Not sensitive to extreme observations

107
Principal of Parsimony

• Suppose two or more models provide good fit for
  data
• Select the simplest model
• Simplest model types
• Least-squares linear
• Least-square quadratic
• 1st order autoregressive
• More complex types
• 2nd and 3rd order autoregressive
• Least-squares exponential

108
Forecasting With Seasonal Data

• Use categorical predictor variables with
  least-square trending fitting
• Exponential model with quarterly data
• The bi provides the multiplier for the i-th
  quarter relative to the 4th quarter.
• Qi 1 if i-th quarter and 0 if not
• Xj the coded variable denoting the time period

109
Forecasting With Quarterly Data Example
Standards and Poors Composite Stock Price Index
Quarter 1994 1995 1996
1997
Excel Output
r2 is .98
Appears to be an excellent fit.
110
Forecasting With Quarterly Data Example
(continued)
Excel Output
Regression Equation for the first quarter
111
Forecasting with Quarterly Data in PHStat

• Use PHStat multiple regression
• Excel spreadsheet for the stock price index
  example

112
Pitfalls Regarding Time-Series Analysis

• Assuming the mechanism that governs the time
  series behavior in the past will still hold in
  the future
• Using mechanical extrapolation of the trend to
  forecast the future without considering personal
  judgments, business experiences, changing
  technologies, and habits, etc.

113
Industrial and Regional Clusters Industrial and
Regional Clusters Concepts and Comparative
ApplicationsEdward M. Bergman and Edward J.
Feser
114
Industry clusters

• refer to the tight connections that bind certain
  firms and industries together in various aspects
  of common behavior, e.g., geographic location,
  sources of innovation, shared suppliers and
  factors of production, and so forth.
• Industry cluster concepts date from the last
  century, but they have captured the imagination
  of active policymakers and the serious attention
  of scholars only in the last decade of the
  twentieth century

115
Examples of cluster members

• End-product or service companies
• Suppliers of specialized inputs, components,
  machinery, financing, and services
• Firms in related and downstream industries (i.e.,
  channels or customers)
• Producers of complementary products
• Specialized infrastructure providers
• Government and other institutions providing
  specialized training, education, information,
  research, and technical support (e.g.
  universities, think tanks, vocational training
  providers)

116

• the industry cluster concept is its capacity to
  help both the analyst and policymaker "see the
  regional economy whole."
• cluster analysis is not so much an innovation in
  regional theory or methods, as it is a
  comprehensive approach for understanding regional
  economic conditions and trends, as well as the
  policy challenges and opportunities those
  conditions and trends portend.
• industry cluster analyses and policies may be
  viewed as applications of a set of well-worn but
  rejuvenated theories of how geography helps drive
  economic growth and change.
• Industry cluster analysis can help exploit the
  growing wealth of regional economic data, provide
  a means of thinking effectively about industrial
  interdependence, and generate unique pictures of
  a regional economy that reveal more effective
  policy options.

117
(No Transcript)
118

• . Regional industry clusters are industry
  clusters that are concentrated geographically,
  normally within a region that constitutes a
  metropolitan area, labor market shed, or other
  functional economic unit.

119
Porters 4 competitive factors

• 1) the nature of firm strategy, structure and
  rivalry in the country, including attitudes
  toward competition, market institutions, the
  degree of local competition, and other cultural
  and historical factors affecting how firms do
  business with each other, their workers, and the
  government
• 2) factor conditions, or the basic endowments or
  conditions on which the firm seeks to compete
  (e.g., cost-related basic factors such as ready
  supplies of natural resources or inexpensive,
  unskilled labor versus knowledge and/or
  technology related advanced factors)
• 3) demand conditions or the nature of local
  demand (e.g., the needs and wants of the consumer
  for foreign and domestic goods as well as the
  existence of local industrial demand for related
  intermediate goods)
• 4) the presence of related and supporting
  industries, including suppliers and successful
  competitors (both to stimulate cooperation, the
  latter to also stimulate rivalry).

120
Porters Conclusion

• the success of an individual company may be
  partly traced to the size, depth, and nature of
  the cluster of related and supporting
  enterprises--both private and public--of which it
  is a part.
• Much of Porters analysis focuses on outlining
  the basic conditions determining cluster
  competitiveness.

121
Francois Perroux

• . In the 1950s, Francois Perroux argued that to
  understand economic growth and change, analysts
  need to focus on the role of propulsive
  industries, those industries that dominate other
  sectors because of their large size, considerable
  market power, and/or role as lead innovators.
• Propulsive industries (or even individual firms)
  represent poles of growth which attract, focus,
  and direct other economic resources (Darwent
  1969). Such constellations of producers,
  suppliers, and other economic actors sound
  surprisingly like clusters.

122

• Perroux (1950) viewed economic space as the
  non-spatial sphere in which relations between
  firms and their buyers and suppliers (as well as
  other key economic institutions) take place.
• For Perroux, there is no reason why physical
  space should necessarily bear any relationship to
  economic space enterprise linkages will extend
  without spatial limit throughout the globe, at
  least where they are economically justified.
• Directing ones analysis to particular regions
  will only provide a distorted picture of the
  growth and development process (geographic space
  as banal).

123

• Perroux defines the concepts, for given sets of
  units (whether agents, firms or industries), the
  growth pole is a set that has the capacity to
  induce growth of another set ("growth" being
  defined as a lasting increase in the dimensional
  indicator) the pole of development is a set that
  has the capacity to engender a dialectic of
  economic and social structures whose effect is to
  increase the complexity of the whole and expand
  its multidimensional return (1988a, p. 49).

124

• The link between domination and the growth pole
  or development pole is "l'industrie motrice," the
  propulsive industry.
• Because units exercise asymmetric effects upon
  one another, some hold the ability, as they
  expand, to induce expansion in others.
• Industries that generate profit opportunities in
  other industries as they expand are "propulsive
  industries," constituting "poles" of growth in
  economic space.

125

• The use of "economic space" rather than
  "geographical space" in the definition of growth
  poles is deliberate.
• Perroux insisted that the pecuniary externalities
  generated by a propulsive firm or industry might
  be circumscribed in "banal" geographical space,
  or they might not be (1950, pp. 95-96).
• Regional agglomeration was supposed to be just
  one special case of the growth pole concept, and
  regional planning just one of its applications.

126
three major drivers of industry clustering

• 1) strategic business opportunities derived from
  specific kinds of interfirm alliances
• 2) traditional regional factor market advantages
  (labor pools and localized knowledge spillovers)
  and
• 3) the role of non-business institutions such as
  universities, colleges, trade unions, and
  associations. (DeBresson 1996). Doeringer and
  Terkla (1997)

127
five core theoretical concepts

• external economies,
• the innovation environment,
• cooperative competition,
• interfirm rivalry, and
• path dependence.

128
External Economies

• Two basic conceptual approaches to understanding
  benefits to concentration dominate the
  literature
• industrial location theory that builds on Weber
  and Hoover (1937), where the benefits are called
  agglomeration economies, and
• Marshallian perspective that takes as its point
  of departure Marshalls (1890 1961) analysis of
  external scale economies and their presence in
  "industrial districts.

129
Industrial Location Theory

• Weber (1929) identifies agglomeration
  economiesdefined as cost savings firms enjoy as
  a result of increased spatial concentrationas
  one of three primary causes of spatial clustering
  or agglomeration.
• It was a theoretical approach and methodological
  emphasis that eventually became the traditional
  regional science/urban economics approach to the
  study of externalities

130
Hoover

• externalities related to proximity among business
  enterprises (localization economies)
• externalities associated with general urban
  advantages (urbanization economies).

131
Other researchers cite particular advantages of
proximity between firms

• increased market power through brokered buying
  and selling,
• better availability and use of specialized repair
  facilities,
• shared infrastructure,
• reduced risk and uncertainty for aspiring
  entrepreneurs, and
• better information (Isard 1956, Lichtenberg 1960,
  Vernon 1960, Carlino 1979).

132
Path Dependence

• Polarization, core-periphery, and cumulative
  causation models all refer to the tendency for
  regional growth or decline to reinforce itself
  (Myrdal 1957, Friedmann 1966, Kaldor 1970).
• Path dependence refers to the general notion that
  technological choiceseven seemingly inefficient,
  inferior, or suboptimal onescan assume a
  dominant lead over alternatives and be
  self-reinforcing, though not necessarily
  irreversible given a significant enough shock.

133
methods for identifying and analyzing industry
clusters

• There are a variety of tools available for the
  task, from simple measures of specialization
  (location quotients) to input-output based
  techniques.

134

• distinction between highly stylized studies of
  pre-determined sectors (micro-level cluster
  applications) and
• studies that attempt to infer the identity of
  clusters embedded within a very diverse and
  reasonably comprehensive set of regional
  industries.

135
regions interested in pursuing industry cluster
analysis

• have become aware of their leading industries but
  desire an understanding of how ties among firms
  within those industries might be strengthened and
  turned to competitive advantage OR
• are aware of their principal industries, but want
  to identify unseen complementarities and
  potential strategic alliances between those and
  wholly different--or perhaps as yet undeveloped--
  regional industries OR
• they have little knowledge of their core regional
  strengths and potentials, apart from what can be
  gleaned from single-sector trends

136

• techniques that permit a comprehensive
  investigation of virtually all sectors in the
  regional economy are labeled "meso-level cluster
  applications

137
Micro-oriented Cluster Applications

• focus placed on how similar-sector firms
  cooperatively share production capacities,
  markets, labor and technologies, reserving for
  such Italianate arrangements the term cluster.
• such clusters typically consist of very similar
  types of firms selling similar consumer or
  household design-intensive products.
• In other words, single-industry clusters set the
  standard for studies under consideration by
  development policy officials that face a large
  portfolio of very different, interacting
  industries.

138

• Further, such studies, by definition, limit
  attention to physically detectable evidence of
  "currents" flowing among similar sector firms
  that are best uncovered up close and at fairly
  small geographic scales by labor-intensive
  investigations (e.g., on-site interviews, Delphi
  techniques, or focus groups).
• Not surprisingly, this approach restricts its
  view to a single visible collection of similar
  sector firms, thereby overlooking linkages that
  some of its members may have with regionally
  co-located firms from very different sectors, or
  the robust clustering of other sectors.
• A micro-level study then tends to document one
  cluster per region, usually that of its policy
  client.

139
Micro study tools

• Location quotients are the most frequently
  applied method to identify unusually high
  relative concentrations of industrial activity,
  which in these studies are taken as evidence of
  "industrial clusters."
• The cluster studies that employ this simple
  technique to widely available employment data are
  generally indifferent to the fact that high
  concentrations arein the hands of other
  analystsinterpreted as inferential evidence of
  local export production (economic base theory).
• Worse, and somewhat perversely, such studies
  often appear completely unaware that employment
  concentrations per se are indistinguishable
  proxies for total industry output, regardless of
  whether that production is concentrated in one
  huge branch plant or distributed within a
  "cluster" of cooperating establishments and
  firms.

140
Methods of Meso Industry Cluster Analysis
141
Committee and Governing Group Planning Session
Maureen K. Robinson [phone],
MKRobin500_at_aol.com
142
Dimensions of the Groups Role

• Legal or Formal
• Functional
• Symbolic

143
Formal Duties

• Obedience to the underlying rules and goals
• Care to make the organization better
• Loyalty to the mission

144
Group Genesis Elements

• Clear sense of what matters (is there a reason
  for being
• Clear sense of groups role and value
• Respect and trust for the Chair
• Knowing the difference between data, information
  and knowledge
• Equating evaluation with learning
• Creating useful structures
• Making the most of meetings

145
What Matters

• What are the critical issues facing the
  organization?
• What is the groups job in addressing them?
• Do we have the right people, the right skills,
  the knowledge?
• What is the plan for matching the group with the
  issues?

146
A Culture of Productivity

• Build Group Leadership
• Model Good Behavior
• Overrule the Unruly
• Understand and Deal with Gorgeous Monsters
• Resolve Conflict
• Come Prepared to Present

147
Individuals Saying Yes Twice

• Understand the commitment
• Make the time
• Be a learner
• Respect the staff and volunteers
• See the big picture
• Have courage
• Keep issues on the table, not under it
• Be prepared to leave
• Say thank you and goodbye

148
Recasting Relationships

• Its not about who does what. Its about what
  needs to be done
• Project Orientation as the Heart of Planning
• Vertical vs Horizontal assignments in project
  planning

149
Strong Partners

• Common goals/shared responsibility
• Culture of productivity
• Enlightened curiosity/interest in learning
• Trust
• Commitment
• Respect
• Ability to recognize success