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Chapter 6. The Evaluation of Programs aimed at Local and Regional Development: Methodology and Twenty Years of Experience using REMI Policy Insight

Chapter 6. The Evaluation of Programs aimed at Local and Regional Development: Methodology and Twenty Years of Experience using REMI Policy Insight

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6. THE EVALUATION OF PROGRAMS AIMED AT LOCAL AND REGIONAL DEVELOPMENT



Foreword

Policy makers need to evaluate the total effect of local and regional

programs in order to make informed decisions. Development proposals have

economic, social, and demographic implications that go well beyond their

direct effects. To understand these effects, analysts need to use a

comprehensive economic forecasting and simulation model. Local and

regional policy analysis models show the full effects of policy changes on the

local economy, including socioeconomic consequences that may otherwise be

unforeseen or unrecognized.

This paper describes the REMI Policy Insight model, the leading regional

economic forecasting and policy analysis model. Over one hundred institutes,

universities, government agencies and other organisations use custom-built

REMI models specified to states, counties, cities, and other regions. These

model users are located primarily in the US, but also include organisations

using or planning to use models for regions in Belgium, France, Germany, Italy,

the Netherlands, Spain, and the United Kingdom. The EU Commission has

recently contracted REMI to develop REMI models for evaluation of structural

fund investments.

Analysts use the REMI model to evaluate the economic effects of

economic development programs, transportation infrastructure investments,

environmental and energy regulations, and other policies that have an effect

on the regional or local economy. REMI studies include evaluations of highspeed rail, new highways, business tax incentive programs, water resources

issues, air pollution controls, electric utility deregulation, and hundreds of

other applications. Often, users incorporate a REMI analysis into their process;

for example, evaluating all potential business relocation proposals for a given

state or city.

REMI provides a comprehensive modeling framework that shows total

policy effects, even those that are not anticipated. For example, a policy to

reduce air pollution may have cost consequences for businesses that will

reduce competitiveness, but the policy may also have the non-pecuniary

effect of making the area a more pleasant place to live. In this case, the loss of

competitiveness will reduce output but the cleaner air will lead to inward

migration that will increase the labor force. These increases will in turn

increase labor productivity and reduce wages, thereby cutting costs and

increasing competitiveness, which will increase economic activity. The net



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6. THE EVALUATION OF PROGRAMS AIMED AT LOCAL AND REGIONAL DEVELOPMENT



effect of these policies can only be captured by a comprehensive model that

includes economic migration, labor force, wage determination, land prices, and

the location effect of competitiveness on employment and output in the area.

Another example of an unintended consequence that would require a

model would be building a rail system with limited stops. This may increase

competitiveness in selling services among areas with stations, but it may also

decrease competitiveness in all services for each of the areas without stations.

The net result of these changes has ramifications that may be unforeseen for

the individual areas and industries and for the regional economy as a whole.

Without an appropriate model, it may be impossible to predict the direction of

economic activity changes in each of the areas in the model, either for

employment in particular industries or in the economy as a whole, when both the

transportation improvements and the cost of these improvements are combined.

Since the overall objective of economic development policy is to improve

economic and social conditions, it is important to predict and evaluate the

total effects of the policies in a systematic way. This will help in choosing the

set of policies that will achieve the maximum benefit for the proposed

expenditures. We have found that, to make this possible, a quantitative model

must incorporate all of the key interactions in the economy and be based on

solid economic theory. Such a model must also be designed to use

relationships that are universal for market economies. It only requires the

estimation of those parameters that cannot be determined by economic

theory. These parameters can be estimated using data sets for a number of

areas with similar behavioral characteristics. We have also learned that the

software for such a model must be easy to use and enable the user to verify the

reasonableness of the results.



The functioning of regional/local development analysis models

used for policy/programme forecasting/simulation in the USA

Regional and local economic models are used in the US for a variety of

policy analysis purposes, including evaluation of economic development

proposals, transportation projects, environmental regulations, and energy

programs. Regional models are also used for planning and programming

purposes, particularly as they relate to infrastructure needs including new

roads, airports, power plants, water facilities, and a broad range of other

public and private services.

Practitioners use a number of methods for forecasting and policy

analysis. Basic models include: input-output, computable general equilibrium,

econometric, and new economic geography. Each method has its strengths

and weaknesses. The REMI model, by integrating all of these methodologies,



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6. THE EVALUATION OF PROGRAMS AIMED AT LOCAL AND REGIONAL DEVELOPMENT



provides a modeling framework that overcomes some of the weaknesses of

using individual modeling methodologies alone.

Input-output models represent the way that the national, regional, and

local economy operates through the interaction of various parts of the

economy. Central to input-output analysis is the interaction of industry

sectors in the economy. For example, to build an automobile, the motor

vehicle manufacturer must use steel, tires, and other intermediate inputs in

production. The use of labor and capital are also considered as inputs into

production, and final demand for consumption, government spending, and

exports are also represented in the input-output accounts. Typically, inputoutput models incorporate a high level of detail for large numbers of

industries and twenty or thirty types of final demand.

Input-output models have several important limitations. First, these

models assume that economic relationships are fixed and do not vary in

response to cost changes, competition for resources, or supply constraints.

Second, input-output models are static in nature and do not show dynamic

processes over time. Third, they are often limited in their description of the

economy; for example, input-output models do not provide for an interaction

between population and economic changes.

Computable general equilibrium (CGE) models are usually based on wellformulated microeconomic foundations: firms maximize profits and

households maximize utility. In contrast to input-output models, computable

general equilibrium models are structured so that prices and wages respond

to market conditions. Since the role of price and costs signals in the economy

is fully specified, CGE models are particularly suitable for policy analysis

regarding changes in taxes and production costs.

Computable general equilibrium models are used to evaluate changes in

trade policy, environmental regulations, and taxes. For example, a CGE model

may be used to show the economic effects of a state-level income tax increase.

CGE models are not widely applied to economic development issues, such as

the effect of a new firm location, since they usually do not have the industry

detail or careful tracking of inter-industry relationships available in inputoutput models. Furthermore, CGE models, as commonly applied, often do not

have an explicit time dimension. Therefore, policy analysis using such models

takes the form of comparative static analysis, which can serve as a useful

input into the policy making process but has significant practical limitations.

Econometric models rigorously employ statistical methods. Such models

have an important basis in economic theory, and are more grounded in

empirically supported relationships. Econometric models almost always have

an important time dimension, and dominate other methods in quarterly and

monthly short-term forecasting. Econometric models are sometimes used for



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6. THE EVALUATION OF PROGRAMS AIMED AT LOCAL AND REGIONAL DEVELOPMENT



policy analysis purposes, but often are not appropriate for this purpose, as the

economic structure may not be represented in sufficient detail for the types of

exogenous shocks typical of policy applications.

Economic geography models have been developed in mostly a theoretical

context in the last ten years. As with CGE models, this type of model is also

based on clear microeconomic foundations but is typically much more

stylized and not intended to represent an actual economy. Economic

geography models are unique in that they are able to account for the

endogenous formation of cities and other economic agglomeration.1

The REMI model brings together the methods of input-output, computable

general equilibrium, econometric, and economic geography models in a

comprehensive, consistent framework. The REMI model captures the interindustry relationships embodied in input-output models. If all of the dynamic

responses in REMI are turned off (as can be done through the “alternative model

specification”), the model is specified as a static input-output model. The REMI

model captures long term general equilibrium tendencies in labor and factor

markets, as in computable general equilibrium models.

Dynamic responses in the REMI model are estimated using econometric

techniques, typically using estimates based on panel data for various regions

or states over a number of years. The model is also based on new economic

geography theory, explicitly accounting for agglomeration economies in labor,

input, and consumption markets.



Description of the structure of REMI2

REMI Policy Insight is a structural economic forecasting and policy analysis

model. As mentioned above, it integrates input-output, computable general

equilibrium, econometric, and economic geography methodologies. The model

is dynamic, with forecasts and simulations generated on an annual basis in

relation to behavioral responses to wage, price, and other economic factors.

The REMI model consists of thousands of simultaneous equations;

however, its basic structure is relatively straightforward. The exact number of

equations varies depending on the extent of industry, demographic, demand,

and other detail in the model. The overall structure of the model can be

summarized in five major blocks: 1) output and demand, 2) labor and capital

demand, 3) population and labor force, 4) wages, prices and costs, and 5) market

shares. The blocks and their key interactions are shown in Figures 6.1 and 6.2.

The output and demand block consists of output, demand, consumption,

investment, government spending, exports, and imports, as well as feedback

from output change due to the change in the productivity of intermediate

inputs. The labor and capital demand block includes labor intensity and

productivity as well as demand for labor and capital. Labor force participation



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6. THE EVALUATION OF PROGRAMS AIMED AT LOCAL AND REGIONAL DEVELOPMENT



Figure 6.1. REMI model linkages

Excluding economic geography linkages



(1) Output



State and local government

spending

Investment



(2) Labor and capital

demand



Population



Participation

rate



Real disposable income



Exports



(3) Demographic

Migration



Consumption



Output



Labor

force



Optimal

capital

stock



Employment



(5) Market shares

Domestic

market

share



International

market

share



Labor/Output

ratio



(4) Wages, prices, and production costs

Composite wage rate



Wage rate



Employment opportunity



Consumer price

deflator



Housing price



Production costs



Real wage rate



Composite price



Figure 6.2. Economic geography linkages



Commodity

access index



Internediate input

productivity



Output

Intermediate input



(3) Demographic

and labor supply

Economic

migrants



(1) Output block



(2) Labor and capital

demand

Labor

access

index



(5) Market shares



Employment

Labor

productivity



Domestic

market share



International

market share



(4) Wages, prices, and production costs

Production costs

Composite

wage

Composite prices



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6. THE EVALUATION OF PROGRAMS AIMED AT LOCAL AND REGIONAL DEVELOPMENT



rate and migration equations are in the population and labor force block. The

wages, prices and costs block includes composite prices, determinants of

production costs, the consumption price deflator, housing prices, and the

wage equations. The proportion of local, inter-regional and export markets

captured by each region is included in the market shares block.

Models can be built as single region, multi-region, or multi-region

national models. A region is defined broadly as a sub-national area, and could

consist of a state, province, county or city, or any combination of sub-national

areas. Within a large, multinational currency zone such as the European

Union, models of a national economy can be built using the same economic

framework employed in regional models.

Single region models consist of an individual region, called the home region.

The rest of the nation is also represented in the model. However, since the home

region is only a small part of the total nation, the changes in the region do not

have an endogenous effect on the variables in the rest of the nation.

Multi-regional models have interactions among regions, such as trade

and commuting flows. These interactions include trade flows from each

region to each of the other regions. These flows are illustrated for a threeregion model in Figure 6.3. There are also multi-regional linkages through

delivered prices from each area to each other area as well as labor and

commodity access among areas.

Figure 6.3. Trade and communter flow linkages



Disposable income



Local earnings by

non-residents



Local demand



Output



Commuter linkages based on

historic commuting data



Local earnings by

non-residents



Disposable income



Disposable income



Local earnings by

non-residents



Output



Local demand



Flows based on

estimated trade flows



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Local demand



Output



REMI

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6. THE EVALUATION OF PROGRAMS AIMED AT LOCAL AND REGIONAL DEVELOPMENT



Multi-regional national models that encompass an entire currency union,

such as the US or EU, may also include a central bank monetary response that

constrains labor markets. Models that only encompass a relatively small

portion of a currency union are not endogenously constrained by changes in

exchange rates or monetary responses.



Block 1. Output and demand

This block includes output, demand, consumption, investment,

government spending, import, product access and export concepts. Output for

each industry in the home region is determined by industry demand in all

regions in the nation, the home region’s share of each market, and

international exports from the region.

For each industry, demand is determined by the amount of output,

consumption, investment and capital demand on that industry. Consumption

depends on real disposable income per capita, relative prices, differential

income elasticities and population.3 Input productivity depends on access to

inputs because the larger the choice set of inputs, the more likely that the

input with the specific characteristics required for the job will be formed. In

the capital stock adjustment process, investment occurs to fill the difference

between optimal and actual capital stock for residential, non-residential, and

equipment investment.4 Government spending changes are determined by

changes in the population.



Block 2. Labor and capital demand

The labor and capital demand block includes the determination of labor

productivity, labor intensity and the optimal capital stocks. Industry-specific

labor productivity depends on the availability of workers with differentiated

skills for the occupations used in each industry. The occupational labor supply

and commuting costs determine firms’ access to a specialized labor force.

Labor intensity is determined by the cost of labor relative to the other

factor inputs, capital and fuel. Demand for capital is driven by the optimal

capital stock equation for both non-residential capital and equipment.

Optimal capital stock for each industry depends on the relative cost of labor

and capital, and the employment weighted by capital use for each industry.

Employment in private industries is determined by the value added and

employment per unit of value added in each industry.



Block 3. Population and labor force

The population and labor force block includes detailed demographic

information about the region. Population data is given for age, gender and

ethnic category, with birth and survival rates for each group. The size and



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6. THE EVALUATION OF PROGRAMS AIMED AT LOCAL AND REGIONAL DEVELOPMENT



labor force participation rate of each group determines the labor supply. These

participation rates respond to changes in employment relative to the potential

labor force and to changes in the real, after tax, wage rate.5 Migration includes

retirement, military, international and economic migration. 6 Economic

migration is determined by the relative real after tax wage rate, relative

employment opportunity and consumer access to variety.



Block 4. Wages, prices and costs

This block includes delivered prices, production costs, equipment cost,

the consumption deflator, consumer prices, the price of housing, and the

wage equation. Economic geography concepts account for the productivity

and price effects of access to specialized labor, goods and services.

These prices measure the price of the industry output, taking into

account the access to production locations. This access is important due to

the specialization of production that takes place within each industry, and

because transportation and transaction costs of distance are significant.

Composite prices for each industry are then calculated based on the

production costs of supplying regions, the effective distance to these regions,

and the index of access to the variety of output in the industry relative to the

access by other users of the product.

The cost of production for each industry is determined by cost of labor,

capital, fuel and intermediate inputs. Labor costs reflect a productivity

adjustment to account for access to specialized labor, as well as underlying wage

rates. Capital costs include costs of non-residential structures and equipment,

while fuel costs incorporate electricity, natural gas and residual fuels.

The consumption deflator converts industry prices to prices for

consumption commodities. For potential migrants, the consumer price is

additionally calculated to include housing prices. Housing price changes from

their initial level depend on changes in income and population density.

Wage changes are due to changes in labor demand and supply conditions

and changes in the national wage rate. Changes in employment opportunities,

relative to the labor force and occupational demand changes, determine wage

rates by industry.



Block 5. Market shares

The market shares equations measure the proportion of local and export

markets that are captured by each industry. These depend on relative

production costs, the estimated price elasticity of demand, and effective

distance between the home region and each of the other regions. The change

in share of a specific area in any region depends on changes in its delivered

price and the quantity it produces compared with the same factors for



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