The Definition of Economic Development Is Not So Obvious

Last Updated: December 15, 2021

Often residents have only a vague notion of the real definition of economic development. They may think it means any type of construction, new business openings, or granting of financial incentives to businesses. Sloppy use of the term abounds in civic dialogue, public meetings, and statements from public officials.

Smarter folks talk about job creation as well. On this page we will explore what it really means to undertake economic development for your community.

A much more precise and correct definition of economic development is the cultivation of activities that create a net gain of money into the community.  This positive money flow is called an economic base, whether you are referring to Hong Kong, Los Angeles, Vienna, Dubuque, or an African village.

The economic base derives from the production of goods and services in excess of local consumption needs for that product, service, or activity. Examples make the point best.

The classic economic development activity in the U.S. in the twentieth century was industry.

If your community contained a toaster factory, for example, it would be pretty obvious that you were not making toasters just for yourselves. A majority of households in your small town might buy the brand of toaster manufactured there. However, the factory made many more toasters that it could sell locally, so it "exported" them all over the state, the country, or the world.

What Is Economic Development?

In this example, the money from the export of the toasters not used locally would be an economic gain for the community, and the net gain is economic development, using the stricter definition of the term advocated here.

It's true that much of the money generated from the work of local laborers escaped from the community and enriched managers elsewhere and corporate ownership, whether the company is privately held or a publicly traded corporation.

However, the wages of local workers are spent in the local community to some extent, and that in turn adds to the income of other community members who work for the local grocery store, own businesses on Main Street, own rental properties, and repair automobiles at the local garage.

When wages are spent at other local businesses, this constitutes the "multiplier effect" that professionals discuss. Because of the toaster manufacturer, other local businesses sell more goods and services than they would otherwise.

To add one more wrinkle, while employment is the most frequent indicator of economic development, recently we saw a comment that increases in the earnings of each individual employee also would represent economic development provided those better incomes are not eaten away by runaway inflation or taxation. However, given the core definition of bringing in income from outside of the community, we don't think that carries very much weight, although higher earnings certainly are welcomed in the community.

Why Selling Things to Each Other Is Not Economic Development

Contrast the toaster example with the example of a taco chain coming to your town. In the case of tacos, there is no surplus left at the end of the day if the business knows what it is doing.

In most cases, the tacos are purchased by local people, so the community is not really generating a "surplus" that it can sell or "export."

The notable exception is with tourism oriented communities, where people outside the community do indeed add to the market for restaurants.

Just as in the toaster manufacturing example, if management and ownership of the taco chain reside outside the community, income leaks out of the community.

Because the multiplier effect only kicks in when income is spent inside the community, the return of money to out-of-town managers, franchise fees, and out-of-town owners or stockholders represents a decrease in the amount of money that is available to feed the local economy.

Here we should stop to explain that the case of the "mom and pop" restaurant is more complicated. While a small, out of the way restaurant frequented only by local residents may not generate an "export," in the sense that out of town money comes to town. However, if there are enough  of these, unique and tiny restaurants could actually form part of the economic base for your community as people from the region come to your town on Saturday night to find good eats.

You can compute the classic measure of your economic base by following directions on our location quotient page.

If you feel that the economic base term has been degraded so much that no one will "hear" you when you use it, a newer and perhaps more accurate way to think of true economic development is emerging.

This centers on the distinction between tradable and non-tradable goods and services, with the tradables being those items that aren't consumed locally.

What’s Your Definition of Economic Development?

Now we have explained the classic definition. I know from many experiences as a consultant that I probably have not talked you out of thinking that any new building is a great thing and of course that constitutes economic development.

Just consider that a better definition of economic development may prevent you from futile gambles on tax incentives, such as tax increment financing, that don't raise the level of prosperity in your community over the long run.

International economic development conversations also should focus on bringing in money from outside the community, not just recirculating the same money.

That's why both basic communication and transportation infrastructure are essential to economic development. Bringing in one cell phone per isolated village, such as was done in Bangladesh, is a potent tactic. Without contact with the outside world, a village can't tell people about its surplus products, whether that consists of bananas or baskets.    And without access to a good road or other dependable, regular transportation network, economic development won't happen.

One more definition of economic development I often hear in lower income communities or international circles is raising income levels of individuals. In fact, some people even use the term when they are speaking about a neighborhood or a block.  We think it would be clearer to adopt our strict definition, and then to talk about poverty at the household or neighborhood level.

Unfortunately, the plain word "poverty" has fallen out of favor. That's a very important issue, and you'll find more about community poverty in developed countries on another page.

Alleviating poverty in the developing countries depends not only on building the transportation and communication infrastructure, but also on encouraging education, creativity and entrepreneurship support.

Come to think of it, those are key ingredients of economic development, whether a nation is relatively rich or relatively poor.

For Deeper Thinking About Economic Development

Economic Base

Location Quotient

Commercial District Revitalization

Tax Increment Financing

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