Hidden Benefits of a Strong Local Economy

The benefit of operating in a local area with a strong economy is often hidden within your manufacturing company's financial data.

This is because many of the benefits of a strong local economy are not listed on your balance sheet as assets. But they play a crucial role in creating higher levels of profits and cash flows.

The higher the level of local economic activity, the better your business will perform.

Strong local economies are key to producing the human capital and infrastructure required to operate your manufacturing business. The local government will have higher levels of tax revenues, which provides it the much needed capital to make investments that directly improve not only your business, but also the personal lives of you and your employees.

It can lead to improvements in education, such as K-12, trade schools, and technical colleges. This can directly improve the quality of human capital for the local workforce, meaning the local workforce available to hire into your business becomes more productive. This leads to reduced costs per unit, which increases profits.

Local infrastructure investments, such as roads, freight railways, utilities, and technology leads to reduced transportation costs, lower vehicle maintenance, and lower energy costs. Other investments help make the quality of life in the local community more attractive for you, your employees, and everyone else. This includes improvements in public safety, emergency services, better parks and recreation, local libraries and museums, and more. This helps increase the retention of not only your employees, but the community as a whole, which helps retain the town's unique culture.

This is just a small list of benefits not visible on your internal financial statements, yet vastly improve your financial performance.

How "Free Trade" Destroyed Economic Prosperity in America

The problem is local economic activity is nowhere near where it could be across the United States.

This was the result of the country focusing on maximizing Exchange Value. This economic concept was theorized to make people wealthier by purchasing goods and services for the lowest cost possible. Since you bought things cheaper, you had more money to buy more goods. The same amount of dollars could purchase more things. This increased imports because many manufacturers were offshored.

Trade imbalances began to accumulate.

In the 1950's, imports and exports as a percentage of the United States' GDP were around 4-5%. The trade balance was near zero to a small surplus. As manufacturers continued to offshore their operations, trade deficits increased. Exports as a percentage of GDP in the 2010s were 12-13% while imports were 14-15%, creating a significant trade deficit, which compounded over decades.

Productive capital, whether it's industrial production capabilities, human capital in terms of a skilled, knowledgeable workforce, and capital as measured in dollars all flows out of the United States and was used to build up production in foreign countries.

The results are devastating for local economies across the United States.

Offshoring manufacturing and other industries decreases labor demand for a local community. This results in lower median incomes that would have otherwise been possible, which produces lower levels of local economic activity. Those entering the workforce are forced to work as some fast food chain or retailer like Wal-Mart instead of being employed by higher valued occupations such as those found in manufacturing. Entry level jobs become scarce and do not provide the level of income they used to. This impacts young people disproportionately as they fall further behind in career earnings.

Despite this headwind to local economic activity, the US remains the largest consumer market in the world. This means businesses are able to command the highest selling prices when selling into the US market than they otherwise would be able to obtain in other countries. Businesses that operate in foreign countries with access to the US market will be able to take advantage of the arbitrage, lowering their costs while reaping the benefits of high selling prices. This is one of the ways foreign countries have been able to progress over the last 50 years.

We've exported American prosperity, to our own detriment.

As economist Friedrich List noted, real wealth lies in the ability to produce things, not spending to acquire things as found in the focus on Exchange Value. The value of the fruit tree is far higher than the fruit itself.

The question is, how can we reverse this trend and shore up our local community's economy?

The Local Wealth Multiplier

The Local Wealth Multiplier is a concept that relates to the amount of local economic activity generated by a single dollar.

As the local wealth multiplier increases, the level of local economic activity increases as well. With higher levels of local economic activity, median incomes rise, local tax revenues rise, and overall quality of life increases.

There are two components to the local wealth multiplier. As a manufacturer, you have the ability to influence both to help create a stronger local economy that benefits not only your business directly, but your employees and your entire community

The Inflow Pipeline

The first component of the local wealth multiplier is the inflow pipeline.

Unfortunately, this component has been on the decline for most communities around the country for decades. Exporting businesses such as manufacturers are able to bring money into the local economy via their exports to non-local areas, such as neighboring towns, counties, states, and even foreign countries. As your revenue grows, so does the amount of money flowing into your local community.

Developing competitive advantages is the only sustainable way to grow revenues, profits, and cash flows over the long term. Take a look at our previous article on The Key To Long Term Profits.

As a manufacturer, you play a pivotal role in bringing money into your local community. To make each dollar go further, we have to shift spending and investment to increase the amount of money that can recirculate throughout the local economy.

Recirculation

Once money enters the local economy thanks to the inflow pipeline, that money has the potential to generate a larger local economic effect, depending on where it is spent.

A single dollar as the opportunity to either exit the local economy immediately if spent on a non-local business, or it can be circulated through the local economy over and over again if spent on local businesses.

A good way to think about this is viewing non-local spending as imports. When you purchase from a non-local business, you are importing goods and services. This means money immediately leaves the community and isn't able to be spent locally again. What we want is to increase our local community's recirculation rate. The higher the recirculation rate, the higher the local wealth multiplier. Here's how we calculate the recirculation rate and local wealth multiplier:

Let's use these as it relates to a business:

Above are two scenarios that lead to dramatically different levels of local economic activity.

Both have revenue and expenses unchanged. The only thing that changes is the percentage of our expenses that is spend on local businesses.

In our 40% local spend scenario, $1.8m of our $4.5m expenses is local spending. These local businesses in turn spend the same ratio (90% spending percentage of income, 40% locally spent). This repeats over and over until there isn't any local spending remaining, which ends up being $2,812,500. Our local wealth multiplier is $1.56 (1 ÷ 0.36 recirculation rate). This means every dollar spend locally generates $1.56 in local economic activity.

What happens if we move non-local spending to local businesses, increasing the percentage of our expenses spent on local business from 40% to 50%?

We can see the first impact is a $450,000 or 25% increase in local spending (10% additional local spend on $4,500,000 total spending). The real magic however, happens when our recirculation rate increases as well. If not only our business, but other local businesses, governments, and consumers make the same improvement, going from 40% of their spending on local businesses to 50%, it causes the local wealth multiplier to increase from $1.56 to $1.82. Our $450,000 or 25% increase in spending on local businesses not only didn't increase our total expenses, but it created an additional $1,278,409 or a 45.5% increase in total local economic activity.

The local wealth multiplier has its limitations.

Some businesses, government entities, and consumers will have higher expense percentages of income and percentages of total spend going to local vs non-local businesses than others. But the underlying mechanics are what matters. If we are able to increase the inflow of money into the local area and allocate a greater proportion of spending to existing local businesses, total economic activity can be vastly improved while maintaining the same level of total spend for your business.

Increasing Your Local Wealth Multiplier

Some will criticize this approach, saying local businesses aren't price competitive and we don't want to increase our expenses to accommodate this strategy.

But local goods and services aren't necessarily higher cost than non-local ones.

Most businesses don't have a formal procurement process. This makes gathering a list of potential suppliers and evaluating which ones make the most sense to purchase from difficult. Businesses may not be aware that lower cost local solutions exist in the first place. You would be doing your business a disservice by not opting to shift your spending to these lower cost local businesses wherever possible. The first step to increasing the local wealth multiplier is simply shifting any existing spend to lower cost local vendors.

The shift to spending on local businesses when possible helps increase their revenues. Local businesses are provided the sales volume and revenues required to make investments that increase productivity, which helps them create a cost advantage and lowers their costs per unit. These local businesses will be able to provide even lower prices in the future as they grow and are able to scale their operations, leading to even more direct cost savings.

There are cases where local businesses offer prices above your current suppliers. Remember, value goes beyond pricing. Don't rule them out just because a local business is not the absolute lowest cost supplier. Look for other value such as responsiveness, better customer experience, and other qualitative factors that aren't as obvious as the price they charge. Switch to local businesses when the value to price paid ratio is higher than non-local alternatives.

As your manufacturing business develops competitive advantages, especially a Cost Advantage, you will be able to increase employee wages and benefits while simultaneously decreasing costs per unit produced/sold. The People & Talent component of a Cost Advantage requires new hire and continuous training in order to make employees more productive and decrease costs. You could take this a step further by creating workforce partnerships with other manufacturing businesses in your area and the local technical college to create certified manufacturing programs. This helps reduce internal training costs as the graduates from this program will already have many of the skills you and your peers value. Another option is creating a formal apprenticeship program to train the next generation of manufacturing experts. Both provide your business with a pipeline of highly productive employees and gives younger residents the ability to earn higher wages, further increasing the local wealth multiplier.

Even something as simple as shifting your banking to a local band or credit union (assuming they can handle your transaction volume) helps keep more money local. Local banks and credit unions tend to lend locally, whether its to other local businesses, residential mortgages, etc. This keeps investment in the local community, instead of being invested halfway around the world.

Local Wealth Multiplier Improvements Benefits You & Your Community

We've only touched on a few ways to begin shifting non-local spending and investment to improve your local community

Improving the local wealth multiplier directly benefits your business and your community.

It doesn't require sacrificing financial performance. All that is needed is evaluating your existing spend and identifying local businesses to determine whether they are actually cheaper or provide more value than your non-local suppliers.

The local wealth multiplier plays an essential role in developing your community's productive powers and increasing the standard of living for all residents. We can begin to reverse the decades long economic decline of local economies by being more intentional about who we decide to do business with.

You can watch videos and read newsletters all day, but nothing beats looking at your own numbers. If you're ready to stop guessing and start implementing a clear financial strategy that puts more profit in your pocket, then it's time for my 1:1 Financial Clarity Assessment. We'll deep-dive into your company's financials to pinpoint the exact levers you need to pull for immediate, actionable improvements.

Click the link here to book your assessment today.

Clarity drives profit and cash flow.