Does Connecticut have a Problem with Economic Growth?
By Pat McPherron, Ph.D., Economist, DOL

To address this question I define economic growth¹ as the change in utility resulting from changes in components of markets. Utility may be measured, usually by the amount of consumption, at a variety of levels: individual, group, community, state, etc. Although not the focus of this article, a related concept is the process of economic development, which increases the returns on investment, even if market demand is constant. For example, at a recent event in Hartford, "Lean Manufacturing" was described as a process that resulted in sustainable increases in productivity.

If the State's workforce is highly skilled and aging, then economic theory expects lower utility from growth,² as wealthier workers focus more on non-essential consumption. Therefore, one could argue Connecticut is growing at the proper rate, based on its demographics. For example, while states with relatively low average wages offer land, resources and other subsidies to attract new businesses, Connecticut's citizens consistently oppose eminent domain, seizure of public lands, or other proposals that affect the quality of life in their communities.

Firms compete on functionality, quality and cost.³ In mature markets, where firms compete primarily on cost, average wages are an indication of capital-to-labor ratios and skill levels of the labor force.⁴ The U.S. has maintained, by global standards, a relatively high capital-to-labor ratio. This usually translates to relatively high per capita income, as labor is more productive (i.e. more tools per worker). In this context, Connecticut's position as the nation's highest per capita income state suggests all is well.

However, as Professor Richard Freeman at Harvard University notes, the global capital-to-labor ratio is plummeting. For instance, China is expected to graduate more Ph.D.'s in technical areas than the U.S. (same number of tools, excess supply of smart workers). This implies that Connecticut's position as the state with the highest per capita income will depend more than ever on providing services that cannot be profitably outsourced.

Also, research⁵ shows that firms historically underpay younger workers, with the expectation that eventually the employees recapture the loss in wages. If it is true that Connecticut's per capita income is largely related to an aging workforce, then there is concern for the State's ability to compete nationally and globally, as other firms hire younger highly educated workers.⁶

In addition to attracting the highly educated, younger cohorts,⁷ the State needs to maintain or compete for a larger percentage of the total dollars spent by consumers. This means responding to changing trends in consumer preferences. Firms most successful in this area are often characterized as stars or question marks.⁸ If it is difficult to "teach an aging workforce new tricks," Connecticut may be vulnerable to economic downturns unrelated to national or global business cycles.

Staying on Top

If the State maintains its share of the average dollar spent by all consumers, then employees can expect to maintain their current levels of income, assuming no changes in the workforce. This implies a growth rate in average real income equal to the national average.⁹ If citizens expect a higher than average growth rate in real income, it is not clear how that is going to happen with an aging workforce concentrated in industries that are losing market share at the national level.¹⁰

The implication of the State's firms not being able to maintain historical levels of competitive advantage is not just a minor reduction in the quality of life. Recent research¹¹ of Connecticut employment patterns confirms earlier estimations from Pennsylvania¹² that earnings losses for displaced workers are large and persistent: 30% reduction in annual income after the first quarter and still greater than 20% reduction five years later. Therefore, Connecticut's growth rate is a very important issue, even for employees who are comfortable with their current level of income.

Wage Distributions

The business strategy of offering wages below the marginal product of labor in order to increase profits is really a short-run strategy, as workers eventually produce at the explicit or implicit level of compensation. Real, sustainable per capita growth in productivity occurs from investments in human and physical capital. Therefore, the incentive structure of a market is a primary determinant of that market's future strength.

One indicator of expected rates of growth is per capita wealth, as wealthier workers tend to save more than less affluent workers.¹³ This may be a blessing when a large part of consumer spending is motivated by spurious credit, but can slow growth below optimal levels if too large a portion of income is concentrated at the uppermost percentiles of wage earners.

Tables I and II show a large concentration of total income distributed to a small percentile of wages earners. Table I shows two-decade changes in U.S. wages and wealth by percentile, using 2001 dollars and a price deflator (CPI-U-RS). Note the highest quintile gains are considerably greater than the other four quintiles, a pattern that is even more noticeable in Connecticut (Table II). Table II uses surveys that are compiled over each three-year period, but despite the different collection methods, Tables I and II tell very similar stories.

In such a market, workers may be less motivated to exhibit work "above and beyond" expectations and less likely to pursue the additional education and training that result in innovations. Although capitalism does not necessarily advocate a uniform distribution of income,¹⁴ these measures of income distribution are an indicator of the State's economic health.

Chart I breaks out the labor market area (LMA) wage distribution,¹⁵ using the ratio of an LMA's percentile wage to its median wage, thereby adjusting for the different costs of living in each LMA. Perhaps surprisingly, the "rich getting richer" syndrome in Connecticut is fairly uniform across the state!

Charts II-IV show the ratios of each industry sector's percentile wage against the percentile wage for all industries. For example, the lowest ten percent of the Retail sector is paid about nine-tenths of the typical wage in the State for the same percentile, while the upper tenth percentile is paid only six-tenths of what the typical worker in the highest percentile earns.

These distributions allow workers to see how their industry pays for increases in their general level of skills, as compared to other industry sectors. This provides one indication of the State's ability to attract younger workers in each industry sector. For example, the State's Financial and Insurance Services sector shows high compensation for all percentiles when compared with U.S. figures. However, the Professional and Business Services, Transportation, Information Technology, and Public Administration sectors are not as well compensated in Connecticut. The charts also show that in both Connecticut and the U.S., the lower third of the wage distribution for the Utilities sector is exceptionally high, while high earners in the Accommodation and Food and Agriculture sectors are substantially below the upper tenth percentile for all wage earners.

Summary

Connecticut's position as the State with the highest per capita income may not be sustainable over the next generation. Of more immediate concern is the ability of the State's firms to respond to the rapidly changing and highly competitive marketplace. Otherwise, in ten years, those same communities that are dead set against economic growth may be looking at flat earnings in a best-case scenario, and for government relief in a worst case.

¹ McPherron, Pat. "A General Theory of Labor Demand and Supply." Working Paper, 2006.

² McPherron, Pat. "Kuhn-Tucker Optimality of the Equity Premium Puzzle." Working Paper, 2006.

³ Cooper, Robin. "When Lean Enterprises Collide: Competing Through Confrontation." 1995, Harvard Business Press.

⁴ Ignoring market impediments.

⁵ Couch, Kenneth A. "Tenure, Turnover, and Earnings Profiles in Germany and the United States." International Business and Economics Research Conference, Program and Proceedings, October 2002.

⁶ Affordability of quality housing, schools, entertainment, etc.

⁷ Six percent of urban 10th graders passed all four sections of the Connecticut Mastery test (CAPT) in 2002.

⁸ Using the Boston Consulting Group matrix: Cash Cows, Stars, Question Marks, and Declining Dogs.

⁹ Not accounting for global exports

¹⁰ McPherron, Pat. "Growth in Employment Slowed by Connecticut's Industry Mix." The Connecticut Economic Digest, March 2006, 11(3), pp. 1-3, 5.

¹¹ Couch, Kenneth A. and Placzek, Dana W. "The Earnings Impact of Job Displacement Measured with Longitudinally Matched Individual and Firm Data." Working Paper, University of Connecticut Economics Department and Connecticut Department of Labor, May 2006.

¹² Jacobson, Louis, LaLonde, Robert, and Sullivan, Daniel. "Earnings Losses of Displaced Workers." American Economic Review, 83(4), pp. 685-709.

¹³ Another concern could be a cohort that tends to buy products with a low multiplier effect on market-wide demand.

¹⁴ Income distribution is often measured by a Gini coefficient.

¹⁵ Occupational Employment Statistics (OES), Connecticut Department of Labor.

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