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Connecticut Economic Digest: March 2006 issue

Growth in Employment Slowed by Connecticut's Industry Mix
By Pat McPherron, Ph.D., Economist, DOL

Connecticut's 2005 employment in nonfarm industries increased by 0.8% from 2004, compared with the 1.5% increase for the U.S. Chart 1 shows how the Labor Market Areas (LMAs) contributed to the changes in the State's employment. The Willimantic-Danielson, Enfield, Norwich-New London, Hartford and Torrington LMAs all gained employment at a rate greater than the State average.

Unemployment Rate

Connecticut's unemployment rate in 2005 was 4.9% and the U.S. unemployment rate was 5.1%, continuing a trend where the State's unemployment rate was lower than the U.S. rate each year during 1996-2005. The average difference between the U.S. and State rates was 0.9% from 1996-2000 and 0.5% for 2001-2005.

Connecticut Industry Mix

The 2004-2005 difference in the U.S. and Connecticut rates of growth in nonfarm employment was typical, as the State consistently lagged behind the U.S.: an annual average of -0.8% during 1996-2000 and -0.6% from 2001-2005. Although consistently lower unemployment rates can partially explain the State's lower growth rate during the expansionary portion of a business cycle, the next section shows this lag is also caused by those industries where the negative effects of substitution dominate the effects of growth. The tables highlight how the State's industry mix affects the rate of employment growth between 1996-2000 and 2001-2005. Most notable is the significant, negative effect of substitution throughout the business cycle in the Manufacturing sector.

Substitution and Growth Effects

Substitution effects are a measure of the employment change brought about primarily by changes in demand, holding income constant. An example is the recent rise in energy prices, causing consumers to allocate a greater percentage of each dollar earned to those products and less to purchases of other goods. Growth effects are changes in consumption of a product due only to changes in real income.

Table 1. EFFECTS OF SUBSTITUTION AND GROWTH
ON Industry Employment: An EXAMPLE
Employment Year Effect on Employment Industry State Employment
Employment
    Ind A Ind B Ind A Ind B  
Observable t     40 60 100
Substitution t+1 -25% 17% -10 10 0
Growth t+1 15% 23% 6 14 20
Observable t+1 -10% 40% 36 84 120

Example

The example in Table 1 shows that Industry A reduces its market share of employment from 40% to 30% of total State employment, resulting in a substitution effect for Industry A of (0.3 - 0.4)/0.4 = -25%. If total State employment remains at 100, Industry A loses 25% of its 40 employees. In this example, State growth in employment is 20% for the year, so the benefit of growth to Industry A's initial employment level is (.3/.4)*20% = 15%. Adding -25% and 15% together indicates that the observable percentage change from 40 is -10%, leaving Industry A's employment at 36.

Changes in Industry Employment

Table 2 (below) presents the effects of substitution and growth on changes in industry employment in Connecticut. During the 1996-2000 period, the growth effects were positive and the reverse was true during 2001-2005. The effects of substitution may dominate the growth effects for changes in employment; significant examples of this scenario are boldfaced in Table 2. Therefore, particularly for the boldfaced industries, employment forecasts must account for changes in preferences or relative prices.

Note that although changes in relative productivity can affect the linkage between percentage changes in employment for an industry and percentage changes in consumption of that industry's output, the largest substitution effects for employment growth in Table 2 are reasonably consistent with the largest substitution effects for U.S. output (BEA) during 1996-2004 (2005 not available).

Table 2. EFFECTS OF SUBSTITUTION AND GROWTH
ON INDUSTRY EMPLOYMENT
  1996-2000 2001-2005
CONNECTICUT * Sub. Effect Growth Effect Change Change * Sub. Growth Effect Change Change
(%) (000s) Effect (%) (000s)
TOTAL NONFARM 0.0% 6.9% 6.9% 79.2 0.0% -1.1% -1.1% -18.3
CONST., NAT. RES. & MIN 15.0% 8.0% 23.0% 12.2 2.2% -1.1% 1.1% 0.7
MANUFACTURING -10.1% 6.2% -3.9% -9.6 -12.8% -0.9% -13.8% -31.3
Durable Goods -11.1% 6.1% -4.9% -9.1 -12.6% -1.0% -13.5% -22.8
Non-Durable Goods -7.3% 6.4% -0.9% -0.5 -13.7% -0.9% -14.6% -8.5
TRADE, TRANSPORT., UTILITIES -0.7% 6.9% 6.1% 18.4 0.8% -1.1% -0.3% -1.1
Wholesale Trade -0.7% 6.9% 6.2% 4.0 -0.2% -1.1% -1.3% -0.9
Retail Trade -0.1% 6.9% 6.8% 12.5 0.0% -1.1% -1.0% -2.0
Transport., Warehousing, & Utilities -3.0% 6.7% 3.7% 1.9 4.8% -1.1% 3.7% 1.9
INFORMATION 0.3% 6.9% 7.3% 3.1 -13.5% -0.9% -14.5% -6.5
FINANCIAL ACTIVITIES 4.0% 7.2% 11.2% 14.4 0.7% -1.1% -0.4% -0.5
Finance and Insurance 4.1% 7.2% 11.3% 12.3 0.8% -1.1% -0.3% -0.3
Real Estate and Rental and Leasing 3.9% 7.2% 11.0% 2.2 0.1% -1.1% -1.0% -0.2
PROFESSIONAL & BUSINESS SERV 7.6% 7.4% 15.0% 28.2 -3.8% -1.0% -4.9% -10.3
Professional, Scientific 11.7% 7.7% 19.5% 15.5 -5.2% -1.0% -6.2% -5.8
Legal Services -3.0% 6.7% 3.7% 0.5 -0.6% -1.1% -1.6% -0.2
Computer Systems Design 58.2% 10.9% 69.1% 9.6 -17.0% -0.9% -17.9% -4.1
Management of Companies -4.2% 6.6% 2.4% 0.7 -11.4% -1.0% -12.4% -3.5
Administrative and Support 7.7% 7.4% 15.1% 12.0 0.0% -1.1% -1.0% -0.9
EDUCATIONAL & HEALTH SERV -0.3% 6.9% 6.6% 15.2 9.1% -1.2% 7.9% 20.1
Educational Services -0.4% 6.9% 6.5% 2.5 15.0% -1.3% 13.8% 6.2
Health Care and Social Assistance -0.3% 6.9% 6.6% 12.8 7.9% -1.2% 6.7% 13.9
LEISURE AND HOSPITALITY -0.3% 6.9% 6.6% 7.5 9.7% -1.2% 8.5% 10.2
Arts, Entertainment, and Recreation 3.2% 7.1% 10.3% 2.1 5.7% -1.2% 4.6% 1.1
Accommodation and Food Services -1.1% 6.8% 5.7% 5.3 10.7% -1.2% 9.4% 9.1
OTHER SERVICES -4.6% 6.6% 2.0% 1.2 2.5% -1.1% 1.3% 0.8
GOVERNMENT 1.5% 7.0% 8.5% 19.0 0.9% -1.1% -0.2% -0.4
Federal Government -6.6% 6.5% -0.1% 0.0 -6.9% -1.0% -7.9% -1.7
State Government -3.5% 6.7% 3.2% 2.1 -6.2% -1.0% -7.2% -5.0
Local Government 5.5% 7.3% 12.8% 16.9 5.3% -1.1% 4.2% 6.4

*The effects of substitution for Connecticut do not separate the effects of growth and substitution from the U.S. or global economies; the percentage changes in substitution for these large-scale economic factors may be different for the State.

Table 2 shows that during 1996-2000, changes in employment from substitution effects dominate any changes from growth for the sectors of Construction, Natural Resources and Mining and Manufacturing, as well as the Professional and Scientific and Computer Systems Design industries in the Professional & Business Services sector. This implies that these industries were more affected by changes in consumer preferences and relative prices than by changes in the State's business cycle. Rates of employment growth in the other industries were more related to the State's rate of employment growth.

From 2001-2005, the substitution effects dominated growth effects for the Manufacturing sector, Information sector, Computer Systems Design industry in the Professional & Business Services sector, Education and Health Services sector, and Leisure and Hospitality sector. Note that the substitution effects of the three levels in the Government sector virtually canceled each other when aggregated.

Changes in State Employment

Table 3 details the impact on total State employment of the effects of substitution and growth from each industry sector. This table weights the effects of substitution and growth in Table 2 by the relative size of the industry. Note that Manufacturing is the largest sector showing negative changes in State employment; if excluding this sector, then State gained in employment during 2001-2005.

During 2001-2005, Educational and Health Services and Leisure and Hospitality sectors accounted for the largest gains in State employment. Within those sectors, the Health Care and Social Assistance and the Accommodation and Food Services industries added 1.3% to Connecticut's employment, but wages in these categories were typically below the State average.

Table 3. EFFECTS OF SUBSTITUTION AND GROWTH
ON TOTAL STATE EMPLOYMENT
  1996-2000 2001-2005
EMPLOYMENT Sub. Effect Growth Effect * Total Chg Sub. Effect Growth Effect * Total Chg
TOTAL NONFARM 0.0% 6.9% 6.9% 0.0% -1.1% -1.1%
CONST., NAT. RES. & MIN 0.5% 0.3% 0.8% 0.1% 0.0% 0.0%
MANUFACTURING -1.6% 1.0% -0.6% -1.7% -0.1% -1.9%
Durable Goods -1.3% 0.7% -0.6% -1.3% -0.1% -1.4%
Non-Durable Goods -0.3% 0.2% 0.0% -0.5% 0.0% -0.5%
TRADE, TRANSPORT., UTILITIES -0.1% 1.3% 1.2% 0.1% -0.2% -0.1%
Wholesale Trade 0.0% 0.3% 0.3% 0.0% 0.0% -0.1%
Retail Trade 0.0% 0.8% 0.8% 0.0% -0.1% -0.1%
Transport., Warehousing, & Utilities -0.1% 0.2% 0.1% 0.1% 0.0% 0.1%
INFORMATION 0.0% 0.2% 0.2% -0.4% 0.0% -0.4%
FINANCIAL ACTIVITIES 0.3% 0.6% 0.9% 0.1% -0.1% 0.0%
Finance and Insurance 0.3% 0.5% 0.8% 0.1% -0.1% 0.0%
Real Estate and Rental and Leasing 0.0% 0.1% 0.1% 0.0% 0.0% 0.0%
PROFESSIONAL & BUSINESS SERV 0.9% 0.9% 1.8% -0.5% -0.1% -0.6%
Professional, Scientific 0.6% 0.4% 1.0% -0.3% -0.1% -0.3%
Legal Services 0.0% 0.1% 0.0% 0.0% 0.0% 0.0%
Computer Systems Design 0.5% 0.1% 0.6% -0.2% 0.0% -0.2%
Management of Companies -0.1% 0.1% 0.0% -0.2% 0.0% -0.2%
Administrative and Support 0.4% 0.4% 0.8% 0.0% -0.1% -0.1%
EDUCATIONAL & HEALTH SERV 0.0% 1.0% 1.0% 1.4% -0.2% 1.2%
Educational Services 0.0% 0.2% 0.2% 0.4% 0.0% 0.4%
Health Care and Social Assistance 0.0% 0.8% 0.8% 1.0% -0.1% 0.8%
LEISURE AND HOSPITALITY 0.0% 0.5% 0.5% 0.7% -0.1% 0.6%
Arts, Entertainment, and Recreation 0.0% 0.1% 0.1% 0.1% 0.0% 0.1%
Accommodation and Food Services -0.1% 0.4% 0.3% 0.6% -0.1% 0.5%
OTHER SERVICES -0.2% 0.2% 0.1% 0.1% 0.0% 0.0%
GOVERNMENT 0.2% 1.0% 1.2% 0.1% -0.2% 0.0%
Federal Government -0.1% 0.1% 0.0% -0.1% 0.0% -0.1%
State Government -0.1% 0.3% 0.1% -0.3% 0.0% -0.3%
Local Government 0.5% 0.6% 1.1% 0.5% -0.1% 0.4%

* subject to rounding

Chart 2 compares the State and the U.S. substitution effects for industry sectors from 2001-2005. Note that the negative impact of the Connecticut Manufacturing sector on the growth rate of total employment was less than the U.S. sector. However, the State substituted growth in both the Educational and Health Services and the Leisure and Hospitality sectors for jobs in Professional and Business Services.

Comparing the State and U.S. ratios of industry employment in Chart 3 with the substitution effects in Chart 2, one sees that Connecticut may expect more adjustments in industry employment percentages. Note in Chart 3 that the ratio of State employment in Manufacturing is still greater than the national average and Chart 2 shows the State and U.S. substitution effects in this sector were significantly negative during 2001-2005.

Summary

The tables and charts present the substitution and growth effects for each industry. Importantly, if the effects of substitution explain the majority of any sizeable change in an industry's employment, then reasonable forecasts for that industry require more than just projections of the growth rates of Gross State Product or State employment.

The Manufacturing sector accounts for a sizable percentage of the State's employment, but suffered large losses from the effects of substitution during both the 1996-2000 and 2001-2005 periods. Therefore, this sector dampened job growth during throughout the business cycle. The Professional and Scientific, Computer Systems Design, and Administrative and Support industries, part of the Professional and Business Services sector, all showed significant positive substitution effects during 1996-2000, but these trends were flat or negative during 2001-2005. Also, the effect of substitution for the Construction, Natural Resources and Mining sector on State employment was much larger for 1996-2000 than during the last several years.

From 2001-2005, the lower paying industries of the Educational and Health Services and Leisure and Hospitality sectors (Health Care and Social Assistance, Accommodation and Food Services) added 1.3% more jobs to the State's total, indicating that all other Connecticut industries combined for a loss of -2.4%. Therefore, despite some positive economic news in 2005, expect that the State may continue to lag behind the U.S. in rates of job growth as Connecticut's industry mix adjusts.

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Published by the Connecticut Department of Labor, Office of Research
Last Updated: March 17, 2006