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Connecticut Economic Digest: November 2006 issue

CONNECTICUT: A Net Exporter of Labor Services - Implications for Income Growth
By Daniel W. Kennedy, Ph.D., Senior Economist, DOL1

Based on the evidence presented in this article, one could argue that an important factor in predicting growth in Connecticut personal income is the growth in net labor income received from the export of labor services. Since the largest portion of Connecticut's income is concentrated in the part of the State that lies south and west of New Haven, the discussion will concentrate on the influence of the New York City economy.

The heart of the analysis lies in the important distinction between income generated by the State's economy and income earned by those who commute to jobs out of state, and bring the income earned back to Connecticut. This is particularly significant for states like Connecticut and New Jersey because of their proximity to, and as important providers of labor services to, the New York City economy. But before proceeding, the next section turns to the distinction, and the significance of the distinction, between income generated by Connecticut's economy and income brought back into the State by commuters.

TWO IMPORTANT DISTINCTIONS: Geographic Location Based versus Residence Based Economic Activities

At the national level, economic output is measured as Gross Domestic Product (GDP). GDP is defined as the dollar value of all current-period production of goods and services for final sale. It is a value-added concept. That is, intermediate inputs in the production process are excluded from GDP, and it includes only those goods and services produced within the territorial boundaries of the U.S., regardless of the country of ownership. Thus, GDP is a Geographic Location Based concept. In this context, "current period" means annual output. The state counterpart to GDP is Gross State Product (GSP). GSP for a state is derived as the sum of the GSP originating in all the industries within the territorial boundaries of the state. Like GDP, GSP measures value added by the state economy for a given period and, like GDP, it is a geographic location based concept. However, GSP is released only on an annual basis.

All states, in the process of producing goods and services for final demand (GSP), generate income that is distributed to the factors of production (i.e., labor, capital, and natural resources) that were combined by each state's businesses to produce GSP. In particular, Work-Based Earnings (i.e., geographic location based earnings) reflect payments to the labor input used to produce Connecticut's GSP. This can be summarized in the following accounting identity:

CT PRODUCED OUTPUT = CT GENERATED INCOME
OR
GROSS STATE PRODUCT = GROSS STATE INCOME

However, State Personal Income (SPI) includes income that is not necessarily generated by economic activity within Connecticut. It includes income generated outside the State and paid to residents who commute to jobs out of state. SPI is defined as income received by persons from participation in production, from government and business transfers, and from government interest. It is a residence-based concept. That is, SPI counts all income earned by Connecticut residents, regardless of whether that income is earned in the State or outside of it. Some components of SPI are collected on a work, or geographic location, basis. To derive the Earnings By Residence component of SPI, Earnings by Place of Work are adjusted for residence.

Graph 1 below tracks Connecticut's work-based earnings (geographic location based) and residence-based earnings from 1990 to 2004. Work-based earnings are composed of the sum of three components: wage and salary disbursements, other labor income, and proprietors' income. Earnings compiled by industry can be used in the analysis of regional economies as a proxy for the income generated from participation in current production. It should be noted that the concept of earnings by residence is on a gross-basis here, and not net. That is, the residence adjustment is included, but social insurance payments are not subtracted out. The logic behind this is that the income is still produced in the economy where the Connecticut out-of-state commuter works, regardless of its being taxed away. It is therefore included in "foreign" GSP, but not in SPI.

CONNECTICUT'S ECONOMIC CONTEXT: Regional and Interregional Flows

Before proceeding, it should be pointed out that there actually is no such thing as a "Connecticut economy." The relevant economic unit, or units, is not necessarily coextensive with a given state's boundaries. The relevant regional economy expands along paths of geographic transactions, without regard to political jurisdiction. Thus, there are at least three identifiable economies that are partially within the borders of the state of Connecticut, but also cross state lines into neighboring states: Hartford-Springfield, New London-Groton-Southeastern CT-RI, and NYC-Fairfield County. Further, unlike the rest of the New England states, Connecticut has one "foot" in one region (the Tri-State Region around NYC) and the other in New England.

Since the largest portion of Connecticut's income is concentrated in the part of the State that lies south and west of New Haven, the discussion will concentrate on the influence of the New York City economy. New York City (NYC), because of the mass of its regional economy, pulls other nearby regional economies into its orbit. As a consequence, the NYC economy is a net importer of labor services from the surrounding areas. NYC businesses import labor services from downstate NY outside the city, Northern NJ, Southwestern CT, and Northeastern PA. Focusing specifically on Connecticut, this area's economies are net exporters of labor services to NYC. This can be measured by the Current Account Balance (CAB), which measures the balance of trade among nations. Such an account exists for regions too, although the data is certainly not as readily available. A regional CAB for Connecticut might look as follows:

CAB = Net Exports + Net Income Payments + Net Transfers Received

Net Exports represents the difference between goods and services produced by Connecticut's businesses that are exported to the rest of the U.S., outside Connecticut, and to the world, minus goods and services purchased by Connecticut households that are imported from outside Connecticut (rest of U.S., outside Connecticut, and the world). If positive, then Connecticut is producing more goods and services than it is consuming; if negative, then Connecticut is consuming more goods and services than it is producing. Net Transfers are payments received for no current-period goods or services, minus payments made to individuals who have provided no current-period goods or services. Finally, the important component for our purposes: Net Income Payments (NIP). If NIP is positive, then the payments to Connecticut residents who export factor services exceed those made by Connecticut businesses to non-Connecticut owners of factor inputs used to produce Connecticut's final goods and services. If negative, then payments to non-Connecticut owners of factor inputs, exceeds those made to Connecticut residents who export factor services. In particular, the focus here is on the labor input, specifically, Labor Income, or more specifically, Net Labor Income Receipts. The above ideas are summarized in Table 1.

TABLE 1: CT Current Account Balance: NET LABOR INCOME RECEIPTS-2004
NET LABOR INCOME RECEIPTS   + $4.0 billion
Receipts (To CT residents working outside CT) (+)  
Payments (To non-residents working in CT) (-)  


Table 1 isolates net income payments and further focuses in on the payments and receipts to the labor services part of net labor income receipts. Thus, in 2004 Connecticut had a net surplus on its CAB for net labor income receipts as Connecticut residents (i.e., Connecticut households exporting their labor services out of state) received $4 billion more in labor income than Connecticut businesses paid to "foreign" households who imported their labor services into the State. Households in New Haven and Fairfield counties export their labor services to NYC businesses, which they use to produce final goods and services (GSP). For exporting labor services, the Southwest Connecticut economies then receive payment for their exports in the form of income, specifically labor income. This represents an exogenous injection (i.e., externally generated) of income into the New Haven and Fairfield county economies. Though Connecticut also imports labor services from surrounding states, the State exports more labor services than it imports. This is reflected by the $4.0 billion surplus for net labor income receipts in Table 1, and as the positive $4.0 billion residence adjustment in State personal income, when work-based earnings are converted to residence-based earnings. Connecticut's residence adjustment was not always positive. In the 1950's and 1960's, Connecticut's residence adjustment was negative. This also implies that the net labor income receipts were also negative. This, in turn, implies that Connecticut, at that time, was a net importer of labor services.

Focusing on Connecticut's Income Flows

The previous section revealed Connecticut's surplus position, in terms of net labor income payments, with surrounding states from a balance-of-payments perspective, as reflected by the State's current account balance. The important result from the discussion is that there is a significant difference between the income generated by economic activity within the borders of Connecticut and that generated outside Connecticut and brought back into the State by out-of-state commuters. What follows investigates the specifics of those mechanisms that bring about this observed difference in the income generated by the State's economy versus that which is externally generated.

Table 2 below presents the commuting patterns of Connecticut commuters to neighboring states from the August 2004 Journey to Work survey (based on the 2000 Census) done by the U.S. Census and U.S. BEA-Regional Economic Information System. The states are ranked according to the number of Connecticut commuters who work there, and for which there are at least 1,000 commuters. Connecticut commuters to New York earn an average wage that is three times higher than intra-state commuters. Connecticut commuters to Massachusetts also earn a higher average wage. Only Connecticut commuters to Rhode Island earn an average wage that is lower than that for intra-state commuters.

TABLE 2: Commuting Patterns, State-to-State for CT and Neighboring States
Residence State Work State Commuters Average Wage
  
  Connecticut
Connecticut 1,175,050 $42,444
New York 51,728 $131,969
Massachusetts 11,925 $54,079
Rhode Island 3,235 $38,474
Total Commuters / Average Wage 66,888 $113,561
(CT. Commuters to NY, MA, and RI)    
   SOURCE: U.S. Census and U.S. BEA, Journey to Work, August 2004


CONNECTICUT'S INCOME SPLIT: Some Implications

Obviously, this split between the income generated by economic activity within Connecticut's borders, and the, on average, higher income earned by its residents employed in jobs outside of the State, even in the same sectors, has some important ramifications.

Graph 2 above presents a scatter plot of the Year-to-Year (YTY) change in Connecticut's residence adjustment against Connecticut personal income over the 1990-2005 period. A line is drawn through the data to suggest a relationship that is upward sloping. This, in turn, suggests a positive relationship between the YTY growth rate in the residence adjustment (RA) and that of personal income.

The relationship between the RA and the U.S. PI is in the opposite direction (and much weaker). This implies that the U.S. economy is a net importer of labor services, and that this component is much less important to U.S. income growth than it is to Connecticut income growth. Also, it could be argued that the direction of causation is reversed. When the U.S. economy grows, it requires the importation of more labor services than it exports; hence, the negative value for U.S. net labor income receipts. Conversely, Connecticut's current account balance is positive for this item. That is, net labor income receipts are positive. Thus, Connecticut's income growth is significantly influenced by the growth of economies beyond its borders, particularly New York City. In fact, the positive, statistical association between the YTY growth rate in NYC work-based earnings and Connecticut's residence adjustment is very strong, and the relationship between the growth rate in NYC PI and Connecticut PI is even stronger. When the NYC economy is experiencing robust growth, particularly in financial services and information, its demand for imports, in the form of labor services, increases. This, in turn, increases the demand for exports, in the form of labor services, from New Jersey, Connecticut, and Northeast Pennsylvania. As the value of Connecticut's exports in labor services increases, the income earned from those exports increases, and that brings about an increase in the State's residence-based income. Since these jobs, generally, are higher paying, Connecticut's high per capita income is, at least in part, a product of its net surplus position in labor income receipts, on its current account balance from exporting labor services.

1 The author wishes to thank Patrick McPherron (Economist, CT DOL-Research) for his valuable comments and suggestions.

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Last Updated: November 7, 2006