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Connecticut Economic Digest: October 1996 issue
Industry Clusters Revisited | Housing Update | A look at the Employment Cost Index | Leading & Coincident Indicators

Industry Clusters Revisited
By Mark Prisloe, Economist

In recent years, the concept of "industry cluster" has gained great currency. In his 1990 book, The Competitive Advantage of Nations, Harvard's Michael Porter defined and developed the concept based on his detailed analysis of regional economies and markets throughout the world. In the course of his work he noted the importance of markets, work force skills, suppliers, technology, infrastructure, and other features that industries share in common. As clusters evolve and strengthen they develop competitive advantages in the marketplace.

Other analysts have built on and modified Porter's work to come up with varying models of cluster structure and function, but they all share a basic trait: a holistic approach to understanding the competitive strengths and weaknesses of regional economies through identification of vertically integrated industry groups which include those firms which sell their goods or services outside the region, the local suppliers and subcontractors who work with these firms, and the economic foundations (e.g., capital, infrastructure, skilled workforce) which are essential to the success of the cluster industries.

Cluster Definition

Strictly speaking, a cluster is not an alternative definition of an industry. Rather a cluster represents a group of firms, or a pronounced geographic concentration of "production chains" for one product or a range of products, as well as linked institutions that influence the competitiveness of these concentrations (e.g. education, infrastructure, and research programs). A cluster denotes an area of unusually high and diverse industrial activity. The steel industry in the Pittsburgh region, the apparel industry in New York City, the machine tool industry in the Connecticut River Valley, the insurance industry in greater Hartford are classic examples of clusters.

Clusters evolve over time, often slowly. Worldwide, they can be found in urban areas, rural areas, and spanning both urban and rural areas. A salient feature of economic clusters, at their more advanced stages, is that their elements are mutually supporting. Michael Porter notes that "Once a cluster forms, the whole group of industries becomes mutually supporting. Benefits flow forward, backward and horizontally." Proximity to customers or suppliers (called value-added chains), markets, sources of information and technology interact to encourage growth.

Successful cluster growth depends on the strength and vitality of all three components. To the extent that one or more components is weak, the overall competitiveness of the cluster is diminished. Without healthy clusters, the rest of Connecticut's economy cannot prosper. When clusters perform well, other businesses, such as restaurants and retail shops, thrive. By selling most of their product to customers outside the state, clusters serve as the bedrock of the Connecticut economy.

Connecticut's Clusters

Identifying clusters is not picking winners or losers. Connecticut's clusters were identified based on their importance to the Connecticut economy--not whether they have stronger growth prospects. Cluster identification merely acknowledges the dominant role of a particular group of industries in the state's economy, it does not connote a most favored industry or target industry status. In fact, some of the clusters that have been identified have been losing jobs for several years, making it more imperative than ever to fully understand the dynamics of Connecticut's economic base industries.

Building on the 1993-94 study carried out by the Connecticut Economic Conference Board, the Department of Economic and Community Development has updated the listing of the state's industry clusters. Based primarily on the "location quotient" methodology (See "Defining a Location Quotient (LQ)" below), the initial set of industry clusters was modified slightly to produce the following set of clusters:

  • Telecommunications and Information
  • Financial Services
  • Health Services
  • High Technology
  • Manufacturing
  • Tourism and Entertainment

Each cluster is comprised of a number of detailed industries, ranging from 5 in the health services area to more than 20 in the manufacturing cluster. Combined, the clusters account for more than 45 percent of state output and around 40 percent of state employment. These industries represent the top layer of the cluster pyramid described above. Work is currently underway to identify the linkage industries and to carry out a detailed analysis of the comparative performance of each of the detailed industries comprising the clusters.

Just as economies and industries grow and change over time, so too will our list of clusters. The concept of an industry cluster is, by its very nature, which constantly evolves to respond to the challenges and opportunities of market forces, technological innovations and shifts in consumer and business demand.

The identification of clusters is just the first step in an ongoing process to develop strong, competitive industries in Connecticut. The next step involves setting up of industry cluster councils, volunteers who will work with their peers and with representatives of the public sector to identify and improve those factors which may be affecting Connecticut's economic competitiveness.

Defining a Location Quotient (LQ)

The first step in identifying the industries which comprise any cluster was to determine those which are in the economic base or traded-sector; that is, the industries that are selling goods and services to national and international markets as opposed to those that are producing for local consumption. A commonly used method for identifying economic base industries involves the calculation of a location quotient.

A location quotient (LQ) is a process which compares the concentration of an industry at a regional level to the concentration of the same industry at the national level. The LQ formula is:

LQ = % of CT employment in industry I divided by % of United States employment in industry I.

A location quotient greater than 1.0 indicates that the industry is more dominant in the state economy than it is nationally. Although LQ's are an imperfect tool for describing a regional economy and estimating exports, they are widely used because they are inexpensive, reflect indirect imports, and apply to both goods and services. All employment above the level necessary to set an industry's LQ equal to 1.0 can be considered export employment.

(Portions of this article are drawn from the following sources: Industrial Strength Strategies, Stuart A. Rosenfeld, Aspen Institute, 1995 and Understanding State Economies through Industry Studies, John M. Redman, CGPA, 1994.

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Housing Update
August housing permits decrease

The Connecticut Department of Economic and Community Development announced that Connecticut communities authorized 710 new housing units in August 1996, a 7.1 percent decrease compared to July 1996 when 764 were authorized.

The Department further indicated that the 710 units permitted in August 1996 represent a decrease of 20.1 percent from the 889 units permitted in August 1995, and that the year-to-date numbers are down 13.2 percent, from 5,706 in 1995 to 4,955 in 1996.

Reports from municipal officials throughout the state indicate that Litchfield County showed the greatest percentage increase in August compared to August 1995: 39.2 percent. New Haven County reported the greatest percentage decline: 45.6 percent.

New Haven County documented the largest number of new, authorized units in August with 160. Fairfield County followed with 149 units and Hartford County had 143 units. Shelton led all Connecticut communities with 28 units, followed by Trumbull with 21 and Southbury with 18.

The permit activity figure for August included the following statewide amounts by structure type: detached single-family units, 645; attached single-family units, 55; two unit structures, 2; three and four unit structures, 3; structures containing five or more units, 5.

Year-to-date totals indicate that Hartford County has issued the most building permits through the first eight months of 1996 with 1,154, followed by New Haven County with 1,018, and Fairfield County with 991. Southington authorized 137 new units during this period, followed by Rocky Hill with 125, Shelton with 122, and Wallingford with 118.

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A look at the Employment Cost Index

It is well-known that a major cost of doing business is the cost of labor. Not so widely known is that there are data available that measure the change in labor costs. Developed in the early 1970's by the United States Department of Labor's Bureau of Labor Statistics (BLS), the Employment Cost Index (ECI) provides a timely, accurate, and comprehensive indicator of change in the cost of labor, and can be a helpful tool for businesses, planners, and policy makers. Among the data that are available are measures of the change in wages and salaries, and in employer costs for employee benefits, as well as the change in total compensation costs.

For purposes of the Employment Cost Index, wages and salaries are defined as the hourly straight-time wage rate or, for workers not paid on an hourly basis, straight-time earnings divided by the corresponding hours. Employee benefits covered by the Employment Cost Index are: paid leave; supplemental pay (e.g., overtime); insurance benefits; retirement and savings benefits; legally required benefits (e.g., social security, Federal and State unemployment insurance, workers' compensation); and other benefits (e.g., severance pay). Total compensation costs are the aggregate of wages and salaries and employee benefits.

The Employment Cost Index provides an array of data for the national civilian economy. This includes both the total private economy and the public sector-excluding farms, households, and the Federal government. Data are also developed for regions of the country (Northeast, South, Midwest, and West). Connecticut is part of the Northeast Region which includes the New England states, New York, New Jersey and Pennsylvania. However, regional data is limited to information on total compensation costs and wage and salary costs, and is available only for private industry workers.

Each quarter, data are collected for the pay period including the 12th day of the survey months of March, June, September, and December. Nearly 21,000 occupations within about 4,100 sample establishments in private industry and nearly 6,000 occupations within about 900 sample establishments in State and local governments are surveyed. Within an establishment, spEmployment Cost Indexfic job categories are selected to represent broader occupational definitions.

Beginning with the March 1990 Employment Cost Index release, indexes were rebased to June 1989=100. Starting with the December 1990 Employment Cost Index release, seasonally adjusted data became available for selected Employment Cost Index reports. Seasonal adjustment removes the effects of events that follow a more or less regular pattern each year making nonseasonal patterns easier to spot.

As a further benefit to the user of the data, Employment Cost Index information is available by industry, occupation, and union/non-union affiliation. The following is a sampling of the information found in the Employment Cost Index for June 1996.

The June 1996 Employment Cost Index level for all civilian workers in the nation, at 129.2, was 2.9 percent higher than in June 1995. Wage and salary costs rose 3.2 percent over the year, while benefit costs rose 1.8 percent.

For private industry workers nationally, total compensation costs increased 2.9 percent, but wages and salaries increased 3.4 percent over the year ending June 1996, up from 2.9 percent for the June 1994-June 1995 period. This was the largest 12-month increase since March 1992. By comparison, total compensation costs in the Northeast increased more slowly, 2.4 percent. The region's wage and salary costs increased by 3.2 percent during this period. Benefit costs increased 1.7 percent, compared with a 2.6 percent increase for the 1994-95 period, reflecting slower rising costs for health benefits, unemployment insurance and workers' compensation.

Total compensation costs in service-producing industries increased 3.0 percent compared with 2.7 percent for goodsproducing industries. Wages and salaries increased 3.5 percent in service-producing industries, compared with 3.0 percent in goods-producing industries. In contrast, benefit increases were larger for goodsproducing industries (2.0 percent), than for serviceproducing industries (1.6 percent).

Compensation costs for whitecollar workers increased 3.0 percent compared with 2.6 percent for blue-collar workers and 2.0 percent for service occupations. Among the major occupational groups, sales occupations had the largest increase, at 3.7 percent, while machine operators, assemblers, and inspectors had the smallest increase, at 1.9 percent.

Compensation cost gains over the year ending June 1996 were higher for union workers (3.1 percent) than for non-union workers (2.8 percent). This pattern held for the service-producing industries (3.7 percent for union and 2.8 percent for non-union), but not for goods-producing industries (2.5 percent for union and 2.8 percent for non-union).

(extracted from United States Bureau of Labor Statistics reports)

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Leading & Coincident Indicators
Will the recovery continue to motor ahead?

Connecticut's coincident employment index moved, once again, to its highest level in the current recovery with the release of the (preliminary) July data, having not fallen on a month-to-month basis since December 1995. The leading index, however, fell somewhat from its peak during June.

The coincident index, a gauge of current employment activity, rose slightly in July, continuing the strong upward movement that emerged in 1996. The 1996 experience follows weak upward movement in the coincident index in the early phases of the current recovery. The bottom line? The economy continues to motor ahead.

The leading index, a barometer of future employment activity, has bounced around considerably during 1996. It reached its highest level in the current expansion in June. Thus, the decline in the index this month is not too surprising. The crucial issue is whether the trend is up or down over the next several months.

The 1996 debate has waxed and waned over whether the national economy is overheating. The Federal Reserve has received intense scrutiny by so-called "Fed" watchers. At this writing, the Fed chose not to boost short-term interest rates in September, even though many had called for a hike. Fed Chair Greenspan wants to nip any inflation bud before it can bloom. The question, at the moment, is if and when the Fed should unsheathe the pruning shears.

Whatever the Fed does or does not do affects the Connecticut economy. National events filter into our economy with some lag. Unfortunately, our recovery from the most recent Great Recession was delayed and weaker than normal. Our recovery only picked up its pace in 1996. Thus, the latest action (inaction) by the Fed was welcomed news in Connecticut. The party may not yet be over.

The coincident employment index rose from 83.0 in July 1995 to 88.3 in July 1996. All four index components continued to point in a positive direction on a year-overyear basis with higher nonfarm employment, higher total employment, a lower total unemployment rate, and a lower insured unemployment rate.

The leading employment index rose from 86.1 in July 1995 to 88.2 in July 1996, or somewhat below its previous peak of June 1996. All five index components sent positive signals on a yearover- year basis with a higher average work week of manufacturing production workers, lower initial claims for unemployment insurance, higher Hartford help wanted advertising, a lower shortduration (less than 15 weeks) unemployment rate, and higher total housing permits.

Source: Connecticut Center for Economic Analysis, University of Connecticut. Developed by Pami Dua [(203) 322-3466, Stamford Campus (on leave)] and Stephen M. Miller [(860) 486-3853, Storrs Campus]. Tara Blois [(860) 486-4752, Storrs Campus] provided research support.

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Last Updated: October 15, 2002