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Connecticut Economic Digest: October 1998 issue
Connecticut's Drug Sector: Healthy, Wealthy, And Getting Wiser | Industry Clusters | Housing Update | Current Conditions, Bullish; Future Conditions, Less-Clear

Connecticut's Drug Sector: Healthy, Wealthy, And Getting Wiser
By Lincoln S. Dyer, Economist

There is an industry well known for being immune to swings inherent in the business cycle. This sector's companies can regularly return double-digit profit gains, year in and year out, regardless of overall economic conditions and is often sought by investors as a safehaven on Wall Street because of dependable earnings growth. This same industry commonly pays average salaries that generally reach twice the State's overall average wage. This sector also routinely spins off new companies or takes equity stakes to infuse capital to biotech startups as frequently as it consolidates in an era of merger mania. This industry group, moreover, has some of the most potent direct job and earnings multipliers of any industry in the State and is a powerful engine of growth when it is aligned with academia, government, and free flowing venture capital. Most importantly, this sector, as a matter of course, saves numerous human and animal lives and makes difficult living situations more than just bearable. Naturally, the topic of above discussion is the drug manufacturing sector of the Nutmeg State.

The Metamorphosis

The sector is specifically defined as Standard Industry Classification (SIC) 283 - Drugs. This group comprises establish- ments principally engaged in manufacturing, fabricating, or processing medical chemicals and pharmaceutical products. This classification also includes firms working in the grading, grinding, and milling of botanicals. But increasingly in Connecticut, SIC 283 - Drugs means value-added research and development. The State's traditional manufacturing sub-component of the chemical industry is phasing out some of its on-going mass production processes and concentrating on the specific creation of patented compounds which have higher profit margin protection over time. This in turn leads to more emphasis on the acceleration of drug research to discover these prospective compounds. Nowadays, most of the employment growth in this sector is coming from increased laboratory research, clinical trial development expenditures, and patented compound fabrication. The focal point is now on the drug "pipeline", which leads to future revenue streams with high profit margins on patented pharmaceuticals, not the low-margin bulk chemical production that can be duplicated cheaper somewhere else.

An example of this would be the former making of penicillin, caffeine, and citric acid in the State. These compounds evolved to become almost bulk commodities that are now generally produced off shore so that companies can compete on cost with other players in the basic production of these products. Once a patented drug loses its exclusivity, the profit margins suffer quickly, and it is no longer efficient to produce such compounds in Connecticut where a skilled and educated workforce demands wages among the highest in the nation. So, drug companies are re-evaluating their operations here to take advantage of Connecticut's intellectual capital to boost profit margins.

Additional circumstances have also facilitated the increased focus on R&D in Connecticut. Technology advances have allowed research scientists to screen many more prospective compounds in a shorter amount of time to gauge the bio-activity of certain substances. This provides a much larger array of prospective reactive compounds for further investigation. Consequently, more scientists are needed for this research. This falls right into play for Connecticut's highly educated workforce (which has among the nation's highest percentages of college degrees per capita). With more prospective substances as candidates for drug patents, the State is also benefiting from the clinical trial development and marketing aspects involved. In the near future, especially with a planned Pfizer expansion in New London that will be engrossed in clinical trials, the development and marketing aspects of the drug sector will expand in Connecticut. Bringing drugs to market is as important to the bottom line as discovering them.

Environmental regulation and heightened corporate citizenship apparently have also helped redirect this sector's objectives. Pollution control efforts, both to meet DEP and EPA requirements and company ethics provisions, have instigated a shift to cleaner production processes that in turn has led to more automation in production. Fewer people are now involved in the actual production of drugs in the State, yet overall employment levels have grown, with the employment need being redirected to research. Research and development is fundamentally less polluting than bulk chemical production and this will reduce emissions, especially of elements like nitrogen, that have had a negative effect on Long Island Sound.

Furthermore, State research and development tax incentives were formerly only favorable for the truly large companies, but now they have been extended to more companies with much lower R&D spending thresholds. The benefits of these tax incentives will spread to smaller companies, further boosting research in this sector and in biotechnology in general.

A Viagra To The Economy

One science advocacy group (CURE) estimates that over 55% of the State's pharmaceutical industry (SIC 283) employment is now already involved with R&D. This percentage will undoubtedly increase as laboratory space shortages are being addressed in a resourceful manner and employment is projected to grow by better than 25% by 2006, to about 11,900 from 9,300 at the end of 1997. Planned drug company laboratory expansions along with a new major clinical facility already under construction will lead this growth, indicating the emphasis on research. Pfizer in Groton and Bayer in West Haven, a couple of wellknown pharmaceutical companies, are currently in the forefront of laboratory and clinical research space creation in the State. Besides adding more lab space, drug companies take equity stakes, buy marketing rights to prospective compounds from biotech firms, and set up joint partnerships that really provide almost a quadruple-boost to employment in the State. There are already some unique relationships in existence between drug companies and the State universities (Pfizer-UCONN) for example, and with Yale University in particular. Health centers will also play a pivotal supporting role in research and are essential for clinical trial programs and evaluations.

The drug sector certainly impacts various areas of business activity as exhibited by the direct-earnings and job multipliers of better than 2.20-to-1 for earnings ($'s) and better than 3.33-to-1 for employment (number of jobs). Obviously, these jobs are worth keeping and are the ones a state should promote. These jobs have also shown that they stick around during times of recession. Connecticut already is a national hotbed for drug manufacturing employment along with New Jersey and Pennsylvania. For a national perspective, look at Connecticut's total nonfarm employment. While Connecticut has just 1.3% of the nation's nonagricultural jobs, its drug sector with about 9,200 positions in 1997, makes up over 3.5% of the nation's 260,300 drug sector jobs.

Nutmeg Panacea

The future of this sector looks bright in Connecticut, with many positive developments assisting growth down the road. The State has targeted the sector as part of the high technology industry cluster, providing support and incentives as a catalyst to further advance job creation, facilitate company expansion, and attract other pharmaceutical firms to the Nutmeg State. Industry-wide trends are also very favorable and they include a more industry responsive FDA and the full realization that drug research is really the engine of growth for the sector. Companies are putting a higher percentage of revenues back into R&D as compared to the early 1990's. At Pfizer, almost 16% of sales went into R&D in 1997 (almost $2 billion, with about $1 billion being spent at the Pfizer Central Research facilities in Groton), up from 11% of sales in 1990. There is also the emergence of the focus on lifestyle drugs, like Viagra, that are in so much demand from the aging baby-boomers. These new drugs now enhance day-to-day life more than they cure a particular disease, opening up vast opportunities for new products. Increased research activity is also being applied in the area of drugs for animals. In addition more federal government research dollars are now inclined to go to non-military areas like national health instead of into defense. Finally, the increasing prevalence of CRO's (Contract Research Organizations), which have the critical mass to conduct large clinical trials for drug companies, could also assist in the creation of high-paying job opportunities in the State as drug companies often have more prospective drug candidates than they can handle. They are already farming out more R&D to biotech firms and may eventually subcontract some work to the CRO's. In the future, a similar seeding of research and testing firms is expected to grow around Pfizer's announced expansion on New London's waterfront.

There appears to be a dynamic unfolding in this industry that summons the need to be on the cutting edge of drug exploration. This important industry sub-group has changed its processes to build more on intellectual capital than physical capital. The State of Connecticut has recognized this and is providing an improved research environment to retain and attract firms in this prime employing sector. Common sense tells us that these research jobs fit well with Connecticut's demographic makeup that includes a bettereducated labor force, higher per capita incomes, and an aging population. Also, as a smaller state with slower but controlled growth, Connecticut needs jobs with potent direct multipliers to help further spread economic gains. One eighteenth-century scientist, Benjamin Franklin, would have noted that fostering research growth could make the State as well as its drug industry, healthy, wealthy, and a whole lot wiser.

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Industry Clusters
Exports Up 1.5 Percent

Connecticut's merchandise exports, which had slipped 0.3 percent in the first quarter, were up 1.5 percent through the second quarter of 1998 from the same period last year. U.S. exports through the second quarter were up only 0.8 percent.

Connecticut's largest export industry, transportation equipment was up 13.7 percent; instruments were up 5.9 percent; and rubber and miscellaneous plastic products were up 4.9 percent. These gains were offset by decreases of 2.8 percent in industrial machinery; 11.9 percent in electronic equipment; 3.3 percent in chemicals; 23.6 percent in fabricated metals; 29.4 percent in primary metals; 19.4 percent in apparel; and 9.1 percent in paper and allied products, among the top ten export industries.

Connecticut's largest trading partner, Canada increased imports of Connecticut products 3.1 percent, while exports to Asian countries overall fell 11.8 percent. The dollar value of exports to all Asian countries represented 21.8 percent of Connecticut's total exports.

Among Connecticut's top ten export destinations, exports to Mexico were up 10.0 percent, along with exports to France, up 100 percent, Germany, up 10.7 percent, and the Netherlands, up 17.2 percent. Exports to the United Kingdom were down 16.4 percent. Exports to all of Connecticut's top ten trading partners were up 7.0 percent.

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Housing Update
August Housing Permits Up 20.8%

Commissioner James F. Abromaitis of the Connecticut Department of Economic and Community Development announced that Connecticut communities authorized 976 new housing units in August 1998, a 23.2 percent increase compared to August of 1997 when 792 were authorized.

The Department further indicated that the 976 units permitted in August 1998 represent a decrease of 24.7 percent from the 1,297 units permitted in July 1998. The year-to-date permits are up 20.8 percent, from 6,279 through August 1997, to 7,586 through August 1998.

"Housing permits continue to show strong, steady growth through August," Commissioner Abromaitis said. "More good news is the fact that the housing sector experienced an increase in most of Connecticut's major cities, namely Bridgeport up 33 units, Hartford up 52 units, and Stamford up 62 units compared with the same period last year."

Reports from municipal officials throughout the state indicate that Fairfield County with 56.6 percent showed the greatest percentage increase in August compared to the same month a year ago. Middlesex County followed with a 50.0 percent increase.

Fairfield County documented the largest number of new, authorized units in August with 260. Hartford County followed with 214 units and New Haven County had 147 units. Danbury led all Connecticut communities with 56 units, followed by Stamford with 54 and Winchester with 49.

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Current Conditions, Bullish; Future Conditions, Less-Clear

The Connecticut coincident employment index paints a picture of continuing growth for the Connecticut economy. The coincident index has followed a strong upward trend for nearly the last three years, unlike its weaker upward movement during the initial phase of the current expansion. The Connecticut leading employment index, however, provides a less-clear vision of the future. The leading index has also been on an upward trend, albeit with less strength and with more ups and downs around this slower trend. The relative strength in the movement of the two indexes is illustrated by their growth rates over the last year - the coincident index rose by 7.3 percent while the leading index increased by only 1.4 percent.

The coincident index, a barometer of current employment activity, reached another new peak with the release of (preliminary) July data. The increase in the coincident index results entirely from the fall in the unemployment rate from 3.8 to 3.4 percent. The other three components each generated small negative signals on a month-over-month basis.

The leading index, a barometer of future employment activity, backed off slightly for the second consecutive month. The June decrease in the leading index was largely a result of the higher initial claims for unemployment insurance. The July fall emerged as a result of lower Hartford help-wanted advertising and a higher short-duration unemployment rate.

A reversal in the direction of movement of the leading index for three consecutive months generally precedes a change in the direction of the economy by six months to a year. As a consequence, future movements in the leading index need close monitoring, since they will signal future movements in the Connecticut economy.

In summary, the coincident employment index rose from 89.2 in July 1997 to 95.7 in July 1998. All four index components, once again, point in a positive direction on a year-over-year basis with higher nonfarm employment, higher total employment, a lower insured unemployment rate, and a lower total unemployment rate.

The leading employment index rose from 89.8 in July 1997 to 91.1 in July 1998. Four of the five index components sent positive signals on a year-overyear basis with a lower shortduration (less than 15 weeks) unemployment rate, higher Hartford help-wanted advertising, higher total housing permits, and a longer average work week of manufacturing production workers. The other component sent a negative signal on a yearover- year basis with higher initial claims for unemployment insurance.

SOURCE: Connecticut Center for or Economic Analysis, University of Connecticut. Developed by Pami Dua [Economic Cycle Research Institute; NY,NY] and Stephen M. Miller [(860) 486-3853, Storrs Campus]. Campus]. Kathryn E. Parr and Hulya Varol [(860) 486-3022, Storrs Campus] provided research support.

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Published by the Connecticut Department of Labor, Office of Research
Last Updated: October 15, 2002