Dennis Heffley

Lei Chen

Subhash Ray

English

Research Papers in Economics

FALL 2010  THE CONNECTICUT ECONOMY  7 
High Wages, Low Costs:  
A Connecticut Paradox?
BY SUBHASH RAY, LEI CHEN, AND 
DENNIS HEFFLEY
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  Last March, Connecticut’s busi-
ness environment made the national 
press when United Technologies’ CFO 
Gregory Hayes told Wall Street analysts 
that “Any place outside of Connecticut 
is low-cost.”  The immediate response 
of our elected officials ranged from 
outrage to full agreement, but even 
many of those who rose to defend 
the state’s economic virtue—highlight-
ing its skilled workforce, high quality 
of life, low corporate taxes and vari-
ous business subsidies—may privately 
harbor the popular view expressed by 
Hayes and many other state residents.  
*+)*%1564'276#6+10
  Connecticut’s high-cost reputation 
is bolstered by several studies that 
rank states by the “cost of doing busi-
ness” (CODB).  A 2007 report by the 
Milken Institute, based on 2006 data, 
ranked Connecticut as the 5th most 
expensive state for business.  Only two 
other states in the continental U.S.—
New York and Massachusetts—were 
more costly.  
Business news channel CNBC also 
gave Connecticut a lackluster overall rat-
ing of 35th in its 2009 list of “America’s 
Top States for Business” (http://www.
cnbc.com/id/31765930/).  CNBC’s 
overall rating is based on 10 sub-
indices, including a “cost of business” 
index that rated Connecticut the 4th 
most costly state, after New York, 
California and Hawaii.  Iowa, South 
Dakota, Arkansas, Missouri, and South 
Carolina were judged to be the cheap-
est states for business.  
  There’s no denying the popular 
perception, based on such reports, that 
Connecticut is an unattractive business 
location.  But are these oft-cited rank-
ings supported by sound analyses of 
available economic data?  And if they 
are correct, why don’t even more firms 
flee Connecticut for lower-wage states?   
We believe there are good answers to 
these questions—ones that may sur-
prise and even encourage Connecticut 
businesses, residents, and public offi-
cials.  
241$.'/5+0/'#574+0)
%1/2'6+6+8'0'55
 A problem with the Milken 
Institute study and many others, 
including the CNBC report, is that 
they confuse input prices (wages, rents, 
energy prices, etc.) with production costs.  
Wages, for example, certainly influence 
costs, but they are not the whole story.   
Firms facing higher wages have an 
economic incentive to use labor more 
efficiently.  Often this entails greater 
use of relatively less expensive inputs or 
of inputs that enhance labor productiv-
ity.  Whether high wages necessarily 
imply high unit costs of production 
also depends on the prices of non-labor 
inputs, as well as the degree to which 
various inputs substitute for or com-
plement one another in the production 
process.   
  In short, the unit cost of produc-
ing a good depends on management 
skills and the technology of production 
as well as on input prices.  High input 
prices foster the creative use of existing 
technologies and the development of 
new, more efficient ones.  Focusing 
only on input prices, and especially the 
price of just one input such as labor, 
ignores basic economic principles and 
says little about the overall cost per 
unit of output.  In fact, strange as it 
may sound, we’ll later see that a state’s 
average manufacturing wage tells us 
virtually nothing about its production 
costs per dollar of output.  
 Another problem with CODB 
indices is that the weights used to con-
struct such measures are often rather 
arbitrary and altogether miss an impor-
tant point.  The Milken 2007 CODB 
table considers four input price sub-
indices for wages, electricity, indus-
trial rents, and office rents, each based 
on just one variable, with respective 
weights of 50%, 15%, 10%, and 5%.       
The remaining 20% weight is assigned 
to “tax burden.” The source of the 
weights is unclear, but the fact that all 
are neatly divisible by 5 suggests that 
they may reflect someone’s best guess 
rather than a systematic analysis.  
  More important, it’s unclear why 
a common set of weights should apply 
to every state.  For example, if produc-
ers in a high-wage state find it efficient 
to substitute other inputs for labor, 
the share of labor in total costs will be 
affected by both the higher wage and 
more conservative use of the expensive 
labor.  The net effect on labor’s share 
of total cost is ambiguous, but it likely 
will differ from the cost share of labor 8  THE CONNECTICUT ECONOMY  FALL 2010
in a low-wage state.  Ultimately, market 
competitiveness depends on the overall 
cost per unit of output, not an index 
based on a common set of weights that, 
at best, may simply reflect the average 
mix of input expenditures across very 
different states.
6*'&#6#
  Data for this analysis come from the 
U.S. Census Bureau’s 2007 Economic 
Census of the manufacturing sector.   
Manufacturing jobs and the sector’s 
competitiveness receive special atten-
tion from politicians, journalists and 
the public, especially in Connecticut 
and other states with a rich history of 
manufacturing.  This attention may be 
misplaced, given the long-term trend 
in the relative importance of manufac-
turing, but more about that later.
 The data show that some per-
ceptions about Connecticut manufac-
turing are quite accurate.  We are 
indeed a high-wage state.  Using 2007 
Economic Census data to calculate the 
average hourly wage of manufactur-
ing production workers, Connecticut 
ranks 4th ($21.28), after Michigan 
($22.39), Louisiana ($21.89) and 
Wyoming ($21.79).  South Dakota 
($15.83), Mississippi ($15.64), 
Arkansas ($15.62) and Alaska ($14.15) 
report the lowest average wages for 
manufacturing production workers. 
  Connecticut fares only slightly bet-
ter in the average cost of hiring a non-
production manufacturing employee.   
New Jersey tops the high-pay list, with 
an average annual salary of $76,268, 
Connecticut ranks 6th at $71,733 and 
Hawaii trails the 50-state list with a 
figure of $46,787.  So, in manufac-
turing, it’s not just hourly production 
workers that cost more to hire in 
Connecticut; non-production work-
ers also earn more here than in most 
other states.  In fact, the “Connecticut 
premium” (percentage above the 50-
state average) is the same 15.1% for 
salaried non-production workers and 
hourly production workers.  Perhaps 
complaints about “overpaid” blue-col-
lar workers and technicians ought to 
be expanded to include white-collar 
employees, but there are other, more 
fundamental problems with using the 
pay of any one group to judge a state’s 
competitiveness.
%#.%7.#6+0)70+6%1565
  As noted earlier, production costs 
are not solely determined by wages, or 
even wages plus the costs of providing 
fringe benefits such as health insur-
ance.  Costs also depend on the prices 
of other inputs, as well as the abil-
ity of firms to find the most efficient 
input mix, given local input prices and 
available technologies.  The Economic 
Census data for 2007 can be used to 
calculate the overall unit cost of pro-
ducing a dollar’s worth of manufac-
tured goods in each state. 
  In Connecticut, for example, the 
total value of shipments ($58.405 
billion) plus net inventory changes 
($0.325 billion) gives the total value 
of gross output ($58.730 billion) in 
manufacturing.  On the cost side, total 
labor costs ($13.377 billion) include 
the annual payroll ($10.345 billion) 
and employers’ payments for fringe 
benefits ($3.032 billion) such as health 
insurance, pension plans, and other 
fringes.  Other outlays include: the 
total cost of materials used in pro-
duction ($23.672 billion); a catchall 
category labeled “total other expenses” 
($6.874 billion) that includes a vari-
ety of services as well as taxes and 
license fees; and annual capital costs 
($2.642 billion).  The latter figure is 
the sum of depreciation ($1.207 bil-
lion), rental payments ($0.398 billion), 
and imputed interest costs ($1.037 bil-
lion). [Note: we calculate the imputed 
interest costs, essentially the oppor-
tunity cost of holding physical assets, 
by applying a 5% rate of interest to 
the average book value of depreciable 
assets.]  Summing these costs and 
dividing the result ($46.565 billion) 
by the value of gross output gives the 
average unit cost ($0.793 or 79.3¢) of 
producing a dollar’s worth of manufac-
turing output in the state.  
  Using the same definitions and 
data from the same source, we calcu-
lated the cost of producing a dollar of 
manufacturing output for each state. 
The bar graph on the next page shows 
results for the 50 states, as well as 
the 50-state average (83.3¢).  By this 
more comprehensive measure of cost, 
Vermont has the dubious distinction 
of being the most costly manufactur-
ing state in the nation: a dollar of 
manufactured goods costs 95.9¢ to 
produce in the land of good dairy and 
small profits.  Other New England 
states with high manufacturing costs 
include New Hampshire and Rhode 
Island, 2nd and 3rd highest, at 93.5¢ 
and 93.0¢, respectively. 
  At the other end of the spectrum, 
North Carolina lives up to its reputa-
tion as a low-cost state for manufactur-
ers: each dollar of output costs just 
71.8¢ to produce, almost 14% below 
the 50-state average.  But, according to 
the federal data, Oregon fares even bet-
ter as a site for manufacturers: 70.6¢ 
produces a dollar’s worth of output 
in the Beaver State.  Other low-cost 
states include Virginia (76.8¢), Arizona 
(76.8¢), New York (78.1¢), Wyoming 
(78.9¢), New Mexico (78.9¢) and, yes, 
Connecticut (79.3¢).   As a manufac-
turing site, we fare better than either 
Massachusetts (83.0¢) or New Jersey 
(84.1¢), often seen as two of our key 
competitors for Northeast manufactur-
ing.
*+)*9#)'5*+)*%1565
  The analysis makes it quite clear 
that a high average wage does not nec-
essarily imply high production costs.   
In fact, the calculated unit cost of man-
ufacturing output is essentially uncor-
related with the average hourly wage of 
production workers. The scatter plot 
on page 10 bears this out: there is no 
positive relationship between wages and 
unit costs, as indicated by the virtually 
flat regression line and the near-zero 
R-squared value (0.0036).  Also note 
that even states with rather low unit 
costs, in the lower portion of the scat-
ter plot—North Carolina, Oregon and FALL 2010  THE CONNECTICUT ECONOMY  9 
Connecticut, for example—have very 
different wages.  Again, this illustrates 
the point that overall unit cost, not the 
price of a single input, determines a 
state’s manufacturing competitiveness.   
It also might explain why, despite fre-
quent complaints about workers’ high 
wages, we haven’t seen a mass exodus 
of Connecticut manufacturers to other 
states.  Apart from New York, the 
nearest state with a lower unit cost of 
manufacturing is Virginia, which has 
been a prime competitor in shipbuild-
ing, one of our traditional defense 
manufacturing strongholds.  Yet, even 
though production worker wages in 
Virginia ($17.36) are 18.4% lower 
than in Connecticut ($21.28), its unit-
cost advantage is just 2.5¢ per dollar of 
gross output. 
 
59+//+0)72564'#/
  Another problem with the claim 
that Connecticut’s loss of manufactur-
ing employment has been driven by 
high wages is that it fails to explain why 
the decline is so pervasive across nearly 
all states, and even across most mature 
economies.  For years, Connecticut has 
been losing manufacturing employ-
ment, both in absolute terms and as a 
share of total employment, but this is 
hardly unique to our state. The final 
graph on page 10 shows the share of 
manufacturing in total employment 
for Connecticut and the U.S., from 
1939 through 2009.  Connecticut 
once had a much higher concentration 
of manufacturing than did the U.S, 
but over time the state has converged 
toward the declining national norm.   
Peaking during World War II, the 
U.S. share of nonfarm employment 
in manufacturing has declined from 
37.9% in 1943 to 9.1% in 2009, while 
Connecticut’s manufacturing share has 
fallen from 56.5% to 10.6%—still 1.5 
points above the national figure.   
  These are powerful trends that will 
not be easily reversed.  Growth sec-
tors in Connecticut and the U.S. have 
been in areas that require high-skill 
services, such as health care, financial 
services, software development, and 
education, and it’s unlikely this secu-
lar pattern will suddenly reverse.  A 
healthy economy requires a balance of 
activities, and manufacturing is cer-
tainly part of that mix.  But our ability 
as a state to establish and maintain an 
appropriate mix of industries is better 
served by a critical analysis of where we 
stand, rather than unexamined claims 
about high costs that repel, rather than 
attract, employers and much-needed 
jobs.  
(+0#.6*17)*65#0&%#76+105
  Why does Connecticut fare well 
in this more complete assessment of 
unit manufacturing costs?  First, much 
to their credit, Connecticut firms have 
60¢ 70¢ 80¢ 90¢ $1.00
Oregon  50
North Carolina  49
Virginia  48
Arizona  47
New York  46
Wyoming  45
New Mexico  44
Connecticut  43
Missouri  42
South Dakota  41
Nevada  40
Iowa  39
Indiana  38
Washington  37
Colorado  36
Florida  35
Hawaii  34
Maryland  33
Delaware  32
Montana  31
Pennsylvania  30
Georgia  29
Massachusetts  28
California  27
Utah  26
Louisiana  25
50-STATE AVERAGE
Oklahoma  24
Maine  23
Texas  22
New Jersey  21
Ohio  20
Arkansas  19
Mississippi  18
Tennessee  17
North Dakota  16
Wisconsin  15
Minnesota  14
Illinois  13
Kansas  12
Alabama  11
Kentucky  10
South Carolina   9
Michigan   8
Alaska   7
Nebraska   6
Idaho   5
West Virginia   4
Rhode Island   3
New Hampshire   2
Vermont   1 95.9¢
83.3¢
79.3¢
70.6¢
Unit Costs of 
Manufacturing 
(2007)
CONNECTICUT HAS LOW MANUFACTURING COSTS
SOURCE: The Connecticut Economy, based on data from the 2007 Economic Census (http://factvafinder.census.gov/servlet/
IBQTable?_bm=y&-geo_id=&-ds_name=EC0731A2&-_lang=en)
%QUVRGT&QNNCTQH/CPWHCEVWTKPI1WVRWV10  THE CONNECTICUT ECONOMY  FALL 2010
likely made sensible adjustments to 
the prevailing structure of input prices 
by economizing on more expensive 
inputs, making fuller use of relatively 
cheaper inputs, and developing more 
efficient production methods.  
  In addition, Connecticut enjoys a 
prime location.  Sandwiched between 
two major metropolitan areas, one of 
which also serves as a world financial 
center, this favorable site inevitably 
brings higher rents.  But those rents 
buy ready access to markets for mate-
rials, various types of skilled labor, 
and the highly specialized inputs 
that modern manufacturing requires.   
Unfortunately, site advantages can be 
eroded by deterioration in transporta-
tion infrastructure, and there is grow-
ing evidence that the state may need 
to invest more heavily in road, rail 
and airport facilities, or better manage 
its current transportation system to 
remain a favorable place for manufac-
turing (see Edward Deak’s article on 
page 6).
  While this more complete analy-
sis of manufacturing costs, based on 
Economic Census data rather than a 
handful of questionable indices, casts 
a different light on the state’s busi-
ness environment, some cautions are 
needed.  First, we think it’s reasonable 
to compare the cost of producing a 
dollar’s worth of manufactured goods 
across states, but it would be useful to 
control for different types of manufac-
turing, perhaps by regressing the calcu-
lated unit costs on measures of product 
mix.  This would require some care, 
since any measure of product mix is 
inherently endogenous: the mix influ-
ences unit costs and vice versa.
  Second, although the Economic 
Census offers a fairly complete tally 
of costs, including “taxes and license 
fees,” this category excludes corporate 
income taxes.  Direct comparisons 
of corporate income tax rates are not 
simple (see: http://www.taxadmin.org/
fta/rate/corp_inc.pdf), but it appears 
that Connecticut’s flat 7.5% rate is 
in the middle of the pack, and below 
that of neighboring Massachusetts 
(8.75%) and Rhode Island (9.0%).   
New York’s rate is 7.1%, and low-cost 
North Carolina’s rate is 6.9%, just 0.6 
percentage points below our own.  
 A third caution involves the 
input-substitution described earlier in 
the article.  While we suspect that 
Connecticut manufacturers have been 
able to achieve relatively low unit costs 
by substituting other inputs (e.g., auto-
mated machinery, and contract labor) 
for regular employees, this will be seen 
as skillful management by some par-
ties and a source of job losses by other 
groups.  
  Fourth, our analysis was purposely 
restricted to manufacturing because 
this sector garners so much public 
attention.  But, given the long-term 
shift away from manufacturing, it 
would be useful to undertake a com-
parable analysis for other major sec-
tors—something we plan to do.  
  Finally, while industry leaders and 
public officials should be careful about 
misrepresenting Connecticut as a high-
cost manufacturing state, we also can-
not afford to ignore the importance 
of maintaining a favorable business 
environment.  This includes efforts to 
keep costs and taxes down, streamlin-
ing state and local regulations and 
requirements, and providing the public 
services and infrastructure needed to 
support businesses and their work-
ers—no small task.
  
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US
CT
2009 1999 1989 1979 1969 1959 1949 1939
CONNECTICUT NOT ALONE IN 
ITS LOSS OF MANUFACTURING
SOURCE:  The Connecticut Economy, based on Bureau of Labor 
Statistics employment data.
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SOURCE: The Connecticut Economy, based on data from the 
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WAGES SAY LITTLE 
ABOUT UNIT COSTS
Subhash Ray is a professor of economics and Lei Chen 
is an assistant professor in residence at the University 
of Connecticut.

High Wages, Low Costs: A Connecticut Paradox?

http://cteconomy.uconn.edu/articles/DH_F2010.pdf

High Wages, Low Costs: A Connecticut Paradox?

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