The economic science of raising Hoosier incomes

Economic takeoff continues to evade Indiana in the 21st century. While the economies of other states have radically reshaped and transformed themselves (such as Idaho¹), Indiana struggles to keep pace with national growth in prosperity despite a nationally recognized pro-business tax and regulatory environment.^2,3,4 This mismatch between outcome and policy environment suggests a need for nuanced investigation into how Indiana can improve its economic strategy. Success requires precisely defined interventions that carefully target root causes of lagging economic performance in Indiana. Without further sophistication in evaluation of choices, monies allocated for economic advancement will continue to generate mediocre returns for Hoosier communities.⁵ Increased efficiency is often a more important driver of effectiveness than increased resources.⁶

Prosperity in Indiana is intrinsically linked to the wages earned by Hoosier workers. A profitable employer pays an employee no more than the revenue their work generates for the business.⁷ This revenue equals the price of the output produced times the quantity of output produced by the employee. The economic value (or willingness to pay) assigned by markets to the output that is produced determines price. Labor productivity determines the quantity of output produced by an employee. Any legitimate policy or initiative to raise Indiana wages must therefore explain how it elevates the competitive market value of goods produced by Hoosiers or the productivity of time spent by Hoosiers in the workplace.

Wages and wage growth in Indiana

Wage data from Table 1 tells the story of a state that is falling behind the nation. In 2007, just before the Great Recession, average hourly earnings for Hoosier workers were 95% of the national average. By 2023, earnings were 88% of the national average. Among all 50 states and the District of Columbia, workers in Indiana fell from being the 29th best paid in 2007 to being the 35th best paid in 2023. During this period, average hourly earnings grew 49% in Indiana while they grew 61% nationwide. Only 11 states grew slower than Indiana over this period.

Wages in Indiana also lag adjacent states. Workers in Illinois, Michigan and Ohio respectively earned 99%, 92% and 91% of the national average in 2023 compared to 88% in Indiana. Average hourly earnings were only lower in Kentucky at 84% of the national average. Indiana’s wage growth more closely matches that of its neighbors. Wage growth of 49% in Indiana between 2007 and 2023 beat 45% in Illinois and Michigan, but lagged 52% in Ohio and 59% in Kentucky. Only 13 states grew faster than Kentucky during this period.

Comparative wage trajectories are best understood through the lens of economic history. The nation’s manufacturing renaissance anchored itself in Indiana and the Midwest just after the Civil War. In 1860, New England hosted 31% of the national manufacturing workforce compared to 11% in the Midwest. By 1920, New England’s share had fallen to 15% while the Midwest’s share had risen to 25%.⁸ Highly concentrated manufacturing industry clusters kept labor productivity in the Midwest comparably high and allowed midwestern wages to match or exceed the national average. As late as 1980, midwestern manufacturing workers enjoyed a wage 16% higher than manufacturing workers in other regions.

Shifts in manufacturing technology, cheaper transportation and communication, and union-driven work stoppages converged in the 1980s to reverse over a century of comparative economic fortune in the Midwest. A 16% regional manufacturing wage premium in 1980 fell to 5% in 2000.⁹ The capacity of wages in midwestern states to stay nationally competitive stalled. Per capita income as a share of the national average in 1979 was 111% in Illinois, 105% in Michigan, 100% in Ohio and 98% in Indiana. By 1989, this ratio had fallen to 105% in Illinois, 98% in Michigan, 93% in Ohio and 91% in Indiana.¹⁰

Economic theory offers a predictable cycle of growth, development and maturation of geographically concentrated industry clusters. This cycle explains the rise and fall of manufacturing-driven prosperity in Indiana and the remainder of the Midwest. The merger of new technologies, new production methods and new products gives birth to new industries. Because rates of learning and innovation are high in a young industry, the private and social economic benefits of geographic proximity between producers (otherwise known as agglomeration economies) are high.¹¹ This explains why the Midwest was such a magnet for manufacturing before 1980—new factories enjoyed high economic returns from locating next to established factories. Learning and innovation, though, typically slow as an industry matures. As unique benefits of geographic proximity weaken with time, more and more producers locate outside of the original cluster in search of cheaper inputs.¹² This explains why more and more new factories chose to locate outside of the Midwest after 1980. Slower industry innovation meant the benefit of cheaper labor, especially in the South, surpassed what used to be a strong benefit of being close to other established midwestern factories.¹³ Silicon Valley is experiencing a similar erosion in agglomeration economies as more and more technology ventures choose to locate outside of California in search of lower overhead and talent costs.¹⁴  

Midwestern states face a unique challenge—they must build new industry clusters upon the remnants of old industry clusters without experience in doing so. Being the oldest industrialized region in the country, New England—unlike the Midwest—has successfully navigated the rise and fall of industry clusters. High-value services successfully replaced labor-intensive manufacturing as the driver of economic growth.¹⁵ For example, the “Massachusetts Miracle” transformed the Boston regional economy in the 1970s.¹⁶ Over just a few decades, a classic blue-collar industrial state became a global biotechnology hub.¹⁷ Unlike the Midwest, comparative wages did not collapse. By 2023, the mean wage in Massachusetts was 20% higher than the national average (see Table 1).

Economic geography explains New England’s higher economic resiliency. Large geographically concentrated populations and a historical legacy of national economic leadership endow New England with critical density in financial capital, physical infrastructure, talent, social networks, cultural diversity, global business linkages and research-oriented educational institutions. This type of density increases the capacity of a region to replace old industries with new industries and avoid permanent economic decline.¹⁸ Lack of similar density made it harder for midwestern states to recover from the retreat of manufacturing in the 1980s and heralded the geographic onset of the “Rust Belt.” Some midwestern regions, such as Gary and Muncie in Indiana, never recovered.¹⁹ In these regions, the exit of labor-intensive manufacturing induced geographical poverty traps that perpetuated devastating, self-reinforcing cycles of divestment, urban decay and depopulation from which communities could not extricate themselves.

The top 10 states in Table 1 where average hourly earnings grew the fastest are in the South or the West. Unlike New England and the Midwest, the South and the West have no historical legacy of industrial economic leadership. Regional economies built to support slave-based commercial agriculture and wealth destruction caused by the Civil War delayed development of modern industry clusters in the South.^20,21 Late settlement of the West kept cities small, commercial density low and distances between centers of economic activity high.²² Unlike New England and the Midwest, the South and the West do not bear the cost of transforming obsolete human, social and physical infrastructure that evolved to drive success in a 20th-century, labor-intensive manufacturing economy. Just as it is cheaper per square foot to build a new house than remodel an old house, it is easier to build a new commercial ecosystem on undeveloped land and attract workers from other regions than to repurpose an existing ecosystem and retool the established workforce that supplies it. Silicon Valley physically grew fast because it geographically replaced farmland and fruit orchards instead of industrial brownfields and shuttered manufacturing sites.²³ The greenfield advantages enjoyed by new industry clusters in the South and West partially explain the faster wage growth of states in these regions.

Comparison of the economic history and geography of Indiana as a midwestern state with peers in New England and the South and West reveal the foundational causes of lagging wage growth. Public discussion often blames poor wage performance in Indiana on cultural conservatism, taxation, unions, attitudes toward education and other observed social or institutional phenomena. These phenomena, though, reflect norms and policies that historically evolved to drive prosperity in regions dominated by labor-intensive manufacturing. Now, as present barriers to economic success, they are symptoms and not root causes of Indiana’s weak linkage with modern high-value industries. Expenditure of energy on short-term reversal of symptoms takes attention away from the more complicated, long-term work required to reprogram and realign Indiana’s economy. Because productivity determines wages, and because productivity increases fastest in high-value industries, a singular focus on productivity can minimize distraction from solutions that permanently accelerate hourly earnings for Indiana workers.

Productivity and productivity growth in Indiana

As explained earlier, the wage paid a worker cannot exceed the revenue value of what they produce in a profitable business. A rise in productivity must therefore precede any rise in wage. Assuming no tightening in the availability of (and therefore competition for) workers, a rise in wage without any rise in productivity reduces profit and destroys stockholder value. Thus, any public strategy to raise wages must, by default, be a strategy to raise labor productivity. Higher labor productivity is a win for all business stakeholders. A worker with higher productivity generates more output in an hour. This earns them a higher wage. Additional output increases revenue and profit for the business. Higher profit means higher tax revenue for state government and higher dividends for stockholders. The cost to produce a unit of output also falls. This allows the firm to reduce its price to be more competitive. A lower price benefits customers and combats inflation. Higher labor productivity is therefore “manna from heaven” that benefits everyone in the economy.

The U.S. Bureau of Economic Analysis recently revamped their methodology of measurement for real gross domestic product (GDP) at the state, metropolitan area and county level. At the time of publication of this article, measurements using this new methodology were only available between 2017 and 2022.²⁴ GDP is the market value of all final goods and services produced in the geographic region. Real labor productivity is real GDP divided by employment and quantifies the market value of output per worker controlled for inflation. Real per capita GDP is real GDP divided by population and measures economic prosperity per resident. Outside of economies that earn generous income through petroleum and other natural resource exports, higher real per capita GDP requires higher real labor productivity.

Table 2 reports real labor productivity and real per capita GDP for Indiana, the nation and neighboring states. Comparatively low productivity in Table 2 confirms the comparatively low average hourly earnings observed in Table 1. Statewide real labor productivity in 2022 was 87% of the national average. This closely matched average hourly earnings in 2023 equal to 88% of the national average. Indiana productivity fares well, though, when contrasted against neighboring states. Indiana’s real labor productivity in 2022 beat all neighboring states except Illinois. Among neighboring states, real labor productivity growth between 2017 and 2022 was highest in Indiana at 7.9%. This was almost one point higher than Michigan, which posted the second-fastest growth of 7.0%. Michigan’s rate of growth matched the national rate of growth. Thus, not only did Indiana beat its neighbors in terms of real productivity growth between 2017 and 2022, but it beat the nation. Achievement of this uncharacteristically high momentum correlates with implementation of the 2018 Next Level Agenda workforce strategy.²⁵ This strategy launched the Governor’s Workforce Cabinet and set ambitious goals for enrollment in postsecondary education and job training programs.²⁶ Higher-than-average productivity growth in Indiana makes future higher-than-average wage growth possible for Hoosiers.

Table 2 additionally provides data for regions within the state. Real labor productivity in 2022 fell short of the national average in all metropolitan areas anchored in Indiana. Not surprisingly, comparatively low productivity is geographically pervasive throughout the state. Some regions, though, demonstrate remarkable bounce. Real labor productivity in seven of the 12 metropolitan areas anchored in Indiana grew at double-digit rates between 2017 and 2022. These include regions like Kokomo, Muncie, South Bend and Terre Haute, historically scarred by the retreat of manufacturing that began in the 1980s. The reshoring of factories and federal subsidy of domestic industrial production through the CHIPS and Science Act and Bipartisan Infrastructure Law fuel a new recovery in manufacturing.²⁷ Successive years of aggressive recruitment of capital investment by the Indiana Economic Development Corporation brought new technologies and new companies to the state that lifted productivity of the average employee.²⁸ Momentum falls notably short in the regions that host the state’s two largest state universities. Among the 12 metropolitan areas anchored in Indiana, real productivity growth between 2017 and 2022 was second-lowest in the Bloomington region at 1.7% and third-lowest in the Lafayette region (which includes West Lafayette) at 3.1%. Intensified work by Indiana University and Purdue University to fuel economic development and recruit corporate partners to their campuses can provide a boost to labor productivity in the state that is not yet realized.^29,30

While education and training are important, recruitment and retention of world-class companies in targeted industries remain the foundation of any work to elevate labor productivity. A competitive state exports products that are highly valued by buyers outside of the state. These products come from industries in which history and geography give the state a natural competitive advantage, especially in terms of operational costs, innovation and new business creation.³¹ Such industries for whom most buyers are outside of the state—called tradable industries—differentiate themselves from industries for whom most buyers are inside the state—called non-tradable industries. Tradable industries bring income to a state that is then spent locally to fuel business for non-tradable industries.³² Because their employers successfully compete for buyers on a global and national scale, workers in tradable industries are typically the best paid and most productive because their work generates the highest valued goods and services in the state.³³ Competitiveness requires these employers to use state-of-the-art technology in the workplace. This, in and of itself, lifts worker productivity. Incentivization of growth for world-class companies in tradable industries is thus an important component of any strategy to increase wages.

World-class companies in tradable industries need highly skilled talent to fuel their business. Talent is the most important factor in corporate site selection decisions.³⁴ Average educational attainment determines the economic destiny of a region. A region needs public schools with curricula that endow high school graduates with baseline workforce-ready skills. Programs that allow students to count time spent in apprenticeships and internships toward diploma requirements are a necessary element.³⁵ Affordability, accessibility and academic programs that relieve regional talent shortages are required for universities and community colleges to be economically relevant. As anchor institutions, they have the resources to build regional talent pipelines that attract students before they leave high school and graduate them into high-paying jobs with postsecondary credentials valued by employers.

Upskilling an existing workforce requires large amounts of time and resources. Retaining university graduates within the state or recruiting workers from other states offer faster and more efficient ways to increase labor productivity. Indiana ranks 14th in the nation in recruitment of university students from other states, but only ranks 40th in retaining them.³⁶ Since 61% of university graduates in the nation prefer to work close to where they went to school,³⁷ extraordinary investment in finding these students fulfilling careers within Indiana companies should deliver high economic returns for the state. Investment in placemaking will not only convince Indiana college graduates to stay, but it can convince more skilled workers to relocate to Indiana. A national ranking among all 50 states of 15th in affordability³⁸ and 14th in lowest tax burden³⁹ give Indiana a competitive advantage in luring new residents. Investment in placemaking and public assets that elevate quality of life can further strengthen Indiana as a destination for well-educated talent from other states.⁴⁰ As recent extraordinary growth in the Middle Tennessee region around Nashville demonstrates, a well-planned strategy that combines selective quality-of-place funding with smart regional branding can spark large inflows of skilled talent.⁴¹

Beyond corporate recruitment and educational attainment, quality of management and physical infrastructure are important drivers of productivity. By themselves, healthier corporate cultures elevate employee engagement, which increases worker productivity.⁴² Employees who are psychologically fulfilled at work are naturally motivated to generate better performance. Such fulfillment depends upon the sophistication of managerial leadership and their knowledge of best practices. Pervasive application of best-in-class management principles and creation of high-performance corporate cultures can lift the labor productivity of entire geographic regions and industries. Public infrastructure can have the same impact.⁴³ Much like better technology in the workplace allows a worker to produce more value in a fixed amount of time, better physical infrastructure can reduce unproductive time linked to transportation bottlenecks, electrical power blackouts or interruption in water access. This eases the tasks that employees must complete and allows for more output during a work period.   

A state’s strategy to increase labor productivity—and therefore wages—is not a simple question of education and training. The knowledge and skills that employees bring to the workplace is central, but how well the environment allows application of such knowledge and skills is just as important. World-class companies in traded industries with state-of-the-art technology allow workers to realize the full potential of their talent. These are the employers that ensure high productivity is rewarded by high market value of the output that is produced. High-functioning corporate cultures reward workers not only with generous pay, but also with a generous sense of purpose and accomplishment. This increases positive energy in the workplace and elevates what employees accomplish in a day. Modern public infrastructure minimizes periods of unproductive time and removes uncertainty about the amount of work that can be accomplished. Successful elevation of labor productivity at the state level requires simultaneous and coordinated improvement in education and training, corporate retention and recruitment, management and corporate culture, and public infrastructure.  

Elements of a strategy to lift productivity and wages of workers in Indiana

As Table 2 reveals, real labor productivity in Indiana and in eight of 12 metropolitan areas in the state grew faster than the nation between 2017 and 2022. As growing companies compete more intensively for scarce labor, faster productivity growth ultimately becomes faster wage growth. This result will allow Indiana to close its wage gap with the national economy and confirm achievement by the Next Level Agenda workforce strategy launched in 2018 of its intended impact. The data suggests continuation and enhancement of the following initiatives inspired by Next Level goals:

1. Aggressive work by the Indiana Economic Development Corporation to recruit and retain world-class companies that deploy state-of-the-art technology to be globally competitive in traded industries should continue. Recruitment of SK Hynix in semiconductors to West Lafayette,⁴⁴ Samsung SDI in electric vehicle batteries to Kokomo⁴⁵ and Meta in data storage to Jeffersonville⁴⁶ along with Eli Lilly in pharmaceutical manufacturing in Lebanon⁴⁷ represent the types of corporate investment which bring new-generation technology that raises the productivity of those who are employed.

2. Career scholarship accounts that provide high school students funds to pay for work-based learning experiences justify expansion.⁴⁸ Acceleration of growth in Swiss-style apprenticeship programs already established in Indiana deserves attention.⁴⁹ Companies that hire and place high school students on professional skill development paths innovate faster and therefore, by default, demonstrate higher levels of labor productivity.⁵⁰ Labor productivity is 12% higher in Switzerland,⁵¹ even though the share of the labor force with a traditional bachelor’s degree is 7% lower.^52,53 Apprenticeships allow Switzerland to achieve a productivity level to which Indiana aspires with a smaller, more efficiently designed system of higher education.

3. Regional Economic Acceleration and Development Initiative (READI) grants provide hundreds of millions of dollars to multi-county regions to fund quality-of-life assets that attract skilled talent and physical infrastructure that increase workplace productivity.⁵⁴ Because the state is an amalgamation of regional economies, the geographic scale of focus is appropriate. Maximum social and economic return of these funds is achieved, though, if monies focus almost exclusively upon residential growth of workers for traded industries.

Broader leverage of market forces in state workforce policy can enhance momentum established by Next Level Agenda programs. As a policy tool, workforce planning is poorly equipped to effectively address talent shortages. Required skills and job descriptions within companies change quickly. Especially in traded industries where global competition is intense, fast technology change drives fast evolution of hiring needs. By the time state agencies codify employee competency needs and shift educational curricula, the changes achieved are often economically obsolete. Instead of intermediating supply and demand and pretending that state government can keep pace with competitive markets, state government can instead empower students (with their families) and workers with more choice on how public funds are used to develop their own human capital. Career scholarship accounts are a movement in this direction.

Such a shift places more trust in students and workers than in state government to efficiently anticipate current and future economic opportunity in labor markets. With more individual discretion on how state funds are disbursed for individual benefit, such as through vouchers, students and workers can hold incumbent educational and training providers more accountable, force positive change within them and financially reward new providers who deliver better value. Research concludes that exercise of choice through state-funded vouchers by students in primary and secondary school improves educational outcomes.^55,56 Conversion of state funds appropriated directly to universities into scholarships appropriated directly to students is the equivalent of a voucher system for higher education.⁵⁷ State-subsidized competition for the business of students and workers by educational and training providers accelerates abandonment of legacy approaches to human capital development rooted in 20th-century, labor-intensive manufacturing. Providers innovate, become more efficient and reduce the public cost of increasing labor productivity.  

Notes

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