Economic Outlook - December 2005

State’s business climate shows signs of warming

It costs more to do business here than in South Carolina, Tennessee and Georgia, but at least North Carolina is cheaper than Virginia and most other states, according to the Milken Institute. The Santa Monica, Calif.-based think tank has been comparing states’ business costs since 2001. Armen Bedroussian is a senior research analyst. He has worked on the institute’s cost-of-doing-business index since its inception.

BNC: North Carolina looks expensive next to some of its neighbors. Time to panic?

Not necessarily. You’ve got to look at the employment trends. You want to see how much job movement occurred in the last couple of years, if jobs have been leaving North Carolina to go to those states. If that’s not the case, there’s no reason to panic.

What cost components do you measure?

Three industrial costs — wages, tax burden and electricity — and two real-estate — the office and industrial rental rates. We believe these are the five key components in deciding where to start or relocate a business, or to show where a company may want to expand. Wages receive the highest weight in the in- dex at 50%. Tax burden gets 20%; electricity, 15%; industrial space, 10%; and office space, 5%.

North Carolina industrial rents were among the lowest, yet its tax burden was heavier than average.

The tax burden is slightly above the national average, but it’s still not as high as some other states. What bodes well is the cost of labor in the state. It’s 11% below the national average, and that’s a significant portion of the overall cost-of-doing-business index.

Overall, how has North Carolina performed in the last five years?

It seems to have become more business-friendly. When you look at the components, those costs haven’t gone down significantly, but they’ve stayed steady. If anything, other states have become more expensive relative to North Carolina. The study compares all states to a national average, so North Carolina, in real terms, has become less expensive for businesses since we started the study.

Why?

It could be that other states have higher budget deficits, so they haven’t really had the opportunity to provide as many incentives as North Carolina. You really have to look at it state by state. But North Carolina hasn’t really fluctuated much. In our real-estate component, North Carolina has become less expensive. The tax burden has also fallen. Those are the two reasons it has become a little bit more business-friendly.

Your study reflects incentives?

They could be indirectly reflected through the tax burden.

Are high costs necessarily a bad thing?

Let’s look at the top five states in terms of costs: California, Massachusetts, Hawaii, New York, New Jersey. Yes, they happen to have high costs for electricity and labor, as well as high rents and taxes. But it’s also spurred by demand. These states have a more established industry and labor force, often with a focus on more innovation, assets and knowledge workers. Their infrastructure for research and development is more established and refined, often with top-grade educational institutions. These are the kinds of things that attract industries and companies into states. Companies move there because they want to be part of that cluster of bustling innovation with a large labor pool to draw from. There’s typically more capital investment in these areas, and there’s capital flowing a little more freely. In order to be part of all that, businesses have to pay higher costs to get into that cluster area.

Then should we be disappointed that our costs are below average? Maybe it just means we’re not very cool.

That’s not necessarily it, either. Where the index really comes in handy is if your state has been losing jobs in the last year or two or even three. If you look at the index and you want to see why companies are relocating or expanding elsewhere, it could be that the state has a high tax burden. It could be that it doesn’t have enough tax incentives for businesses. It could be electricity costs. It provides more of a warning sign.

So is it better to be a high-cost state or a low-cost state?

If you look at New York and California, they’re among the most expensive states in which to do business. Some would argue that they’re not really business-friendly, but the flip side to that is they offer more in terms of a high-skilled labor force. So while there might be more opportunities, there are high costs to offset those opportunities.

But if you’re examining cost only, lower means more business-friendly?

Correct.

And if you're the highest-cost state

That’s sort of a sign that something is wrong.

What should business people take away?

A quick snapshot of their state’s health in the business climate. It lets people see where they stand and where their peers and competitors are standing. It’s a warning and a report card — an idea of what they should look at in the future to see what they can do to expand business growth, instead of limiting it.