The last measurement of economic performance that this report will consider is arguably the most important for the long-term health of the state: the productivity of labor. For these purposes we use a measurement that reflects the cost of labor to employers, the unit labor cost index calculated by Moody’s Economy.com. This index reflects labor compensation relative to productivity for each state.[31]

This is not merely a measure of compensation per hour; consequently, lower costs do not necessarily translate into lower wages or less generous pension and health-care benefits. A high-wage state can be competitive in this measurement as long as labor produces enough output to justify the compensation.

In 2000, Michigan’s unit labor costs were among the highest in the nation, at 109.2. Only New Jersey had higher labor costs than Michigan. Overall the average labor cost index for right-to-work states was 4.9 points lower than for non-right-to-work states, meaning that labor was roughly 5 percent more productive in right-to-work states.[32]

By 2005, Michigan’s per-unit labor costs had improved somewhat, dropping to 105. But several other high-labor-cost states have also seen improvements in productivity; consequently the only two states with higher per-unit labor costs than Michigan are Massachusetts and Maryland. And the advantage held by right-to-work states has grown to an average of 6.4 points.[33]

While Michigan’s labor cost has been reduced somewhat, the state remains at a significant disadvantage in this area. Unit labor costs are arguably the single largest component in determining competitiveness. In calculating its state business cost index, Moody’s Economy.com will use labor costs as 75 percent of the overall index, more than all other factors combined.[34]

Michigan’s high labor costs have a severe effect on the state’s ability to attract and retain employers. A Mackinac Center review of applications for business tax relief that were submitted to the Michigan Economic Development Commission found that 66 percent of applicants listed the costs of employment in Michigan as a reason they were likely to locate or expand elsewhere. By comparison, only 40 percent mentioned taxes, 34 percent listed building costs and 31 percent described economic incentives given by other states.[35]

As communications and transportation become more advanced, the opportunities for businesses to reach new markets have expanded greatly, but at the same time so has the level of competition. In such an environment, it is essential that labor costs be in line with labor productivity. Michigan’s high per-unit labor costs are likely to remain a serious burden on the state’s economy, dragging down both job creation and wages. Addressing this problem does not mean reducing wages and benefits, but if high wages are to be preserved they must be matched by high output, high quality and workplace flexibility.