California’s Lingering Recession Keeps the Lid on a National Recovery

The U.S. economy’s fitful performance is at least partially due to the inability of California to emerge from its three-year economic slump. Accounting for nearly 15% of U.S. gross domestic product, California’s current business woes extend far beyond its borders and right to Washington, where the Clinton Administration is not only trying to figure out how to deliver on its promise of better times ahead, but is also attempting to convince the state’s congressional delegation that the proposed North American Free Trade Agreement wouldn’t make matters worse.

NAFTA may be the least of California’s problems, especially when you consider the painful defense industry downsizing now underway, the punishing plunge of home prices and the acute fiscal woes plaguing the state. While the growth of foreign trade and the rebound of Silicon Valley are distant lights at the end of the tunnel, the pronounced slowing of net immigration into the state signals the deferral, if not abandonment, of the California “dream” for many.

At its core, the California economy is foundering on the shoals of a shrinking employment base.

With Pentagon spending drastically reduced, aircraft orders tapering, commercial office space overbuilt and residential real estate still apparently overpriced, California’s defense, aerospace and construction industries have found themselves at the steepest pitch of the state’s economic downturn.

Since 1990, the inflation-adjusted gross state product has shriveled by some 4% while the pace of business failures has soared. As a result, payrolls have taken it on the chin. With more than 350,000 manufacturing jobs alone disappearing over the last three years, statewide employment has tumbled by better than half a million people during the period.

Nonetheless, as bleak as these numbers are, California’s recession has been uneven, with the northern part of the state faring somewhat better than the southern. Although hardly emerging unscathed, the blow to Northern California was cushioned by its well-diversified manufacturing base.

Sales of Silicon Valley’s top 100 companies vaulted to record levels last year, profitability increased and venture capital investment soared. What is more, the recovery of the San Francisco Bay Area was given an added lift by the rapid growth of foreign trade, with Bay Area ports and airports tripling their volume handled over the past decade.

Unfortunately for California, the reawakening of economic activity in the north has yet to be matched in the south--where most of the businesses, jobs and people are located. In fact, Southern California’s economic distress is part and parcel of an economy in the midst of substantial transition. For although the Los Angeles Basin’s boosters like to point to the region’s large consumer market, skilled labor force and numerous educational institutions as the ingredients for an eventual renaissance, the harsh diagnosis is that the older economic base centered around the aerospace and defense industries is shrinking far more rapidly than tomorrow’s foreign-trade-, high-technology and entertainment-based economy can supplant it.

Business failures in the Los Angeles Basin are running well above woeful state levels, retail sales are languishing and one-way truck rentals out of the region are soaring. As if all this wasn’t bad enough, employers are migrating as well, fleeing from the burden of high costs, heavy taxes and unwieldy regulations.

Recognizing the need to nurture business, the Legislature is trying to heal some self-inflicted wounds. It passed a sweeping tax reform bill last month, designed to encourage research and development as well as investment spending. This bill not only grants tax credits for R&D; spending and manufacturing equipment purchases, but it also extends preferential treatment for capital gains on small-company stocks and reduces tax rates for certain corporations.

While this legislation is hardly a cure-all, it does address some of the business community’s complaints and comes on top of several other bills intended to curtail the proliferation of red tape and overhaul the costly workers’ compensation system.

With long-overdue legislative reform in the works, California should be setting the stage for a comeback. But what one hand gives, another is about to take away. While Sacramento’s lawmakers are waking up to the business-stifling reality of lofty taxes and excessive regulation, their tax-happy cousins in Washington aren’t--and Californians will pay dearly.

For one thing, boosting the marginal income tax rate on the wealthy hits California especially hard. The state contains the largest slice of the nation’s taxpayers reporting adjusted gross incomes in excess of $200,000. For another, California has the nation’s largest contingent of wealthy elderly, those households that will soon be sharing their Social Security benefits to a greater extent with the tax collector.