Economy May Not Help Governor

Republican Gov. Arnold Schwarzenegger will need plenty of cooperation from the Democratic-controlled California Legislature to pass his $99-billion budget and bring future state spending in line with revenue. But he seems to recognize that he probably won’t get much help from a truly uncompromising partner: the economy.

Analysts say Schwarzenegger used a fairly conservative set of assumptions in estimating revenue growth for his 2004-05 budget, which was released Friday. And that’s a good thing, they said, because California can’t depend on a strong economic rebound to lift it out of its deep fiscal hole.

“We will not be able to grow our way out of the state budget deficit in any way with revenue growth,” said Stephen Levy, director of the Center for the Continuing Study of the California Economy, one of four economists who spoke at a teleconference this week about the state’s economic prospects. “The challenge that we face ahead is not going to disappear from anything on the economic side.”

Schwarzenegger’s budget relies on California Department of Finance projections for tax revenue growth based in part on U.S. gross domestic product expanding by 4.2% next year, nonfarm payrolls in California rising by a modest 1.1%, personal income gaining by 5.6% and taxable sales climbing by 5.8%.

Those figures are more aggressive than a recent forecast made by economists at UCLA, who have been more pessimistic than most prognosticators. But they’re in line with other estimates, such as those by California’s legislative analyst’s office, the Western Blue Chip Economic Forecast and Chapman University.

Former Gov. Gray Davis, Schwarzenegger’s predecessor, was criticized for allegedly ignoring evidence that the economy was faltering and for making false assumptions about future revenue in the budget passed just before his reelection in 2002. His decisions came back to bite him during last year’s recall campaign as challengers accused him of trying to hide the severity of California’s budget mess.

Observers say Schwarzenegger has every reason to downplay expectations for the state’s performance. That way, he stands to reap the political and fiscal benefits if the economy perks up more than expected.

Ted Gibson, former chief economist with the Department of Finance, whose tenure included part of the Davis administration, said Schwarzenegger’s budget team appeared to have taken a conservative approach in its underlying forecast. In fact, he said, he wouldn’t be surprised to see revenue come in slightly better than expected this year.

“My take is that there’s a better chance that they’ve underestimated than overestimated, and that’s not a bad place to be,” he said.

But other experts aren’t as optimistic as Gibson. Despite recent government statistics showing stunning growth in U.S. GDP and productivity, economists say 2004 is likely to be a middling year at best for the state and nation.

One of the big reasons was underscored Friday with the release of the nation’s employment figures, which showed that U.S. employers in December created a measly 1,000 net jobs across the economy. It was a disappointment to analysts who had been expecting the labor market to stir to life after nearly three years with no job creation.

“It’s pretty discouraging,” said Howard Roth, chief economist with the state Department of Finance. “We really need to start seeing some pickup.”

It’s the longest jobless recovery in the post-World War II era and quite a contrast to the years after the 1990s recession, when the nation’s job engine shifted into high gear. At the height of the technology boom in 2000, California alone created nearly half a million jobs in a single 12-month period.

But experts say California finds itself in a very different position from that coming out of the last recession. For starters, no one anticipates another explosion in business investment in technology as in the late 1990s, which created tens of thousands of high-paying jobs that fattened the state’s tax coffers. Also, U.S. companies have accelerated the movement of both blue- and white-collar jobs offshore, another drag on hiring and wages.

In addition, analysts say consumers won’t fuel the recovery the way they have after previous downturns. Thanks to the lowest interest rates in 40 years, consumers in California and elsewhere didn’t stop spending on homes and cars after the U.S. economy toppled into recession in early 2001.

That helped cushion the fallout from the tech crash. But the bad news now, analysts say, is that the economy won’t get a boost from pent-up demand for big-ticket items that typically fuels production, jobs -- and government tax revenue -- coming out of a recession.

In fact, some economists fear that consumers will become the economy’s weakness rather than its strength. Government figures show that U.S. consumer debt is at record levels, a vulnerable position for American households if interest rates shoot up later in 2004 as predicted. Analysts say that would bode particularly ill for the housing sector, especially in overheated markets such as Southern California and the Bay Area, where there is growing concern about a price bubble and a sharp correction in home values.

UCLA economist Ed Leamer said such imbalances pointed to another economic slowdown, perhaps as early as 2005 or 2006. Thus, he and others are dubious of Schwarzenegger’s strategy to close California’s budget gap by borrowing billions to pay for deficit spending.

“Now is not the time, I don’t believe, to be ramping up debt loads around the country for state governments,” Leamer said.

“You don’t want to enter that new economic downturn heavily in debt when revenue streams are going to be weak and it’s going to be very, very difficult to service that debt.”

He and other economists likewise question the wisdom of Schwarzenegger’s determination to bring the budget into balance through immediate, deep cuts in government spending. In his budget address Friday, Schwarzenegger renewed his pledge not to raise taxes “because it will hurt our economy ... and do the opposite of what we’re trying to do.”

But some economists say sharp cuts in government spending might stall the recovery instead of jump-starting it. Love it or hate it, government spending is highly stimulative and could be a source of support until the private sector starts hiring again, according to Levy, who supports temporary tax hikes on the wealthiest Californians instead of cuts in education, transportation and other vital services.

“The state budget investments play a tremendous role in creating the kind of business climate that the governor talks about,” Levy said.

“We are at the position now, that if we don’t raise revenues, of cutting investments that I think are vital to maintain our business climate.”