The National Barometer
For better or worse, California's economy can set the country's pace
Everybody is interested in California, billionaire financier Warren Buffett said in August when asked why he agreed to advise then gubernatorial hopeful Arnold Schwarzenegger. But Buffett meant more than a morbid fascination with car chases and Hollywood glitterati. "You can't have trouble out there without it affecting the rest of the country."
As usual, the Oracle of Omaha was dead on. California's economy accounts for an eighth of the U.S. economy and is larger than the economies of all but four nations, ranking between Britain and France. Its technology, agriculture, and entertainment industries lead the nation. So when the Golden State sneezes, the national economy can easily catch a cold. And the state is ailing now. Unemployment stands at 6.4 percent, higher than the national average, and growth has slowed to a crawl since the 2001 recession.
Much of the economic carnage can be found in Silicon Valley. Desperate for skilled workers during the height of the tech boom, the industry lured them with lucrative stock options and bonuses. But then came the tech meltdown and the loss of 19 percent of its jobs, most tech-related. "What was good in the boom is bad in the bust," says Stephen Levy, director of the Center for Continuing Study of the California Economy, in Palo Alto.
The state also faces an $8 billion budget shortfall, thanks largely to taxes lost on those vanished options and bonuses. That number could grow to $20 billion if the state is unable to borrow and Schwarzenegger makes good on his promise to eliminate an unpopular car tax. The gap will have to be bridged through tax hikes, spending cuts, or borrowing, with negative impact on the economy. The governor-elect plans to cut taxes and roll back regulations, while maintaining education funding and expanding children's healthcare. "The math of his promises is very difficult," says state Treasurer Phil Angelides. And with 20 percent of the workforce in the public sector, employment will suffer. Any way you slice it, says Levy, "we have to pay the piper."
Many businesses consider California a tough place to operate, too. The state is ranked fifth worst in a recent cost-of-doing-business survey. "I'm not sure I'll miss California," says Aki Korhonen, who is moving his software firm from the Bay Area to Reno, Nev., because he finds the state too pricey. "I won't miss paying $2 a gallon for gasoline."
Yet there are hopeful signs. Though unemployment is high, it's trending down from December's peak of 6.9 percent. Despite the brutal bloodletting in the Bay Area, venture capitalists still think highly of California: 42 percent of U.S. venture capital funds so far this year have been invested there. And like the rest of the nation, California may be on the cusp of a strong recovery, says Union Bank of California senior economist Keitaro Matsuda. He predicts real growth of 2 percent this year, expanding to a 4 percent clip in 2004. The latest Congressional Budget Office forecast predicts U.S. growth of 2.2 percent this year and 3.8 percent in 2004.
Bright side. "I'm optimistic," says Bob Damon, West Coast managing director of the executive search firm Spencer Stuart, where revenue from California operations was up 12 percent last quarter. Demand for new hires was particularly strong at consumer goods and life sciences firms. And though tech is still patchy, the outlook for the wireless and semiconductor sectors is upbeat, says Damon, "even telecom, which is finally showing signs of life after being dead for three years."
Most observers believe the state's indomitable spirit will eventually get it back on track. That vitality may stem from what a recent Wells Fargo study calls California's "triple endowment": an entrepreneurial culture, access to capital, and a pool of talent not easily replicated. The potent combination will allow the state to create new jobs in burgeoning areas like biotechnology and nanotechnology. "Nobody else has been able to duplicate Silicon Valley, where people are skilled and risk taking," says Tom Lieser, of the University of California-Los Angeles Anderson Forecast.
"The start-up culture is in our DNA," says Chip Adams, managing director of San Francisco-based venture capital firm Rosewood Capital. "And that hasn't really changed despite the downturn."
A MIGHTY FORCE
If California were a nation, its economy would rank fifth in the world. No wonder it's so influential.
CALIFORNIA UNITED STATES
Population 35.6 mil. 292.3 mil.
GDP (2003, estimated) $1.5 tril. $10.8 tril.
Median family income $48,113 $43,052
Unemployment rate 6.4 pct. 6.1 pct.
Deficit (2004, projected) $8 bil. $480 bil.
Sources: U.S. Census; UCLA Anderson Forecast; California Dept. of Finance; CBO; Bureau of Labor Statistics
With Tom Stein
This story appears in the October 20, 2003 print edition of U.S. News & World Report.