República bananera de California

This last month has among the most embarrassing for the dysfunctional joke that is California state government. The state is issuing IOUs to pay its bills (which banks accepted for 10 days before they gave up), the state has missed its budget deadline for the 23rd consecutive year, the state credit rating is approaching junk bond status, and unemployment has reached 11.5%. After years of papering over and deferring a solution to long-term budget woes, apparently politicians are stalling hoping that President Obama bails out the state rather than lose its electoral votes in 2012.

The government needs employers and employees to pay taxes that keep government running, but instead the problems of the dysfunctional political system are bubbling over to do further damage to the real economy. The state’s budget problems are also damaging the system of higher education that contributions to local innovation and once (decades ago) the envy of other states.

In fact, beyond chronic deficit spending (papered over by accounting tricks and borrowing) the state is resembling a banana republic. Urban economist Joel Kotin wrote last week:

The state that once boasted the seventh-largest gross domestic product in the world is looking less like a celebrated global innovator and more like a fiscal basket case along the lines of Argentina or Latvia.

The problem is that state spending — ratcheted up during good times — is out of control. The governator is hoping to solve the long-term problem once and for all. As he told the Financial Times from his (“Bedouin-style”) smoke-filled tent:

"If you can't get them to cut down the costs of government when the state is facing such a financial crisis then it's never going to happen," he says. "If we don't make these changes [the deficit] will keep increasing."

Even the reliably liberal Mercury News agrees:

Gov. Arnold Schwarzenegger is demanding changes to retirement benefits in any deal to resolve a $26 billion deficit. And insist he should.
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The unfortunate truth is that the Democrat-controlled Legislature has been too quick to increase pension benefits and will resist reconsidering them unless it's forced to. Now is the time to do that.

Schwarzenegger wants to repeal a huge mistake of Gov. Gray Davis's administration. It happened in a flash in 1999, when, with but a minute's debate, the Legislature greatly expanded pension benefits based on the promise by CalPERS, the state's pension manager, that it wouldn't cost taxpayers a dime.

Now, because of stock market declines and rising costs of health care, retirement costs are already siphoning $3.3 billion from the state budget, just when California is facing substantial cuts in education and services to the poor. That cost is expected to rise steeply.
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County and city officials should be cheering on Schwarzenegger. The Davis era escalations in benefits, like retiring at 50 with 90 percent of pay, have had a domino effect, leading police and firefighters to demand and get the same terms. Now cities and counties also are looking at huge budget deficits inflated by millions in pension and retiree health costs. If the state rolls back unaffordable benefits, local government will have more leverage to negotiate with police and fire unions.

Schwarzenegger blew a chance for pension reform in 2005, when voters rejected a poorly drafted initiative. This will be his last chance. He must not waver.

Despite his recent efforts, the governor’s record is mixed. Kotkin — as unsentimental and presicent an analyst as any in the state — lists five major causes of “who killed California’s economy”:

1. Arnold Schwarzenegger

The Terminator came to power with the support of much of the middle class and business community. But since taking office, he's resembled not the single-minded character for which he's famous but rather someone with multiple personalities.

First, he played the governator, a tough guy ready to blow up the dysfunctional structure of government. … Next Arnold quickly discovered his feminine side, becoming a kinder, ultra-green terminator. … With the state reeling, Arnold has decided, once again, to try out a new part. Now he's posturing as the strong man who stands up to dominant liberal interests. But few on the left, few on the right or few in the middle take him seriously anymore. He may still earn acclaim from Manhattan media offices or Barack Obama's EPA, but in his home state he looks more an over-sized lame duck, quacking meaninglessly for the cameras.

2. The Public Sector

Who needs an economy when you have fat pensions and almost unlimited political power? That's the mentality of California's 356,000 workers and their unions, who make up the best-organized, best-funded and most powerful interest group in the state.

State government continued to expand in size even when anyone with a room-temperature IQ knew California was headed for a massive financial meltdown. … Almost no one dares suggest trimming the pension funds, particularly Democrats who are often pawns of the public unions. Some reforms on the table, like gutting the two-thirds majority required to pass the budget, would effectively hand these unions keys to the treasury.

3. The Environment
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In California today, everyone who makes a buck in the private sector--from developers and manufacturers to energy producers and farmers--cringes in fear of draconian regulations in the name of protecting the environment. The activists don't much care, since they get their money from trust-funders and their nonprofits. The losers are California's middle and working classes, the people who drive trucks, who work in factories and warehouses or who have white-collar jobs tied to these industries.

4. The Business Community

This insanity has been enabled by a lack of strong opposition to it. One potential source--California's business leadership--has become progressively more feeble over the past generation. Some members of the business elite, like those who work in Hollywood and Silicon Valley, tend to be too self-referential and complacent to care about the bigger issues. Others have either given up or are afraid to oppose the dominant forces of the environmental activists and the public sector.
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"The business community is so afraid they are keeping their heads down," observes Ross DeVol, director of regional economics at the Milken Institute. "I feel they if they keep this up much longer, they won't have heads."

5. Californians

At some point Californians--the ones paying the bills and getting little in return--need to rouse themselves. The problem could be demographic. Over the past few years much of our middle class has fled the state, including a growing number to "dust bowl" states like Oklahoma, Texas and Arkansas from which so many Californians trace their roots.

The last hope lies with those of us still enamored with California. We have allowed ourselves to be ruled by a motley alliance of self-righteous zealots, fools and cowards; now we must do something.

(To this, I’d add that the politicians have been consistently putting off tough choices — which apparently will continue into the next administration unless Tom Campbell is the next governor. This is exacerbated by California large-state retail political market, which insulates all but the most corrupt politicians from any semblance of individual accountability.)

Noticeably absent from Kotkin’s list is the favorite scapegoat of high-spending politicians:

I covered the Proposition 13 campaign for the Washington Post and examined its aftermath up close. It passed because California was running huge surpluses at the time, even as soaring property taxes were driving people from their homes.

Admittedly it was a crude instrument, but by limiting those property taxes Proposition 13 managed to save people's houses.To the surprise of many prognosticators, the state government did not go out of business. It has continued to expand faster than either its income or population. Between 2003 and 2007, spending grew 31%, compared with a 5% population increase. Today the overall tax burden as percent of state income, according to the Tax Foundation, has risen to the sixth-highest in the nation.

(High-spending politicians blame Prop 13 for the requirement for a 2/3 vote to pass the state budget, but that requirement actually dates back 70+ years).

All of this has taken a toll on the business climate. Even before the latest downturn, the state lost 21% of its manufacturing jobs from 2000-2007, and 23% of its high-tech manufacturing jobs. In fact, a group of seven peer states studied by the Milken Institute has been increasing high-tech manufacturing jobs. As Kotkin and Milken note, such jobs have previously provided blue collar workers an entree to the middle-class.

To add insult to injury, the financial shortages is causing already stifling regulators to ignore the rule of law in an arbitrary display of bureaucratic power. The founder of LA-based Creators Syndicate notes that the city of Los Angeles in 2007 ignored its own precedent to reclassify the company (retroactively) at a higher rate.

Politicians and bureaucrats seem to assume that regulations and taxes can be increased indefinitely, when in reality one of the (few remaining) advantages of our system is Federalism is that individuals and firms have choices and can flee an unfavorable business climate for a favorable one.

In a reverse of the great Okie migration of the Great Depression — made famous by John Steinbeck (and then Henry Fonda) in the Grapes of Wrath — a few Californians are migrating back to the Dust Bowl:

From 2004 through 2007, about 275,000 Californians left the Golden State for the old Dust Bowl states of Oklahoma and Texas, twice the number that left those two states for California, recent Internal Revenue Service figures show. In fact, the mid-South gained more residents from California during those four years than either Oregon, Nevada or Arizona. The trend continued into 2008.

As someone a decade or two from retirement, with all my (and my wife’s) living relatives in California, we’re likely to tough it out. But I’ll be recommending that my daughter consider other states for college and the workforce when she leaves high school in seven years, particularly if she has an entrepreneurial bent.

Graphic credit: Cartoon by Steve Breen, San Diego-Union Tribune, July 2, 2009.