Analysis: California Best Positioned for Recovery

Monday, 26 Jan 2009 09:45 AM

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LOS ANGELES -- With California facing a $42 billion deficit in the current economic downturn, a glum Gov. Arnold Schwarzenegger has warned that the Golden State is on the brink of insolvency.

More people have left California than any other U.S. state over the past year, some disenchanted with snarled traffic, scarce jobs and some of the highest taxes in the nation. Add the prospect of still higher taxes and fewer public services, and normally sunny Californians have little to celebrate.

Still, experts say the most populous U.S. state and the world's eighth-largest economy is well placed to rise again and that this crisis could spur major changes in the economy that will pay dividends in the long term.

Abundant natural resources, big ports, access to the Pacific Rim, a large, relatively young work force, entrepreneurial draw and tech-oriented industries augur well for the future, economists and historians say.

"The prophets of doom and gloom are just not looking at the reality of California," said Jerry Nickelsburg, senior economist at the UCLA Anderson Forecast.

"The government has created kind of a mess and that's a problem to be solved, but the negatives are actually fairly small. I think you can expect a lot of good out of California," he said.

The typically upbeat Schwarzenegger made international headlines this month when, instead of delivering his usual cheery "state of the state" speech, he issued a short, bleak message about California's roughly $1.5 trillion economy.

"A ROCK UPON OUR CHEST"

"California is in a state of emergency," said the former actor and bodybuilder, whose second term ends next year. "Addressing this emergency is the first and greatest thing we must do for the people. The $42 billion deficit is a rock upon our chest and we cannot breathe until we get it off."

Controller John Chiang then told Californians he would delay sending out $3.7 billion in tax refunds and other payments because the state was running out of money.

The dismal state of the state would have been hard to imagine in California's post-World War Two golden years, when incomes were rising, land was plentiful, homes were affordable and wide-open freeways stretched in all directions.

The good times came to a screeching halt with the 1973 OPEC recession, said Dowell Myers, a professor of urban planning and demography at the University of Southern California, and in some ways they have never really returned.

At the heart of California's problems, economists say, is the government's heavy reliance on personal income taxes, which produces wild swings in revenue as its coffers overflow in good years and dry up in leaner times.

California is a pioneer state famous for its entrepreneurial spirit. But an entrepreneur who might make $2 million in boom times could go bust in a recession.

A big reason for the state's reliance on income taxes is Proposition 13, a voter-approved change to the state Constitution that limits property tax increases and requires any plan to boost taxes to receive the approval of at least two-thirds of the legislature.

The 1978 measure was credited with sparking anti-tax sentiment in other states and assisting Ronald Reagan's election as U.S. president two years later.

Legislators have responded by burdening state residents with some of the highest income and sales taxes in the country.

Economists say the state has long needed to fix that revenue roller-coaster ride and are hopeful that this crisis will force leaders to face the music.

They also place little long-term significance on the number of people moving out, saying it is misleading to compare absolute numbers with other states when California's population is so much larger.

'LONG OVERDUE REASSESSMENT'

Moreover, California's population is actually still growing thanks to immigration and births, and the state's relatively young work force may give it an edge as baby boomers retire.

California's population could hit 60 million by 2050, according to some projections, six times 1950's 10.5 million people and 60 percent more than the current 38 million.

Hard-hit by the mortgage crisis and foreclosures, home prices dropped 35 percent in 2008 in Southern California -- making home ownership realistic for young families in California for the first time in nearly a decade.

The unemployment news has been grim, with the state's jobless rate in December rising to a 14-year high of 9.3 percent, above the national average of 7.2 percent.

The rate is approaching the one posted during the recession in the early 1990s, when California's economy suffered from gutted aerospace payrolls and unemployment rose to nearly 10 percent.

But the state remains a leader in green energy, biotechnology, aerospace and other industries that are expected to fare well in the world economy and create new job markets.

"What people may think is that you can't really solve the problems in California until you totally wreck the train," Myers said. "You have to shake them up, wake them up. The outlook is very hopeful right now because this crisis is forcing a long-overdue reassessment."

Jessica Gould, a 25-year-old graduate student at USC who moved from Atlanta and fell in love with the mild climate, natural beauty, health-conscious lifestyle and anything-goes culture, is optimistic.

"I am hoping we make some changes," Gould said. "(The budget mess) does concern me, to be honest. But you are going to face problems anywhere and there are so many other things I get from living here, I guess it's a small price to pay."

© Thomson Reuters 2009 All rights reserved

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