Is California Bad for Business?
November 17, 2003

By James Klein, Larta VOX Editor

Is California bad for business? The answer is yes. And no. Judging from the Milken Institute’s annual State of the State Conference, California's glass is half full and half empty.

Speakers at the Milken Institute's annual State of the State Conference described numerous challenges affecting the state's business climate, which has become one of the worst in the nation, according to some. Others were equally as optimistic, however, emphasizing the many advantages that will continue to attract business to the state.

The conference panels seemed equally comprised of Cassandras and Pollyannas, providing a balanced overall impression of the state's current status: we are facing a myriad of problems, but we have the human capital to solve them.

In a panel discussion on California's business climate, former Los Angeles Mayor Richard Riordan perhaps summarized the whole conference when he said, "It's true, we are the worst state in the union to do business, except you happen to have the brightest people, the best people, and the best climate."

Many speakers accentuated the challenges hindering California's economy: unnecessary regulation, inflated utility prices, rising workers' compensation rates, a health care system in crisis, a dysfunctional political environment, a crumbling infrastructure, an under-funded educational system, and a host of other problems, not to mention a $38 billion deficit.

Others bestowed praise on a state that is buoyed by its many assets and attributes: a highly educated, vastly talented, and extremely productive workforce; world-class universities and research centers; an ethnically diverse culture; and the best climate in the continental United States.

Ross DeVol, Director of Regional Economics for the Milken Institute, described the "perception gap" that exists in the media, which periodically pronounces the "Death of California," or "California in Crisis," hyping one problem or another as evidence that the state is sliding into bankruptcy, decay and irrelevance. News stories portend the region's destruction by natural calamities (earthquakes, wildfires, mudslides), man-made causes (air pollution, traffic jams, housing shortages), and economic disasters (technology bubbles, utility scandals, budget shortfalls).

This may be a case of wishful thinking, jealousy, or anti-California schadenfreude on behalf of the rest of the country, envious of our sunny climate, stunning landscapes, and the plethora of movie stars and millionaires we seem to so effortlessly produce.

There's no doubt that California has slipped of late. The state is no longer the fifth largest economy in the world, having dropped all the way down to sixth place. Of course, everyone else on the list is a country, which can print its own money, run deficits, and form distinct international trade policy. California can do none of those things, nor take advantage of joining the European Union. Some have speculated that France's rise may be due largely to EU currency adjustments. It also bears noting that California has significantly fewer people, so its neck-and-neck finish with France is probably more indicative of our state's phenomenal productivity than France's economic ascendancy.

The first two panels epitomized California's dualistic outlook, focusing on one of the gloomiest and one of the brightest spots in the state's economic picture. The first panel, "Health Care: Caring for Californians in the 21st Century", detailed the numerous problems plaguing the state's health care system, which is beset by government cuts, rising costs, and a high rate of uninsured patients. Panelists alluded to the complexity, inequality and irrationality of California's health care system, which, as one panelist pointed out, shouldn't be called a "system" at all.

The second panel, "California and Asia: What Lies Ahead?", focused on the great potential California has to do business with Asia, and particularly China, which is predicted to become the world's most prolific economy in the coming century. Panel speakers emphasized that California is geographically situated to take advantage of the emerging markets, manufacturing centers, and investment opportunities in China, the Pacific Rim, and the rest of Asia; and also has unique cultural advantages: a history of Asian immigration, an ethnically diverse population, and a tolerant social environment.

"For businesses coming out from China, Hong Kong, Taiwan, Korean, Japan, and so forth, they very much have to look for that social infrastructure," explained Dominic Ng, Chairman, President and CEO of East West Bank, in the panel on California's Economic Future. "The social infrastructure in California is so conducive, there's no way they're going to be able to look at…Wyoming, and say 'There's no state tax there - I'm going there!'"

Russell Goldsmith, Chairman and CEO of City National Bank, served as Moderator for the panel entitled "California's Business: Leading the Way to a More Attractive Climate". His introductory remarks reflected the two sides of California's coin.

Goldsmith began on an optimistic note by reminding the audience that, "California's economy is a $1.4 trillion powerhouse. It is number one in any number of industries. We know it's the entertainment capital of the world. But it's also the leader in everything from agriculture to international trade, from defense to technology to creative design. California is also home to 800,000 small and mid-sized companies and over 400,000 millionaire households."

However, Goldsmith also emphasized the troubling income and wealth disparities in California. "Almost a quarter of the Forbes 400 lives in California," said Goldsmith. "It also has millions of people who live below the poverty line."

Goldsmith also addressed the perception gap that exists in the national media when it comes to California. "Despite the tremendous success and talent and an economy that has generally outpaced the United States economy as a whole, despite the economic diversity globalization, California has a reputation, according to the Wall Street Journal, as the worst place to do business in America.

"I personally don't think North Dakota, for example, would be more attractive," joked Goldsmith, but then carefully enumerated the many reasons California is considered so unattractive.

"By one measure, the cost of doing business here in California is higher than in forty-seven other states," said Goldsmith. "If you look at it based on composite costs, which have elements like wages, electricity and taxes, you can see that doing business in California is among the most expensive in the nation.

"Worker's compensation costs have gone up an average of 67% last year. Energy costs…up 51% higher in California than in the other western states. The state government even this year has mandated expensive new increases in health care and paid family leave.

"California has also been mandated, though not necessarily funded, to do many things by the federal government. Few people I think realize California…is 45th among the 50 states in terms of dollars we send to Washington versus dollars we get back from Washington.

"The budget deficit is real and needs to be resolved. The complex structure of government, the initiative process…that complicates solving these problems. Our infrastructure has suffered years of neglect, giving rise to what has been called the 'quiet crisis.' In the next 25 years they say our population will grow by more than 50%; our ability to enhance the infrastructure for that is critically important. The list goes on and on."

The discussion that followed Goldsmith's remarks took place among a panel that included small business, big business, and the business of government. Representatives of Deloitte and Intel were joined by the president of a small metal forming company, and former Los Angeles Mayor Richard Riordan.

Riordan provided a necessary political dimension to the discussion, laying the blame for the "big impediments in this economy" squarely in Sacramento. Riordan described a polarized state legislature, divided by an extreme political schism that hinders compromise and progress.

"You have a legislature where the Democrats are radically liberal, the Republicans are radically conservative, and I think one of the major changes has to be to re-do things so that moderates, who make up the majority of the voters, get elected to office," said Riordan, who offered a creative solution to address the state's asymmetric political landscape.

"I'm backing an open primary initiative," Riordan explained. "That will make the election of governor, etc., nonpartisan. Everybody votes for the same people in the primary and the two top vote-getters run off; it could be two Democrats or two Republicans."

Riordan went on to describe some of the problems - created or exacerbated by the state legislature - that are hurting California's business climate. "We've got to get rid of the hundreds literally of anti-business things that come out of Sacramento," he said. "Many of these rules and regulations hurt small to medium-size businesses, most of which have been started by minorities, particularly by Latinos.

"We have electricity costs," continued Riordan. "Small companies and everybody are bailing out the mistakes of PG&E and Edison, because it doesn't cost them any more to create electricity in California than it does in [any of the other] western states, so that 50% more we pay is to bail out these energy companies.

"We have…overtime pay, this ridiculous thing where we pay someone time and a half if they're eight hours even if they stay for a half hour and come in an hour late the next day, you still have to pay them the overtime.

"We have this bill that just came through…the health care rule that makes every small business over a certain number of employees pay 80% of the health care of their employees. It adds up and adds up and people don't want to do business in this state. It also means that a lot of companies are cutting down on the number of employees, they're contracting out rather than reach that magical number of 100 employees."

Ray Rossi, Director of External Tax Affairs at Intel Corporation, also addressed political impediments that retard California's economic growth. "Things are done late in the game, where no input comes from industry at all. That is not good public policy," he said.

Rossi challenged the audience to act in a timely manner, claiming, "We are about to hopefully come out of a downturn…people are now going to have the wherewithal to make the investments that they may have postponed during the downturn. It is the least likely time that we would want to not have the right policies in place to have those investments happen in California."

Rossi mentioned the Manufacturers Investment Credit as one example, a provision that is set to expire at the end of the year. "Come January 1st, everything a manufacturer buys in this state, in terms of productive assets…just got 6% more expensive," he said.

Other panelists emphasized how aggressive other states have been recruiting companies to their regions, while California has been relatively laissez-faire in its efforts to retain companies and attract those from out of state.

"I got a call yesterday from the state of Virginia, trying to recruit us there," recounted Kellie Dodson, President of ACE Clearwater Enterprises, a metal forming company located in Dominguez Hills. "I wish that California would be more proactive. Other states are very aggressive trying to recruit business, offering tax credits, helping with relocation costs, and training of the workforce. Mexico is just as aggressive. We need to learn a lesson from this," said Dodson.

Russell Goldsmith concluded the panel discussion on a positive note, quoting Hewlett-Packard CEO Carly Fiorina, who told a group of state governors, "Keep your tax incentives and highway interchanges - we will go where the highly skilled people are."

Goldsmith continued, "We need to look at these long-term investments in things like education and infrastructure, tax policy, benefits policies, and understand the economic impact, but I think as it has in the past, the allure and the talents of this great state will prevail and we will continue to be the leading economy in this country, and in many ways the leading economy in the world."

The "California's Economic Future at a Crossroads" panel helped put the state's economic situation in a broader context, possibly dispelling some myths, as it appears the state is not doing as poorly, compared with the rest of the nation, and the rest of the world, as is perhaps commonly thought.

Stephen Levy, Director and Senior Economist, Center for Continuing Study of the California Economy, showed a series of slides that, while revealing weaknesses in the state's economy, indicated that California is doing no worse than the rest of the country.

"Our unemployment rate is higher than the rest of the nation," claimed Levy. "But it's less higher than at any point in the last fifteen years."

John Bryson, Chairman, President, and CEO of Edison International, addressed energy costs in California, which while high, do not appear to be having a detrimental affect on the state's ability to attract and retain companies.

"California electricity costs are too high, they're well higher than the national average," explained Bryson. "They were driven and will be burdened for some years by the California power crisis, and the burdens associated with the contracts the state of California entered in that crisis. The specific question: 'Who's moving out as a consequence of high electricity costs?' At least so far, not many."

Ross DeVol, who moderated the panel, explained how the state's phenomenal productivity has outstripped the rest of the nation. "Why would a company stay here, choose to expand here, or even start here, just solely looking at the landscape of costs?" asked DeVol.

"Productivity in the state of California is almost $90,000 per employees versus the U.S., somewhere around…$72,000," DeVol revealed. "Businesses choose to be here despite higher costs, I would argue, perhaps because there's something to being here that makes people more productive."

Steve Westly, Controller for the State of California, provided a uniquely positioned perspective on California's economy. His comments reflected the overall tenor of the panel's discussion, emphasizing that while California is besieged by problems, it is nevertheless comparably strong.

Westly began by addressing the situation in Silicon Valley, where he worked prior to moving to Sacramento. "Although unemployment went from roughly 1.7% up to 7%, you can understand why people there truly felt the bottom had fallen out," said Westly, who then put Silicon Valley's experience in a global perspective. "I will tell you there are people in virtually every other country who will say, 'When can I move to that county that has only 7% unemployment at its worst?' So I think things were never perhaps quite as bad as we thought."

"This is the most diversified economy in the world. We are extremely strongly positioned," argued Westly, who nevertheless warned, "This is not a reason to be complacent for a moment. We still need to fix worker's comp. We need to make this a better environment to do business, especially for the small and medium-sized businesses that are the real economic drivers of the state.

"Relative to the rest of the world," concluded Westly. "We are doing pretty well."

More information on Milken's State of the State Conference
California/Regional Economy section of Larta Research Archives