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The Cost of Doing Business Puts State at a Disadvantage
Jul 19, 2009
Publisher: Sacramento Bee

News reports over the past several months have focused on all the problems facing California: the ongoing budget crisis, rising unemployment and a discouraging economic outlook i? 1/2 all of which have justifiably attracted a great deal of attention.

Lost in all the focus on the state's fiscal woes, however, is another issue that has contributed to the state's economic problems and may well hamper any efforts at recovery: a widening economic performance gap. Put simply: California isn't producing enough economic growth and jobs relative to the amount of money it costs to run a business in the state or enough tax revenue to fund existing government programs.

California is already a costly state in which to do business. Without enough economic growth, businesses' expenses become even more burdensome, and government can't pay for all the things it wants.

Over the past several years, there has been an increasing disparity between our "inputs," such as spending on research and venture capital, and our "outputs," such as gross state product and employment. The state's economy, jobs and personal income aren't rising as quickly as the money we are spending on education and other public programs, which is one of the reasons why the state's fiscal situation has declined as badly as it has.

Milken Institute research shows that California has been underperforming for years in terms of the state's economic performance vs. expenditures. The current predicament has only served to highlight this problem. Put another way: Even if the economy were to recover immediately, the state is still projected to have $20 billion deficits per year if spending isn't cut.

On the surface, there seem to be few reasons for California's economy to be slipping. It remains the world's center for venture capital and has the largest number of high-tech start-ups in the country. Even on a per-capita basis, the state still ranks third in tech start-ups. Five of the top 10 high-tech centers in North America are in the state, including Silicon Valley, the world's leader.

California also has three of the top 10 metropolitan areas in terms of life sciences, perhaps the fastest-growing and most-sought sector after technology.

The problem lies in the fact that the state simply isn't creating enough new economic growth to keep up with the rise in government expenditures and the increasing costs borne by the private sector. California's unemployment rate (currently at 11.5 percent) has routinely exceeded the national average since 2004, and growth in the state's gross domestic product has lagged behind that of the country as a whole.

Exacerbating this problem has been the consistent decline of California's manufacturing base over the past 20 years. Although historically the decline is associated with that of the aerospace and apparel industries, numerous sectors have been and continue to be affected i? 1/2 including those in high-tech, which saw a 23 percent decline in manufacturing jobs between 2000 and 2007.

What's causing this widening gap? There are numerous factors, but some of the most significant involve the sheer cost of running a business in the state.

California is the sixth-costliest place in the nation to do business, with both individual and corporate tax burdens well above the national average. When combined with the high price of real estate and electricity, the result is fewer and fewer companies willing to locate in California.

One recent example is General Electric's decision to build a $100 million high-tech manufacturing facility in Detroit that is expected to create more than 1,100 jobs with an average salary of $100,000 per year. Even though Michigan's economy is considered worse off than California's, the state government considered attracting new high-wage jobs enough of a priority to offer GE $60 million in tax breaks and incentives.

When California manufacturers and other companies leave the state, or choose to expand out-of-state and cut local positions, they take good-paying jobs with them, further shrinking the tax base.

California's high-tech potential alone cannot overcome an unfriendly business climate, high taxes, restrictive regulations and a difficult economic policy-making environment that is tone-deaf to the needs of job creators. The underperformance of California's economy is not simply a byproduct of recent events but is due in large part to structural problems that predate the current recession and years of unheeded warnings about the implications of policies that erode the state's competitiveness. The persistent underperformance of the economy further chips away at the amount and quality of the state's economic inputs, widening the gap even further.

If left unaddressed, when the state does emerge from recession along with the rest of the country, California's already rising costs of doing business will further limit the state's ability to recover quickly and achieve sustained economic growth over the long term.

The reasons behind California's economic performance gap are complex, but what should be clear is that the economic policies of the past will not sustain California in the future.

Perry Wong and Kevin Klowden have recently completed research on the technology assets of all 50 states and the state of manufacturing in California and several competitor states; available at www.milkeninstitute.org. Perry Wong is senior managing economist and Kevin Klowden is managing economist for the Milken Institute, a nonprofit, independent economic think thank.