California budget crisis could bring lasting economic harm

The short-term pain of budget cuts could pale next to a long-term loss of companies and academic talent.

By Martin Zimmerman, Marc Lifsher and Andrea Chang

May 23, 2009

As bad as California's budget crisis is for the state's $1.8-trillion economy, just wait. It could get worse.

The spectacle that played out in the national media this week of a state unable to get its fiscal act together is reinforcing the notion that the Golden State is a rotten place to do business, experts say.

Corporate leaders and Wall Street investors, watching the daily festival of seeming incompetence, political partisanship and governmental dysfunction, could be persuaded to limit or eliminate their investments here.

"We lose competitive advantage by being the state that can't solve its problems," economist Stephen Levy said. "Regardless of what we think the solution is, the fact is we can't find a solution."

The budget crisis threatens to further weaken the state's job market, which lost 63,700 more jobs last month, according to figures released Friday. The state's overall unemployment rate actually fell slightly, to 11% from 11.2%. But new job losses could prolong the vicious cycle in which the California economy is now trapped, with rising joblessness reducing consumer spending and delaying a housing rebound, thus leading to more layoffs.

The long-term effects of Sacramento's financial woes, meanwhile, could far outweigh the near-term effects. In particular, the expected deep cuts in education spending could thin the state's human capital, potentially forcing California companies to look elsewhere for skilled workers as well as new plants or even headquarters.

It's the equivalent of "eating the seed corn," said Levy, chief economist at the Center for the Continuing Study of the California Economy in Palo Alto.

Of course, there would still be plenty of short-term pain to go around. How much won't be known for a while. But eliminating as much as $24 billion from the proposed $95.5-billion general-fund portion of the 2009-10 state budget would further corrode an economy already creaking under the weight of a national recession.

Distressed car dealers could see sales to state agencies shrink, printing shops may lose business as courts and other government operations shorten their workweek, and office-equipment suppliers would lose sales as cash-strapped agencies make do with aging copiers.

And cutting as many as 5,000 state jobs, and perhaps thousands more as budget reductions cascade down to schools and local governments, would hit especially hard in a state that already has the fifth-highest unemployment rate in the nation.

Gov. Arnold Schwarzenegger has proposed slashing state spending on education by $3 billion to help close the budget gap, and the state would pay dearly for canceling classes, firing instructors, cutting class days and shortening the school year, experts said.

Promising students would go to other states, taking their future skills, earnings and, possibly, Nobel Prizes elsewhere. California companies would then find it harder to attract high-value employees who might be dubious about moving to a state with sub-par schools.

The implications hit home to Ross DeVol this week while he attended a national biotechnology conference in Atlanta.

Governors of Maryland, Massachusetts and Texas were stalking biotech firms in hopes of luring them to their states with promises of job-training funds, improved educational systems and other inducements, said DeVol, head of regional economics at the Milken Institute in Santa Monica.

California's shortcomings, both real and perceived, "make it difficult not just to recruit new business but to keep what we have," he said.

John Sedgwick, co-founder of Santa Clara solar-energy company Solaicx, agreed.

"When you think about the genesis of Silicon Valley, it really started from its superior educational base" at Stanford and UC Berkeley, said Sedgwick, whose company makes the building blocks for photovoltaic cells. "That indicates that you don't want to kill the goose that's laying the golden eggs."

The failure of the budget measures at the ballot box this week has some Californians calling for a constitutional convention that could, among other things, rewrite the state's tax system.

Businesses have long complained about big-spending government in California. But with state and local spending accounting for about one-fifth of the state's gross domestic product, California is in line with some other heavily populated, expensive-to-manage states, such as New York and Florida.

Still, companies such as Solaicx have found the burden heavy enough to look elsewhere to invest.

In 2007, the company built a plant in Portland, Ore., in part because the state offered a tax incentive unavailable in its home state. California had an added disincentive: It is one of only a handful of states that charges sales tax on manufacturing equipment.

Schwarzenegger and state lawmakers have said they "got the message" that voters want to see the budget gap closed with spending cuts, not tax increases. Though that may be somewhat reassuring to corporate executives, it won't necessarily allow them to sleep easily.

"At some point, you have to believe that somebody's taxes are going to go up," DeVol said.

Even before that day comes -- if it does -- many businesses would already be smarting from the loss of state and local government dollars. It will take weeks to thrash out where and by how much the state budget will be cut. But some businesses are bracing for the worst.

At Folsom Lake Ford near Sacramento, the fleet department has seen fewer orders from state and local government agencies, said government sales manager Mark Paoli.

A few years ago, government purchases amounted to more than 50% of the Folsom dealership's new-car sales, with as many as 2,000 vehicles sold for rescue units, pursuit cars and other transportation.

This year, Paoli estimated that the dealership would sell only 300 cars to government entities in California, or about 20% of the store's projected total new-car sales for 2009. But after Tuesday's special election, Paoli worried that government sales would decrease further.

"We knew 2009 would start the downward spiral, and we're anticipating the same thing next year, if not worse," he said. "I'm worried for myself and for my workers, people whose livelihoods rely on government business. It has been an integral part of our dealership's operations and we hate to see it go away."

The cuts would affect business in more subtle ways, experts said. If hours for state and local offices are cut back and personnel reduced, it would take longer for building applications, environmental permits and other paperwork to clear, adding to the time and cost of completing a project.

"Government is supposed to be a stabilizing influence, and instead they're becoming part of the problem," said Christopher Thornberg of Beacon Economics. "They should be spending when everyone else is cutting back. They should be buying cars when no one else is buying cars."

martin.zimmerman @latimes.com

marc.lifsher@latimes.com

andrea.chang@latimes.com