Ca Li For Nia, There It Goes...

For most of its 22 years, business boomed at Erika's Bake Shop in the upscale village of Westlake. But after more than a 25% drop in sales since 1990, owner Deiterich Heinzelmann closed up shop. He just couldn't justify the $200,000 investment he needed in order to stay in business. "I would have taken the risk in 1988," he says. "But not in this economy."

Just six months ago, California seemed to be on the mend. Hollywood, the state's highest-paying employer, had added 10,000 jobs in 1994, up 8% from the previous year. Retail sales had risen 8%. And the housing market was coming back to life.

Now, California's recovery is slower than the Ventura Freeway at rush hour. And the economic engine that once pulled along the rest of the U.S. is in danger of being dragged down further. Battered by continued job losses in the defense industry, a new round of cuts by local governments, and a soft housing market, California appears stuck in low gear for the foreseeable future--with the risk of a recession in the offing.

MILITARY LOSSES. No one is as worried about California's prospects as President Clinton, whose reelection hopes rest heavily on a win in the once-Golden State. With $10 billion in defense procurement cuts and a loss of more than 300,000 aerospace jobs since 1989, Californians are poised to blame the U.S. government for their tough times. So it was a reluctant Clinton who on July 12 endorsed a federal commission's recommendations to close 14 California military installations--and only after assurances that over 90% of the 11,000 job losses at McClellan Air Force Base in Sacramento could be saved by contracting them out. Still, the closures will cost the state some 22,898 "indirect" job losses on top of the military cuts.

Already, the Golden State's unemployment rate, at 7.6%, remains two percentage points above the national average--despite modest gains in June. And there are more layoffs yet to come. In June, Los Angeles County announced it would eliminate up to 18,000 jobs to help close a $1.2 billion budget shortfall. Bankrupt Orange County, which already has cut its workforce by 11% and its budget by 41% since the beginning of the year, has more cuts coming. "California's margin of error is pretty slim," says David Hensley, regional economist with Salomon Brothers Inc. "Any job slippage in government increases the risk of recession."

Complicating the employment picture is the anemic demand for California's products because of ailing economies in other regions of the U.S. and abroad. Exports to Japan, California's largest trading partner, for instance, grew a skimpy 1.4% in the first quarter, compared with 26.2% in the first three months of 1994, according to the Massachusetts Institute for Social and Economic Research.

Faced with shrinking job prospects, Californians have stayed away from home purchases--once a catalyst for the state economy. Sales of new and existing homes in Southern California fell 19% during the first five months of the year, according to TRW-REDI Property Data, a real estate researcher. "The investment incentive is gone," says Todd Schwartz, a 29-year-old executive with NBC Inc. "Ten years ago, everyone was rushing to buy. Now `condo' is a dirty word."

Not all is doom and gloom, however. Many economists insist that once the impact of the Federal Reserve Board's July 7 rate cut works its way through the economy, other California industries will be following in Hollywood's footsteps. "California should be improving from here on out," predicts Lynn Reaser, chief economist at First Interstate Bank of California.

If Reaser is wrong, residents of communities like Westlake may see more than just their bakeries suffer. In the meantime, Californians are keeping their fingers crossed that their wobbly state economy doesn't take another dive.

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