Some Golden State

California's dire finances are a drag on national recovery

He was already California's least popular governor. Now, scarcely eight months after winning a narrow reelection, Democratic Governor Gray Davis is fighting to avoid a new distinction: California's only sitting governor to be recalled from office. Political activists, whipped up by California Republicans, are rapidly gathering the 900,000 signatures they need to force a recall vote in November. Among those contemplating a challenge: movie star Arnold Schwarzenegger.

But the Terminator might want to think again about that. California, which only a few months ago looked like it would help lift the country from its economic woes, has suddenly become a drag on the rest of the nation. Job losses are mounting. Bond agencies have downgraded California's credit to the lowest state rating in the country. And legislators in Sacramento, emboldened by the drive to force Davis out of office, are enmeshed in a bitter partisan battle that is paralyzing efforts to close a yawning $38 billion deficit.

With California accounting for an estimated 13% of the country's overall economic activity, the state's problems threaten to slow the national recovery. California has lost 54,000 jobs this year, one-fifth of all pink slips in the country. In May, the country as a whole would have gained 4,500 jobs if not for the state's 21,500 layoffs. "Nationally, we're groping for a bottom," says Jack Kyser, chief economist for the Los Angeles County Economic Development Corp. "In California, it looks like we're sliding back down."

So why is California still struggling? Despite signs of new orders and increasing profits, the tech industry is still a sore spot. The state has lost more than 12,000 technology jobs this year, part of the torrent that has included more than 220,000 tech positions since state employment peaked in December, 2000. Typical is Milpitas (Calif.)-based Solectron (SLR ) a major assembler of hardware for companies like Sun Microsystems (SUNW ) and Cisco Systems (CSCO ). Now less than halfway through a 16% reduction of its 75,000 workforce, it's shifting more work to Asia from higher-cost places like California. "We are winning new business," says Kevin O'Connor, Solectron Corp.'s senior vice-president for human resources. "But the cost pressures remain."

Tech industry consolidation also continues to depress the job outlook. Hewlett-Packard Co.'s acquisition of Compaq Computer Corp. cost 16,800 jobs, many of them in California. A merger between Oracle (ORCL ) Corp. and PeopleSoft (PSFT ) Inc. could involve thousands more. "Tech is back, but with productivity increasing at 2% per year, businesses don't need to add to their employment," notes Esmael Adibi, director of the Anderson Center for Economic Research at Chapman University in Orange, Calif.

For a while, the widely diversified California economy was better able to weather the tech slump. As tech employment fell, new jobs emerged in homebuilding, mortgage lending, and a suddenly resurgent Southern California defense industry. But while those sectors remain strong, others have weakened. Demand for professional services such as accountants, designers, and building managers has fallen along with the decline in technology employment. More important, budget pressures have eliminated 27,900 jobs this year in state and local government, a big source of growth in years past. Even the trend toward lightly staffed reality-TV shows may be playing a role: Some 2,400 fewer people are employed in movie and television production so far this year, a 2% decline.

Much as they did in the early 1990s, the tough economic times are exposing California's intrinsic economic weaknesses, namely sky-high taxes as well as soaring utility, insurance, and other business costs. While the cost of workers' compensation insurance has jumped 50% in the U.S. over the past three years, rates have nearly doubled in California over the same period. Since the Golden State's allowances for procedures like chiropractic care and day surgery are far more generous than those in other states, insurers have been fleeing the market. And while proposed settlements between state regulators and California's two largest utilities should lower electric rates, they will remain 50% above national averages.

Such conditions threaten a new exodus from a state long criticized for its high cost of doing business. Fidelity National Financial (FNF ) Inc., the nation's largest title insurer, is in the process of relocating its 450-employee headquarters to lower-cost Jacksonville, Fla. Home-lending giant Countrywide Financial (CFC ) Corp. has said it won't increase its 15,000-person workforce in California unless legislators do something about what it considers overly generous overtime, insurance, and family medical leave laws. "We love California," says Leora Goren, Countrywide's managing director of human resources, "but it would be irresponsible to build in the state with the incredible costs."

Given the stalemate in Sacramento, the business climate is likely to get worse before it gets better. State legislators missed a self-imposed June 15 deadline to pass a budget. Eager to build their case for recalling Davis, state Republicans are blocking his half-percentage-point sales tax increase, which would raise an estimated $2.3 billion. They're also threatening to go to court to block another big hike in the state's vehicle registration fees.

Whatever budget compromise ultimately emerges, it will almost certainly involve new taxes and reductions in state spending, both of which would act as further drags on California's economy. "Businesses' worst fear is that inaction will force more severe tax increases, making California an even worse place to do business," says Ross DeVol, director of regional economics at the Milken Institute, a Santa Monica (Calif.)-based think tank.

All of this means a bitter inheritance for Davis' successor, should it come to that. An estimated 51% of voters would vote to recall the second-term governor, according to a recent poll by the nonpartisan Public Policy Institute of California. That has sent Davis back to the stump, where he is blasting the recall effort as "partisan mischief by the right wing." It may make for slam-bang entertainment in the film industry's home state. But if California continues to hemorrhage jobs, even the Terminator would find it hard to blast his way out of this mess.

By Christopher Palmeri and Ronald Grover in Los Angeles

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