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What We Won't Learn From Our Recession

July 10, 1994|David Friedman | David Friedman is director of the New Economy Project

None of California's candidates have addressed the most important questions of the election: What caused the state's recession? What must government do in response?

To an extent unmatched in the rest of the country, California's recession was, first and foremost, caused by its increasingly dysfunctional relationship with Washington. Fully 50% of its 600,000 job losses resulted from cutbacks in defense.

Furthermore, at a time when Californians could least afford it, the Clinton Administration's 1993 budget "reforms" weighed even more heavily against the state. "Deficit reductions" were achieved with huge defense cuts scheduled to take effect in 1997--conveniently after the next presidential election. Meanwhile, income and payroll taxes to support Social Security, Medicare and Medicaid programs were dramatically increased. Since California is much younger, has a higher cost of living and thus generates higher wages than the national norm, the new taxes shifted an additional $10 billion to $20 billion a year from the state to the rest of the country.

Also damaging was a federal trade policy that severely weakened the dollar, reducing the value of California's relatively price-insensitive exports while driving up the cost of its imports. Finally, a magnificently ill-timed burst of renewed activism by the Environmental Protection Agency took a toll. Recent Bay Delta water-policy interventions sent shock waves through such California economic mainstays as agriculture, biomedical engineering and textiles--threatening to weaken the state's bond ratings, which are anchored by the giant Metropolitan Water District agency.

To be sure, home-grown factors amplified California's problems, the most important of which was the collapse of its manufacturing sector. A generator of 2.1 million jobs in its peak year of 1990, manufacturing played a critical role in the upward mobility of the state's growing Latino and Asian populations.

Trouble began in the 1980s, however, when state and local officials enacted a series of often counterproductive, fraud-prone environmental, social-justice and safety legislation that hit manufacturing particularly hard. Even before the recession, manufacturing job growth stagnated during the decade, after rising by nearly 470,000 in the 1970s.

The bottom fell out when the worldwide recession cut into already razor-thin manufacturing margins. Since 1990, California's manufacturing industries have lost a staggering 150,000 jobs on top of defense cutbacks. Total manufacturing employment fell by 15%, to levels not seen since the early 1970s.

California's political leadership, meanwhile, was so enamored of the fantasy of government-subsidized industrial development that it ignored sectors such as finance, insurance, real estate and business services that collectively added 55,000 jobs during the recession. Entertainment, electronics, textile and biomedical companies, whose growth might have offset the state's manufacturing and defense declines, also suffered from inattention.

Then came a self-destructive publicity campaign, led by defense giants, that was eagerly embellished by development officials and media from outside the region. As a result, exaggerated accounts of California's decline became conventional wisdom throughout the world.

Since a region's image crucially affects its international money, trade and technology flows, investors shunned California. Typical were the Japanese, who shifted thousands of jobs to Mexico, reduced tourism and slashed their real-estate investment from $3 billion in 1989 to virtually nothing in 1993. Housing and commercial markets dependent on positive expectations nose-dived, costing 115,000 construction jobs.

This profile of California's recession suggests a clear political agenda for the state's future prosperity. Most critical is to stop looking to Washington for bailouts that almost certainly will never materialize. Instead, Californians should press for tax parity, insisting, in the least, that increasingly anti-California federal payroll and income levies should be indexed to reflect the higher cost of living in the state. And rather than further muddy the complex, delicate issues of water policy or urban development, the federal government should return to Californians the money and authority required for the state to solve its social and environmental problems on its own terms.

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