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Manufacturing a Political Crisis: The Job Flight Controversy

By

Jock O'Connell

www.jockoconnell.com

(This article originally appeared in the Sacramento Bee Forum section on Sunday, January 5, 1992.)

California has long prided itself on being a haven for the dreamers, entrepreneurs and industrialists who together have built the Golden State into one of the world's most vibrant and prosperous economies. But are the good times behind us? Is California's economy going to hell in the proverbial hand basket? Plenty of apparently knowledgeable people seem to be saying so. In a virtual frenzy of California-bashing, newspapers, magazines and television news programs around the state and throughout nation have lately been painting a disturbing picture of a state that, far from being a magnate attracting new and dynamic business ventures, is rapidly losing companies and jobs to other regions of the country.

Could this be true? Are companies, especially manufacturing firms with their high-paying jobs, leaving California in droves? If so, what's prompting them to go elsewhere, and what can or should public officials do to keep them here? The answers -- where there are any -- may be both surprising and unsettling.

For starters, there is very little solid evidence of what Wilford Godbold, the chairman of the California Chamber of Commerce's Task Force on Saving California Jobs, has described as "the mass exodus of job-providers from the state." In fact, no one actually has any idea how many California jobs may have been lost as a result of companies packing their bags and leaving for other states. Thomas Nagle, the director of California's Employment Development Department, told a state Senate hearing in November that: "To our knowledge, there is no source of data to answer this question." Likewise, a spokeswoman for the state Department of Commerce said that sharp budget cuts have prevented her department from collecting or analyzing data on "job flight," a term now firmly established in California's political lexicon.

What about all those press accounts of companies leaving California? In the context of an $750 billion economy comprising well over 700,000 private businesses (nearly 50,000 of which are engaged in manufacturing), such reports prove little. Even during its most expansive and free-wheeling periods, California sustained its share of corporate desertions, plant closings and displaced workers. For example, between 1984 and 1988, employment in California increased by a total of 1.6 million jobs. But that gratifying accomplishment obscures a less pleasant reality: fully 3.6 million jobs were actually eliminated during those otherwise prosperous years as companies left the state, downsized, went completely out of business or, in the case of the state's computer and semiconductor industries, "exported" tens of thousands of jobs to low- cost manufacturing sites in Southeast Asia and Mexico. Fortunately, the birth of new firms, corporate expansions and the arrival of companies from other states and from overseas created 5.2 million new jobs over the same period, more than replacing all those that had been lost.

Clearly, anyone who had read only the reports of plant closings and job losses in the mid-1980s would have drawn some highly distorted conclusions about California's economic condition, just as many may be doing today.

But what about the dismal employment picture we keep hearing about? California's employment rolls have declined by more than 420,000 jobs since the middle of 1990, as many as 133,000 of them in manufacturing industries. But, according to a study released last month by the Palo Alto-based Center for the Continuing Study of the California Economy, most of the overall drop in employment is attributable to the national recession George Bush had until lately been trying to deny. Moreover, as Commission on State Finance economist Joseph Fitz estimates, post- Cold War cuts in defense spending account for the lion's share of the job losses that have occurred in California's celebrated aerospace industry as well as among other firms dependent on military contracts. On top of this are the jobs being permanently eliminated as major corporations throughout the country restructure their operations and trim their workforces to boost their competitiveness.

But there is no convincing proof that business conditions in California have turned uniquely sour. According to a November 15 report issued by the Federal Reserve Bank of San Francisco, manufacturing job losses in the US during the current recession have not shown any unusual geographic concentrations. The latest state-by- state data available from the US Bureau of Labor Statistics show that the number of manufacturing jobs nationally fell by 2.9 percent from October 1990 to October 1991. While California's decline has been greater (4.1 percent) than the US average, the Golden State has suffered a good deal less than a number of other major industrial states. Connecticut, Massachusetts, Michigan, New Jersey, New York and Pennsylvania all recorded higher rates of lost manufacturing jobs in the past twelve months.

Even the emerging industrial powerhouses of the "New South" have sustained substantial declines in manufacturing employment. Georgia, the Carolinas, Virginia, Tennessee, Alabama and Mississippi collectively lost 58,700 manufacturing jobs in the last year. By contrast, the "big" winners were Arkansas, Nebraska, Oklahoma and South Dakota. Together they gained a total of 13,600 manufacturing jobs in the past year. Of the nine other Western states (Washington, Oregon, Idaho, Nevada, Utah, Colorado, Arizona, New Mexico and Texas) most often mentioned by California firms considering out-of-state moves, all recorded some decline in manufacturing employment between October 1990 and October 1991. Oregon lost 6,800 manufacturing jobs, Arizona 6,700, Washington State 6,000 and Texas 14,400. Even Utah lost 1,400 manufacturing jobs in the last year.

An historical analysis also helps place today's job loss figures in a less alarming light. From its all-time peak in mid-1989, manufacturing employment in California has dropped about six percent. During the last major recession, manufacturing employment in this state fell by just over four percent (between 1981 and 1983), even though a massive defense buildup was then underway. This time around a defense build-down is aggravating the economic situation in California.

Looking back a bit further, California endured another significant economic slump twenty years ago which bears striking resemblance to present conditions. Then, as now, a national recession coincided with deep cuts in military spending as the Nixon administration began to reduce America's involvement in Vietnam. But the result then was far more extreme -- a whopping 11.3 percent drop in manufacturing employment in California between 1969 and 1971. (Nationally, manufacturing jobs fell by 7.7 percent during the same period.) As we now know, however, California recovered rather nicely from that assault on its economic integrity.

Other bits of evidence also suggest that California's economy has not exactly gone into fibrillation. In October 1990, Forbes magazine published a derogatory cover story entitled "California's Fading Boom." Thirteen months later -- in November 1991 - - that magazine's annual listing of America's Best 200 Small Businesses revealed that 43 (21.5 percent) are headquartered in California. (Not bad for a state with only 12 percent of the nation's population and an allegedly hostile attitude toward entrepreneurs.) Likewise, a recent Business Week survey showed that 37 of the nation's 200 fastest growing large companies are located in California, as are 13 of the 25 fastest growing high-tech start-ups. And Inc. magazine's latest annual index of America's 500 fastest-growing privately-held companies includes 84 California firms, including seven situated in San Francisco, a city long criticized for having the sort of business climate only the Berkeley City Council could admire.

Gazing ahead, a June report issued by the First Interstate Bank estimated that California, which entered the 1990s with 11.1 percent of all US manufacturing jobs, will finish the decade with a 12.5 percent share. Even California Business, as establishment a publication as they come, ran a special report this past May which concluded: "The lure of the California economy is still strong despite some companies that are moving or expanding elsewhere." And, although it has been saddled with doubts about its business climate that date back at least to the mid-1970s, California continues to be a mecca for foreign investors, capturing fully one-fourth of the direct investment poured into the United States in recent years by the Japanese. Just within the past few months, Sony, Sanyo, Hitachi and NUMMI (the Toyota-General Motors joint venture in Fremont) have all announced major expansions of their California manufacturing plants.

The economic problems facing both California and the nation as a whole cannot be taken lightly. Nevertheless, one could be forgiven for feeling that the kinds of aspersions now being cast on California's business climate are reminiscent of the famous critique of a popular restaurant that is variously attributed to either Yogi Berra or Casey Stengel: "People don't go there anymore because it's too crowded."

Still, business people in California today seem about as cheerful as Anna Karenina waiting for the train to come. According to a controversial survey conducted on behalf of the California Business Roundtable this fall, 23 percent of the 1,462 responding firms claimed they had plans to relocate some or all of their operations out- of-state. Meanwhile, 24 percent indicated that their business expansion plans would likely involve sites located outside of California. And, in contrast to the findings of a similar report issued last year, the business community now appears to be more pessimistic about the business outlook in California than they are about the economic prospects of the nation as a whole.

What, if anything, should California's government officials be doing in response to such views? As in medicine, prescriptions for treatment follow from diagnoses. Yet, there are conflicting interpretations of the state's current economic doldrums and hence disagreement over the public policy choices facing California.

Many economic analysts like Stephen Levy of the Center for the Continuing Study of the California Economy ascribe recent job losses almost entirely to the national recession and to a shrinking defense budget. Along with politicians such as Senate President pro tempore David Roberti, Levy argues that there is nothing wrong with California's economic picture that a robust national recovery will not soon cure. Their primary concern is that corporate decision makers will heed the advice of those bad-mouthing business conditions in California and fulfill the prophecy of gloom by foregoing new investment and business expansion plans.

A decidedly different view is offered by many in the business community who argue that there are serious flaws in California's business climate that, if left unaddressed, will prompt more and more companies to take their business (and jobs) elsewhere. Among the disincentives most commonly cited are: California's high taxes, over-priced housing, proliferating local fees and special assessments, traffic congestion, concern over water supplies, high wages, an initiative process run amok, a veritable thicket of regulations and red tape, a government bureaucracy that is hostile when it is not just plain unresponsive to business interests, and a workers' compensation insurance system which charges exorbitant premiums but pays niggardly benefits. Not surprisingly, business organizations such as the California Chamber of Commerce, the Californian Manufacturers Association and the California Business Roundtable are petitioning the Governor and the Legislature to take immediate steps to enhance the state's business climate. Less stringent regulations, tax relief and workers' compensation insurance reform figure prominently on the business community's New Year's wish list.

But are California's woes really unique? As a look beyond the state's borders soon reveals, California business people are by no means alone in their distress. Business climate surveys conducted in other areas of the nation reveal familiar cries of lamentation. In the New England states, hardly noted for their high levels of mobility, four in ten businesses are now talking about leaving the region (thus possibly giving up season tickets at Fenway Park and Boston Garden) if business conditions there do not soon improve. Even companies north of the border seem to feel the same. According to a recent Canadian Manufacturers Association poll, nearly half of the group's membership claimed to be looking into moving their operations to the United States. As conversations with political figures and economic development officials throughout the country suggest, whenever times are gloomy, corporate executives are evidently no less prone than anyone else to presume that the grass must be greener somewhere else.

More remarkable than the uniformity of mood among business people nationally is the near unanimity over what they regard as the chief culprits for the economic plight they face. Apart from the recession, blame is routinely attributed to crippling tax burdens, high wages and excessive government regulation. As for environmental controls, California business executives might heed the advice of Northrop chairman Kent Kresa, who told the Los Angeles Times last spring that "California is only five years ahead of the new regulations in a number of others states, so you just don't put your plant in a new area to escape California regulations." Even workers' compensation reform turns out to be an issue common to most states.

Just because the types of problems faced by California's business community are not unique does not mean they are not uniquely severe. After all, California has one of the highest per capita tax burdens of any state in the union. It also has the highest paid workforce of any state west of the Mississippi, and, according to at least one major survey, the third highest workers' compensation insurance premiums in the country. But are these factors really pushing companies out of California? A closer look at the taxes, wages and workers' comp premiums California firms could wind up paying in other states suggests that the conventional wisdom about California's business climate should be treated with considerable skepticism.

Taxes. Polls routinely show that business people are nearly unanimous in rejecting any new taxes. Many are even clamoring for a measure of tax relief. While good, old-fashioned avarice cannot be entirely dismissed as a factor, what no doubt accounts for such resistance to higher taxes in California (and across the nation) is a gnawing perception that neither businesses nor individuals are getting full value for their taxes. With the schools in trouble and basic infrastructure crumbling, people are understandably concerned about where their taxes are going. Beyond that hovers the possibility that the US Supreme Court may overturn Proposition 13 property tax limitations sometime next spring and thereby precipitate a major political brawl in California. With ample justification, businesses fear that the state might adopt a so- called split-role formula under which commercial property would be taxes at a higher rate than residential property.

However, for as long as anyone can recall, California has been regarded as a high tax jurisdiction. Complaints about the state's tax burden are therefore hardly new. It was California, after all, which spawned the property tax revolt that swept the nation in the late 1970s. What is often forgotten, however, is that during most of this state's astonishing post-World War II industrial boom, the state tax burden on businesses was no less onerous than it is today. Indeed, since the passage of Proposition 13 in 1978, California has repealed the business inventory tax, reformed the so-called unitary tax, cut the basic corporate income tax rate to 9.3 percent and, most recently, extended the net loss carry-over provision for businesses. On the other hand, California was one of 34 states which did raise some taxes and fees earlier this year. Partly as a result, the combined state and local tax burden per capita remains heavier in California than in all of the adjacent Western states by margins ranging from 9.3 percent (Washington) to 16.5 percent (Nevada).

But taxes affect different companies in different ways. Some firms may be acutely sensitive to property tax rates but indifferent to changes in the basic corporate income tax rate. Moreover, comparisons of the tax burdens from state to state are often as misleading as they are enlightening. Most comparisons include only major statewide levies such as income or sales taxes. As businesses executives recognize, state and local authorities regularly impose a number of other taxes, assessments, surcharges and fees which quickly nibble away at income. Thus, while Washington State is quick to tout the absence of a corporate income tax, it does levy a gross receipts tax on businesses (including service providers), regardless of whether they have a profitable year or not. If anything, California offers a more congenial atmosphere for new businesses, especially start-ups in advanced technology fields. Because such companies are generally paying off debt and plowing left-over earnings back into research and development, they are usually insensitive to high corporate income tax rates. For such firms, it is often far more important that they be near major universities or research facilities or being part of the intellectual synergy created wherever firms in a developing industry cluster (as new biotechnology firms are doing in the San Francisco Bay Area).

Like Washington, Nevada also celebrates the fact that it imposes no personal or corporate income tax. But its property taxes can be as much as three times higher than would be paid for comparable property in California. For most manufacturers this is not an inconsequential consideration. Where accountants can legitimately employ any number of devices to reduce a company's exposure to corporate income taxes, land and buildings cannot be made to vanish as handily as profits. According to some studies, property taxes account for 30-40 percent of the overall tax bite on US companies.

One of the more systematic studies comparing the tax burdens corporations face in different states was published last year by the Wisconsin Department of Revenue. To gauge the combined state and local tax burden manufacturers would encounter in nineteen selected states (including California, Arizona, Colorado and Texas), six hypothetical corporations were created. These fictitious companies were engaged in the manufacturing of paper products, fabricated metal products, machinery, scientific instruments, food products and printed materials.

For those California business people who assume they would automatically be able to cut their firms' taxes by moving to Arizona, the Wisconsin study contains a big surprise. In the case of four of the six hypothetical companies, Arizona actually imposed a higher total state and local tax bill than did California. Only in the case of the scientific instrument manufacturer and the printer were California's taxes higher. In terms of the total tax bill for all six companies, state and local taxes were found to be about 8 percent lighter in California than in Arizona, even after last summer's tax increases are factored in.

On the other hand, California companies moving to Colorado could probably realize significant tax savings. For each of the six companies, Colorado's taxes were less than California's by margins ranging from 11 percent (paper products) to as much as 30 percent (fabricated metal products). Overall the combined state and local taxes paid by the six companies in California were some 20 percent higher than in Colorado. In the case of Texas, overall taxes were approximately about 9 percent lower than in California. However, the machinery manufacturer and food processor wound up paying higher taxes in Texas than in California. (It is worth noting that Texas is now reportedly considering the adoption of a state income tax.)

The Wisconsin study does not necessarily contest the conventional belief that California is a high tax jurisdiction. (California ranked sixth among the nineteen states in terms of overall state and local tax burden on all six companies.) What it amply illustrates, though, is how much the actual tax burden can vary depending on the nature of the individual company's business. In other words, a California firm could very well find its tax burden a good deal heavier somewhere else.

Labor costs. High wages are also frequently cited by businesses executives as a major disincentive to doing business in California. In a very broad sense, the impression that labor costs are higher in California than in most other states is correct. According to the US Bureau of Labor Statistics, average weekly wages in California are the seventh highest in the nation and the highest among the Western states. However, such figures may be as irrelevant to business executives pondering out-of-state relocation or expansion plans as their grandmother's maiden name. For one thing, interstate wage differentials for employees in highly skilled positions are much narrower than the wage differentials for unskilled workers. Thus, even assuming that a migrating California firm can find sufficient numbers of qualified workers in the much smaller labor pools in adjacent states, California manufacturers should not necessarily expect to reap substantial operating cost savings by relocating.

As with interstate tax comparisons, there is less substance to the conventional wisdom about California's labor costs than meets the eye. While there is no question that a manufacturer in Santa Clara County (where the average manufacturing wage is $41,420) would realize significant savings in personnel costs by moving to, say, Tucson (where the average manufacturing wage is $26,955), this does not condemn California as a high wage jurisdiction.

There are, in fact, several Californias. According to the US Census Bureau, manufacturing sector wages in Fresno ($24,089) compare well with Salt Lake City's ($25,428), while Sacramento ($27,845) is about identical to Portland, Oregon ($27,642). Chico ($21,145) offers a lower manufacturing wage structure than either Provo-Orem, Utah ($24,355), Pueblo, Colorado ($23,900) or Reno ($23,392). Even in some of the state's supposedly "high cost" areas, the prevailing manufacturing wages are surprisingly competitive with those paid in similar metropolitan areas in the West. For example, the manufacturing wages in San Francisco ($28,965) or Oakland ($30,445) are actually less than those in Seattle ($33,843). Likewise, manufacturing wages in Los Angeles ($28,647) are lower than those in Dallas/Fort Worth ($29,736) and Austin ($33,108) while just a shade higher than those in Phoenix ($28,276) and in Oregon's Silicon Forest ($28,090). Nationally, San Francisco, Los Angeles and San Diego ($29,231) are all less costly manufacturing areas than either the areas around Boston ($32,612) or New York City ($34,183).

Workers' compensation reform. Many critics regard California's workers' compensation insurance system as an income redistribution scheme in which employers income is diverted to attorneys, physicians and, from time to time, to workers with legitimate injuries. It is a system in which California employers pay the third highest premiums in the nation, even though employees on temporary disability -- the most common claim -- receive less than they would in 35 other states.

There is no question that workers' comp premiums in California are exceptionally high for many industries. Whether the premiums charged California firms are actually driving companies out of California is another question, however. As one insurance industry official remarked: "Workers' comp is a problem nationally, not just in California."

Judging by the current premium rate schedules, the California firms paying the most exorbitant premium rates generally are "captive" industries -- firms which exist solely to provide certain services in a limited geographic area. Roofers, for example, are charged a rate of $39.79 per $100 of payroll, while carpenters are rated between $15.38 and $24.00 per $100 of payroll. While the rates they must pay for this state- mandated expense do ripple through the economy, their chief effect may be to reinforce the belief among business executives that workers' comp premiums in California are unusually high.

In fact, the premium rates paid by many of the kinds of firms California officials most fear losing to nearby states are fairly modest. In fact, a comparison of premium rates charged for selected industrial classifications reveals only one clear-cut conclusion: Utah is a haven for low workers' comp premiums. There, the exceptionally low rates reflect a remarkably low incidence of claims. (Workers in California are more than six times more likely to apply for benefits than are Utah workers.) But living and working in Utah is not everyone's cup of tea. With other Western states with whom California competes for industry, California's premium rates are neither the highest nor the lowest and in most cases seem surprisingly competitive.

For example, a computer manufacturer in California currently pays $2.63 per $100 of payroll for workers' compensation insurance coverage. All other things being equal, the same company could expect to pay lower rates in Utah ($.79), but higher rates in Arizona ($3.32), Oregon ($4.33), Texas ($5.33) and Nevada ($6.54). Viewed another way, the premium savings per million dollars of payroll would be approximately $18,400 for a computer maker relocating to Utah. On the other hand, computer manufacturers leaving California for Nevada, Arizona, Texas or Oregon would likely see their workers' comp premiums rise, by as much as $39,100 for each million dollars of payroll in the case of Nevada and $27,000 in the case of Texas.

Similarly, a firm making scientific instruments, charged $2.63 per $100 of payroll in California, would pay lower premium rates in Utah ($.67) but higher rates in Arizona ($2.99), Texas ($3.15), Oregon ($3.53) and Nevada ($7.38). A California manufacturer of household appliances, currently paying a $6.45 rate, would encounter higher premiums in Texas ($11.44) and Arizona ($9.92) but lower rates in Nevada ($6.54), Oregon ($4.82) and Utah ($1.66). For clerical office workers, California employers currently pay a $.94 rate, while rates elsewhere in the West range from $.29 in Utah to $.82 in Oregon.

According to Michael Dubin, an official with the National Council on Compensation Insurance, "While premiums on the whole may seem higher in California, there are many California companies which would be better off staying put." Only by moving to Utah would California firms, almost irrespective of industry, be assured of substantial premium savings. Whether these savings are large enough to justify a move is a question only individual companies can answer. California's workers compensation insurance program may have its inequities and shortcomings, but there seems little reason to conclude that current rates are actually driving businesses out of the state.

Whether there is really much that state and local officials can do to prevent companies from leaving California entirely is open to debate. As most academic research bears out, most corporate site location decisions are idiosyncratic. They have much more to do with an individual company's specific requirements than with the advantages of one state's business climate over another's. Even state and local taxes do not always figure prominently in site location decisions. According to a June 1991 report by the National Bureau of Economic Research: "In most surveys of company executives, in spite of a consistent and strongly maintained public position that business taxes are a major impediment to economic development, business taxes as rated either a `moderate' or `insignificant' influence on location." Sometimes companies sometimes relocate for no other reason than to facilitate a corporate restructuring that would be too difficult or painful to pull off at home, especially where substantial personnel reductions are necessary. For the most part, though, firms move or expand elsewhere because they wish to be closer to an expanding market or, in some instances, to important political patrons.

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