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Can California's chief executive still run

the world's seventh largest economy?

By Jock O'Connell

This article appeared in the Forum section of the Sacramento Bee on Sunday, November 1, 1998.

If the fearful gyrations of the global economy in recent months have taught us any important lessons, the most alarming may be how little power fully sovereign national governments seem to have over their own economic affairs.

In such a world, it scarcely seems possible that a mere governor can shape the destiny of an economy that, apart from being an integral part of a huge national economy, has become as internationalized as California's. Approximately 15 percent of California's trillion dollar gross state product now comes from foreign trade, and that, remarkably enough, is roughly equal to the amount of commerce California conducts with the rest of the United States.

So exactly what caliber of economic performance should we reasonably expect from the man we elect as our next governor on Tuesday? Will voters simply be saddling up Dan Lungren or Gray Davis for a wild ride aboard an economy whose disposition in coming years is apt to range between mildly quirky and just plain surly? Or is there still sufficient latitude for the governor to prod and cajole the beast in favorable directions?

The answer is of transcendent importance not only because it bears on how well the Golden State will be able to cope with a potentially apocalyptic stew of social and economic challenges - including massive population growth - over the next several years. The answer also goes to the larger question of whether the entire architecture of the federalism is appropriate to the 21st century. At a time when, paradoxically, the federal government seems inclined to devolve more and more responsibility to state capitols, the emergence of the global economy threatens to undermine the state's ability to effectively govern a diverse assortment of regions and city-states that just happen to lie within lines drawn on a map - 150 years ago in California's case.

Of course, not everyone thinks that governors and legislators are powerless to play decisive roles in the sphere of economic policy. For example, if Pete Wilson seeks the Republican nomination for the presidency in 2000, he'll doubtless begin the beguile of New Hampshire's first-in-the-nation primary voters with boasts of how, as governor, he engineered California's comeback from its worst economic recession since the 1930s.

But however it plays as politics, Wilson's self-serving claim won't win many plaudits as economics. For years now, economists have resoundingly dismissed the notion that there is anything significant state policymakers can do to affect the state's economy in the short-term.

After all, state governments do not have access to the levers of macroeconomic policy federal authorities can call upon to influence economic behavior. States can't cut interest rates as the Federal Reserve Board does to spur economic activity. And even die-hard supply-side economists can't make a convincing case that cuts in state taxes can spur economic growth locally.

(There are two major reasons state tax cuts generally do not constitute much of a fiscal stimulus. Besides representing a relatively modest addition to the bottom line of most companies and families, state tax cuts also leak out to other jurisdictions simply because, for all practical purposes, California's economy can't be walled off from the rest of the nation or, increasingly, from the rest of the world. Thus, the beneficiaries of a cut in California's corporate income tax will include numerous non-California entities such as Japanese multinationals, New York hedge fund investors, British banks, and the Beardstown Ladies, who of course live in Illinois.)

There is nothing new about these sorts of limitations on the state's ability to influence economic developments. In recent years, though, the internationalization of the California economy has further constrained state government's power.

The collapse of once prosperous economies in the Far East is being felt here in the form of reduced exports, lower corporate earnings, and lay-offs in industries from California agriculture to aerospace. Only a few days ago, Boeing announced it would delay the start-up of a new 737 jetliner assembly line in Long Beach which would have employed thousands of aerospace workers. The company attributed the decision in part to a sharp drop in aircraft orders from Far East. Similarly, Russia's economic and fiscal woes and deepening concern about Latin American economies certainly played a major role in the sudden spike in home mortgage rates three weeks ago, a move that has played havoc with the state's residential housing market and construction industries.

At the same time, the worldwide drop in investor confidence has dried up credit markets here in California. As the Los Angeles Times recently reported, "many of Southern California's once-fast-growing companies are now unable to raise the money they were counting on to add jobs, expand into new space or introduce products."

Under these changing circumstances, is there anything state leaders can do to promote economic prosperity?

The short answer is yes, they can, but only over the long term and in three specific ways: (1) by providing the basic human and physical capital needed for sustained economic growth; (2) ensuring an equitable balance between legitimate public and private sector interests; and (3) making the best possible use of government programs and other public resources to encourage business development and job growth.

Historically, economists have argued that far and away the most valuable and tangible contribution state officials can make to economic prosperity is to provide for a well- educated, highly skilled workforce and an efficient infrastructure of roads, ports, bridges, dams, canals, levees, sewers, waste treatment systems, and other facilities upon which businesses depend.

Yet, from a California politician's perspective, this sage advice is not entirely helpful. For one thing, good schools and quality infrastructure aren't cheap. For another, the benefits don't accrue next year or even in time for the next election cycle. More critically, though, the prospect of having to channel more revenue toward education and infrastructure only serves to remind officials of how little discretion they have over the state budget.

In his recent book, Paradise Lost: California's Experience, America's Future, Peter Schrag details the restraints on state government spending authority imposed by two decades of legislation and ballot initiatives dating back to Proposition 13. After satisfying the demands of various constitutional provisions, federal mandates and other statutory requirements, elected leaders have no more than a sliver left of the state budget for what is euphemistically called discretionary spending. Indeed, when it comes to setting budget priorities, Schrag concludes we no longer have a representative government in Sacramento but rather a government operating on auto-pilot guided by a collection of mandated formulas for distributing revenue.

Charting a path through this thicket of restraints represents the principal challenge for any governor who seriously wishes to reverse the steady decline in California's schools and infrastructure.

Unfortunately, neither Dan Lungren nor Gray Davis have had much to say about the state's economic agenda. In all fairness to the candidates, the future of the Golden State's economy has not weighed heavily on the electorate's mind this year as have those issues -- education, three-strikes, abortion rights -- on which Lungren and Davis have been trying to exploit each other's alleged inconsistencies and false steps.

Although Davis, as Lieutenant Governor, chairs the California Commission on Economic Development, it is almost impossible to piece together a coherent economic policy from his few speeches and position papers. On tax cuts, he is much more ambivalent than his opponent. Rather than urging sweeping tax cuts, Davis favors manipulating the tax code to induce economic activity he thinks should be encouraged. He supports a larger investment tax credit and the abolition of the so- called minimum business tax. But on critical issues such as the North American Free trade Agreement and Proposition 211 (the 1966 initiative that would have restricted shareholder lawsuits against corporations), Davis stayed in the neutral corner.

Both men insist they are sincerely committed to remedying universally lamented deficiencies in the state's educational system and its infrastructure. However, they have not explained how they plan to deal with the same vexing problem that has haunted all of their predecessors: Where's the needed money to come from?

As even Pete Wilson knows, beating up on the trade unions representing teachers, CalTrans engineers and construction workers does not suffice as public policy. At some point, you have to sit down and talk seriously about finding new money to care for dilapidated school buildings, unsafe bridges and crumbling sewer lines. As might be expected, the revenue issue is somewhat more dicey for the explicitly anti-tax Lungren. In a luncheon speech to the Sacramento Metropolitan Chamber of Commerce on September 10, the attorney general left no doubt that tax reduction would be the principal ingredient in his strategy for propelling California's economy forward. "I'm convinced that California's taxes are too high, and that this is hurting our state's economy," he told his audience of local business leaders. That's the voice of the anti-tax Lungren, the one who seldom strays from the gospel according to Ronald Reagan.

But there's also a Lungren who clearly has a high regard for the biggest tax-and-spend liberal in California history, former Governor Edmund G. (Pat) Brown, Sr. In the candidates own words: "California's rise to economic prominence was no mistake. It was the result of leadership and investment in critical infrastructure that built our state and federal water projects, the highways, ports and schools. California's infrastructure is aging, and has gone without major reinvestment for over thirty years."

Now one of the most durable - and evidently bipartisan - legends in California history is the saga of how, during his two terms in office (1959-67), Brown the Elder embarked on a bold vision by initiating the vast State Water Project, dramatically expanding the state's network of freeways, and building a system of public education that became a model for the nation. It is not uncommon to hear politicians of all stripes concede that even thirty years later, as Lungren puts it, "we stand on Pat Brown's shoulders."

Yet Lungren's desire to reduce taxes while simultaneously attending to the needs of education and infrastructure suggests that he fails to appreciate that in today's political climate even Pat Brown couldn't be Pat Brown.

It scarcely diminishes the former governor's accomplishments to point out that he came to power in an era significantly more receptive to activist government and public investment. Even the Republican administration of Dwight Eisenhower was a patron of massive public works projects such as the interstate highway system and the St. Lawrence Seaway. Government, especially the federal government, enjoyed an image (at least outside of the South) as a positive force in society. And why not? It had orchestrated America's victory in World War II and, in the process, ended the Great Depression. It harnessed the nation's resources to rebuild Europe and Japan so as to better resist Soviet expansion. Millions of returning servicemen and women seized upon the G.I. Bill to attend college and training schools.

While Americans in the 1950s and early 1960s were not all exactly Keynesians enamored of big government, it would be fair to say that Pat Brown had the luxury of governing before thirty years of anti-tax, anti-government rhetoric had severely compromised state government's ability to do anything constructive, especially if it involves a need for new revenues.

The overarching challenge facing any governor serious about tackling the awesome agenda of restoring California's schools and infrastructure to world-class status is ultimately more political than economic in nature. For without a new consensus about state government's legitimate role in building the kind of prosperous and equitable society most Californians say they want, it is pointless to propose any economic development strategies that may require state government to assume the activist role in did in Pat Brown's time.

Given the current level of popular antipathy toward government as well as the political temperaments of the two leading candidates, California's next governor is unlikely to leave the imprint on the state's economy Pat Brown did. More than likely, the governor and the Legislature will continue instead to place great emphasis on an important but decidedly second-order set of economic concerns, namely those dealing with the state's "business climate."

As in any state, California's business community has any number of legitimate beefs with public officials at all levels of government. Finding the proper balance between the often conflicting needs and interests of the public and private sectors on issues such worker safety or the environment or public health is a never-ending task for policymakers.

That having been said, state policymakers do need to be more discerning in analyzing the legislative agendas advocated by the more prominent business organizations at the capitol. For what are commonly portrayed as economically costly conflicts between private businesses and public bureaucracies often mask a more profound divergence of interests between California's older, more established, and frequently less competitive corporations and its future. The former, often disparaged as dinosaurs, have needs that seldom coincide with those of their mirror images, the fast-growing gazelles who represent the Golden State's industrial future.

For many economic pundits, the choice is self-evident: the state tax code and regulatory system should reward gazelles and perhaps even penalize dinosaurs. After all, it's our future that matters foremost, not our past. Well, maybe. The problem with such glib economic advice is that it callously ignores that gazelles normally do not offer rich employment opportunities for California's semi-skilled and unskilled workforce. If anything, the types of targeted tax credits often advocated by proponents of The New Economy would only exacerbate the ever- widening and socially unsettling disparity between California's haves and have-nots. In any event, to keep matters in perspective, few economists believe that eliminating pointless regulations or reducing especially onerous business taxes will revitalize the economy of a state whose schools and infrastructure are increasingly below par.

Finally, however modest in overall impact they may be, there are an array of state government programs and services designed to foster economic growth and job creation, often in partnership with private enterprise. Some of these programs are intended to promote exports by working with small and medium-sized California firms that are relatively new to the export trade.

Regrettably, elected officials have sometimes tended to give little more than lip-service to these programs, failing to understand what they really do (or don't do) and, in some instances, subverting these programs to narrow political ends. Taking their cues from elected officials, those managing these programs have little reason to embrace innovation.

One of the more dubious examples of bad governance involves California's overseas trade offices which, in recent years, have been sited more with an eye to pleasing domestic constituencies than any particular need of the state's exporters. In one particularly appalling case, this year's budget provides for a new state office in Calgary not because Alberta is regarded as an especially vital market but evidently because an influential California state senator enjoys duck-hunting there with local government officials.

With so little leeway for positive action on the economic front, it behooves a governor to make maximum use of every existing resource. Fortunately, changes in administration provide the best opportunity for reforming and reinvigorating the apparatus of state government.

Perhaps term limits do have their uses after all.

Copyright 1998 by J. A. O'Connell