There are no surprises in our California forecast.  There aren’t any changes either.  We expect California to continue plugging along as it has for several years now.  The growth on average will be slow, but the Bay Area will do better.

We don’t see much upside potential.  That is, we would be very surprised if California’s economy did a lot better than the forecast.

We see plenty of downside potential.  New regulations and taxes will have a negative impact, but we would not expect to see an immediate or dramatic drop.  Instead, we’d expect to see California’s economy slowly lose vigor.

A national or global financial—it’s possible, leverage is high and banks are stressed worldwide, particularly in Europe—crisis would have more direct impact.  The immediate impact would be a large fiscal deficit at the state level.  The State’s response would likely be as always.  Taxes would go up.  Transfers to local governments would go down.  Debt would go up.

California’s financial situation has improved during Brown’s two terms, but California has not made the fundamental changes necessary to increase the budget’s resiliency.

Making California’s budget less susceptible to business cycles would require a major tax restructuring, reducing the reliance on a wealthy few while broadening the tax base.  It would also require that the State’s pension obligations be brought under control.

Is Sacramento likely to make the changes necessary to strengthen California’s budget?  Probably not, but now seems like an excellent time to do so.

A one-party state provides opportunity.  While the required changes would help most Californian’s, some groups would be hurt.  Those groups are part of the ruling party’s coalition, government employees and those who despise the existence of wealthy people.  The opportunity comes from the fact that these people have no place else to go.  They will not vote Republican.  The worst they could do to Democrats is sit out the election, but the party could easily retain power if that happened.

California’s Democrat Party now dominates California’s politics to such an extent that it has a unique opportunity to confront California’s long-standing issue without paying a political price.  It’s a perfect time for Governor Brown to cement a legacy.

The post California Forecast appeared first on Center for Economic Research and Forecasting.

I have complained for years that California’s economy is not performing as it should, and it’s not working for a large part of the population, young people, minorities, less educated workers, even much of the middle class.  Those who disagree with me point out that, measured by job growth and GDP growth, California is doing better than the United States.  Therefore, California is doing great, and Bill Watkins is a cranky old hack.

Bill Watkins may be a cranky old hack, but that argument is ridiculous.

The argument that California is doing better than the U.S. and therefore doing well is based on the implicit assumption that the U.S. economy is doing well.  It’s not.

We are almost a decade into America’s weakest post-war recovery, a recovery characterized by low investment, slow economic growth, slow productivity growth, slow job growth, a falling labor force participation rate, increasing welfare rolls, and persistent high poverty rates.

It’s not like its close.  This recovery is dramatically weaker than previous recoveries.

Doing better than the weakest recovery in 70 years is not good enough for California.

At one time, the very name California was synonymous with prosperity and opportunity.  The state attracted people from throughout the world.  California was the model of the good life.

Today, California has the nation’s highest poverty rate, after consideration of housing costs.  Net domestic migration is negative, as Californians move to places like Texas and Oklahoma to find the prosperity, opportunity, and life-style they can’t find in California.  Businesses are leaving, and taking their jobs with them.  College graduates must leave to find appropriate jobs, because California creates more college graduates than jobs.  Home ownership is beyond the imagination of most young families.

California is not doing well because its policies have been hijacked by a coastal elite, which has molded policy to meet their utility functions, utility functions with no consideration for the well-being of California’s less fortunate.

California’s elite are really no different than our two presidential candidates.  Trump was born into wealth.  He was sent to the best schools.  He had every advantage.  Much of that advantage has been squandered as he followed his whims into gambling casinos, beauty pageants, reality shows, buildings, whatever attracted his attention at the time.  In his wake, he’s left failed businesses and consequently destroyed lives.  But, as they say, he’s a winner.  He’s maximized his wealth without concern for the lives of the less fortunate he’s used to maximize that wealth.

Clinton didn’t start with Trump’s wealth, but she went to the best schools, and along with her husband, has risen to the heights of power and wealth.  Like Trump, Clinton rose without concern for the lives of the less fortunate that she used to maximize her wealth and power.  From Arkansas to Washington DC and beyond, she has left a landscape that is littered with broken lives.

So it is with California’s coastal elite who dominate policy.  They have their homes and their lives in beautiful places with world-class weather and abundant amenities.  Economic growth threatens their lifestyle.  They don’t want factories or even other people’s homes marring their viewsheds.  Their attitude is that if you can’t find a job or buy a home here, well you can probably do both in Texas or Arizona.  Never mind that many people can’t afford the cost of the move.  If you live in poverty, they tell you about California’s generous safety net, ignoring the devastating impacts of a life on the dole.

Of course, California’s coastal elite who dominate policy aren’t the majority.  It seems to me that when policy is optimized for a fortunate few and actually detrimental to the interest of the majority of the population, something is seriously wrong.  Somehow, we managed to lose our way with how we select policy makers and how we make policy.

It’s not a just a California problem.  When I look at the presidential candidates and the political leaders of both parties in Congress, I see failure, failure to put competent leaders in important leadership positions.  The problem is worse in California than most other states.  Is there anywhere else in America where policy is optimized for so few at the cost to so many?

It’s difficult to believe that this is a sustainable situation.  It seems that it must reach a crisis at some point.  For California that crisis is likely to be financial, a fiscal crisis.  California’s fiscal position is fragile and volatile.  At some point, California’s under-achieving economy won’t generate the resources needed to meet California’s commitments.

California’s commitments were made based on the twin assumptions that California’s golden economy is everlasting, and there is nothing policy makers do can do to harm that economy.  Those assumptions aren’t true.  For many Californians, the state is already in crisis.  That sounds extreme, but when you can’t find a job, you have a crisis.

We need to make California work for everyone.  I’m not sure how to do that.  I am sure that we won’t make California work for everyone until we admit we have a problem.  Only then, we can start trying to find a way to choose policy makers and set up a policy infrastructure that works for everyone.

The post California Economy appeared first on Center for Economic Research and Forecasting.

California has a long history of boom and bust cycles, but over the past 25 years or so, California’s cycles appear to be becoming more volatile, with increasing frequency, higher highs, and lower lows.  The fast-moving business cycle may not provide the time necessary for many people to recover from previous busts, and may be too limited in its impact. Even now, 22 of California’s 58 counties have unemployment rates of 7.5 percent or higher. Eleven California counties have unemployment rates of at least nine percent.  And these, we are told, are the best of times.

Policy behavior is predictable throughout the business cycle.

Sacramento is awash in cash during a boom, because California’s revenues are more closely related to asset prices than economic activity.  As the economy grows, particularly in an era of ultra-low interest rates, asset prices climb faster than the economy grows, and California is flush.  Sacramento acts as if the boom will continue forever.  Spending commitments are increased, or taxes are decreased.  Politicians congratulate themselves on “fixing” the budget problem.

For Sacramento, economic busts and the resulting fiscal crisis are acts of God, completely independent of policy.  State revenues fall more rapidly than economic activity falls, because asset prices fall faster than overall economic activity. Sacramento tries to transfer the fiscal pain to local governments.  Mostly, they are successful. As of July, Local government employment was still down almost five percent from its pre-recession high, while state government employment is up about 4.5 percent over the same period.

Sacramento is currently enjoying a boom, but this boom, like all booms, will ultimately lead to a bust.  There are signs that California’s confrontation with its next bust could come soon.

Asset prices are cause for concern.  After a five-year Bull Market that saw cumulative gains of over 70 percent, the S&P is little changed this year.  Over the past 60 days, it’s been very volatile.  California’s median home price is up over 70 percent from its recession low.  It too has recently shown volatility, reflecting the huge differences between regional markets.

Housing affordability (percentage of population that could afford the median home) is down too.  It’s fallen from over 50 percent to about 30 percent.  We can’t be sure, but it’s probably below a sustainable level.  That is, below a level that can sustain a middle-class population.  Several California communities have lower levels home ownership rates, but places like Marin County have minimal middle classes.

California’s tech sector has served the state well over the past business cycle.  In quarter after quarter the Bay Area has led the state in job creation.  In many quarters, the Bay Area was the only California region to gain jobs.

But California’s tech sector can be very volatile, as the last dot.com bust in 2000 showed.  Today, venture capital investment is near the levels we saw just before tech’s big bust.  The number of deals is lower though.  It’s not clear that it is again a bubble about to bust, the possibility should be seriously considered.  Ideally, we would have a plan to deal with the subsequent fiscal challenges.

If tech does decline, the impacts will be more than fiscal.  California’s Information sector, down more than 100,000 jobs from its previous high, still has not recovered from the dot.com bust:

Recent data imply that continued economic growth, even the slow growth we’ve become accustomed to, is threatened.  California’s most recent jobs report was a big disappointment.  National data was disappointing too.  Only 20 states saw employment increases in September.

California’s position on the Pacific Rim between Asia’s manufacturing sector and the world’s largest consumer market guarantees that trade is an important sector for California.  Increasingly, however, that sector is at risk.  China’s economic growth is weakening.  Competing ports in Mexico and Canada threaten California’s trade sector, as does the Panama Canal expansion.  California’s response has been to ignore the challenges and to refuse to expand ports to accept today’s largest ships.  California’s share of North American trade will surely continue to decline:

An economic downturn would have a huge impact on California and its citizens.  California’s budget surplus is precarious, and the state has failed to make any real changes in California’s fiscal structure.  Instead of using California’s period of good fortune to reduce the budget’s vulnerability to volatile asset prices, by broadening the tax base, Sacramento has amazingly elected to increase revenue volatility by augmenting the status quo with a temporary tax.

The games that partisan politicians play leads me to the conclusion that they either don’t believe that their policies adversely affect real lives, or they don’t care.  Certainly, economic outcomes   affect real lives.  There is abundant evidence that unemployment and poverty cause drug abuse, domestic violence, broken families, poor health outcomes, and many other social pathologies.

The question, then, is do policies affect economic outcomes?  In their book Why Nations Fail, Acemoglu and Robinson compare side-by-side communities that appear identical but have different economic outcomes, cities like Nogales Arizona and Nogales Mexico.  These two cities, and the other pairs in the book, are identical, except for being in different countries.  They are adjacent to other.  They have the same resources.  They are demographically very similar.  They only differ by political regimes.   Acemoglu and Robinson find that policy decisions and the inclusiveness of the decision process have dramatic impacts on economic outcomes, and thus people’s lives.

California policy is dominated by a rich coastal elite who control most of the media, finance campaigns, rule over the universities and generally dominate all discussion.  The result is extreme inequality, persistent nation-leading poverty, high housing costs, and limited opportunity for California’s most disadvantaged populations.  And, California’s most disadvantaged will pay the most for California’s next downturn.  They won’t write checks, because they can’t.  Their net worth won’t decline, because it’s already at or below zero.  They’ll pay a far higher cost in broken homes, broken families, and broken lives.

The post Is California’s Bubble Bursting? appeared first on Center for Economic Research and Forecasting.

As California weathers its fourth straight year of extreme drought, policy makers and their cheerleaders continue to scapegoat California’s agricultural industry. Writing in the Sacramento Bee, economist Christopher Thornberg, for example, refers to the industry as “feckless” and advocates using eminent domain to seize farmers’ water. In truth, the agricultural industry has made ground-breaking efficiency gains in the past twenty years.

Consider this: In the late 1980s, following the last big drought, total groundwater extraction by farmers within Fox Canyon, a robust agricultural region in Ventura County, declined sharply and then settled in to a five-year average of approximately 80,000 acre feet per year. That level of extraction has now been stable for over 20 years. During that same 20-year period, production of notoriously water-hungry strawberries has increased 145 percent. Production of raspberries has increased an astonishing 425 percent. Ventura County farmers are doing vastly more with the same amount of water. This pattern holds true statewide. The total value of agricultural output in California increased from $16.3 billion in 1998 to $22.3 billion in 2010, without any increase in total agricultural water use. Rather than a story of fecklessness, this is a story of fabulous innovation; one that producers in other industries can look to for inspiration.

Source: Fox Canyon Groundwater Management Agency (www.fcgma.org)

California farmers have made these efficiency gains in part because they have experienced government-imposed water rationing for more than two decades. The Central Valley Project Improvement Act of 1992 marked the start of an era of policy making which set aside 76 percent of water flowing into the San Francisco Bay Delta, immediately curtailing over 800,000 acre feet of irrigation water. On top of those losses, between 1993 and 2006, all years in which precipitation fell within historical norms, farmers in the Central Valley received only 75 percent of their contractual allocations from the US Bureau of Reclamation. Urban use, which policy makers routinely privilege over agricultural use, received 94 percent. Between 2009 and 2012, farmers received only 38 percent of their contracted allocations, while urban users received 70 percent. And since 2012, farms have received an average of 15 percent, with cities getting 55 percent. These cuts to agricultural water have forced farmers to innovate.

Efficiency gains like those enjoyed in Ventura County and the Central Valley have not been universal. As Thornberg notes, farmers still grow rice in northern parts of the state and alfalfa in some of California’s deserts. But this is not evidence of farmers’ fecklessness. Rather, it is the only rational economic choice that California law affords them. Farmers have to use their water on their own property or lose access to it in future years. This is the economic equivalent of forcing them to grow hay in the desert. These farmers might prefer to sell their water, while temporarily leaving their land fallow, but California law prohibits this. Seizing farmers’ water, as Thornberg advocates, may provide relief to cities; however, allowing alfalfa and rice farmers to sell their water to the cities would be far more economically efficient. It might even free up water to support California’s environmental goals.

What about the role that water plays in achieving environmental goals? Countless commenters, including Thornberg, have pointed out that agriculture makes up just 2 percent of California’s economy but uses 80 percent of its ‘consumable’ water. This claim is deeply misleading. In fact, farmers consume just 41 percent of the state’s total water. Water use in California is actually divided into three critical categories: urban use, agricultural use, and environmental use. Fully 48 percent of the state’s water is allocated to environmental uses, which include mandated stream flows that serve the State’s endangered species and sensitive habitats. Environmental water use often requires curtailment of agricultural water use and substantial releases of water from California reservoirs.

Any attempt to solve California’s chronic water shortages must balance the demand for water in each of these three categories . This means looking at all water— including that which is now designated for environmental use—and then allowing water users, buying and selling specific allocations of water in a water market, to decide the uses they value most highly. Water markets in Oregon, Colorado, and Nebraska are doing just this with considerable success. There are even successful, if isolated, examples to look to in California.

Perhaps the finest example of water markets that function in this way are those used in Australia. Trading within water markets equipped that country to endure the 15-year long Millennium Drought which lasted from 1995-2009. Water markets protected cities from the most severe restrictions, supported agriculture, and provided for environmental needs.

The case is instructive because not long ago Australia’s water laws looked a lot like California’s. Australia gradually introduced the leasing of water allocations during the 1980s. Its biggest departure from a California-style system occurred in 1994, when the country unbundled water rights and land ownership. Australia further liberalized markets by allowing trading across basins and across state lines beginning in 2004. And then it engaged in something truly radical: a government buy-back program purchased allocations of water from farmers totaling more than 800,000 acre feet (an ironic amount if you think back to 1992 in California), in order to secure water for the country’s environmental needs. Australia treats the environment as a public good, and taxpayers collectively bear the burden of preservation.

The results of these fundamental changes in water law are undeniable. In an end of drought survey, 90 percent of Australian farmers reported that water trading supports the viability of their businesses. According to the Australian National Water Commission, trading increased Australia’s GDP by $220 million in 2008/09. Given the $1.84 billion and 10,100 jobs lost in California’s agricultural industry in 2015 as a result of the water shortage, the economic returns from water trading can not arrive soon enough.

Allowing markets to allocate water has one other profound benefit. Under market allocation, as water becomes scarcer, remaining allocations become more and more valuable, increasing the economic returns to conservation. Applied in California, this will drive innovation of the sort that the state’s “feckless” agricultural industry has been practicing for years. Imagine industries across the economic spectrum doing more with less water. It will also bring alternative forms of supply on line, such as waste water re-use and brackish water desalination. Currently, the effective price of water is simply too low in most jurisdictions for groups to invest in these forms of new supply on a scale that will make a difference.

So what is holding us back? The 2014 Sustainable Groundwater Management Act, known as SGMA, has finally arrived. Under the authority of dozens of SGMA-mandated Groundwater Sustainability Agencies (GSAs), profound change is coming to the way that water is managed. The question is, what kind of change will California get? California has the opportunity to move towards a decentralized, market allocation of water which creates economic value for all water users. SGMA explicitly authorizes allocation of this kind. But there is significant risk that policy makers will miss the opportunity, instead reinforcing the worst parts of existing law. The continued scapegoating of California’s agricultural industry makes the latter more likely.

If a move to water markets is too big a lift for California policy makers and the local GSAs, there is always eminent domain. I recommend that we start by seizing economists’ water.

The post Don’t Seize Farmers Water, Let Them Trade It appeared first on Center for Economic Research and Forecasting.

“It’s no longer legal to say, ‘We don’t want African-Americans to live here,’ but you can say, ‘I’m going to make sure no one who makes less than two times the median income lives here,’” Jargowsky told me.

The above quote is from an Atlantic article on the resurrection of American slums.  I recommend the entire article.  It highlights the cycle that our slums have gone through over the past 25 years or so.

However, the quote succinctly tells a story that I’ve been trying to tell for the past 15 years.  California is now dominated by a wealthy elite, an elite that has molded policy to advance their preference.  Those preferences are all about the elite’s consumption.  They are nothing about opportunity for the less fortunate.

By implementing policies that limit opportunity, the elite are ossifying our society, limiting socioeconomic mobility.  The New York Times has an article on the correlation between a person’s parents’ income and their own.  Here’s the money quote:

I hear from people who say something like: I grew up poor, but I worked hard and I made it. If other people tried, they could, too. Bravo! Sure, there are extraordinary people who have overcome mind-boggling hurdles. But they’re like the N.B.A. centers with short parents.

Too true.

Bloomberg has noticed that our young people aren’t working summer jobs as much as they used to, but they get it all wrong.  Our young people aren’t lazy.  The decline in teen jobs is not exogenous, or an act of God.  Immigrants may be taking some traditionally teen jobs, but policy is the reason there aren’t enough to go around.

Each of these three articles highlights some results of policies optimized for the elite’s consumption rather than economic opportunity.  California, of course, is the nation’s forerunner in policy optimized for the elite.  The results are sometimes beautiful cities.  Santa Barbara, Monterey, and Malibu are excellent examples.  Just as often, the results are ugly cities.  Consider that San Bernardino has the second highest poverty rate among large U.S. cites, second only to Detroit.

The ugly results on people are not so obvious, but these three articles show that they are starting to become unavoidable.  Now, if people would take them as serious as a dead lion, we’d be getting someplace.

The post Ugly Outcomes of Elite Policy appeared first on Center for Economic Research and Forecasting.

Since allocation in California is increasingly a political process, there is no reason to believe it’s economically efficient.  Indeed, there is every reason to believe that it is massively inefficient.  The lost production for foregone efficient uses is probably huge.

Here’s the intro to a recent AP piece:

FRESNO, Calif. (AP) — California water regulators flexed their muscles on Thursday by ordering a group of farmers to stop pumping from a branch of the San Joaquin River amid an escalating battle over how much power the state has to protect waterways that are drying up in the drought.

The State Water Resources Control Board issued the cease and desist order against an irrigation district in California’s agriculture-rich Central Valley that it said had failed to obey a previous warning to stop pumping. Hefty fines could follow.

As you read on, you eventually get to the human costs:

“I’ve made investments as a farmer based on the rule of law,” said David Phippen, an almond grower in the South San Joaquin Irrigation District. “Now, somebody’s changing the law that we depend on.”

Phippen said his grandfather paid a premium price in the 1930s for hundreds of acres because it came with nearly ironclad senior water rights.

Phippen said he takes those rights to the bank when he needs loans to replant almond orchards or install new irrigation lines. He fears that state officials are tampering with that time-tested system.

“In the water world, the pre-1914 rights were considered to be gold,” said Ed Casey, a water attorney who says the battle between the state water board and farmers “tests … the limitations on that piece of gold.”

The human costs are hard to measure, but they are real.  Families may lose their land and end up bankrupt.  Families may be destroyed, as financial issues are a major cause of domestic violence and family breakup.

What’s so disheartening about this is that it is entirely avoidable.  A rational system, one based on market prices, would provide for a far more efficient, and ultimately humane, allocation.

The post “In any other state, this wouldn’t be a question,” he said. appeared first on Center for Economic Research and Forecasting.

Early on, they not that Los Angeles’ economy has been almost unique in not creating jobs:

In their March 2014 report, UCLA Anderson Forecast noted that “L.A. [County] has gone 23 years without positive job growth.” From December 1990 to December 2013, this report showed Los Angeles County was one of only two metropolitan areas in the US to show a decline in its job base, losing 3.1% of Nonfarm Wage & Salary Jobs over this period.

The conclusions are dismal:

Los Angeles presents a trend largely of jobs stagnation under which middle class wage jobs have been steadily replaced by lower wage service jobs for a population that has continued to grow. Rather than reinvent its economy in response to the changing economic conditions as it has in the past, the region instead has reshaped its economic structure with a severe contraction of the middle class wage jobs that long provided new economic opportunities to prior generations.

This decline in middle class wage jobs and the associated growing income divide has led to considerable policy interest in recent years on both the state and local levels. Many of the policy prescriptions to date, however, have been more palliative, responding to the results of growing income inequality and the state’s rising costs of living rather than addressing the root causes.

It’s considered impolite in California to discuss weak job creation.  Until Californians have a serious discussion, nothing will change.

(Originally published on my personal blog 5-16-2015)

The post Los Angeles in Decline appeared first on Center for Economic Research and Forecasting.

This paper demonstrates that even the complete elimination of state GHG emissions will have no measurable effect on climate change risks unless Cali- fornia-style policies are widely adopted throughout the United States, and particularly in other countries that now generate much larger GHG emissions.

There’s this:

In 2011 California accounted for less than 1% of global CO2e emissions, and less than 0.065% of the worldwide annual CO2e emissions increase that occurred during 1990-2011. The state’s per capita CO2e emissions are much lower than in the rest of the United States, and comparable with relatively efficient advanced industrial countries like Germany and Japan.

And this:

Despite its sizable population and economy, California generates a relatively minute, and falling, share of global CO2e emissions. The amount of global CO2e emissions and atmospheric concentrations would have been virtually unchanged, even if California’s GHG emissions were zero from 1990-2011, and remained at that level and assuming cur- rent emission trends in other locations continued through 2050.

The summary is here.  The report is here.  Both are highly recommended.  Both should be mandatory reading for the legislature and Governor Brown.

(Originally published on my personal blog 5-16-2015)

The post California Greenhouse Gas Regulations Don’t Impact World Carbon Levels appeared first on Center for Economic Research and Forecasting.

Part two of a two-part report. Read part 1.

The problem with analyzing California’s economy — or with assessing its vigor — is that there is not one California economy. Instead, we have a group of regions that will see completely different economic outcomes. Then, those outcomes will be averaged, and that average of regional outcomes is California’s economy. It is possible, even likely, that no region will see the average outcome, just as we rarely see average rainfall in California.

California’s Silicon Valley region continues to be a source of innovation, economic vigor, and wealth creation. But the Silicon Valley, named because silicon is the primary component of computer chips, no longer produces any chips. The demands for venture capital are also changing, with the demand for cash falling because new products often take the form of apps instead of something that is manufactured. This type of investing doesn’t need the infrastructure that the Silicon Valley provides. Increasingly, other communities such as Boston, Northern Virginia, and Houston are becoming centers of technological innovation.

Workers recognize the changes. They may not know the reasons, but they know the impacts, and they are voting with their feet. Domestic migration — migration between states, — is a good measure of how workers see opportunity. California’s domestic migration, in a dramatic reversal of a 150-year trend, has now been negative for over 20 consecutive years. That is, for over 20 years more people have left California for other states than have come to California from other states. Workers simply haven’t seen opportunity in California. How can this be? Why would people be leaving when jobs are being created in the Silicon Valley?

The Silicon Valley jobs are rather specific. They require higher skill sets than most workers possess. One consequence is that the Silicon Valley’s prosperity hasn’t helped California’s other workers much. We are left with a situation where California’s tech firms search worldwide for workers, while California workers search for work.

It didn’t have to be this way. High housing prices and environmental regulations, a result of state policies, have driven away the jobs that could be performed by typical California workers. Those jobs are now in Oregon, Texas, or China.

A short distance away, in California’s Great Central Valley, there is poverty as persistent, deep, and widespread as anyplace in the United States. A recent report shows that California has three of the 20 fastest growing US cities in terms of jobs. It has four in the bottom 20.

For a while, at least, the differences between California’s fastest growing regions and its slowest (or declining) areas will grow. In general, coastal areas will see more rapid economic growth than inland ones. Even within these broad regions, there will great heterogeneity. Bakersfield, boosted by a booming oil sector, will see stronger growth than Stockton. San Jose, with its thriving tech sector, will see far more growth than Santa Barbara or Monterey. Furthermore, the best performer among California’s inland cities will probably see faster growth than the slowest growing coastal city.

On average, California’s economic growth will be far below its potential. In most of the state it will be disappointingly low to dismal, as California’s economy is held back by well-meaning but seriously flawed regulations. At the same time, a few super-performing cities may see spectacular growth, at least for a few years.

Eventually, even California’s most vibrant economies will slow, gradually strangled by the lack of affordable housing and of an infrastructure necessary to move people from affordable housing to their jobs. People are willing to drive very long distances daily in pursuit of the twin goals of income security and the American dream of a home in the suburbs. The traffic on Highway 14 between Palmdale and Los Angeles reminds us of this twice every working day. But, they need roads, and affordable housing within commuting distance.

Different growth rates and different levels of economic vitality will exacerbate the vast gulf that exists between California’s wealthiest communities and its poorest. Inequality will increase as California’s fabulously wealthy become ever wealthier, and California’s poor suffer in surprising silence, living on whatever aid we give them, denied the hope and the basic dignity that comes from a job.

Domestic outmigration will increase, but the people who leave won’t be California’s poorest. Instead, young middle-class people will lead the exodus, as they move to wherever opportunity is more abundant. This, of course, will further increase California’s inequality and decrease its economic vitality.

We will also see an increase in consumption communities. Already, many of California’s coastal communities are reflexively averse to any new activity that actually creates value, opting instead to become ever more exclusive playgrounds for the very rich. These communities will see rising home prices as they restrict new units, and will see rising demand, a result of ever greater concentrations of wealth worldwide and the unmatched amenities available in Coastal California.

By contrast, some inland areas will see declining home values and eventually declining populations, as the lack of opportunity drives potential home buyers to places like Phoenix and Houston.

For many of us, this is a depressing forecast, and it is fair to ask whether or not it is inevitable. It isn’t. Few things are. At a statewide level, I hope that representatives of California’s large and growing minority communities demand policies that support the opportunity that previous generations of Californians enjoyed. Absent such demands, California’s policies are unlikely to change.

At a local level, cities would do well to eliminate all policies that contribute to economic stagnation. When a business is making locational decisions, it reviews lists of positive and negatives for the candidate communities. No place has only positives, and few places have only negatives. California cities are endowed with one huge positive: California is a wonderful place to live. That’s not enough, though. A city would do well to minimize the list of negatives.

For businesses, an aggressive minimum wage is a negative, as it raises costs. Uncertainty and delay in a city’s response to an economic proposal increases the risk and costs of proposals. It’s a negative. So is unaffordable housing, as it increases wage demands and makes it harder for businesses to recruit top talent. The best way for a city to encourage the supply of affordable housing is to allow new-home development.

Finally, areas of economic blight increase crime, raise city costs, reduce city revenues, and are unattractive to businesses considering moving to or expanding in an area. Cities need to be flexible in responses to proposals for these areas. Our work at CERF convinces us that we will need less commercial space in the future. Therefore, almost any proposal for dealing with these areas is preferable to inflexible adherence to existing zoning or plans.

California cities are constrained by California policy. That doesn’t mean that California cities are without tools for economic development. Almost any California city — no matter which region it is in — is a better place to live than almost any city in, say, Texas. If that can be leveraged by minimized costs, flexibility, and creativity in adapting to the needs of job-creating businesses, a California city, even today, can assist businesses creating opportunity for its citizens.

The post The California Economy: A Strength VS Weakness Breakdown appeared first on Center for Economic Research and Forecasting.

Part one of a two-part report.

California is a place of extremes. It has beaches, mountains, valleys and deserts. It has glaciers and, just a few miles away, hot, dry deserts. Some years it doesn’t rain. Some years it rains all winter. Those extremes are part of what makes California the attractive place that it is, and, west of the high mountains, California is mostly an extremely comfortable place to live.

Today, we have some new extremes. Some of our coastal communities are as wealthy as any in the world. At the other extreme, we have some of America’s poorest communities. San Bernardino, for example, has America’s second-highest poverty rate for cities with population over 200,000.

From the beginning, we’ve had the fabulously wealthy. For the first 140 years after gold was found, California was a place where people could find, or, more correctly, build, success. The new part is the poverty. It used to be that the poor were mostly newcomers, people who hadn’t yet had time to show that they had what it takes. Today, our poverty is dominated by families who have been here a long time. While San Bernardino certainly has some newcomers, it is mostly a city of native Californians.

The change became visible in the early 1990s. Many analysts will tell you that the change was caused by the collapse of the Soviet Union and the resulting peace dividend, which led to a dramatic downsizing of America’s defense sector, once a major component of California’s economy.

I believe the way to think about this is that the downsizing of the defense sector exposed the weaknesses in California’s economy, as opposed to causing them. Sure, the downsizing had an economic impact. California lost hundreds of thousands of jobs. But the defense sector eventually bounced back and again became a source of good jobs. The problem is that it bounced back someplace else. It didn’t come back in California. In fact, it continues to decline in California.

The decline in California’s economic opportunities began way before the 1990s. As the 1960s progressed, Californians, or at the least the ones making decisions, changed their priorities. California’s spending for infrastructure had once consumed between 15 and 20 percent of the State’s budget. It precipitously fell to five percent or below.

In the ’50s and early ’60s, governors Goodwin Knight and Pat Brown presided over a fabulous investment boom in universities, highways, water projects and the like. None of their successors has even attempted anything on that scale. The profound prosperity that accompanied and followed California’s investment boom hid the impacts of subsequent policy changes for decades.

The decline in public capital spending wasn’t the cause of our changed priorities. It was the change in priorities that caused the change in spending. It is as if we decided that we were wealthy enough, and that future spending would be on social and environmental programs. If we weren’t looking for economic growth, why invest?

At California Lutheran University’s Center for Economic Research and Forecasting, we’ve created a vigor index. It’s composed of net in-migration, job creation, and new housing permits, each equally weighted. It is quite sensitive to changes in economic opportunity. For example, in 2000, North Dakota had the nation’s lowest score, 0.9, and Nevada led the nation with a score of 24.1. By 2013, North Dakota led the country with a score of 20.0, while Nevada had seen its index value fall to only 6.4.

In the following chart, we show California’s index (red bars) compared to that of Texas, Oregon, and Tennessee, from 1980 through 2013.

California is apparently different than the comparison states. The Tennessee, Oregon, and Texas indexes have behaved more similarly to each other than to California since the late 1980s. Texas’ index behaved uniquely in the early 1980s, because of its dependency on oil and the long-term decline in oil prices that occurred during the 1980s.

California appears to be different than the other states throughout the period, but the nature of the difference has changed. Prior to the late 1980s, California tended to outperform the others. For example, its score didn’t decline nearly as much as the others during the early 1980s recession. Given California’s resource endowment, we think this is natural.

Since 1990, though, California’s vigor index has generally remained below those of Texas, Tennessee, and Oregon. Indeed, since 1990, California’s score has rarely exceeded the score of any of the comparison states, and it has never led them all.

The index also shows that California’s investment in infrastructure during the 1950s and 1960s helped drive economic opportunity for two decades. It took two decades without any investment before we saw the consequences of the decision to not invest.

Recently, California has seen budget surpluses and faster job growth than the average American state. The forces for the status quo now claim that this confirms the wisdom of their policies. They are wrong.

California’s budget surpluses are a product of a temporary tax, and an incredible bull market in equities. Our dependence on a highly progressive income tax means that California’s fiscal condition swings on the fortunes of a small group of wealthy individuals.

Equity markets have been amazing over the past few years. The Dow has increased by over 10,000 since it bottomed out on March 9, 2009, and it appears to be divorced from economic activity. It increases on good news and bad, propelled by an unprecedented monetary expansion. Right now, California’s largest taxpayers are reaping huge profits in the stock markets, and California is reaping huge windfalls in its tax revenues.

Someday, the market gains will cease, or worse reverse. Someday, too, the temporary tax will expire. California’s surpluses will wash away like sand on a beach. The state will face a new crisis, a result of a progressive tax structure where revenues swing on paper profits and losses, not on economic activity.

As for our job gains being better than the average state’s, California should not be average.

Employment should be far higher than it is. Even the weak job growth we’ve seen is largely a legacy of a previous age. California has the world’s best venture capital infrastructure, partly because of the investment previous generations of Californians made in the university system. It is also, in part, a result of chance.

An amazing period of innovation was initiated in Coastal California by a few incredibly talented individuals, who were funded by a few far-sighted capitalists. It was one of those rare coincidences that happen from time to time and change the world. The eventual result was the Silicon Valley and economic powerhouses such as Intel, HP, Apple, Yahoo, Google, Facebook, Twitter, and many more.

Another result was the creation of a private, capitalist, vibrant infrastructure. It takes time and vast sums of money before a new idea generates profits. Product design is just the first step. An organization needs to be created to produce and sell the product. Factories need to be designed. Marketing plans need to be put in place.

No inventor or entrepreneur can be expected to have all of the necessary skills or money to turn an idea into a profitable firm. So, an infrastructure appeared. The Silicon Valley’s world-leading venture capital markets and the support structure to enable the fabulous innovation and economic value created there was not the result of any government program or initiative. It was the spontaneous result of lots of people driven to innovate and profit from those innovations. It was capitalism at its very best.

California’s Silicon Valley became the place for talented young people to turn great ideas into reality. It was also the place to go if you had money and wished to invest in vibrant, risky new technologies, or if you knew how to design factories, how to market products, how to build organizations, or how to finance rapid growth. The infrastructure that arose is supporting California today. This amazing capitalist engine of jobs, innovation and wealth is the source of most of California’s economic vigor. But it is a legacy that will eventually slip away, unless California changes its priorities.

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