Economy.com Letter to the New Californa Governor

You may find this letter to California's new governor to be of interest. It is written by the economists at Economy.com and addresses the economic competitiveness issues facing the state. Interesting read, indeed.


MEMORANDUM

TO: California’s Next Governor

DATE: October 8, 2003

RE: The California Economy

The California economy is in peril of losing its long-term competitiveness. Yesterday’s recall election has created a political will that has generated an environment suitable for change. You must seize this opportunity to make fundamental changes in the state’s economic competitiveness before the 2004 elections divert the attention of lawmakers and voters.

Of course, as the new governor your first task will be to assure the electorate that you are taking charge of the budget, using your line-item veto to cut spending where possible, to raise taxes judiciously and temporarily where necessary, and avoid encumbering the state with massive long-term debt.

Yet while the budget was the trigger for the recall election, it is not California’s most intractable problem. Your task during this abbreviated term will be to address longer-term issues that put the California economy at risk. There are at least five critical issues that could relegate California to the ranks of mediocrity for many years to come. Resolving these issues would make a fundamental difference that would keep California competitive at the top rung of state and national economies.

First, workers’ compensation costs must be brought under control. Skyrocketing workers’ comp insurance premiums are a primary factor driving jobs out of California towards other states and overseas. One might think workers’ comp problems impact only industries with high-risk occupations such as construction or manufacturing, but it hurts everyone. For example, discount retailer Costco, which is self insured, reported a decline in profits earlier this year due to the need to boost its insurance reserves in California by a whopping $26 million. Rising medical costs, fraud, extensive litigation and increased benefits provided under last year’s AB749 legislation are driving up insurance costs for large and small employers alike. That is, if they can find an insurer. Private insurance is unaffordable for many yet the California State Compensation Insurance Fund, the insurer of last resort, is in deep financial trouble itself and cannot accommodate current demand. The recall election may be enough to galvanize support for a special legislative session this fall that, with renewed leadership from the governor’s office, would consider all various reform proposals and reshape the state’s workers’ compensation insurance industry.

Second, state pension programs will prove to be budget busters over the long term. State pension formulas are illustrative of the kind of permanent spending increases that took place when the stock market bubble boosted state revenue beyond expectations, rather than spending the windfall on one-time projects. Illustrative of the pension changes passed in 1999 was a new formula for Highway Patrol pensions. Officers may now retire with up to 90% of their pay at age 50 as officers now get 3% of their final salary for every year they worked for the state. State police and firefighters also have this increased benefit, and it also is available to local government employees. The cost was to have been paid by interest earned from state surpluses parked in state pension benefit funds. But the surpluses have disappeared so the increased benefits are paid out of the state budget. The cost is estimated to be $500 million per year, although this could rise further depending on local government employee participation. With retirees already benefiting from the plan, changes are difficult. But changes will be necessary if future budgets are to be balanced.

Third, supplies of water and power must be addressed over the long term. The impact of power shortages already is far too clear in the minds of Californians. Moreover, the California Energy Commission estimates that power shortages could arise as early as the summer of 2007 should another hot summer occur at that time. Water similarly is a festering long-term problem. Already, badly needed homebuilding is being delayed until homebuilders, particularly in southern California, can show that there will be adequate water supplies over the long term for the households that will buy the homes that they will build. The state is locked in negotiations with its Mountain State neighbors over the use of Colorado River water. The state must go further very soon in ensuring additional supplies of power and water, and of extending its already considerable practices of resource conservation.

Fourth, housing is becoming increasingly unaffordable in California due to a lack of supply. Some day, only those who have already attained considerable wealth will be able to afford a home. Yet it has been the arrival of those still seeking their fortune that has fueled the state’s dynamic economy since even before the 1849 gold rush. Even with lower mortgage interest rates since the 2001 recession, Economy.com’s index of housing affordability for California has worsened. Only Hawaii and Massachusetts rank worse than California. Indeed, the Silicon Valley housing market remains one of the most unaffordable despite a loss of population last year. Environmental regulations are one reason for the housing shortage, but this is a long-standing source of friction. Increasingly, as land use in metropolitan areas becomes denser, multifamily housing will provide a larger share of new housing. Yet rising costs of construction liability insurance for multifamily housing limits the ability to supply the multifamily housing that will be needed to meet demand in an environmentally sensible manner. Thus, as with workers’ compensation, insurance reform remains high on the policy agenda.

Fifth, throw out term limits for the legislature. And while at it, repeal the “two thirds rules” that require two-thirds majorities of the legislature and local boards to raise taxes and to pass the state budget each year. Term limits, while popular as a way of removing entrenched politicians in the state legislature, have created a legislature with no long-term view of state issues and little expertise on budget processes. Each of the issues described above requires a long-term perspective, and the ability to fight off short-term political forces for long-term gain. The two-thirds rules create an environment in which extreme views can rule the day, whereas compromise is really the necessary political vehicle. Again, this allows near-term politically popular views to trump the long-term solutions of the intractable problems that inevitably arise in an economy and a society as large and complex as California’s.

These actions will not be easy, particularly as laws such as term limits and the two-thirds rules were passed by referendum, not by the legislature. They will take a strong political will among all parties, which may be available only for a few months to come. But most of all, without strong leadership in the legislature, these actions will take strong leadership from the governor. The time is now to improve the fundamentals of California’s economy for the next generation.