California Recovery: Connecting the Dots to See the Big Picture

More and more commentators are pronouncing the end of California’s worst recession since World War II. Leading bank economists in the state, Wall Street firms and the previously bearish UCLA Business Forecasting Unit all either have said that the state has begun a turnaround or that one will commence this quarter.

The reaction from citizens and the business community is mixed. Some say that improvement began a few months ago; others say jobs are still difficult to find. Both statements are correct, and delving a little deeper into what is actually going on in the state’s economy reveals why.

First, just as the nationwide economy is a complex amalgam of many interrelated sub-economies defined by region and industry, the same is true of California. The sectors seldom all expand or contract at the same pace.

For instance, the condition of California agriculture depends much more on world prices for its products--and factors such as weather--than on the condition of the urban economies of the Bay Area and Los Angeles. With a fifth of federal defense spending (including aerospace procurement) in California, the large defense drawdown--which President Clinton proposes to expand enormously--has been a cause of much of the state’s job loss during the recession. The boom in business investment in computers and telecommunications equipment has helped Silicon Valley firms and workers.

When forecasters say that California’s $800-billion economy is in recovery, they are measuring an average condition. For example, the statewide employment rate has been rising for the last three months, building permits are up and house prices are firming. Yet the north is doing better than the south, and in Southern California, Los Angeles County has been hit particularly hard. Perhaps the best news is that the growing industries, such as construction, finally outweigh those still declining, such as aerospace.

Second, a semantic distinction needs to be made. When these economists say the recession is over, they are not saying the state is in good shape, or back to where it was before the recession began. Recession means the economy is declining. Recovery means it is improving, however slowly and unevenly. Like a patient recuperating from an illness, full recovery takes some time. For example, construction employment has finally started to increase modestly, but it is still at just two thirds of its peak level in 1990.

Third, there is always legitimate uncertainty about the strength and durability of any turnaround. The hardest thing to predict about the economy is the exact timing of turning points in the business cycle. Around turning points, signals are much more mixed; some turn positive and others stay negative. It is only after a recovery has been going on for some time that the overwhelming indication of economic gauges tends to be positive month after month.

The recent statements declaring the California recession to be over reflect the forecasters’ judgment that enough indicators are turning positive to suggest that the state is in the early stages of recovery. If these forecasts prove accurate, it will take some time for the California economy to get back to 1990 peak levels of output and employment.

Among the positive signs for the state is the solid recovery of the nation’s economy. The rest of the country is California’s largest trading partner, so its continued improvement will increase demand for goods and services produced in California. Southern California is getting a short-term boost from post-earthquake rebuilding. Freeway repairs are reported running ahead of schedule. Kudos to Gov. Pete Wilson and Caltrans for cutting through the red tape that usually slows state transportation projects--and for the use of innovative contracts providing bonuses for early completion and fines for the kind of behind-schedule performance that often dogs such construction.

The biggest negative for the state is the continued shrinkage of defense and aerospace work. While some other sectors are growing, the Clinton defense drawdown is pulling tens of billions of dollars out of California’s economy.

The emerging view of California, on average, being in a slow recovery--with some regions and industries growing solidly while others lag behind--at some point will give way to more solid growth and a brighter outlook for the long term.

California is ideally suited to take advantage of growing Pacific Rim trade, and it has always been an incubator of small businesses--and even whole new industries, given the entrepreneurial spirit that is such an important part of the state’s heritage.

Finally, California’s anti-business public policy also has turned the corner with important tax changes, workers’ compensation reform and regulatory simplification, much of which were worked out on a bipartisan basis between the governor and Legislature last year. Building on those achievements is the best way to get state and local public policy behind the recovery and ensure California’s future economic vitality.