Uncertainty Clouds State Economic Horizon

Despite a series of reassuring forecasts about the California economy, the state faces an increasing array of problems that have begun to cloud the outlook for 2001.

Some of the state’s leading business forecasters are edging away from economic predictions that they announced only weeks ago. While none expects a recession in California next year, more and more anticipate a substantial slowdown from this year’s brisk expansion.

“It’s going to be a shock after a year like 2000,” said Jack Kyser, chief economist for the Los Angeles County Economic Development Corp.

Kyser, who issued a forecast early this month that the state’s job total would grow 2.8% in 2001, now is saying there is a good chance the gain will be only 2.1%. Either way, it would mark an abrupt decline from this year’s 3.6% increase, the best since 1988.

Troubling vulnerabilities and uncertainties abound: What happens if California’s skyrocketing natural gas and electricity prices, a threat to industry and consumers, can’t be brought under control? What if something like the so-called Asian economic flu of 1997-98 torpedoes the state’s foreign trade? What if Hollywood fails to rebound vigorously from the feared midyear strikes by actors and writers? Or if the Internet boom, and the vast stock market wealth it created in the Bay Area, continues to dissolve and triggers a real estate collapse?

All told, experts acknowledge that a combination of bad surprises could mean trouble for millions of Californians, despite the strengths that have made the state the world’s sixth-largest economy.

The circumstances recall, to some degree, the difficulties state economists faced almost exactly a decade ago, when 10 leading forecasters were polled on their outlooks for the next year. Their crystal balls apparently were on the blink. Not one of them saw the huge collapse that arrived in 1991.

David Hensley, UCLA’s director of economic forecasting in the early 1990s and now an economist with Tiger Management in New York, was one of the most bearish California forecasters in 1990. Yet Hensley acknowledges that he, too, failed to predict the severity of the state’s downturn.

One of the key lessons Hensley says he learned is that California’s economy is dependent on, and similar to, the national economy. For that reason, he dismisses recent predictions that the state could come through next year with just a moderate slowdown, even if the rapidly slowing national expansion sinks into a bona fide recession.

“If a recession actually develops in the U.S., I say, ‘Look out.’ I doubt that California could avoid it,” Hensley said.

If that’s true, the factors that could help tip the U.S. economy into recession--persistently high energy costs, a depressed stock market that leads to reduced consumer spending, a slumping dollar or an international political crisis--would seriously hurt California, too.

At the same time, California is a major player in the world economy, and much of its prosperity depends on foreign trade.

Ted Gibson, chief economist for the California Department of Finance, estimates that although nearly 20% of California’s $1.35-trillion annual output of goods and services is sold to the other 49 states, about 15% is exported to other countries. Most of those export sales are concentrated in East Asia and Mexico, making California particularly vulnerable to problems in a relatively small number of Pacific Rim economies.

That fact worries Sung Won Sohn, chief economist of Wells Fargo & Co. He points out that two of California’s key export partners, South Korea and Japan, never fully restructured their economies after the Asian flu and now are stumbling again.

“If that storm cloud comes to California, it will affect everything from demand for chip-making equipment from Silicon Valley to business on the loading docks of Long Beach,” Sohn said.

Most-Feared Wild Card Is Energy

But probably the most feared wild card is energy. At a time when high oil prices already are raising concerns around the world, California is being hammered by soaring natural gas costs. Temporary and even permanent plant shutdowns already have begun in blue-collar industries that are heavy users of natural gas, including textiles manufacturing.

On top of that comes the current crisis brought on by the deregulation of the electricity market in California. If policymakers and industry officials can’t craft a solution to ease the turmoil, electricity customers throughout much of the state face periodic blackouts and major cost increases. Over the summer, the San Diego area became the first to be hit by the electricity crunch, and consumers saw their bills double and triple before the Legislature imposed a rate freeze.

Tom Lieser, author of this month’s UCLA California economic forecast, said the consequences could well be “more than anyone expected, and it may be difficult to get a quick fix.”

Without fully accounting for the energy problem, UCLA predicted a moderate slowdown for California in 2001 and a brief, mild recession for the nation. Lieser said if he were to redo his forecast today, he would be “slightly” more pessimistic about California’s prospects for next year.

California’s wealth of high-technology companies, particularly in Silicon Valley and elsewhere in the Bay Area, is one of the state’s major strengths. Even if dot-coms keep going out of business, the argument goes, there is no end in sight to the need for the technically proficient people who work for those companies, so they are sure to get jobs elsewhere. So far, with unemployment rates in the Bay Area still hovering at 2%, that argument appears valid.

Still, capital spending--including lots of spending on new technology--already appears to be falling. If that pattern speeds up, Silicon Valley “could turn out to be ground zero of the downturn,” Hensley said.

A big technology slump, economists say, would quickly ripple through other important segments of the California economy. In Silicon Valley, that would be likely to mean a reversal in the area’s extraordinary run-up of home prices. That, in turn, could burden banks with problem loans and deflate the upbeat consumer psychology fueling much retail spending.

Researchers differ over whether prices for single-family homes in Silicon Valley already have peaked or are continuing to rise, yet they agree that prices are extremely high: the current median cost is in the range of $515,000 to $530,000.

Southern California could be hit by midyear strikes in Hollywood with far-reaching consequences. Protracted walkouts would hurt not just the actors and writers, but also thousands of crafts workers and the owners and employees of small businesses that serve the industry.

And even if there is no strike, the Los Angeles area faces a substantial slowdown in the TV and movie industry because so much advance production has been done in anticipation of a walkout. Kyser estimates that even this sort of minimal slowdown next year will cost the county $3.6 billion in business revenue--more than 10% of the revenue that the TV and movie industry brings to the area annually.

Scant Evidence of a Slowdown

For now at least, there is scant evidence in California that a slowdown has begun. California’s unemployment rate has remained 4.8% for the last three months, close to the 30-year low of 4.6% achieved in February. In addition, state officials report that their withholding tax revenues are up a stunning 19% through the first 11 months of this year, suggesting that lots of workers are receiving fatter paychecks and stock options profits.

Michael C. Rebholtz, head of the Internet businesses practice for the accounting firm Grant Thornton in San Jose, said his clients that manufacture equipment for the semiconductor industry are expecting 2001 to be even better than this year, based on the orders they have received. For these manufacturers, he said, “The ‘soft landing’ isn’t evident. They might not even land in 2001.”

Many job-placement specialists tell a similar story, saying most workers with good skills can find jobs easily. These employment specialists contend that, in the current tight labor market, it’s the employers who are struggling to cope.

“You have to come up with a good salary or good benefits or something like that to make a person want to change jobs,” said Cheryl Smith, employment service manager for the CHARO Community Development Corp., a nonprofit economic development group in East Los Angeles.

Smith said customer service workers with as little as six months to a year of experience were getting jobs with hourly pay in the $7 to $9 range about two years ago. Now, Smith said, equivalent workers are fetching hourly pay of $8 to $12.

Given that evidence of strength, some of the state’s leading forecasters still express more concern about the long-term threats to the state’s economy and general well-being than the short-term outlook. They point to issues such as the prevalence of the working poor, inadequate training programs for people who lack basic job skills, high housing costs that have put homes beyond the reach of many families, traffic congestion, overburdened airports and the likelihood of future water shortages.

However, veteran forecasters know how fast an economy can turn--and how fallible their short-term predictions can be.

Economic forecasting always is chancy, said Tracy Clark, an economist with the Western Blue Chip Economic Forecast. For years the group has tracked predictions by California economists--including the 10 off-target predictions for the state made in December 1990.

Knowing What to Watch For Is Key

Whether the focus is California or the country, Clark said, “What economics is good for is not so much saying, ‘We’re going to have a recession starting next Thursday,’ or that ‘GDP will be precisely 3.26% next year.’ What economics is useful for is saying, ‘Here are the risks, here’s what to watch, here’s what could go wrong based on what we know about the economy.’ ”

Clark added, “If we have a recession or a slowdown triggered by inventory buildups or something like that, then economists have a reasonable chance of predicting that there is a real danger. However, most recessions, at least in the recent past, have started because of external shocks, an oil embargo, a war, something like that. . . . We don’t do a very good job of forecasting those.”