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Enough With Faith-Based Economics


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Dennis Meyers of the California Department of Finance has recently been writing a series of articles arguing that the state’s economy is not in the midst of a massive economic collapse as some have characterized. In response Bill Watkins, who runs the Center for Economic Research and Forecasting at California Lutheran University, wrote a rebuttal piece titled “No, It's the Deniers who Are Wrong” which was published on a website called New Geography. It has been reprinted in other locations, including by Stephan Frank on his California Political News & Views site. While Mr. Meyers work was the focus of the piece, I was also lumped in with the ‘denialists’—as Dr. Watkins refers to those who don’t share his dismal assessments of the California economy.

Dr. Watkins, humorously, paints me as a denialist by citing a line of reasoning that has nothing to do with my views on the long run ability of California’s economy to succeed. Don’t get me wrong, I do not agree with most of his positions on the state economy, but if he is going to critique my work, he should at least reference something related to the issue at hand. He writes:

“Chris Thornberg, Beacon Economics founder and economist, recently came up with a novel argument to deny California’s decline. He says that since recent jobs data have been revised upward, ‘we are in full recovery mode and not looking back.’”

This quote is referring to a piece of empirical evidence that comes from a natural bias built into the Bureau of Labor Statistics' Current Employment Statistics (CES) survey, which is the basis for monthly payroll numbers in all 50 states. Without getting too technical, the way the survey handles the natural loss of small firms that occurs between the January benchmarks, causes the survey to overestimate job growth when the economy is slowing, and underestimate it when the economy is accelerating. The consistent pattern of upward revisions in the recent CES data suggests that economic growth is accelerating.

This has nothing to do with whether California is a competitive economy or not, nor does it really have anything to do with the state’s overall pace of growth. If the estimated employment growth was revised from 5% to 6% or from -5% to -4%, the implication is the same—job growth is starting to accelerate or equivalently job losses are starting to decelerate. This is an issue having to do with the business cycle, not long run competitiveness.

Dr. Watkins goes on to note:

“Four and half years after the recession, the U.S. is still down almost 5 million jobs. This represents about a 3.5 percent net decline. California, down almost a million jobs, is even worse — down a net 6.2 percent.”

This is true, but it isn’t the point. Because California’s economic growth seems to have been accelerating over the past year has nothing to do with the state’s relative job losses or gains as compared to the nation. Dr. Watkins’ analysis of the data confuses the trends and the bends. What both the United States and California have been going through in recent years is what economists refer to as a business cycle—a period of time when the economy underperforms as a result of some negative shock or shocks to the system. This has little to do with longer term growth trends driven by capital investments and expansion of the labor force.

Missed point aside, I am writing this primarily because I feel the need to respond to what I call the ‘faith-based’ economics, as preached by Dr. Watkins and his cohort of like-minded thinkers and pundits—including Grover Norquist, Art Laffer, and Stephan Frank, among others. These folks know what makes economies grow: few regulations and low taxes—and states that violate these fundamental principles suffer the consequences of slow growth or even decline.

California certainly has a broken tax system and excessive level of regulations— I’ve said that many, many times. But there are other forces that drive economic growth. If the marginal tax rate on high-income earners meant they would flee the state, California would long be bereft of wealthy residents since the state has long had one of the highest tax rates on these earners in the nation (Texas has no income tax at all). Still California has a remarkably large share of high-income households. And, if the state is such an undesirable place to run a business because of the regulatory burden, then why are home prices and rent on office space so high?

The evidence makes the point clearly: From 1994 to 2007 California grew faster than the United States overall on the basis of any major statistic from employment, to income per capita, to manufacturing output, to population growth. California even kept up with Texas, that bastion of business friendliness, as real economic output in both states grew lockstep over this time period. Texas had more population growth and added more jobs, but California saw a greater increase in worker productivity.

For those who practice faith-based economics the ‘Great Recession’ was confirmation of their beliefs because California did suffer more than most other places and Texas managed to muddle through and recover much more quickly. To them, the ‘Truth’ was being revealed, and they took advantage of the opportunity to intensify their message.

But realistically, the relative performance of the Texas and California economies throughout the recession had little to do with taxes and regulations and everything to do with the structure of the two economies. California, like Arizona, Nevada, and Florida, had an enormous housing bubble—and therefore a huge surge and then subsequent collapse in consumer spending, not to mention construction. Texas and most of the South Central portion of the nation saw little of this turmoil. California is also home to many high tech firms, which bore the brunt of the decline in business investment. Texas is a commodity-based economy—and commodities have remained one of the strongest portions of the world economy.

Twenty percent of the Texas economy is in petroleum, mining, refining, and various other parts of the commodity market. Compare this to 3% or 4% in California. If the commodity markets had collapsed instead of housing we would have seen opposite outcomes in the two states—not unlike in the mid 1980s when the collapse of oil prices put Texas in the midst of one of the worst regional recessions ever seen in the United States—considerably worse than what California is dealing with now.

In his article, Dr. Watkins accuses Mr. Meyers of being illogical and using selective data to prove that California is not on the cusp of collapse. Dr. Watkins then goes on to make a number of very illogical points—and use selective data analysis to prove his faith-based economic view of the world.

For example, he notes that Detroit was once a vibrant economy that fell on hard times—so California can too. I fail to see the connection. Detroit is a single city that was largely reliant on a single industry, auto manufacturing, for prosperity. When the private sector ‘big three’ automakers failed to respond to growing competition from foreign imports, the city’s economy began to suffer terribly. How this is a relevant lesson for a state with 35 million people, vast numbers of cities, and a wide-ranging variety of industries is unclear. It is also unclear what the connection is between a private sector failure and what Dr. Watkins feels are our greatest problems, high taxes and excessive regulation.

Dr. Watkins also cites the fact that California has two of the nation’s poorest cities as defined by level of poverty: San Bernardino and Fresno. Maybe—I haven’t checked the actual numbers. But I know that there are also many poor cities in Texas. This says nothing about either state’s economy or ability to compete. All it illustrates is that both states are on the border with Mexico and have large agricultural communities. As a result, both states have had very large influxes of low-skilled immigrants seeking work over the past four decades. And in any case, why is this evidence of California’s pending economic collapse? This issue has been with us for decades, through good times and bad.

Dr. Watkins goes on to contrast California’s overall loss of jobs in March to gains seen at the national level… he has been in the business long enough to know that one month of data means nothing, particularly when you are trying to make a point about the long-run ability of the state to grow. Since March, California has had two months in which its payroll workforce grew by a greater amount than the United States overall.

Pulling our focus from the noisy monthly numbers, over the course of the last year, California’s economy seems to be growing faster than the nation’s. From May 2011 to May 2012 California saw its non-farm payrolls grow by 1.58%, compared to 1.36% for the United States overall. And the weakest part of California’s labor market recovery is the public sector. Remove public sector job losses from the equation and the difference between the state’s and the nation’s job recovery is even more stark. California’s private sector workforce expanded by 2.22% over the last 12 months compared to 1.78% for the country as a whole.

The Bureau of Economic Analysis recently released its estimate of 2011 economic output for California and the United States. From 2010, the state’s economic output expanded at a pace of 1.96%, compared to 1.46% for the nation overall. California's private sector output grew by 2.29% compared to 1.76% for the nation. And while I am concerned that manufacturing employment in the state hasn’t started to grow, I am somewhat comforted by the fact that manufacturing output increased by 3.83%, just slightly less than the national total of 4.27%.

Dr. Watkins also cites the fact that domestic migration in California has been negative for a number of years as evidence of the state’s imminent decline. Again, this has little to do with the labor markets or the business climate. Even a cursory glance at who is leaving shows that it is not high skilled or high income residents, but rather mid skilled workers. This has everything to do with the ridiculously high cost of housing in the state.

California has the second least affordable housing market in the nation—something that is deeply concerning, and about which Beacon Economics has written repeatedly. The cost of housing certainly reflects problems with overregulation and tax burdens on builders, but only as combined with the great and sustained desire (demand) to live here. High housing costs will not collapse the California economy, but they surely slow the ability for the state to grow.

I’m not being Pollyannaish. In addition to housing costs, I worry about California’s unbalanced revenue system, and about the regulatory burden faced by many firms, including my own. I worry that the state’s manufacturing base is responding to excessive problems with permitting and regulations and the NIMBYism that wants to prevent manufacturing expansion (all business climate issues).

But I also recognize that California offers one of the best standards of living in the United States and tremendous economic opportunities for those who choose to deal with the hassles of high taxes and regulation. The long-term performance of the state’s economy proves that it remains competitive, despite its problems. While some sectors suffer, others are starting to prosper. On net, the state is recovering from the downturn and, ultimately, its prospects remain bright.

We should work hard to reform what is broken or overly burdensome, but not because of a threat of imminent decline. We should do it because it will improve our standard of living.  And in the meantime, our conversations on the economy and policy should be based on data and reasoned analysis, not slanted interpretations of data that support a particular point of view. Faith-based economics has no role in this debate.

CATEGORY: General Economy



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