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The Not-So-Golden State

CEOs aren’t happy with Schwarzenegger’s latest performance.

It was May 2004, and Gov. Arnold Schwarzenegger’s  Hollywood star power was lighting up Sacramento. His approval rating stood at 65 percent; workers’ compensation costs, once the highest in the nation, were headed downward; and the state’s severe budget crisis had been transformed into a manageable budget problem without raising taxes. For the first time in recent memory, business leaders were thinking that maybe, just maybe, California’s longtime reputation as a hostile-to-business, regulation-happy, job-killing state might finally be turning around.


Whip ahead 14 months, to July 2005, and fickle California voters have started kicking sand in Schwarzenegger’s face. His once-muscular approval rating has plummeted to a wimpy 37 percent. Reform has stalled, and the state’s business climate has barely shifted. While the annual budget was approved this summer in record time, several major policy issues on a special ballot this fall, pushed hard by the governor, are failing in the polls. And a choir of business leaders continues to complain-loudly. Clorox CEO Jerry Johnston calls California “an anti-business state.” Wells Fargo CEO Richard Kovacevich, who moved to San Francisco from Minneapolis in 1999 when Norwest Bank merged with Wells, says “the national perception is that California is one of the worst places to do business in the country.” (Of 458 CEOs polled by Chief Executive, 182 cited California as the worst state in the nation for business on the basis of tax rates, regulations, work force attitudes and quality of life issues [January/February 2005].)


California native Bruce Choate, CEO at the Watson Land Company, a major industrial-site developer in Southern California, sums it up best by saying that, in effect, California fiddles while competitors earn. “We’re at a crossroads as a state that we’ve not faced before,” he says. He’s just not sure the politicians know it.


Regulatory Rat’s Nest


These issues didn’t sprout like mushrooms overnight. California is wrestling with all the same problems it has been dealing with for decades, but now it’s evident that they’re worsening. Housing prices are officially recognized as obscene; crumbling bridges and highways are unsafely jammed with maddening traffic; and there’s scant money and even fewer ideas in place to fix these problems. The tax burden on both businesses and on individuals is among the very highest in the nation, and California’s maze of regulations is a virtual rat’s nest. Meantime, new employment is going elsewhere-and not just to China. Other Western states are luring business and jobs from California companies that find themselves unable to afford job creation in their own state.


If California’s political leadership fails to act wisely now, Choate believes, the Golden State is headed toward persistent, grinding decline. The housing prices, traffic jams, taxes and regulations are the symptoms. “Our disease is our public policy,” he says, “There just seems to be a growing ambivalence among our political leadership toward economic growth.”

Schwarzenegger was supposed to change all that; the fact that he hasn’t is frustrating business leaders. It’s not that they don’t support the governor-they simply expected a lot more from him. Senior executives are still loathe to criticize Schwarzenegger publicly, perhaps fearing they’d risk spoiling whatever clout or good graces they have left in Sacramento. But their chief complaint is that the governor was so ham-handed in promoting a special election to be held this fall, which aims to ask the people to enact pension reform, spending limits, legislative redistricting, teacher tenure, merit pay and more. (He’s since been forced to drop the pension and merit pay measures.) Says one CEO: “Schwarzenegger should have limited the issues to a few. Instead, he raised too many issues with too much complexity, and he lost his momentum.”


The general feeling across the state is that he didn’t simply lose momentum-he antagonized his enemies, who proved far stronger than he’d expected, and responded with haughty dismissals whenever his views were challenged. He called teachers and nurses “special interests” while traveling the country to raise millions to fight them but felt it somehow appropriate to “borrow” $4 billion from education to plug a budget hole, then said “hasta la vista, baby,” when it came time to pay it back. His “State of the State” message in January was laced with an anti-teacher rant, and he repeatedly called for cuts in government pensions to solve budget problems, drawing the ire of policemen, firefighters and nurses.


As if scripted, the unions began dogging him from appearance to appearance, drawing plenty of local news coverage in the act, and when they opened their $40 million campaign war chest to pay for sophisticated TV advertisements focusing on Schwarzenegger’s Terminator-like obstinence to cut vital public services, he mocked them for it. “He overplayed the Hollywood thing,” says economist John Husing, the primary analyst at Economics & Politics, and an active Southern California business booster who is working to improve transportation and distribution around the Los Angeles area’s overwhelmed seaports. “The photo ops are nice, but how about governing?  He’s squandered an incredible opportunity.”


Legislative Gridlock


For all Schwarzenegger’s  failings, business leaders see the legislature as a far more serious problem. “The California legislature is dominated by the Democratic Party, and within the Democratic Party it is dominated by its green wing,” says Husing. “The party has left its base. In the past, the Democratic Party was all about creating  jobs and helping people. Today, it’s €˜let’s take care of the environment.’ The result is very anti-business.”


The main problem, says Husing, is the way statewide candidates are chosen. California is a blue state, and its voters, in polls, are generally more moderate than representatives of either party. “The primaries choose candidates from the left wing of the Democratic Party and the right wing of the Republican Party. By the time of the general election, the middle part of the body politic has no say.” There are, however, more far-left-leaning voters in California than voters who lean far-right, so the far-left Democrats dominate the state House and Senate.


The Legislature redrew its own districts several years ago, effectively locking districts for one party or the other: In the most recent election, not a single  district kicked a Democrat out to bring a Republican in, or vice versa. A November ballot measure would redraw districts again, this time by a panel of judges. But the measure is behind in the polls, and if it fails, it’ll be déjà vu all over again. “It’s not that [the left and right wings] dislike each other,” says Husing. “They hate each other, with no willingness to compromise.”


Businesses that fight against regulation in such a divisive climate are often painted as belching, selfish polluters. Surely some are, but many, and perhaps most, are in tune with Wells Fargo’s Kovacevich, who acknowledges that strong regulations are needed to protect the environment but worries about regulations running amok. “I keep asking people in California, €˜Do you think the environment in Colorado is awful?'” he says. “Do you think people in Colorado don’t care about the environment? Or that Californians care more about the environment than people in Colorado do, or Utah?”


The problem is not regulation as such, but such a surfeit of complicated, detailed, sometimes conflicting regulations required by several bureaucracies that don’t communicate with one another and gum up any major construction project, causing long delays and persistent cost overruns. “Many of the home builders with headquarters in California do business in other Western states,” says Kovacevich. “They’ll tell you that about 30 percent of the cost of new housing is simply the difference in regulatory environment in California, but that 30 percent is because of the regulations themselves, not because the environment is being more protected.”


A perfect example of California’s regulatory obstacles is PEX tubing, a flexible, highly durable plastic piping material that doesn’t corrode. Stored on 1,000-foot coils, contractors reel it out and plumb a new house in a jiffy. So PEX is saving hundreds of millions of dollars in the cost of home construction across the country. The inert plastic has passed independent safety certification and has been added to the national Uniform Plumbing Code as well as the building codes of 49 states and Canada. But not in California, where after years of hearings the courts have decreed that the code change will require a lengthy and complicated environmental impact review. That pleases the plumbers’ union, which pressed the case and just happens to be a big donor to the Democrats.


Intel Says Sayonara


Rising home prices in California aren’t a new story, but as those prices march higher, jobs are leaving the state. In 2003, Intel CEO Craig Barrett announced that Intel would no longer expand in California, citing housing prices and onerous regulations. (Intel has been growing in other states and around the world, but not in California.)


Just recently, in the latest example of the Intel exodus, the company announced it would close a San Diego facility and send 300 workers to Portland. Fact is, some Intel employees couldn’t be happier. Housing prices in Portland make it easier to recruit new workers: A comfy three-bedroom home on a good piece of land can be had for $350,000, which would hardly buy a cheesy one-bedroom condo in San Diego. Citing California politics, Intel employee Bob Davidson wrote on the Voice of San Diego Web site,  “I can’t think of a better time to leave.”


The high price of housing compounds congestion on the highways as well, as employees must live farther inland-away from work on the coast-to find affordable homes. And imports from China and elsewhere are filling the highways with pavement-pounding container trucks-more than 43 percent of shipping containers bound for the U.S. enter through Los Angeles-area ports.


Californians voted in a special 2002 election to tax themselves to improve highways and bridges. But that extra money has been mostly diverted to solve the state’s deficit problem. “They should use the money for what it’s intended for,” says Kevin Kelly, chief executive at Emerald  Packaging, a manufacturer based near the port of Oakland in northern California. He talked about highways that were supposed to be expanded but never were. “They did widen the San Mateo bridge,” he says. “But they didn’t widen the roads leading to it. Highway 283 was supposed to be widened two or three years ago, but it never happened.” So the jams keep getting worse. “This really does impact business,” Kelly says. “It’s almost a Third World situation.”


Under pressure, the governor and legislature are promising to spend $1.8 billion more on roads and bridges and other transportation projects in the next budget year. That’s good news, but the state’s own studies, according to Husing, say the state requires $158 billion in new infrastructure spending over the next 20 years.


California Dreaming


For all the gloom, no one is expecting California to drop far below its position as the world’s fifth or sixth biggest economy anytime soon. As the Center for Continuing Studies of the California Economy notes, most of California’s growth tracks close to the nation’s economic growth, and the population is expected to increase another 7 million to 11 million over the next 20 years, from 37 million to as high as 48 million.


The state remains blessed with competitive advantages: a beautiful climate, great universities, a rich technical base in computers, software and biotechnology, loads of venture capital and a culture that supports innovation. (That was exemplified by voters’ approval of up to $6 billion in stem cell research funding. As Husing puts it: “The religious fanatics can have the center of the country; we’ll take their brains.”)


Yet, despite all the advantages, Kovacevich watches with wonder as politicians and voters fail to fully grasp the changing world around them, and continue to put economic growth at risk. “When you come in fresh and new like I did, you just kind of shake your head,” he says. In a global economy, where competitive advantage shifts so rapidly, Gov. Schwarzenegger’s California could be losing some of its luck and glory.

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