Can Arnold Put a Shine on a Tarnished Golden State?

A Recovering Economy and an Optimistic Celebrity Governor Boost Odds for an Improved California Business Climate

By Don Lipper and Michael J. Marando

From its problems to its politics, little about California is normal, making even tougher the greatest challenge in a generation to face California’s corporate and political establishments: forging a top-to-bottom reorganization of state government and creating a more inviting and competitive business environment. If history is any indication, California’s entrepreneurial spirit – and its belief that competition fuels innovation – will rise above the state’s woes, and the state will reconfirm its role as a leader in new technology, invention, discovery and job creation. Gaining a new marketing asset in last year’s recall election may be a first step. After appearing in broadcast commercials pumping the state’s produce, Gov. Arnold Schwarzenegger was turning on his charm and turning to Hollywood-style glitz to sell California in a nationwide marketing campaign.

“Open for Business”
Billboards went up in 10 cities across the nation (Atlanta, Boston, Chicago, Dallas, Las Vegas, Los Angeles, Phoenix, Portland, Seattle, and San Francisco) as part of the “California: Open for Business” campaign commissioned by the governor’s nonprofit California Commission for Jobs and Economic Growth. The billboards featured a photo of the Republican governor and the pitch, “Arnold says California wants your business.” A Las Vegas photo-op depicted him in the driver’s seat of an 18-wheeler moving van whose side was plastered with another message: “Arnold’s Moving Company.” The governor said he’d send the van to help move any company that wanted to locate, relocate or expand in California — and drive it himself.
Meanwhile, California’s vital signs are improving on Wall Street. At the end of August, Standard & Poor’s upgraded California’s credit rating on nearly $33 billion of state bonds to “A” from “BBB,” the second boost this year, after Moody’s Investors in May hiked California’s rating to A3 from Baa1. In another positive move, Fitch Ratings removed the state from its “watch” list. The shifts mean California will pay lower interest on future bond sales. A proactive governor and progress on Wall Street are positive and promising, but much remains to be done — from creating new jobs to reducing regulations — for California’s economic climate and business environment improvement efforts to get wheels. California’s economic problems have been well-chronicled: high costs for workers’ compensation, housing, energy, and water; a time-consuming, expensive and onerous regulatory climate; and fiscal policies that some complain are confusing, even confiscatory.

All have contributed to the loss of businesses and jobs to other states and abroad. An alarming number of  California manufacturing jobs — nearly 353,000 — have disappeared since the end of 2000, reports the California Manufacturers Technology Association (CMTA). Over the past four years, employment in California’s manufacturing sector, the major driver of new job creation, has fallen 18 percent, far off the mark for a state that needs to deliver 250,000 to 300,000 new jobs yearly to sustain and grow a strong economy.

Paying More in California
California is the second-most expensive state in which to do business, with a cost index of 128.5. That means, says Jack Stewart, president of the CMTA, the cost of manufacturing in California is 28.5 percent higher than the national average.

Only Hawaii is more costly. Oregon, Utah, and Texas in the West/Southwest are well below the national average and 40 percent less costly than California. Little wonder 40 percent of California companies are considering expanding or relocating out of state, according to the “California Competitiveness Project,” a study by Bain & Company for the California Business Roundtable, a non-partisan Sacramento association of chief executives. Bain, a global business consultancy, also found 100 percent of senior executives surveyed view the state’s business climate unfavorably.

Adding to the gloom is that 50 percent of the companies in the Bain survey have explicit policies to cap their employment growth in California, while fewer than 5 percent of companies in the state have retention policies to keep jobs here.

How Bad Is It?
California’s long competitive decline has been gathering steam over the past few years, leading to the state’s 19th place ranking in the Beacon Hill Institute’s “Competitiveness Study 2003,” down for the third year in a row, from 10th in 2001 and 16th in 2002. The state of Delaware, on the other hand, has held its No. 1 ranking three years in a row. An evaluation of the nation’s metropolitan markets shows Sacramento ranked 41st for long-term competitiveness, up a notch from 42nd in 2002. However, 34th-ranked San Diego dropped from 25th. Other factors leading to California’s steady slippage in competitive rankings are decreases in bank deposits and increases in crime statistics, says the Beacon Hill report. In 2003, the state’s
heavy-handed environmental regulations placed California 38th in that category for the third consecutive year. The lure of lower operating and living costs and fewer regulatory burdens have drawn California companies and jobs to other states, particularly Texas, which has captured more California businesses than all of the other 48 states combined.

Exits and Transplants
At the same time, foreign countries also are eagerly in the hunt to snatch California companies. The government of Singapore, as one example, has more investment-promotion specialists in California than any other U.S. state or foreign nation. And the technology jobs going to telecommuters in other parts of the world aren’t the only ones leaving. Entire factories are being transplanted from California’s manufacturing sector to locations overseas. In 2002, when Hewlett-Packard Company and Compaq Computer completed the largest-ever merger in the high-tech industry, the company had two server manufacturing facilities: one in Roseville, the other in Houston. After examining the cost structures between the two states, the new HP relocated the Roseville operation to Texas, costing California — more precisely, the Sacramento area — 500 jobs.

The Arnold Factor
Business leaders here speak about two California business epochs: B.A., or “Before Arnold,” the dark, gloomy days when business toiled under Capitol regimes seen by some as downright hostile to business, and A.A., or “After Arnold,” the much-hyped glorious new dawn for business and California. There is no question Arnold Schwarzenegger’s victory in the gubernatorial recall election last fall sparked a wave of hope and optimism that swept the state’s business community. “Since he’s been elected,” says Barbara Hayes, executive director of the Sacramento Area Commerce and Trade Organization, “the governor has checked things off his list: First the bond initiative (propositions 57 and 58), then getting through the workers’ compensation agreement. He’s really gotten the economic development ball rolling.” “The governor has said it’s important for companies to know California is serious about being open for business again,” says Vince Sollitto, Gov. Schwarzenegger’s deputy press secretary. “He wants the state to be the job-creating machine it once was.”

Action Traction
There are signs of action traction. Although the Bain report notes that, on average, it costs 30 percent more to do business here than in other states, California Business Roundtable President Bill Hauck sees the workers’ compensation reforms pushed by the governor as the first major step in improving the business environment. And Cassandra Pye, chief of staff for external affairs in the Schwarzenegger administration, says, “From the meetings we’ve held with CEOs, the governor definitely gets very high marks for trying to make a difference and being effective.” Savings from lower premium costs for workers’ comp began flowing to businesses this July, the kind of expense reversal “small- and medium-sized businesses want to see first,” says Hauck, named by the governor to co-chair the California Performance Review Commission, which has the goal of reforming state government by reorganizing and restructuring. Small companies (those with payrolls of 50 or fewer employees and that account for close to 90 percent of California’s 2.1 million businesses) may not see their workers’ compensation costs taper off at the desired speed, but Hauck believes the cuts will be “a positive signal” in and outside the state. Boeing Corp., the state’s largest private manufacturing employer with nearly 35,000 employees throughout Southern California, remains committed to the state, although “rising costs in the areas of energy and unemployment insurance premiums have had an impact on our business,” says company spokesperson Dianna Rameriz. Negative assessments of doing business in California are rampant, but not all of them are correct, creating misconceptions among the perceptions. Anti-tax lobbying groups, using various types of criteria, toss out estimates claiming Californians rank anywhere between 18th and 24th in the nation in the amount of state and federal taxes they pay as a percentage of income. For example, California ranks 15th highest by the Milkin Institute, which considers a wide range of taxes, including personal, corporate, property and a host of other lesser-known taxes paid by individuals and employers. Conversely, Oregon, Texas, and Arizona fared much better in the Milkin survey. But it should be noted those rankings are a result of California borrowing $15 billion today in the form of bonds that will show up as increased taxes sometime in the future to pay them off, plus interest. In 2002, the Tax Foundation, an organization that explores the effect of tax policy on businesses and individuals and channels information to the general public, ranked California 49th, in terms of business tax climate. This year, the foundation called the state’s corporate income-tax rate the highest in the nation and its sales-tax rate among the highest in the United States. “Despite Proposition 13, California ranks in the middle of the pack when the states are ranked on combined state/local (property) tax collections,” the Tax Foundation says.

Projecting Solid Growth
Although California’s overall job losses to other states have increased in recent years, the return of healthier economic times will slow the outflow, believes Lynn Reaser, chief economist at Banc of America Capital Management in St. Louis. But there are bright spots for California businesses. The University of California, Los Angeles, Anderson Forecast anticipates that solid growth over the next 18 months in the Los Angeles region will outweigh concerns about rising housing and energy costs. “California seems to be in the beginning of a sustainable recovery,” the former California-based economist says. “We’re seeing signs of business activity in Northern California and Silicon Valley, while Southern California is enjoying strong growth. But going forward,” she adds, “the state faces a continued number of issues.” Brook Ohlson, executive director of the Northern California World Trade Center in Sacramento, also sees greater daylight ahead. After nearly four years of steady declines, California exports are on the rebound, he says.

Shipping Out
Confirming his outlook were this year’s first quarter state exports totaling $27.1 billion, up 25 percent from the comparable 2003 period and on a pace to eclipse last year’s $93.9 billion in total export volume, reports the Office of Trade and Economic Analysis, U.S. Dept. of Commerce.

California’s Celebrity Cheerleader
Meanwhile, California has its own eternally optimistic star salesman. Gov. Schwarzenegger, flexing his celebrity and determination, has declared, “California is open for business.” A recent trip to Israel for opening ceremonies for a Holocaust museum netted him five Israeli companies that will bring 800 jobs to California. What a difference a Terminator can make.

Business leaders are crediting Gov. Schwarzenegger with being the driving force behind a rebound in optimism about California’s business environment, a sunny outlook beginning to spread throughout the state.

The following was reported in May in the California Chamber of Commerce’s Annual Business Legislative Summit Opinion Poll:

• 67 percent of respondents believe California now is moving in the right direction vs. just 5 percent in the survey one year ago.
• In comparing current business conditions in California with those of two years ago (2002), 27 percent believe they’re better and 44 percent believe they’re worse vs. the 1 percent better and 90 percent worse the 2003 poll takers perceived of 2001.
• The number of employers planning to expand their workforce this year was up more than 11 percent over 2003, while those planning layoffs or cutbacks declined 15 percent from last year.

The respondents’ greatest concern, after the governor had signed a workers’ comp reform bill, is healthcare costs, indicated by 40 percent.

“The Legislature should look carefully at these poll results,” says Allan Zaremberg, president of the chamber. “If we continue on this job creation path and stop considering policies that only hurt California’s business climate, we can continue to reinvigorate California’s economy.” Gov. Schwarzenegger has changed the rules of politics in the Capitol because he’s shown he can effectively lobby his agenda directly to voters. Backed by his success in getting Propositions 57 and 58 passed, he was able to threaten the Legislature that if it didn’t work with him to reform workers’ comp, he would take his proposals directly to the people as a ballot initiative.

The governor was able to take an issue “as arcane and dry as workers’ comp and turn it into an applause line at every event he had,” trumpets Gov. Schwarzenegger deputy Sollitto. “It worked, because workers’ comp touched people’s lives and kept businesses from growing.”

On his first day in office in January, Gov. Schwarzenegger emphasized improving business conditions and creating jobs by issuing Executive Order S02. Within 60 days of taking office, he had formed the California Performance Review to streamline and maximize efficiency in state government.
“There are a number of things we’re looking at to bring businesses back to our state,” says Sara Lee, media relations vice president for the California Chamber of Commerce. “The first is stopping mandates of regulations that are unique to California and provide severe disincentives for business to come or expand here,” she says. “We’ve termed this approach, ‘Do No More Harm’ to California’s economy.”

Measuring the Measures
In 2000, the unemployment insurance trust fund had more than $ 5.7 billion. But the Legislature approved four years of benefit increases (raising the maximum weekly benefit from $230-$450) without cost-saving reforms that would keep the system solvent. Today the fund is considered bankrupt. For the first time ever, the Employment Development Department triggered a 15 percent surcharge on unemployment insurance taxes employers already pay.
Problems also stem from not only what’s been added but also what’s been taken away. An example: the manufacturers’ investment tax credit, which allowed businesses to deduct sales tax on new equipment, ended last year, while many other states still offer such credits.

The Bain & Company report proposes a sweeping pro-business agenda (see “A Pro-Business Agenda,” page 38) and suggests that “by closing just half of California’s competitiveness gap, the state could, without requiring the expenditure of one tax dollar, add more than 173,000 jobs per year and collect an additional $35 billion in tax revenue over a 10-year period.”

The Sacramento-based state chamber is targeting the following measures on the November ballot as anti-business and using its pressure and influence to block or rescind them.

• Proposition 72. A “No” vote repeals SB2. The Senate bill imposes a $7 billion healthcare tax on California employers and employees.
• Proposition 64. A “Yes” vote amends unfair business competition laws by placing limitations on enforcement.

Biotech Clusters
California has always been a great incubator for businesses by providing access to talent, leadership and venture capital. Two-thirds of the world’s biotechnology companies and a third of the world’s venture capital are still here despite the dotcom bust, sour economy and the state’s unfriendly business climate.

The state has a world-renowned biotechnology presence, with the San Diego area’s biotech industry the third-largest in the world and other strong biotech clusters in San Francisco and the East Bay, as well as a center of research activity at the University of California, Davis.

Scientific discoveries throughout the University of California system will create 100,000 new jobs over the next decade in the state, predicts ICF Consulting Group, an independent think tank. But, wonders Sean Randolph, president, and CEO of the Bay Area Economic Forum, “Will businesses created here choose to expand in California when they have other options where costs are lower and their market is growing?”

In California’s favor is what he calls “a strong force for innovation, which is our strongest card for new companies to grow.”
“This region,” Randolph notes, “is a  terrific wellspring of ideas.”