California’s Welfare Crisis

The Greek tragedy is being played out in the US through California

Writes Professor Michael Boskin and Professor John Cogan at the Wall Street Journal, (hat tip Professor Antony Mueller) [bold emphasis mine]

No one should write off the Golden State. But it will take massive reforms to reverse its economic decline…

California's rising standards of living and outstanding public schools and universities once attracted millions seeking upward economic mobility. But then something went radically wrong as California legislatures and governors built a welfare state on high tax rates, liberal entitlement benefits, and excessive regulation. The results, though predictable, are nonetheless striking. From the mid-1980s to 2005, California's population grew by 10 million, while Medicaid recipients soared by seven million; tax filers paying income taxes rose by just 150,000; and the prison population swelled by 115,000.

California's economy, which used to outperform the rest of the country, now substantially underperforms. The unemployment rate, at 10.9%, is higher than every other state except Nevada and Rhode Island. With 12% of America's population, California has one third of the nation's welfare recipients.

Partly due to generous union wages and benefits, inflexible work rules and lobbying for more spending, many state programs and institutions spend too much and achieve too little. For example, annual spending on each California prison inmate is equal to an entire middle-income family's after-tax income. Many of California's K-12 public schools rank poorly on standardized tests. The unfunded pension and retiree health-care liabilities of workers in the state-run Calpers system, which includes teachers and university personnel, totals around $250 billion.

Meanwhile, the state lurches from fiscal tragedy to fiscal farce, running deficits in good times as well as bad. The general fund's spending exceeded its tax revenues in nine of the last 10 years (the only exceptions being 2005 at the height of the housing bubble), abetted by creative accounting and temporary IOUs.

There is no currency union to put the blame on this time.

Yet the above exposes much of the fraud in analyzing the Greek crisis. Both Greece and California have been plagued by the unsustainable welfare state system.

And like Greece, the repercussion has been a stream of ongoing business exodus

From Fox Business

Loss of Economic Freedom means Business Exodus: The California Experience

This is what happens when Economic Freedom gets curtailed: economic opportunities shrivels as investors leave for better alternatives. In short, money goes where it is treated best.

The California experience from CNN:

Buffeted by high taxes, strict regulations and uncertain state budgets, a growing number of California companies are seeking friendlier business environments outside of the Golden State.

And governors around the country, smelling blood in the water, have stepped up their courtship of California companies. Officials in states like Florida, Texas, Arizona and Utah are telling California firms how business-friendly they are in comparison.

Companies are "disinvesting" in California at a rate five times greater than just two years ago, said Joseph Vranich, a business relocation expert based in Irvine. This includes leaving altogether, establishing divisions elsewhere or opting not to set up shop in California.

People respond to incentives. This is what regulators and policymakers everywhere, including the Philippines, don’t seem to understand.

Credit Default Risk: From PIIGS To The 4 US States

Four US states, particularly California, Illinois, New Jersey, and New York, has been in a race with the European "PIIGS" in terms of credit risks or default risk as measured by CDS (Credit Default Risk).

As Bespoke Invest notes,

``All four states are closer to the top of the list than the bottom in terms of default risk. As noted earlier, Illinois has the highest default risk at 368.6 bps. The state sits between Dubai and Bulgaria. California ranks second out of the four at 352.9 bps, while New York and New Jersey are both right around the 290 bp level. Illinois and California are both at higher risk than Portugal, while all four are in a worse situation than Spain. In terms of year-to-date change, Illinois default risk is up 117%, New York and New Jersey are both up about 87%, and California is up 35%."

The difference is that the European PIIGS constitute about 18% of EU's GDP while the US contemporary is about 29% of the US GDP. Incidentally, the 4 states are among the biggest (in terms of share of GDP): California (ranked 1st), New York (3rd), Illinois (5th) and New Jersey (8th).

Yet financial markets seem to be singing contrasting tunes which seem inconsistent: jump in the Euro, firming CDS of 4 US states while new lows in 10 year US treasury yields. If there is a shift in concerns towards the 4 US states then treasuries yields are suppose to go higher.

I'd like to add that the gap between the PIIGS and the US-4 relative to the ASEAN-4 led by Indonesia and the Philippines seems to have widened. This partly explains the signs of 'decoupling'.