Recall could throw California economy into further turmoil

SAN FRANCISCO -- Just when California's wounded economy needs a little tender loving care, a rancorous recall election comes along that could inflict more pain. Experts say the political turmoil could scare off business, delay needed reforms and cause economic fallout nationwide.

The Oct. 7 election to recall Gov. Gray Davis is coming as a three-year slide in the high-tech industry has bottomed out, and the state's $1.36 trillion economy -- the sixth-largest in the world -- appears poised for a turnaround.

But economists say the recovery might not amount to much if, amid the political uncertainty, California fails to solve structural problems that can lead to recurring budget deficits and fix a workers' compensation system that discourages job growth.

"It makes a difficult situation much more difficult," said Tapan Munroe, chief economist for the Capital Corp. of the West. "A sound economy needs a sound political infrastructure. It's hard to imagine how we are going to have that now."

Efforts to recall Davis were sparked by the California's flagging economy, as well as state government's record $38 billion deficit and the decades-long debt to be paid for the 2000-2001 energy crisis.

More bad economic news came Friday -- the state lost 21,800 jobs in July, the state Employment Development Department said.

But should Davis be recalled, those problems will be dumped into the lap of a neophyte governor who will have just 30 days to form a transition administration before taking office.

Wall Street bond rating agencies say voter-approved restrictions on state and local tax increases mean fixing the problems won't be easy, no matter who sits behind the governor's desk.

Short-term fix

Davis signed a short-term fix into law last week -- a $99 billion budget patched together with billions in borrowing and deferred expenses. One permanent change -- the elimination of 16,000 state jobs -- will bring its own turmoil as workers are laid off and services cut.

Prompted by the state's fiscal problems and the looming recall, Standard & Poor's dropped California's credit rating to near-junk status -- a move expected to raise the state's future borrowing costs by roughly $1 billion.

To put the state on more stable financial footing, California needs to adopt reforms that generate more reliable sources of revenue, according to a wide range of politicians, economists and analysts.

The state's income tax system depends heavily on the prosperity of high-income households and businesses -- a system that generates fat surpluses in good times like the dot-com boom of the 1990s and excruciating shortfalls in tougher times.

"California needs to bite the bullet and this (recall) is wasting precious time," said Sung Won Sohn, chief economist for San Francisco-based Wells Fargo Bank.

What happens to California's economy has implications for the entire country. The state's enormous economic engine provides the nation with crucial technology, a bounty of agricultural products and feeds the culture with movies and television shows.

Businesses are clamoring for reforms that would make the state more attractive for them, including changes that would lower the cost of mandatory workers' compensation insurance.

For clothing manufacturer Russ Berens in the Los Angeles suburb of Chatsworth, workers' comp costs once amounted to less than $2 per $100 of payroll. Now, it's $8.30 -- a financial strain that caused him to lay off 35 of his roughly 200 workers. Without some relief, Berens, who has made clothes in California for 34 years, says he probably will have to shift more manufacturing to offshore contractors.

"This is really brutal," Berens said. "I'm trying to save jobs for my people and their families and it's like (the politicians) are just walking around in a fog."

Many companies also complain about the state's minimum wage of $6.75 per hour -- 31 percent higher than the federal minimum of $5.15 per hour. And starting next year, another California law will entitle workers to continue getting part of their salary while on leave to tend to a baby or a sick family member.

The recall gives businesses yet another reason to avoid California, economists say.

"This sends a warning to businesses -- Californians don't have their acts together and really can't govern themselves," said Stephen Levy, director for the Center for Continuing Study of the California Economy.

Of course, politics is just one of many factors that influence business decisions, and there are signs that California's economy will thrive no matter what happens in Sacramento. Business is booming in Southern California, where the economic base is more diversified than technology-dominated Northern California.

After the recall vote, things could get better -- or much worse. If Davis is voted out, a replacement candidate in what promises to be a crowded field could win with a relatively low percentage of votes. That could leave a new governor without a mandate to take on entrenched interests in Sacramento.

In addition, Democrats and Republicans could be left with such hard feelings "that we will have total gridlock and nothing will get done," worries Jack Kyser, chief economist for the Los Angeles Economic Development Corp.

However, this is hardly the first time people have fretted about California's economy, which has seen one wild swing of fortune after another since the Gold Rush.

"It's a high-risk economy that always seems to bounce back," said Munroe, of Capital Corp. of the West.