Why Everyone Thinks California Is Collapsing

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California is a condensed version of absolutely everything advanced economies get right and everything they get wrong. The general sentiment towards California's economy has been overwhelmingly negative, with endless stories about companies and people moving out of the state, a huge buildup of poverty, misguided and ineffective government programs, unaffordable housing, all exacerbated by high taxes, poor infrastructure and growing environmental...

Add to this the significant uncertainty surrounding the state's global companies thanks to haphazard tariffs, and there are a lot of genuine concerns. The state's major industries are also highly mobile, so if it can't quickly and materially address these problems, there's no reason why Silicon Valley or Hollywood really needs to be in Silicon Valley or Hollywood.

So far, a lot of what has kept industries in California is that their supporting industries are in California. And the thing that's kept the supporting industries in California is that the industries that they support are in California. This kind of industrial agglomeration can create a powerful feedback loop, but it works in the other direction as well. When businesses and talented individuals start leaving, there's less keeping the others in place.

So, with all of this going on, it's no surprise that the Californian economy has been under some serious screw- But even still, by the numbers, it's remained one of the largest and fastest growing economies in the world.

Its per capita output is higher than all but a few economic outliers that have significantly smaller populations overall, and most of those economic figures are technicalities rather than a true reflection of economic prosperity. That's pretty good for an economy supposedly on the verge of class. It's also important to recognize that, for better or worse, California by its very nature attracts a lot of attention.

And there are issues that go beyond purely economics that means that a lot of people like to shine a light on any problems and blow them out of proportion. But just because we want something to be true doesn't mean that So, is California's economy really entering a slow death spiral? Are there any ways to reverse these trends? And finally, is California actually in as big a trouble as the headlines would make out? Hey there, I'm Dylan Lewis, one of the hosts of Motley Fool Money.

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California is home to some of the most valuable industries and companies in the world. Obviously the standouts are technology and entertainment, but it also has a large financial services sector, it's a shipping hub to the rest of the USA, it has world-famous educational institutions like Stanford, UC Berkeley, UCLA and Caltech. and that's also made it popular with aerospace and defense companies looking to soak up some of that talent for themselves.

On top of this all, it's one of the most complex and diverse agricultural centres in the USA, producing a lot of the more valuable crops that aren't just endless rows of corn. Then, on top of these foundational industries, there are other industries that have grown off them. like tourism and real estate that helps by being a global centre.

So yeah, California has a diverse set of highly technical and valuable industries, which means even if one of them hits hard times, the others should theoretically make sure that they are still economic opportunities in this state. And largely, that has been the case.

Despite all of the doom and gloom, California has been growing comfortably without too many major interruptions for decades now. Growing faster than the USA as a whole, which itself has been growing faster than any other major economy in the world, with the exception of only China. Now to be fair, California is

Kind of annoying. What with their influences, tech bros, progressive policies and overpriced grocery stores, it's almost understandable why people would get a bit of schadenfreude from seeing these smug, well-tanned, activewear enthusiasts be put in their place a little bit with their economy crumbling around them. That may genuinely be a factor in all.

Realistically, California's biggest economic strength is its economic strength Technology companies are started in California because that's where talented technicians and venture capitalists are. Both smart people and risk-seeking investors go to California because that's where technology companies are getting started. Agglomeration is the idea that industries run better when all aspects of that industry are within a small geographic space.

Operating a startup in the Bay Area comes with significant financial commitments because the place is so expensive. But that startup will be closer to suppliers, consulting with experts could mean just a short drive down to a university, investors have offices dotted around every square kilometre, and businesses will also be closer to their competitors, so they can keep an eye on what they're doing. which, overall, creates a more competitive environment.

Now, agglomeration does genuinely have a lot of benefits, but they are less pronounced in the fields of technology where most operations are handled digitally, so the need to be within a set distance of a supplier is a lot less important than it would be for something like manufacturing. The same is true to a lesser extent for entertainment.

The entertainment industry got started in California as studios wanted to distance themselves from regulators on the east coast But since then, actors, producers, studios, and investors go to Hollywood because that's where movies are made, and movies are made in Hollywood because that's where the actors, producers, studios, and investors are.

Yeah, sure, it sounds a little bit silly, but it's normally very hard for one grip to remove themselves without just being replaced by a competitor, so the status quo remains. Except this lovely feedback loop that has been working so well for California up until now is showing signs of reversing.

California has been the most moved from state by net migration in the USA for years now. People are moving out for a variety of reasons, but it all ultimately boils down to the fact that they can get a better quality of life elsewhere without too many sacrifices.

California and its major cities are some of the most expensive places to live anywhere in the world. And yes, as someone personally from Sydney, I can't say too much. But the thing is, in places like LA and San Francisco, is that even though their affordability looks better, that doesn't actually help out a lot of people.

Housing affordability is normally measured using average home prices versus average incomes in an area, which kind of makes sense as a good baseline measurement. If homes are extremely expensive, but everyone's making a lot of money, then it doesn't really matter. Sort of.

People in the Bay Area in particular do make a lot of money on average, but that is an average dragged up a lot by a small handful of people working in or owning some of the extremely well-financed tech or tech adjacent companies in the area. These people can afford expensive homes without really thinking too much. but everybody else working normal jobs and supporting industries will naturally struggle to keep up.

So, even though a city like Sydney looks less affordable on paper, the reality is that most residents are in a more comfortable housing situation. If a city's real estate situation is being compared unfavourably to Sydney, something has gone terribly wrong. There are other problems with this too that are a little bit harder to track.

In areas with so many high-income households, it just starts to make more business sense to sell goods and services to cater to those wealthy people, instead of developing budget-friendly options. This is a major pressure, pushing a lot of people to find cheaper cities to live and work in. If the cost of living was pushing average people out, the cost of taxes is what's pushing the wealthy people out. California has the highest state income taxes in the USA.

Now again, for a while they were able to get away with this, because if someone wanted to land a high paying tech job or work in a Hollywood studio, they needed to live in California. California also has high capital gains taxes, which were meant to benefit from the fact that a lot of people sell their valuable startups in the state for huge amounts of money. But new technology and the pandemic was a massive shock that showed that a lot of these jobs could now be done from anywhere.

Workers got the opportunity to move to a state with lower income taxes and lower cost of living, and companies could get away with paying them less because people were often times willing to take a pay cut to get out of California.

This presented a problem because California's taxes aren't actually that high compared to the rest of the USA. In fact, for most people, they are lower than they would be in places like Texas or Florida, where taxes are primarily collected from property or sales instead of income. California has a very modest property tax rate and also has no sales tax, which disproportionately hit lower-owning households who spend a higher percentage of their income on consumption.

It's just in California, taxes are particularly high on the highest income Now fortunately, California has a lot of high income earners, and taxing the rich is something that most economies should be doing more of, but to California in particular, it has created some problem.

This has always created a bit of a boom and bust in tax revenues because often the highest earners aren't making a consistent salary, but are instead getting money from cashing out stock options or running a successful business.

And capital gains only occur when people make sales of assets, which typically occurs much more during good times. Now, this happens everywhere. Tax revenues are, all other things being equal, going to be lower when less people are employed and businesses are making less money.

But the amount of revenue that California has previously received from extreme incomes has made them particularly sensitive to these fluctuations. The other major problem with high incomes in California is that it's not always Californians generated. A lot of attention has been paid to all of the people leaving California in recent years, but it's only become the most popular state in the US because a lot of people move to it as well.

It's a statistic so pronounced that it has its own mythos of people heading west to California to chase their dreams in show business, or more recently to get a highly paid job in the world leading companies out there. Now, with lots of people coming in and lots of people going out, it creates something of a transience problem for long-term economic planning.

People are happy to move to the state for the opportunities it provides, but they're also just as happy to leave at the earliest inconvenience, because for a lot of these people it's not really their home, and they often don't even have any long-term plans of staying there.

A lot of the highly skilled workers getting the big jobs and paying the high taxes there came from out of the state with a plan to spend a few years working for a big company to save up some money, polish up their resume, and then move to an area where their money will go a lot further.

If anything, new remote working technologies and the shift away from centralised offices has just accelerated a trend that already existed. Now on one hand, this has been a great way to make sure the state is always filled with skilled young people earning lots of money and paying lots of taxes. But it also means that those same people don't really have much of a vested interest in the long-term prosperity of the state. They are there to get in and get out.

So, naturally their support for programs that will contribute to the common good in the long term is not going to be as strong as populations that plan to spend their entire lives in one place. Now, with this, it's difficult to compare California to most national economies, even though it's larger and more technical than all but a handful of them, because despite its size and influence, it's still just a state in the USA.

So the barriers to people moving in and out and the autonomy over things like taxation are lower. This has created a broader problem where more and more individual states are competing with one another for high income earners and businesses, which really undermines the whole, well, you know, United States thing.

California also struggles because for high income earners, they can get similar amenities in other places that don't have the same clearly visible social issues like homelessness and petty crime. Now, this might all sound pedantic given the fact that California's economy is still growing. However, it would be surprisingly easy for it to lose its critical mass of economic activity that's kept it together for so long.

Of course there are some differences, but it would have been unthinkable that Detroit could lose its status as an industrial super centre because everything had been built around it. So, is California doomed?

Well, nobody can predict the future, least of all economists, but in just the last six months, there have been some major changes that will accelerate these already concerning trends. California has been losing people to other states on net for decades now. And yes, a lot of people still move there from other states for high income jobs, but that wasn't actually what was maintaining the population. What was, was people moving there from across the world.

Skilled immigration has always been a big source of workers for these industries, but clearly that now has a less certain future as visa programs are scrutinised and foreign nationals become less certain about moving to the USA.

Now the big disclaimer here is that, at this point, the actual impact of this is unknown. It's so new and changing so rapidly that data hasn't been collected for it, but overall it certainly hasn't been positive. The same is true for the ultimate fate of the official avenues for immigration.

Different factions within the government are fighting for and against the continuation of things like the H1B program, which is the primary way that skilled foreigners can work legally for companies in the USA. Trade wars are another thing that will hit California disproportionately hard. The state is home to some of the biggest ports in the country, and it's the logical drop-off point for ships moving cargo from China.

California also has the second highest rate of goods exports to the USA, only falling behind Texas, which exports a lot of oil and natural gas to Mexico. A trade war with China and Mexico could cut off this source of revenue, and that's not even the worst part. California exports a lot of goods, but it exports way more services. Already as retaliation for trade wars, things like Hollywood movies have been banned in China, which is the largest movie market in the world now.

Again, it's really too early to know the full impact, but other things like American smartphones, American social media and, well, American electric cars are going to be hurt by this either directly through reciprocal Paris or indirectly through people not wanting to consume products or services from the US. This will hurt the US as a whole, but California in particular. There's also the environmental threat.

Most visibly seen with the recent wildfires, a lot of Californian homes are becoming uninsurable, potentially undermining one of the largest real estate markets in the country. Now, while cheaper homes might sound like a good thing, a lot of lenders require some home insurance before they'll give a mortgage on a house.

So, if these homes become uninsurable, it might only be all cash buyers that can afford them. Now there's one last factor that is worth considering, even though it falls outside the realm of strictly economics. And that is that...

California has problems, but arguably those problems get a lot more attention than they would anywhere else, because California, by its very nature, attracts a lot of attention. California has a lower poverty rate than a lot of other states that are getting praised for not having the same visible problems.

So realistically, they're just better at hiding them. But when every influencer and their selfie stick are out broadcasting these issues to the world, poverty in Los Angeles gets much more attention than poverty in some no-name town in Oklahoma. So yeah, as with a lot of economic crises, it's not as bad as it looks, but it's also something that's not likely to get better any time soon.

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