Monday, 21 May 2012

Never mind Greece, there's a bigger basket case

Its the world's ninth largest economy. Its six times the size of Greece. Its actually bigger than India. And its hopelessly bust . Yet; we aren't hearing much about it. Only because ,  its not a country. Its a state. The State of California. The world's biggest basket case ! This has been a favourite topic of mine having blogged before here and here.

California has a state budget of some $90 bn. And it just projected a deficit of $15 bn. What sort of an economy runs a deficit of 18% of the budget ?? This has been going on for years . And what does that state do - simply borrow . And borrow. And borrow.  And with no hope of ever bridging that gap. If California had its own currency, I would be merrily shorting it. It would be a prime candidate for begging at IMF's door. 

For once you can't blame the political leaders for the mess, although they are the ones being vilified and quartered. The blame must squarely rest on the citizens of California. For they are the ones who have brought this mess upon themselves by indulging in direct democracy.

California is a perfect example of democracy run wild. For decades they have been passing laws through referendums without the level of serious evaluation and trade offs that are necessary for good governance. The infamous Proposition 13 of 1978 drastically limited property tax and imposed a requirement for a two third majority to raise any taxes , making it virtually impossible to do so. Then they passed scores of spending laws like Proposition 98 of 1988 which mandate 40-50% of the general revenue to be spent on education. And Propositions like 117 of 1990 that mandated a minimum spend of $30m on wildlife habitat. Proposition 49 of 2002 increased spending on before and after school programs by some $450m. There are tons of such mandated spending with barely a thought on how they would be funded. They also pass whimsical Propositions that mandate that a chicken must be able to spread its wings and turn a full circle without touching another chicken as I outlined in this post !

The problem is simple. California depends for more than 50% of its income on personal income taxes. These unfortunately fluctuate. Recessions drastically reduce tax revenues. In boom times the revenue increases are spent away and nothing is saved. In hard times, there's a massive hole in the budget. There is zero political will ( read citizen appetite) to do anything about it. Budgets are never passed on time. Fiscal irresponsibility has a new meaning in California that would make Greece blush. California is the perfect example of how not to run an economy.

The puzzling thing is that California is also home to the smartest people in the world.  It is arguably the most intelligent place on earth. And yet ..... 

Maybe intelligence is no insurance against stupidity !

23 comments:

Shachi said...

ouch - thank god I don't/can't vote yet, else I would be hiding in shame right now!

FTB's revenue sucks this year as well. On top of it we are facing a drought which affects farming n agriculture. Doomed is the word!

Prats said...

Brilliant blog post and you have brought out the paradox in California. The fact that it is a state and is not getting the attention it should is very pertinent of the world we are making through our democracy.

Exkalibur666 said...

Isn't this typical of smart people.. they live off borrowed money. This is exactly what california is doing and having fun while they are at it.

Ramesh said...

@Shachi - No No No - this post does not apply to the three / four wonderful Folsom residents.

@Prats - Actually the other states in the US should refuse to "bail out" irresponsible states. Actually, isn't that what is happening in Europe.

@Excalibur - There's something to what you say. Except that one fine day it will catch up and the smart alecs will end up looking very dumb.

Deepa said...

Ok first thing first, what happened to the Sunday post?

You summed it up in your last line. Intelligence is no insurance against stupidity. For a country that is run by an 'Economist' we've crossed all boundries of stupidity. They can see the rupee depreciating below the point of embarassment, what more do they need to understand.

sriram khe said...

I like to think that California is in a mess because I left the state ten years ago :)

To paraphrase an old joke, by leaving California and moving to Oregon, I simultaneously increased the average IQ in both the states :)



Ok, enough with the kidding around!



Even two decades ago, it was clear that California was on an unsustainable path, with its finances out of sync with reality.  For a few years, we Californians (I was in CA then) could ignore all that thanks to the boom-boom internet bubble years when it seemed like everybody other than me was getting fabulously rich by mumbling some high-tech phrases.



To cut a long story short (I am prone to digressions!) two years ago, I blogged about a Slate.com "explainer" item that caught my attention--on California's mess and whether a state can declare bankruptcy. 



Local government bankruptcy was not something I thought I would see happen, but it did when the government of Orange County--a wealthy suburb of Los Angeles--was forced into bankruptcy.

Yep, two decades ago it was .... unfortunately, the government of the State of California doesn't have that option.

Ramesh said...

@Deepa - Given my laziness in blogging, sometimes the urge to be true to my blog title overtakes me and the frivolous Sunday post morphs into a so called business post ! Oh Indian economic stupidity is now so all pervasive that it helps once ina while to rant about somebody else's stupidity.

@sriram - Nice take from an "insider". No doubt you foresaw all this and hence decided to move to a state where the locals are happy logging timber, growing hazelnuts, fishing salmon and generally enjoying the good life.

TMM said...

How 'bout the famous state budgets that our state governments in India pass. Full of freebies, subsidies and all kinds of 'yojanas' and 'thittams'. Many of the state govt budgets in India are worse than the CA budget methinks!

Sandhya Sriram said...

I am wondering, if the whole world runs on single entry accounting system like this, there is someone who is passing the other side entry. so if the single entry go bust, who will take the write off. and i think, he is the only guy who need to worry. and no one seems to be worrying.

Some one downgraded america's rating. every one worried like crazy until the downgrade. after the downgrade, they forgot about it.

Every one cried foul about Greece, but then every one forgot about that also.

well some one some day will pay for it and i know that i am going to be part of that someone, but i will worry about it when it comes

J said...

And this may not even be the worst of it, considering their pension obligations and projected healthcare costs. Maybe the boom times were a curse for the state because when things are going well it is easy to think that it will last forever. It is clear that Californians love the state, but I visited the Bay Area recently after a long time and somehow I felt that it was missing a vibrancy that I had felt in earlier visits (maybe just in my head). Unless something is done, the state will definitely see a flight of businesses and talent.

Ramesh said...

@kiwi - Actually India's state budgets are not as bad as California's because the Centre exercises an iron hold on funds release (that's why Mamata Banerjee is making so much noise). States have to borrow only through the RBI and the RBI exercises a lot of discipline. Having said that, a number of Indian states would be very comfortable in a summit meeting with California !!!

@Sandhya - One of the biggest holes is exactly what you identified - governments all over the world run on single entry book keeping. Perhaps a thought for J, who is a distinguished academic in accounting, to perhaps consider research in this area.

@J - Totally true, but I suspect almost everybody accepts that the state will default on its pension obligations - water down entitlements, raise eligible age, etc etc. The problem is single entry accounting as Sandhya identifies. see my suggestion to you in response to her.

Hema said...

Insightful post and good comments.
Spending borrowed money seems to be the glorified westerner's way of life.
How long will this last before another huge crisis erupts?

TMM said...

Ha ha, I help keep books for a part of her majesty's govt in NZ. We run Oracle 12, close our books in 2 days, report variances by day 4 and complete year to go forecast by day 7. And yes sir, we do follow accrual accounting and double entry. I guess it's got something to do with the kiwi image of being corruption free and running a transparent govt. (we are usually up there in the top 5 slots with the Scandinavians. The usual suspects in that list of least corruption and highest transparency are NZ, Denmark, Finland, Norway and Sweden - I guess closer to the pole you are the more honest you are!!!)

J said...

... and I might find some excellent co-authors for that research from the various people here :)

sriram khe said...

yes, enjoying the wonderful paradise that this part of Oregon is, despite the fact that i don't eat fish ... but, there are moments when i miss the old california, and then those moments pass :)

btw, folsom? hmmm ... a long, long, time ago, sacramento was briefly semi-home for me, for about six months ...

as for NZ, met some of the friendliest people ever. like this one couple, absolute strangers were were, who even offered us room in their huge home by a lake, and to top it, had warm breakfast and hot coffee ready in the morning ...

wait, what is this blog post about? :)

Ramesh said...

@Hema- yeah - debt is a potent drug somewhat like cocaine

@kiwi - Really !! I am totally impressed.Didn't know that any govt anywhere did double entry accounting. Not at all surprised that kiwis are the leaders in counting - having much practice in counting sheep !!

@ J - can I apply to be your research assistant !

@ sriram- who cares what the post is about when we can have such lovely comments

J said...

LOL! I cant afford it!

sriram khe said...

I have been thinking more about this .... If I had lived in, say, San Diego, I doubt whether I would have moved to Oregon. Bakersfield, where I lived, is a different story. I quite seriously tell friends and students that if I have a million dollars, I might quickly relocate to La Jolla.

My point is simply that it is not California's economic mess, or a dysfunctional governance system that keeps me away from California. My long-term bets, if I were a betting man, will always be on California and not on, say, Oregon, just as the bets will favor the US over any other country in the world.

I suppose this comment merely confirms what I already know well--after kidding around, I become way too serious, again!

Ramesh said...

@J - Really ?? What's a million or two to you ?? Just small change :)

@sriram - Long term bet on California - mmmm not sure. My money is on New York. Long term bet on the US ? You'll win hands down.

Reflections said...

"The puzzling thing is that California is also home to the smartest people in the world. It is arguably the most intelligent place on earth."

Errr.....how did u come to that conclusion????

p.s: Good thing you added arguably;-D

Ramesh said...

@Reflections - You doubt that ?? The home of Silicon Valley, the home to a clutch of world leading universities, the home of Appler, Google, Amazon, etc etc, home to Paolo Alto Research Centre which invented many of what we take for granted today, you could go on and on. Surely no other region on earth is comparable ........

Vishal said...

//intelligence is no insurance against stupidity //

Very well said, does not matter whose stupidity it is (for no one is dumb now a days).. but it costs dearly. Read an article on Indian economy sometime back (I guess by ex-CFO of JSW steel) which said, it was a case of boiling a frog. It also said the people of 60s and 70s saved us until 2010s but there is serious doubts from now onwards with so many infections surrounding the economy.

Sounded so logical!

Ramesh said...

@Vishal - I am afraid the boiling the frog analogy is unfortunately true.

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