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FRBSF

WEEKLY LETTER

Number 94-17, April 29, 1994

California Recession and Recovery
The California recession has been one of the
most prominent developments in the Twelfth District economy during the 1990s. This is due to the
sheer size of the California economy, the spillover effects California has on its neighbor states,
and the prolonged and severe nature of California's recession. This extreme distress in a major
regional economy has influenced the national
economy and attracted the attention of policymakers at all levels of government.
Recently, though, there have been signs that the
California recession has bottomed out. With the
California economy at a possible turningpoint,
this Letter will review the course of the recession-why it matters and why it happened. Of
particular importance is the unbalanced nature
of the downturn in the California economy, with
Southern California suffering a disproportionate
share of the job losses. The uneven nature of the
California recession sheds some light on competing theories regarding California's economic
problems. Furthermore, recent encouraging news
from the southern part of the state is evidence
that California's hard times are coming to an end.

Why California's recession matters
Over the past three and a half years, California
has experienced its most prolonged economic
contraction since the end of World War II. As
shown in Figure 1, payroll employment dropped
by 614,000 or about 4.9 percent between its
peak in July 1990 and its trough in December
1993. By comparison, the peak-to-trough period
for the U.S. was much shorter Ouly 1990 to February 1992), and the fall in payroll employment
was much less severe-only 1.7 percent.
California's recession matters for several reasons.
First is the pure human cost of lost wages and
financial distress to laid-off workers. Many who
kept their jobs also suffered as wages and incomes lagged in a weak economic environment.
Furthermore, falling tax revenues had statewide
effects, as the state government has had to make
up lost revenues with higher tax rates and budget
cuts in government services. In addition, several
years of tight budgets have hindered the state's
ability to make needed investments in public
infrastructure and in education. The cost of

this underinvestment will be borne by future
generations.
The effects go beyond the state. In an accounting
sense, California's recession has driven regional
and national economic statistics by virtue of its
size: Its 12 million jobs account for 61 percent of
District employment and 11 percent of the nation's jobs. As a result, California's unemployment
rate of 8,6 percent raises the national unemployment rate from 6.2 percent to 6.5 percent.
Beyond the statistical effects of California's weakness, the last three years of the state's recession
also have had spillover effects. on its neighboring
states. A recent Weekly Letter (Cromwell 1993)
presents evidence on the linkage between California and its neighbor states and suggests that
on balance, the California recession resulted in
significant job losses in Arizona, Nevada, and
Hawaii due to reduced sales of goods and services. Another measure of California spillovers,
however, is the out-migration of workers looking for jobs in other states. According to driver's
license records, California went from having a
net in-migration of 130,000 individuals in 1988
to a net out-migration of 150,000 in 1993 (visa-vis the other 49 states).

Figure 1
Payroll Employment (Seasonally Adjusted)
(000,000)
112 '

(000,000)
~ 12.7

California
(Right Hand Scale)

..
•
.

111

,"

,

110

12.5
12.3

109

108
107

.•

,

12.1

Of

U.S.
(Left Hand Scale)

11.9

106

105
104

11.7
11.5

Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94

FRBSF
California's problems have attracted the attention
of local, state, regional, and national leaders. In
trying to determine appropriate policies to address these problems, however, there has been
much debate among economists and policymakeis as to the nature of California's economic
difficulties.
In general, a case can be made that the prolonged, severe California recession was due to
large aerospace and defense cutbacks, combined
with the bust of an overbuilt commercial real
estate market that occurred during a period of
national recession. For example, a study by the
Center for Real Estate and Urban Economics at
U.c. Berkeley suggests that combining the direct
and indirect effects on employment, cutbacks in
aerospace and defense could easily account for
about half of the job losses in the state. Furthermore, the reduction in construction jobs alone accounts for an add itional 20 percent of the job loss.
Given this vievv-vvhichl call the "aerospace/
shock" view-California should be expected to
have a normal cyclical rebound in response to the
national economic recovery, the completion of
the shakeout in commercial real estate, and an
end to (or lessening of) cutbacks in defense and
aerospace. Policy responses that are being directly implemented or that are at least consistent
with this aerospace/shock view of California's
problems include federal aid (for converting military bases to civilian purposes, rebuilding South
Central L.A., and responding to recent disasters),
regulatorv relief for banking institutions in hardhitareas,' and a state policy of avoiding tax increases in favor of "deficit" spending.
A longer-run view of California's problems, however, argues that California is a high-cost place to
do busi ness and that the state has lost its competitive position relative to other states and countries. High taxes, government regulation, and red
tape are causing firms to flee California, leading
to a permanent loss of jobs. Policy responses in
line with this "long-run competitive" view range
from reducing the burden of workers compensation to reducing regulation and red tape.
Note that the aerospace/shock and long-run competitive views of California's problems are by no
means exclusive, and in some cases they are complementary. Indeed, one reason that aerospace
and defense cutbacks are disproportionately
hurting the California economy is that defense
contractors are consolidating and moving their
operations to lower-cost states. However, in order

to determine which view best explains California's recent economic weakness, we turn to an
analysis of the regional pattern of this cycle
within California.

Regional imbalance
One striking feature of the most recent national
recession Ouly 1990-March 1991) was its regional imbalance, with most of the job losses
concentrated inthe Northeast and California.
Like\rvise, lwvithin California, the recession hit re=
gions unevenly (see Figure 2). The most striking
aspect of the regional breakdown is the concentration of job losses in the southern part of
the state. Of the 614,000 jobs lost statewide,
543,000 or almost 90 percent of these jobs were
lost in the southern part of the state which suffered a 7.5 percent decline in employment. The
Los Angeles-Long Beach area suffered the worst,
with a loss of 461,000 jobs for a decline of 11.1 percent, or 75 percent ofthe job losses in the state.
Northern Cal ifornia fared worse than the Central
Valley and was closer to the average loss for the
state. Employment fell by 101,000 jobs for a loss
of 3.4 percent. The dedi nes were led by losses of
48/000 in San Francisco (5.1 percent), 34/000 in
San Jose (4.1 percent), and 24,000 in Oakland
(2.8 percent). The losses in Northern California,
however, accounted for only 16 percent of the net
loss in the state.
The Central. Valley region of California performed
better than the average for California, but did not
completely escape the recession. Employment in
the region showed up an down variation, but on
balance was flat, increasing 0.6 percent over the
period. Sacramento, however, showed a decline

Figure 2
Northern, Southern, Central Valley
California Employment Trends
July 1990 =100
104
Central Valley

102
100
.. ,

98
96

-

-

..... ........

Northern California

,

\-_.~

-',,.

\

.......

Southern California

94
92
90 - 1 - - - - - . - - - - - - - , - - - - - , . - Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan91
91
92
92
93
93
94
90

of 11 percent for a loss of 69,000 jobs, reflecting
a contraction in state government.
The salient point of this regional breakdown is
that Los Angeles accounted for three-quarters of
the jobs lost in California during its recession.
The story of the California recession is therefore
to a large extent the story of Los Angeles County.
While the "long-run competitive" view accounts
for some aspects of the L.A. recession, the "aerospace/shock" view probably is a better explanation for Los Angeles.
For example, Los Angeles County accounted for
60 percent of the state's aerospace jobs at the
start of the recession. Aerospace employment in
L.A. then dropped by 85,000 over the period, a
decline of 42 percent. While the rest of California also suffered from aerospace cutbacks-a
loss of 51,000 jobs or 37 percent-Los Angeles
bore the brunt of the aerospace bust due to its
concentration on the industry and accounted for
63 percent of the aerospace jobs lost in the state.
The construction bust-associated with overbuilt
commercial real estate-also affected Los Angeles disproportionately. At the start of the recession, Los Angeles had an office vacancy rate of
18 percent due to an office construction boom
fueled by money from large commercial banks,
insurance and pension funds, and overseas investors. Construction activity, rents, and real
estate values, however, then fell precipitously as
demand for office space weakened relative to the
newly added supply. Construction employment
fell by 36,000, a decline of 27 percent. Construction activity in the rest of California was also
weak, with employment declining 18 percent,
but less so than in Los Angeles. For example, in
San Francisco the vacancy rate never exceeded
14 percent due to building construction limits,
and construction employment declined by 5,800
jobs or 18 percent.
Competitive aspects of the Los Angeles business
environment also have received attention. These
long-run competitive problems, however, existed
before the recession as well, and the job losses
associated with the outward migration of firms
are small relative to the size of the job losses in
the recession. Furthermore, statewide policies
that affect competitiveness should not disproportionately affect the Los Angeles area-although
some environmental regulations are specific to
the Los Angeles area. On balance, the compet-

itive issues are important, but more for determining long-run growth than for explaining the
California recession.
Signs of recovery
At the end of 1993, anecdotal information began
to suggest that the California economy was beginning to bottom out. In particular, the Central
Valley was reported to be expanding, Northern
California was turning around, and Southern California was bottoming-out, with the exc;eption of
Los Angeles. The regional employment data at
that time, however, were not consistent with that
story. The Central Valley was flat, and job losses
were still reported for both Northern and Southern California.
Newly revised employment data, however, show
that statewide employment reached a trough in
December 1993 and has now grown by 43,000
since December 1993, for an annual rate of
1.3 percent. The growth in early 1994 has been
led by construction (up at a 7.3 percent annual
rate) and trade (3.5 percent annual rate). Most
other industries posted only modest gains, and
the manufacturing sector continues to lose jobs
(largely in aerospace),
Most impressive has been the broad spread of
this regional performance. Employment is up not
only in the Central Valley and in Northern California, but also in Southern California and even in
Los Angeles, where employment has grown since
November 1993. In particular, between November
1993 and February 1994, employment in Los Angeles grew by 20,000 reflecting growth in construction (2,500), nonaerospace manufacturing (5,400),
trade (3,600), and services (9,400). Aerospace
employment, however, continues to fall.
These signals are encouraging but preliminary.
Continued weakness in aerospace suggests that
any "cyclical" rebound will be constrained. Further attention to California's competitive position
also is needed for long·run growth. As these issues are addressed, however, we can hope that
current predictions of anemic growth will prove
to be pessimistic.
Brian Cromwell
Economist
Reference
Cromwell, Brian A. 1993. "California's Neighborhood."
Federal Reserve Bank of San Francisco Weekly
Letter (October 8).

Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of
San Francisco, or of the Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor or to the author.... Free copies of Federal Reserve publications can be
obtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 94120.
Phone (415) 974-2246, Fax (415) 974-3341.

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Index to Recent Issues of FRBSF Weekly Letter

DATE NUMBER TITLE
10/29
11 /5
11/12
11/19
11/26

12/3
12/17
12/31
1/7
1/14
1/21
1/28
2/4
2/11
2/18
2/25
3/4
3/11
3/18
3/25
4/1
4/8
4/15
4/21

93-37
93-38
93-39
93-40
93-41
93-42
93-43
93-44
94-01
94-02
94-03
94-04
94-05
94-06
94-07
94-08
94-09
94-10
94-11
94-12
94-13
94-14
94-15
94-16

Regional Comparative Advantage
Real Interest Rates
A Pacific Economic Bloc: Is There Such an Animal?
NAFTA and the Western Economv
Are World Incomes Converging?'
Monetary Policy and Long-Term Real Interest Rates
Banks and Mutual Funds
Inflation and Growth
Market Risk and Bank Capital: Part 1
Market Risk and Bank Capital: Part 2
The Real Effects of Exchange Rates
Banking Market Structure in the West
Is There a Cost to Having an Independent Central Bank?
Stock Prices and Bank Lending Behavior in Japan
Taiwan at the Crossroads
1994 District Agricultural Outlook
Monetary Policy in the 1990s
The IPa Underpricing Puzzle
New Measures of the Work Force
Industry Effects: Stock Returns of Banks and Nonfinancial Firms
Monetary Policy in a Low Inflation Regime
Measuring the Gains from International Portfolio Diversification
Interstate Banking in the West
California Banks Playing Catch-up

AUTHOR
Schmidt
Trehan
Frankel/Wei

Schmidt/Sherwood-Cal!
Moreno
Cogley
Laderrnan
Motley
Levonian
Levonian
Throop
Laderman
Walsh
Kim/Moreno
Cheng
Dean
Parry
Booth
Motley
Neuberger
Cogley
Kasa
Furlong
Furlong/Soller

The FRBSF Weekly Letter appears on an abbreviated schedule in June, July, August, and December.