STEADY AS SHE GOES!

CALIFORNIA'S ECONOMY SAILE SMOOTHLY INTO 2001

California's econmoy is like the month of March: in like a lion and out like a lamb. After five years of a loud roar, moving into 2001, economists statewide agree that the key descriptor for the new year is "moderation."

"[2000] will be a transitional year," states Jack Kyser, chief economist with the Los Angeles Economic Development Corp., a nonprofit group that tracks and promotes the five-county Los Angeles area's business community. "The economy will transition to a more subdued pace of growth."

Joe Mattey, economist and researcher with the San Francisco Federal Reserve Bank says 2001 will equalize the state: "It's an exciting time-in the Bay Area in particular. For California as a whole, next year is going to be one in which there is a leveling of the playing field-a diffusion of the prosperity to other parts of California and other parts of the nation."

SIXTH LARGEST ECONOMY

After experiencing slow growth for the first five years of the 1990s, the "new economics," spurred by the information technology revolution, sped everything up in the second half of the decade, recalling the "golden days" of the 1980s. California now boasts the sixth largest economy in the world-surpassing Italy in 1999. The last time California held sixth place was in the mid-1980s when the dollar was extremely strong. And the state might be poised to overtake Great Britain. The UCLA Anderson Forecast projects California's gross state product for 2000 at $1.35 trillion-just ahead of the U.K's 1999 figure.

Does this mean that the state has made up for losses suffered during the early-1998s' recession, in which it lost 250,000 jobs? "Is a sense, the answer is yes," states Rajeev Dhawan, director of econometric forecasting with the UCLA Anderson Forecast. "Employment levels in California recovered to their pre-recession levels by late 1995 and since then have added almost 2 million jobs. It is expected that [the state] will add another 4 million jobs in the coming decade."

Dhawan notes that if growth had continued at the 1980s' 2.4 percent, employment levels for 2010 would have been projected at 2.2 million higher.

"The loss of aerospace jobs [after defense spending cutbacks] was a structural event that permanently hurt the potential growth rate of the California economy," says Dhawan, adding that California's employment growth was double the national rate in 2000. He predicts this trend to continue in the new year.

"For the California economy as a whole, another source of momentum is the improved state fiscal conditions that partly reflect the strength of income tax revenues coming from the high levels of personal income," says Mattey. "We are entering a year in which some of the natural equilibrating mechanisms are kicking in. In 1999 and the early part of 2000, the national economy grew very fast, and over the broader period the equity market posted tremendous gains. There was tremendous job growth in the state pushing the employment rate low and driving rental vacancy rates for unoccupied housing close to zero--that is not a very sustainable pace for the California economy."

Although the economy is robust and moving along nicely, experts warn that a few challenges lie ahead. Demand for housing and commercial real estate continues to exceed supply. Uncertainty in the Middle East, and subsequent oil-price fluctuations, might affect the bottom-line of doing business--and consumers will end up paying the price. "One big factor is energy costs," says Kyser. "Gas prices this winter are going to be much higher than they have been in the past, and electricity deregulation has not been going according to plan. This will all have an impact on business profits."

HIGH TECH INTERNATIONAL

According to the experts, international trade will be one of the hot areas to watch in 2001. Mexico is the state's largest trading partner, and Dhawan reports that the recent upsurge in exports to Asia (up 26 percent this year, following on the heels of the recent recovery of the Asian markets) will continue to be strong in the coming year. "Our international competitiveness with respect to Mexico and Asia is much better than the rest of the U.S.," says Dhawan.

California's biggest export by volume is electronics, followed by industrial machinery, transportation equipment, instruments, agriculture and finally, chemicals. But out of the total, one-third is electronics, and if instruments are added to that total, it represents about 40 percent of all exports--all high tech and mostly coming out of Silicon Valley.

However, Southern California is claiming its slice of the high-tech pie. "We are beginning to see clusters of high-tech corridors in Orange County, the L.A.-Ventura border and the [Highway] 101 corridor," says Kyser, adding that San Diego's biotech industries and the low-tech industries, such as aerospace and transportation equipment, are also doing well in Southern California. "High tech is transitioning in the south. Companies that once did work for the U.S. Department of Defense and NASA now are getting involved in emerging technologies. Exports to Asia are doing very well in high tech and all three customs districts in California. It's not as great as last year, but still good."

Mattey looks to the financial markets as a key indicator of economic health for the high-tech industries in Northern California. "A lot of the recent weakness in the stock market has been in the high-tech sector--both with Internet and more established companies--and we are seeing an increase in lay-offs and job destruction due to that. So, for the Bay Area, which has been one of the hottest markets in terms of jobs and housing and a lot of other measures of activity, [the market] is a very important issue to watch."

While news reports warn that the Bay Area's dot-com craze in the mid-to-late part of the decade has taken a downturn, experts say the high-tech industry is not mortally wounded. "High tech start-ups are still doing well north and south," notes Kyser. "But investors will continue to be more discriminating."

The market transition from high tech to other business types doesn't mean high tech is doomed. "In the aggregate, we still had a tremendous transformation," says Mattey, referring to the pre- and post-high-tech economies. "I wouldn't say that this burst of activity we've seen in the past couple years has been ex post revealed to be a mistake. It generated so much wealth, the market has voted with its money and it says that this new economy is here to stay. In evidence of that fact is a low unemployment rate."

Dhawan echoes this sentiment, but is cautious. "The only trouble is if the stock market goes into a bad funk," he says. "That would impact Northern California much more than Southern California. California has the [high-tech] advantage. Even if the dollar remains strong, which hurts exports, we will still do OK. If someone wants to buy routers, they have to buy them from Northern California--from Cisco and other companies like that. They can't go to Kentucky and get them."

RESIDENTIAL REAL ESTATE

The outlook for the California real estate market in 2001 is all a matter of perspective. If you own, life couldn't be rosier. If you want to buy, well, in the words of one transplanted New Yorker: "Forget about it."

Dhawan notes that the average price of Bay Area real estate is twice the national average and 50 percent higher than Southern California's. "The dream of owning a three-bedroom house with a yard, pool and two-car garage for a family of four is an American icon that is coming under pressure even in a land-rich state like California," says Dhawan. He predicts that 145,000 new housing permits will be issued in the coming year and a net immigration to California, from all sources, at slightly less than 250,000 through 2002.

Mattey sees growth commonalities between Northern and Southern California's metropolitan areas. "L.A. has clusters of high-tech jobs and more wealthy residents who have benefited more from the equity wealth build," says Mattey. "In terms of the pattern of house price changes, the upper ends of the markets both in the Bay Area and in the L.A. area benefit more from those developments." According to Mattey, this means more pressure for change in the less densely populated, amenity-rich places where people want to keep their backyards nice and free of traffic congestion.

Tax incentives that make it more attractive for cities to offer building permits to retail businesses rather than housing, as well as strict no-growth policies, primarily in the north are blamed for high prices and the imbalance of supply and demand in residential real estate over the past few years.

"Local governance issues are really coming to the forefront as people grapple with the question of 'How do we as regions accommodate the job growth and the increase in wealth?"' says Mattey. "We're seeing this in terms of transformations in San Francisco's Mission district and in Oakland, via gentrifications and such things as bidding up the rents."

Also, tax incentives that favor retail over housing drive up the cost of living. "There is a tax structure in place that makes it more attractive for cities to have retail establishments built, rather than housing," says Kyser, who suggests a change to the tax system that would better support residential housing, and finding more innovative use of existing property structures such as changing old warehouse space into lofts.

Although the housing crunch is felt most acutely in the Bay Area, experts agree that this is a statewide issue. For example, due to very strict no-growth policies in Yolo County, home of the University of California at Davis, overall housing prices have been going up $10,000 each month for the past few years. "And that doesn't look like it's going to turn around anytime soon," says Art Jensen, director of the Sacramento Forecast Project and professor of marketing at Cal State Sacramento. "Davis is what I would call a 'green' community. There is an interesting clash of development vs. non-development factors in that county. The demand is there, but there are too many restrictions on development."

Jensen notes that the same pattern is happening in Sacramento and Placer counties, although the restrictions on growth are not nearly as strenuous. "Sacramento County is finally beginning to crawl out from underneath the inventory of houses from the closing of three military bases over the past five years," says Jensen. "When military personnel moved out, that left a lot of housing, and overall housing prices were depressed because of that, and now that's not a factor. I think now we've finally surpassed that glut [and the prices are starting to go up]."

COMMERCIAL REAL ESTATE

Despite recent reports that companies and employees, fed up with increasing traffic congestion, high rents and the high cost of doing business in areas like the Silicon Valley, are moving to Sacramento and Stockton in order to escape, not all economists agree that that trend is really happening.

"There has been a reinforcing of the clustering effect despite the fact that technology allows people to work from long distances," states Mattey. "We've seen newspaper stories that document specific examples of companies that have moved from the Bay Area to Sacramento, for example. But my guess is that in reality, a surprisingly large number of companies still choose to be at ground zero despite the incredibly high costs and difficulty in getting the commercial space.

If you look at the overall potential benefits from location for young companies that are trying to attract new workers as well as rely on their interaction with, financiers, lawyers, and all of the service professionals that help a young company grow--[these companies] realize that they need to be close to ground zero if they really want a chance to make it."

Plus, it's more attractive to employees to be in the Bay Area. "If work with one risky firm doesn't work out," says Mattey, "workers value the ability to be able to jump to another without having to move from their family or friends."

In the end, Mattey speculates that moving out of the Bay Area to places like Sacramento is practical only for more mature companies and projects.

Jensen agrees. "[The Sacramento area] has had great success with larger companies like Hewlett Packard and Intel because the operations we have here are hub operations, and we have the air support to allow fast commuting to the Bay Area." Jensen cites Intel's private air shuttle that runs between Sacramento and the Bay Area as a luxury that only a larger, well-established company can afford. "If they ever would extend BART to areas like Stockton and Tracy, we will probably see more of the smaller companies migrating to those areas. But that is very far into the future."

CALIFORNIA CPAs IN 2001

"If 2000 was a good year for CPAs, 2001 will be even better," predicts Dhawan. "When the overall economic activity is higher, that's when needs for supporting services are also higher. The services of a CPA firm will be in good demand no matter which way the market or economy goes. There are more people being put to work, more firms in existence, so the prognosis is good. I am only worried about a war or some big flare-up in the Middle East. That is the biggest risk at this point. Six months ago, I predicted that inflation may be low right now, but it's going to pick up, and that has happened. I said the market has to go down for the economy to moderate and that's what is happening. I am not panicking. The only thing that would panic me is if the oil market gets into trouble because of a war or something."

In fact Dhawan is so confident, he's even allowing himself a moment of pride. "Everything is going so hunky-dory," he jokes, "that I'm like the cat who swallowed the canary."

Deanna McCrary is a CaICPA editor/writer.