PPIC Downplays Bad CA Biz Climate

APRIL 18, 2011

By WAYNE LUSVARDI

You can’t eat California’s mild weather, but you can tax it.  That seems to be the consensus online opinion of the average Joe and Jane about a study released last week that concluded that California’s weather assets offset the many negative ratings about its business and tax policies.

The left-leaning Public Policy Institute of California (PPIC) completed the so-called impartial study,  “Business Climate Rankings and the California Economy,” funded by the Donald Bren Foundation and the David A. Coulter Family Foundation.  Bren is real estate developer of the Irvine Ranch in Orange County and Coulter is a private fund manager and PG&E Board member.

A summary of the study’s findings states:

California fares poorly on many national ranking of business climate, yet over the past 30 years the state’s economy has grown at roughly the same rate as the national average. This report examines this California puzzle, finding that factors beyond policy matter more for economic growth. California’s advantages — particularly its favorable climate and industry mix — offset its unfavorable rankings.

Cherry Picking an Index

The PPIC reviewed state rankings of economic productivity, taxes and costs, and other measures produced by 11 think tanks and organizations, as shown in the table below.

Conspicuously absent were state rankings from free-market think tanks such as the Pacific Research Institute (parent think tank of Calwatchdog.com), the Tax Foundation, the Milken Institute, the Cato Institute, the Kauffman Foundation or the Corporation for Enterprise Development, all of which rank California at or near the bottom in tax and business policy performance.

PPIC averaged all the rankings to produce an average rank for California of 31, or slightly less than average for all 50 states. The problem with this arithmetic is that it mixes rankings based on state productive capacity with rankings of taxes, costs and regulations. This is sort of like comparing a ripe apple and a rotten orange and coming up with a nectarine.

High Variance is a Red Flag

As any statistician will tell you, averages are prone to be misleading without also understanding the variance.  In the table below, the average ranking for California is 31, but the variance — the average distance of data values from the overall average — is 15, which is a red flag.

Statistician Howard Wainer in his book, Picturing the Uncertain World, explains how billionaire philanthropist Bill Gates got hoodwinked into investing $1.7 billion into a project for promoting smaller school class sizes based on not understanding that student test scores with a high statistical variance are misleading. Small class sizes are not statistically related to better student test scores.  Neither is PPIC’s economic ranking of 31 for California reliably related to its economic performance, which every Tom, Dick and Harry knows is doing poorly.

It would be a hard sell to tell the average middle class family in California that its natural weather advantages more than offset unfavorable business conditions.  With high gas prices, inflation in food prices, looming large increases in electricity rates to pay for green energy and a governor and Legislature that can only propose raising taxes to solve budget problems, such a study will surely fall on deaf ears.

No.	Index	Rank
Productivity Indexes
1	State New Economy Index	4
2	Development Report Card for the States — Business Vitality	4
3	Development Report Card for the States — Development Capacity	17
4	State Competitiveness Index	20
5	Development Report Card for the States — Performance	31
Taxes, Costs & Regulations Indexes
6	Economic Freedom Index of North America	43
7	State Business Tax Climate	45
8	Small Business Survival Index	46
9	Cost of Doing Business Index	47
10	Economic Freedom Index	47
Other Indexes
11	Fiscal Policy Report Card on the Nation’s Governors	31
Statistics
	Minimum	4
	Maximum	47
	Average	31
	Variance (average difference from average)	15.2

Sure, California’s weather contributes to its huge agricultural, tourist and luxury real estate economies.  But coastal-oriented luxury real estate and tourism have curtailed any expansion of offshore oil drilling. And prolonged economic recessions are likely to severely affect tourism and coastal luxury home development leading to holes in state and local government budgets.

$42 Billion Tax on Air

The PPIC report fails to factor in the enormous cost to provide luxury public goods such as clean air for views of the ocean and mountains and tourism.

PPIC considers California’s mild climate a “non-policy” factor. But cleaning the air to enjoy the climate in California is anything but the result of “non-policy” factors. In 2001, for example, the cost to clean the air as a result of the California Energy Crisis came at a high price of $42 billion. The California Energy Crisis was about running out of clean air, not running out of electricity.

In the mid 1990’s, the U.S. Environmental Protection Agency mandated California to clean up its smoggy urban air basins or risk having federal highway and school funds cut off by 2001. According to the online chronology of air quality in California compiled by the California Air Resources Board (CARB), the first two-way catalytic converters came into use as part of the CARB’s Motor Vehicle Emission Control Program in 1975. But the improvement of air quality was modest at best and was not visually observable.

The only way to achieve a dramatic improvement in air quality in the Los Angeles Basin to comply with the EPA was to mothball or modernize all the old polluting coastal fossil-fuel power plants in California.  But a problem arose: Who was going to pay for the stranded debt — the unpaid bonds or mortgages — on all those old, dirty power plants? The California Energy Crisis of the late 1990s and early 2000s was a financial crisis involving a game of political hot potato over who was going to pay off the old bonds more than it was a lack of electrons from a lack of building new power plants.

Was the proposed deregulated electricity market magically going to pay for the stranded debt as part of the more competitive price of electricity from so-called deregulation?  Were the stock and bond investors of the regulated monopoly electric utility companies, Edison, PG&E and SDG&E, going to suck it up and pay for it, which would have resulted in a bond-market default crisis?  Or were politicians going to ante up and pay for it, thus risking their political careers?  This was a political crisis as much as it was an energy or debt crisis.

Why Energy Deregulation Failed

The first policy attempted was electricity deregulation, which failed when implemented in 1996. Deregulation was an attempt to inject competition into the electric grid hoping for, say, a 20 percent or greater reduction in electricity bills.  A portion of this cost savings, maybe about 10 percent, would go toward paying off the bonds on the mothballed power plants and the other savings would go to utility customers.

Deregulation failed in the 2000-01 period not so much from Enron gaming the system, as widely believed by the media, but from the policies of the Democratic Party-run Legislature and the new governor, Gray Davis. The Legislature and governor pulled the plug on the deregulation for fear of it resulting in greater dependence on cheap imported electricity from the Republican states of Texas, Arizona and Utah. Democrats feared that further reliance on imported power to clean the air in California would lead to a hole in state and local taxes. Many California cities passed Utility User’s Tax ballot measures, charging from 5 percent to 10 percent higher taxes, to plug the loss of tax revenues from having to depend on imported power from other states.

Creating an Energy Pricing Bubble

The second policy attempted by Gov. Davis and the Democratic legislature was to intentionally create a pricing fever that would pay off the bonds on the old polluting power plants. Putting caps on the retail price of electricity induced a pricing fever, just as a doctor may induce a fever to cure a patient of infection.

In economics, a fever is called a bubble.

This shifted the burden of paying off the bonds on the old dirty power plants to the public utilities (Edison, PG&E, SDG&E), which effectively went bankrupt by intentional regulatory policy.  This was not “unplanned” or due to electricity market speculation.  This is what we experienced in the early 2000s as the “energy crisis” with rolling blackouts and defaulting monopoly energy companies.  This also failed because price caps never succeed in the long run and, if continued, would have created a panic in the bond market.

In 2011, We’re Running Out of Affordable Gas, Not Climate

New Gov. Arnold Schwarzenegger came into office in 2003 on a recall election largely called over the misnamed energy deregulation debacle. He folded the burden of the old corporate bonds of Edison, PG&E and SDG&E into a state-wide $42 billion general obligation bond issue to be paid off by higher priced long-term power contracts which were set to expire in 2012.

So the undisclosed price of eradicating the visual smog in California’s urban air basins was $42 billion, traffic fatalities due to blackouts and failed traffic signals and a number of institutions in debt due to unpaid utility bills.

In 2001, we were running out of clean sky, not energy per se.  In 2011, we are not running out of good climate but money to pay for gasoline, food and looming higher green energy prices that will kick in beginning in 2012.

The intent of AB 32, California’s Global Warming Solutions Act of 2006, is to capture the electricity rate monies from the payoff of the California Energy Crisis bonds starting in 2012, the year the state’s green power law kicks in.  This is most obviously not a non-policy factor.  It is a deliberate “climate change” policy.

California depends on imported electricity for about 30 percent of its energy needs. Replacing conventional power imported from out of state with green power, however, will not result in clear, clean air in California’s smoggy air basins because wind and solar power farms are located in remote deserts and mountain passes.  Neither will California’s cap and trade policy, imposed by AB 32, result in cleaner air because urban polluters will buy pollution credits from remote wind and solar farms that do not clean the air in cities and only replace out-of-state power plants.

Study is Exercise in Damage Control

So California does have a great climate. But it also has a declining economy for reasons that seem not fully explainable to public-policy analysts. And part of the reason is that the unacknowledged maintenance costs of being able to enjoy that climate in a highly technological society have been enormous and have contributed to suffocating the economy.

As California government bureaucrats are prone to say: “Everybody wants clean air, but nobody wants to pay for it.”  I might add that we’re now paying for it and will continue to do so under California’s climate-change laws.

There is no free lunch or free climate that generates sunshine which can always overcome bad public policy. Sound public policy needs to recognize the hierarchy of needs: people need to eat, drive to work and pay the rent or mortgage before they can enjoy the climate or are taxed.  The average person has a better grasp of this than public policy analysts.

The PPIC study on California’s economic “climate” is an exercise in image management and damage control often communicated by an unquestioning and mathematically illiterate newspaper press. What is apparently important is the control over public perceptions by elites who have vested interests in beach proximate real estate development and stock investments in California green energy industries.

Public policy researchers seem to cast a blind eye to the costs to maintain the advantages of California’s climate. But the average person in the street seems to be aware that, although the weather climate is superior, the business climate isn’t.