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California is gripped by economic problems, with no easy fix

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HOME TO MANY of America’s most progressive policies, from criminal justice to vehicle emissions, California serves a unique role as a punchbag for right-wing politicians. Every few years it becomes fashionable to declare that it is a failed state, or that the California dream is turning into a nightmare. This rhetoric is often overblown: in terms of pure economic heft California remains the most powerful American state. But for all its continuing prowess in innovation (not least in artificial intelligence), California again appears to be entering one of its periodic rough patches.

The state faces three overlapping challenges: rising unemployment, growing fiscal strains and population outflows. All of these should abate over time, but for now they mark out California as a pocket of relative weakness in an otherwise robust American economy.

Chart: The Economist

When the Federal Reserve jacked up interest rates in 2022 in order to tame inflation, many analysts and investors fretted that this monetary tightening would lead to a recession. Instead, the broader economy has been surprisingly resilient. The national unemployment rate remains less than 4%, within spitting distance of a six-decade low. In California, by contrast, the unemployment rate has shot up to 5.3%, the highest of any state (see chart 1).

On its surface the reason for the rise in joblessness in California is no bad thing: as the aftershocks of the covid pandemic fade away, more people are actively seeking jobs. Until they find work, they show up in official data as unemployed. The deeper problem is that the state does not have enough work for them. In California there are roughly 0.8 job openings per unemployed person—the lowest in the country—whereas in America’s other 49 states the overall ratio is 1.6. On Indeed, a recruitment website, California is one of only a handful of states to have suffered a decline in job postings since the eve of the pandemic. Tech firms, which had hired aggressively during the long period of low interest rates, are now retrenching. Silicon Valley’s downsizing has seeped into other parts of the Californian economy, with transport, financial and manufacturing companies all shedding workers.

The Legislative Analyst’s Office (LAO), a nonpartisan fiscal adviser for California’s legislature, last autumn pointed to the rise in unemployment as a potential signal of a recession in the state. The LAO’s judgment matters because it focuses on the state’s fiscal picture, which appears to be badly frayed. Last year California’s income-tax collection tumbled by 25%, similar to falls during the global financial crisis of 2007-09 and the dotcom bust of the early 2000s.

Weakness has persisted. In his budget for the new fiscal year, which begins on July 1st, Gavin Newsom, California’s governor, projected that the state’s deficit would hit $38bn. But the LAO estimates that it is instead on track to hit $73bn. A slightly different methodology accounts for roughly half of that discrepancy, but however the numbers are sliced, California’s constitution requires a balanced budget and it must find a way to close its fiscal hole.

The state has built up a rainy-day fund over the past decade, but Mr Newsom’s proposed budget will draw down roughly half of it. Other solutions have involved deferring promised funding—for universities, the homeless and the disabled. That, however, will only add to shortfalls in the near future, when the LAO projects continued deficits. “It might be easier to tell various stakeholders that the money has just been delayed, but the reality is much of it needs to be eliminated,” says Gabriel Petek, head of the LAO.

As for the outflow of Californians—the third worry—it is not new. Since the early 1990s Californians moving out have usually outnumbered other Americans moving in. But the impact of this out-migration has become more serious. In the past immigrants from abroad more than made up for the domestic outflows, such that California’s population continued to grow. The slowdown in international arrivals during the covid pandemic changed that dynamic. California has recorded an outright decline in its population for three straight years, the first sustained drop since 1850, the year it became a state.

Chart: The Economist

From a fiscal standpoint, the damage has been compounded by the wealth of those leaving. California has lost a steadily growing number of high-earning residents, with the trend accelerating at the height of covid. In 2021 California lost nearly $30bn in net taxpayer income to other states, amounting to about 2% of its tax base. And given its reliance on capital-gains taxes as a big, if volatile, source of revenue, departures of the wealthy may hurt its future fiscal position. Taken together these outflows limit the state’s flexibility in fixing its budget mess. Raising taxes would be one possible solution but doing so may just drive more rich Californians to leave.

As it stands, the overall tax burden on Californians is the fifth-highest in the country, according to the Tax Foundation, a think-tank. The one area where the state’s tax revenues are low—absurdly so—is on property because of a law, passed by popular vote in 1978, which has led to homes being assessed well below their market value. That in turn contributes to inflated housing prices in California, pushing yet more people away from the state.

Golden handcuffs
It is salutary to remember that California has experienced worse. In the early 1990s, reeling from a deep recession, more than 1m Californians left for other states. In 2000-01 a grossly mismanaged electricity market (plus Enron’s corruption) led to blackouts. In 2009 California began paying IOUs to businesses, students and taxpayers to whom it owed money. California’s unemployment rate tends to run a little higher than the rest of America’s. This partly reflects the churn of its tech sector, with firms expanding rapidly but also, when times are tough, pulling back sharply. Throughout California’s many brushes with economic trouble, its innovation-led growth model has been remarkably resilient. The state accounted for about 14% of America’s total output last year, up from 12.5% in the late 1990s (see chart 2).

“People are always judging us on past metrics. So they’re looking at what’s receding, and not enough at what is emerging,” says Dee Dee Myers, a senior adviser to the governor. She points to rising stars across different parts of the state: AI, quantum computing, space tech, immunotherapy, electric vehicles and more. California’s entrenched strengths include the largest higher-education system in the country, more national laboratories than any other state, a location that makes it the gateway for a third of America’s foreign trade and—rumour has it—some pretty nice beaches and mountains. “I also think it’s the culture of California, which often gets maligned. It’s not an accident that all these new ideas are happening here,” says Ms Myers.

Another transition is under way, with more of California’s population and, by extension, economy shifting inland. Among people who left the two biggest Bay Area cities (San Jose and San Francisco) between 2016 and 2020, five of their six most popular destinations were within California, not to other states, according to Oxford Economics, a research firm. Two of the winners were Sacramento and Stockton in the Central Valley, both less than three hours by car from San Francisco. That is spreading tech expertise more widely. “If you’ve got the talent elsewhere and you don’t need to be in San Francisco, why would you build a factory there? You can build in the greater San Francisco area, where land is much cheaper,” says Jerry Nickelsburg of UCLA.

Yet the inland migration by itself is not enough to solve California’s problems. A recent research paper by the Hoover Institution, a conservative think-tank, counted 352 firms that had moved their headquarters to other states in the four years to the end of 2021. A bevy of cost factors were, it argued, pushing them out: high taxes, high energy prices and high wages. Lee Ohanian, one of the report’s authors, thinks more of the same—a steady decay, not a crash—is in store for California’s economy. “The more you have this insidious drop, the tougher it becomes for the state government,” he says. “We have hit the wall where we really can’t get any more tax revenue without significantly damaging the economy.”

One fulcrum that could dramatically alter California’s fortunes is the property market. Housing has become more unaffordable throughout America over the past decade but California continues to claim the dubious crown as the least affordable big state. The price-to-income ratio for buying homes is 12 in San Jose and 11.3 in San Francisco, double the national median, according to researchers at Harvard University. The root cause is a lack of new housing. Mr Newsom is well aware of this and has sought to kick-start construction. Since 2017 lawmakers have passed more than 100 separate pieces of legislation to make it easier to build homes. But the results have been dismal so far. Construction permits have plateaued at about 110,000 housing units per year, far short of what California needs.

Instead, the property sector stands as an example of how California often ties itself in regulatory knots. The state has sped up its notoriously cumbersome environmental reviews for housing, especially for affordable projects. Yet to benefit from this provision, companies must demonstrate that they are using highly skilled workers at prevailing wages—a requirement that in practice compels them to hire union contractors. Alexis Gevorgian, a developer, calculates that this can increase costs by as much as 40%, turning affordable housing into a guaranteed loss-making venture. “The expedited reviews themselves are useless unless you get a subsidy from the government,” Mr Gevorgian says. One of the things on the chopping block as California looks to close its budget deficit? About $1bn of funding for affordable housing, including subsidies for developers. California is no failed state. But it certainly is a struggling one.

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Euro zone inflation, March 2025

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A man pushes his shopping cart filled with food shopping and walks in front of an aisle of canned vegetables with “Down price” labels in an Auchan supermarket in Guilherand Granges, France, March 8, 2025.

Nicolas Guyonnet | Afp | Getty Images

Annual Euro zone inflation dipped as expected to 2.2% in March, according to flash data from statistics agency Eurostat published Tuesday.

The Tuesday print sits just below the 2.3% final reading of February.

So called core-inflation, which excludes more volatile food, energy, alcohol and tobacco prices, edged lower to 2.4% in March from 2.6% in February. The closely watched services inflation print, which had long been sticky around the 4% mark, also fell to 3.4% in March from 3.7% in the preceding month.

Recent preliminary data had showed that March inflation came in lower than forecast in several major euro zone economies. Last month’s inflation hit 2.3% in Germany and fell to 2.2% in Spain, while staying unchanged at 0.9% in France.

The figures, which are harmonized across the euro area for comparability, boosted expectations for a further 25-basis-point interest rate cut from the European Central Bank during its upcoming meeting on April 17. Markets were pricing in an around 76% chance of such a reduction ahead of the release of the euro zone inflation data on Tuesday, according to LSEG data.

The European Union is set to be slapped with tariffs due in effect later this week from the U.S. administration of Donald Trump — including a 25% levy on imported cars.

While the exact impact of the tariffs and retaliatory measures remains uncertain, many economists have warned for months that their effect could be inflationary.

This is a breaking news story, please check back for updates.

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Will Elon Musk’s cash splash pay off in Wisconsin?

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TO GET A sense of what the Republican Party thinks of the electoral value of Elon Musk, listen to what Brad Schimel, a conservative candidate for the Supreme Court of Wisconsin, has to say about the billionaire. At an event on March 29th at an airsoft range (a more serious version of paintball) just outside Kenosha, five speakers, including Mr Schimel, spoke for over an hour about the importance of the election to the Republican cause. Mr Musk’s political action committees (PACs) have poured over $20m into the race, far more than any other donor’s. But over the course of the event, his name came up precisely zero times.

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German inflation, March 2025

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Customers shop for fresh fruits and vegetables in a supermarket in Munich, Germany, on March 8, 2025.

Michael Nguyen | Nurphoto | Getty Images

German inflation came in at a lower-than-expected 2.3% in March, preliminary data from the country’s statistics office Destatis showed Monday.

It compares to February’s 2.6% print, which was revised lower from a preliminary reading, and a poll of Reuters economists who had been expecting inflation to come in at 2.4% The print is harmonized across the euro area for comparability. 

On a monthly basis, harmonized inflation rose 0.4%. Core inflation, which excludes food and energy costs, came in at 2.5%, below February’s 2.7% reading.

Meanwhile services inflation, which had long been sticky, also eased to 3.4% in March, from 3.8% in the previous month.

The data comes at a critical time for the German economy as U.S. President Donald Trump’s tariffs loom and fiscal and economic policy shifts at home could be imminent.

Trade is a key pillar for the German economy, making it more vulnerable to the uncertainty and quickly changing developments currently dominating global trade policy. A slew of levies from the U.S. are set to come into force this week, including 25% tariffs on imported cars — a sector that is key to Germany’s economy. The country’s political leaders and car industry heavyweights have slammed Trump’s plans.

Meanwhile Germany’s political parties are working to establish a new coalition government following the results of the February 2025 federal election. Negotiations are underway between the Christian Democratic Union, alongside its sister party the Christian Social Union, and the Social Democratic Union.

While various points of contention appear to remain between the parties, their talks have already yielded some results. Earlier this month, Germany’s lawmakers voted in favor of a major fiscal package, which included amendments to long-standing debt rules to allow for higher defense spending and a 500-billion-euro ($541 billion) infrastructure fund.

This is a breaking news story, please check back for updates.

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