In 2013 I published a post titled “Is California’s Budget Endangering Silicon Valley?”. This was driven at the time by the publication of the first book by Meredith Whitney, an investor who became famous for essentially predicting in 2007 the upcoming 2008 financial crisis through her analysis of Citibank (which ended up being a prime beneficiary of the government bailouts).
Her book “The Fate of the States” outlined the case for a collapsing California and a rising Texas and middle of the country boom. That case, as outlined in my previous blog post, was basic economics: the state of California had taken on a ton of debt to provide social services and had over-promised high quality retirement benefits to pensioners which the state couldn’t afford to pay.
A reason I wrote that post is that, given I studied computer science and economics in undergrad, it overlapped with my personal interests. And the economics side of me, coming out of the 2008 financial crisis which directly negatively impacted my family, was highly skeptical of unstable systems.
That’s not to say I was opposed to moving to California, considering I applied to or interview with companies in the state in 2014, 2018, and 2020, as well as spending a couple months there in 2022 for work. But interesting job opportunities in other states always moved faster, probably because they had to for tech roles. But certainly California having a history of being poorly run didn’t make me feel FOMO about not being there because it was always at high risk of a major economic meltdown.
Now looking back at, the question is: were Meredith Whitney and I right about California?
There are two stances one could take:
- No, we weren’t right because California did not collapse in the 2010s.
- Yes, because in the 2020s, California’s reputation and economic state has been in decline and will only continue to get worse.
There is a phrase in the finance community that goes “being early is the same as being wrong”, so in practice whichever argument one would make above leads to Meredith and I being “wrong”. What did we get wrong?
Primarily we underestimated that the greatest growth industries for the country coming out of the great financial crisis would be based in California: technology in Silicon Valley and entertainment in Los Angeles.
Why did I underestimate this? Again from a finance perspective, a lot of software work could just as easily be done in any location in a literal sense (unlike most other industries which require physical facilities to produce output). So if any work was to be mobile between states, it would be software engineering, and relocating would come with tax and cost of living advantages. In fact, this is what we saw during 2020-2022 due to covid, but the option was available years earlier in the 2010s. I expected companies would’ve taken advantage of the cost savings sooner.
However, two other economic concepts overrode the simple financials: network effects and game theory. Network effects meant that all the smart tech talent and companies hiring them felt they learned and earned faster by being in the same geographic region. Game theory meant that few of those same individuals and companies would be willing to take the risk of leaving California and being the ones without the top programmers. Even if they’d save hundreds of millions of dollars short term, they don’t want to lose out on possible billions by being the “dumb” company with the lesser talent.
This consolidation of intellectual capital into coastal cities such as California has a strong connection to why we’re in the political situation we are as a country as well. The 2010s were spent building up a few major metropolitan areas in a highly leveraged fashion, hollowing out the economic gains from the middle of the country at a time when it would’ve been possible to spread them out. Not through government redistributions, but by simply having more of the smart software work done across more locations at lower tax rates. Not doing this is part of what encouraged the populist movement which gave us the Trump presidency.
Referring back to Whitney’s “Fate of the States”, she predicted that individual state finances would cause an economic boom in the middle of the country because financial logic would dictate it. She was apparently wrong about that, either in the senses I mentioned earlier of it not happening or at least hasn’t happened yet. But what happened in place of sound economics supporting the whole country was increased divisiveness in our politics because, consciously or subconsciously, people knew this process was working against them. People do not acknowledge this close link between how the economics of the country work and its political outcomes.
As a technologist, it personally felt like the Internet should’ve disrupted the coalescing of talent into a few locations because the Internet is inherently a distributed technology. I’ve always been struck by what seems like a contradiction in the tech industry: software enables everyone everywhere to contribute to the information economy, but you can only be the best at it in one valley.
Then earlier this month Pirate Wires published a piece on the “California Tax Apocalypse”, which essentially remakes Whitney’s arguments a decade later with updated data:
- California’s budget has a $36 billion deficit next year
- $150 billion of the state employee pensions are promised to pensioners but are not funded (the money doesn’t exist to pay them)
- Home insurance companies are hiking prices or not providing insurance in California altogether due to climate change risks
The primary sources of California’s revenue (66% per the Pirate Wires article) are personal income and capital gains taxes. There is a high risk that California will have to do one of a few things:
- Raise everyone’s taxes to pay for old people’s retirements, and people will probably leave the state to avoid paying the taxes.
- Renege on promises to old people and public servants that they will not get the retirement they want and they either have to accept a lower quality of life in old age or leave the state.
- Some negotiated middle ground of the first two which leaves everyone disgruntled but maybe keeps them in the state with everyone’s standard of living being lower but not so terrible as to leave.
For the folks who have succeeded in California, the strong argument in their favor the past decade has been that their income growth outpaced the cost of higher taxes, making being there a net income win. The question that the state has delayed answering is how high can they raise taxes before people will break rank and leave because the opportunity cost of not living somewhere where they can afford rent and save money is too high.
There are strong counterarguments to my stance backed by evidence. Last year, California minted more millionaires than ever before as the state’s GDP continued to grow. But most of these boil back down to the argument that computer technology is the most important driver for economic growth and as long as Silicon Valley dominates it, it can afford to pay whatever costs for the rest of society’s mistakes. Possibly, but reading it laid out that way seems like a fragile approach to running a state, let alone the entire country.
California is a very representative of the overall US fiscal debate: Can we technologically grow our way out of bad economic policy? It’s possible, as California’s success in the 2010s demonstrated. I would make the counter proposal that we could have technological improvements with good economic policy, do more intellectual work in all the states, and that would be greater for society than what we’ve been doing. Even if the prior path worked for a decade, that’s not very long in the grand scheme of history and there’s no guarantee it will continue to. Rather than playing the lottery with people’s lives and the national politics, we could all make smarter decisions and create a more optimally effective and sustainable society.
Logan Frederick 