By Junfu Zhang, research fellow, Public Policy Institute of California
This opinion article appeared in the San Diego Union-Tribune on September 24, 2003

In a recall election fueled by California's sagging economic fortunes, bewailing the state's inhospitable business climate has become the mantra of many candidates. They view many of California's regulations, fees and taxes – as well as its soaring energy costs and assorted forms of compensation – as responsible for driving businesses into the low-cost clutches of other states.

But despite all the politicking, there is very little solid information to confirm whether or not California is really driving businesses away. The reality is that no state agency tracks business movements, and policy-makers generally rely on anecdotal evidence to support their arguments about business relocation.

There is also a more fundamental issue: Is business relocation the only or best measure of the state's business climate? The claims about fleeing firms virtually ignore how hospitable California is for the creation of new firms. Policy-makers are in serious need of systematic information.

The reality of California's business climate is far more complex than the rhetoric might suggest. While it's true that many firms have moved out of California, others have moved in. Moreover, throughout the 1990s, many more firms opened and closed within the state than moved into or out of it. In other words, it was the "vitality" not the "mobility" of firms that drove fluctuations in the labor market.

In a recent study of Silicon Valley's industry dynamics by the Public Policy Institute of California, we examined both directions for relocation between 1990-2001 and found that Silicon Valley is indeed losing business establishments (stand-alone firms or branches or subsidiaries of firms) to other states. During those years, 844 establishments moved from Silicon Valley to locations outside California, eliminating 22,534 jobs in the region.

However, firm relocation was not a one-way street. During the same period, 398 establishments moved into Silicon Valley from outside California, adding 10,441 jobs to the region, cutting the net job loss from relocation nearly in half.

Although out-moving establishments are most likely to go to California's neighbors such as Oregon and Nevada, those moving into Silicon Valley are most likely to come from New York and Massachusetts, states with strong high-tech economies. Moreover, business establishments moving out are different from those moving in, and are moving for different reasons. The evidence shows that Silicon Valley is more attractive to young high-tech start-ups than it is to mature non-tech firms.

In separate research, we examined the dynamics of California's biotechnology industry and found very similar relocation patterns: More biotech establishments left California than arrived between 1990-2001, and those moving out of California tended to be older.

What do these studies tell us overall? Although more businesses moved out of California than moved in, two developments mitigate the negative effect on the state economy.

First, our analysis of Silicon Valley shows that newly formed businesses overwhelmingly outnumber businesses lost to relocation. Between 1990-2001, for every business Silicon Valley lost to other states, nearly 150 new establishments were created, which was more than enough to compensate.

Second, although more establishments move out of the state than move in, the long-term net effect on the economy may not be negative. In the biotech industry, despite the fact that more firms left California than arrived, the ones that moved in hired 4,049 employees by 2001, more than twice the number (1,181) that had been employed by those who moved out.

The concern over California losing businesses to other states is certainly legitimate, but it must be understood in a broader context of industry dynamics. We need to look at the complete picture of firm relocation and creation. Firms are leaving California, but others are coming, and many new ones are being created. In this context, policy-makers might address business relocation in three ways:

First, state and local governments could consider ways to encourage and facilitate new firm formation and growth.

Second, although there are legitimate concerns about these policy levers, state and local governments may want to look into ways of improving the business environment through tax breaks and by supporting some deregulation. Several proposals have already emerged in the Legislature seeking to restructure state tax incentives to keep companies in California.

Finally, state and local governments could help reinforce the comparative advantages that attract businesses to California in the first place. The state has a diverse economy, a high-quality labor force, a culture that encourages innovation and entrepreneurship, a lifestyle that is alluring to all sorts of talented workers and a geographic proximity to the fast-growing Asian economies. Efforts to promote these positives could enhance California's appeal for potential businesses.

Whatever the outcome of the recall, discussions of California's business climate could use a little more substance and far fewer sound bites. The state's economic realities simply defy common definitions. Those realities – as well as potential fixes – are complicated by our unique nature, but understanding and bolstering the state's real business climate remains central to our economic vitality.