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Study Sheds Light on Why State Keeps Growing Despite Poor Business Climate Rankings

SAN FRANCISCO, April 13, 2011—California fares poorly on many national rankings of business climate, particularly those focused on taxes and the cost of doing business. Yet over the past 30 years, the state’s economy has grown at roughly the same rate as the national average. What is the explanation for this California puzzle? The state’s natural advantages such as its mild climate and longer-term factors like its industry mix are more strongly associated with economic growth than the measures included in business climate rankings. This is a key finding of a study released today by the Public Policy Institute of California (PPIC).

The cross-state analysis examines relationships between business climate rankings published by a variety of national organizations and several measures of economic performance. These rankings, or indexes, are based on measures of state policies and other factors believed to affect the health of businesses and consequently, the economic prosperity of states. They have come to play a prominent role in policy debates about economic growth.

The PPIC study finds that the business climate indexes emphasizing taxes and the cost of doing business are associated with economic growth. That is, states ranking more favorably than California on these indexes do tend to grow faster. In an examination of the factors used in the indexes, the PPIC analysis identifies two that are most closely associated with growth: a smaller share of government spending on welfare and transfer payments and a more uniform and simple corporate income tax structure.

But the factors that have the strongest relationship to economic growth are not captured in the business climate rankings and are largely beyond the reach of short-term policy decisions. They include natural advantages or disadvantages, such as weather and geography. They also include industry composition and population density, which may be the outcome of cumulative long-term decisions and cannot be significantly altered in a short time by policy changes.

“California’s poor rankings on the business climate indexes focusing on taxes and costs is offset by natural advantages, particularly good weather and historical conditions,” says study co-author Jed Kolko, PPIC associate director of research. “These favorable factors enable the state’s economy to perform reasonably well. Still, our findings imply that a better business climate would promote faster economic growth in California.”

Kolko co-authored the study with David Neumark, Bren Fellow at PPIC and professor of economics at UC Irvine, and Marisol Cuellar Mejia, research associate at PPIC’s Sacramento Center.

The study, Business Climate Rankings and the California Economy, is supported with funding from the David A. Coulter Family Foundation and the Donald Bren Foundation.

ABOUT PPIC

PPIC is dedicated to informing and improving public policy in California through independent, objective, nonpartisan research on major economic, social, and political issues. The institute was established in 1994 with an endowment from William R. Hewlett. As a private operating foundation, PPIC does not take or support positions on any ballot measure or on any local, state, or federal legislation, nor does it endorse, support, or oppose any political parties or candidates for public office.

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