Key Assumptions on State’s Economy Challenged : Report: Two economists say the focus on job flight, regulations and defense cuts misses the point.

A new report on the California economy, drafted in the wake of the Los Angeles riots, challenges conventional wisdom about job flight, the state’s business climate and the effects of defense cuts on the economy.

The result is that public debate about the state’s economy has failed to address fundamental problems, focusing instead on the short-term, argue the report’s authors, economists Stephen Levy and Robert K. Arnold of the Center for Continuing Study of the California Economy in Palo Alto.

“There’s a decades-old problem of very slow economic growth and rising income inequality, and that’s the backdrop for (the violence in southern Los Angeles), as well as the backdrop for many other areas in the United States,” Levy said.

The report, to be released today, challenges three main assumptions about the state.

According to the report:

* There is little evidence to support dire warnings--from Peter V. Ueberroth’s Council on California Competitiveness and others in industry--that jobs and business are leaving California in significant numbers.

The loss of 541,500 jobs in the state since 1990 is attributable instead to the national recession, defense cuts and a sharp decline in construction, the authors contend. Relative to the rest of the country, they say, the worst job losses in California occurred in retailing and construction--two sectors that are not normally affected by business flight.

* The loss of aerospace jobs poses no substantial long-term threat to the state’s economic health, despite conclusions to the contrary by a Los Angeles County task force and others. Citing a Congressional Budget Office analysis, the report estimates that defense cuts, while important, would trim state output by only 0.5% to 1% at the peak of the decline.

* The state’s rules and regulations are not the main obstacles to business growth or improved economic performance, contrary to arguments by business leaders.

Job losses in 1971-72, the report says, mirrored those of the last couple of years--long before current environmental regulations, workers’ compensation laws and other bureaucratic machinery existed.

Rather, the main problems facing California are the same as those facing the nation as a whole: slow economic growth, rising income inequality and high health care costs, Levy said in an interview.

“We think the explanations for the current downturn are very, very misleading,” Levy said. “We think it’s flat wrong for the state to be primarily concerned with its competitive position vis-a-vis other states,” such as Arizona, Utah and Nevada.

Instead, Levy argues, the state should focus on its position relative to foreign countries, including Germany and Japan, and seek common causes with other states in developing national policies.

Focusing undue attention on business flight, aerospace jobs and regulation may divert attention from more pressing items that could aid California’s economic prosperity, the report argues.

These include:

* Boosting investment in education, infrastructure, research and development and new technology.

* Improving the quality of life in the state by relieving traffic congestion, high housing prices and pollution.

* Pushing for national policies aimed at helping workers cope with structural changes in the economy.

* Reducing health care costs.

Business leaders--led by Ueberroth, who is chairman of the Rebuild L.A. task force--have argued that the state’s high workers’ compensation costs, tangled regulatory environment and other stumbling blocks have prompted businesses to flee to neighboring states.

But Levy and Arnold--while agreeing that workers’ compensation reform and other suggested measures would be valuable--dispute the business viewpoint.

“No one has been able to produce a list of companies that have left California for business-climate reasons that would account for as much as 5% of recent job losses,” the report said.

Richard D. C. Whilden, project director for the Council on California Competitiveness, took issue with the report. In hearings across the state, he noted, the council repeatedly heard stories of excessive regulation and costs driving businesses away.

Levy and Arnold also argue that the effect of defense cutbacks has been overplayed as a factor in the state’s economic future.

Defense spending now accounts for less than 8% of gross state product, compared to more than 14% in 1967, the report said. Defense jobs make up only 3.5% of total jobs, compared to 8.2% in 1967, it added.

In its projection of devastating job losses, the report said, the Los Angeles County task force failed to consider that money cut from defense contracts would be spent elsewhere, offsetting the loss of jobs. Even if the money were used simply to reduce the federal deficit, the result could be lower interest rates and an increase in investment, productivity, output and jobs, Levy and Arnold write.

“Past experience and numerous studies show (that) cuts in defense are a challenge that can be met,” the report says.

But Gary Conley, president of the public-private Economic Development Corp. of Los Angeles County and a member of the aerospace task force’s staff, said the impact of defense cuts cannot be overstated.

“They are very significant, because they threaten the entirety of the high-technology industrial base,” he said. “And to minimize that impact is to ignore the devastating impact the loss of manufacturing has had on other communities throughout the country.”