Greece-ification: Is California the Next Greece?

You’ve heard it already and you’ll hear it again: California is the next Greece.  Everyone loves the catchiness and simplicity of the analogy, but is there a real connection? A simple Google search yields countless articles with “California is the next Greece…” in the title.  There are just too many such articles to pick one to dissect and link to.   Why is this an important question?  The answer lies in the consequences and remedies of a potential policy response.

When one asserts that two ailments are the same, those two ailments should be treated with the same remedy.  Shaping the discourse around California’s troubles being the same as those in Greece allows for problem solvers to view potential solutions under a very narrow and confined  lens.   Rather than discuss the particular assertions of any one article, I went about my own analysis in search of whether Greece and California (and to some extent New York and Illinois) are really all that analogous.

In conducting this analysis, I wanted to know if there really is some sort of common theme or thread between the two–California and Greece–other than a solvency crisis and sure enough, the more I looked, the more I learned, the more it became clear that the two are very different situations altogether, requiring rather different remedies.  Let’s take a closer look to prepare for what will certainly be the next hot-button topic in this ongoing economic crisis saga.

The Similarities:

Both California and Greece are facing significant short-falls in their 2010 budgets and both need to figure out a way to close that gap in the future.  California’s right now sits at about $26.3 billion, while Greece is at a $17 billion following their recent austerity measures.  California and Greece both also have short term debt that will require rolling over into longer-term maturities.  This leaves them vulnerable to credit market risk tolerance.

To an extent, California and Greece are both federations within a larger monetary union.  California is part of the United States and the US Federal Reserve System, while Greece is part of the European Union and the Economic Central Bank zone.  Neither locality controls their own monetary policy, and neither has the power to print their way out of their respective debt crises.  As a result, they both are subject to the monetary policy actions and decisions of their respective monetary federations/unions.

The Differences:

There are several crucial distinctions between California and Greece in the economic sphere that are critical to any analysis.

Economic Might:

Greece has a GDP of $356 billion, while the Eurozone on the whole has a $13.6 trillion GDP.  Contrast that to California, which has a Gross State Product (GSP) of about $1.85 trillion, in a US economy with a $14.1 trillion GDP and it’s hard to equate the significance of Greece to California.  On the whole, California accounts for 13.1% of all productivity in the United States, while Greece accounts for a mere 2.6% of the Eurozone economy.

Whether looking at the gross numbers or the relative numbers, it is clear that California’s economic might dwarfs that of Greece.  California is a much larger economy and counts for a significantly larger share of its federation’s (the US) economy than does Greece.  In this context, size does matter.  Greece is largely inconsequential to the Eurozone in terms of its GDP output.  They do matter in terms of the sovereign contagion risk, but a significant deflation in Greece will have little impact on the Eurozone GDP.  Pain in California, on the other hand, would have a major negative effect on the United States economy on the whole at a time when the US could least afford it.

Political Structure:

While Greece is a sovereign, California is a region within a larger sovereignty.  As a result, Californians must pay federal taxes to the US government, while Greek citizens pay no such equivalent tax.  Additionally, the US government spends money in California, while no such body does the same for Greece.  Greece as a country spent well past their means.  One can assert that in light of the fact that California’s budget faces a shortfall, so too did California, but we need to look at one additional element to assess just how true this really is.

Between 1981 and 2005, Californians paid a total of approximately $4.08 trillion in federal taxes.  Meanwhile, the federal government spent a total of roughly $3.59 trillion in and on the state of California.  Altogether, Californians contributed a net total of $495 billion to the federal system.  While Californians paid more than they received from the federal government, other states received far more than they spent (all data on the tax flow to individual states comes from the Tax Foundation’s Federal Taxes Paid vs. Federal Spending Received by State report from 2007).

This problem is not unique to California.  Two other big states (in terms of population and economy), New York and Illinois also had net federal outflows of over $400 billion.  Combined, California, Illinois and New York were net contributors to the federal system in the amount of $1.31 trillion between 1981 and 2005.  While these states were net contributors, many states were net recipients.  Between 1981 and 2005, the US federal government accrued a $3.88 trillion federal deficit.  Were it not for the contributions of these Big Three States, the budget short fall would have been 33% greater.

While California has had huge outflows of funds to the federal system, Greece has had no similar economic drain.

What to do with California (and also New York and Illinois):

Yes California and Greece have superficial similarities, but in no way is “California the next Greece” other than in terms of the likelihood for a default without some form of bailout or aid.  The differences are so strikingly huge, that the powers that be should take note and attempt to anticipate a California default rather than react to one should eventually happen.  One thing we learned when it comes to Greece is that the longer one waits for a solution, the more contagious the risks become and the more expensive the solution.

Without a healthy California, it is nearly impossible for a healthy US economy.  Additionally, should California’s economic troubles persist, this would bode increasingly more difficult for net recipient states (those states who pay in less to the federal system than they receive) to continue on their present paths.  Pain in the big states in the US equates to pain in the entirety of the US.

Not only are the consequences far larger when it comes to California, so too is the economic and moral obligation greater.  It is in the interest of just about every party involved for the federal government to use its cheaper cost of capital in aiding the troubling state governments in California, New York and Illinois in realigning their respective state budgets and cleaning the slate for a solid foundation for the future.  Without helping these Big Three States, the US federal budget would look increasingly more troubling.  Sometimes you have to spend a little to save a lot.

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