Texas vs California: Which economic model really works?

Rick Perry and Jerry Brown traded shots over California’s business climate earlier this year. (Photo Credit: Gage Skidmore (left) & Bob Tilden (right))

Originally published on Doug Henton’s blog.

There has been much debate lately about whether Texas is gaining on California in journals as diverse as the Atlantic and the Wall Street Journal.

In fact, the WSJ has made “California bashing” a regular sport. In covering the latest poaching trip by the Texas Governor Rick Perry to California, the Journal said:

“This isn’t just Texas versus California,” Mr. Perry tells me. “It’s a competition of ideologies” with Texas representing freedom and California embodying government’s ever-visible hand reaching into taxpayers’ back pockets. That said, the Texas governor has “great respect for California.” He even wants “California to succeed. It’s too important to this country’s fate. But you’re not going to get better unless you play at a higher level.”

The basic argument is the Texas low regulation/low tax, small government model is creating more jobs. Recently, a new book by Erica Grieder, former southwestern correspondent for the Economist, praised the Texas model. In her book Big, Hot, Cheap and Right: What America Can learn from the Strange Genius for Texas, Grieder makes the case that building on the early roots of Texas as an independent nation and its recent discovery of oil, Texas has created a model that combines a long standing suspicion of government with a passion for business. The results have been successful job creation, especially when others states have had difficulty recovering from the Great Recession.

Unfortunately, as reported in the Atlantic, recent facts have gotten in the way of this basic argument.

After the Great Recession, it became something of a sport to compare the relative merits of Texas’ and California’s economies: with high-unemployment, big government-loving California vs. the low-regulation, job-creating Texas.

But the Golden State now seems to be getting the upper hand:

California added 365,100 nonfarm jobs in the year ending in July 2012, a 2.6 percent increase and the state’s largest 12-month gain since 2000. Texas picked up 222,500, or 2.1 percent, according to U.S. Labor Department statistics.

But why the switch? California’s economy thrives off housing while Texas’ runs on oil. And lately, housing has been on the mend, while oil hasn’t moved much year over year.

Which model really works? Let me offer a personal perspective. Having helped Austin become a leading technology region when I worked at SRI International in the 1980s and then co-founding Joint Venture: Silicon Valley in the 1990s, I have a unique perspective on the relative merits of the Texas vs. California debate.

The Texas model is really about more than low taxes, limited regulations and small government. It is about business-government collaboration to create an innovation economy in regions, such as Austin, Houston, Dallas, San Antonio and other metro areas where they have major universities that have joined with industry to create the technologies of the future in information, medical and energy technologies.

The secret of Texas is that they have used their oil money to reinvest in their higher education system through its Permanent Fund (PUF) a Sovereign Wealth Fund established in 1876 by the State of Texas to fund public higher education within the state. Its current assets are $14 billion.

According to Erica Grieder, Texas also uses its oil wealth to fund an industrial policy:

“The secret ingredient in (Governor) Perry’s recipe for making Texas business friendly is industrial policy. In 2003 and 2005, the legislature established two funds that allocated money the governor could use to woo (or poach, if you prefer) businesses from elsewhere via subsidies and incentives. The Texas Emerging Technology Fund (TETF) was designed to steer money to half a dozen industry clusters—aerospace and defense, biotech and life sciences, and so on. The Texas Enterprise Fund (TEF) was a general-purpose pool, which Republicans called the “deal-closing fund” and everyone else called the “slush fund.” (Page 28)

So Texas’ model is about more than low taxes, it is really about investing in the future and a collaboration between industry, government and universities and using the state’s oil money to diversify its economy. The remarkable success of Austin in becoming a leading technology region is an example of the success of this model.

What about the California model? California has a different history and tradition than Texas starting with the Gold Rush of 1849. Entrepreneurs rushed to the Golden State seeking their fortunes in the gold mines and have never quit coming. California’s economic history has been the result of the interplay of successive entrepreneurial opportunities from agriculture and oil in the 19th century to movies, aerospace and microelectronics in the 20th century. This has been supported by public investment in critical infrastructure including railroads, water systems, highways, and the science and technology investment essential for winning WWII and the Cold War.

Every step of the way, entrepreneurs succeeded because of a combination of their own innovation and investment along with government support. In more recent years, federal government support of the integrated circuits and ARPNET for defense led to the semiconductor industry and the Internet in Silicon Valley, while support for NIH led to the biotechnology industry in the Bay Area and San Diego. The aerospace industry in Southern California was the product of decades of public-private investment to create a strong defense capability.

So what is the secret of Silicon Valley, the most well known example of the California entrepreneurial model? What Silicon Valley industry, universities and governments learned is that it must “collaborate to compete globally.” This became the motto of Joint Venture Silicon Valley, a unique collaboration of over 30 local governments, hundreds of businesses, four universities and several non-profits focused on promoting the economic competitiveness and quality of life of the region.

A recent book by Deborah Perry Piscione, a former member of the White House staff during the George H.W. Bush Administration and current Silicon Valley resident, traces the evolution of the Valley’s ecosystem where “meritocracy is king, collaboration and information sharing is embraced and ideas are the primary currency.” In her book Secrets of Silicon Valley, Piscione argues Silicon Valley’s framework for innovation rests on three pillars: advancement of knowledge, tolerance of risk and failure and the brainpower of its people. Entrepreneurs still come to California seeking their fortune, and the opportunities and environment continues to evolution. Underneath it all has been investment in the foundations for innovation.

In 2012, Silicon Valley grew faster than any region in the nation, and has been ranked by the Milken Institute as America’s top high tech region. So the California innovation model is still working well in Silicon Valley.

What about the rest of the state? According to the Economist, while California was hit by the Great Recession and faces structural problems at the state level, there is much that California and Texas can learn from each other.

Back in its golden age in the 1950s and 1960s, California offered middle-class people, not just techy high-fliers, a shot at the American dream—complete with superb schools and universities, and an enviable physical infrastructure. These days California’s unemployment rate is running at 11.5%, two points ahead of the national average. In such Californian cities as Fresno, Merced and El Centro, jobless rates are higher than in Detroit. Its roads and schools are crumbling. Every year, over 100,000 more Americans leave the state than enter it.

The second worry has to do with dysfunctional government. No state has quite so many overlapping systems of accountability or such a gerrymandered legislature. Ballot initiatives, the crack cocaine of democracy, have left only around a quarter of its budget within the power of its representative politicians. Not that Californian government comes cheap: it has the second-highest top level of state income tax in America Indeed, high taxes, coupled with intrusive regulation of business and greenery taken to silly extremes, have gradually strangled what was once America’s most dynamic state economy. Chief Executive magazine, to take just one example, has ranked California the very worst state to do business in for each of the past four years.

By contrast, Texas was the best state in that poll. It has coped well with the recession, with an unemployment rate two points below the national average and one of the lowest rates of housing repossession. In part this is because Texan banks, hard hit in the last property bust, did not overexpand this time.

American conservatives have seized on this reversal of fortune: Arthur Laffer, a Reaganite economist, hails the Texan model over the Gipper’s now hopelessly leftish home. Despite all this, it still seems too early to cede America’s future to the Lone Star state. To begin with, that lean Texan model has its own problems. It has not invested enough in education, and many experts rightly worry about a “lost generation” of mostly Hispanic Texans with insufficient skills for the demands of the knowledge economy. Now immigration is likely to reconvert Texas from Republican red to Democratic blue; Latinos may justly demand a bigger, more “Californian” state to educate them and provide them with decent health care. But Texas could then end up with the same over-empowered public-sector unions who have helped wreck government in California.

Second, it has never paid to bet against a state with as many inventive people as California. Even if Hollywood is in the dumps (see article), it still boasts an unequalled array of sunrise industries and the most agile venture-capital industry on the planet; there is no prospect of the likes of Google decamping from Mountain View for Austin, though many start-ups have. The state also has an awesome ability to reinvent itself—as it did when its defense industry collapsed at the end of the cold war.

The truth is that both states could learn from each other. Texas still lacks California’s great universities and lags in terms of culture. California could adopt not just Texas’s leaner state, but also its more bipartisan approach to politics and its more welcoming attitude towards Mexico. There is no perfect model of government: it is America’s genius to have 50 public-policy laboratories competing to find out what works best—just as it is the relentless competition of clever new firms from Portland to Pittsburgh that will pull the country out of its current gloom. But, to give Texas some credit, at this moment America’s two most futuristic states look a lot more like equals than ever before.

California is an economy of regions. Today, sixteen regions of California from San Diego and Los Angeles to Silicon Valley and the Redwood Coast are working together as part of the California Economic Summit to share regional innovation and develop strategies for economic competitiveness based on investment in people, infrastructure and innovation as well as regulatory reform. The search for the best economic strategy for the new realities continues. We are fortunate that we can learn from many different models. Stay tuned.