Introduction

California’s prosperity has long rested on shared state and federal investment in modernizing infrastructure, technology, and education. Starting in the 19th Century, state government supported large water and irrigation projects to create farms from deserts. During World War II, the federal government created the state’s aerospace and information and communications industries. And after World War II, California built a world-class and universal higher education system.

California needs to do so again to unleash and take advantage of  the coming autonomous vehicle and other revolutions. Higher rates of productivity result in higher rates of economic growth, higher incomes, and greater overall wealth in the society. Increasing productivity is the process both of moving workers from low-productivity sectors to higher productivity sectors and making low-productivity sectors more productive.

Growth, Productivity, and Exports

While the relationship between technology, productivity, economic growth, and wages has been researched for over 100 years, new economic evidence supports a stronger focus on the special role of an economy’s export sectors, of which manufacturing is an important part. In 2013, the Nobel Prize-winning economist and former dean of Stanford University’s Graduate School of Business, Michael Spence, published a paper that found the “traded sector” drove the greatest increases in growth and wages. [1]

Along with a colleague, Spence divided the economy into two parts: those sectors that export services and products, and those that do not. This traded sector, they found, constitutes about one-third of gross national product (GNP) and includes most manufacturing, agriculture, mining, energy and a significant amount of financial and other business services, while the non-traded sector constitutes the rest: health care, hotels, retail, construction, and transportation.[2]

Between 1990 to 2008, they discovered, most job growth in the U.S. came from the non-tradable sector (especially health care and government) while most of the job losses occurred in the tradable sector, mainly manufacturing. Their most surprising finding — at least for non-economists — is that the traded sector enjoyed the greatest increase in GNP and wages.[3]

Rising wealth, wages, and unemployment in the traded sector, along with rising employment and stagnating wages in the non-traded sector, help explain much of the rising social inequality we have seen in California. And these trends have only continued since the economic recovery began in 2009. The traded sector has, since that year, produced over half of all GNP gains despite constituting one-third of the economy.[4]

The reason is not difficult to understand. U.S. companies that compete in global trade have outsourced less-skilled labor to lower-wage countries. The skilled workers who remained in the traded sector benefited from that outsourcing in the form of higher salaries, while the unskilled Americans in non-traded and less-productive sectors saw their salaries remain stagnant or decline.

A California growth strategy must be aimed at increasing wage growth among low-wage individuals. Economists and analysts have long acknowledged that manufacturing plays a special role in providing high wage jobs while driving productivity. The mechanism for this is that manufacturing supports much longer supply chains and knock-on benefits than sectors such as retail and low-skill services.[5]

While California’s manufacturing sector has declined significantly, it is still the nation’s largest manufacturing sector. Manufacturing still produces 11 percent of the state’s economic output — about ten times more than the output of the state’s more high-profile agriculture industry.[6] Today, manufacturing employs eight percent of the workforce — 1.3 million people.[7]

Promoting automation supports the goal of increasing the value of low-wage labor. While replacing low-skilled McDonald’s workers with kiosks for customers to order and pay through a machine, for example, can create short-term hardship, over the medium to long-term, the substitution of machines for labor is what increases productivity, growth, profits, and wages.[8] 

This California Growth strategy can also borrow from agreements U.S. states negotiated with Japanese automakers in the 1980s and 1990s. In order to sell in the United States, foreign automakers were required to establish factories here.[9] The jobs were non-union and the wages lower than those paid by U.S. automakers in Detroit but higher than prevailing wages in the U.S. south.

Over time, thanks to training programs and reinvestment, foreign automakers were able to produce high-quality vehicles in the US at competitive prices. “Without that little “nudge” provided by the government,” Washington Post economics columnist Steven Perlstein noted, "the American auto industry might have gone the way of shoes and textiles.”

The formula for encouraging technological substitution for resources and labor is cheap and reliable energy, cheap technology (including cheap capital for investment in equipment) and moderately expensive resources and high wages — not just a high government minimum wage but also tight labor markets at the bottom. To be sure, wage increases should be phased in over time to give laggard industries like housing and agriculture the time they need to make the needed productivity investments.

Just as there is no incentive for automakers to make more fuel efficient engines without regulations, there is no incentive for agricultural, construction and other low-wage industries to substitute technology for labor when labor is cheap. Consider the American South. It owes much of its growth and prosperity to the federal minimum wage. When it was imposed, Southern farmers fought against it. But after it passed they invested in tractors and other machinery to save money on hired hands.[10] 

There was transitional unemployment among former sharecroppers as depicted in John Steinbeck’s The Grapes of Wrath. The tenant Joads were kicked off their shack by their landlord who was mechanizing farming and needed only a few workers. The Joads moved to California and, in the never-written sequel, bought homes, educated their children, and joined the middle class. Today, nobody laments the loss of chimney sweeps, match girls, and shoeshine boys, just as few regret not working as farmworkers.

Such a “rising boats” strategy means California should seek to gradually let go of low-wage jobs. Some economists note that even modest increases in the minimum wage could result in a loss of jobs in the low wage low tech restaurant and retail sectors. But even the most pessimistic economists admit that a higher minimum wage would likely motivate businesses to use technology instead of cheap labor.[11]

The obvious place for a new industrial center is the Central Valley — California’s Heartland — with its abundant and cheap agricultural land, its close proximity to California’s ports, and its abundance of relatively low-skilled workers. Most industrial clusters start on former farmlands. Steam-powered textile factories grew up among the streams in Manchester, not Covet Garden, London. Silicon Valley research labs grew up as Quonset huts on former ranch land not in the high rent districts of Cambridge and New York.

Heartland Strategy

A Heartland strategy would compete for the high-value traded sectors of the economy. A new industrial center would compete for Germany and Japan and Singapore in information technology, advanced manufacturing and biotech, not the low-wage jobs of Mississippi and Alabama.

Some of this is already happening in California’s Inland Empire near Los Angeles. Since 2011, the region added about 13,000 manufacturing jobs with a median pay of $50,500, largely thanks to Costco, Wal-Mart, Amazon and Home Depot, which located logistics and warehouse building there.[12]

This strategy would also address the housing crisis. While government must remove barriers to more housing in the cities, it must also seek to expand housing in California’s heartland, while competing for the factories that supply large multinational firms such as Boeing, Apple, and Toyota.

California must offer these firms the infrastructure and incentives they need to locate in California’s Heartland, and not in competitor states of Texas and Utah. “Streamlining the regulatory and permitting processes and removing financial disincentives on capital investment,” the California Manufacturers and Technology Association concluded, “could make California a more attractive destination for growing companies.”[13]

 Competing for key sectors requires targeted support for companies to relocate to California’s interior, where land prices are lower. These supports should be tied to California’s system of higher education, as well as high school vocational educational, with oversight by the companies for training workers and apprenticeships.

Texas has achieved this strategy successfully. Its largest export is energy from oil and petroleum and second largest is electronics.[14] From automotive to aerospace manufacturing, Texas is out-competing California in the sectors that create the kinds of high-wage jobs that can sustain the California Dream for decades to come.

California can create a virtuous cycle by giving tax credits and other incentives to companies that train their workers. The case for subsidies for firms to do the training is straightforward. All firms in an industry can benefit from a skilled workforce. While training or retraining a worker, the firm is not making money and may be losing out to rivals. There is a danger that after the firm trains the worker, the worker will quit and go to work for a rival.

A significant amount of training is best led by employers, even if it involves California’s world class college and community college system. Students, workers, teachers, and professors are simply not going to know which skills they’ll need. By contrast, the employers know exactly what skills they need, since the training benefits the industry and the economy as a whole its cost should be socialized.

And because California is such a large market, it can impose local sourcing requirements on companies that sell in-state. California already imposes its own efficiency demands on automakers. It could impose local sourcing requirements on them as well.

The pro-productivity and pro-growth strategy described above could be a net positive for California’s natural environment. Humans are able to conserve natural environments when they do not need them for agriculture, which is by far humankind’s largest impact.

The key to achieving this ecological modernization is “intensification,” which is shorthand for producing more with less, and the key to intensification is cheap and abundant energy. Producing more food on less land through using modern fertilizers and irrigation allows for less productive farmlands to revert back to being grasslands and forests. Manufacturing and the creation of cities from farmlands are other examples of intensification. Such intensification requires higher inputs of energy. To avoid higher levels of pollution, this energy should come from increasingly clean sources.[15] 

[1] Sandile Hlatshwayo & Michael Spence, "Demand and Defective Growth Patterns: The Role of the Tradable and Non-tradable Sectors in an Open Economy," American Economic Review, 104(5): 272-77,  May 2014.

[2] Ibid

[3] Ibid

[4] Ibid

[5] Alexander Hamilton,  “Report on Manufactures,” 1791; Michael Lind, “Land of Promise: An Economic History of the United States,” Harpercollins, 2012;  Ha-Joon Chang, “Kicking Away the Ladder: Development Strategy in Historical Perspective,” 2003;  Dani Rodrik, “The Manufacturing Imperative,” Project Syndicate, August 10, 2011;  Robert Atkinson, “Manufacturing Institutes: A Key to Revitalizing U.S. Manufacturing,” GE Reports, Jan 30, 2014.

[6] United States Bureau of Economic Analysis “Gross domestic product (GDP) by state (millions of current dollars) (2016): Regional Data: California” Last updated: November 21, 2017. The industries were selected based on the 2007 North American Industry Classification System (NAICS). The three codes selected were: All industries total, manufacturing, and agriculture, forestry, fishing, and hunting. Data is from 2016 estimates.

[7] United States Bureau of Labor Statistics, “Economy at a Glance: California: Manufacturing: July 2017,” United States Department of Labor, January 26, 2018.

[8]Jack Karsten & Darrell M. West, “Rising minimum wages make automation more cost-effective,” The Brookings Institution, September 30, 2015.

[9]Masao Satake, "Trade Conflicts between Japan and the United States over Market Access: The Case of Automobiles and Automotive Parts," Asia Pacific Economic Papers 310, Australia-Japan Research Centre, Crawford School of Public Policy, The Australian National University, December 2000

[10]Michael Lind, “Land of Promise,” Harper Collins, 2015.

[11]Grace Lordan & David Neumark, “People Versus Machines: The Impact of Minimum Wages on Automatable Jobs,” National Bureau of Economic Research (NBER) , NBER Working Paper No. 23667, January 2018.

[12] Kevin Smith, “LA County’s manufacturing jobs have been replaced by lower paying work,” San Gabriel Valley Tribune, February 22, 2017.

[13] Chang, ibid, 2012.

[14] Foreign Trade Div., Data Dissemination Branch, "State Exports From Texas,” United States Census Bureau, 2018. Accessed January 19 2018.

[15] Blomqvist, Ibid.