Expert View: The tech-wreck and a terminator

Private affluence and public squalor. I thought of this neat summary of modern America when the great blackout hit New York on Thursday. "How are you coping?" I asked a Wall Street friend, conscious of 9/11 sensitivities. He quipped back quickly: "Fine, I'm from California." It was a timely reminder that the "Sunshine State" gave the US an early lesson in energy dis-economics.

Private affluence and public squalor. I thought of this neat summary of modern America when the great blackout hit New York on Thursday. "How are you coping?" I asked a Wall Street friend, conscious of 9/11 sensitivities. He quipped back quickly: "Fine, I'm from California." It was a timely reminder that the "Sunshine State" gave the US an early lesson in energy dis-economics.

It may be with hindsight that we come to see the black- outs of California in 2000 and 2001 as the opening shots in the recent crisis of capitalism. It was Enron's role in bringing a little bit of the Third World to downtown LA that put the spotlight on sharp practices in the deregulated energy market. The final report on the crisis, which came out earlier this year, found 37 energy firms had engaged in market manipulation and ordered the return of $3.3bn (£2bn)to Californians.

While this crisis was an early contributor to the unravelling of the Enron puzzle, more important to Californians was that their state had suddenly became the laughing stock of the world. What was going on?

The Californians famously boast that they have the sixth- largest economy in the world, and the statistics are certainly impressive: a state with only 36 million people has a GDP that is greater than China, some $1,392bn, and contributes $111bn to US exports. And yet this huge economy is dangerously narrowly based.

For a long time this wealth was concentrated in just three industries: agriculture, defence and entertainment. So the rapid rise of Silicon Valley was welcomed as a diversifying force, and had real importance as defence spending cuts in the early 1990s began to bite.

This diversification proved illusory: the "tech-wreck" has given Californians yet another taste of boom/bust econom-ics. In the first quarter of 2001, 143,000 jobs were suddenly lost in the San Francisco Bay area and property prices nose-dived. That year, real earnings across the state contracted. Now, unemployment in Silicon Valley is calculated at 8.5 per cent and office vacancies are running at some 30 per cent.

The consequence for the finances of California have been equally dramatic. A state that just three years ago could boast a surplus of $18bn is suddenly grappling with a $38bn deficit. The Governor has had to issue an unprecedented $10.7bn deficit bond and is resorting to emergency taxes like the tripling of the vehicle licence fee. There are still fears that the state will simply not have the cash flow to get through to the end of the year.

Enter the Terminator. Governor Gray Davis is threatened with removal. As the crisis has intensified over the past couple of weeks, so it has become more plausible that he will be replaced by the film star Arnold Schwarzenegger. Further credence for this came from the addition of the "Sage of Omaha" to Arnie's team. Ace fund manager Warren Buffett is now his chief economic adviser and last week started to suggest policy. Property tax, which has been frozen since 1978, looks set for a review. It is assumed, however, given the 35 per cent rise in state spending under Mr Davis, that cuts will also be on Mr Buffett's agenda.

Lateral thinking from the unlikely Buffett/Schwarzenegger duo may produce interesting results, though let's pray we don't return to Reagan- omics. Alternatively, help may come from a more traditional direction. The Bush administration is steadily cranking up defence expenditure, and this means the balance of economic power within the state is once more shifting south, with Boeing, Northrop Grumman and TRW all based there.

As ever, what happens in California matters. Having opened this latest chapter in the crisis of capitalism, it may be that the "State of the Future" is now about to close it.

Christopher.walker@tiscali.co.uk