California: Too Big Not to Fail? by Jeffrey M. O'Brien @FortuneMagazine October 21, 2009, 12:14 PM EST E-mail Tweet Facebook Google Plus Linkedin Share icons The state of the state? “A train wreck,” says one official. If the world’s eighth-largest economy were a member of the proper religious order, it’d be time to call in a priest to administer last rites. Name almost any serious malady and the state of California has it: the nation’s highest marginal tax rate coupled with an abysmal public education system; the most home foreclosures; a free-falling commercial real estate sector; lame-duck governor with no legislative support and a disdain for an annual budget process that he refers to as kabuki theater; unemployment somewhere between the official number of 12% and the whisper number of 18%; a 20% drop in year-over-year revenue; municipalities that have either declared bankruptcy (Vallejo) or are on the verge (Los Angeles); and a black-box permitting process that scares away business investment even while every week, 3,000 more taxpayers migrate to greener pastures. Californians may be a can-do lot, but faced with all that evidence and much more, the political and economic leaders who spoke at the Milken Institute’s annual “State of the State” conference held yesterday at the Beverly Hilton could hardly have been more dour. “It’s a train wreck, and it’s getting worse,” said Bill Lockyer, California State Treasurer. Added former Assembly speaker Bob Hertzberg, now co-chair of governance reform group California Forward, “A high-speed train wreck.” What’s this got to do with technology? Nothing, unless you consider that California is home to the many of the biggest tech companies on the planet (and 51 members of the FORTUNE 500), the bulk of the venture capital industry, many leaders of green-tech, two of the most patent-producing universities in the world in Stanford and UC Berkeley, and top thinkers across all spectra. “California represents 10% of the population of the United States,” said Eric McAfee, chairman of McAfee Capital and CEO of AE Biofuels. “but probably 50% of innovation.” Tech into ploughshares? Ironically, Silicon Valley has built the tools and infrastructure to allow talented people to work anywhere in the world they choose, and as the state circles the drain, the fear is that businesses, entrepreneurs, and students will no longer feel the pull of the Golden State. From a political and budgetary perspective, California has myriad problems – from Proposition 13 to direct-democracy ballot initiatives to abysmal credit ratings. But the biggest problem may be girth. The state increasingly seems too big not to fail. “States were never intended to be the size of the entire eastern seaboard,” said Hertzberg. “What is the commonality between the folks in Calexico and Crescent City? This manifests itself in a politboro style of government in Sacramaento.” None of the speakers–including gubernatorial candidates Gavin Newsom and Steve Poizner–offered a magic bullet, but there was some consensus on where to start. Many called for an adjustment to the mandate that 2/3 of the legislature must approve a budget or a repeal of term limits that seem to enslave legislatures to special interests. Others craved less (or more, take your pick) taxes and a lessened (or at least consistent) regulatory structure. Chevron’s CVX John Watson, who will assume the CEO role in January, said the permit process for an upgrade to the company’s Richmond, California, refinery took four years while an Indian company built its own entire refinery in half the time. Still others offered hope that things will somehow work themselves out–because California has been in the dumps before and that the state will continue to be a magnet for the brightest immigrants. “The combination of great science and great local universities and venture capital money started not just Genentech in 1976, but an entire industry,” says former Genentech president and current UCSF chancellor Susan Desmond-Hellmann, showing a slide of California tech companies that were either founded by immigrants or where immigrants played key roles in the early days, including Yahoo YHOO , Sun JAVA , eBay EBAY , Intel INTC , Google GOOG , Viewsonic, SanDisk SNDK , and Nvidia NVDA . “There’s something special about California: the atmosphere, the diversity, a wish to be curious and ask questions. The secret sauce behind Genentech, the Googles, Yahoos, and Amgens is the combination of entrepreneurial spirit, great universities, and a willingess to marry business and science.” Desmond-Hellman warned, however, that Genentech has remained a biotech powerhouse because it has never lost sight of where its power comes from. “We always believed that the company would be no better than the people we recruited and we keep,” she said. “We never took for granted that people had to work at Genentech. They have choices.” So do the 3,000 Californians leaving the state every week.