California's economy is now 4th largest in world... or is it?

Michael Hiltzik, Tribune News Service

Forget the wildfires, earthquakes, water shortages and all the other factors that place the California dream in doubt, according to pundits. Gov. Gavin Newsom has some good news, citing federal and international statistics: California has just moved up a notch to become the world’s fourth-largest economy. That happened because the state’s gross domestic product was measured at $4.1 trillion as of the end of 2024, eclipsing Japan ($4.02 trillion). All that stands between California and the top spot are the United States ($29.18 trillion), China ($18.74 trillion) and Germany ($4.65 trillion). “California isn’t just keeping pace with the world — we’re setting the pace,” Newsom declared in announcing the latest figures from the Bureau of Economic Analysis and the International Monetary Fund. “Our economy is thriving because we invest in people, prioritise sustainability and believe in the power of innovation.”

Newsom made some good points in his announcement, citing the state’s national leadership in high technology, agriculture and access to venture funding, among other spheres. But he also voiced a cautionary note about the Trump administration’s “reckless tariff policies,” which are already pointing to a steep downturn in imports landed at the ports of Long Beach and Los Angeles. Word of California’s somersault over the fading Japan generated coverage in newspapers coast to coast, cable news and even as far afield as the BBC. None of this reportage, however, addressed the most pertinent question about the feat, which is: So what? Some of the reports did qualify California’s ranking, by acknowledging that it would be germane if California were a country, not a state. But they didn’t go very deeply, if at all, into why that should make a difference. So let’s take a closer look.

Californians do take pride in the state’s economic potency. While I traveled around the state recently, giving talks to promote my newly published book about California’s history, it was a rare stop where I didn’t get a question about whether California should secede from the union in order to inoculate itself from the depredations of the Trump administration. I gave a short answer and a longer one. The short answer is that the issue of whether a state can secede was settled, permanently, in 1865. The long answer is that California, for all its economic primacy, is not only tightly bound with the entire domestic U.S. economy, but its role in international trade is also dependent on federal trade policies — for good or ill. We can see the effects of that at the ports — traffic grew by leaps and bounds over recent decades due to the explosive growth in trade with China and Southeast Asia, even though it’s currently threatened by President Donald Trump’s preposterous tariff war.

Despite its size, California has discovered that it can’t go it alone on many important goals. The state was unable to enact its own universal healthcare insurance system, a goal of then-Gov. Arnold Schwarzenegger. It can’t finance its state-level health programs without billions of dollars annually in federal funding. In normal times, its universities are the largest recipients of federal research grants. (Never mind that those are threatened by Trump — he won’t be around forever.) In February, Newsom asked Congress for nearly $40 billion in emergency funding for relief in the wake of January’s devastating Southern California wildfires. One reason for circumspection is that the international rankings are notoriously squishy. They’re dependent on numerous factors that may have less to do with economic growth as such than with factors such as currency exchange rates. Indeed, the main factor in California’s leapfrogging over Japan was the decline in the yen’s value against the dollar, an artifact of the Bank of Japan’s decision to maintain low, even negative interest rates.

Since national GDP is typically calculated in dollar terms, that hurt Japan in relation to its nearest rival in the rankings, Germany — even though Japan’s growth rate in GDP in recent years has actually exceeded Germany’s. Nothing about all this ensures that some combination of factors in California or the rest of the world won’t rejumble these rankings, perhaps to the state’s disadvantage. The last time I wrote about California’s international ranking (in 2003), most news reports placed the state fifth, but some placed it sixth or even seventh. At that time, China didn’t rank in the top fifth, though it was scuttling upward. The year before, California had fallen to sixth from fifth because of currency fluctuations. Another source of squishiness is the disconnect between raw GDP figures and the standards of living in individual countries. “While California enjoys a high GDP, it dissipates the effective purchasing power through high and increasing costs of living,” the California Center for Jobs and the Economy observed after the latest announcement. Adjusting California’s GDP for the purchasing power of its residents, the center calculated, would drop California’s ranking all the way down to 11th, behind Japan (fifth), but also behind Russia, Brazil and Indonesia.

For those reasons, it may make more sense to measure California’s economy against those of other states. In that respect, at least, everyone occupies a similar playing field — same currency and same trade policies — which allow us to better examine the states’ differences in tax rates, export goods and social environments and try to judge their effect on economic growth. There, however, we run into trouble assessing how those factors actually do affect growth. That’s because those assessments tend to be encrusted in partisan ideologies. Consider a couple of state rankings based on their supposed friendliness to business: the “Best and Worst States for Business” published by Chief Executive Magazine, and the ALEC-Laffer State Economic Competitive Index, published annually under the title “Rich States, Poor States.” Both rosters purport to explain why some states grow faster than others. Neither does a very good job of it. In fact, both are very bad at it. The Chief Executive rankings are based on, naturally enough, a survey of more than 650 CEOs and business owners. In the 2025 edition, Texas and Florida rank first and second, and California ranks 50th. Third and fourth are Tennessee and North Carolina.

The top-ranked states earned their positions in part by having right-to-work (i.e., anti-union) laws and low corporate tax rates: Texas has no corporate tax at all, and the others range from a maximum of 2.25% (North Carolina) to 6.5% (Tennessee); Texas, Florida and Tennessee don’t tax personal income. California is dinged for not being a right-to-work state and having notoriously high taxes — a top rate of 8.84% on corporate income and 13.3% on personal income. The ALEC-Laffer index is more granular. Its top five states, in order, are Utah, Tennessee, Indiana, North Carolina and North Dakota, with Texas at No. 9 and Florida at No. 15. California is down in the dungeon, at No. 47, besting only New Jersey, Vermont and New York. What do the index authors look for? Utah has a top tax rate of only 4.55% on personal and corporate income, no estate tax, a rock-bottom minimum wage of $7.25 an hour and a right-to-work law. Texas, in addition to having no personal income tax or estate tax, has a $7.25 minimum wage and a right-to-work law. Florida gains by having no personal income or estate tax and a right-to-work law, though it’s punished a bit for having a $13 minimum wage.

One assumes that the authors of the ALEC-Laffer index, including conservative economist Arthur Laffer himself, held their noses in laying out California’s dismal business environment. There are those sky-high personal and corporate tax rates (though California charges no estate tax), a minimum wage of $16.50 and no right-to-work law. If these rankings are of any value at all, they should be reflected in economic strength. They’re not. In fact, as I’ve reported in the past, there’s a negative correlation between a state’s ranking in the ALEC-Laffer index and its economic growth. Economist Menzie Chinn of the University of Wisconsin noticed this a few years ago, prompting him to label the index “a manifestation of faith-based economics.” (I asked Laffer to comment on the gap between the index and reality, but didn’t hear back.)