While California’s annual budget no longer makes the headlines that it used to make and Jerry Brown is crowing about the state being “back”, the bomb that is California’s public pensions has the state on a trajectory to fiscal ruin. This trajectory has the potential to completely remake the political landscape in California, to go along with the changing economic landscape.

Currently, the powerful public employee unions that have controlled the state government (and the California Democrat Party) have protected and expanded retirement benefits for public retirees far beyond the level of benefits available for the average California taxpayer. Over the last 40 years, the Democrats in California have controlled the state legislature for all but 2 years (when they only controlled one legislative house). What this means is that every law passed by the normal legislative process in an entire generation (California also passes laws through direct ballot initiative) was written by Democrats. Over the last 40 years, California’s Republicans have become largely irrelevant to the governing of California for a variety of reasons; an irrelevance that does not appear likely to be reversed anytime soon.

However, the coming pension crisis has the potential to at least, if not make the Republicans in California relevant, at least turn a large fraction of Democrats into fiscal conservatives in that they will have to support cuts to public pensions or see certain Republicans begin to gain a statewide hearing. Specifically, as the case of San Jose has shown in which 30% (or about $300 million dollars) is going to pay for public employee pensions, other public services that the tax paying public actually notices are going to get squeezed as pensions begin to eat up more tax dollars. In the case of San Jose, the city can’t even afford to maintain a burglary unit in its police department.

Simply put, California’s taxpayers are on a collision course with public employees, public employee unions, and the California Democrat Party as it is currently constituted. Not only will California taxpayers resent paying for lavish benefits that they themselves do not enjoy, but they will also resent paying taxes and receiving reduced public services as money is siphoned off to pay for those who are no longer working in the public sector. Even those who don’t pay taxes and consume public services will resent that there are fewer public services to consume. While the system as it is currently constructed can continue awhile longer, and while the government can attempt to stave off the inevitable by finding ways to squeeze more and more tax revenue from the population, eventually the government will become, in eyes of many people, little more than a private pension fund for lucky public employee retirees. When that point is reached, the government itself will lose legitimacy and public employee unions will not be entities that politicians will want to be associated with, as these entities will be vote-losers, rather than vote-winners. This will result in a political realignment. Whether that means a reshaping of the Democrat Party to put it more in line with political/economic realities or a resurgence of the Republican Party in California remains to be seen.

Currently, California’s business/regulatory environment can charitably be called ‘challenging’, and businesses and people (aka taxpayers) continue to leave the state. Piling more taxes on tax-paying Californians to fund existing public pension benefits while keeping public service levels constant will do nothing to alter this trend. At some point, there simply aren’t enough taxes, taxpayers, or public service cuts to maintain public pensions in their current form. The public pension ‘bomb’ is likely to ensure that the political alignment & political coalitions that exist in California 20 years from now will look much different than they do today.

As the labor market numbers have continued to be underwhelming and pundits have offered multiple theories as to why, one potential hurdle to a labor market recovery may be due to the fact that the U.S. labor market is not as flexible as many economists believe. Many on the right will point to the explosion of labor regulations to explain this, and certainly this is likely part of the story. However, another reason may be that the nature of work has changed over the decades leading to reduced flexibility, with the result that those who lose work have trouble finding new jobs and exit the labor force. At the same time, many companies are trying to find workers and can’t. In short, something strange appears to be happening.

Over the last 60-70 years, and accelerating over the last 2 or 3 decades, work has become increasingly complex. Two or three generations ago, a person with a high school diploma (or less) could go from a farm, to a factory, to a construction site, with minimal additional training. Sure, the worker might need to learn how a specific assembly line operated, but mostly the jobs required brawn and grit and also didn’t change too much.

Today, many jobs are much more highly specialized, even at what would be considered to be the lower end of the labor spectrum. For example, take a person sitting in a call center for Company A that produces and sells widgets to retail customers. The call center employee needs to have some knowledge of the business, the types of widgets that the company makes, what they do, what they can be used for, etc., to either answer the customer’s question, or to be able to direct them to the person who can answer the question. Furthermore, over time, the company may make changes to the widgets or certain regulations regarding the widgets may change, all of which the call center employee will need to be familiar with to continue to be a productive worker.

Now, suppose that the call center employee leaves after 10 years and tries to find work in another call center in a completely different industry, say a beauty products supply company. Their skills and knowledge that they obtained with the widget company (apart from working in a call center environment) are of no value to the beauty supply company. In short, this fictional person has been in a career field for 10 years, and going to a similar job in another industry means that he/she is essentially starting another career. Contrast this with a factory worker who, union rules notwithstanding, should be able to go from a car factory to a soup factory to a detergent factory with minimal additional training. In fact, one of the reasons that unions were formed was to protect incumbent workers from competition as the jobs were such a commodity that anybody with minimal training could do them.

Apart from the complexity of many seemingly simple jobs, another item that has reduced flexibility in the labor market has been the internet. With job boards like Monster.com and Careerbuilder, employers have been able to narrow in on exactly the job skills that they are seeking, rather than take on someone who has similar skills and train them in the additional skills that the employer needs. What I mean is that in the old days, the employer would put an ad in the local paper, receive a few resumes, interview a few people who kinda-sorta fit what the employer was looking for, choose one and move on with life. If you had say 3 of the 5 skills that the employer was looking for, you would probably land an interview. Today, you have to have all 5 skills just as a starting point, and even then you might not get an interview. The internet has reduced the cost of looking for an employee and so no matter what odd and unlikely combination of skills an employer may need (Master’s Degree in Economics, lived overseas, worked in the transportation industry and has agriculture experience), the employer can find someone who has it. What this does is lock people into a specific career path and makes them unsuited to any job outside of a very narrow range; in short, less flexibility. If somebody works for years in a specific career path and is let go, in many cases they are going to have to effectively start over somewhere else. This lack of flexibility means that a productive worker is likely to end up in a much less productive job, or as is becoming increasingly the case, end up being locked out of the labor force altogether.

Whatever is happening to the labor force that is causing the anemic employment numbers, part of the answer lies in a labor market that seems to be less flexible than it was. While the internet has changed the world, much as the internal combustion engine did, it is also causing massive economic disruption. While increasing economic complexity has coincided in the U.S. with increasing living standards, it appears to also have led to less labor market flexibility. It remains to be seen how this impacts the social fabric of the U.S., but the impact is not likely to be miniscule.

Recently, the RVI Group out of Stamford, Connecticut (www.rvigroup.com) put out a series of charts in their 1^st Quarter 2014 newsletter. One of the charts showed a trend for the seasonally adjusted unemployment rate (March to March) going back to 1997. A quick look at the chart reveals that the current unemployment rate is higher, 5 years after the recovery began, than it was at the depth of the 2001-2002 recession. When one considers that the unemployment number in recent years has “improved” in part due to the number of people leaving the labor force and therefore no longer considered unemployed, it is hard to shake the feeling that something fundamental has changed from an economic standpoint.

While Republicans may point to Obama’s policies as the culprit and Democrats may retort that Obama inherited an economic mess, some of the slow recovery is simply due to the fact that the recession was caused due to a financial crisis. Recessions caused by banking crisis’ are often longer and deeper than cyclical recessions. In this way, the experience of the U.S. since 2009 is not as abnormal as it may at first glance appear. That being said, the Federal Reserve has engaged in unprecedented activities aimed first at forestalling a financial collapse, and then propping up the market, all the while waiting for the economy to achieve so-called “escape velocity”.

While Obama partisans can take satisfaction the preceding paragraph, it doesn’t absolve him from the fact that his policies don’t seem to have had a really noticeable effect apart from “goosing” the numbers for a quarter here and there. In addition, as Obama enters his 6^th year as President, one cannot simply claim that the economic difficulties are currently still mostly the fault of the prior administration. At some point, one is forced to admit that whatever his economic policies were trying to achieve, this probably isn’t it.

So what HAS changed? While it is still really too early to say with any confidence, it appears that a fraction of America’s labor potential has been permanently put out of commission or otherwise seriously damaged. What I mean by this is that American productivity is not merely industrial machines cranking out products, but also the creativity, ingenuity, and industriousness of its population. While labor has been displaced by machinery in the past, overall standards of living increased as the displaced labor moved into other economically productive activities. As labor gained more and more experience in these new endeavors, it became even more productive. However, as evidenced by the decline in the labor force participation rates, the displaced labor is not necessarily being displaced into other economically productive activities. In many cases, we have people basically being forced to retire early. In other cases, others are leaving the labor market out of discouragement. In still others, college graduates are moving back into their parent’s home or they are taking “survival” jobs that do not require a college degree. None of these activities fundamentally improves the overall productivity of the economy.In addition, we now have the phenomenon of “downward mobility”, something that was largely alien to the American experience up until recently. One example of this would be a worker displaced by machinery in an industrial plant who then has to take a job flipping burgers. The worker has been displaced, but not into a more economically productive activity.

What should be clear by now is that the American economic landscape has changed to the point of being virtually unrecognizable to many who would have lived even 15 years ago. The policy makers appear to be focused on the same solutions that they would have peddled 15, 30, even 40 years ago, when the economic landscape is much different. Until policymakers let go of the past and the intellectual baggage that they carry from it, they will be unable craft appropriate policies for the new American economic landscape.