California could soon rise to the world's 4th-largest economy, surpassing Germany

By Grace TooheyStaff Writer

Nov. 2, 2022 Updated 7:07 AM PT

California has long faced criticism for driving away businesses and workers, due to high taxes and prices and tough regulations.

A few high-profile business titans have loudly departed, most notably Tesla and SpaceX Chief Executive Elon Musk, who moved Tesla’s headquarters — and himself — to Texas during the pandemic (though SpaceX remains headquartered in Southern California).

Nonetheless, there are mounting predictions from some economists that the Golden State could soon surpass Germany to become the world’s fourth-largest economy.

Moving from the world’s fifth- to fourth-largest economy would be another step up for California — which would trail only the U.S., China and Japan. But some economic experts say the expected bump may have more to do with Germany’s struggling economy and the falling value of the euro than California’s growth.

“The U.S. as a whole over the past decade grew a bit faster than Germany, and California grew faster than the U.S., on average,” said David Zeke, a USC assistant professor of economics. “So you have that growth trend there. But the reason why it might happen next year is because of this 15% depreciation” of the euro.

California would probably topple Germany because of its “relatively resilient” economy, even during the pandemic and amid high inflation, according to a recent Bloomberg opinion piece. The piece analyzed California’s and Germany’s past and projected gross domestic product, which in 2021 measured $3.4 trillion and $4.2 trillion, respectively. The Bloomberg analysis forecast that this year and into next, California’s GDP would continue to grow slightly, while Germany’s would shrink, allowing California to take the lead.

Eugene Cornelius, senior director at the Center for Regional Economics at the Santa Monica-based Milken Institute, said he found Bloomberg’s prediction on target and expects California to surpass Germany in economic size soon, if it hasn’t already.

“I think this was the best kept secret,” Cornelius said. “Everybody was focusing on the California exoduses, the wildfires, the earthquakes and everything that was negative going on, but I don’t think anybody was paying attention to the growth.”

Although Gov. Gavin Newsom quickly touted the prediction as a sign of California’s prosperity, some experts note the metric is just one measure of California’s economy. It fails to take into consideration important factors such as housing affordability, income inequality, cost of living and wealth distribution, all key areas in which California has continued to struggle, making it difficult for middle- and low-income families to thrive in many parts of the state, according to economic experts.

“California GDP being pretty big doesn’t mean that your median [person] in California is necessarily better off,” Zeke said. “It just means the aggregate economy is more important, is larger, compared to other large economies.”

So, what is GDP?

GDP stands for gross domestic product and is an economic data point that is “widely used as a reference point for the health of national and global economies,” according to the International Monetary Fund.

“It counts all of the output generated” in a certain geopolitical region, such as a country or state, according to the IMF.

GDP measures the monetary value of all final goods and services produced in one jurisdiction during a specific period, often quarterly or yearly. GDP can be measured by taking into account inflation, called “real GDP,” or population, called “GDP per capita,” but most basically is measured in nominal GDP — simply the value of a region’s outputs at current prices. This is the measurement used in world rankings in which California is compared with other countries.

“This is just a statement about the aggregate scale of the California economy,” Zeke said, noting the nominal GDP doesn’t look at inequality or wages. “That’s not a statement about the welfare of the average Californian, ... that’s a completely different measure.”

Why is California in a position to surpass Germany?

California businesses in the last year have outpaced German companies, especially in three of the state’s top industries: technology hardware, media and software, according to Bloomberg editor in chief emeritus Matthew Winkler. But he also noted the state’s strides in renewable energy — a sector that Winkler said has been the “fastest-growing” in recent years for both California and Germany.

“The margin of Germany’s nominal GDP of $4.22 trillion over California’s $3.357 trillion last year was the smallest on record and is about to disappear,” Winkler wrote in the piece.

Other economic analysts pointed to California’s low unemployment rate, strong entrepreneurial spirit, sustained tourism and development, as well as government spending that has helped mitigate potential economic stressors.

“California has a really innovative economy,” said Irena Asmundson, a research scholar at the Stanford Institute for Economic Policy Research. “We have strengths and a lot of different sectors, it’s not just technology. ... And we continually try to invent the things that are going to make a difference in the future.”

She pointed out that California is home to the nation’s largest manufacturing hub as well as a huge agricultural sector, though it accounts for only a fraction of the state’s overall GDP — all points she said makes California’s advance in rankings “a very real possibility.”

She noted that when California’s economy surpassed the U.K.’s in 2017, it required a strong and resilient California, but challenges in Britain played a more prominent role.

“The U.K. was a very similar situation, and the exchange rate moved a lot after Brexit,” Asmundson said, referring to Britain’s exit from the European Union in 2020. “It’s not as though this is all California innovation, it’s also partially those external factors.”

Although Winkler mentions in his analysis that “Germany, of course, has been severely impacted by the war in Ukraine,” many experts say that aspect of the equation was heavily downplayed in the probability that California will surpass Germany.

“It is true that California’s GDP has grown slightly faster annually than Germany’s over the past decade,” Zeke said. “But what’s really dramatic recently is the deterioration of the euro versus the dollar.”

When could California move to No. 4?

Winkler said that some of Bloomberg’s “estimates suggest the state may have already caught Germany, with at least one forecast implying California is ahead by $72 billion when considering the state’s recent growth rate.”

Figures on GDP won’t be published until spring next year to confirm any projections, but most of the experts who spoke with The Times agreed it was likely to occur, if not this year, by the end of 2023.

“It’s likely to occur now because Germany is going to be growing a lot slower, it appears, than California will over the next year or two,” said Mark Schniepp, director of the California Economic Forecast, an economic consulting firm.

But leaders at the California Business Roundtable, a nonprofit that often criticizes the regulations imposed on state businesses, were not convinced the Golden State would usurp Germany in the rankings. In the group’s “fact check” of Bloomberg’s data, its analysts showed more conservative projections for 2023, in which the gap between California and Germany would further shrink but not flip.

What does being the fourth-largest economy mean for California?

Robert Lapsley, president of the California Business Roundtable, said a higher ranking for California is an indicator of “the health of the state as a whole,” though he doubted it would become a factor in most businesses’ decisions about moving or growing in California.

“It is an important point to be able to understand where our economy fits in from a global perspective, and to be able to try to understand what are the strengths of our different sectors, and then how can we continue to help them grow,” Lapsley said.

Cornelius, with the Milken Institute, said it may not factor directly into a company’s decisions, but it could slowly change how industries move forward.

“I think it means that we will have access to even more talent,” Cornelius said. “This will make California more marketable.”

As for continuing to drive manufacturing or green standards, Zeke said moving up in world rankings increases California’s power to do so.

“The bigger California is, ... the more likely companies will try to create a product that meets the California requirements,” Zeke said. “I think for being a center of trade, for being a place that attracts business, being big can be helpful.”

Schniepp said a new ranking for California most basically “puts things in perspective” about the size of California’s economy. In his mind, it’s “just a ranking,” he said, calling GDP “an elusive, ethereal” concept that isn’t relevant to the average Californian.

What is missing in GDP rankings?

The GDP ranking doesn’t take into consideration issues such as cost of living, high taxes, poverty and unemployment, which some experts say are still big problems for California.

Looking just at nominal GDP ignores the very real concerns that average Californians and business owners face, Lapsley said. “We would like to catch Germany, we are ideally making progress on Germany, but the bottom line is that we have some major issues,” he said.

The California Business Roundtable did a separate analysis, taking into consideration parity in pricing — or cost of living — which showed California well behind Germany, at No. 11 on the world stage.

Zeke agreed that such a massive data point as GDP doesn’t take into consideration factors such as poverty, unemployment, inequality and population changes — which are also important to consider.