(FORTUNE Magazine) – Two weeks before the recall election, California corporate leaders took an extraordinary step. On Sept. 22, 30 prominent CEOs--including Craig Barrett of Intel, Carly Fiorina of HP, and David Pottruck of Charles Schwab--ran a full-page open letter in the L.A. Times and other state papers with the headline CALIFORNIA AT THE CROSSROADS. For chieftains who prefer to do their lobbying behind the scenes, the manifesto carried megabyte bite. "California," warned the heavyweights, "has become one of the worst places to do business, not only in the U.S. but in the world."

Can Arnold Schwarzenegger transform the world's fifth-largest economy from a disaster flick into a fertile land for business? CEOs who feared an apocalypse are hailing his victory. "When I woke up the morning after the election, my funk had lifted!" says Angelo Mozilo, chief of Countrywide, the big mortgage provider near Los Angeles. Indeed, companies have reason for guarded optimism. Though short on specifics, Schwarzenegger centered his campaign on a powerful, promising theme, "bringing jobs back to California." His economic team, packed with CEOs like Brian Halla of National Semiconductor and conservative economists including Stanford's Michael Boskin, are keenly aware of the burden on business.

At worst, Schwarzenegger will stop the bleeding. The Democatic legislature and Gray Davis have passed a historic raft of anti-business legislation; Schwarzenegger is certain to veto such future bills. Since the Democrats lack the votes to override his veto, their agenda is essentially dead. But halting the barrage of new laws isn't enough. "If the current scenario stays in effect, California will remain uncompetitive," warns Tim McCallion, who heads Verizon's California operations. The cost of doing business in the Golden State is now 32% above the national average, and states like Texas are poaching jobs. Countrywide just chose Fort Worth for its new servicing center, which will employ 2,000 people. Now Schwarzenegger must prove himself by rolling back or reforming a tangle of laws.

The first is workers' compensation. Since 1999, costs have quadrupled to $6 for every $100 in wages, by far the highest in the nation. Unlike most states, California pays workers' comp based not on the pay that workers actually lose but on the wages they might lose in the future. So recovering workers can return to the same paycheck--and get an extra 25% tacked on in workers' comp. By moving from California to Nevada, where workers' comp costs are 50% lower, a company with 200 employees can save $250,000 a year.

Second, unemployment benefits are scheduled to increase every year from an annual rate of $218 per worker today to $415 in 2007. By next year California will be saddled with the highest unemployment insurance rates in the U.S.

Third, in July 2004, California will start offering the first paid family-leave law in the U.S. Workers will be able to take off up to six weeks a year to care for a sick relative. While on leave, they'll collect 55% of their pay, up to $68,000 a year, tax-free. To fill the breach, employers face huge costs for training and hiring temps.

Fourth, in a bill Davis signed two days before the recall, in 2006 all companies with 200 or more employees must pay 80% of the medical-insurance premiums for workers and dependents; the burden spreads to smaller companies in 2007. That would make California the only state other than Hawaii to mandate medical benefits. The extra cost to employers: almost $2,000 a year for each of the one to two million workers who don't have benefits. "This is a one-size-fits-all program that we'd like to see repealed," says Bob McAdam, VP of government relations for Wal-Mart.

Schwarzenegger can reverse or slow the damage. The California Chamber of Commerce is considering a referendum to overturn the health-care mandate; Schwarzenegger's support could be key. His message "gets so amplified by the media that he can press Democrats on their home turf to back his reforms, or risk losing in 2004," says Chamber president Allan Zaremberg. Rescuing California will take a modern-day Hercules. Good thing Arnold is all muscle.