2007 Economic Report: Slowdown, Not a Meltdown

August, 2007

By Carl S. Bonham and Byron Gangnes, University of Hawaii Economic Research Organization, www.uhero.hawaii.edu

Hawaii tourism has had a poor start to the year. And with U.S. economic conditions relatively weak, gains for the rest of the year will be limited. As a result, the visitor industry is expected to post its second consecutive year of zero growth. Construction slowing continues, although a late surge in nonresidential activity will help to moderate the cycle. Deceleration in the broader economy will proceed in the face of still very tight local labor markets.

Hawaii’s Recent Economic Performance

After reaching a plateau in 2006, the visitor industry started 2007 with a weak first quarter. Mainland U.S. visitor days were flat, due to meager arrivals growth (1.4 percent) and a slight decline in the length of stay. Japanese visitor days fell 7.4 percent, continuing a pattern of losses for that market. Visitor arrivals from markets other than the U.S. and Japan were down 4.5 percent. The continued slowdown in all markets caused total visitor arrivals to drop 1.1 percent and visitor days to decline by 2.2 percent. The 2.2 percent growth in visitor expenditures continued to lag behind inflation, implying moderate year-on-year declines in inflation-adjusted real spending.

Visitor industry troubles this year have been centered on Oahu and Maui, where visitor days fell 4.3 percent and 2.2 percent, respectively, in the first quarter. In contrast, the Big Island saw 3.4 percent growth in visitor arrivals and a surge of 12 percent in total expenditures. Kauai saw perhaps the strongest visitor performance of all islands, with arrivals up 10.8 percent, visitor days up 4.4 percent, and total expenditures 7.2 percent higher. Like the Big Island, Kauai enjoyed strong arrivals growth from both the U.S. market and the non-U.S., non-Japanese market.

Real (inflation-adjusted) personal income expanded by only 0.4 percent last year, a significant drop from 5.2 percent in 2004 and 2.9 percent in 2005. The decline was due in part to slower nominal income growth, but the big culprit was much-higher-than-expected inflation. It appears that real income bottomed out in the first quarter of last year, and there has been some recovery since then, to 0.6 percent growth in the fourth quarter.

Inflation surged last year, posting its biggest increase since 1991. The Honolulu Consumer Price Index (CPI) rose at a blistering 5.8 percent pace, accelerating from 4.5 percent in the second half of 2005. Core inflation (all items less food and energy) rose 5.5 percent, up from 3.5 percent in the second half of 2005. The largest percentage increases were seen in shelter costs (up 9.4 percent), and fuel costs (up 23 percent in the first half before falling back to just 5 percent in the year’s second half). Because of the heavy weight of rent and imputed rent in the typical household budget, the majority of the experienced inflation (3.6 percentage points) came from rising shelter costs.

The housing market cooled markedly in 2006, with home resales well off the pace of the previous year and prices flattening or falling across the state. First-quarter 2007 data continued to show weakness, but with reassuring signs of stabilizing prices. Oahu median single-family home prices fell from their peak of $649,000 in the second quarter of last year to $620,000 in the fourth quarter, but they firmed slightly to $624,000 in the first quarter of this year. Prices also firmed a bit in the Neighbor Island counties, but remain lower than a year ago. On Maui, median home prices were 7.7 percent lower in the first quarter than a year earlier; on Kauai, they were down 4.3 percent. Hawaii county saw a year-on-year drop of about 1 percent. Resale volume continues to languish, although rates of decline have eased, and Maui has actually seen year-on-year gains since the fourth quarter of last year.

Residential building permits were down 19.3 percent statewide in the first quarter. Commercial and industrial permits also softened after a spike at the end of last year.

The labor market remains very tight, but the pace of hiring has cooled. The average unemployment rate for 2006 was 2.4 percent, the lowest annual Hawaii unemployment rate on record. In the first quarter of 2007, the number of non-farm payroll jobs rose 2.2 percent statewide, down from the 2.4 percent rate seen in the fourth quarter of last year. Growth in employment (which includes self-employed persons) peaked at 3.2 percent at the end of 2005, and slowed to a 2 percent pace by the third quarter of last year.

The slowdown in employment growth has been shared by all islands, with first-quarter 2007 growth ranging from 1.4 percent on Maui to 2 percent on Oahu, compared with a year earlier. The statewide seasonally adjusted unemployment rate edged up from 2.1 percent in the fourth quarter to 2.3 percent in the first quarter of this year.

Economic performance by sector has been mixed. Job slowing was most evident in construction, where job growth fell from 11.1 percent in the first quarter of 2006 to 5.1 percent in the first quarter of this year, still a healthy rate of job creation. In real estate, job growth slowed from 4.3 percent to a 1 percent decline. More gradual slowing was seen in accommodation and food services, wholesale and retail trade, and professional and technical services. In contrast, transportation and utilities held up at a healthy 4.6 percent growth in the first quarter. Jobs in state and local government and health care accelerated to 2.4 percent to 2.7 percent in the first quarter.

The UHERO Hawaii Forecast

The external environment has been moderately favorable, but recent U.S. weakness is a concern. Measured by real gross domestic product, the U.S. economy ground to a halt in the first quarter. According to preliminary estimates, real GDP grew at a 0.6 percent annual rate, down from 2.5 percent in the fourth quarter. The sharp deceleration was primarily due to continuing weakness in residential investment, inventory shedding and weak net exports. Together, these sectors trimmed 2.6 percent from GDP growth. The bright spot—and one that bodes well for the rest of the year—was personal consumption expenditure, which expanded at a 4.4 percent pace.

Payroll job gains have slowed from average increases of 189,000 per month in 2006 to 129,000 per month in the year to April. (May saw an increase to 157,000 new jobs.) The unemployment rate has remained low at 4.5 percent in May.

In its May meeting, the Federal Reserve decided to keep the federal funds rate target at 5.25 percent. Concerns that inflation will fail to ease as expected have constrained the Fed from cutting rates since the middle of last year. In the first quarter, headline inflation jumped to 3.3 percent, while core inflation (which excludes food and energy) edged up to 2.2 percent. The increase was partly due to the run-up of oil prices from $55 per barrel in January to $64 in April.

We expect a recovery of U.S. growth over the remainder of the year. After 3.3 percent growth in 2006, we expect growth of 1.9 percent this year, strengthening to between 2.7 percent and 3 percent in the following two years. The unemployment rate will remain near its current 4.5 percent rate. Uncertainty about the oil price path makes inflation forecasting more difficult. We expect inflation of 2.7 percent this year, easing to 2.5 percent by 2009.

Japanese real GDP grew at a respectable 2.4 percent annual rate in the first quarter of the year, fueled by a surge in exports (13.9 percent, annualized) and strong consumption (3.5 percent, annualized). Consumer confidence and business optimism (the latter from the March Tankan survey) have been strong, both surpassing their peaks in 2004. With healthy 1.2 percent year-on-year employment growth in April, the unemployment rate fell to 3.8 percent, the lowest in almost a decade.

As evidence of price stabilization emerged early last year, the Bank of Japan raised its policy interest rate to 0.5 percent in February. However, recent readings indicate that inflation has turned negative again, with core inflation (excluding food, but including energy) falling for three consecutive months. It fell by 0.1 percent in the year to April, after a 0.3 percent decline in March. Headline inflation remained flat in April, after a 0.1 percent decline in March.

Overall, we continue to expect measured growth for the Japanese economy for the next two years, with trend slowing beginning in 2009. After 2.2 percent growth in 2006, the economy will expand by the same rate this year, slowing to 1.5 percent by 2009. There is some possibility that 2008 growth could be a bit stronger than this, if consumer spending spikes prior to the consumption tax increase expected in 2009.

For Hawaii, prospects are for continued economic growth, but with a continuation of the gradual slowing evident since mid-2005.

The pace of Japanese arrivals decline has slowed somewhat in recent months, although April showed a nearly 9 percent year-on-year decline. We expect the market to stabilize by the second half of the year. For 2007 as whole, we expect a 3.6 percent decline in the Japanese market, strengthening to about 1 percent growth in 2008 and 2009. On the U.S. side, the rest of the year is expected to be stronger than the first quarter, but with relatively little year-on-year growth. U.S. arrivals are expected to grow by less than 1 percent for the year as a whole, strengthening a little to 1.4 percent growth by 2009.

Overall visitor arrivals for 2007 will be essentially unchanged from 2006 levels, the second straight year of zero arrivals growth. Growth of 1.6 percent is expected in 2008 to 2009. Visitor days will show a slight decline this year and grow at just over 2 percent through 2009.

Occupancy rates, which averaged about 80 percent for the past two years, fell to 73.7 percent on a seasonally adjusted basis in the first quarter. We expect statewide occupancy to average about 75 percent this year and next.

Turning to the labor market, we expect that non-farm payroll job growth will slow from last year’s 2.5 percent pace to 1.9 percent this year. Further slowing toward 1.2 percent annual growth will occur by 2009. The annual unemployment rate bottomed out at 2.4 percent last year and will ease to 3 percent by 2009.

Residential construction is now clearly past its peak, and activity will continue to slow this year. The peak in nonresidential construction will come this year or possibly in 2008. The end of the current cycle will be characterized by a slow decline in total real construction spending, but continued increase in the nominal tax base as construction costs rise at a 4 percent to 5 percent rate. Construction employment and earnings will remain above 2006 levels over the forecast horizon.

For 2006 as a whole, construction jobs expanded by 7.4 percent. This compares with nearly 14 percent construction job growth in 2005. Construction jobs will grow by 4.2 percent this year, 0.5 percent in 2008, and decline by 1.1 percent in 2009.

Over the next three years, the strongest job growth will be seen in the “other services” category, which includes business, administrative, and professional services. Job growth for wholesale and retail trade and for the accommodation and food service sectors will be limited, because of the flat conditions in tourism. Finance, insurance and real estate will also slow. The healthcare sector, which had a weak year in 2006, will recover to moderate growth.

Government jobs will expand by about 1 percent per year, with relatively more strength in state and local jobs than in federal. Agriculture jobs were revised upward sharply, so that 2006 actually showed a small gain statewide. That will end this year, as Del Monte’s closing on Oahu and the end of pineapple canning by Maui Land & Pine reduce agriculture jobs by about 6 percent.

Inflation will only gradually recede from the near-6 percent level recorded in 2006. Home price appreciation of the 2000 to 2006 period continues to feed through into consumer prices, and the recent fuel price spike will also exert some upward pressure. We expect the Honolulu CPI to rise by 4.8 percent this year, gradually cooling to 3.3 percent by 2009.

Nominal income barely kept pace with the inflation surge last year, so measured real (inflation-adjusted) income suffered. Real income growth will recover somewhat this year, as market wages begin to adjust upward to reflect the higher prices. Still, this year’s projected 1.4 percent real income growth will be fairly anemic. Strengthening to near 2 percent is expected in 2008–2009.

The outlook for the Hawaii economy is for more of the same slowing that we have witnessed over the past two years. The drivers are the same: a peaking construction cycle, slower tourism growth and generally tight labor market conditions that make it difficult to find qualified workers. Inflation will gradually recede from its current high level. By 2008, the local economy will have converged to a path that is broadly consistent with sustainable trend growth.

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Carl S. Bonham and Byron Gangnes