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Recovery Continues But Japanese Stay Home

Japanese travel to the Islands has collapsed for the second time in 18 months. This time, the war in Iraq was the proximate cause, but concerns about Severe Acute Respiratory Syndrome (SARS) and the perennial weakness of the Japanese economy also played a role. While strength in the U.S. market has supported a healthy tourism recovery on the Neighbor Islands, Waikiki continues to struggle.

Despite the mixed tourism picture, the Hawaii economy is performing well. Income growth has rebounded in the post-Sept. 11 period, buoyed by nontourism strength in government, construction and financial services. Also, a bona fide job market recovery has taken hold. Local sources of strength will continue to propel the economy forward over the next year.


Recent Developments
The past year met or exceeded expectations as the economy regained ground lost after Sept. 11. The visitor industry made a substantial recovery in 2002, although expectations for 2003 were dealt a blow by the growing anticipation of war as well as the unexpected slowing of the U.S. and global economies. With interest rates at 30-year lows, the housing market continued to power ahead.

Notable developments over the past year include:

• The number of payroll jobs has signaled a solid turnabout from the events of Sept. 11 and the 2001 national recession. The number of filled jobs hit an all-time high in December and this trend has continued into 2003. Meanwhile, the unemployment rate dropped to a seasonally unadjusted 3 percent in February, its lowest level in more than a decade, before rebounding moderately to 3.8 percent in April.

Payroll Job Forecast
Source: UHERO

• Visitor arrivals finished 2002 much improved, but still lagged pre-Sept. 11 levels. By February 2003, amid war talk, the number of Mainland visitors began to fall back a modest 5 percent compared to the year before. Japanese arrivals fell 30 percent with the outbreak of hostilities and even further in April. Both Japan Airlines and Northwest Airlines made flight reductions that guaranteed weak Japanese arrivals throughout the spring.

U.S. Visitor Forecast
Source: UHERO

Japanese Visitor Forecast
Source: UHERO

• Real personal income continued to post impressive gains, rising 3.8 percent in 2002. The financial services and construction sectors grew strongly, bolstered by record low interest rates. Construction income finished the year more than 10 percent higher. Income of state and local government employees also rose. The transportation and hotel sectors, and, to a lesser extent, retail, continue to bear the brunt of the struggling visitor market. Personal income in the hotel industry was down several percentage points, and income in the retail sector was flat. • The housing market remains strong. Early this year, the Oahu resale market for condominiums reached its highest level since 1990. The number of units sold and the median price were up 21 percent and 15 percent in May compared with last year. Single family home resales are still rising but more moderately with May sales and median price up 7.1 percent and 1.4 percent.

Real Income Growth
Source: UHERO

• The value of private building permits rose throughout 2002, peaking at $254 million in January of this year. In real terms, the fourth-quarter 2002 permit value rose 31 percent from fourth quarter 2001. Private residential permits also rose dramatically in 2002, closing the year 42 percent higher in real terms than fourth quarter 2001.

• Honolulu inflation has remained tame, in line with developments on the U.S. mainland. Higher energy prices in recent months will likely lead to some upward movement in overall prices for the first half of this year.

US vs Honolulu Inflation
Source: UHERO


The Year Ahead
Despite familiar troubles for Japanese tourism, the local economy displays considerable health. Some fallout from the Japanese tourism slump may yet be felt on Oahu, but indications are good for continued expansion in aggregate Hawaii jobs and income.

The end of war in Iraq removes one impediment to global economic recovery. Now the question is whether there is sufficient underlying strength in the U.S. economy to move beyond the meager growth we have experienced so far in this recovery. The Federal Reserve has signaled a willingness to provide further stimulus if current labor market weakness does not rapidly abate. Either way, our expectation is for gradual strengthening of the U.S. economy over the coming months, but probably not a sharp acceleration. As a result, U.S. arrivals will remain firm, but grow only moderately from here.

We are not optimistic about prospects for recovery of the Japanese market. The recently announced restoration of Japan Airline flights is certainly good news, but it is too early to tell how visitors will respond. With economic factors showing weak expansion at best, Japanese visitor counts will take some time to reclaim past levels. We expect Japanese arrivals to end the year 13 percent lower than in 2002.

This implies another relatively weak year for the Hawaii visitor industry overall, but tempered by U.S. visitor momentum. We expect U.S. arrivals to rise just 2.5 percent for 2003 as a whole, climbing back toward record levels. After their big fall this year, Japanese arrivals will post an impressive-looking 26 percent rise in 2004, as recovery finally sets in, but this will still leave Japanese arrivals below year-2000 levels.

The job market's newfound strength is expected to continue. There may be more job losses this summer in tourism-related areas, but growth will continue in service areas, including business services, healthcare, finance, real estate and related fields. On the strength of permit numbers, construction is expected to add another 7 percent new jobs in 2003. Overall, we expect a 3.1 percent rise in payroll jobs in 2003, and 2.4 percent in 2004. The unemployment rate will remain in its current 4 percent range.

The real income growth pattern will largely follow that of payroll jobs, and aggregate income will expand 3.6 percent this year. Income growth is likely to cool slightly in 2004, partly because gradually rising interest rates are expected to cause substantial cooling - but not declines - in income in construction, finance and related areas. Inflation will build modestly, as the effects of rising home prices, rents and higher energy costs work their way through the local economy.

Conclusion and Forecast Risks
This is a fairly upbeat forecast, in our opinion one that is well founded, considering the excellent performance and prospects of key nontourism sectors. Japan will continue to be a drag on tourism, offset to some degree by a healthy U.S. market. Of course, not all areas or sectors will share equally; this is likely to be a poor year for Waikiki. The same can be said for sectors such as telecommunications and transportation, which are struggling to climb back from deep cyclical downturns.

With major conflict in Iraq apparently over, there remains considerable uncertainty about geopolitics in the near term. The recent terror attacks in Saudi Arabia-and others that were apparently thwarted-remind us that terrorism remains a threat. Uncertainty carries over to the economic sphere. A U.S. economy that was clearly on the mend a year ago has now faltered. Continued expansion depends on a revival of corporate optimism that is not yet evident. Japan's woes are familiar and deep and provide little room for optimism.

Hawaii can celebrate the rare occurrence of a local economy that by many measures is outperforming the nation as a whole. We must hope that conditions in the rest of the world permit this good performance to continue.

For more on the UHERO forecast, go to www.uhero.hawaii.edu

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