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Hawaii Outlook

The Hawaii economy continues to grow strongly. A hot housing market, healthy Mainland tourism and buoyant construction spending support expansion in jobs and incomes, despite a less-than-complete recovery of the Japanese tourism market. Even with high oil prices and rising interest rates, global economic conditions will continue to contribute to growth. Military housing renovation will add to construction in the pipeline, maintaining a high level of construction activity, as well. All these factors add up to a very positive outlook for the state for the next two years.

Hawaii Economic Indicators
(Annual Growth Rates by percent)
 
2001
2002
2003
2004
2005
Total Visitor Arrivals
-9.3
-1.4
-0.6
6.3
5.1
U.S. Visitor Arrivals
-4.5
2.8
2.9
5.0
1.9
Japan Visitor Arrivals
-15.9
-3.0
-10.6
11.9
15.4
Payroll Jobs
0.7
0.3
1.9
2.0
2.0
Employment
2.2
-1.8
1.9
2.4
1.1
Inflation Rate, Honolulu MSA(%)
1.2
1.0
2.3
3.2
2.9
Real Personal Income
0.8
4.4
2.5
2.8
3.6
Source: UHERO. Figures for 2004–2005 are forecasts.

Recent Developments

In the past 12 months, Hawaii has shrugged off the tourism disruptions from early 2003 and maintained robust economic growth. Interest-rate-sensitive sectors have been a big part of this, with rapid new construction, healthy auto sales and home resales. Home sales have boomed, and prices have followed suit.

External conditions have also turned out better than they looked in early 2003. After a year that saw the buildup to the Iraq war and the onset of severe, acute, respiratory syndrome (SARS), economic conditions in both the United States and Japan have improved. Higher fuel prices and the overseas deployment of Hawaii-based U.S. forces have acted as a restraining force.

Hawaii's economic expansion continues to be mostly home-grown. Growth is now increasingly broad based, touching nearly every sector of Hawaii's economy. This year will mark the eighth straight year of economic expansion as measured by growth in state real (inflation-adjusted) personal income.

Real Income Growth
Source: UHERO

 

Notable developments over the past year include:

o The number of non-farm payroll jobs rose by a healthy 1.9 percent in 2003, and it has continued at roughly that pace in the first part of 2004. Job recovery is broad based, with virtually all sectors seeing gains. As the recovery has strengthened, more workers have entered the labor force. Unemployment fell to 3.6 percent in April, a considerably better performance than in most other states.

o Not surprisingly, the strongest job performer has been construction, where jobs rose more than 7 percent last year and 5.3 percent through April 2004. Financial activities and services - particularly health care - were also strong. Accommodations and food-service jobs completed their recovery from the losses seen after 9/11, expanding at a rate of about 2 percent.

o Visitor arrivals for 2003 gave a misleadingly weak picture of tourism-sector health. Arrivals were down slightly from 2002, with a strong Mainland market not quite offsetting a weakness in Japanese arrivals. However, with significantly longer lengths of stay in both markets, the average daily census powered ahead by 2.9 percent. Total visitor days approached the record levels set in the banner year of 2000. For the first quarter of this year, U.S. arrivals were up 6.5 percent, but Japanese arrivals, which had a very weak January and February, fell 1.6 percent. Japanese arrival numbers were much better in April, giving hope that recovery will strengthen.

o Real payroll income increased strongly last year in most sectors, rising 7.6 percent in construction, 6 percent in wholesale trade, 10 percent in real estate and 3 percent to 6 percent in many service sectors. Information technology continued to decline by 5 percent last year. Overall real wage and salary income rose 4 percent for the year as a whole, and total real personal income rose 2.5 percent, down from the unusually strong 4.4 percent growth seen in 2002.

o The housing market remains very strong, both in sales numbers and rising prices. The median Oahu home price hit $445,000 in May, an all-time high, and the average time on the market of Oahu homes is just 19 days. Prices of single-family homes are about 22 percent higher than a year ago; prices of condos are up nearly 18 percent. The Big Island and Kauai have seen much greater home-price increases - for the first quarter of the year, median condo prices surged 50 percent on Kauai, and they nearly doubled on the Big Island compared with a year earlier.

Payroll Job Forecast
Source: UHERO

o The value of private building permits has receded from the extraordinarily high volume seen in late 2002 and early 2003. Residential permits were 24 percent higher, and commercial permits jumped 117 percent, but fell off sharply late in the year. Government contracts awarded were lower, but this does not include the impact of the huge federal contracts for military housing. The relatively strong residential permitting suggests that the current construction boom still has life in it.

o The government's fiscal condition has been on a general recovery path since its low point early in 2002. General-fund revenues were 3.1 percent higher for the 2003 calendar year. General-excise and use taxes were up a strong 8.4 percent in the calendar year, a reflection of strength in the broader economy. Cumulative tax collections for the current fiscal year were up 8.3 percent through April.

o As anticipated, Honolulu inflation has picked up over the past year, averaging 2.3 percent for the year. Most of this was due to higher energy prices, which drove utility costs up more than 8 percent. The rental (and, for homeowners, imputed rental) component of shelter costs remained very tame in federal government estimates, rising just 2 percent over 2002 levels. This is hard to believe, and we still expect to see acceleration in this category over the next few years.

THE YEAR AHEAD

The Hawaii economy entered 2004 with much more favorable conditions than we had seen a year earlier. The pall that had hung over tourism prior to the Iraq war had dissipated, housing markets were strong and plans for military spending here promised more support for the construction industry. Together with an improving external environment, these factors will underpin continued strong growth.

The U.S. economy expanded at 3.1 percent last year, but was accelerating into 2004. The first quarter saw 4.1 percent growth, and chances are good for second-quarter growth between 3 percent and 4 percent. Labor-market weakness, which has burdened the economy (and the Bush administration) since 2001, has finally begun to abate. Nevertheless, the unemployment rate remains at 5.6 percent. We expect labor-market improvement to continue at a modest pace, so that the unemployment rate returns to the 4.5-percent to 5-percent range over the next two years.

Monetary policy has played a leading role in supporting the economy through the 2001 recession and the past few years of sub-par growth. The picture has now begun to change, and the Open Market Committee is expected to start raising short-term rates before the third quarter of this year. Long-term rates have already moved higher, anticipating the shift in policy, but also heightened inflationary concerns and looming fiscal deficits. Lending rates are still relatively low by historical standards.

Japan's recovery is finally on a firm path. The world's second-largest economy has now posted eight consecutive quarters of positive growth, rising 5.6 percent in the first quarter. The economy has expanded by 4.7 percent over the past year. Most encouraging is the pickup in private demand, which has been very weak until now.

Japanese Visitor Forecast
Source: UHERO

To be sure, Japan still faces a number of familiar structural challenges: overcapacity in some key industries, continuing unresolved bad-debt problems in the banking and commercial sectors and a fiscal shortfall that has the government borrowing nearly half of what it spends. However, the strength of the private sector will support continued growth at or above 3 percent in 2004, with some slowing thereafter. With a more aggressive monetary stance, prices in Japan should stop falling by the end of the year.

A big story for the next several years in Hawaii will be the sharply increased impact of the military sector. There are two aspects to the story: changes in the number of military personnel and dependents on Oahu as a result of new military basings and deployments, and the stimulus to construction associated with military housing renovation projects.

Military deployments are a decidedly mixed bag for Hawaii over the next year. However, they are likely to become a significant, positive factor later in the decade. In the short term, the deployment to Iraq of 8,000 soldiers from the 25th Infantry Division (Light) and the 45th Corps Support Forward units of Schofield Barracks means a sharp downturn in local spending in Central Oahu. The upside is the planned deployment here of between 1,000 and nearly 5,000 additional military personnel and a larger number of dependents, between mid-2004 and the end of the decade, in connection with a Stryker Brigade and C-17 aircraft.

A large stimulus to construction is coming in the form of roughly $3.5 billion of military home construction and renovation over the next decade. These projects will add several thousand construction workers to payrolls in the next few years.

Tourism will have another banner year in 2004, due almost entirely to strong Mainland travel. Recovery of the Japanese market has been more attenuated than expected. With good news in the April numbers, we are now more confident that recovery can be sustained, but we do not expect Japanese arrivals to surpass year 2000 levels until the end of 2006.

U.S. Visitor Forecast
Source: UHERO

Hawaii tourism can continue to count on a healthy U.S. visitor market. Overall, 2004 should see arrivals grow by more than 6 percent, falling just a few hundred thousand short of the year 2000 record. U.S. arrivals will rise by 5 percent, building on last year's 2.9 percent growth. Japanese arrivals will rise by nearly 12 percent. In 2005, with continued recovery of the Japanese market, overall arrivals growth will be about 5 percent.

Strong labor-market conditions in 2003 nearly returned to 2000 levels. Job growth this year and next will match that pace. Hawaii's unemployment rate, which averaged 4.3 percent in 2003, is expected to remain below 4 percent for the next several years in a tight local labor market.

While permitting growth has slowed from the torrid pace set early in 2003, it remains very strong. Together with the beginning of hiring for military housing construction, we expect an additional 6 percent increase in construction workers this year and 4.5 percent in 2005. The concrete workers' strike earlier this year led to temporary slowing in construction job growth, but will not have a significant impact on the annual numbers. Transportation and warehousing will also benefit from this stimulus, and service areas will generally be strong.

Aggregate Hawaii real personal income growth will exceed the 2.5 percent growth rate experienced in 2003, accelerating to 2.8 percent this year and 3.6 percent next year as military construction, public sector raises and Japanese visitor recovery work their way through the economy. Inflation is likely to pick up further, probably exceeding 3 percent this year and dropping back only slowly thereafter. Both surging home prices and high energy costs will contribute to a more inflationary environment for the next several years.

CONCLUDING REMARKS AND FORECAST RISKS

Hawaii's economic expansion has hit its stride. Many of the risks that concerned us last year-a precarious U.S. recovery and an even more precarious Japanese one-have receded. The worst of Japan's tourism slump is now behind us, in spite of a slower-than-hoped-for recovery.

The biggest threats to the Hawaii outlook are external to our economy. Oil prices, which have recently hovered above the $40-per-barrel level, will almost certainly feed through to somewhat higher U.S. inflation this year, and possibly slower growth, acting as taxes on economic activity. Higher oil prices also introduce the risk that the Federal Reserve will begin to raise interest rates more aggressively.

U.S. vs. Honolulu Inflation
Source: UHERO

High home prices, while providing welcome support for consumer spending here, represent further risks. First, housing prices have yet to feed through significantly into measured consumer prices. When (not if) they begin to do so, they will impart further upward pressure on prices. In addition, while current Hawaii home-price increases do not appear excessively high, there is a risk that the bursting of a global housing price bubble could spill over here.

At the national level, the biggest risk to strong sustained growth now lies in the re-emergence of the "twin deficits" on the federal budget and the trade balance. The federal fiscal stance is clearly unsustainable in the medium term and has reinforced trade deficits that require massive foreign borrowing. The dollar's average decline by 25 percent over the past two years is evidence of foreign resistance to the status quo. If dollar depreciation and higher interest rates start to slow the U.S. economy, our U.S. growth forecast-and Mainland tourist spending-may turn out to be too optimistic.

Related to these concerns is the recent strength of the yen. While a strong yen historically has been associated with robust spending by Japanese visitors, excessive yen appreciation poses the risk of choking off the first real Japanese expansion in a number of years.

Finally, warnings on the continued risk of instability in Iraq, a crisis with North Korea and a terror attack on U.S. soil may seem overdone, but nevertheless remain real concerns for the U.S. and Hawaii economies.

Our view is that for the near-term, all but the last (and unknowable) of these risks are manageable, and should not derail Hawaii's excellent growth prospects. Looking further down the road, it is hard to be as optimistic about the external environment that is so important to the state's continuing growth.

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