UHERO Hawaii Outlook

Recovery Continues Despite Tourism Woes

February, 2003

Few of the tourism jobs lost after 9-11 have returned. While the broader economy fares better, with a partial recovery in the non-agriculture job count, we have yet to see net gains in employment. In fact, extraordinary strength in several domestic sectors, such as the housing market and some service areas, means that Hawaii has maintained real income growth throughout this two-year economic downturn.

This year, the external environment for Hawaii will improve, but only gradually. The U.S. economy will make steady, but not dramatic, progress toward recovery, but little help can be expected from a still-battered Japanese market. Hawaii’s visitor industry will struggle for some time to fully recover, and the rest of the state will continue to depend on other local sources of strength to generate moderate income gains.

Recent Developments
The effects of Hawaii’s recent slowdown have been centered in tourism. Segments dependent on Japanese visitors have been hurt more than Mainland-oriented businesses. Outside of tourism, interest sensitive sectors — construction, real estate, auto sales and consumer durables — have benefited from the Fed’s succession of interest rate cuts. With mortgage rates at 30-year lows, the refinancing pipeline at local banks has been full, which boosts profits for banks and mortgage brokers but also puts extra money into the pockets of local consumers.

In the past year, payroll jobs have recovered about half of the 2 percent drop they experienced in the wake of Sept. 11, but improvement in the labor market appears to have stalled for now. The state unemployment rate has receded to a deceivingly healthy-looking 4 percent, but this is due entirely to a decline in the labor force; no net gains in employment have yet been seen in Hawaii.

The most severely affected tourism sectors continue to have job levels far below their previous peaks. There are: 2,500 fewer hotel jobs than in early 2001; 5,600 fewer jobs in wholesale and retail trade; and 4,400 fewer jobs in the transportation sector. Other sectors, such as construction, health care and, most notably, state and local government, have added jobs.

  • Domestic visitor arrivals have fully recovered from the falloff that accompanied the U.S. recession and the disruptions of 9/11. Japanese tourists have been much slower to return and remained 15 percent below 2000 levels in the third quarter of 2002.
  • Overall visitors to the Islands remain 5 percent below 2001 levels through the third quarter of 2002 and well below their 2000 peak. Real personal income for the State was up 2.7 percent in the first half of 2002, considerably better than expected. Income growth halted during the fourth quarter of last year but quickly rebounded. The strong income growth last year was due largely to finance, insurance and real estate (up 9.7 percent), and health services (up 4 percent), as well as a string of public-sector pay increases that raised government sector income by 6 percent.
  • Barring substantial downward revision, these income numbers mean that Hawaii has managed to escape an income recession during the past year. (Third-quarter income data was not available as of this writing.) Because robust income growth has been confined to a small number of sectors, the significant decline in total jobs and employment may provide a better measure of the human toll of Hawaii’s most recent economic downturn.
  • Inflation in Hawaii fell below the national average during the past decade of stagnant growth here, although the gap nearly closed by 1999. A weaker global economy since 2001 has helped to reduce price pressures both in Hawaii and the U.S.
  • Hawaii’s housing market has been more robust than in any recent year, with resale volume continuing to grow strongly, and home prices moving up sharply in many areas. For the first nine months of 2002, Oahu single-family home sales rose 12 percent and condominium sales increased 21 percent over 2001 levels. Neighbor Island markets were also active, although not quite as buoyant as Oahu. Low interest rates continued longer last year than expected, underpinning the market.
  • The real value of private building permits increased by 4 percent in the first nine months of 2002, after falling off early in the year. Residential permits were up strongly, suggesting that there is still life left in the local residential housing market.
  • The state budget situation has worsened. General fund revenues for the calendar year through the third quarter of 2002 declined more than 4 percent in real terms. The decrease is primarily due to weaker income tax withholding and estimated income tax payments, painting a bleaker picture than the aggregate real income growth mentioned earlier.
  • At the sectoral level, the tourism-related industries of transportation, trade and hotel services saw the biggest proportional job losses over the past year, and there is little evidence of a job recovery in these sectors. Construction employment has recovered from a brief fall after Sept. 11 and is now 3 percent higher than 2001. Non-tourism services are up about 2 percent. The state government payroll is nearly 4 percent higher.

The Year Ahead
Hawaii’s economy is on the road to recovery, but there is still plenty of unfinished business. Despite continuing weakness in tourism and the overall job market, Hawaii’s economy has made progress in recovering from the 2001 slowdown. We expect that recovery to continue in 2003, supported by income growth in the local construction industry, services and government. Relative weakness in key external markets will limit Hawaii growth over this year. The world economy continues to recover from the 2001 recession, but at a slower pace than expected.

The United States has led the global recovery, albeit less robust than expected. After a strong rise in real gross domestic product (GDP) in the first quarter of 2002, the U.S. economy managed only meager growth in the second quarter. The third quarter saw stronger growth. Still, it is taking longer than expected to get back on a firm growth path. Despite low interest rates that have buoyed the housing market, business investment has been slow to recover because of low profitability. Consumers now express less confidence about their economic security. We expect the U.S. economy to expand by about 3 percent for 2003. Japan’s prospects continue to be dismal.

The country’s most recent crisis began in the stock market, where low equity prices have exacerbated the country’s long-standing bad-debt problems. The value of Japan’s bad debts has continued to rise to $430 billion. On the positive side, industrial production reversed its yearlong slide in December 2001 and has since risen more than 8 percent. Business confidence rose in the second and third quarters of 2002, and the inventory cycle has eased. Consumer spending continues to suffer from anemic income growth and job insecurity, and business investment remains weak. Unemployment has stuck at about 5.5 percent for the second half of 2002. While the economy should continue to expand modestly, it is likely to remain below potential for the next few years. We expect overall Japanese economic growth of less than 1 percent for 2003. As result, weak Japanese tourism can be expected to weigh on Hawaii for some time.

The strengthening U.S. economy and struggling Japanese economy leave Hawaii with a visitor sector that continues to lag behind 2000 levels. That pattern will continue. U.S. Mainland visitor arrivals are expected to rise 3 percent in 2003, bringing us back to the high levels seen in early 2000. Japanese arrivals, which have fallen a cumulative 20 percent over the past two years, will recover just 10.2 percent in 2003. It will take several more years for Japanese visitors to regain to 2000 levels, let alone the record levels seen in 1997. Job growth will continue to be anemic in the near term. In tourism, an incomplete recovery will mean little rehiring for the coming year. As they have over the past year, areas that are not directly related to visitor spending will fare better. The stimulating effects of lower interest rates are likely to be with us for some time, considering the modest pace of U.S. economic recovery.

When the Fed does begin to raise rates — perhaps by mid-2003 — a strengthening U.S. economy should help to offset any negative impact here. Non-tourism sectors will account for much of the job growth over the next year, particularly construction and health services. Other non-tourism services are also expected to add jobs more rapidly than average. For the economy as a whole, aggregate job growth will resume in 2003, with the number of jobs rising by about seven-tenths of 1 percent, bringing non-agricultural jobs back to pre-attack levels by year’s end.

Income Growth
Real (inflation-adjusted) personal income gives us the best aggregate measure of Hawaii’s economic activity. We do not expect last year’s income windfall in the housing and finance industries to persist at a healthy rate; we expect a leveling off of real income growth at about 2.3 percent in 2003.

Hawaii’s brief respite from inflation ended in 2001. Inflation has already picked up modestly here and will accelerate to 2 percent in 2003. Concluding remarks and forecast risks in many ways, conditions in Hawaii ought to be worse than they are. More than a year after Sept. 11, 2001, Hawaii’s leading industry has not fully recovered, and the job market is much weaker than the unemployment rate would suggest. Nevertheless, incomes in Hawaii continue to grow — as they have throughout the slowdown — and the lowest interest rates in decades have helped to support finance and construction activities.

We hope for full recovery. The precariousness of Hawaii’s situation cannot be overstated. Like the U.S. and global economies, in Hawaii these are early days. Growth is tentative and may stall quickly if another disruption strikes. Unfortunately, as we are all aware, there are plenty of potential risks: war in Iraq and the travel and tourism disruptions that would undoubtedly follow; higher oil prices; the ”discouragement” effects on consumer spending. In fact, war concerns may explain part of the softness we have seen in the U.S. recovery. There are other risks to the global economy: the recent increase in financial problems in the developing world, particularly in Latin America. There is the continuing risk of further economic fallout in Japan from the now decade-old banking crisis. That makes all forecasting at this point contingent on a lack of surprises from outside the state. It is a reminder to hope for peace on earth in 2003.

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Carl Bonham and Byron Gagnes