Kauai`s Outlook is Buoyed by Strong Tourism

EcOnOmIc FOrEcAST
kauai edition 2015-2016
Kauai’s Outlook is Buoyed By Strong Tourism
F
ollowing the statewide pattern, Kauai’s
economy is benefiting from strong
visitor numbers that will set records
in 2015. Construction is gaining momentum
and will add to economic vitality in 2016.
Confidence is reflected in airline seat
commitments and, more firmly, by investments
in resort, commercial, and residential real
estate. Diversifying the economic base
should continue to be a priority for Kauai.
More than any other island, Kauai’s economic
health depends on tourism. Even some
diversified agriculture businesses such as
Kauai Coffee and Koloa Rum owe their
success to tourism sales. Chart 1 illustrates
tourism’s economic importance in a simple
way: annual visitor arrivals divided by resident
population. As seen here, Kauai’s ratio has
been declining, as is the case for all the
state’s counties. Yet, Kauai continues to have
the highest ratio, three times that of Oahu
and twice that of Hawaii Island.
Chart 1 - relative importanCe
of tourism seCtor
Chart 2 - monthly arrivals & growth rates, 2008-15
Source: Hawaii Tourism Authority
Chart 3 - kauai monthly visitor spending, 2008-15
Source: Hawaii Tourism Authority via DBEDT
into 2015, strong growth returned. For the
first 6 months of 2015, growth averaged
5.3% over 2014. If this pace continues, total
2015 arrivals will approach 1.2 million.
visitor arrivals rebound
Most of Kauai’s visitors come from the U.S.
west (50% of total) and east coasts (31%).
However, much of the recent growth has
come, surprisingly, from other markets.
Canada and other (Australia, Korea) markets
have contributed significantly to the 2015
growth. This diversification of the visitor base
will help maintain Kauai’s tourism viability.
A year ago, we were concerned about
surprising bumpiness in visitor arrivals.
As seen in Chart 2, visitor arrivals, always
highly seasonal, saw declines starting in
late 2013 and into 2014. In all, 2014 ended
about level with the 2013 total of 1.1 million.
However, starting in December and going
As visitor arrivals rebounded, visitor spending
on Kauai has continued to grow. (See Chart 3.)
Total spending in 2013 was up by 8% over
2012 to $1.4 billion. 2014 was even better,
up 5% to nearly $1.5 billion. If the pace for
early 2015 continues for the full year, total
Source: Hawaii DBEDT
spending will reach $1.6 billion in spite of
relatively low per-person daily spending by
Kauai visitors. As seen in Chart 4 (on page 2),
daily spending by Kauai visitors is consistently
below the statewide average. As of mid-2015,
the state average was $194 per day while
Kauai’s was $182. In recent years we saw
the gap between Kauai and the state average
narrowing. This suggests that strategies to
improve the value proposition of the Kauai
experience are paying off in greater spending.
(Continued on page 2)
On THE InSIDE
7 Global Economy
Downshifts to Slower
Growth Pattern
Analysis by Dr. Jack Suyderhoud, Professor of Business Economics, Shidler College of Business, University of Hawaii at Manoa and
Economic Adviser to First Hawaiian Bank
KAUAI COUNTY (Continued from page 1)
Chart 4 - daily visitor spending, kauai vs. state, 2007-15
It also suggests that Kauai can do more to
improve the value of tourism stays and
improve the economic benefits from tourism
without increasing visitor counts.
One reason for the lower per-capita spending
by tourists on Kauai is related to the visitor
plant. Compared to other islands, Kauai
relies less on hotels and more on condo
hotels, individual vacation rental units, and
timeshares. (See Chart 5.) Timeshares help
with return visitor frequencies, but those
staying in non-hotel units tend to spend less.
Airlines continue to expand seat capacity
in serving Lihue. The latest seat numbers
show positive growth for both domestically
originating flights as well as international
(Canadian) flights. (See Chart 6.) There appears
to be no retreat in the airline commitment to
serving Kauai. Seats for the late summer to
early fall months are expected to stay level
for domestic-origin flights while those from
international origins are expected to grow
somewhat.
*YTD June 2015. Source: HTA monthly reports
Chart 5 - visitor plant inventory by island, 2014
Source: Hawaii Tourism Authority
Chart 6 - airline seats, january-june 2015 vs. 2014
If the U.S. government is able to implement
pre-clearance in Japan for immigration and
customs, this will not help Kauai directly, but
it may reduce the arrival hassles at Honolulu
and allow travelers easier transit to Kauai.
The only bad airline news is the departure of
Island Air and Mokulele, leaving Kauai more
dependent than ever on Hawaiian Airlines
for interisland service.
It is possible for an industry to have too
much success. Kauai tourism may be in
such a situation as the annual arrival count
approaches 1.2 million. Traffic is an ongoing
concern as are potential frictions between
tourists and residents at venues with limited
space. Likewise, residents are increasingly
frustrated with having to expend resources
and risk lives rescuing visitors from places
where they should not go.
The Kauai Tourism Strategic Plan update
recognizes these issues and calls for strategies
to lessen the impact of tourism on Kauai.
2 | EcOnOmIc FOrEcAST - 2015-2016
Source: HTA monthly Visitor Statistics
These include better traffic infrastructure
and management, more resources from the
hotel room tax, better communication
between the visitor industry and residents,
and increased awareness of the Hawaiian
culture among residents and the visitor
industry. Efforts by the county and the
industry to provide transportation options
such as shuttles could be very helpful.
renovations with the goal of being Coco
Palms Resort by Hyatt. They are looking to be
a niche player on the east side at $225 per
night with 350 rooms and 8,000 square feet
of retail space with 550 direct hotel jobs.
Their hope is to start demolition by the end
of 2015 with construction to begin in 2016.
Sheraton Kauai plans to convert its space on
the mauka side of the road to timeshares.
These initiatives will be put to the test as
more inventory is added. Two additional
condo/timeshare facilities bookending
the Courtyard by Marriott are proposed.
Coco Palms is moving ahead with its
For the most part, the visitor numbers are
benefiting retailers as well. This includes
those targeted at resort guests. For example,
the shops at Kukuiula are doing well as are
other Poipu-area retailers.
ConstruCtion and
development
Construction on Kauai, as elsewhere in the
state, has been perplexing to watch. On the
one hand, industry insiders report robust
activity with rising employment. For example,
Shioi Construction has more than doubled
its workforce in the last year and is trying to
find more workers. Likewise, those wanting
to have construction done are having a
hard time finding willing contractors. Driving
around the island confirms activity in all
areas. Upscale housing at Kukuiula continues
to expand and workforce housing at
Princeville will finish later this year.
In spite of all this activity, officially reported
construction job numbers (Chart 7) continue
to lag. They are now reported to be about
half of the 2,000 peak in 2007. It is hard to
reconcile these job numbers with what we
see and hear about the industry. Perhaps
this is due to the classification of workers
hired by employment agencies rather than
directly by construction companies. Some
workers employed on Kauai may be listed as
being employed on Oahu due to company
addresses. Whatever the reason, it is likely
that the job numbers are understating true
employment. We just can’t say by how much.
However, there is also good news in Chart 7.
The value of private residential permits has
shown a good trend increase since mid-2011.
As of 2015, permits are running over $10
million per month compared to less that
half that in 2011. Chart 8 provides additional
details on an annual basis. As of 2014, total
permits, including public construction,
increased to $252 million. This is still well off
the pace in 2005-08, but foreshadows more
activity ahead.
County housing for Rice Camp Phase II will
depend on funding and may start in 2016.
At the other end of the spectrum, Discovery
Land Co. is planning 75 lots for lifestyle club
living at property above Anini Beach on the
north side. When completed, this yet-to-benamed development will create 150-200
local jobs. In between, Grove Farm is moving
Chart 7 - kauai ConstruCtion aCtivity, 2009-15
Source: county Building Department via DBEDT
Chart 8 - kauai ConstruCtion permits by type, 2005-14
Source: Author’s calculations based on county permit data, compiled by Shioi construction and PrP
Chart 9 - kauai jobs and unemployment, 2008-15
Source: Hawaii DLIr via DBEDT
forward at its Puakea Golf Course community
and DR Horton/Schuler is moving ahead with
Kohea Loa at Hanamaolu.
On the commercial side, Grove Farm is
awaiting financing for Phase II of the Hokulei
development, but this is unlikely to occur in
2016.
kauai’s strong labor market
Thanks to strength in tourism, Kauai’s labor
market continues to improve. Job growth
stalled in 2014, as can be seen in Chart 9.
However, 2015 shows a bounce back in
employment. The total job count is still 1,200
below the prior peak, but recent trends are
good. Likewise, the county’s unemployment
rate continues to decline and is now slightly
above 4% and only marginally higher than
the statewide average.
Most job growth since 2010 has been
in tourism-related sectors: restaurants,
accommodations and retailing. In fact, these
three sectors have added more jobs than all
the other sectors combined.
(Continued on page 4)
EcOnOmIc FOrEcAST - 2015-2016 | 3
KAUAI COUNTY (Continued from page 3)
Chart 10 - kauai real estate sales, 2004-15
kauai real estate reCovery
Slowly and surely, Kauai real estate continues
to bounce back from the effects of the Great
Recession. As seen in Chart 10, the number
of single-family sales continued to climb
in 2014 even as condo sales backed off
somewhat. Single-family median prices
(Chart 11) increased and are nearly at the
pre-recession peak. Condo prices, on the
other hand, are still well below their prior
high point. This likely reflects weak demand
from Canadian buyers whose dollars have
depreciated relative to the U.S. greenback.
Price recovery has been seen in all Kauai
markets. (See Chart 12.) Hanalei median
sales prices are now above $1 million and
Koloa is above $650,000. Improvements in
other markets have also occurred. Lihue
appears to be one of the more affordable.
However, through mid-2015 it had the tightest
inventory. Average days on the market were
only 109 compared to 145 in Hanalei and
170 in Waimea. Foreclosures and short sales
have leveled off with sales prices nearly
equal to true market values.
*YTD July 2015. Source: Hawaii Information Service
Chart 11 - kauai median priCes, 2004-15
*YTD July 2015. Source: Hawaii Information Service
Chart 12 - single-family resale median priCes, 2012-15
kauai eleCtriCity trends
The Kauai Island Utility Cooperative (KIUC)
remains an important and interesting part
of Kauai’s economy. It is receiving attention
from the rest of the state as an alternative
business model to investor-owned utilities.
KIUC continues to shift electricity generation
away from fossil fuels. At the start of 2015,
16% of KIUC’s electricity was generated by
non-fossil fuels. By the end of the year this
will be 38% as the 12 megawatt solar farm
at Anahola and a 7 MW wood-fueled facility
come on line. In spite of a growing customer
base, as measured by the number of meters
hooked up, total power use by the grid is
down, reflecting increased penetration of
rooftop solar. (See Chart 13.) Ratepayers are
hopeful that renewable sources will allow
the co-op to reduce rates, but that has yet
to materialize in a significant way.
paCifiC missile range faCility
PMRF continues to be the dominant economic
entity on the west side of Kauai. Its operating
budget is $130 million in 2015, with additional
4 | EcOnOmIc FOrEcAST - 2015-2016
*YTD July 2015. Source: Hawaii Information Service
Chart 13 - kauai eleCtriCity sales and meters, 2003-15
*YTD 2015. Source: KIUc
spending of $2.5-$5 million for each of four
to six testing events per year. One such
event will be the fall launch of Super Strypi,
a cooperative effort with the University of
Hawaii Office of Responsive Space, to put a
400-pound payload into orbit on a 62,000pound, two-stage rocket. On a long-term
basis, the base is looking forward to a $31
million upgrade in its electricity infrastructure
to occur in fiscal 2016-18. This will allow
PMRF to consolidate its electrical grid and
take advantage of power generated at the
Kekaha Landfill and to offer testing of new
technologies such as laser weapons and rail
guns. The number of contract employees
is down to about 925 from a prior 1,000.
Civilian employees are at 140 at about
$100,000 per job, including benefits. Military
personnel numbers are at 85 with an
additional 16-18 planned for base security.
Overall, slow, steady growth seems to be the
posture at PMRF.
diversified agriCulture
With the virtual disappearance of sugar and
pineapple, all farming on Kauai is diversified
agriculture. Chart 14, based on periodic
U.S. Census data, shows what anyone driving
around the island can see: there is a lot of
agricultural land that is not being fully utilized.
Thus, any use of such land is good news for
the island.
Seed corn accounts for less than 5,000 acres
of land use, but has significant employment
and sales. For example, Pioneer Hi-Bred
employs 114 full-time workers plus over
100 seasonal hires. The number of full-time
workers is down by 10% due to reduced
demand for seed. Globally, corn prices are
down and farmers are not planting as much.
Seed companies such as Pioneer and Dow
AgroSciences have reduced their output
and employment. However, their economic
impact on Kauai remains significant. For
example, Pioneer spends $15-$20 million
per year in local payrolls and purchasing.
Regulatory uncertainty remains a problem
as the issue of GMO’s has morphed into one
on pesticides. Resolving these issues would
allow this industry and other agriculture
ventures to move ahead with more stability.
Kauai Coffee is Hawaii’s only vertically
integrated coffee company, from orchards
to retail. By farming 2,500 acres, the
state’s largest by a factor of 10, it can use
mechanical harvesting and other techniques
to create economies of scale. Kauai Coffee
is owned by Massimo Zanetti Beverage, the
Chart 14 - kauai agriCultural trends
Source: U.S. Department of Agriculture, census of Agriculture, various years
European-based coffee giant. This gives
Kauai Coffee unique marketing leverage as it
reaches new customers with new products
such as single-serve offerings. Recently the
company has cut back on output and taken
some acreage out of production due to
drought. However, it employs 120 workers
as a base and an additional 60 during
harvesting. A big concern for the company is
the spread of the coffee berry borer, which
has added 20% to growing costs in Kona.
Another part of Kauai’s agriculture export
sector is Kauai Shrimp, now the third largest
brood stock supplier in the world with
customers in China, Vietnam and India.
This speaks to the company’s success in
a highly competitive industry where price
and quality are the determining factors.
As of 2015, the company has 43 full-time
employees plus additional part-timers and
casual hires. Total revenues have nearly
doubled since 2013 to $9 million. Kauai
Shrimp also grows its own product for retail
consumption in restaurants in the U.S. and
Japan and sales by Sam’s Club, with Costco
on the horizon. The company will also
expand its scope with complementary
products such as clams and services such
as technological consulting.
Koloa Rum is another example of the
synergies between agriculture and tourism.
At their Kalaheo facility they produce five
rum products plus ready-to-drink mixes and
a coffee-based liqueur. Most of the sales are
in Hawaii through its Kilohana outlet. They
hope to consolidate manufacturing and sales
at their planned Koloa location, now in its
design phase. At present they employ 24
workers and gross about $4 million per year.
In cooperation with Dow AgroSciences, sugar
is once again being grown and harvested on
Kauai and being used to make Koloa Rum.
Kauai agriculture may become more
diversified if Ulupono Initiative’s Hawaii Dairy
Farm at Mahalepu goes forward. At present
there are plans for a 699-cow herd to
eventually produce 1.2 million gallons of milk
per year with 10-15 employees. Ulupono is
conducting a voluntary environmental impact
study that should be published in draft form
this fall with the hope of a finalized version
in the spring of 2016. Building permits have
been obtained, but legal challenges are
coming from the owners of the Grand Hyatt
as well as some Poipu residents. If these
are overcome, the 580-acre area could be
in operation in 2017.
kauai tourism and
entertainment
The synergies between tourism and the
entertainment industry continue to be on
display on Kauai. The recent premier of
“Jurassic World” should bring more “free”
publicity to Kauai as a destination, and clever
tour and attraction operators will leverage
the film’s success. Likewise for the 2015
Sports Illustrated swim suit edition.
The Kauai Film Board estimates that in
2014 the film and entertainment industry
contributed over $4.8 million in local
spending, directly employing about 130 local
workers. Considering multiplier effects, this
supports another 80 or so local jobs.
EcOnOmIc FOrEcAST - 2015-2016 | 5
statewide eConomy
Tourism Boosts Hawaii’s Growth
D
riven by a robust tourism sector,
Hawaii’s economy is doing well. 2015
will be the sixth year of Hawaii’s GDP
growth, leaving the Great Recession as an
increasingly remote memory. (See Chart 1)
While growth has been positive, and is expected
to remain so into 2016, the rates of GDP
growth have been modest: in the 2-3% range.
Chart 3 - growth in
visitor arrivals, 2007-14
Chart 6a - gov’t ContraCt
award trends, 2007-15
Chart 1 - gdp growth, 1997-2016
Source: Hawaii Tourism Authority
Chart 4 - hawaii visitor
spending growth, 2008-15
Source: DBEDT
Chart 6b - private permit
trends, 2007-15
*2015 Estimate, 2016 Forecast
Source: U.S. Bureau of Economic Analysis
labor market: As seen in Chart 2, total state
jobs have returned to the pre-recession level
of 635,000 and the unemployment rate has
dropped to 4%. In fact, the tight labor market
is now a constraint to growth as employers
finding it more difficult and costly to hire.
Not surprisingly, these trends are not uniform
among the state’s counties. Oahu and Maui
have both recovered the jobs lost since the
Great Recession. However, on Hawaii Island
and Kauai, job growth came to a halt in late
2013 and has only recently rebounded. Total
jobs are still 5% below pre-recession peaks
on these islands.
Statewide personal income, adjusted for
inflation, has continued to expand and is
now 8% above the low point in 2009.
Chart 2 - state jobs &
unemployment, 2007-15
Source: Hawaii Tourism Authority
The news for visitor spending was less
upbeat. Since 2013, spending growth has
been somewhat erratic. (See Chart 4.) Total
spending remained relatively flat over the
last two years and has not kept up with
inflation. Nevertheless, recent months have
seen some up-tick in this important metric.
Construction: For five years we have been
expecting construction to contribute to
overall growth. After another year of waiting
in 2014, this year shows more promise.
Over 12,000 construction jobs were lost after
2007. (See Chart 5.) As of mid-2015 about
6,000 jobs had been recovered. Given the
visible signs of construction activity and
anecdotal evidence from industry insiders,
stronger growth was expected. This proved
not to be the case. The construction tax base
actually declined for five consecutive quarters
starting in July 2013 and only recently returned
to positive growth. But there are reasons for
optimism. Private construction permits are
Chart 5 - total ConstruCtion jobs
Source: DBEDT
tourism: The health of Hawaii’s economy
remains tied to tourism. In 2014 tourism
growth sputtered early, then came back
strong in the second half. As a result, 2014
visitor arrivals grew a modest 2% over 2013,
but this represented a record 8.16 million.
(See Chart 3.)
6 | EcOnOmIc FOrEcAST - 2015-2016
Source: DBEDT
Source: DBEDT
accelerating to their highest growth since
2012. This will help offset slower growth in
government construction contracts awarded.
(See Charts 6A and 6B.)
More jobs, higher incomes, and favorable
financing conditions continue to stimulate
demand for housing that is unmet by greater
supply. As a result, single-family and condominium sales and prices are up everywhere.
The Oahu single-family residential median price
rose above $700,000 in mid-2015, up 10%
from the pre-recession peak. Markets on all
neighbor islands are also in recovery mode,
but have yet to achieve their prior peaks.
state tax revenues: The rising economic tide
has lifted many boats, including the state’s
treasury. General Fund tax collection growth
has been erratic on a quarterly basis due to
swings in economic factors such as tourism
spending, but also in tax collection practices
such as income tax refund timing. On a fiscal
year basis, general fund revenues were up by
10% in FY 2013, down by 1.8% in FY 2014, and
up by 6.8% in FY 2015. On average, general
fund revenues increased by 4.9% annually
for the last three fiscal years. Spending this
money will further boost economic activity.
In sum, the neighbor islands will continue to
benefit from an overall strong state economy
that is in its sixth year of expansion. Tourism
is the primary force behind this trend, and
construction will make an increasing
contribution into 2016.
global eConomy
Global Economy Downshifts to Slower Growth Pattern
By Dr. Ken Miller, CFA, Chief Investment Strategist & Director of Investment Services, First Hawaiian Bank
the big piCture: mixed
The global economy has downshifted into
a period of slower growth in the aftermath
of the financial crisis. World GDP (Chart 1)
expanded at only a 3.4% rate over the past
three years, down from a 5.1% rate during
the five pre-crisis years, 2003-2007. Growth
will be only 3.3% in 2015, according to the
International Monetary Fund (IMF). Beyond
the residual effects of the financial crisis,
the slowdown has been caused by global
shocks, including lower commodity prices,
as well as varied regional factors. In addition,
medium- and long-term trends, such as
aging populations and lower productivity
growth, are having an effect. Growth should
be stronger in 2015 relative to 2014 in
advanced economies, but weaker in emerging markets. By 2016, both advanced and
emerging economies are projected to show
mild acceleration, bringing the global growth
rate up to 3.8%
In the developed economies, growth is
expected to increase from 1.8% in 2014 to
2.1% in 2015 and 2.4% in 2016. The growth
outlook for the U.S. has been downgraded
following the weak first quarter, but Europe
and Japan have been surprisingly strong.
Despite the market turmoil accompanying
the Greek bailout negotiations, the Eurozone
is seeing quite robust recovery in domestic
demand, as Europe’s expansionist monetary
policy begins to gain traction. Japan is also
experiencing stronger growth due to the
effects of aggressive monetary policy and the
falling yen, which is down some 37% vs. the
dollar over the past three years, boosting the
performance of Japanese exporters.
The projected 4.3% growth in emerging
markets for 2015 marks the fifth consecutive
year of decline. Several factors are behind
the slowdown. Oil exporters have been hit
hard by the falling price of oil, particularly
countries like Russia and Venezuela, which
were already in turmoil. In addition, the
outlook for several other Latin American
countries has weakened due to price
declines in non-energy commodities.
Finally, China, by far the largest developing
economy, is experiencing slower growth as
it tries to transition to a more sustainable,
balanced growth model that is less driven by
investment spending. As the impacts of these
factors wane in 2016, emerging markets are
projected to grow a little faster, at 4.7%.
Chart 1 - world eConomiC
growth foreCast
*Forecast Source: International monetary Fund,
World Economic Outlook Update July 2015
the u.s. eConomy:
stronger growth ahead
Recent financial troubles in Greece, China,
and even Puerto Rico pushed the U.S.
economy off the front page. That was a
shame, because the news on the domestic
economy has been mostly good. After a
dismal, weather-affected, first quarter, the
U.S economy began bouncing back. Payrolls
are growing at over 200,000 jobs per month,
and in June the unemployment rate fell to
5.3%, lowest since 2008. Consumers began
to pick up the pace in the spring, at last
starting to spend the windfall from lower
gasoline prices. Incomes grew a healthy
0.4% in April, May, and June. Importantly,
the housing sector is also showing positive
signs of recovery.
With unemployment approaching steady
state, wage growth has assumed outsized
importance as an indicator of labor market
health. Average hourly earnings have hardly
budged during the recovery, showing a
1.8% increase in July, barely above inflation.
However, an alternative measure, the
Employment Cost Index (Chart 2), which
measures both wages and indirect compensation, has been trending upwards. Using
a different approach, the Atlanta Federal
Reserve looks at year-over-year wage growth
for individual respondents to the Census
Bureau’s Current Population Survey. This
“same store” methodology minimizes
distortions caused by the changing mix in
Chart 2 - employment Cost index,
wage growth
Source: Federal reserve Bank of Atlanta,
Bureau of Labor Statistics
the job market, possibly providing a more
accurate gauge of labor market slack, and
shows much stronger wage growth of 3.2%
in June.
Inflation is still too low for comfort. The Fed’s
preferred measure of inflation, the core
Personal Consumption Expenditure (PCE)
price index, was up 0.3% year over year in
June, under the Fed’s 2% target for the 38th
consecutive month. Inflation has also been
pushed down by falling prices in non-energy
imports due to the strengthening of the dollar.
As these effects wane, inflation should move
closer to the Fed’s 2% target.
Over the next couple of years, increases in
consumer spending, business investment,
and residential investment should drive
the economy back to 2.5-3.0% growth rates.
Underlying factors which should support
growth in these categories of spending are
higher average hourly wages, lower oil
prices, and a bounce back in the rate of
household formation. On the negative side,
a major issue for the U.S. economy is the
impact of the stronger dollar, which is already
hurting manufacturing and exports. Exchange
rate movements are unpredictable, affected
for example by China’s recent devaluation of
the yuan. However, the dollar’s rise stalled in
March, and there is reason to believe that
rapid appreciation will not resume. The
dollar has appreciated much faster than
(Continued on page 8)
Chart 3 - u.s. dollar real effeCtive exChange rate 1970-2015
Source: Bruegel
EcOnOmIc FOrEcAST - 2015-2016 | 7
glObAl eCONOmY (Continued from page 7)
would be expected by differences in inflation
rates (Chart 3, on page 7). While the dollar is
not especially overvalued relative to previous
peaks in 1985 and 2002, and certainly could
go higher, the persistent trade deficit will
tend to push the dollar down. Excluding
oil imports, which have plunged, the trade
deficit is at record levels (Chart 4).
all the trouble in the world
Another risk to the outlook is potential
spillover from the troubled economies of
Europe and China. The recent events in
Greece could hardly have been more
dramatic. Almost literally at the last minute,
Greece was able to reach a deal with its
creditors to prevent a collapse of the banking
system and exit from the euro currency bloc,
but only by acquiescing to economic reforms
and budget cuts far more severe than those
which had been rejected in a national
referendum only days before. With street
protests in Athens, the implementation of
further austerity promises to be anything
but smooth, nor does it seem likely that
Greece’s economy can grow fast enough to
meet its debt obligations. Even though the
IMF, the European Central Bank, and most
economists outside of Germany believe
that Greece cannot escape its predicament
without drastically modifying the terms of
existing debt, any talk of meaningful debt
relief remains verboten. Nonetheless, if
Greece ends up exiting the Eurozone, the
damage should be contained, as you might
expect for a country that represents less
than 2% of euro-area economy. Compared
to 2012, when Greece was last on the verge
of debt default, today there appears to be
much less risk of financial contagion, and the
risks to the U.S. economy are pretty small.
China is a different story. A financial crisis in
the world’s second largest economy clearly
has implications for the U.S., which is why
the gyrations of the Chinese stock market
are concerning. Since mid-2014, the
Shanghai Composite Index increased 150%
in less than a year, then fell 30% in about
three weeks. These dramatic moves cannot
be explained by any fundamental changes
in the economic outlook, good or bad, but
are instead largely the result of Chinese
government policy. Never shy to pull
economic levers, policymakers in China have
8 | EcOnOmIc FOrEcAST - 2015-2016
Chart 4 - monthly u.s. trade
balanCe (exCl. petroleum)
Source: Department of commerce
deliberately set about boosting the stock
market through measures such as increasing
the availability of margin debt. Their aim has
been to bolster economic growth by
creating household wealth and by funneling
capital to Chinese companies. Going forward,
there is no guarantee that policymakers
will be able to support the market. However,
the wealth effects of the stock market are
limited in China, where perhaps 10% of
households own stocks, and Chinese
companies rely relatively little on equity
capital. Thus, we do not anticipate any
more than a gradual slowing of the Chinese
economy, even with further declines in the
stock market. (If we are wrong, and China
experiences a “hard landing”, there would
likely be ancillary benefits to the U.S. in the
form of lower commodity prices, which in
recent years have been largely driven by
demand from China).
is eConomy underaChieving, or
is potential growth lower? yes.
“Potential growth” to an economist is the
sustainable growth rate of economic output
that can be achieved without causing inflation.
Potential growth can be seen pretty well
in hindsight, but can only be estimated at
any point in time. While there is plenty of
controversy about the exact level of potential
growth, almost everyone agrees that it has
been falling, due to slower expansion of the
workforce and lower productivity growth
(output per hour of work). The Congressional
Budget Office (CBO) estimates that potential
growth will only be about 2.1% over the next
10 years, down from a long-term average of
about 3.3%. Most of the decline is due to
slower expansion of the workforce —
particularly because we are now past the
multi-year demographic shift of women
entering the workplace. However, there has
also been a puzzling decline in productivity
Chart 5 - u.s. gdp potential vs. reality
Source: cBO, Federal reserve Bank of St. Louis
growth. Part of the problem is that lagging
business investment has depleted capital
stock. But worn-out factory equipment
cannot be the whole story.
Over the past several decades, technological
innovation has been the major driver of
productivity growth. Could it be that many
of today’s technological advances (e.g., social
networking and mobile apps) are having less
impact on economic output? There may be
a measurement problem here, as output
statistics fail to capture the full value of
an increasingly services-based economy.
There may also be a matter of timing —
perhaps the full productivity benefits of
nascent technologies will develop gradually
(as has happened in the past).
This is not the first time we have wrestled
with periods of slower productivity growth:
In the 1930s some economists predicted a
weak economy for many years to come
due to slowdowns in population growth
and technological advance — right on the
cusp of a huge economic boom. Oh, well.
Accordingly, today in our view, it is much
too early to extrapolate from the recent
decline in productivity growth, or the failure
to identify (yet) technological advances on
par with the internal combustion engine
or mainframe computers in terms of
economic impact.
Nonetheless, absent a sharp increase in
immigration, for the next several years it
appears that potential growth in the U.S.
will be at least 1% lower than in the past.
However, the economy can grow faster
until the gap between actual and potential
output, i.e., economic slack, is closed.
Today, the CBO estimates the output gap
to be about 4% of GDP (Chart 5), implying
that we may have several years of abovetrend growth.
EcOnOmIc FOrEcAST - 2015-2016 KAUAI EDITIOn © FIrST HAWAIIAn BAnK