kauai edition 2015-2016

EcOnOmIc FOrEcAST

Kauai’s Outlook is Buoyed By Strong Tourism

On THE InSIDE

7 Global EconomyDownshifts to SlowerGrowth 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

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.

visitor arrivals rebound 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

F

Chart 1 - relative importanCeof tourism seCtor

Chart 2 - monthly arrivals & growth rates, 2008-15

Source: Hawaii DBEDT

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.

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.

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

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)

KAUAI COUNTY (Continued from page 1)

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.

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.

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.

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

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.

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.

Chart 4 - daily visitor spending, kauai vs. state, 2007-15

Chart 6 - airline seats, january-june 2015 vs. 2014

*YTD June 2015. Source: HTA monthly reports

Source: HTA monthly Visitor Statistics

2 | EcOnOmIc FOrEcAST - 2015-2016

Chart 5 - visitor plant inventory by island, 2014

Source: Hawaii Tourism Authority

ConstruCtion anddevelopmentConstruction 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-be-

named development will create 150-200

local jobs. In between, Grove Farm is moving

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)

Source: Author’s calculations based on county permit data, compiled by Shioi construction and PrP

Source: Hawaii DLIr via DBEDT

Source: county Building Department via DBEDT

EcOnOmIc FOrEcAST - 2015-2016 | 3

Chart 9 - kauai jobs and unemployment, 2008-15

Chart 8 - kauai ConstruCtion permits by type, 2005-14

Chart 7 - kauai ConstruCtion aCtivity, 2009-15

KAUAI COUNTY (Continued from page 3)

kauai real estate reCoverySlowly 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.

kauai eleCtriCity trendsThe 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 faCilityPMRF continues to be the dominant economic

entity on the west side of Kauai. Its operating

budget is $130 million in 2015, with additional

Chart 11 - kauai median priCes, 2004-15

Chart 12 - single-family resale median priCes, 2012-15

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 62,000-

pound, two-stage rocket. On a long-term

basis, the base is looking forward to a $31

Chart 13 - kauai eleCtriCity sales and meters, 2003-15

*YTD July 2015. Source: Hawaii Information Service

*YTD 2015. Source: KIUc

4 | EcOnOmIc FOrEcAST - 2015-2016

Chart 10 - kauai real estate sales, 2004-15

*YTD July 2015. Source: Hawaii Information Service

*YTD July 2015. Source: Hawaii Information Service

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 agriCultureWith 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

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 andentertainment 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.

Source: U.S. Department of Agriculture, census of Agriculture, various years

EcOnOmIc FOrEcAST - 2015-2016 | 5

Chart 14 - kauai agriCultural trends

6 | EcOnOmIc FOrEcAST - 2015-2016

Source: DBEDT

Tourism Boosts Hawaii’s Growth

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.

D

Chart 1 - gdp growth, 1997-2016

Chart 2 - state jobs & unemployment, 2007-15

Chart 3 - growth in visitor arrivals, 2007-14

Chart 4 - hawaii visitor spending growth, 2008-15

Chart 5 - total ConstruCtion jobs

Chart 6a - gov’t ContraCt award trends, 2007-15

Chart 6b - private permit trends, 2007-15

*2015 Estimate, 2016 Forecast Source: U.S. Bureau of Economic Analysis

Source: Hawaii Tourism Authority

Source: Hawaii Tourism Authority

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.

Source: DBEDT

Source: DBEDT

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.)

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

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 condo-

minium 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.

statewide eConomy

EcOnOmIc FOrEcAST - 2015-2016 | 7EcOnOmIc FOrEcAST - 2015-2016 | 7

Source: Bruegel

Global Economy Downshifts to Slower Growth Pattern

the big piCture: mixedThe 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 emerg-

ing 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%.

global eConomy

By Dr. Ken Miller, CFA, Chief Investment Strategist & Director of Investment Services, First Hawaiian Bank

the u.s. eConomy: stronger growth aheadRecent 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 compen-

sation, 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

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 1 - world eConomiCgrowth foreCast

Chart 2 - employment Cost index,wage growth

Source: Bruegel

Chart 3 - u.s. dollar real effeCtive exChange rate 1970-2015

*Forecast Source: International monetary Fund, World Economic Outlook Update July 2015

Source: Federal reserve Bank of Atlanta, Bureau of Labor Statistics

8 | EcOnOmIc FOrEcAST - 2015-2016 EcOnOmIc FOrEcAST - 2015-2016 KAUAI EDITIOn © FIrST HAWAIIAn BAnK

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 worldAnother 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

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, oris 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

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 above-

trend growth.

Source: Department of commerce

Chart 4 - monthly u.s. trade balanCe (exCl. petroleum)

Source: cBO, Federal reserve Bank of St. Louis

Chart 5 - u.s. gdp - potential vs. reality