Hawai'I Becalmed: Economic Lessons of the 1990s

Hawai‘i Becalmed Economic Lessons of the 1990s

CHRISTOPHER GRANDY

Hawai‘i Becalmed

Hawai‘i Becalmed Economic Lessons of the 1990s


Christopher Grandy

University of Hawai‘i Press Honolulu

© 2002 University of Hawai‘i Press All rights reserved. Printed in the United States of America 07 06 05 04 03 02 01

654321

Library of Congress Cataloging-in-Publication Data Grandy, Christopher. Hawai‘i becalmed: economic lessons of the 1990s/Christopher Grandy. p. cm. Includes bibliographical references and index. ISBN 0-8248-2630-2 (paperback: alk. paper) 1. Hawaii—Economic conditions—1959–2. Hawaii—Economic policy. I. Title. HC107.H3 G73 2002 3330.9969'04—dc21 20020039988

University of Hawai‘i Press books are printed on acid-free paper and meet the guidelines for permanence and durability of the Council on Library Resources. Designed by Argosy Publishing Printed by Versa Press, Inc.

For Harvey “Sei” Kaneshiro

Contents

Preface

ix

Acronyms

xi

1

Introduction

1

2

The Bubble

9

3

Three Pinpricks

23

4

A Change in Fortune

34

5

A Change in Administration

45

6

COR, ERTF, and Crisis

59

7

The Election

76

8

Second-Term Agenda

86

9

Lessons and Conclusions

104

Appendix 1: Economic Revitalization Task Force Proposals

115

Appendix 2: The Lingle Plan and Detailed Potential Response

119

References

123

Index

127

vii

Preface

This book offers a personal view of Hawai‘i’s economic voyage during the 1990s— along with some of the lessons that I hope we learned. I came to Hawai‘i as an assistant professor in the Department of Economics at the University of Hawai‘i, Ma– noa in 1991, on leave from Barnard College at Columbia University. Personal and professional interests kept me in Hawai‘i. While teaching in the Economics Department I learned a good deal about Hawai‘i’s economy from people like Jim Mak, Sumner La Croix, Lou Rose, Jim Roumasset, Seiji Naya, and others. I learned even more after moving downtown to the state Department of Business, Economic Development, and Tourism (DBEDT) when Seiji Naya became director of DBEDT in Governor Ben Cayetano’s first administration. Working directly with Pearl Imada Iboshi, head of the Research and Economic Analysis Division, we tried to understand what was happening to Hawai‘i’s economy and what we could do to improve things. It was a valuable and fascinating experience in a difficult period for the state. This book reflects, then, what I learned about Hawai‘i’s economy at the university and at DBEDT. The analysis and opinions expressed here are mine. While my colleagues might agree with some of the views expressed here, they will disagree with others. I have been fortunate to work with people who not only tolerate but encourage differing perspectives. I wrote this book with a number of goals in mind. First, I wanted to tell the story of Hawai‘i’s economic voyage during the 1990s as I understand it. Second, I wanted to convey my sense of what we should learn about economic policy from this period. Finally, I wanted to convey this story in a way that would be accessible to—and hold the interest of—students, business people, and government workers and officials. To some extent this is an idiosyncratic work. I do not pretend to know everything there is to know about Hawai‘i’s economy. There are several issues I do not touch on at all, such as education, native Hawaiian issues, details of environmental policy, public health matters, and so on. Rather, this book reflects my experience, with all it limitations, in the field of economics and economic policy as applied to Hawai‘i. I would like readers to see this book as a contribution to the existing body of knowledge on Hawai‘i. It is not intended to be definitive in any dimension, but I hope it will contribute to the ongoing debate in Hawai‘i about our economy and our relations with the rest of the world.

ix

x


Preface

I have many debts of gratitude. Jim Mak willingly served as an advisor and supporter in my effort to write and publish this book. He has been a valued mentor and friend since I arrived in Hawai‘i more than 10 years ago. Seiji Naya has been a colleague and friend, and I am deeply grateful for the opportunity he provided me to work at DBEDT for six years. Pearl Imada Iboshi was my immediate supervisor and colleague in the Research and Economic Analysis Division of DBEDT. We spent many hours together talking about Hawai‘i’s economy, economic policy, and political realities in the state. Sumner La Croix and Jim Mak read the manuscript carefully (more than once!) and made extensive comments. While I have not taken all of their suggestions, I greatly appreciate the professionalism and care with which they reviewed this work. I also received valuable comments from Dick Pratt and an anonymous reviewer for the University of Hawai‘i Press. I must also thank Bill Hamilton of the University of Hawai‘i Press. He has kindly invested time and effort in reviewing the book and putting it through the publishing process. I am very grateful for his flexibility in ensuring that the book came out in a timely manner. Finally, thanks and love to my wife and son. Both were understanding and supportive over the many months that Dad disappeared in the evenings.

Acronyms

CIP

Capital Improvement Project

COR

Council on Revenues, State of Hawai‘i

DBEDT

Department of Business, Economic Development, and Tourism, State of Hawai‘i

ERTF

Economic Revitalization Task Force

FY

Fiscal Year

GET

General Excise Tax

HRS

Hawai‘i Revised Statutes

HVB

Hawai‘i Visitors Bureau

LUC

Land Use Commission

PUC

Public Utilities Commission

QHTB

Qualified High Technology Business

SLH

Session Laws of Hawai‘i

TAT

Transient Accomodations Tax

xi

1


Introduction In the 1990s, after years of excitement and prosperity, the economic winds suddenly dropped from Hawai‘i’s sails, and the state found itself perplexingly and unhappily becalmed for seven years. This was unprecedented in the state’s economic history—perhaps unprecedented since Captain James Cook’s arrival in 1778. To put this in perspective, the annual average rate of growth Hawai‘i experienced between 1959 and 1990 meant the economy doubled every 14 years. At the rate of growth experienced between 1991 and 1998, it would take Hawai‘i’s economy 93 years to double in size. The economic slowdown significantly changed how Hawai‘i’s people think about their economy. In the high-growth years, Hawai‘i developed a reputation for innovative land use regulation, environmental remediation, and labor practices. The socially conscious looked to Hawai‘i as a model of progressivity. The high rate of economic growth made that progressivity politically acceptable because it hid the costs. When incomes grow at 7% or 8% per year, no one really worries about policies that shave one quarter to one half of one percentage point from the long-term rate of growth. But in the 1990s Hawai‘i came to value those fractions of a percentage point. Voters forced Hawai‘i’s leaders to reconsider policies that may have met a political or economic need at one time but that came with a cost in terms of foregone economic activity. Hawai‘i made some adjustments during the period and showed a willingness to look at even more changes. Most tellingly, many in Hawai‘i began to realize the implications of the state’s economic connections to the rest of the world. Those connections imply pursuing policies with an eye to the economic alternatives available elsewhere. This means that we cannot examine policies just by looking at their 1

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Hawai‘i Becalmed

benefits—the costs, also, must be acknowledged. At high growth rates (such as 7% per year), we could too easily ignore or understate the costs; at growth rates of 0.5% per year, those costs became clearer. Yet no matter what it did, Hawai‘i could not have avoided the downturn of the 1990s. Precisely because Hawai‘i is so connected (some would say dependent on) the outside world, external economic events can sweep Hawai‘i up.1 This is largely what happened early in the 1990s. To their credit, many in Hawai‘i took this as an opportunity to reexamine their ideas about how the economy should operate. Political leaders, responding to constituent demands that something be done, opened themselves to exploring formerly taboo policy options yet policy makers could do little to substantially improve Hawai‘i’s economic performance. Hawai‘i’s economy simply relies so heavily on export earnings (principally from the mainland and Japan), that its economic growth policies hardly leave a trace in economic statistics. But in accepting this, we run a serious risk of becoming complacent. For while policy makers find it difficult to substantially improve Hawai‘i’s economic fortunes, they can easily impair its economic health. Policies that impose significant regulatory costs on individuals and businesses, that raise tax rates out of line with taxes elsewhere, and that ignore consumer choices beyond Hawai‘i’s goods and services, can easily plunge the state’s economy into decline. There are simply too many alternatives. Hawai‘i must compete or wither.

The Bubble Hawai‘i emerged from the recession of 1981–1982 with a roar, fueled by demand from Japanese visitors and investors. Japan’s economy inflated during the second half of the 1980s in what turned out to be a bubble—an unsustainable expansion of income and wealth. Hawai‘i participated in Japan’s bubble in the form of surging numbers of yen-spending visitors and direct Japanese investment in Hawai‘i’s commercial and residential properties.

Three Pinpricks A confluence of three events brought Hawai‘i up short. First, Iraq invaded Kuwait. Ordinarily, Middle Eastern events would have little effect in the Pacific, but the short Gulf War sent worldwide tourism demand into a nosedive. For several months during 1991 and 1992 many people

Introduction




3

thought better of stepping onto an airplane—and that spelled trouble for Hawai‘i. As the United States basked in the glow of winning the Gulf War, the American economy reached the depths of recession. This was the second of the three shocks to Hawai‘i’s economy. While most of the mainland’s recession proved short, California’s economy dipped again in 1993; this was enough to flatten westbound tourism for most of the decade, and with it Hawai‘i’s economy. The third shock, the bursting of the Japanese economic bubble, turned out to be longer lasting and of greater effect than the other two. Hawai‘i’s economy had become tethered to the Japanese economy. This was not because most tourists came from Japan (most tourists were westbound), nor was it because of Japan’s economic size (the mainland is larger by far). Instead, Hawai‘i’s economic growth pattern mirrored Japan’s because that was where the action was: Japan generated Hawai‘i’s fastest-growing tourism segment and fastest-growing investment component. Compared to a more stable (though larger) base from the mainland, the movement in Hawai‘i’s economy reflected the movement in Japan’s economy. So when the bubble burst—when Japan’s stock market fell, when the real estate market collapsed, and so on—Hawai‘i felt the pain. Doubledigit growth in visitor arrivals and expenditures fell to the low single digits. Investment in lavish hotels and restaurants dried up. While some background activity continued, by comparison with the go-go years of the 1980s, Hawai‘i’s economy in the early 1990s felt sluggish.

A Change in Fortune From1992 through 1994 Hawai‘i’s private and public leaders denied the depth of the economic problem. While there was talk that government had grown too large, that taxes were too high, and so on, leaders expected to ride it out. They had some rationale for this: after all, Hawai‘i had seen recessions before and the downturns had been short, if unhappy, affairs. In the past, gross state product (GSP) would fall for one, or at most two, years and then start growing again. Thus it made sense to take a wait-andsee attitude. During this period, a number of issues percolated in Hawai‘i, including whether to fund rail transit and whether to compel the conversion of residential leasehold property to fee interest. These issues affected how Hawai‘i’s economy would work in detail, but they were only the background of the basic macroeconomic picture. The one exception was the growing

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concern over the size of state government. Many concluded that Hawai‘i’s government had grown too much during the 1980s and that its size was at least partly responsible for the poor economic performance—this despite the argument’s vagueness (what size is “too large”?) and in spite of evidence against it. That government had grown too large nevertheless became accepted as fact.

A Change in Administration By the time Benjamin J. Cayetano was inaugurated as governor in 1995, Hawai‘i seemed ready for change. Cayetano used his first state of the state address to reveal how severely the budget was strained, and to lay the political groundwork for budget cuts and layoffs. The layoffs proved rather small compared with the total number of state workers, but the fact that they happened at all was remarkable. During this period there was also talk about the need to establish a rainy day fund when times got better. The dramatic deterioration in the state’s fiscal fortunes paved the way for other changes that promised to have an even more profound impact on the economy. The Cayetano administration began to explore deregulating the telecommunications industry; Hawai‘i made a promising start with the passage of Act 225 (1995 SLH) early in Cayetano’s first year. (Unfortunately, this effort bogged down later.) Initial inquiries into maritime and land use regulations proved even less successful. Still, the issues were raised and serious efforts were made to examine them. Raising the level of consciousness about these and other issues was an important contribution of the Cayetano administration that may ultimately pay off down the road.

COR, ERTF, and Crisis Through all of this the economy struggled, straining the state budget. The Council on Revenues (COR), constitutionally charged with forecasting revenues available to the state, sharply lowered its estimates in the middle of the 1997 legislative session. The ensuing administration challenge to the COR’s competence ultimately revealed that the COR had an important political, as well as economic and fiscal function. In the year before his election to a second term, Governor Cayetano assembled a forum of community leaders to discuss problems and to determine an agenda for moving Hawai‘i’s economy forward. This forum evolved into the Economic Revitalization Task Force (ERTF), and it proved to be

Introduction




5

a source of both controversy and some of the most sweeping proposals to be considered in Hawai‘i for decades. The ERTF made recommendations about, and legislation was eventually enacted on, tourism, education, university autonomy, government budget reform, taxation, and more. The ERTF dominated policy discussion in Hawai‘i from mid-1997 through the election in 1998. Ultimately, it helped secure Cayetano’s reelection. As the ERTF began to form its proposal, in the summer of 1997, financial analysts around the world were maneuvering madly to pull their money out of an increasingly risky-looking Thailand. In July, the Thai baht collapsed and the ensuing creditor rush to the exits pulled down much of eastern Asia and threatened the rest of the world as well. The Asian crisis loosed a torrent of discussion about economic policies and institutions that in some ways mimicked the discussions taking place in Hawai‘i, discussions about deregulation, honesty and transparency in government, premiums on efficiency, and so on. Fortunately, the Asian crisis was contained; unfortunately, the deeper causes of the crisis may not have been addressed. It is unclear whether they were addressed in Hawai‘i.

The Election For Hawai‘i Democrats, 1998 was the year of the great escape. Gubernatorial candidate Linda Lingle came within a whisker of ousting Cayetano to become the first Republican governor in 36 years. Ultimately, Cayetano convinced enough people that he was a “new Democrat” (that is, fiscally prudent and tolerant of lower taxes) without alienating the left. As far as economics goes, the challenger’s proposals and the incumbent’s record looked very much the same, and that probably saved Cayetano.

Second-Term Agenda A second-term governor under a two-term limit enjoys certain freedoms. Without the pressure of reelection the incumbent can pursue policies that he or she truly believes in. Three such initiatives emerged in Cayetano’s second term: a tax credit for refurbishing hotels, incentives for attracting high-tech firms, and an increase in the minimum wage. All three have serious economic drawbacks. The hotel tax credit and the incentives for high-tech firms were of a piece. Both targeted specific industries or firms for special treatment on the argument that they will boost economic growth. Whether this kind of industrial policy works in fact is an open question.

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Hawai‘i Becalmed

The minimum wage hike had a slightly different goal. Supporters argued for “sharing the gains” of renewed economic activity with low-income workers. This is a long-standing Democratic policy, successfully promoted on the national level. Yet standard economic analysis and some evidence suggest that the policy throws out of work the very people it intends to help. These policies emerged in the last two years of the 1990s as Hawai‘i’s economy showed signs of recovery. A number of economic indicators turned upward including real gross state product growth, visitor arrivals, personal income, and jobs. It is interesting that policies about which many economists have reservations began to emerge once the economy picked up. Worryingly, this suggests a return to the Hawai‘i of the 1980s, when strong economic growth masked the costs of economically questionable public policy.

Lessons and Conclusions In some ways the 1990s delivered a wake-up call to Hawai‘i. While it was clear that economic growth rates were trending downward from the very high levels of the 1960s and 1970s, no one expected the unprecedented, sustained collapse of the 1990s. To a large extent, the collapse lay outside Hawai‘i’s control. The Gulf War, the mainland recession of 1990–1991 (including California’s longer decline), and the deflation of Japan’s economic bubble all combined to slam Hawai‘i’s economic base. After some hesitation it became clear that Hawai‘i’s economy would not bounce back within a year or two that. Something more serious was going on. When Hawai‘i’s residents came to this realization, our leaders began to look at things anew, to reexamine assumptions, and to question the old formulas and standard solutions. In terms of action, this fell well short of a revolution, yet we did take some steps and, perhaps at least as important, started thinking anew about Hawai‘i’s economy and its place in the world. Hawai‘i’s economy began to recover in 1999. Growth rates picked up in a number of indicators, including personal income, employment, jobs, and tax revenue. As the economy rebounded some leaders felt pressured to adopt politically popular policies. Many of these policies were disguised as attempts to further strengthen the economy—such as tax credits for hotels and high-tech firms. Yet the economic arguments for such policies were weak at best. Other policies, such as raising the minimum wage, were directed at equalizing incomes, but in a way that could harm the very people the policy was trying to help.

Introduction




7

Hawai‘i vigorously pursued these kinds of policies when the economy grew at double-digit rates in the 1980s. Such policies enjoy strong political backing, and probably reduce long-term economic growth by only small amounts. That makes them almost irresistibly tempting because the political benefits are clear whereas the economic costs are not. Something like this has also happened in Asia. With the exception of Japan, the Asian economies that were hit hard by the economic crisis of 1997 and 1998—South Korea, Thailand, Indonesia, and Malaysia— rebounded smartly. Yet some observers worry that the recovery might have been too fast—that policy makers have not addressed the underlying problems and that the recovery undermined the pressure to deal with those problems. Similarly, Hawai‘i’s decision makers are inclined to support policies that make a great deal of political sense but that have dubious economic merit. While individual measures do not seriously threaten the economy, an accumulation of such policies can impair Hawai‘i’s competitiveness, as our experience of the1990s has shown. An important caveat must accompany this questioning of recent Hawai‘i policy. Economists’ concerns about certain policies really only apply as long as the costs go unrecognized. That is, environmental, regulatory, and other statutory requirements designed to achieve one goal or another will often have some negative implication for economic growth. The economist’s job is to remind policy makers of the costs and to encourage decisions that explicitly weigh the benefits against them. Once that point is made and appreciated, the economist’s task is done. If Hawai‘i’s leaders—and, more importantly, Hawai‘i’s people—decide that the benefits of certain environmental protection measures, of particular regulatory actions, and of specific market interventions, are worth the costs, then economists have no more to say. Oftentimes we cannot accurately measure the benefits, yet they may well be quite high. For example, how highly does a community value pristine beaches and green space, or nearuniversal health coverage? As long as the community is aware of the costs of those policy positions, there can be no objection to incurring those costs. Economists may weigh things differently, but then they merely express their opinions as individuals and members of a community, with no greater say in what happens than anyone else. So it comes down to weighing costs and benefits. Perhaps that is a prosaic, predictable conclusion for a book written by an economist. In my view, Hawai‘i’s experience in the 1990s drove this lesson home—at least for a time. As Hawai‘i’s citizens struggled to find a solution to our state’s economic problems, people began to think seriously about the costs of existing

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policies, and in some cases, they made changes. Whether Hawai‘i continues this practice—particularly in the wake of uncertain economic conditions following the September 11 terrorist attacks—remains to be seen.

Notes 1. Noel J. Kent has made the classic statement of dependency theory as it applies to Hawai‘i. While acknowledging the costs of external connections, this book differs from Kent in arguing that Hawai‘i’s dependence also explains its relatively high standard of living.

2


The Bubble From the perspective of the early twenty-first century, the 1980s seem like a golden period in Hawai‘i’s economic history: Nearly everyone was working, property values soared, and personal incomes grew. On the other hand, the supply of affordable housing dwindled, the cost of living accelerated, and many worried about the rapid changes in Hawai‘i. Japan’s economic ascent drove Hawai‘i’s performance during the 1980s, clearly illustrating the potential benefits of engaging the global economy. Yet, in hindsight, some of Hawai‘i’s economic success was an aberration built on an unsustainable Japanese bubble. The 1980s boom, generated by increased Japanese demand, was actually a relatively minor blip in a long-term reduction in growth rates. Tourism had long-since replaced agriculture (sugar and pineapple) as the main driver of Hawai‘i’s economy. Figure 1 shows that the surge of visitor arrivals peaked in 1967. This also translated into a surge in general economic activity that peaked in 1969 (Figure 2). By the 1980s Hawai‘i’s economy had settled into a period of solid, if unspectacular, growth. Even in terms of visitor arrivals, the growth rates of the 1980s reached only one quarter of those in the early 1960s. Real gross state product (GSP) growth in the 1980s came to only half the level of the 1960s. It is easy to look back on the late 1980s as an unprecedented period of economic prosperity in Hawai‘i’s history, but these figures throw some sober light on the more extreme claims for the decade.

Japan’s Expansion Still, the growth generated from Japan in the 1980s did reverse the process for a while. By 1985 Hawai‘i’s economy was more than twice the size of 9

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Figure 1 Visitor Arrival Growth, 1960–1989 Annual Percentage Change Source: DBEDT

its 1965 economy. Thus, 4.8% real GSP growth in 1985 translated into an increase of $1.1 billion over the previous year, easily larger than the 8.9% growth of 1965 ($860 million). The additional visitor arrivals in 1986 (722,870) nearly equaled all of the visitor arrivals in 1966 (835,456). Japanese investment reached a peak of $2.3 billion in 1991, more than four times the total gross investment of 1965.1 Thus, from one perspective the trend in Hawai‘i’s growth rates simply indicates a maturing economy with a break in the 1980s. From another perspective, in absolute dollars and visitor arrivals, the 1980s’ surge in economic activity was indeed notable. Hawai‘i’s 1980s expansion depended on Japan’s boom, reflected in the growing Japanese trade surplus, soaring stock market prices, and rising incomes. With substantial help from the United States, Japan rebuilt its economy after the devastation of World War II. In the 1950s and 1960s the Japanese government successfully promoted and protected industries that could accelerate economic development. Japan shifted resources to industries, such as shipping, steel, and automobiles, that exhibited economies of scale, surging productivity increases via the latest technology, and high export potential.2 Japan went through a remarkable period of accelerated

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Figure 2 Real Gross State Product Growth, 1959–1989 Annual Percentage Change Source: DBEDT

industrialization and economic development that, by the 1970s, placed it among the strongest economies in the world. Japan’s economic development strategy focused on promoting export earnings. With explicit government assistance, Japan subsidized research and development with low-interest loans and tax breaks, protected the domestic market from foreign competition, and encouraged the creation of cartels for favored industries. In some cases (such as steel) the new technologies and physical plant, combined with relatively inexpensive labor, meant that the Japanese were the lowest-cost producers in the world. In other cases, protection of the domestic market from foreign competition and cartels allowed Japanese producers to sell at very competitive prices abroad while maintaining high prices (and profits) at home. These practices posed a serious challenge to U.S. producers, who continued to use older facilities and technologies and who enjoyed much less protection. The success of the export-oriented development strategy is evident in the data on net exports (Figure 3). In 1980 Japan began exporting more than it imported on a sustained basis. Prior to that, Japanese net exports

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Figure 3 Real Japan Net Exports, 1955–1989 Quarterly Exports Less Imports Source: Japan Economic Planning Agency

were negative—imports exceeded exports. Thus, the 1980s marked a period of unprecedented success for Japan in its export-led growth strategy. Indeed, Figure 3 shows that net exports peaked in real terms in 1985 (at just over 4 trillion 1990 yen or 4.3% of gross domestic product). At the same time, the share of real exports in real gross domestic product exceeded 11%, up from less than 6% in the 1960s.3 Japan’s leaders accomplished this by cutting deals with various constituencies. First, lifetime employment offered workers a large measure of economic security and made them less likely to oppose labor-saving technical change. Second, the Japanese political system protected small groups threatened by changing market forces. Farmers, construction workers, small grocery store owners, and others developed successful political strategies to protect themselves from both external and internal competition. In many cases, the Japanese consumer paid the price.4 By the 1980s these policies appeared to make Japan’s the most vibrant economy in the world and instilled real fear into the hearts and minds of CEOs and government leaders in other countries. Japan appeared destined to rule the world economically. One could hardly find a popular business

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or economic journal that did not wring its hands over the competitive threat posed by Japan and the apparent failure of U.S. business to respond. Pundits in the United States side lauded everything Japanese, from lifetime employment and tightly-knit interlocking directorships to just-in-time inventory management and total quality management circles.5 Paradoxically, some of these practices would later be cited as the sources of Japanese uncompetitiveness in the 1990s; others were quietly and effectively adopted. For example, lifetime employment and interlocking directorates have both been criticized as sources of problems for Japan’s economy.6 The former is seen as an expense that can no longer be supported, the latter as one reason the financial infrastructure failed to identify troubled firms and to act decisively to remedy the problems. Other practices (such as justin-time inventory control and total quality management) have found a place in the best-run businesses around the world. The willingness of some nonJapanese, especially American, firms to scrutinize and adopt what appeared to be the best practices may be one of the most important responses to the Japanese threat of the 1980s—even if some of the “best” practices turned out to be not so good. As Japanese economic activity expanded, asset values rose. Stock market values grew at double-digit rates beginning in 1983. Residential real estate grew at those rates in 1980 and 1981, quieted for a time, and then surged again in 1987and 1988.7 For several months in 1987, the Japanese stock market expanded at more than 50% per year (Figure 4). Those convinced of the superiority of the Japanese economy saw this as vindication of their views: It was the inherent productivity of Japanese manufacturing and superior economic policies that explained the rise in values. Share prices rose, it was argued, because of the expectation of huge future profits. Few recognized the rise in asset prices for what it was—a bubble that would soon burst. Moreover, the Japanese economy and asset prices fed off of each other. Not only did profits and incomes drive up share values, but the rising wealth of share values also justified higher consumer spending. Indeed, growth in real private consumption in Japan rose from near zero in 1980 to 5% per year in the last two years of the decade. This added further fuel to the economy’s fires.

Hawai‘i Benefits By the second half of the 1980s Japanese citizens were looking for ways to spend their new wealth. For Hawai‘i, this meant a surge of eastbound

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Figure 4 Japanese Share Prices, 1980–1990 Monthly Nikkei Average Source: Bank of Japan

visitors, beginning in late 1982. Monthly year-over-year eastbound arrival growth rates averaged 9.5% between 1982 and the beginning of 1990. In some months year-over-year eastbound visitor growth topped 30%. Not only did the numbers of Japanese visitors increase, but the Japanese also spent more than other visitors. In 1988, the average Japanese visitor spent $350 per day while the U.S. mainland visitor spent only $121 per day.8 An appreciating yen further supported Japanese spending. The productivity of Japan’s economy, and the large and growing trade surpluses run with the United States, meant that the yen had appreciated against the dollar (and most other currencies) since the global abandonment of the Bretton Woods fixed exchange rate system in the early 1970s (Figure 5). Between early 1985 and 1989 the yen rose from 260 per dollar to 144 per dollar—an 81% appreciation. The rising yen made Hawai‘i products and services less expensive for the Japanese consumer, and this stimulated Japanese-based visitor spending in Hawai‘i. The effects of increased Japanese visitors to Hawai‘i were not confined to the numbers of tourists or their spending alone. The forces that drove

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Figure 5 Yen-Dollar Exchange Rate, 1975–1989 Monthly Yen per Dollar Source: http://pacific.commerce.ubc.ca/xr/data.html

up real estate and stock prices in Japan had similar effects on Hawai‘i. Japanese investors increasingly came to Hawai‘i to buy assets, largely tourismrelated investment—such as the Halekulani Hotel on O‘ahu and the Westin hotels on Maui and Kaua‘i. Other purchases might qualify as “trophy” properties such as Ala Moana Shopping Center, the Sheraton Moana Surfrider, and Grand Wailea Resort on Maui. Japanese investment in Hawai‘i peaked in 1991 at $2.3 billion.9 Of the total foreign-owned assets in Hawai‘i in 1977, Japan accounted for 55.7%. By 1992, the Japanese share of foreignowned property had jumped to 88%.10 Economists do not count all of the spending for hotels, shopping centers, and so on as new investment. Purchases of existing structures merely change ownership and do not add new productive capacity to the economy. Still, even discounting the transfer of existing assets to Japanese buyers, economically meaningful Japanese investment in Hawai‘i was substantial. As an indicator of total investment, consider the contracting portion of the general excise and use tax base. This is essentially the value of construction

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activity subject to the tax. Figure 6 shows that construction activity took off in the second half of the 1980s, reaching a peak in 1991.

Hawai‘i’s Expansion This construction boom profoundly affected Hawai‘i. Incomes and jobs were bolstered by the construction necessary to produce the capital requirements of the higher visitor demand. As a share of total nonagricultural jobs, construction jobs had declined since the early 1970s from more than 8% of total jobs to just over 3% in 1984. This was the combined result of the maturing of Hawai‘i’s economy after tourism became dominant during the 1960s, and of the recession of the early 1980s. But the declining trend reversed in late 1984, and the construction jobs share started rising, reaching a peak of 6.4% in late 1990. As argued in Chapter 4, this expansion led to a hangover. When the original visitor demand disappeared, Hawai‘i was left with excess capital, which all but assured the economy would suffer a long period of slow growth as the superfluous capital was worked off.

Figure 6 Contracting Tax Base, 1978–1991 Monthly General Excise Tax Contracting Base ($1,000s) Source: Department of Taxation

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Increased economic activity in the late 1980s also had other implications. First, government coffers began to fill faster than elected leaders could spend it. At the local level, rising property values buoyed county funds. Indeed, property values rose so dramatically that counties could lower effective tax rates at the same time. Figure 7 demonstrates the increase in property values during the late 1980s and early 1990s, as well as the sharp decline in the average property tax rate. At the state level, the fiscal effect of increased economic activity was even more dramatic. The flow of revenue from general excise and individual income taxes created a large surplus in the state treasury. In 1989, to satisfy a constitutional requirement, the state granted a tax credit of $125 per exemption to residents because general fund balances in two successive fiscal years exceeded 5% of revenues in those years.11 By 1991 the cash balance had reached nearly $1.1 billion.12 The booming economy also led to unsustainably low unemployment rates. Hawai‘i employers faced a serious problem in finding workers, qualified or not. The unemployment rate fell below 3% in November 1987 and, with only a few exceptions, stayed there until January 1992. At its

Figure 7 Average Hawai‘i Real Property Values and Effective Tax Rates, 1986–2000 Source: State of Hawai‘i Data Book 1999, Table 9.21

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lowest level in August 1989, the unemployment rate reached 1.6%. Employers, especially construction contractors, had to import workers to meet their needs. As much as 20% of the skilled construction workforce came from the mainland and received up to $50 per hour when the normal wage rate was $30 per hour.13 There were downsides to this rapid economic pace. Complaints about the cost of living in Hawai‘i became especially acute in the late 1980s and early 1990s. While the Federal Reserve was wringing inflation out of the mainland economy during the late 1980s, inflation raged in Hawai‘i. But inflation estimates (as measured by the increase in the consumer price index) only track the change in prices over time in a given place. They cannot capture the difference in the cost of living between two places. A cost-ofliving measure that appropriately compared living costs between locations showed dramatic increases over the 1980s. At its height, Hawai‘i’s overall cost-of-living premium, as measured by estimated living costs for a family of four, reached 36.2% in 1992, up from 22.1% in 1985.14 In addition to the costs of daily living in Hawai‘i, many began to express concern about other effects of the high economic activity, such as environmental and cultural costs.15 As developers pushed new projects in response to the current and potential demand of new visitors, those concerned with the associated damage became more vocal. As wealth grew in Hawai‘i, and the costs of stricter regulation appeared supportable, the legislature acceded to these concerns and required a higher level of development scrutiny. For example, Act 230, 1985 SLH, added a new section to the land use statute. When the State Land Use Commission considered petitions for land use boundary changes (regularly required for new development projects) it would have to consider the impact on “natural systems and habitats”; “cultural, historical, or natural resources”; maintenance of “agricultural resources”; employment opportunities; and low-income housing. Indeed, it is a remarkable testament to the expectations of Hawai‘i’s potential that developers could still financially justify their projects even in the face of high and rising costs associated with land use and environmental restrictions. In hindsight, these expectations may have proved too optimistic, and the justifications unreasonable. Hawai‘i’s additional income and wealth during this period also encouraged political leaders to indulge the demands of other constituents. Hawai‘i had adopted the most comprehensive health care law in the country in 1974, requiring all employers to offer health insurance to employees working at least 20 hours per week.16 In 1988, the legislature required accident or sickness insurance policies to include coverage for alcohol and drug abuse treat-

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19

ment and for mental health treatment.17 The previous year the legislature created an endowment with state funds for the Honolulu Symphony.18 An Office of Space Industry was created.19 In 1989 the legislature expressed concerns about the “destructive forces” arising from the free flow of capital and a preference for affordable housing development for Hawai‘i residents as opposed to “housing intended primarily for individuals outside of Hawai‘i.”20 A “works of art special fund” was established with 1% of the annual capital improvement project appropriations for state buildings.21 A statewide after-school program was begun for elementary students that required justification for exceeding the general fund expenditure ceiling.22 Visitor industry training courses were established at local high schools.23 A commission was funded to celebrate the “Year of the Family.”24 The minimum wage was raised in 1992.25 An executive committee was funded to organize the eighty-fifth anniversary celebration of the first Filipino arrivals to Hawai‘i.26 And tax breaks, subsidies, and exemptions were doled out for various purposes.27 To cite these examples is not necessarily to criticize them, though many deserve critique. Rather, the point is that the increased resources from economic expansion made them possible. To a very real degree, Hawai‘i’s residents only acquired strong environmental protection, universal health care, and a steeply progressive tax structure because they could “afford” such measures as a consequence of good economic times. Hawai‘i might not have achieved so much in the way of social and environmental welfare legislation had the economy been less robust. These social goods are goods like anything else—they come with costs. The more economic resources a society enjoys, the more social goods it can afford. The causality does not run the other way. These examples also reveal that Hawai‘i’s experience echoed that of Japan. Just as Japan chose to spend some of its rising income subsidizing specific businesses, protecting politically sensitive groups, and nurturing political insiders, Hawai‘i chose to spend some of its income on social and environmental protections and the care of the politically influential. In both cases, such spending may have been politically necessary to permit policies that expanded the economy, but lower economic growth in later years would throw such expenditures into question. In an important sense, Hawai‘i’s economic experience in the 1980s was simply an extension of its history.28 From sandalwood, whaling, and the sugar and pineapple industries, to the military and tourism, Hawai‘i has been an export-oriented economy for two centuries. For example, Figure 8 shows the ratio of exports to gross product for Hawai‘i, the mainland

20




Figure 8

Hawai‘i Becalmed

Exports as a Share of Gross Product, 1958–2000

Note: The Japan series breaks in 1980 and the Hawai‘i series breaks in 1985. While the series on either side of the break are not strictly comparable, they are broadly consistent. Source: U.S. Bureau of Economic Analysis, Japan Economic and Social Research Institute, DBEDT

United States, and Japan for the poststatehood period. Hawai‘i’s ratio of exports to gross product lies in the range of 50% to 60%, while that of the United States and Japan (often associated with intensive export activity) is around 10% to 15%.29 A similar figure for other states would also show high export-to-GSP ratios because state exports include interstate activity. But this does not detract from the point that Hawai‘i’s economy relies to a great extent on exports. This external orientation is the source both of Hawai‘i’s high standard of living and of its economic uncertainty.

Conclusion This chapter argues that the economic surge in Japan brought with it a wave of economic growth in Hawai‘i, vividly showing residents both the benefits and costs of open economic engagement with the rest of the world. If the Japanese demand that fueled the economic boom had been perma-

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21

nent, Hawai‘i’s income and wealth would have been permanently higher. The increased visitor demand generated by the remarkable rise in Japanese incomes and wealth during the 1980s lifted Hawai‘i’s economy. The lift became even more pronounced as construction activity accelerated to build the capital base needed to meet the higher level of demand. This proved to be the manifestation in Hawai‘i of Japan’s economic bubble. As we will see, when Japan’s bubble burst, Hawai‘i’s ride came to an end.

Notes 1. DBEDT, A Listing of Foreign Investments in Hawai‘i, 1995, p. 152; and Hawai‘i Gross State Product Accounts, 1958–1985, June 1989. Data on foreign investment in Hawai‘i is particularly troublesome. A later DBEDT report (Foreign Investment Activities in Hawai‘i and the United States, 1954 through 1998, by Country, February 1999) discusses some of the difficulties and the tenuous nature of these estimates. 2. Richard Katz, Japan, The System That Soured: The Rise and Fall of the Japanese Economic Miracle, Armonk, NY: M.E. Sharpe, 1998, pp. 118–120. 3. For Japan, the ratio of exports to gross product rises dramatically between 1960 and 1980 when the numerator and denominator are first converted to real terms (adjusted for price changes). In contrast, the ratio that appears in Figure 8, calculated from nominal exports and gross product, is much more stable at around 10%. The difference probably reflects technological change that lowers the relative price of Japanese exports. 4. Katz, pp. 102–106. 5. See, for example, Chalmers Johnson, Laura d’Andrea Tyson, and John Zysman, eds., Politics and Productivity: The Real Story of Why Japan Works (New York: Harper Business, 1989). 6. For a broad review see “Survey: Business in Japan,” The Economist, 25 November 1999. 7. Kozo Yamamura, “LDP Dominance and High Land Price in Japan: A Study in Positive Political Economy,” in Land Issues in Japan: A Policy Failure? ed. John O. Haley and Kozo Yamamura (Seattle: Society of Japanese Studies, 1992). 8. Calculations of visitor arrival growth from DBEDT monthly data; visitor spending from DBEDT, The State of Hawai‘i Data Book, 1992, Table 204, p. 196. However, U.S. visitors stayed almost twice as long as Japanese visitors—10 days versus 5 or 6 days. 9. See comment in footnote 1. 10. DBEDT, Foreign Investment Activities in Hawai‘i and the United States, 1954 through 1998, by Country, February 1999, Table 1.1a. 11. Act 323, 1989 SLH. In fact, this requirement was triggered every year from 1981 through 1995. The 1989 payment was the largest per exemption; in most years the credit was a nominal $1 per exemption. 12. Tax Foundation of Hawai‘i, Government in Hawai‘i, various years. 13. Honolulu Advertiser, 13 August 1989: H1. 14. State of Hawai‘i Data Book, 1998, Table 14.07.

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Hawai‘i Becalmed

15. These and many other issues related to the effects of rapid economic development, gathering economic storm clouds, and Hawai‘i’s unique institutions were taken up in the two Price of Paradise volumes edited by Randall W. Roth in the early 1990s. 16. Chapter 393, Hawai‘i Revised Statutes. 17. Act 202, 1988 SLH. 18. Act 382, 1987 SLH. 19. Act 355, 1988 SLH. 20. Act 250, 1989 SLH. 21. Act 389, 1989 SLH. 22. Acts 1 and 334, 1990 SLH. 23. Act 335, 1990 SLH. 24. Act 337, 1990 SLH. 25. Act 264, 1991 SLH. 26. Act 271, 1991 SLH. 27. The cruise ship exemption to the public service company tax, set to expire in 1991, was extended for another five years by Act 228, 1991 SLH. Prescription drugs and prosthetic devices were exempted from the general excise tax under Act 306, 1986 SLH; a food tax credit and a capital goods excise tax credit against income taxes was adopted to offset the general excise tax on those items in Act 239, 1987 SLH; and a refundable medical services excise tax credit was granted under Act 321, 1988 SLH. 28. For a classic review of Hawai‘i’s early economic history see Theodore Morgan, Hawai‘i: A Century of Economic Change, 1776–1876 (Cambridge, Mass.: Harvard University Press, 1948). For a more recent assessment prior to the 1990s, see Thomas Hitch, Islands in Transition: The Past, Present, and Future of Hawai‘i’s Economy (Honolulu: University of Hawai‘i Press, 1992). 29. These ratios divide nominal exports by nominal gross product. As discussed in note 3, the ratios differ from those calculated by dividing real (price-adjusted) exports by real gross product. Even so, the general point of Figure 8 holds.

3


Three Pinpricks The curtain came down on Hawai‘i’s strong economic performance in the late 1980s relatively quickly. The early 1990s were particularly cruel to Hawai‘i. First came the Gulf War, which frightened overseas travelers and raised Hawai‘i’s oil-dominated energy costs. At virtually the same time, the U.S. economy slipped into recession, which ushered in a break in westbound visitor demand. Finally, the Japanese economy followed the U.S. downturn, thereby threatening the heart of the 1980s economic boom. Together, these three pinpricks burst Hawai‘i’s economic bubble. As if to add insult to injury, Mother Nature contributed to Hawai‘i’s woes as Hurricane Iniki flattened a large part of Kaua‘i’s economy. Such shocks reflect the downside of open economies that, like Hawai‘i’s, provide high standards of living. It may be impossible to reduce these risks through diversification because they are systemwide. Even so, as argued in later chapters, the pace of recovery from such shocks can be increased through economic policies that preserve openness to new ideas and capital and that allow businesses both to succeed and fail.

The Gulf War Iraq’s invasion of Kuwait is a good example of how events on the opposite side of the globe can directly affect Hawai‘i. In fact, the effect was not only direct it was immediate. The Iraqi invasion on August 2, 1990 drew an ultimatum from the United States and a buildup of U.S. military in the Middle East. Mounting tensions between Iraq and the United States raised the specter of terrorism, and long-range travel became a highprobability target. Consumers placed travel plans on hold, a troubling development for Hawai‘i’s major export industry. Indeed, within two weeks of 23

24




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the invasion the Hawai‘i Visitors Bureau reported an expected drop in bookings due, in part, to fears of “terrorist reprisals.”1 As the buildup to confrontation developed, the fear of terrorism rose. The United States began sending supplies and personnel to the Middle East the day after the invasion (August 3). A couple of weeks later, the buildup stranded Los Angeles-bound passengers in Honolulu for 19 hours because of delays associated with Hawaiian Airlines fulfilling its commitment to ferry troops.2 The U.S. Department of State warned of rising terrorist threats, especially to civil aviation.3 Security measures at airports around the world tightened throughout the fall. Unfortunately for Hawai‘i, the need for improved security imposed real economic costs. World oil prices soared from $17 per barrel to $36 per barrel between June and October 1990. Gasoline prices in Hawai‘i and across the country jumped by 4 or 5 cents per gallon within 24 hours of the invasion.4 Electricity prices rose an average $6 per month due to the automatic fuel oil adjustment clause.5 This was an additional source of worry for Hawai‘i. Dependent as Hawai‘i is on imported oil, a third oil price shock would have had serious implications for the state. Together with the direct increase in the cost of travel (higher jet fuel prices) and growing travel security concerns, the buildup to the Gulf War was a wrenching experience for those concerned about Hawai‘i’s economic fortunes. Worldwide, travel demand slipped by 15% to 20%.6 By late January 1991, between 2,000 and 3,000 convention bookings to Hawai‘i had cancelled.7 General bookings from the mainland were off by 10% and Japan bookings fell 20%.8 The Westin on Kaua‘i, which normally charged $175 per night, began advertising rooms at $55 per night, double occupancy, at what was normally peak season. By February 1991, with the war under way, security precautions had put a dent in the aloha spirit, there were noticeably fewer travelers, and the drop in airport concession business led to requests for relief from the terms of ordinary lease agreements.9 Hawai‘i officials took special measures to bolster flagging demand. The Hawai‘i Visitors Bureau asked for $1.6 million in emergency marketing funds and an increase of $9 million for the 1991 budget over the previous year’s level of $15 million.10 Act 13 (“Act Relating to Tourism”) of the 1991 legislative session provided for a special appropriation of $6 million. The Act noted that the visitor industry was “impacted by a downturn in the national economy and uncertainty regarding world events. Marked declines in reservation booking activity are being experienced.” Because the Act would exceed the general fund expenditure ceiling, Hawai‘i’s constitution required a justification. The legislature explained

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25

the law was needed to “serve the public interest and to meet the needs provided for by this Act.”11 One can see a clear dip in the visitor data during this period. Figure 9 shows that visitor arrival growth turned negative in December 1990. In February 1991, at the height of the war, total arrivals were 20% below figures for February 1990. Both westbound and eastbound arrivals roughly followed the same pattern, with the number of arrivals dropping sharply in February 1991. In the following year, eastbound visitor growth jumped back, pulling total growth with it. But westbound arrival growth remained ominously subdued. In late 1992, the Hawai‘i Visitors Bureau asked the legislature to nearly triple tourism promotion spending to help the state recover from two years of decline due to war, recession, and mainland airfare wars.12 Hawai‘i’s Council on Revenues (COR) and the newspapers braced for the economic fallout from reduced travel demand. In September 1990, the COR mentioned the Iraq conflict as a potential source of serious disruption but did not adjust its forecast. The COR predicted 8.1% revenue

Figure 9 Visitor Arrival Growth, 1987–1992 Percent Change from Year-Earlier Month Source: DBEDT

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growth for FY1991 (ending June 30) and 11.0% growth in FY1992.13 In January the COR convened a special meeting “to review and discuss the impact of the Middle East war and the U.S. mainland recession.” By that point the COR had lowered its forecast to 7.0% in FY1991, 9.4% in FY1992, and 6.5% in FY1993.14 The forecasts would continue to fall. In early 1991 the economists at DBEDT also anticipated a marked reduction in economic growth. Real personal income had grown at an average annual 3.7% in the previous three years. In April 1991, DBEDT forecast 1.6% growth in that year, rising to 2.8% in 1992, and then settling at just above 2% until 1995.15 Even these lowered expectations would prove optimistic.

U.S. Recession While the Gulf War was scary, Hawai‘i had more to fear from the fact that the United States had fallen into recession. The Gulf War was a short, sharp disruption in Hawai‘i’s otherwise-flourishing economy. It showed that Hawai‘i was as vulnerable as the rest of the world to interruptions in the increasingly global economy. But the war was probably the weakest of the three pinpricks to Hawai‘i’s bubble. The U.S. economy had enjoyed a long period of growth by 1989. After the relatively deep recession of 1981 and 1982, in which the unemployment rate hit 10.8% (the highest since the Great Depression), the U.S. economy began to gather steam (see Figure 10). Economic growth averaged 4.3% per year from 1983 to 1989. Unemployment averaged 6.9% and inflation came under control at 3.7%. Some attributed the strong 1980s growth to Paul Volcker’s iron hand at the Federal Reserve. Volcker had taken the helm in 1979 when inflation was soaring at more than 11%. In a few short years, Volcker put the brakes on the expanding money supply and forced interest rates upward. In August 1981 the prime rate hit a high of 20.5%. This drove the economy into recession, but it also effectively ended inflation. By 1983, the rate of consumer price inflation had fallen to 3.2% compared to 13.5% only three years earlier. Others pointed to Reagan’s “supply-side” tax cuts. Reagan won the 1980 election in part on promises of lowering taxes and increasing defense spending. The top marginal income tax rate was 70% in that year, and Reagan popularized the notion of the Laffer curve. Economist Arthur Laffer supposedly sketched a graph on a cocktail napkin one evening that related the rate of taxation to the amount of tax revenue collected. The

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27

Figure 10 Average Annual Growth in U.S. Real Gross Domestic Product, 1980–1992 Percent Change from Year-Earlier Quarter Source: U.S. Bureau of Economic Analysis

idea was that at some point tax rates would become so high that lowering rates could actually increase revenue because people would work harder and spend fewer resources avoiding taxes. Few economists actually thought this prescription fit the U.S. economy, but the idea nevertheless took hold. Income tax rates were cut in 1981 and 1986. Whether this, in fact, generated the economic boom is still debated. Still others saw those tax cuts, and the associated increase in defense spending, as a classic Keynesian fiscal stimulus. Those who rejected the supplyside explanation painted Reagan as the quintessential Keynesian, a term the president would have found anathema. Still, Northwestern University economist Robert Eisner, among others, points out that the combination of tax cuts and massive defense spending resulted in unprecedented peace-time budget deficits and a classic fiscal stimulus.16 The economy boomed because the government went on a spending spree financed by debt. Figure 11 shows the sharp increase in federal budget deficits and debt as a percentage of gross domestic product (GDP) after 1981.

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Figure 11

Hawai‘i Becalmed

U.S. Budget Surplus and Debt as Percent of GDP, 1960–1992

Source: U.S. Office of Management and Budget. http://w3.access.gpo.gov/usbudget/fy2001/hist.html

Whatever the cause, the U.S. economy performed remarkably well in the 1980s and the quick recovery from the stock market crash of 1987 suggested that things would continue to run smoothly. The October 1987 stock market scare was indeed a heart-stopper. The market had grown strongly throughout the 1980s. In August 1987 the Dow Jones Industrial Average reached the then-giddy height of 2,722, reflecting an annual average rate of growth of 16% over the previous seven years. On October 19 the Dow dropped 508 points to 1,739, a 23% fall. The crash brought with it fearful memories of 1929 and the Great Depression. Fortunately for the market, Alan Greenspan, who had replaced Paul Volcker as chair of the Federal Reserve, pumped funds into the markets and promised more, thereby calming the situation and moving the economy quickly past the danger. The situation was handled well, but the recession could not be avoided entirely. In reaction to signs of recession, the Federal Reserve began lowering interest rates in mid-1989. The Fed targeted the federal funds rate, the rate at which banks lend to one another, at 9.75% in early 1989. Then the Fed gradually ratcheted the rate down over a period of months. By the

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29

end of the first quarter of 1991 (the first quarter of official recession), the targeted federal funds rate was down to 6%. Over the same period the supply of money, as measured by M1, began to rise dramatically as the Fed tried to inflate the sagging economy. As indicated in Figure 10, these actions did not prevent the economy from experiencing negative real growth in 1991. The recession could not be avoided, but it was short and shallow. By the fourth quarter of 1991 the recession had ended, although almost no one knew it. The Fed’s response to the early warning signs probably deserves much of the credit for the short duration and mild nature of the downturn.17 There was no way to know this at the time, but the short mainland recession would prove the start of a shift in the trend of westbound visitor arrivals to Hawai‘i. Until then westbound arrivals had grown at about 4.0% per year. As Figure 12 demonstrates, the trend of westbound arrivals thereafter took a marked shift downward. Through 1997, the average rate of growth in westbound arrivals was –1.5% per year. The U.S. economy came out of recession in April 1991, about the time Bill Clinton was beginning his run for the White House by focusing on “the economy, stupid.” Unfortunately for President George H. W. Bush,

Figure 12

Monthly Westbound Visitor Arrivals, 1980–1997

Source: DBEDT

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Hawai‘i Becalmed

it was difficult to tell that the U.S. economy was recovering. Unemployment rates continued to rise until June 1992, reaching 7.8%. They did not fall below 7% until the following year. By the time the slow improvement in the economy had become noticeable, Clinton had convinced much of the American public that it was time for a change. But mainland economic growth would mean relatively little to Hawai‘i for many years. As the shift in the trend of visitor arrivals illustrates, the link between the mainland economy and that of Hawai‘i had weakened. Indeed Hawai‘i’s economy had already become more heavily influenced by Japan.

Japan’s Slowdown Initially this seemed a good thing. Japan appeared to continue its strong economic performance even as the U.S. economy cooled. Hawai‘i had managed to diversify its economy—at least as far as tourism went—away from the mainland and toward Japan. If the mainland slid into recession, there was some hope that Japan might keep Hawai‘i’s economy going. This worked for a while. Once the fear of the Gulf War began to pass, eastbound visitor arrivals regained their relatively strong growth even as westbound arrivals lagged. By September 1991 eastbound visitor arrival growth had returned to the 20% level regularly seen in the late 1980s. Japanese GDP growth remained relatively high during the Gulf War (5.6%). But Japanese growth rates soon followed the U.S. pattern downward. One year later, in the first quarter of 1992, Japanese economic growth was only 2.2%. By 1993 growth had become negative (Figure 13). This was hardly surprising since the United States was Japan’s largest export customer—and Japan had an export-driven economy. Still, it did surprise those who saw Japan’s economic vibrancy as unassailable. And this was often the view in places where the Japanese vacationed, like Hawai‘i. But something more ominous than a brief recessionary episode was happening in Japan. In December 1989 the Japanese stock market peaked. The asset bubble burst and Japan’s economy was in for a long period of stagnation. Businesses and individuals had borrowed heavily against the inflated asset values. The plunge in values threatened not only these borrowers, but their lenders as well. Japan responded by circling the wagons and protecting its own. This did not address the problems, it merely put them off. Paul Krugman, writing in Foreign Affairs, offers an explanation for troubles like Japan’s.18 Krugman argues that the miracle of the Asian economies

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31

Figure 13 Japanese Real GDP Growth, 1985–1994 Percent Change from Year-Earlier Quarter Source: Japan Economic Planning Agency

was largely a myth. When proper economic accounting was used, the vaunted productivity disappeared. Instead, the rapid rates of growth were more readily attributable to increases in the amounts of labor and capital. Additional output came from more inputs, not because of improved production methods. This meant that at some point the ride would come to an end. There is only so much labor and capital. Without productivityenhancing technological change, the Asian tigers would turn into kittens. While Japan had experienced genuine productivity growth, Krugman observes that that era “now lies well in the past.”19 By 1990 Japan could no longer rely on adding more capital and labor to its economy nor on importing productivity-enhancing technological change. Japan was now fully developed and shared the leading edge of technology with the United States and a few other developed economies. From now on, growth would come less quickly and more unevenly. It would depend more on the ability to think of new and better ways to combine inputs to produce output than on simply adding more inputs or leaping over generations of innovation by importing the latest technology.

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There were other problems, too. Japan’s financial system stood on weak legs. This became clearer in 1997 and 1998 when the Asian crisis plunged Japan into recession anew and many of its banks came close to toppling.

Conclusion Open economic engagement with the outside world carries risks as well as rewards. This chapter has discussed three events that shocked Hawai‘i’s economy in the early 1990s and marked the beginning of what would turn out to be a long period of little or no growth. Such risks are always a possibility for open economies. Whether and how fast an economy recovers depends on the economic structure prior to the shocks and the willingness to respond in appropriate ways. As we will see in the next chapter, Hawai‘i went through a period of blame and denial in the early 1990s. It was also a period of crisis, soul-searching, and reform. Ultimately, Hawai‘i took steps to redress some of the problems at home. These could not guarantee economic recovery, but they were important because they showed that Hawai‘i can take necessary, if not sufficient, steps toward long-term economic health.

Notes 1. Honolulu Advertiser, 16 August 1990. Concerns about a mainland recession and rising oil prices were also cited. 2. Honolulu Star-Bulletin, 17 August, 1990. 3. New York Times, 8 September, 1990: I5; and 27 October, 1990: I4. 4. Honolulu Advertiser, 3 August, 1990. 5. Honolulu Advertiser, 27 August, 1990: A3. 6. Alberto Bin, Richard Hill, and Archer Jones, Desert Storm: A Forgotten War. (Westport, Conn.: Praeger, 1998), p. 125. 7. Honolulu Advertiser, 24 January 1991: A3. 8. Honolulu Advertiser, 1 February 1991. 9. Honolulu Advertiser, 6 February 1991. 10. Honolulu Star-Bulletin, 11 December 1990. 11. Not all legislators were convinced of the appropriateness of state financing of visitor promotion. Representative Dennis Arakaki suggested that visitor promotion was really an industry responsibility. Honolulu Star-Bulletin, 15 March 1991: A5. 12. Honolulu Star-Bulletin, 4 December 1992: A1. 13. Letter from J. Ming Chew, Chairman of the Council on Revenues, to Samuel B. K. Chang, Director of the Legislative Reference Bureau, 10 September 1990, with attachments. 14. Letter from J. Ming Chew, Chairman of the Council on Revenues, to Governor John Waihe‘e, 25 January 1991, with attachments.

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33

15. DBEDT, Quarterly Statistical and Economic Report, 1st Quarter 1991, Table 1-4, p. 7. 16. Robert Eisner, How Real Is the Federal Deficit? (New York: The Free Press, 1986): Chapter 12. 17. Figure 10, based on year-over-year percentage growth, shows the recession starting in the first quarter of 1991. An alternative calculation of the percentage growth from the previous quarter would time the recession somewhat earlier—beginning in the third quarter of 1990. Some view the Fed’s reaction to the recession in the early 1990s as too slow; see Richard W. Stevenson, “Two Economic Policy Captains Working with Different Tools; Greenspan Is Determined to Avoid Repeating the Mistake of 1990,” New York Times, 5 January 2001; and Bob Woodward, Maestro, Greenspan’s Fed and the American Boom (New York: Simon and Schuster, 2000) pp. 84–85. 18. Paul Krugman, “The Myth of Asia’s Miracle,” Foreign Affairs 73(1994): 62–78. Krugman’s main argument applied more to the “Asian tigers” (Singapore, Thailand, Taiwan, Hong Kong, Korea, and Malaysia) than to Japan, but the corollary of slower future growth fit Japan as well. 19. Ibid, p. 73.

4


A Change in Fortune Hawai‘i initially met the blows to its economy with denial. Since statehood, Hawai‘i had never suffered two consecutive years of recession. For most of its history, the economy had grown at rates of at least 4% per year. It was simply implausible that Hawai‘i’s economy would enter a period of sustained, nonpositive growth. Yet as time passed and the economy failed to improve, as state budget ink turned from black to red, as job growth fell and unemployment rose, it became increasingly clear that this was something different. People had to face the fact that the 1980s party was over. Only when that happened could Hawai‘i leaders begin to entertain constructive ideas. Hawai‘i’s recessions had always been relatively short. A graph of the path of Hawai‘i’s gross state product (GSP) indicates that periods of negative growth never lasted for more than one year (Figure 14) and often reflected conditions on the mainland. The dip in 1961 matched a short national recession: the 1974 drop into negative growth followed the first oil crisis and the associated U.S. downturn. Then came a larger contraction in 1982 as Hawai‘i felt the effects of the Federal Reserve’s inflation-control measures. These recessions proved to be blips on an otherwise high (though moderating) growth path. As discussed in Chapter 2, Hawai‘i enjoyed strong economic growth from 1959 through the 1980s. Although the level of growth trended downward as the economy matured, the high overall growth assured that any downturn in economic activity would be short. So it made sense that Hawai‘i’s leaders viewed the 1991 dip in growth as an understandable, if regrettable, payment for nearly a decade of vigorous growth. The drop would prove to be just another of the relatively

34

A Change in Fortune




35

Figure 14 Real Gross State Product Growth, 1959–1994 Annual Percentage Change Source: DBEDT. A revised GSP series for 1985 forward is not strictly comparable with the earlier series.

rare breaks in Hawai‘i’s otherwise-uninterrupted economic growth. It was inconceivable that the downturn could be something more serious. But growth did not revive as it had in the past. In 1993 and in 1994, Hawai‘i’s economic growth remained below 1%, job losses mounted, and businesses and the press began to worry. It was becoming clear that something different was going on.

Fiscal Constraints and Government Size The state’s growing fiscal crisis hastened the realization that the problem was serious. The usual pattern of revenues outpacing expenditures abruptly stopped. In 1992, for the first time in eight years, expenditures actually exceeded receipts. Most states have a balanced budget requirement of some sort. Article VII of Hawai‘i’s constitution states that “General fund expenditures for

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any fiscal year shall not exceed the state’s current general fund revenues and unencumbered cash balances, except when the governor publicly declares the public health, safety or welfare is threatened as provided by law.” Thus, although expenditures began to exceed receipts, Hawai‘i was not in technical violation of Article VII because of substantial accumulated balances. But the large general fund balances Hawai‘i had amassed over the boom period began to dwindle. By 1991 the state’s general fund had accumulated enough annual surpluses that the balance stood in excess of $1.25 billion—more than 4% of GSP. This was the effect of revenues flowing to the state faster than even politicians could figure out how to spend it. But by 1994 the balance was less than half this amount and headed south. Terminology is sometimes confusing. In Hawai‘i, “surplus” has been used to refer to both the difference between receipts and expenditures over a given year and to the amount in the general fund on a certain date of the year. But the two are as different as the excess of a person’s income over spending in a month and the amount of money in the bank at the end of the month. This book refers to the excess of receipts over expenditure as a surplus (a deficit occurs when receipts fall short of expenditures). The amount in the general fund at a point in time is called the “balance,” which could be positive or negative. The constitutional provision in Article VII effectively prohibits the general fund balance from becoming negative. Thus, the state began running deficits (expenditures greater than receipts) in 1992. This reduced the general fund balance (Figure 15).1 Moreover, as others have noted, the state transferred money from the general fund to a number of special funds, which effectively placed large portions of the government revenue away for specific purposes.2 These funds would be tapped in future years as fiscal conditions failed to improve with the economy. Many criticized Governor John Waihe‘e’s administration for running deficits and spending down the general fund balance. Waihe‘e became the epitome of the “typical” Democrat who padded state government with cronies during the boom years even as the economy slid into recession. Yet Waihe‘e apparently understood early that things had changed: In his 1990 inaugural address, as hostilities in the Gulf loomed, the governor noted that “the days of the big state surpluses are behind us.”3 One month later, in his state-of-the-state address, the governor warned that budget cuts might be necessary due to the Gulf War and the mainland recession.4 From a standard economic perspective, running down the balance was just what the economy needed as it slid into recession. Mainstream Keynesian

A Change in Fortune

Figure 15




37

General Fund Position, 1980–1994

Source: Calculated from Tax Foundation of Hawai‘i, Government in Hawai‘i, various years.

fiscal policy recognizes that government spending should rise during recessions in order to soften the downturn. Particularly if a large, positive balance has been amassed during a prior boom, it makes sense to draw down the balance to soften the shock of an economic downturn. This is especially true if it appears (as it did) that the downturn would be brief. Indeed, this is precisely what a rainy day fund is for. Hawai‘i did not have an official rainy day fund, but the balance provided an unofficial substitute. In general, states enjoy much less scope to engage in counter-cyclical fiscal policy than the federal government, but Hawai‘i’s large general fund balance put it in a unique fiscal position in the early 1990s.5 The problem was not that the balance ran down, but that the long period of negative or zero economic growth outlasted the general fund balance. Hawai‘i’s years of economic stagnation would prove to be long and durable, probably related to the extent of the boom in the late 1980s. Spending down the accumulated fund balance was simply insufficient to jolt Hawai‘i out of recession. Indeed, given the apparent extent of overbuilding in the 1980s, there may have been no realistic level of state spending that could have

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preserved the high rates of economic growth to which Hawai‘i’s residents had become accustomed. Many in Hawai‘i were not (and are not) inclined to give much credence to this view. In their eyes, Waihe‘e made a serious mistake by continuing to expand government hiring into the recession. Moreover, the spending may have had nothing to do with Keynesian macroeconomic policy and everything to do with cronyism. Perhaps there is some validity to this criticism in the sense that it might have been better to build valuable public works than to hire additional state workers. Keynesian analysis usually does not make such fine distinctions: Additional spending matters wherever it goes. Moreover, regardless of motive, the timing of the deficit spending was just right from a Keynesian perspective. However, by the early 1990s Hawai‘i’s people were in no mood to consider the fine points of macroeconomic policy. Indeed criticism of government size grew louder during this period. Big government made a compelling scapegoat for the economy’s poor performance. It was argued that government had grown so large (as measured by the number of state workers) that the economy could no longer support it.6 The size of government, it was said, resulted in excessive taxation and a drain of resources from the private sector. That the size of government had not proved an insuperable burden just a few years earlier was rarely noted. By some measures Hawai‘i’s state government was indeed out of control. There was a clear surge in the number of state employees during the early 1990s. Even relative to the population, the number of state workers had expanded dramatically. The unstated assumption was that government services should be proportional to population. That might be true for some types of services (processing drivers licenses, perhaps), but not others (providing high-quality education). By other, equally plausible measures, there was nothing really unusual about the government’s size. Another assumption about the number of government workers is that it should be proportional to the size of the economy as measured by inflation-adjusted (real) personal income. By this measure the government was no larger in the early 1990s than in the 1970s. Figure 16 shows the number of state jobs adjusted by both population and real personal income. The difference is clear. Both measures are indexed to 1970=100, yet the adjustment by population shows steady growth while the adjustment by the size of the economy (real personal income) shows stability. When this was pointed out at the time, the observation that government employment had not necessarily grown dramatically was treated

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Figure 16 Two Measures of Hawai‘i Government Size, 1970–1998 Index 1970=100 Source: Calculated from DLIR job data, U.S. Bureau of Economic Analysis personal income, and population from State of Hawai‘i Data Book.

as something of a curiosity.7 It was relatively easily ignored because everyone “knew” that government was too big. The concern about government size probably also had something to do with killing a project that might have provided much-needed stimulus to Hawai‘i’s economy—the mass transit system in Honolulu. The debate on mass transit has a long history in Hawai‘i, but in the early 1990s it was particularly heated. On one side were those who saw a light rail system as part of a solution to Honolulu’s traffic congestion problems. On the other side were those who pointed out that rail systems frequently lost money and contribute little to reducing congestion. The latter view prevailed, as the Honolulu city council proved unwilling to raise the general excise tax rate from 4% to 4.5% to fund the local portion of the system. In doing so, Honolulu and Hawai‘i walked away from more than $600 million in federal funds. At about 2% of gross state product (though spread over several years), this would have been a significant stimulus.8

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In the face of all this, observers of Hawai‘i’s economy regarded the signs of economic stagnation with increasing alarm. The two daily newspapers regularly cited evidence of the economy’s weakness. They used these signs to editorialize about the main culprit in their view—government’s excessive size.

Signs of Stagnation The signs of sustained subpar performance were indeed growing. Prominent among these was the near absence of growth in visitor arrival numbers. Until early 1994 the number of visitor arrivals fell each year. The bottom had fallen out of westbound arrivals, Hawai‘i’s largest market. Eastbound arrival growth was also going nowhere as the Japanese economy followed the United States into recession. Between July 1992 and June 1994 the number of eastbound arrivals fell at an annual average of more than 3%. In 1994, arrival numbers improved, but at nothing like the high growth rates of the late 1980s. Another sign of weakness could be read in the loss of jobs. Long-term job losses began to appear in the statistics in December 1992. Hawai‘i had endured sustained job losses before, but the economy was now in for 47 months of consecutive decline. There was then a brief period of low job growth in 1996–1997and then another 14 months of job losses. This was unprecedented in the state’s history. Some of the job losses involved structural change, such as the closing of several remaining sugar plantations and mills. These were among the most difficult losses to adjust to. It was not simply a matter of the business cycle moving down and up again. Observers had known for decades that sugar and pineapple were disappearing. Still, as some of the last plantations and mills closed—such as those in Hamakua on the Big Island and on O‘ahu—the long-anticipated demise shocked residents. Even more important in terms of sheer numbers, construction jobs began to evaporate, starting in October 1991. As demand from the visitor industry waned, construction activity dried up. There was a brief revival of growth in 1993 due to reconstruction after Hurricane Iniki, but by October, jobs again headed down (Figure 17). Honolulu was said to be seriously overbuilt in terms of both commercial and residential structures. As a result, prices started falling. Residential housing prices, which had peaked in 1990, only began to firm up 10 years later.

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Figure 17 Construction Job Growth, 1991–1994 Percent Change from Year-Earlier Month Source: State of Hawai‘i, Department of Labor and Industrial Labor Relations

Though unidentified at the time, the decline in construction was a natural result of the excess building of a few years before, which had created an oversupply of commercial and residential space in the first place. The downturn in the construction cycle would prove particularly long in Hawai‘i because the boom had been particularly strong in the 1980s. To this extent, the speculative bubble in both Japan and Hawai‘i had long-term negative consequences for the real economy. In 1994 Hawai‘i’s unemployment rate rose above the national rate and stayed there (Figure 18). Of course, this was a function of both the national rate falling, as the mainland recovery gathered steam, and the Hawai‘i rate rising, as the island economy slid into recession or slow growth. But it was still shocking to see, in May 1994, the Hawai‘i unemployment rate hit 6.2% while the national rate had fallen from a high of 7.8% in June 1992 to 6.1%. Hawai‘i had not experienced a higher unemployment rate than the United States as a whole since July 1979.

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Figure 18 U.S. and Hawai‘i Monthly Unemployment Rates, 1993–1995 Seasonally Adjusted Source: U.S. Bureau of Labor Statistics

Denial: Thumbs Up! People responded to these signs of slowing economic activity at first by denying their importance. We all do this; we ignore the evidence in front of us, or we interpret it in the best possible light. This is especially easy to do when we have recently lived through extraordinarily good times. Surely that was the norm and this is just a temporary correction, right? One of the most blatant examples of denial was the “Thumbs Up!” campaign sponsored by Bank of Hawai‘i, First Hawaiian Bank, and other businesses.9 The campaign was built on the notion that the only problem with Hawai‘i’s economy was lack of confidence. If everyone would stop moaning about the economy and start focusing on the positive, the thinking went, we would soon be better off. In other words, the “Thumbs Up!” campaign implied that Hawai‘i had talked itself into recession. While the leaders of the “Thumbs Up!” campaign no doubt had their hearts in the right place, the economic situation was not simply a matter of insufficient consumer confidence. There was some justification for impa-

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tience with those—especially the newspapers that seemed to glory in every misstep of the economy—who wanted to dwell on bad economic news. But the news was bad for real reasons, and no amount of talking up the economy was going to change that. The public recognized the “Thumbs Up!” campaign for what it was—a public relations solution—and they rejected it. Yet many others also expected the economy to turn around quickly. The Council on Revenues (COR), charged by state law with producing revenue forecasts, was repeatedly upbeat. In September 1990, the COR projected 8% general fund revenue growth in FY1991, 11% the following year, and roughly 7% growth in the next three years. The following year, in September 1991, the COR projected a similar pattern but at 1 to 2 percentage points lower. The next year, the set of projections dropped another 1 to 2 percentage points. And so on. As the economy continued to deteriorate, the COR continued to forecast stabilization at lower and lower levels. The COR was not alone. The Department of Business, Economic Development, and Tourism (DBEDT) repeatedly forecast growth of real personal income in the 2% to 2.5% range through 1994. In fact, the average growth in real personal income from 1991 through 1994 was less than 0.10%. One of the few exceptions to this things-will-soon-be-better view was that of First Hawaiian Bank’s chief economist, Leroy Laney. From 1991 through 1993, Laney regularly expressed the view that Hawai‘i’s economy was either headed for or already experiencing recession.10 Laney actually stated what many people believed—or, at least, feared. Interestingly, Laney’s statements gradually made it okay to admit the poor performance of the economy. Perhaps that was the point at which more serious work could be done on thinking about what Hawai‘i could do to get out of the mess.

Conclusion In sum, Hawai‘i’s leaders understandably reacted to the slowdown in economic growth by referring to their experience. At that point Hawai‘i had never experienced even two consecutive years of negative growth, but now the economy was just barely keeping its head above water year after year. This suggested that the world had changed, and that something more was called for than simply waiting for the state’s economic sails to fill again. In spite of their incoherence and ham-handedness, the complaints about

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the size of government can be read as reflecting that call for change. Perhaps it was time to pay serious attention to the internal policies that affected Hawai‘i’s economy. In this light, the ill-fated “Thumbs Up!” campaign was the last gasp of the no-real-problem-here point of view. Once this period of denial and blame was past, something more constructive could be contemplated.

Notes 1. The data in Figure 15 are calculated from the receipts and expenditures and the 1971 general fund balance reported in the Tax Foundation of Hawai‘i’s Government in Hawai‘i, various years. The balance does not precisely correspond to other general fund balance estimates because of various transactions and transfers. 2. Paul H. Brewbaker, Lowell L. Kalapa, Randall W. Roth, and Marcia Y. Sakai, “Government Spending: Smoke & Mirrors,” in The Price of Paradise, ed. Randall W. Roth (Honolulu: Mutual Publishing, 1992), p. 77. 3. Honolulu Star-Bulletin, 13 December1990. 4. Honolulu Advertiser, 23 January1991: A1. 5. A state usually cannot engage in the macroeconomic stimulus role suggested here. But sometimes it can. Recently, Federal Reserve Board Chairman Alan Greenspan indicated that, to be effective, an economic stimulus of about 1% of gross domestic product (GDP) would be necessary (“Greenspan Says Any Stimulus Package Should Total as Much as $100 Billion,” Wall Street Journal, 25 September 2001). Because states have a much higher share of imports than the country as a whole, a larger stimulus is probably needed to produce a similar effect. This may help explain why the sizable deficit spending in the early 1990s did not prevent recession in Hawai‘i. 6. Editorials in the Honolulu Advertiser and the Honolulu Star-Bulletin from 1992 through 1994 repeatedly made this argument. “State government has become a growth industry that Hawai‘i can’t afford.” Honolulu Star-Bulletin, 18 January 1994: A10. Similar arguments appeared in the Honolulu Advertiser, 21 December 1994, A1; editorial, 15 June 1994; and editorial 27 June 1994. 7. Christopher Grandy, “...and Maybe Government Didn’t Grow Much, After All,” Honolulu Advertiser, 29 September 1994. 8. See note 5. As the economy slowed in 1992, some concern was expressed about whether the one-half percentage point increase would generate sufficient revenue to cover the city’s portion of the transit system; see Honolulu Advertiser, 7 June, 1992, A1. 9. The “Thumbs Up!” campaign was announced in August 1995, and therefore should actually be treated in the following chapter. However, the campaign had all the markings of a temporary solution and therefore seems more appropriately discussed here. Honolulu Advertiser, 29 August 1995, A3; Honolulu Star-Bulletin, 29 August 1995, B1. 10. Honolulu Star-Bulletin, 14 June 1991: C1; 5 August 1992: D4; and Honolulu Advertiser, 15 August 1992: A23; 7 January 1993: A11; 11 August 1993: C1.

5


A Change in Administration The period of slow growth in Hawai‘i had become uncomfortably long. By election time in 1994, Hawai‘i’s residents were ready for change. Lieutenant Governor Benjamin Cayetano managed to win the gubernatorial election in part by consciously putting some distance between himself and Governor John Waihe‘e. On assuming office, Cayetano learned that the state’s fiscal condition was much worse than anticipated, and his sober stateof-the-state address set the tone for a period of retrenchment and reevaluation. In general, the change in governors, combined with fiscal constraints, provided the opportunity to identify and begin to address some of the underlying economic problems facing Hawai‘i. By 1994, Governor John Waihe‘e had accumulated so much animosity that his ability to make serious progress toward addressing Hawai‘i’s economic problems was probably nonexistent. It was hard to find anyone in the state who would publicly support John Waihe‘e. The economy was struggling. Government had grown too large. It was time for a change. Of course Hawai‘i voters could have selected the Republican candidate Pat Saiki in 1994, but the conventional wisdom is that Saiki ran an ineffectual campaign and that Frank Fasi’s independent candidacy split the Republican vote.1 Cayetano acted as a thorn in the governor’s side during Waihe‘e’s second term, as he consciously separated himself from the incumbent. The lieutenant governor pushed through the A+ after-school program, criticized the public school teachers’ union, split with Waihe‘e on rail transit, termed Waihe‘e’s campaign finance initiatives “cosmetic” and “inadequate,” called for the resignation of Waihe‘e’s budget director, and opposed Waihe‘e’s supreme court candidate.2 With so little invested in the previous administration, Cayetano could more easily and credibly make changes. Of course 45

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he did not have the mandate that might have come with a change in party, but, like Bill Clinton two years earlier, Cayetano effectively moved toward the middle of the political spectrum, and this also helped secure him the governor’s office. The new governor made clear precisely how far he was willing to distance himself with his first state-of-the-state address: “No governor, no legislature since statehood has faced a financial crisis of the magnitude and severity that we face today.”3 Until the previous Saturday (January 21, 1995) Cayetano had expected a $150 million shortfall in the general fund (based on the Waihe‘e administration’s budget). Instead, over the weekend, the new governor explained, further analysis suggested this would be more like $250 million. Cayetano made clear that the first order of business was to put the state on sound financial footing; the second would be to get the economy moving again. While some might find the weekend surprise hard to believe (since Cayetano was part of the previous administration), the crisis was real. The state’s fiscal position had gradually deteriorated over the previous two or three years. Expenditures began exceeding receipts in 1992 and the general fund balance had been steadily drawn down. The last budget submitted by the Waihe‘e administration forecast a $73 million general fund shortfall. In fact, the shortfall exceeded $200 million, primarily because of lower revenues.4 Even the COR was surprised by the degree to which general fund tax revenues declined in FY1995 (ending in June). In September 1994, the COR had projected growth of 4.0%—about the same level as the 4.5% growth of FY1993 and the 4.1% growth of FY1994. By December 1994, the COR had cut the FY1995 growth estimate to 2.8%, which would be followed by a drop to 1.9% in April and to 0.8% at the end of May. In fact, all of these forecasts proved optimistic: FY1995 general fund tax revenue actually declined by 1.1% compared to FY1994.5 If the new governor intended to get state residents’ attention and to signal a clear change in administrations, the first state-of-the-state address did it. Cayetano followed through on the get-tough fiscal policy by beginning the reduction in force (RIF) process. This effort would require several months of negotiating with the government unions. In August of 1995, the first RIF in Hawai‘i’s history was implemented. In fact, only about 145 “warm bodies” were let go. Many employees were affected by the RIF in the form of senior people “bumping” junior people.6 Perhaps even more significant than the RIF, Cayetano restrained actual spending by wielding his authority to restrict funds. The administration imposed budget restrictions during that first year, and continued to

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do so in every year thereafter. Cayetano’s director of Budget and Finance, Earl Anzai, was a perfect character for this task, being gruff, grumpy, and intimidating. It would not become clear for some time, but this was the start of a real change in Hawai‘i’s fiscal performance—the trend in state government spending shifted decidedly downward. In the meantime, the administration explored other proposals to get the state’s fiscal house in order. One suggestion was to start a rainy day fund, as had been done in other states. The government would set funds aside during boom periods and draw on it during periods of fiscal distress. One reason this idea never went anywhere was that such legislation would have no effect on the current situation—it was too late. Another was that the governor already had other powers (such as budget restrictions) to control the budget. A third was that Hawai‘i had in fact operated in recent years as though it had a rainy day fund, in the form of a large balance that had been spent down as the economy worsened. Two constitutional constraints contributed to the surplus. Like other states, Hawai‘i has a balanced budget requirement. In Hawai‘i’s case this means that expenditures cannot exceed revenue plus the current general fund balance.7 The other constraint is that growth in expenditures in any year cannot exceed the average rate of growth in the economy (measured by personal income over the previous three years).8 These two features affect the economy differently at different stages of the business cycle. As the economy expands in a boom period, revenues tend to grow rapidly. The same would happen to expenditures except that the expenditure ceiling is based on the previous three years’ growth in personal income. The expanding economy means, therefore, that expenditures are held back by the lower growth rates of previous years. This leads to a surplus. During an expansion, the expenditure constraint is more important than the balanced budget constraint. On the other hand, as the economy peaks and begins to decline, revenue growth falls. Suddenly the balanced budget constraint matters and the expenditure ceiling becomes less relevant because it is based on the relatively high rates of growth in the previous three years, presumably the years with the highest rates of economic growth. Thus, in a downturn, the balanced budget constraint matters while the expenditure constraint does not. Figure 19 illustrates these effects in Hawai‘i. The figure depicts the annual percentage changes in personal income, the expenditure ceiling, and revenue.9 During the late 1980s, as Hawai‘i’s economy expanded, the expenditure constraint grew more slowly than revenue or the economy. While revenue flowed in faster than politicians could spend it, the expenditure

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Figure 19 Annual Percent Change in Personal Income, Expenditure Ceiling, and Revenue, 1980–1999 Note: Personal Income from U.S. Bureau of Economic Analysis, revenue from Hawai‘i Department of Taxation, expenditure ceiling from author’s calculations

ceiling also constrained spending. In effect, the expenditure ceiling created a rainy day fund. Later, in the 1990s, the balanced budget constraint proved more important. The expenditure ceiling remained relatively high, reflecting the high growth of the late 1980s. But this was irrelevant because revenue growth had fallen. Now the balanced budget constraint was binding. But the fiscal situation was only one of the areas in which the governor sought action. The administration also tried to bring new thinking to economic problems in telecommunications, maritime policy, land use regulation, and tourism promotion, among others. The combination of unprecedented economic stagnation and a new governor created a mandate to look at a number of economic policy areas. Actual changes would prove more modest than initial proposals, and they would take time to implement; still, it was significant that they were explored at all.

Telecommunications When Cayetano took office, work had already started on a mechanism to bring competition to Hawai‘i’s telecommunications markets. This took

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the form of a hearing before the Public Utilities Commission (PUC) known as Docket 7702. Docket 7702 provided a framework for the various parties interested in telecommunications—the incumbent, GTE Hawaiian Tel (now Verizon Hawai‘i Inc.); potential entrants such as AT&T, Sprint, and MCI; the state; the Consumer Advocate; and others—to discuss issues and timing related to opening Hawai‘i’s telecommunications markets to competition. As the Cayetano Administration took office, Sprint and AT&T were introducing competition for interisland telephone service. But this was only the beginning. Many other issues remained to be determined, such as how fast and on what terms competitors could enter local telecom markets, markets for pay phones, communications systems within large office or apartment buildings, portability of phone numbers across communications companies, and emergency 911 service costs. All of these issues and more were expected to be worked out over a period of years in Docket 7702. The administration supported these efforts and worked with legislators to pass Act 225 in the 1995 legislative session. Act 225 set into state law some of the agreements the parties had reached in Docket 7702. It required each telecommunications carrier to allow others to interconnect with it on “reasonable” terms. It provided for a universal service fund, to which all telecommunications firms would contribute, that would help cover the costs of basic telecommunications services for low-income customers, customers with disabilities, and those living in high-cost areas. The act directed the PUC to ensure “number portability” (the ability of customers to retain their phone numbers when they switched from one telecommunications provider to another) as soon as “technically feasible and economically reasonable.” The PUC would also oversee compensation agreements among carriers to cover costs as consumers moved from one carrier to another. And the act directed the PUC to prevent cross-subsidization, whereby the profits earned by a firm on services not subject to competition are used to subsidize the costs on competitive services in order to underprice other firms. Act 225 placed Hawai‘i among the leading states in telecommunications reform at the time. The legislation also anticipated some of the features of the federal telecommunications law that Congress was developing and that President Clinton would sign in February 1996. Like the Federal Telecommunications Act of 1996, however, Act 225 would lead to less action than had been hoped for. Some progress has been made; for example, through July 2000 more than 200 telecommunications companies had applied to the PUC for certificates of authority to provide service. Still, most of the major issues pending in 1995 remain today, unsurprising in an industry

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transitioning from regulation to competition against a background of multiple jurisdictions and rapid technological change.

Maritime The Cayetano administration also began reevaluating the uses of harbor facilities and the relationships among interested parties there. A growing dispute had emerged over uses of waterfront property. On one side, traditional waterfront users sought to preserve shipping and boating facilities. On the other side, those interested in economic development looked to the waterfront for other uses: restaurants, hotels, condominiums, and recreation facilities. Representatives of these groups were at odds with each other even within state government: The Department of Transportation, Harbors Division, tended to sympathize with traditional harbor and shipping uses. The Hawai‘i Community Development Authority and the Aloha Tower Development Corporation, both attached to the Department of Business, Economic Development, and Tourism (DBEDT), supported developing other uses for waterfront lands. Senate Concurrent Resolution 214 in the 1995 legislative session created the Hawai‘i Maritime Industry Policy Advisory Task Force, composed of public and private representatives charged with investigating a number of issues. Prominent among these was the effect of federal maritime laws on Hawai‘i. The Passenger Services Act of 1886 and the Jones Act of 1920 limit the types of vessels that can serve U.S. ports—the former applies to passengers and the latter covers cargo. Only U.S. flagged vessels may transport passengers or cargo between U.S. ports. To be U.S. flagged, a vessel must be U.S.-built, U.S.-owned, and largely U.S.-staff. These federal “cabotage” laws have limited the passenger and cargo trade in Hawai‘i. Only two companies provide regular cargo service between the mainland and Hawai‘i. Until recently, there was only one active U.S.flagged ocean-going passenger vessel that toured the Hawaiian Islands, the SS Independence.10 Charges had been made for years that the cabotage laws effectively granted monopoly status to the transit companies serving Hawai‘i, raising the cost of goods in the state (nearly 80% of goods consumed in Hawai‘i arrive on ocean-going vessels). On the other side, the companies, unions, and Hawai‘i’s Congressional delegation have argued that cabotage protects American jobs, preserves Hawai‘i’s fragile marine environment and serves an important military function. The 1995 Concurrent Resolution directed the task force to “ascertain the advantages and disadvantages” of “[a]ssessing

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the macroeconomic effectiveness of the present maritime regime as it impacts the State, recommending changes, and appraising the possible effects of these changes.” However, lengthy and detailed discussions among the task force’s members could not even yield agreement on the nature of such an assessment. Entrenched interests also blocked meaningful progress on other issues specified in the resolution. For example, the discussion of the relative merits of a port authority for Hawai‘i directly confronted the conflicting interests in waterfront property. In principle, a port authority might resolve such conflicts by weighing alternative waterfront uses on economic grounds. Yet such an institutional change would also challenge the multiple existing waterfront authorities. Discussions soon made clear that existing political and economic struggles over waterfront uses would require protracted negotiation about a port authority. The Hawai‘i Maritime Industry Policy Advisory Task Force presented a report to the legislature, as required by the resolution, but there has been little follow-up. Most of the issues continue to lurk in the background of Hawai‘i’s political-economic scene.

Land Use Differing interests have also debated land use regulatory reform over the years. Hawai‘i officials wrote the state’s land use statute in the early 1960s with heavy influence from agricultural concerns. State land use boundaries divided Hawai‘i’s land into four districts: urban, rural, agricultural, and conservation. Chapter 187, 1961 SLH, created the State Land Use Commission (LUC) to oversee this system and to hear petitions to modify land use district boundaries as Hawai‘i’s economy and development demands evolved. At the same time, the individual counties administer a more detailed zoning categorization. Finally, the federal government has had a hand in Hawai‘i’s land use regulation through the Federal Coastal Zone Management Act.11 Through the 1970s and 1980s, this byzantine system of land use regulation evolved to deal with the competing interests in Hawai‘i. While agricultural interests played a major role in establishing the system, agricultural influence waned with the decline of the sugar and pineapple plantations. In agriculture’s wake, environmental and development (tourism and residential) interests became more prominent. In 1964 the percentage of Hawai‘i’s land in the state agricultural district stood at 51.7%; by 1999, the agricultural share had fallen to 47.1%, and the amount in the urban

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and conservation districts were 4.5% and 48.1%, respectively.12 Hawai‘i’s overlapping land use regulations did a good job of preserving important environmental and cultural assets. However, developers regularly complained about the high costs of the regulatory system, and as Hawai‘i’s economy declined in the 1990s, these complaints grew louder.13 The new administration made several efforts to evaluate and modify aspects of land use regulation. Analyses were drafted, meetings with the Office of State Planning (OSP) were held, and legislative initiatives were proposed for inclusion in the governor’s legislative packages. These proposals included devolving authority from the state to the counties by discouraging the LUC from requiring detailed financial and market information of developers. Instead, the LUC would confine itself to longrange, basic decisions on the amount of land in each of the four land use districts. During the course of these activities, OSP, the executive agency responsible for state land use planning, which had been elevated to special status in the governor’s office during the Waihe‘e administration, was made an attached agency to DBEDT. While the idea of eliminating the once powerful OSP was bandied about, the agency continued to operate by redefining itself and keeping a low profile. Major overhaul of the land use regulatory system has not been achieved, but some important steps were taken later.

Tourism Promotion The Cayetano administration also examined the role of the Hawai‘i Visitors Bureau (HVB, later the Hawai‘i Visitors and Convention Bureau) and the generic promotion of tourism in Hawai‘i.14 In some form or other, the HVB, a private association of individuals and organizations interested in promoting Hawai‘i tourism, had existed since 1902. By 1959, HVB and the State of Hawai‘i had agreed on how to finance generic promotion of Hawai‘i as a tourist destination. In essence, the HVB and the state would each contribute 50% to a fund that would be administered by HVB (with state supervision) to market Hawai‘i.15 Over time, the private share of HVB funding fell while the state share rose. Indeed, during the 1980s, HVB regularly came to the legislature, hat in hand, to plead for additional promotion funds. Since tourism had obviously replaced agriculture and the military as the mainstays of Hawai‘i’s economy, legislators found it difficult to resist these requests. Thus, by the mid-1990s, the state was providing more than 90% of HVB funding (Figure 20).

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Figure 20




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Shares of HVB Income, 1959–1997

Source: Bonham and Mak 1996

Constrained state budget resources made this arrangement increasingly problematic, and DBEDT contracted with professors at the University of Hawai‘i to analyze the situation and make proposals. Professors James Mak and Carl Bonham presented a report arguing that, in principle, the beneficiaries of generic tourism promotion should pay the costs. However, because tourism promotion benefits many companies with diverse interests, a private organization like HVB has difficulty raising sufficient resources to adequately fund such promotion. In effect, each member has an incentive to coast on the contributions of others—each member benefits regardless of whether or not it contributes. This explains the falling private share and rising state share of HVB funding. Bonham and Mak recommended looking at attempts in other states to address this problem. Colorado and California created private tourism associations with quasi-governmental powers in which members voted on the desired level of tourism promotion. These organizations relied on members’ dues for funding. This suggested an alternative method of funding visitor promotion while forcing the main beneficiaries, rather than taxpayers, to pay.

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The consultant report went nowhere in 1996, but Bonham and Mak’s recommendations found their way into legislation in 1998. As a result, this is one of the areas in which the Cayetano administration can claim to have successfully enacted meaningful economic reform. Through all of this, Hawai‘i’s economy began to improve. Most notably, eastbound visitor arrivals rebounded, thanks in large part to an appreciation in the yen. The yen had reached the level of 111 per dollar in January 1994. Then, because of apparent recovery in Japan, the yen started rising again. Remarkably, the Japanese currency broke through the 100 yen-perdollar mark later in 1994 and eventually rose to almost 80 in April 1995. A strong yen effectively lowers the cost of Japanese purchases of goods and services in Hawai‘i, and Hawai‘i began to see increased visitor interest from Japan in the second quarter of 1995 and into 1996. Indeed, from January 1995 through June 1996 average monthly eastbound visitor arrival growth was 10.8%. There were other signs through the spring and summer of 1995 that the recession would soon come to a close. Personal income in the fourth quarter of 1994 had come in at a relatively strong 4.9%, followed by 4.1% average growth in the first half of 1995.16 In March, the unemployment rate dipped below the year-earlier rate and continued to fall through most of the year. Finally, in early 1995 the decline in wage and salary jobs, which had begun in 1992, came to an end and the economy began generating jobs again. But these faint signs of economic recovery soon reversed. By late autumn, the economic signals had turned sour again. Personal income growth declined, falling below 2% in late 1995 and early 1996. Unemployment rose again in December 1995 and continued rising through 1996. Finally, as Figure 21 shows, the hope for positive job growth in early 1995 faded and job losses continued. In the fall of 1995, the administration began work on a document that would lay out the governor’s vision for Hawai‘i in general and for the economy in particular. Governor Cayetano had increasingly come under attack in the local press for having failed to articulate a “vision” in his first year.17 The administration felt the heat, and DBEDT began working on a document describing where the governor saw Hawai‘i’s economy going and specifying a public policy agenda for getting there. Restoring Hawai‘i’s Economic Momentum analyzed Hawai‘i’s recent economic history. This included the long decline of the sugar and pineapple plantations, from statehood in 1959 to the present, and the replacement

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Figure 21 Wage and Salary Job Growth, 1994–1996 Percent Change from Year-Earlier Month Source: Department of Labor and Industrial Relations

of agriculture and the military with tourism as the main driver of Hawai‘i’s economy. The analysis noted that Hawai‘i’s growth pattern paralleled that of Japan rather than the mainland, and it highlighted the effects of large Japanese investment in the 1980s and the subsequent drop-off in the 1990s. The report described the economic stagnation from 1990 as a “structural change” in Hawai‘i’s economy, suggesting that with a maturing visitor industry a number of internal steps (deregulation, smaller government, and so on) were needed to move Hawai‘i into the next century. Restoring Hawai‘i’s Economic Momentum became a marketing tool for the administration. Items that the administration had done, was working on, or could claim to be contemplating were inserted. As the document developed, and the publication deadline approached, more and more self-promotion found its way into the report. Of the 67 pages that made up the report, 42 were devoted to an appendix listing accomplishments and ongoing programs. Ultimately, this material substituted for a serious

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evaluation of Hawai‘i’s economic plight and thoughtful suggestion as to where Hawai‘i should go. Timing of the release of Restoring Hawai‘i’s Economic Momentum coincided with the governor’s second state-of-the-state address in January 1996, and the report caused a stir. Requests for the report poured in, and the contents received favorable review. In spite of its flaws, nothing like this had been produced in Hawai‘i for some time. Perhaps after all, the governor was serious about defining a vision for the state. Ultimately, however, the document failed to deliver on its promise to map a course for Hawai‘i’s economy, and it found its way on to the rarely visited corners of bookshelves. The year 1996 proved long and difficult. The economy continued to deteriorate—indeed by some measures 1996 marked the trough of the recession for Hawai‘i. In real terms, personal income fell by 0.9% in 1996, completing three consecutive years of decline. This had never happened before in Hawai‘i’s history as a state. Unemployment was on its way up again while jobs continued their decline. Whatever the administration was doing to get Hawai‘i out of recession, it did not seem to be working. In sharp contrast, meanwhile, the mainland economy gathered steam. U.S. gross domestic product grew by 2.7% in 1995 and by 3.6% in 1996. The stock market surged to new heights, with the S&P 500 up 19% in 1995 and 23% in 1996. To the consternation of observers of Hawai‘i’s economy, the mainland unemployment rate dropped to near-historic lows. Yet little of this seemed to translate into increased economic activity in Hawai‘i. Westbound visitor arrival growth was negative in 1995; while there was some revival through early 1996, by the end of the year westbound arrivals were again lower than in the previous year. Meanwhile, it looked as though the Japanese economy was making a comeback. Real gross domestic product in Japan grew by 6.4% in the first quarter of 1996, compared to the first quarter of 1995. For the remainder of the year, Japanese growth stayed well above 4%. This inspired hope that Japan’s economy had at last recovered and that the “normal” economic activity of the late-1980s and early-1990s would soon return.

Conclusion During its first two years, the Cayetano administration tried to address institutional features of Hawai‘i’s economy that arguably hampered the state’s

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economic performance. Some changes were made with respect to telecommunications and, eventually, tourism promotion. In other areas, such as maritime issues and land use regulation, political jockeying continued among those whose interests were threatened. Even so, all of these efforts qualified as structural responses to what was obviously more than a short interruption in Hawai‘i’s economic growth. They raised the kinds of questions that Hawai‘i leaders must address, even if the responses establish only necessary, rather than sufficient, conditions for economic health.

Notes 1. Saiki spent more than any other candidate in 1994 yet still finished behind Cayetano and Fasi. See Jeff Barrus, “Long Year’s Journey Into Third: How Pat Saiki lost the Race for Governor,” Hawai‘i Business Magazine, 23, 25 (January 1995). 2. Act 1, 1990 SLH (A+ Program); Honolulu Advertiser, 25 September 1991, A1 (public education unions); Honolulu Star-Bulletin, 24 September 1992, A3 (rail transit), Honolulu Star-Bulletin, 2 April 1993, A4; Honolulu Advertiser, 3 April 1993, A1 (campaign finance); Honolulu Star-Bulletin, 30 September 1993, A1 (budget director); Honolulu Advertiser, 13 October 1993, A3 (budget director and supreme court nominee). 3. Honolulu Advertiser, 24 January 1995: A8. See Pratt (2000, 172-175) for a related discussion. 4. State of Hawai‘i, The Multi-Year Program and Financial Plan and Executive Budget, vol. 1, December 1994, p. 68; and State of Hawai‘i, The Executive Budget Supplemental, vol. 1, January 1996, p. 77. 5. In fairness to the COR, there had been an increase in the maximum income tax withholding rate for tax year 1994 that had the effect of increasing income tax refunds in 1995 (Act 73, 1993 SLH). 6. Rob Perez, “It’s My Job: Even in a Bad Economy Laying Off Workers Is Difficult,” Honolulu Star-Bulletin, 13 October 1998. The expression “warm bodies” distinguished filled from vacant positions, and government union contracts allowed senior people to fill the jobs of junior people, thereby “bumping” the latter. 7. Constitution of the State of Hawai‘i, Article VII, Section 5. This constraint may be violated if the governor “publicly declares the public health, safety or welfare is threatened.” 8. Constitution of the State of Hawai‘i, Article VII, Section 9. The expenditure ceiling may be exceeded on a vote of two thirds of each house of the legislature. 9. The revenue line reflects only general excise and use tax revenues plus net individual income tax revenues. Together, these two sources of revenue account for about 85% of general fund receipts. 10. In 1997, Hawai‘i’s senior senator, Daniel Inouye, sponsored a section of the 1998 Department of Defense appropriations act that allowed American Hawai‘i Cruises to skirt the Passenger Services Act by putting a foreign-built ship into service in the Hawaiian trade in exchange for contracting to build two new cruise ships in the United States. The law also effectively granted a monopoly of the Hawaiian trade for the

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11.

12. 13. 14.

15.

16.

17.




Hawai‘i Becalmed

life of the new cruise ships. See Public Law 105-56, Title VIII, Section 8109. In 2000, the senator inserted language into another appropriations bill that prohibited gambling on any cruise vessel beginning and ending a voyage in Hawai‘i. This would prevent Norwegian Cruise Lines from operating a casino on the vessel it had recently decided to base in Hawai‘i in competition with American Hawai‘i Cruises. Norwegian would avoid the Passenger Services Act restriction by including Fanning Island (a non-U.S. port) in its itinerary. See Public Law 106-554, Division B, Title I, Sec. 147; and Russ Lynch, “Cruise Ship Switching to Ship with No Casino,” Honolulu Star-Bulletin, 8 March 2000. Despite Senator Inouye’s assistance, American Hawai‘i Cruises declared bankruptcy and stopped service among the Hawaiian Islands on October 18, 2001. For a detailed review of Hawai‘i’s land use regulations see David L. Callies, Regulating Paradise: Land Use Controls in Hawai‘i. (Honolulu: University of Hawai‘i Press, 1984); and David L. Callies, Preserving Paradise: Why Regulation Won’t Work. (Honolulu: University of Hawai‘i Press, 1994). Hawai‘i State Data Book, 1999, Table 6.03. Indeed, Kent M. Keith (1993), a former director of the Department of Planning and Economic Development, recommended eliminating the Land Use Commission. “Generic promotion” refers to the marketing of Hawai‘i per se rather than the promotion of a particular firm’s or industry’s services in Hawai‘i (hotel, airline, restaurant, etc.). H. Mok, The Effectiveness of Destinational Advertising: The Case of Hawai‘i’s City Magazine Campaign. Ph.D. diss., University of Hawai‘i (Ma–noa), 1986. Also see L. J. Crampon, Hawai‘i’s Visitor Industry, Its Growth and Development. University of Hawai‘i, School of Travel Industry Management, 1976. Personal income is estimated by the U.S. Bureau of Economic Analysis (BEA). These figures were reported as of September 1996. In later years, BEA substantially revised downward the personal income estimates for this period. Honolulu Star-Bulletin, 25 July 1995: A8; 18 November 1995: B1; Honolulu Advertiser, 17 December 1995: B1.

6


COR, ERTF, and Crisis The years 1997 and 1998 proved tumultuous in both Hawai‘i and the rest of the world. In Hawai‘i, an unprecedented challenge to the Council on Revenues’ forecasting function by the Department of Business, Economic Development, and Tourism highlighted the COR’s important political, rather than fiscal, functions. Through the second half of 1997 and the first half of 1998, Hawai‘i wrestled with some of the most far-reaching proposals for change in decades, initiated by the Economic Revitalization Task Force. At the same time, the financial crisis spread from one Asian country to another. In the summer of 1998 Japan was back in recession and Hawai‘i’s residents faced real doubt about the economic health of the supposed Asian tigers.

COR In the scheme of things, the challenge to the forecasts in the spring of 1997 was hardly momentous. However, the episode highlights the possibility that public institutions can work in the face of powerful forces to adopt shortterm actions that might cause long-term problems. The COR’s forecasts of general fund revenue proved highly inconvenient for the governor and the legislature. A serious challenge to those forecasts, accompanied by press coverage and legislative hearings, failed to undermine the COR’s public accountability. Hawai‘i citizens discovered that the COR not only provides necessary forecasts of state revenue, it also helps politicians live within those forecasts. The episode suggests that it is possible to construct public institutions that serve their intended purpose.

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In spite of the state’s poor economic performance in 1996, revenue prospects looked positive. Back in March 1992, the COR had forecast that general fund tax revenue would grow by as much as 7.3% in FY1996 (ending June 30). Over subsequent years the FY1996 COR forecast declined, dropping to as low as 3.4% in May 1995. However, things turned out much better than predicted: general fund revenue finished FY1996 up 6.4% over the previous year. A number of factors unrelated to the economy’s health influenced 1996 tax revenue. First, lowering the maximum income tax withholding rate in 1995 resulted in unusually large refunds and low tax revenue. Thus, by comparison, 1996 individual income tax revenues looked strong. Second, in the spring of 1996 the Department of Taxation began implementing electronic filing for monthly payments of the general excise tax (GET). Because this accelerated GET payments by about one month, in the last six months of FY1996 the Department of Taxation received the equivalent of seven months of revenue. The COR recognized the transitory nature of these effects. So in September 1996 the Council’s 2.1% forecast for FY1997 was much lower than the FY1996 6.4% actual revenue growth. The COR made a rather large upward revision in its prediction of FY1998 revenue (8.5% compared to the 4.9% forecast in May) largely due to a technical adjustment in individual income tax withholding rates, an adjustment that turned out to be erroneous. A few months later, in December 1996, the COR shaved still more off its forecasts. General fund tax revenues in fiscal year 1997 (which was now half over) would rise by 1.2% and FY1998 revenues would grow by 7.5%. The Department of Budget and Finance makes its preliminary financial plan based on the September COR forecast. The administration uses the December forecast to make final adjustments before submitting the executive budget to the legislature. Even with the reduction, the benign forecast in December permitted the governor’s budget to go forward as planned. In March 1997, the COR sharply lowered its forecasts. The FY1997 forecast remained unchanged at 1.2%, but the expected growth for FY1998 was cut by more than half, from 7.5% to 3.7%. And the forecast for FY1999 fell from 4.3% to 2.9%. In dollars, this meant that anticipated revenue was expected to drop by more than $105 million in FY1998 and $150 million in FY1999. In other words, the fiscal situation had deteriorated. The March downward revision caused havoc in the legislature as the budget bills that had been based on the December forecasts were thrown out

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the window. Not only did the COR’s revision upset the governor’s financial plan, it drastically changed the negotiations taking place in the legislature. The downward revision of the forecast made front-page news for three days in mid-March, with a discussion of programs likely to be reduced and a call by the Senate Ways and Means Committee for an across-theboard cut of 8% in the executive departments.1 Of course, this had always been a possibility. Chapter 37-111, Hawai‘i Revised Statutes, directs the COR’s revenue forecasting meetings to take place in September, January, March, and June. No one could seriously claim to be surprised that the COR had met and changed its forecast. Rather, the surprise was that the COR had lowered the forecast so dramatically. Political agreements about which programs to protect and which to cut became useless. Everyone had to start over, with a more severely binding budget constraint. At this point, a remarkable event took place. The Department of Business, Economic Development, and Tourism (DBEDT) challenged the COR’s forecast.2 Chapter 37-112 of Hawai‘i Revised Statutes states that the governor and legislature must consider the COR’s revenue forecasts, not necessarily adopt them. If the governor or legislature choose to deviate from the COR’s revenue projections, they must explain why. With some pressure from the governor’s office, DBEDT analyzed the quality of the COR’s forecasts in previous years with the idea of generating its own, presumably improved, forecast.3 The COR had been created through an amendment to the state constitution arising from the Constitutional Convention of 1978 (Con-Con). Previously the Department of Taxation or the Department of Planning and Economic Development (DBEDT’s predecessor) constructed the executive revenue forecasts while the legislature made its own projections. Conflicts between the two forecasts led to the creation of an outside, independent body of experts to assure some level of objectivity in revenue projections. As just noted, the governor and the legislature were not required to accept the COR’s forecasts, but they had to specify why they would not adopt them. The COR’s forecasts have almost always been adopted.4 Thus, DBEDT’s challenge of the COR forecast startled observers. It was a slap at the COR with the thinly disguised suggestion that the members had done a less-than-serious job. Of course, because service on the COR is entirely voluntary, one might expect less-than-full attention to the forecasts by members with other, demanding, full-time jobs. Still, professional pride and a spirit of public service no doubt made DBEDT’s challenge to the COR’s forecast unwelcome.

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DBEDT’s report began by reviewing the past forecast errors of the COR but found little to quibble with. The COR’s average forecast error (the percentage by which forecast revenue growth deviated from actual growth) varied by forecast length. Unsurprisingly, the longer the period from the forecast date to the actual date, the higher the error. Still, on average, the error rate of 5% for a one-year forecast horizon and 7% for a two-year horizon lay within normal bounds. So DBEDT focused on other issues. DBEDT made three arguments. First, the COR had erred in its September 1996 adjustment for the change in individual income tax withholding rates. As part of a measure conforming to the Internal Revenue code, Act 73 (1993 SLH) effectively raised maximum withholding rates in 1994 from 8% to 10%. Because individual income tax liabilities did not change (tax rates had not changed), the higher 1994 withholding resulted in large refunds in FY1995, thereby lowering general fund revenues below expectations. To correct what appeared to be a short-term revenue action by the previous administration, the Cayetano administration reversed this legislation, lowering the maximum effective rate from 10% to 8% beginning in October 1996.5 In calculating the effect of this reversal, the COR mistakenly assumed that additional revenue would flow to the state in FY1998 and FY1999 (due to lower refunds in those years). But this was not the case because lower refunds merely offset lower withholding throughout those years. The COR’s correction of the erroneous assumption accounted for almost 40% of the downward revision in FY1998 and 10% of the FY1999 revision. Second, DBEDT argued that economic conditions were better than the COR forecast. Positive nonagricultural wage and salary job growth, fasterthan-expected growth in Japan’s economy, and the ongoing strength of the mainland economy led DBEDT to expect nominal personal income growth of 3.5% in FY1998 and 4.5% in FY1999. By contrast, the average of COR member forecasts was 2.5% in FY1998 and 3.0% in FY1999. Finally, DBEDT argued that the COR’s inflation forecasts were too low. The average COR member forecast for inflation (as measured by the Honolulu CPI) was 1.0% for FY1998 and 1.5% for FY1999. Based on the historical relationship between Hawai‘i and mainland inflation rates, DBEDT expected prices to rise by a higher 2.0% and 2.5% in FY1998 and FY1999, respectively. Using these higher economic forecasts, DBEDT then generated revenue forecasts. The department developed its own model of general fund revenues to come up with a baseline forecast. It then considered other factors that the COR normally does not take into account, such as a $1 billion

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CIP stimulus and a $10 million “emergency” funding of tourism promotion that had not yet passed the legislature. The bottom line was that DBEDT’s analysis added about $78 million to the COR forecast for FY1998 and FY1999. While a large sum, this was less than 1.5% of the total budget and did not significantly differ from the COR forecast. Rather than accept the COR forecast, the Department reasoned that the legislature should therefore adopt its own somewhat higher forecast. This would have the desirable effect of giving both the governor and the legislature a little breathing room. Perhaps predictably, the legislature declined to use DBEDT’s alternative forecast and stuck with the COR projection. The episode revealed that the COR serves an important political, as well as economic, function. The COR’s forecasts are surely important. But from some perspectives, and at some times, it is more important that the COR provides political cover on revenue projections. Thus, even if DBEDT (or any other state agency) could produce more accurate forecasts—a big if—it simply could not provide the institutional cover that an independent COR made possible. In hindsight, there was no way that legislators, or even the governor, would adopt DBEDT’s forecast rather than the COR’s. To do so would have meant accepting responsibility for decisions that were more safely left in others’ hands. As a final note, Figure 22 compares the COR and DBEDT forecasts to what actually occurred. As the figure makes clear, at least in this case, the COR forecast turned out to be much closer than the DBEDT forecast.

ERTF By the summer of 1997, Hawai‘i’s economy showed few signs of improvement and DBEDT began preparing for the governor’s 1998 legislative package. Visitor arrivals had fallen for much of early 1997, the unemployment rate reached 7.2% in June, and while personal income growth had revived from 1996, it was still less than half 1995 levels.6 DBEDT began to examine the economic literature on taxation with the view of making recommendations for the governor’s legislative package, which was due in September. Independently, the Governor’s Office came to a similar conclusion. Addressing Hawai‘i’s tax issues seemed the next logical step in dealing with the economic stagnation. In July, some of the governor’s advisors began inquiring into DBEDT’s work, and the pace of activity picked up. The initial goal was to develop an analytical framework that would show the

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Figure 22

Hawai‘i Becalmed

COR and DBEDT Forecasts Versus Actual Growth, 1998 and 1999

Source: DBEDT from COR data

effects of alternative tax policy mixes on revenues, after-tax household income, and other economic measures. Such a framework could show the governor alternative scenarios on request and calculate the economic implications quickly. As DBEDT and the Department of Taxation carried out this analysis over the summer, plans were made to convene an economic task force. The idea was to assemble a group of recognized community leaders who would consider the critical issues facing Hawai‘i and develop a set of initiatives to help revitalize the economy. Organizers gave considerable attention to the composition of the task force. It quickly proved impossible to include everyone who might represent an important constituency and still keep the group small enough to actually work seriously together. Eventually the task force consisted of the 26 individuals whose names and affiliations appear in Table 1. It also became clear early on that the task force would have to be as broad as functionally possible to win some degree of buy-in from the community. Too often, past attempts at significant change had foundered on the

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Table 1 Economic Revitalization Task Force Members Name

Position

Organization

J.W.A. “Doc” Buyers Benjamin Cayetano Robert Clarke Bruce Coppa John Couch

Chairman Governor President and CEO Director Chairman, President, and CEO Chairman and CEO Publisher Judge (retired) President and CEO

C. Brewer & Co. State of Hawai‘i Hawaiian Electric Industries Pacific Resources Partnership Alexander & Baldwin, Inc.

Walter Dods Lawrence Fuller Walter Heen Stanley Hong Lawrence Johnson Richard Kelley Charles King Patricia Loui Donald Malcolm Norman Mizuguchi Kenneth Mortimer Russell Okata

CEO and Chairman of the Board Chairman of the Board President President Chairman of the Board Senate President President Executive Director

Diane Plotts

General Partner

John Reed Gary Rodrigues Stephany Sofos Joseph Souki Stanley Takahashi

President State Director President Speaker of the House Executive Vice President and COO President and CEO President and CEO President

Barry Taniguchi Roy Tokujo Chatt Wright

First Hawaiian Bank Honolulu Advertiser State of Hawai‘i Chamber of Commerce of Hawai‘i Bank of Hawai‘i Outrigger Enterprises Inc. King Auto Center Omnitrak Group Maui Pacific Center State of Hawai‘i University of Hawai‘i Hawai‘i Government Employees Association Mid-East and China Trading Co. DFS Hawai‘i United Public Workers SL Sofos and Co., Ltd. State of Hawai‘i Kyo-Ya Company, Ltd. KTA Super Stores Cove Marketing Hawai‘i Pacific University

rocks of specific interests. If as many people as possible who affected Hawai‘i public opinion could be brought into the process, then the recommendations, however they turned out, would stand a better chance of surviving.

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With luck, the Economic Revitalization task force (ERTF) could present the legislature with a political mandate for important changes that would prevent the disintegration of proposals through the contention of different interests. The desire for buy-in explained why so much time was devoted to assembling a series of five working groups to discuss issues and make general recommendations. The planners created working groups for five general economic areas: (1) education and workforce development, (2) taxation, (3) business climate, (4) role of government, and (5) economic development. Functionally, the groups were to assemble a list of issues under each topic and forward recommendations to the task force. Politically, the groups were to extend the concept of buy-in further than the task force could. Ideally, the working groups would broaden the support for the ultimate proposals that would go to the legislature. Over a period of six weeks in the fall of 1997 the working groups met with facilitators while comment sheets and e-mail solicited public opinion. Some of the working groups were more successful than others in formulating concrete recommendations—policy actions that could be implemented either by the Executive or via legislation. In addition, some working group recommendations failed to find their way into the task force recommendations or were greatly modified. For example, the tax working group specifically supported reducing GET pyramiding and absolutely opposed an increase in the GET rate.7 The fact that the task force eventually proposed raising the GET rate caused some consternation among working group members and weakened the buy-in that the groups were supposed to achieve. The task force met on October 20 and 21 at the Japan-America Institute of Management Science. Peter Adler and Thomas Leppert served as facilitators. In an adjacent room, Cayetano administration staff, with computers, documents, and data, provided support. The staff produced alternative impact analyses, especially on tax issues, as the task force generated and refined proposals. At the end of the two-day period, the ERTF had come up with a number of recommendations in several areas. The task force applied two criteria to each recommendation: (1) the recommendation had to be “bold”—manini proposals would undermine the credibility of the task force, and (2) the recommendation had to be feasible—proposals that would take years to implement or that had zero chance of passing would not be accepted. The goal, after all, was to generate broad support for action in the com-

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ing (1998) legislative session that would have some chance of revitalizing Hawai‘i’s economy in the short term. Appendix 1 lists the ERTF’s recommendations. Many clearly satisfied the “bold” criterion. The transient accommodations tax (TAT) would rise from 6% to 7% and three percentage points of revenue would be dedicated to tourism promotion, overseen by a 7- to 11-member executive board.8 The State Land Use Commission would be abolished, its functions distributed to the counties and the Board of Natural Resources. Government agencies would have a limited time period in which to consider permits, approvals, and licenses; otherwise those petitions would win approval by default. Four county-level school boards, appointed by the governor and overseen by a superintendent, would replace the elected State Board of Education. The University of Hawai‘i would become a quasi-public corporation with autonomy from state government. It was immediately clear that most of the attention would focus on the recommendations dealing with taxes. The task force proposed a sharp reduction in individual income tax rates: All rates would fall proportionally with the top rate dropping from 10% to 7% in the first year and then to 6% three years later. Low-income households would receive tax credits that would phase out as income rose. Corporate tax rates would drop by half. Exported services would be exempt from the GET (thereby treating them comparably to exported goods), and imported services would be subject to the use tax. Pyramiding of the GET would be cut by exempting direct interbusiness transactions. Because the task force felt that the resulting $600 million loss in revenue would prove too large, it proposed an increase in the GET rate from 4.0 to 5.35%. On net, the state’s tax revenue would fall by about $100 million in the first year. The essence of the tax proposals made economic sense. The proposals would reallocate revenues away from the high-rate individual income tax toward the low-rate GET while reducing the average citizen’s tax burden. Economists concerned with economic efficiency focus on rates of taxation rather than the total or average amounts collected. They believe that people respond to the world incrementally, that the decision to take a second job or to expand into a new line of business depends on the expected additional costs and additional benefits. In the tax portion of these calculations the marginal (additional) tax rate matters: How much higher will my tax bill be if I take action X or Y? At 10%, Hawai‘i’s top individual income tax rate was relatively high; indeed, in 1997, the top marginal income tax rate was the third highest in the country. Moreover, that rate started hitting

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joint tax filers at $41,000 and single tax filers at $20,500 of taxable income. On the other hand, the marginal GET rate is constant at 4.166%. Even accounting for pyramiding effects (the fact that on some goods and services the tax is levied at each stage of production and so can be much higher on the final consumer), the overall rate is still probably less than 5%. Thus, the ERTF tax proposals sought to shift the source of taxation from the relatively high-rate income tax to the relatively low-rate GET. The lower income tax rates more than offset the increase in the GET rate so that on average tax rates fell. As long as the resulting revenue could still finance critical government services, economic efficiency would rise. In an interesting and useful break from tradition, the ERTF decided against writing a report. The task force instead presented its proposals in a public meeting at the state capitol building, and the recommendations were formulated into bills to be introduced in the 1998 legislative session. The initial hope that a broad cross section of support would back the proposals seemed fulfilled as Gary Rodrigues of the United Public Workers and Russell Okata of the Hawai‘i Government Employees Association stood next to Larry Johnson of Bank of Hawai‘i and Walter Dods of First Hawaiian Bank (along with other task force members) in active, unanimous, support of the proposals. As expected, the majority of comment and criticism focused on the tax proposals. Some argued that the cut in income tax rates was unfair because most of the tax reduction would go to those with higher incomes. Of course, the fact that those with higher incomes pay most of the income tax was not mentioned. Others argued that the cut in corporate income taxes was an undue sop to the rich. Yet most of the criticism was reserved for the increase in the GET rate. Many mistakenly argued that the increase in the GET would simply offset the reduction in income tax rates. That this was not the case, that on net virtually every household would pay less total taxes while the tax system as a whole moved into a more economically rational alignment, was repeatedly argued and repeatedly ignored. The ERTF members and those who supported the proposals maintained that the reduction in the income tax rates and the increase in the GET rate were tied together as a single proposal. These words fell on deaf ears. By the beginning of February 1998, Governor Cayetano decided that the original ERTF proposal could not pass, and he modified it. The opposition to the GET increase mounted, and the governor looked for a way to adjust. However, the original tax cuts could not be financed without some offsetting increase in revenues. The $600 million in revenue losses from individual and corporate income tax cuts and the depyramiding of

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the GET would prove too large. Without another source of revenue the scale of the tax relief had to be reduced. The first item to go was the reduction in pyramiding. Lowering pyramiding would cost about $160 million, and the governor noted that in much of the business criticism of the proposed GET rate increase there was no statement of support for the reduction in pyramiding. If no one cared to speak up for reduced pyramiding, it was gone. Next, the corporate income tax reduction was pared back to 30% from 50%. Then the individual income tax cuts were lowered so that the top rate would fall to only 7.5% (rather than 6%). Finally, the GET would rise to 4.75% rather than the original 5.35%. The overall reduction in taxes would still amount to about $75 million, but the bet was that the reduced scale would prove more palatable. This modification was a risky step for the governor because it signaled that compromise was possible and it threatened the support of the other ERTF members. Cayetano apparently calculated that the ERTF members would have little choice but to go along, and he did not consult with them as a group. From the governor’s perspective, the ERTF’s work was largely done. Their job was to make the initial recommendation and show support. His job was to get whatever he could passed through the legislature. Not all of the ERTF members saw it quite that way. But ultimately, the governor was right about the ERTF support—what other choice was there? Over the course of the legislative session, the administration lobbied both legislators and the community for the proposals. Community groups were contacted; the Chamber of Commerce presented two events; there were town meetings, television appearances, radio spots, neighborhood board meetings, and various monthly club meetings (Lions, Rotary, and so on). Over the same period, the tax proposals went through a number of revisions as they moved through the legislature. The Senate entertained a couple of plans; one supported by the Ways and Means cochairs, Senators Rosalind “Roz” Baker and Carol Fukunaga, and one supported by Senator Randy Iwase. The House coalesced behind a single plan that was closest to the governor’s modified ERTF proposal. By the end of the legislative session, the tax proposals emerged in a quite different form. As mentioned, pyramiding was gone (though it would pass in a different form the next year). The corporate income tax reduction was gone. And, most significantly, the GET increase did not survive. This meant that the individual income tax reduction could only be modest in comparison with the original proposal and it had to be phased in over four years. Still, in retrospect, this was the most significant change in Hawai‘i’s

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income tax structure since the 1960s. As Figure 23 indicates, marginal income tax rates were lowered across the board. Many of the other ERTF proposals passed in one form or another and appeared in the 1998 volume of the Session Laws of Hawai‘i (1998 SLH). The Hawai‘i Tourism Authority was established with dedicated funding from the TAT (Act 156). Responsibility for tourism research statistics moved from the Hawai‘i Visitors Bureau to DBEDT (Act 156). A mandatory time frame for permits, approvals and licenses was adopted (Act 164). Legislation to promote the adoption of performance-based public budgeting and accounting passed (Act 230). A form of autonomy for the University of Hawai‘i was passed (Act 115). A few of the major proposals failed to move forward. For example, the Land Use Commission survived and countylevel school boards did not replace the State Board of Education. It is common now to view the ERTF as a failure. This is remarkable in light of the record: Of the 13 major proposals offered by the ERTF, eight eventually passed in one form or another. In addition, several of the collateral proposals also passed. This was an impressive record by any measure, but perhaps particularly so in the fractious condition of the Hawai‘i

Figure 23

Marginal Tax Rates; Joint Filer

Source: Act 157, SLH 1998 and DBEDT

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state legislature after years of slow—or no—economic growth. Some of the proposals (tax reform and the dedicated funding of the Hawai‘i Tourism Authority) were more important than others, yet most moved in the direction of improving the workings of Hawai‘i’s economy.

Asian Crisis For those caught up in the process, the ERTF effort overshadowed the other significant economic phenomenon of 1997 and 1998—the Asian financial and economic crisis. The early signs of problems emerged in the spring of 1997, before ERTF was a glimmer in the governor’s eye. That summer, when the Thai baht collapsed, the ERTF was only beginning to take shape. Through the fall of 1997, as one Asian currency after the other collapsed and as the International Monetary Fund (IMF) hurriedly tried to make loans and impose sound economic policies on the debtors, Hawai‘i leaders were formulating and finalizing their ERTF proposals. At the end of the 1998 legislative session, ERTF participants raised their heads to find the Asian half of Hawai‘i’s economic structure in deep trouble. Signs of distress began to appear early in 1997. Hanbo Steel, one of South Korea’s chaebol (large conglomerates), declared bankruptcy in January and others soon followed. A large Thai real estate developer went bankrupt in February; in June, Finance One, a major Thai financial company, also failed, imposing large losses on both Thai and foreign creditors.9 Rumors of insufficient government capital and the prospect of new controls swept through the markets.10 Stock markets began to slide in Thailand and South Korea. As the pressure on Asian currencies and economies mounted the only question was which investors would bolt first. In July 1997 Thailand was forced to let its currency float and experienced a rapid and dramatic depreciation. In a vain attempt to bolster confidence in the currency, the Thai government had imposed exchange controls on foreign investors and spent large amounts of foreign exchange reserves defending the baht.11 Even so, the currency fell 15% from 24.7 per dollar on Friday, June 30 to 29.1 per dollar the following Monday, July 2. The baht reached bottom at 55.8 per dollar on January 12, 1998, a 57% decline from the June 30, 1997 value. Other currencies followed. • The Malay ringgit began dropping on July 14, 1997, falling 2.4% to 2.56 per dollar; it continued to fall until it reached a bottom of 4.66 per dollar on January 8, 1998, a depreciation of 46.3%.

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• The South Korean won maintained its value into the fall of 1997 primarily because of Korean government intervention. However, in late November the currency started sliding quickly, falling 9.6% on November 20 to 1,139 won per dollar. The won hit a low of 1,953 on December 23, a 55% depreciation from its value in early July. • The Philippine peso hit a low of 44.8 per dollar on January 7, 1998, down 42% from its July 1997 value. • The Indonesian rupiah maintained value into the fall but began dropping in early November 1997. By January 23, 1998, the rupiah had fallen to 14,555 per dollar, a depreciation of 82% from its value six months earlier. The Taiwan, Singapore, and Hong Kong currencies all did substantially better. Though each saw some depreciation, they avoided the crashes that the others experienced.12 Currencies collapsed because investors tried to move their money out of Asia as fast as possible. Events in Thailand and South Korea made investments in Indonesia or Malaysia look shaky, and vice versa. That is, investors behaved as though all Asia investments were alike. This mentality strongly suggested that the initial decision to invest had less to do with the merits of individual projects than it did with quickly getting into the hot Asian market. Much has been made of the fact that adequate banking and investment rules were missing in many of these countries. The markets simply lacked the legal and regulatory infrastructure to handle the inflows of capital made available by financial liberalization in the early 1990s.13 Thus, investors funded projects with very little prospect of viability, either because they received insufficient information or because they failed to demand adequate information, or both. The International Monetary Fund (IMF) attempted to stem the tide and to dispense economic wisdom. Initially the IMF saw the crises in Thailand, Malaysia, and Korea as all of a kind—a speculative run on currencies that could be reversed by raising the rate of return in the target country. Thus the IMF urged countries to raise interest rates in order to keep money at home. This raised the cost of borrowing in those countries and thus chilled real economic activity. These early prescriptions are now considered to have deepened the crisis. In the face of an investor stampede out of Asia, increases in Thai or Malay interest rates were not going to keep funds invested. All they would do was undermine economic growth.14

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For Hawai‘i, the events seemed to mean relatively little. For all the talk about Hawai‘i being close to Asia, the reality is that Hawai‘i is close to Japan. Had the crisis somehow been confined to non-Japan Asia (admittedly, an impossibility), Hawai‘i probably would have felt little impact. Hawai‘i’s direct economic activity with South Korea, Malaysia, and Indonesia is simply not that large. For Hawai‘i, Japan is Asia.15 But Japan was eventually struck hard by the crisis as well as by policies that tended to dampen Japanese consumer confidence. Asian countries account for about 40% of Japan exports. The rapid depreciation of those currencies meant that the Japanese yen became prohibitively expensive. As a result, Japanese exports to these countries dried up, and the yen itself began to weaken. Japan’s negative growth continued through 1998, until the first quarter of 1999. The decline in exports dragged the Japanese economy down with it (Figure 24). In addition, consumer demand was dampened by an increase in sales tax rates imposed to close the gaping budget deficit. Japan

Figure 24 Real Japanese Export Growth, 1990–1998 Percent Change from Year-Earlier Quarter Source: Economic Planning Agency of Japan

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policy makers could do little to reverse the problem because interest rates were already very close to zero. Hawai‘i began to feel the effects of the Asian (renewed Japanese) crisis within six months. Japanese visitor arrivals started to fall in January 1998 and declined in every subsequent month until April 2000. In addition, the yen had depreciated to 127 per dollar on April 9, 1997. It strengthened to 111.3 on June 11, 1997, but then began depreciating again, hitting a low on August 11, 1998, of 147.1. The declining yen meant that Japanese purchasing power in Hawai‘i weakened further. By July 1997, when the Thai baht collapsed, the Fed’s maximum target for the U.S. federal funds rate (the rate at which banks lend to each other) stood at 5.5%, having been raised a quarter of a percentage point in March. The Fed held to the 5.5% rate for 13 more months. Then, in September 1998, following the collapse of Long-Term Capital Management, a prominent U.S. hedge fund, the Fed lowered the target rate by a quarter point. The Fed continued lowering the rate in quarter-point increments for the next two months until the federal funds target stood at 4.75% in November. This action probably contributed to the continued expansion of the stock market, consumption, and the U.S. economy. To some degree, the Fed’s actions bolstered the Asian economies as the United States served as importer of last resort. The Federal Reserve recognized that a decline in U.S. economic activity in 1998 could turn into global catastrophe. If the U.S. economy could stay strong, boosting imports from countries particularly hard hit by the crisis, perhaps the world would not slide into depression. This thinking worked to Hawai‘i’s benefit. The increased income and wealth from the stock market began to manifest itself late in the year. Westbound visitor arrivals had begun to grow strongly in the fourth quarter of 1997. The continuation of the mainland’s strong growth supported and extended this trend. While total visitor arrivals to Hawai‘i fell by 2.4% in 1998, they would have fallen much further without the unusual strength from the westbound market. In addition, there were increasing signs that mainland interest in Hawai‘i properties was renewing—the number of real estate transactions had begun to rise.

Conclusion 1997 and 1998 were years of transition for Hawai‘i. Economic stagnation had lasted so long by 1997 that people started to challenge the workings of familiar institutions and the standard assumptions about what could and

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75

could not be done. DBEDT’s questioning of the COR’s forecasting ability reflected the challenge to familiar institutions. The ERTF proposals reflected skepticism about what was and was not possible in Hawai‘i. More importantly, the ERTF process represented a realization that Hawai‘i must keep its economic institutions in order. The Asian crisis now appears to have been a wobble in the flight path of globalization. Because several countries recovered so quickly, it remains to be seen whether the crisis’s lessons about getting economic institutions right were learned there.

Notes 1. 2. 3. 4.

5. 6. 7. 8. 9. 10. 11. 12.

13. 14.

15.

Honolulu Advertiser, 12–14 March 1997. “A Reconsideration of Council on Revenues Projections,” DBEDT, 21 March 1997. Honolulu Advertiser, 14 March 1997: A1. Proceedings of the Constitutional Convention of Hawai‘i 1978, Honolulu: 1980, v. 1, p. 615. On adoption of COR forecasts, see Rob Perez, “HEI Exec Often Absent for Revenues Council,” Honolulu Star-Bulletin, 30 May 2001. Act 187, 1996 SLH. These personal income growth rates were estimated by the U.S. Bureau of Economic Analysis as of December 1996. The rates have been revised since then. “Pyramiding” means the tax applies to each transaction as a good moves from production and distribution to final sale to the consumer. This was essentially the recommendation of the Bonham and Mak analysis discussed in Chapter 5. Frederic S. Mishkin, “Global Financial Instability: Framework, Events, Issues,” Journal of Economic Perspectives, 13(4) (Fall 1999): 14. See “Thailand’s Economy: Feeling the Heat,” The Economist, 15May 1997; and “The Baht Spills Over,” The Economist, 24 May 1997. “Thaied Up in Knots,” The Economist, 3 July 1997. The Taiwan and Singapore currencies fell about 20% between July 2, 1997 and January 1998. The Hong Kong dollar experienced virtually no change, as its peg with the U.S. dollar remained unchallenged in the face of flexible prices and large foreign currency reserves. See “Asian Currencies: More Turbulence Ahead,” The Economist, 21 August 1997; and “How Many Paths to Salvation?” in “Survey: East Asian Economies,” The Economist, 5 March 1998. For a review of developments as of March 1998, see “Survey: East Asian Economies,” The Economist, 5 March 1998. Joseph Stiglitz, former chair of the President’s Council of Economic Advisors and former chief economist at the World Bank, has been particularly critical of the IMF’s role. See, for example, “The Insider: What I Learned at the World Economic Crisis,” The New Republic, 17 April 2000. Of course this may well change. If the number of visitors from Taiwan, Korea, and (especially) China significantly increases, then future crises will have much larger direct effects on the state.

7


The Election By November 3, 1998—election day—Hawai‘i’s economy had been stuck in an economic quagmire for seven years. The Democrats had held political power in the state for more than 30 years. And yet a young, energetic challenger could not convince voters to elect her over an older, traditional, incumbent governor. Amazingly, the challenger simply could not offer a significant economic policy alternative. Cayetano proved unassailable on economic grounds because he had tried or considered virtually everything, regardless of political provenance. After seven years of near-zero economic growth, one would think that the 35-year Democratic dynasty in Hawai‘i was near its end. The resounding beat of the big-government-is-our-problem drum had become as pervasive as traffic noise. The failure of the economy to revive seemed to support this view. Elections in which pocketbook issues dominate are often turning points: Cayetano was surely doomed to be a one-term governor. Hawai‘i’s economic fortunes may lie outside its control, but political incumbents no doubt find this little comfort. Voters want to hold someone accountable, and the person who runs for executive office effectively offers to make himself or herself a scapegoat. It hardly mattered that Hawai‘i has a very open economy—that is, sensitive to outside economic influences. It hardly mattered that, as a result, an incumbent can do relatively little to affect the state’s economic fortunes for the good—though an incumbent may do much that can devastate the economy. What presumably mattered was that many people were not better off in 1998 than in 1994. Cayetano had a long history with the Democratic Party. The Democrats had controlled the governor’s office and the legislature since 1963. While 76

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loyalty to the Democratic Party was strong in Hawai‘i, many had come to believe that the Democrats had simply held power for too long. There was no effective second party in Hawai‘i, and even some lifelong Democrats believed this was unhealthy. Cayetano started his public career as a state representative from Pearl City in 1975 and moved on to the state senate in 1979. He began a two-term stint as lieutenant governor in 1986, serving all eight years with Waihe‘e. By 1998 Cayetano had finished his own first term as governor.1 The Democrats and Cayetano had had a good run, but change seemed in the air. Moreover, Cayetano arguably could be tarred with the same brush that many used to paint John Waihe‘e’s administration. In 1994, Cayetano was heir-apparent to the governor’s office. He was part of the administration that had been charged with an unconscionable run-up of government spending and hiring. He was part of the administration accused of causing Hawai‘i’s economic malaise. Politically, Waihe‘e came as close to being a pariah in Hawai‘i as it was possible to come without having actually committed a crime. Cayetano was a part of that—although his independence and feuding with the former governor were well known. His opponent Linda Lingle was an ideal non-Republican Republican. She was relatively young, female, and articulate, a refreshing change from the predominantly older male Republicans of Hawai‘i’s plantation era. Lingle also had a solid reputation for innovation, earned during her two terms as mayor of Maui. After having served on the Maui county council throughout the 1980s, Lingle ran for mayor in 1990 and, to the surprise of many, won. She was the youngest person ever elected mayor of Maui County. Lingle’s administrations were noted for fiscal prudence and an attention to detail. Despite the usual political tempests that dog any public official in a contentious democracy, Lingle enjoyed a reputation for honesty and competence. Her work in promoting government efficiency through performance-based management, measurement, and accountability was also admired. In short, Lingle seemed to fit the public’s demand for a competent administrator who would bring a cold, hard eye to the “bloated” state bureaucracy. And yet Lingle and the Republicans fell short by 5,254 votes. Political historians must still explore this story.2 But in the important economic dimension, Cayetano won because he left his opponent no ground. The seeds of Cayetano’s 1998 win were sown in his 1994 victory. Especially in Waihe‘e’s second term, Cayetano distanced himself from the administration. He was especially vocal about excessive union influence in public

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education. He split with Waihe‘e in opposing rail transit on O‘ahu, belittled the governor’s campaign finance initiatives and opposed Waihe‘e’s supreme court nominations. As discussed in Chapter 5, Cayetano opened his first term with a message of fiscal responsibility that would do any Republican proud. He noted the decline in the budget surplus over the previous several years and announced in no uncertain terms that the party was over. He invoked executive privilege to restrict spending and implemented an austerity budget. By the middle of his first year he had actually initiated the state’s first reduction in force (RIF). Moreover, as much by force of circumstances as anything, Cayetano presided over a marked downshift in the growth of government. Indeed, by some measures the government had actually shrunk. The number of state government jobs stood at 65,000 in 1994; by 1997 the number was 64,250. The ratio of state spending to gross state product remained virtually unchanged over the period after rising steadily for several years. Figure 25 shows the rotation downward of the growth in state wage and salary jobs during these years.

Figure 25

Hawai‘i State Government Jobs, 1980–1998

Source: Department of Labor and Industrial Relations

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In other respects, Cayetano’s administration had embraced principles of deregulation, or government as “facilitator rather than regulator.” As noted in Chapter 5, the administration supported the ongoing efforts to introduce competition into telecommunications, and it explored deregulation in land use regulation, ground transportation, and in the maritime industry. All of this was part of a general effort to look at anything and everything that might move Hawai‘i’s economy forward. Finally, and perhaps most importantly, Cayetano lowered individual income tax rates. This was probably a difficult task for a long-time Democrat comfortable with the once highly progressive income tax structure in Hawai‘i.3 No doubt the Economic Revitalization Task Force (ERTF) provided some political cover by including so many of Hawai‘i’s leaders. Although some of the ERTF tax recommendations were sacrificed—the increase in the general excise tax (GET) being the most prominent— individual income tax rates were lowered. That effectively took the tax issue off the 1998 election table. A full-page Lingle campaign advertisement appeared in the daily newspapers on August 16, 1998. The ad, titled “The Lingle Plan,” purported to offer Lingle’s detailed program to fix what was wrong with Hawai‘i, and especially with Hawai‘i’s economy. Table 2 reproduces the content of the ad pertaining to the economy.4 A more detailed explanation of the potential responses available to Cayetano appears in Appendix 2. The Lingle Plan had three elements. First, it called for improving Hawai‘i’s business climate by eliminating unnecessary regulations, establishing zero tolerance for favoritism in government contracting, introducing privatization and performance-based budgeting, and establishing a small-business preference program in government contracts. Second, the plan proposed tax reform that would include cash rebates for increasing payroll, reducing the general excise tax on commercial leases, returning the counties’ share of the transient accommodations tax (TAT), and eliminating the GET on exported professional services. Finally Lingle planned to diversify Hawai‘i’s economy: While “never taking tourism and the military for granted,” the plan would develop the health and wellness industry, establish a Hawai‘i film school, develop “High Tech Hawai‘i” partnerships, and make Hawai‘i a center for agriculture, biotechnology, and marine research. The advertisement’s blunder is clear: The Cayetano administration could claim to have addressed or seriously considered nearly every item on the list. As a result, the ad did little more than highlight the breadth of the administration’s response to the economic crisis. By implication, it revealed

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Table 2

Hawai‘i Becalmed

The Lingle Plan and Potential Response*

Lingle Proposal

Potential Response*

1. Improve the Business Climate Eliminate unnecessary regulations

✓

Addressed

Zero tolerance for favoritism

✓

Addressed

performance-based budgeting

✓

Addressed

Small business preference program

✓

Addressed

Selective privatization and

2. Tax Reform Cash rebate for Hawai‘i businesses that increase payroll

✓

Addressed

Reduce 4% GET on commercial leases to 1%

✓

Addressed

Eliminate GET on exported professional services

✓

Addressed

Fight attempts to tax pensions

X

Rejected

Return counties’ share of TAT

X

Rejected

✓

Addressed Addressed

3. Economic Diversification Never take military or tourism for granted Develop health and wellness industry

✓

Establish a Hawai‘i film school

?

Develop technology partnerships

✓

Addressed

Encourage agriculture, biotechnology, and marine research

✓

Addressed

* Honolulu Advertiser, 16 August 1998, A14. The “Potential Response” indicated here and elaborated on in Appendix 2 constitutes my assessment of the responses available to the Cayetano campaign in 1998. They do not represent official positions taken by the Cayetano campaign.

the lack of new ideas offered by the Lingle campaign. Apparently everything had been tried. Appendix 2 provides a list of potential responses to the Lingle Plan. For example, with respect to improving the business climate, DBEDT’s business advocate regularly reviews proposed regulations for their business impact. The administration hosted the Small Business Task Force on Regulatory Relief, backed the establishment of mandatory maximum timeframes for permit review, and the governor made several trips to the mainland and Asia to promote Hawai‘i business opportunities. Second, in light of the

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ERTF it was hard to believe the Lingle campaign would even raise the tax reform issue. The administration had lowered the GET rate on subleases to 0.5%—lower than the Lingle proposal—and had submitted legislation to exempt all exported services (not just professional services) from the GET. Finally, in response to the diversification suggestions, Cayetano could point to the Convention Center, the provision of a dedicated, industry source of funding for tourism promotion, efforts to bring the Mayo Clinic and M.D. Anderson to Hawai‘i, promotion of competition in telecommunications, and high-tech initiatives. In only three cases might the Cayetano campaign have responded to the Lingle Plan with something other than “been there, done that.” Two had to do with tax reform issues. Hawai‘i is one of a few states to exclude certain types of pensions from income taxation. The most recent Tax Review Commission (a constitutionally-required assembly of experts that meets every five years to assess Hawai‘i’s tax system and to make recommendations) suggested phasing out the exemption.5 This issue has received little serious debate, and in light of the rapid aging of Hawai‘i’s population the Lingle proposal to oppose consideration of the phase-out seemed premature at best. Second, Lingle’s tourism tax reform proposal would have reversed the recently achieved dedicated funding of tourism promotion through part of the transient accommodations tax. The financing for general tourism promotion had been put on a more rational economic basis— stressing industry funding rather than taxpayer financing—after years of wrangling. In sum, the Cayetano campaign might have responded to each of the two proposals with “been there, rejected that.” The third item involved Lingle’s proposal to establish a film school in Hawai‘i, perhaps as an extension of a film program elsewhere. To this writer’s knowledge the Cayetano administration had not considered such a proposal, and this was, therefore, a legitimately new idea. Overall, however, the Lingle Plan was a list of initiatives that had already been tried, implemented, or rejected for one reason or another. There was little to distinguish this program of change from the status quo. In some circles—particularly at the university—it became fashionable to bemoan the lack of a Democratic alternative in the 1998 gubernatorial race. The wisecrack went that there was already a functioning Republican in the governor’s office. In many ways this was unfair, but it rang true when it came to economic issues. Faced with the worst performance of Hawai‘i’s economy since statehood, Cayetano’s administration had looked everywhere for solutions. And it did not always stop to run those solutions through the political filter to test whether they fit traditional Democratic Party rhetoric.

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So in 1998 there was no economic policy critique to be made from the political right. Cayetano’s four-year struggle with the economy had taken the Republicans’ best issue off the table. In being willing to consider anything and everything that might restore economic growth in Hawai‘i, Cayetano had left his opponent with nothing to suggest. In one sense, Cayetano had gone to China. Just as it took the conservative Richard Nixon to open a dialogue with communist China, it took a liberal Hawai‘i Democrat to adopt economic actions that would have been politically impossible for a Republican. Cayetano essentially did in Hawai‘i what Bill Clinton did in the country as a whole. But Clinton was luckier. Clinton successfully moved Democrats to the center politically. He was brilliant at taking the pulse of the public and charting a pragmatic course that appealed to the electorate’s common sense without offending Democratic constituencies too much. Cayetano also moved to the center on economic issues. Cayetano was probably not as politically skillful as Clinton, but he effectively charted the same course.6 To Clinton’s benefit, the U.S. economy soared. Unfortunately for Cayetano, Hawai‘i’s economy was becalmed. In any case, the traditional Democratic base had nowhere to go but with Cayetano. The unions and voters on the political left did not want Linda Lingle and Stan Koki occupying the fifth floor of the state capitol building. While rumors were rife of deals with public union officials and promises of support for certain spending measures, the traditional Democratic constituencies really had little choice. Cayetano had made decisions and taken actions that would have been suicide for a Republican in Hawai‘i. He had done so in the name of finding some sort of fix for Hawai‘i’s economy. Democrats simply had to go along. Cayetano’s victory was even more unusual in light of the main economic indicators on November 3, 1998. Most of the standard economic performance measures were down. In the third quarter of 1998, total visitor arrivals had fallen about 3% below year-earlier figures, dragged down by a heart-stopping drop of nearly 12% in eastbound (mainly Japanese) arrivals (Figure 26). Nonagricultural jobs seemed to be falling at an accelerating rate (Figure 27). Finally, while real personal income growth had jumped up to 2.7% in the second quarter of 1997 and remained above 2% through the second quarter of 1998 (the latest available data near the election), some of this strength was illusory (Figure 28). Real (priceadjusted) personal income growth was high in part because the general price level was falling. From the first through the third quarters of 1998, the general level of prices actually fell in Hawai‘i. This had not happened

Figure 26 Visitor Arrival Growth, 1996 Q1–1998 Q3 Percent Change from Year-Earlier Quarter Source: DBEDT, Quarterly Statistical and Economic Report, December 1998

Figure 27 Nonagricultural Wage and Salary Job Growth, 1996 Q1–1998 Q3 Percent Change on Year-Earlier Quarter Source: DBEDT, Quarterly Statistical and Economic Report, December 1998

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Figure 28 Real Personal Income and Consumer Price Index Growth 1996 Q1– 1998 Q2 Percent Change from Year-Earlier Quarter Sources: Income: U.S. Bureau of Economic Analysis as reported in DBEDT, QSER, December 1998. CPI: Author’s interpolation of semiannual data from U.S. Bureau of Labor Statistics

since 1950. If prices fall because the cost of goods and services declines, that is good news; but if prices fall because of insufficient economic activity, that is a problem. Unfortunately, the latter seemed a more plausible explanation than the former.7 Apparently Hawai‘i citizens did not choose Cayetano because they saw a light at the end of the tunnel but because they simply did not believe the Republicans offered an alternative.

Conclusion Many factors contributed to Ben Cayetano’s close victory over Linda Lingle in 1998. Swing voters may have felt the Republican candidate for lieutenant governor, Stan Koki, stood too far to the right. The traditional political alliance between the unions and the Democratic Party also kicked in at the end of the campaign. And Lingle’s decision to stick to her spending restraint pledge left her campaign virtually silent in the last several

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days before the voting. All of these factors played a role in the outcome. But in the important economic realm, Lingle had nothing new to offer. Perhaps Hawai‘i’s economy in the global scheme of things requires a level of policy pragmatism that transcends political party lines. Any governor vaguely interested in the economic health of Hawai‘i must face certain realities—maybe there really is little choice.

Notes 1. Also see Richard C. Pratt, Hawai‘i Politics and Government, with Zachary Smith (Lincoln, Neb.: University of Nebraska Press, 2000), pp. 170–171. 2. See Richard C. Pratt, Hawai‘i Politics and Government, with Zachary Smith (Lincoln, Neb.: University of Nebraska Press, 2000), pp. 128-131, for an early exploration. 3. At the time Cayetano was inaugurated, Hawai‘i’s income tax rates for joint filers started at 2% on taxable income up to $4,000 and rose to a maximum of 10% on income above $41,000. Whether this constitutes a steeply progressive tax structure or, because many joint filers had income above $41,000, this qualifies as a flat tax structure depends on one’s point of view. 4. In addition to the three major economy-related sections discussed here, the Lingle Plan included sections on the environment, crime reduction, and welfare reform. 5. Report of the 1995–1997 Tax Review Commission, p. 19. 6. Pratt makes a similar point. See Richard C. Pratt, Hawai‘i Politics and Government, with Zachary Smith (Lincoln, Neb.: University of Nebraska Press, 2000), p. 258. 7. Prices declined across a broad range of goods and services, including housing, apparel and upkeep, and transportation. For all the variables, these were the available data in late 1998. With the exception of visitors and prices, these data have since been revised.

8


Second-Term Agenda Having won the 1998 election, Governor Cayetano could act with a freer hand. Second-term governors must feel a certain sense of freedom knowing that a third election is not possible. They can pursue policies in which they truly believe with no worry about positioning themselves for the next election. They need not consider as carefully distasteful policies that citizens find attractive. Of course the pressure to leave a legacy, and the possibility of other office, presumably limit reckless and irresponsible actions. In particular, after 1998 Cayetano could pursue policies he felt more comfortable: hotel tax breaks, inducements for high-tech firms, and a higher minimum wage. To many, including Democrats, granting specific, narrow tax breaks to certain industries is a preeminent economic development strategy. Bill Clinton pursued such strategies throughout the 1990s (as did his predecessors, both Republican and Democrat). High tech, in spite of the dot-com collapse, is still the darling of economic development specialists. This approach also applies in the social sphere: for example, many see raising the minimum wage as a targeted measure designed to share economic gains with low-income people. Serious economic objections attend each of these policies. Targeted tax breaks for hotels and high-tech companies skew economic incentives. Tax breaks may benefit the targeted businesses or industries, but they unintentionally raise the opportunity costs for other businesses. Moreover, they may simply waste public resources. Increases in the minimum wage can raise the incomes of some low-income people, but they may also lower the incomes of others who are priced out of the labor market—those laid off or never hired. Pursued within the boundaries of existing political constraints, none of these policies will seriously harm Hawai‘i’s economy and they will lower long-run growth only a little. Still, it is interesting that leaders 86

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indulge these policies when the economy begins growing again; the same proposals would have faced much greater opposition when the economy was in serious trouble.

Hotel Tax Credits The results of efforts to give hotels a tax break for renovating their properties ended in fiasco in the 1999 legislative session. The legislature passed a flawed bill that granted a tax break for renovation without specifying the amount of the credit. Once the error was found, legislative leaders decided to send the bill to the governor uncorrected and thereby either force him to veto a bill that he had supported or call the legislature back into session to repair it.1 Amusingly, Cayetano simply allowed the measure to pass into law unsigned, leaving the defective statute as testimony to the legislature’s incompetence. Thus, Act 306 (1999 SLH) which created Chapter 235D of Hawai‘i Revised Statutes, states that the “applicable credit percentage shall be per cent.” Literally, blank. Yet the issue behind the hotel renovation tax credit is serious. Many feel that Waikiki, the heart of the visitor industry, suffers from a deteriorating infrastructure and insufficient investment. Newer resort facilities around the world outshine Waikiki in physical beauty and modern conveniences. Yet while everyone “knows” that Waikiki must be refurbished, curiously, this has not happened. Figure 29, which suggests the problem of aging facilities, shows the number of visitor accommodation units by county from 1965 through 1999. The circles indicate the year in which the number of units in a county reached a high. O‘ahu visitor units reached a maximum in 1986, Kaua‘i’s and Maui’s units peaked in 1992, and Hawai‘i County’s maximum occurred in 1997. Of course, the number of accommodation units indicates their average age imperfectly because businesses can move existing units on and off the visitor market at will. Even so, the figure suggests that O‘ahu’s visitor units are significantly older than those of the Neighbor Islands. The Cayetano administration initially responded to the renovation issue in 1997. Act 108, 1997 SLH, provided a two-year, 4% refundable tax credit for “qualified hotel facilities.” The law capped the annual dollar amount of the credit at 10% of the property’s transient accommodations tax payment in the previous year. The administration saw this as a way of jumpstarting investment at a reasonable cost. The two-year time limit would ensure that negative budget implications would be modest. Yet the limit also made the legislation virtually unusable. It was simply not enough time

88




Figure 29

Hawai‘i Becalmed

Visitor Accommodation Units by County, 1965–1999

Source: DBEDT

to get the really expensive portion of refurbishment and renovation—the construction phase—up and running so that the tax breaks could be used. Moreover, the Asian crisis upset any kind of short-term investment plans for new facilities. Eastbound visitors were not coming to Hawai‘i in growing numbers anytime soon, and westbound visitors did not particularly favor Waikiki. Later efforts were more successful. In 2000 the Cayetano administration proposed a 4% refundable credit that would apply to both new construction and renovations, and it imposed no cap related to the payment of transient accommodations tax.2 Moreover, the credit would apply retroactively to 1999 and extend through 2001. Other bills in the 2000 legislative session were even more generous. For example, House Bill 2018 proposed to modify the flawed 1999 statute, Chapter 235D. It would grant a tax credit for any construction or equipment expenditure on (1) property zoned for hotel/resort use, (2) property primarily used for hotel/resort purposes, or (3) property used in commercial or recreational ventures that supported hotel/resort use such as golf courses or retail centers. Moreover, this bill provided much larger credits than

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the 4% offered in the administration bill: 10% for qualified improvement costs of between $1 million and $5 million, rising to as much as 20% for such costs over $10 million. Finally, while not refundable, the credit could be applied against net income tax, general excise tax, or public service company tax liability over a 10-year period. Effectively, this bill would have Hawai‘i taxpayers subsidize the cost of any type of construction or equipment purchase for a much wider range of activities than hotel operations. While some visitor industry officials might argue that the benefits of tourism to Hawai‘i justify such subsidies, many residents and virtually all economists reject such arguments. Ultimately, Act 195 (2000 SLH) came much closer to the administration proposal. It granted a 4% tax credit for construction or renovation costs of a “qualified hotel facility.” The credit could be taken against income taxes and was refundable, which meant that the state would write checks to the hotels in the event the credit exceeded their tax liability. The credit would apply for four years but was made retroactive to January 1999. In signing the bill into law, Governor Cayetano noted that Hilton Hawaiian Village had relied on the credit when it committed to building the Kalia Tower in 1999.3 While differing in degree, these efforts all sought to encourage renovation by raising the after-tax return to such investment. Presumably this would encourage hotel management to invest funds in their Hawai‘i properties rather than in another industry or state. That is good policy only if you know that refurbishing Hawai‘i hotels is the best use of investable funds in the state—a big “if.” From an economist’s perspective, the bills provided a solution to a problem without asking why hotels faced insufficient investment incentives in the first place. Presumably a hotel’s management knows better than anyone whether refurbishing facilities makes sense. It should give policy makers pause that Waikiki hotel owners have been slow to make that investment. Perhaps hotel management expects visitor arrival growth to continue declining. Perhaps management has run the numbers and found that investing another $1 million in Waikiki facilities is unlikely to bring sufficient returns. In other words, policy makers should ask whether it makes sense to devote state funds to such projects when the principal beneficiaries seem unwilling to make that investment themselves. Unless there is a reason to believe hotel management would underinvest in renovation, there is no economic justification for the tax breaks. Management might underinvest if refurbishing the hotel generates benefits that

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accrue to others. For example, if sprucing up a hotel’s appearance brings additional visitors to surrounding businesses—which have not contributed to the renovation—then some sort of subsidy might be called for. But proponents seldom make this argument—and it is not obviously true even if made. The real problem with such industry-specific tax breaks is that they can direct investment to the wrong places. For example, suppose that an investor can devote $1 million to one of two projects that differ only by rate of return: an aquaculture investment likely to yield a 10% return, or a Waikiki hotel renovation expected to yield 8%. In the absence of the hotel tax credit the investor knows that aquaculture uses the money more productively because it can pay a higher rate of return. With a 4% refundable tax credit, however, the after-tax rate of return on the renovation rises close to 12%, and the investor would choose the hotel investment rather than aquaculture. The tax credit “succeeds” in the sense that hotels receive more funds. But the more productive (in this example) aquaculture industry does not get funded. Is Hawai‘i’s economy better off for the extra hotel investment? That depends on how much Hawai‘i loses by foregoing investment in aquaculture. Ironically, the more “successful” the policy in attracting hotel investment, the greater the likelihood that valuable alternatives have been foregone elsewhere.4 Some offer the mistaken argument that tax breaks cost the state nothing because the favored activity would not take place otherwise. When offered by the beneficiaries, the self-serving nature of this argument should doom it. But even if the premise were true, that a hotel would not have made the investment without the break, there are still costs. Virtually all economic activity generates demand for public goods and services. Hotel management uses the courts to enforce contracts and uphold property rights; hotel guests demand clean, safe sidewalks and streets; hotel employees want their children educated; and so on. In other words, tax breaks are not costless—the activity they encourage raises expenditures on governmentprovided services that are explicitly not paid by the beneficiaries of that activity. Who pays the extra costs? The rest of us. Hotels are not the only businesses in Hawai‘i that have successfully lobbied for tax subsidies. In 1981 American Hawai‘i Cruises received an exemption from the public service company tax for more than 10 years. Such exemptions, deductions, and credits have been a favorite method of economic development policy for years. Indeed, so much so that every Hawai‘i State Tax Review Commission has suggested abolishing such exceptions to the basic tax code—or at least, adding sunset dates.5

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High Tech High tech was the second major area of economic legislation in Governor Cayetano’s second term, and the latest to be granted special tax concessions. Many economic experts, including Federal Reserve Board Chairman Alan Greenspan, credit high-tech with the long economic expansion on the mainland during the 1990s and see it as a likely source of economic growth in the new century. From this perspective, it is hardly surprising that Hawai‘i has tried to jump on the technology bandwagon. The Cayetano administration high-tech support efforts began with Act 178 of the 1999 legislative session. With administration support, Act 178 (1999 SLH) established the Governor’s Special Advisor for Technology Development, to be assisted by an advisory council, which would coordinate efforts of existing agencies to develop high-tech industries in Hawai‘i. The act created the Millennium Workforce Development Program to encourage training in science and technology, and it provided funds to the Department of Labor and Industrial Relations and the University of Hawai‘i to implement the program. The law appropriated funds to the Department of Education (DOE) to establish “e-academies” that would provide distance learning in technology, math, science, and engineering. It also directed DOE to provide e-mail accounts upon request to all public school students in the ninth grade or above. As with the hotel renovation act, the heart of Act 178 lay in the tax incentives to attract high-tech firms to Hawai‘i. The tax provisions began with the Hawai‘i Internet Tax Freedom Act, which prohibited discriminatory state or county taxes on electronic commerce. Then came five tax relief measures. First, the act provided an income tax exemption for employee income from stock options issued by a “qualified high-technology business” (QHTB). The act defined a QHTB as a company engaged in qualified research as defined by the IRS code. It then listed types of businesses that did not qualify, including law, banking, insurance, hotels, and restaurants. Second, the act excluded from taxable income “royalties and other income” from patents and copyrights developed by QHTBs. Third, the act created a nonrefundable high-tech business tax credit equal to 10% of the investment in each QHTB up to a maximum of $500,000 per taxpayer. Fourth, the legislation adopted certain IRS code provisions with respect to income tax credits for increasing research activities. Finally, the act applied the high-tech investment tax credit to financial institutions and insurance companies.

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The legislature continued its high-tech work in Act 297 of the 2000 legislative session. In areas other than taxation, Act 297 exempted the High Technology Development Advisory Council, created under Act 178, from senate confirmation and the financial disclosure requirements of the State Ethics Commission. It allowed the public Employees Retirement System to invest in Hawai‘i high-tech businesses and venture capital projects, and it directed the Hawai‘i Tourism Authority to promote the state as “a place to do high-technology business.” The act included a number of provisions to increase the autonomy and authority of the High Technology Development Corporation, an agency attached to DBEDT. Finally, Act 297 directed the Hawai‘i Strategic Development Corporation, another DBEDT-attached agency, to establish the Hawai‘i Technology Investment Program, which would allow small investors to pool funds in order to meet the standards of an “accredited investor” in the regulated investment company provisions of the IRS code. The new tax feature in Act 297 permitted qualified high-tech companies to sell their net operating losses to others. In this way, new technology companies could recover some of their losses and the purchasing firm could offset some tax liability. Act 297 also tweaked some of the provisions introduced in Act 178 by (1) extending the income tax exclusion of royalties and copyrights derived from QHTBs to companies producing commercial television and film; (2) extending the employee stock option income exemption to directors, officers, and otherwise qualified investors; and (3) effectively raising the tax credit on certain research activity and making the credit refundable. Yet apparently some legislators felt that even these incentives were insufficient, for the 2001 session produced even more generous proposals. Three of the most lavish appeared in the companion bills SB 648 and HB 175. The first proposed to grant a refundable tax credit for “the tax benefit of any unused net operating loss.” Because the bill did not define “tax benefit,” under this provision the state would annually write checks to QHTBs to cover their losses. Second, the bills proposed a refundable credit to cover 100% of worthless debt by QHTBs up to $100,000 and 50% of worthless debt above that amount. In other words, the state would write another set of checks to investors in QHTBs to cover losses on bad debts from investments in those companies. Third, the bills converted the 10% investment tax credit of Act 178 to a 100% tax credit for investments in hightech firms, to be taken over five years. Thus, individuals could reduce their income tax liability dollar-for-dollar over five years to the extent they invested in a “qualified high technology business.”6 The bills also contained refund-

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able renovation and construction tax credits of 4% on expenditures to upgrade or construct buildings with high-tech telecommunications facilities. They proposed exempting from the general excise tax and the public service company tax income derived from providing Internet access. And they extended the stock option income exclusion to holding companies of high-tech businesses. The legislation that finally became law on June 8, 2001 (Act 221, 2001 SLH) excluded the credits for operating losses and bad debts. These policies added Hawai‘i to the list of local, state, and national governments that hope to attract high-tech firms by such breaks.7 Silicon Valley, Route 128, and Austin, Texas, are seen as the American meccas of high-tech development. Internationally, Singapore, Hong Kong, Malaysia, Indonesia, India, Ireland, and others have committed substantial public resources to developing high-tech industries. It seems that every city, state, and country wants to emulate the high-tech leaders. The objections to hotel tax breaks already discussed also apply to high tech. Not all high-tech ideas, firms, or industry segments will succeed. How do we know that the particular tax-favored technology firms should receive public funds? How do we know that the high-tech industry should be favored over hotels, or retail, or agriculture, or other businesses? In fact, on its face, it is not clear that high tech has suffered from insufficient investment—rather, the reverse. Venture capital firms and stock market investors poured money into high-tech ventures in the 1990s. Indeed, there was so much capital looking for promising investments that much of it was poorly invested. This played a large role in the Asian crisis of 1997–1998 and the implosion of high-tech stock market values since 2000. Still, some people argue that the high-tech industry is different. Theoretical work in economics over the last 15 to 20 years, called the “new growth theory,” looks to technological innovation to explain the persistent differences between income and wealth levels across countries.8 Technological innovation depends on new knowledge, and the new growth theory has suggested that knowledge production displays “scale effects.” That is, the ability to produce knowledge increases more rapidly the more you produce. Thus, nations that enjoyed early success in technological innovation have an advantage because success breeds even more success. The focus on knowledge production highlights a second aspect used to justify government support of technology. Knowledge is a special economic phenomenon. Unlike capital and labor, one firm’s use of a given bit of knowledge does not preclude its use by other firms. Once knowledge is produced, it can be distributed and used at very low, perhaps even zero, cost. This is

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part of the reason technological innovation made possible by new knowledge raises our standard of living by lowering costs. Yet this feature often undermines the incentive for private firms to produce knowledge. If everyone can use the knowledge at low cost, and if it is difficult to prevent people from acquiring the knowledge without paying for it, then why should a company spend money producing it? Research and development (knowledge production) cannot pay for itself. This is one of the arguments for government support of knowledge-based sectors such as various high-tech industries. Government support can take the form of patent, copyright, and trademark protection. Or it can take the form of directly providing funds to subsidize private research and development, perhaps through tax breaks. More recent theoretical work has taken a different perspective. In this view, technological innovation and knowledge are only the effects of what distinguishes wealthy from poor countries. What really matters are “good” versus “bad” economic policies. Policies that protect property rights and enforce contracts, that refrain from excessive interference in private arrangements, that suppress corruption and cronyism, and so on, are “good” policies. They support economic activity and innovation. Policies that fail in these areas are “bad.” They undermine economic incentives.9 In this view the economic environment of “good policy” makes it possible for entrepreneurs to risk capital by investing in new ideas, knowledge, and technology. From this second perspective, the pursuit of high tech via tax breaks and special deals is counterproductive. Such breaks violate “good policy” principles because they interfere with private arrangements. The tax incentives may encourage poor investment decisions (if the money is not your own, then why worry too much about the returns?). It may also encourage other industries to claim similar tax breaks out of fairness if nothing else. This undermines the tax base and drains the public resources necessary to do the legitimate work of “good economic policy,” such as protecting property rights and enforcing contracts. Finally, there is little economic sense in the fear that Hawai‘i will lose if it fails to compete with other jurisdictions by subsidizing high-tech industries. Some believe that, in the face of the high-tech economic development efforts in other places, Hawai‘i must compete. But this is to misunderstand the relevant game. Technological innovation has value because it can raise productivity, lower costs, and, ultimately, increase our standard of living, not because it can provide high-wage jobs. That is, technology’s real economic value lies in its use rather than its production. Other cities, states, or countries that attract high-tech firms through their public expenditures

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or tax breaks effectively lower the cost of high-tech goods and services for everyone. The best response to others who subsidize high tech may not be to join the competition, but simply to say “Gee, thanks!” Of course, these arguments fly in the face of conventional wisdom, making them hard for politicians to embrace. Especially when “everyone else is doing it,” those in public office have difficulty refraining from popular policies, even when the officials remain unconvinced of their wisdom. A large part of the public looks to its elected officials to “do something” while in office and that pressure becomes especially intense around election time and at the end of terms, when concerns about “legacy” arise.

The Minimum Wage The third area that Governor Cayetano pursued once he was safely reelected was an increase in the minimum wage. This is favorite Democratic Party policy. It is deceptively simple in that it apparently favors the lowest wage earners and is touted as a means of sharing economic good fortune or of cushioning the effects of hard economic times on those least able to bear it. Many see raising the minimum wage as a direct method of increasing the incomes of low-income working people. Cayetano was never completely comfortable with the income tax reductions of 1998, especially the suggestion that the cuts benefited the wellto-do more than others. As noted in Chapter 6, critics of the rate reduction argued that high-income people received larger cuts (in dollar terms) than low-income people. The fact that this simply reflected the existing progressive income tax structure (those with higher incomes pay higher income tax rates) was rarely noticed. To some extent, perhaps the governor felt there was some truth in the suggestion that he had strayed too close to standard Republican policies. This is somewhat curious since, proportionally, low-income people received the largest tax reductions and the new low-income tax credit added even more. In fact, Governor Cayetano and others made a considerable point in the 1997 ERTF meetings to ensure that low-income workers benefited at least as much as high-income workers. These considerations led to the creation of a low-income tax credit financed in part by converting the food tax credit (which had been available to all taxpayers regardless of income). Even without the low-income tax credit, those with taxable incomes below $25,000 received a larger percentage tax cut (more than 30%) than those with incomes above that amount (about 21%).

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In any case, the governor apparently believed that something more should be done for low-income people and the minimum wage was an obvious choice. Since 1960, Hawai‘i’s minimum wage generally coincided with the national minimum wage, and through the early 1980s both grew faster than Hawai‘i’s inflation rate as measured by the Honolulu consumer price index. Since 1992 Hawai‘i’s minimum wage has stayed above the federal minimum wage. But, as indicated by Figure 30, inflation grew even faster. President Clinton successfully raised the national minimum wage in 1996 and 1997. This revived debate over the effects of the minimum wage, with Republicans opposing and Democrats supporting. As usual, Clinton’s political timing was impeccable. The national economy was surging, the stock market was rising at 25% per year, and people felt flush. Although, as usual, some grumbled about the minimum wage increase, the strong economy made it hard to talk about the costs, and Clinton could reward Democ-

Figure 30 Minimum Wage Rates and Honolulu CPI, 1960–2001 Minimum Wage in $/hour, CPI Index 1960=1 Note: Honolulu CPI rescaled to 1960=1 Source: U.S. Department of Labor; Hawai‘i: DBEDT, 1999 Data Book, Tables 12.33 and 14.02

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ratic Party stalwarts who, after NAFTA, had begun to wonder what the point of winning the White House had been. In Hawai‘i, bills to raise the minimum wage appeared in 1999, 2000, and 2001. The administration offered its own bills in the 2000 and 2001 sessions. The preambles to the 1999 bills recalled the 1938 federal legislation’s intention to set a minimum wage equal to one half the national average wage of nonfarm, nonsupervisory workers.10 The 1999 bills therefore proposed raising Hawai‘i’s minimum to $6.50 per hour in the fall of that year and then to one half of the national average nonsupervisory hourly wage, plus a cost-of-living differential between Hawai‘i and the mainland, on January 1, 2000. Thereafter, the minimum wage would then be annually adjusted for cost-of-living increases.11 All of these bills died in committee. The administration offered a bill in 2000. HB 2552 and its companion, SB 2893, sought to permanently increase the Hawai‘i minimum wage to 50 cents above the prevailing federal minimum. Another house bill would have raised the minimum to $5.75 per hour and annually adjusted it for inflation (HB 2984). And an even more dramatic increase appeared in SB 2230 that would have raised the minimum to $7.50 on July 1, 2000, to $8.50 in 2001, and to $9.50 in 2002. Two of these bills (SB 2893 and HB 2984) got as far as a conference committee but did not emerge. The 2001 legislative session saw further efforts: bills to raise Hawai‘i’s minimum wage to either 50 cents or $1 above the federal minimum, to raise the minimum wage and then index to inflation, and to raise the minimum to half of the national average wage for nonsupervisory workers plus a cost-of-living differential.12 The administration bills (HB 669 and SB 1144) in the 2001 session would have raised the minimum wage in three increments to $5.95 in 2001, $6.10 in 2002, and $6.20 in 2003. Ultimately, SB 1144 passed out of conference committee with an increase in the minimum to $5.75 on January 1, 2002 and to $6.25 on January 1, 2003. Lieutenant Governor Mazie Hirono signed the measure into law as Act 279, 2001 SLH, on June 25, 2001. The theoretical effects of the minimum wage are not much in dispute, and they argue against it. Standard economic analysis points out that the minimum wage operates as a price floor. When it is effective—that is, when the market-determined wage would otherwise fall below the legal minimum—the supply of labor exceeds demand for labor. Yet, by law, the price cannot fall. More people want to work at that wage than employers are willing to hire, a condition called unemployment. Moreover, unemployment rises most for precisely the group the minimum wage supposedly

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tries to help: low-income workers. Those workers who stand to receive a significant pay increase because of the law are the very ones most likely to be laid off because the higher minimum wage has priced them out of the market. However, the empirical evidence is less clear. When Clinton proposed his minimum wage increase two respected economists, David Card and Alan Krueger, published a book challenging the conventional view of minimum wage effects.13 Card and Krueger presented evidence from “natural experiments,” in which measurements of employment were taken before and after increases in the minimum wage at the national level and in particular states (New Jersey, Texas, and California). In general, the two economists found little evidence of negative employment impacts, and there was even some evidence that employment levels increased after the minimum wage rose. The Card and Krueger results are still controversial. In a review of the book combined with a survey of the empirical literature, John Kennan challenged Card’s and Krueger’s interpretation of the evidence.14 In general, the changes in employment, both up and down, were so large that no clear trends emerged. Factors other than the increased minimum wage had at least as large an effect. The article concluded that the evidence remained unclear but that the general view stood that the minimum wage caused negative, but relatively small, employment effects. A recent replication of the Card and Krueger results for New Jersey comes to the same conclusion. While Card and Krueger question some of the data used in the replication, they conclude that there have been no employment effects of the New Jersey minimum wage increase.15 Even more recent work on the minimum wage raises the intriguing possibility that the disemployment effects may not appear in lost jobs but in the form of jobs not being created in the first place.16 That is, raising the minimum wage may increase the equilibrium level of unemployment in an economy. An increase in the minimum wage raises the employer’s cost of hiring. Even if the higher cost is not sufficient to lay off existing workers, it may be enough to discourage the addition of more workers. Over time, this effect could lead to an upward drift in the unemployment rate. Preliminary evidence suggests that a 10% increase in the minimum wage can raise the unemployment rate by one half of a percentage point. Thus, if true, the disemployment effects are to be found not in the number of lost jobs but in the number of jobs not created in the first place. These academic debates aside, if the goal of increasing the minimum wage is to raise the incomes of the poor, there are more efficient ways of

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doing so. Raising the minimum wage affects teenagers in part-time jobs and may have upward ripple effects on the wage structure. These effects are likely to have little relationship to poverty and, from that perspective, the policy’s benefits are dissipated. Many economists suggest that a more effective approach to helping low-income workers is through a generous earned income tax credit. This concentrates resources on those with low income. In fact, this was precisely the approach taken through Hawai‘i’s low-income tax credit in 1998. On the other hand, the real purpose of raising the minimum wage may be simply political. That is, perhaps both Bill Clinton and Ben Cayetano decided it was time to return to traditional Democratic policies. After a bruising battle over the ERTF tax proposals and a narrowly won reelection, the political gains of the minimum wage may have made the uncertain economic risks worth taking. While these policy debates raged, Hawai‘i’s economy improved. Indeed, economic activity had already picked up in 1998. Real personal income and gross state product both rose to their highest levels since 1990. This was at least partially due to the fact that the overall price level fell in 1998. The irony is that deflation usually signals economic weakness rather than strength. Even so, economic activity quickened. In 1999 and 2000, personal income growth was strong. Indeed, as Figure 31 indicates, in recent years real personal income grew at sustained rates unseen since the late 1980s. Most of this growth came in wages and salaries, suggesting that the strength was fairly widespread. By contrast, much of the lower growth of the mid-1990s was due to transfer payments and dividends, interest, and rent. Hawai‘i’s unemployment rate started dropping in September 1998 and by the summer of 2000, the Hawai‘i rate again matched the mainland rate (Figure 32). In late 1997 and early 1998 the number of mainland visitor arrivals began rising and annual growth rates averaged 5% per year through mid-1999 (Figure 33). Then growth accelerated to more than 10% until falling back to 5% in late 2000. In contrast, following the Asian crisis, the number of Japanese visitor arrivals plunged in early 1998, falling by as much as 15%. Only in 2000 did positive year-over-year growth from Japan return. The U.S. economy slowed in the first half of 2001 and Japan’s economic progress has been frustratingly slow. More worryingly, the terrorist attacks of September 11 and their aftermath have returned us to the global uncertainty experienced during the Gulf War.

Figure 31 Real Personal Income Growth, 1985 Q1–2000 Q4 Percent Change from Year-Earlier Quarter Source: Calculated from U.S. Bureau of Economic Analysis data and Honolulu CPI

Figure 32 U.S. and Hawai‘i Unemployment Rates, 1989–2001 Seasonally Adjusted Source: U.S. Bureau of Labor Statistics

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Figure 33 U.S. and Japan Visitor Arrival Growth, 1997–2001 Percent Change from Year-Earlier Month Source: DBEDT

Conclusion In contrast to many of the economic initiatives pursued in the first administration, the second Cayetano administration backed policies of dubious economic merit. Hotel tax breaks, incentives for high tech, and raising the minimum wage all have advocates of one sort or another. But none of them seem likely to enhance the economic health of Hawai‘i as a whole. At best, the tax incentives for hotels and technology are economic gambles. No one even argues that the minimum wage increase will boost economic activity; instead, it is meant to support low-wage incomes. The minimum wage hike may actually have the opposite effect. These measures emerged as Hawai‘i’s economic fortunes began to revive. In a sense reminiscent of the late 1980s, economic improvement may have made these policies appear affordable. If so, perhaps we have not learned our lessons from the 1990s. After nearly a decade of very slow growth, Hawai‘i’s economy began to expand again at respectable rates in late 1999 and 2000. It is a foregone conclusion that Hawai‘i politicians will claim some credit for the recov-

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ery, just as President Clinton claimed credit for the strength of the national economy. Even more than the national economy, that claim is of dubious merit in Hawai‘i. Hawai‘i’s economic fortunes are largely bound up with what happens outside the state. Hawai‘i can affect that for good or ill on the margin, but there is not a great deal that Hawai‘i policy makers can do to substantially improve the situation. On the other hand, there is much that can be done locally to undermine Hawai‘i’s economy. These are themes taken up in the next, and last, chapter.

Notes 1. 2. 3. 4.

5.

6. 7.

8.

9.

10. 11. 12.

Editorial, Honolulu Advertiser, 7 May 1999: A12. Senate Bill 2781, 2000 Regular Legislative Session. Honolulu Advertiser, 24 May 2000: A1. The tax break might attract foreign investment to Hawai‘i hotels at 12% that would not be attracted by the 10% return in aquaculture. But in that case Hawai‘i would do even better to grant the break on all types of investment rather than on hotels alone; then the foreign investment would go to the more productive (in this example) aquaculture. See recommendations of the First Tax Review Commission in “Follow-up to First Commission,” Report of the Tax Review Commission, 1 December 1989, p. 64; “Recommendations” in Executive Summary, Report of the Tax Review Commission, 1 December 1989, p. 4; and “Recommendations and Analysis,” Report of the 1995–1997 Tax Review Commission, 16 December 1996. The bill proposed limitations on the total amount of the credit per year. A similar provision appeared in the administration bill HB 722. Anthony Lawrence Clapes has argued that Hawai‘i has not done nearly enough to attract high tech. See Anthony Lawrence Clapes, Blue Wave Millennium: A Future for Hawai‘i. (Honolulu: Dark Matter Press, 2000). Paul Romer and Robert Lucas are among the leading writers in this area. See Paul Romer, “The Origins of Endogenous Growth,” Journal of Economic Perspectives 8:1(1994): 3–22; and Robert E. Lucas, Jr., “On the Mechanics of Economic Development,” Journal of Monetary Economics 22(1988): 3–42. See Robert E. Hall. and Charles I. Jones, “Levels of Economic Activity Across Countries,” American Economic Review, Papers and Proceedings 87:2(1997): 173–177; Robert E. Hall and Charles I. Jones, “Why Do Some Countries Produce So Much More Output Per Worker than Others?” Quarterly Journal of Economics 114 (1999): 83–116; and Mancur Olson, Jr., “Big Bills Left on the Sidewalk: Why Some Nations are Rich, and Others Poor,” Journal of Economic Perspectives 10(2): 3–24. The 1938 Fair Labor Standards Act initiated the national minimum wage. See SB 637, 819, and 1239, and HB 625 and 825; language differs slightly among the bills. 50 cents above federal minimum: HB 166 and SB 444; $1 above federal minimum: HB 27, HB 102, SB 22, and SB 96; raise with index to inflation: HB 1594; raise

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13. 14. 15.

16.

103

to half national average wage of nonsupervisory workers plus cost-of-living differential: SB 760. Myth and Measurement: The New Economics of the Minimum Wage. (Princeton: Princeton University Press, 1995). John Kennan, “The Elusive Effects of Minimum Wages,” Journal of Economic Literature 33 (1995). David Neumark, and William Wascher, “Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania: Comment,” American Economic Review 90(5) December 2000 1362-1396 ; Card, David and Alan B. Krueger, “Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania: Reply,” American Economic Review 90(5) December 2000 1397-1420. Peter Tulip, “Do minimum wages raise the NAIRU?” Federal Reserve Board Working Paper, August 2000.

9


Lessons and Conclusions Hawai‘i’s economic history over the 1990s demonstrated that high poststatehood growth was not destiny. External events could take the wind out of Hawai‘i’s sails, and the accumulated policies that injected inefficiencies into Hawai‘i’s economy would come to matter when growth rates hovered near zero. In retrospect, Hawai‘i’s economic lessons over the last decade suggest a fundamental asymmetry in our policy options: On the one hand, Hawai‘i policy makers can do little to substantially improve our economic fortunes. On the other hand, they can do much to significantly impair those fortunes. This chapter briefly reviews the economic history of the 1990s, then turns to lessons and conclusions. Hawai‘i began the decade at the peak of a brief interruption of its transition to a stable, developed economy. As explored in Chapter 2, by the mid-1980s Hawai‘i’s economic growth rates had already slowed to levels consistent with a developed, mature economy. This reflected the passing of the first long wave of visitor-led growth following the transition from the days of sugar and pineapple plantations to tourism. The expansion associated with the Japanese economic bubble merely interrupted this trend. The economic surge of the late 1980s and early 1990s reminded Hawai‘i residents of both the benefits and costs of economic engagement with the rest of the world. Incomes and jobs soared, but so did housing costs and congestion. Partially in response to such pressures, Hawai‘i leaders pursued expensive policies financed by the high growth that followed statehood. Hawai‘i’s complex land regulation system, mandated universal health care for employees, extensive business regulation, environmental protections, and generous tax exemptions were all policies that Hawai‘i felt it could afford. When the economy grows at 7% to 8% per year, people tend to forget the costs of policies designed to share the wealth. 104

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Hawai‘i’s economic growth would have slowed even without the mainland and Japan recessions in the early 1990s. Long-term growth rates were trending downward in any case. In the absence of the negative external shocks, Hawai‘i might have settled in to a growth zone of 2.5% to 3% and indefinitely postponed the policy debates that occurred in the 1990s. Instead these negative external events combined with the maturing of the economy to push Hawai‘i into stagnation. Being open to the rest of the world means being vulnerable to events outside your control. The Gulf War was one of these events, a conflict on the other side of the world that had real and immediate effects on Hawai‘i’s economic fortunes. The slide of the mainland economy into recession, followed by the bursting of Japan’s stock and property market bubbles brought Hawai‘i’s economic growth to zero. Hawai‘i residents initially reacted to the stagnation with blame and denial. Perhaps that is a natural reaction to events that suggest the necessity to reevaluate long-cherished policies. The disappearance of accumulated balances in the state general fund signaled the severity of the downturn. Cries that government had become too big grew louder and more frequent. That by some measures this was not the case—that the size of state government was no larger than it had been 20 years earlier—went largely ignored. When they could no longer ignore the signs of economic slowdown, Hawai‘i leaders briefly experimented with positive thinking. But Hawai‘i residents rejected the “Thumbs Up!” campaign for what it was—a public relations program that failed to recognize the real contraction in economic activity reflected in (among other indicators) a rising unemployment rate. Perhaps only a new governor could have gained the breathing room to deal with the state’s decidedly bleak fiscal condition and to challenge longheld views. Lieutenant Governor Ben Cayetano consciously separated himself politically from Governor John Waihe‘e in order to win the election in 1994. Governor Ben Cayetano’s first state-of-the-state speech startled Hawai‘i with blunt talk that set the tone for the new administration. During the course of its first few years, the Cayetano administration continued efforts to deregulate telecommunications markets, examined long-cherished maritime restrictions, critically reviewed the land use regulatory system, and challenged the logic of general taxpayer support for the visitor industry. Though these efforts often did little more than raise, rather than resolve, issues, they started the process of self-evaluation—a process that every open economy must undertake periodically. The third and fourth years of the administration’s first term saw some contributions in Hawai‘i’s economic policy. The period got off to a rocky

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start as the administration challenged the COR’s forecasts, and DBEDT ended up on the short end of the forecast-accuracy stick. But the episode highlighted the political (as opposed to economic) value of the COR. Of more significance, the 1997 Economic Revitalization Task Force’s proposals reflected a willingness to make adjustments to keep Hawai‘i’s economic institutions in order. Many of those proposals were adopted in one form or another, including lower marginal income tax rates, dedication of a portion of the transient accommodations tax to tourism promotion, creation of the Hawai‘i Tourism Authority, setting mandatory time frames for permit reviews, and establishing the principle of university autonomy. At the same time the Asian financial and economic crisis served to remind Hawai‘i’s people that forces outside the islands could severely impact the economy. The administration’s first-term efforts to deal with Hawai‘i’s economic quagmire probably saved Ben Cayetano from defeat by Linda Lingle in the 1998 election. Cayetano could legitimately claim to have tried anything and everything to deal with the slow economic pace. This became clear when the Lingle campaign presented a prescription for the economy that read like a list of items already addressed by the Cayetano administration. Perhaps this should not surprise—it may be that Hawai‘i’s ties to the rest of the world constrain economic policy, at least if politicians want to support economic growth. Having won reelection, Cayetano turned to economic policies that had less hope of substantially improving the economy but that played to popular opinion. These included tax breaks for hotels and high-tech companies and an increase in the minimum wage. On the one hand, each of these policies poses problems from an economic perspective. On the other hand, the economic impacts, as long as they remain small, may be beside the point—their impact may be largely political. Still, many public officials would have hesitated to adopt such policies amid the weak growth rates of the mid-1990s. After growth picked up in 1999 and 2000, Hawai‘i officials apparently felt the economy could afford them. Hawai‘i relies to a great extent on outside economic forces. As illustrated in Chapter 2, Hawai‘i’s ratio of exports to gross product is five times the level of the nation as a whole. And this has long been the case. From sandalwood export to whaling, from the sugar and pineapple trade to armed services bases and tourism, Hawai‘i has built its economic fortunes on external engagements for more than 200 years. This fact largely explains why Hawai‘i enjoys such a high standard of living. Most economists acknowledge the role of free trade in raising standards of living, but this is particularly easy to see in Hawai‘i. Imagine our

Lessons and Conclusions




107

standard of living if we had to produce our own automobiles or refrigerators or food. The first two would probably be impossible. As for the third, while we would certainly not starve, we would enjoy much less choice in what we consume. But our export-oriented economy also means that Hawai‘i must compete with the rest of the world. We cannot partake of the best the world has to offer without providing something in return. And we cannot expect the world to buy our products and services while at the same time protecting our markets from foreign and mainland competition. Hawai‘i cannot afford significant market interventions—or, more accurately, it must bear the costs of such interventions. Such policies raise the costs of producing goods and services, which has a substantial economic impact in the face of keen outside competition. Special tax benefits for local construction contractors, preferences for local companies, mandated health insurance for full-time workers, and prohibitive environmental protection measures all have costs as well as benefits. In some cases the costs may be worth the benefits; in others, they may not. Perhaps it is a virtue that we are so tied to the outside world—the resulting competition helps clarify the costs of growth-reducing policies by showing what we give up. With that information, at least we will make better decisions. To some degree those who warn against Hawai‘i’s dependence on the outside have a point—much lies outside our control.1 We do not fully determine our own destiny. We are at the mercy of forces beyond our borders. Hawai‘i relies on the outside world for almost all the goods and services that it consumes, and it pays for them by providing tourism, military support, and other goods and services. To date, Hawai‘i has effectively decided that the costs of these ties to the rest of the world justify the benefits. As suggested in Figure 34, two hundred years of an outward-focused economy have brought a level of prosperity unknown in the Pacific, not to mention the rest of the world. Of course high per capita income is not identical to a high standard of living. Still, it is hard to believe that many in Hawai‘i today would trade places with someone living in an economy with a much lower per capita income. Money can’t buy you love, but it provides more options than poverty. But this perspective leads to certain policy implications. It is sometimes easy to believe that our relative prosperity will last no matter what actions we take. We fail to recognize the dangers of policies framed in the appealing language of “family” or “local business” or “tradition.” We may value policies promoted to advance each of these concepts. But such policies also

108


Figure 34

Hawai‘i Becalmed

Per Capita Gross Product 1999 (unless indicated otherwise)

Source: All but Hawai‘i and Guam from U.S. Central Intelligence Agency, The World Fact Book 2000, http://www.odci.gov/cia/publications/factbook/index.html. GDP calculations by purchasing power parity. Hawai‘i from DBEDT. Guam from http://www.admin.gov.gu/commerce/guam_income_indicators.htm

come with costs that we should recognize. Only if we weigh both the benefits and costs will we make wise decisions. In my view some of the policy implications of enjoying the benefits of an export-oriented economy—and some of the lessons of the 1990s— include the following. First, Hawai‘i must resist protectionist policies. For a society that has built its wealth on open exchange with the rest of the world, it is startling how often one hears demands from Hawai‘i leaders to “protect local business,” to “preserve local jobs,” or, more vaguely, “to keep Hawai‘i Hawai‘i.” These words often mean that outside competition is too stiff, that local businesses do not want to be disturbed too much, and so on. The problem with these demands is that policies adopted to respond to them raise the costs of living and doing business in Hawai‘i. As discussed in Chapter 2, during the economic frenzy of the late 1980s we hardly noticed the

Lessons and Conclusions




109

negative effects of protectionist policies; when growth rates fell to near zero, those effects became clearer. Second, Hawai‘i will find it increasingly costly to favor certain industries. In the past, Hawai‘i’s economy benefited from an export orientation at the same time it favored specific export industries. So earning income through trade does not require abstaining from subsidies. Still, past cases of economic favoritism also accompanied sound underlying reasons for exports. Hawai‘i’s sugar and pineapple trade benefited from the unusually temperate climate and rich soils. Climate and natural beauty also provided advantages to Hawai‘i’s visitor industry. But, as discussed in Chapters 5 and 6, the end of general fund subsidies for visitor promotion suggests that, even in the case of tourism, the argument for continued subsidy has weakened. Natural advantages made Hawai‘i’s exports competitive—not the subsidies that firms or organizations managed to convince the political establishment to grant. As the world becomes more open and competitive, as other countries learn that the path to development and rising standards of living involves efficient production and open global markets, it will prove more difficult for Hawai‘i residents to pay subsidies to favorite industries. Hawai‘i’s industries will increasingly have to pay their own way, and those that cannot will have defined themselves as inappropriate for Hawai‘i. As discussed in Chapter 8 this turns on its head the argument that hotels and high-tech firms need tax breaks in order to operate in Hawai‘i. Third, rather than bemoaning the so-called brain drain, Hawai‘i should cheer the opportunities and dynamism of outside ideas. Being open to the outside world cannot stop with trade in goods and services. The real source of wealth for a society lies in its people—what they know, what they can learn, and what they can do. This makes the concerns of those who worry about Hawai‘i children leaving the state for better educational or employment opportunities seem strange. When educated and experienced former residents return, Hawai‘i gains new ideas and concepts. Of course not everyone chooses to return, but who are we to decide for them? Fourth, the perennial search for economic diversification is fraught with peril. Multiple, independent sources of income can reduce risk. Diversification limits the risk of an event that affects agriculture, for example, but not the visitor industry, or vice versa. But diversification cannot eliminate or reduce all types of risk. Diversification can reduce unsystematic risk—the risk that one sector of the economy might decline—but diversification cannot reduce systematic risk—the threat from a global recession or catastrophic

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event. Systematic risk affects all sectors of the economy, and diversification offers no protection. Moreover, even in the case of unsystematic risk it matters how diversification is pursued. Those who support high-tech subsidies often base their argument on diversification. But trying to pick winners involves yet another type of risk—the risk of wasting resources and misdirecting capital toward relatively unproductive investments. Government can support diversification efforts by processing business licenses quickly, minimizing the costs of necessary regulation, and keeping taxes as low as possible. Governments undermine real diversification efforts by getting involved too directly—by choosing industries or individual firms that will receive subsidies in the name of diversifying the economy. In some areas Hawai‘i government can play a valuable, active role in supporting the economy. For example, Hawai‘i’s physical environment plays a crucial part in its economic success. Protection of natural resources seems necessary and economically beneficial. Yet even here we can protect with less costly or more costly methods. Protection of the environment, the water and land, entails costs. We must recognize and weigh those costs in deciding how best to preserve and utilize what we have. These four lessons offer some guidance on specific current public policy issues. The proposal to regulate gasoline prices, airline fares, and health care premiums, is likely to end as some form of industry protection. While supposedly for consumers’ benefit, such actions often simply protect the regulated industries from competition. Indeed, the deregulation movement of the last 25 years effectively recognized that shielding regulated firms from competition allowed them to operate at higher-than-necessary cost, to the long-term detriment of consumers. Similarly, exempting food and rent from the general excise tax is likely to distort economic incentives in the same way favoring local industries does. The strength of Hawai‘i’s excise tax is its broad base and relatively low rate. Just as with granting tax subsidies to specific industries, exempting food and rent from taxation would narrow the tax base and place upward pressure on the tax rate. It would also introduce a whole set of unnecessary, costly distortions related to the definitions of “food” and “rent.” Supporters of gambling often talk about diversifying Hawai‘i’s economy. Yet gambling is an unusual industry in that it generates large, external social costs. It may be only a slight exaggeration to say that diversifying Hawai‘i’s economy through legalized gambling would be like diversifying the economy by legalizing narcotics—the indirect costs need to be carefully considered.

Lessons and Conclusions




111

The broad lessons discussed here also suggest a few issues that are not on the 2002 policy agenda but that perhaps should be. The implications of avoiding protectionist legislation and ending subsidies for specific industries suggest that Hawai‘i should revive past efforts to deregulate common carriers. Trucking has been deregulated on the mainland for years, but Hawai‘i’s industry received an exemption from the deregulation requirement; it may be time to end that special treatment. Perhaps Hawai‘i needs to seek an exemption from federal maritime regulation in order to introduce competition into the cargo and passenger trades. Finally, Hawai‘i’s long-suffering public education system is constantly on the public agenda. The problem with Hawai‘i’s public schools may be the result of prolonged protection of a favored industry—public education is a state monopoly. It is time to think seriously about introducing competition among public schools, perhaps through a voucher system. Such a system could make the important distinction between public financing of elementary and secondary education and public provision of education. The first does not require the second. Specific issues aside, Hawai‘i economic policy is likely to have an asymmetric effect on the economy. With Hawai‘i’s small, open economy, much of its well-being depends on outside forces. Many bemoan this fact, noting the dangers inherent in not fully controlling our destiny. But running that risk also gives rise to our relatively high standard of living. Because Hawai‘i depends on external influences, we can do relatively little to improve our position. Hawai‘i policy makers can tinker at the edges of our economic engine to try to improve things. Certainly, we can take steps to remove unnecessary and costly barriers. Certainly we can improve our educational systems. Certainly we can market what Hawai‘i has to offer. Certainly public policy must respond to changes in technology or events elsewhere. But the fact remains that Hawai‘i can do little to radically improve its economic position—especially since it has adopted relatively open policies in the first place. Bad policy can markedly undermine Hawai‘i’s economy, precisely because Hawai‘i relies on outside relationships. Policy mistakes, such as prohibiting all types of development or imposing discriminatory access to Hawai‘i’s markets, could have large and swift repercussions. On a competitive, global field, policy errors can simply eliminate Hawai‘i as a viable participant. There are just too many alternatives. Hawai‘i sits on a knife edge. While our policy decisions are necessary but not sufficient for our economic well-being, our policy mistakes may well prove sufficient to undermine our standard of living, thus the need

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for vigilance against protectionism and special treatment. When someone suggests leveling the playing field with the real intent of getting a leg up, we must take care that we do not level the economy. Hawai‘i seemed to have learned some of these lessons during the difficult economic period of the 1990s. Will we remember them as our economy improves in the next decade?

Postscript: September 11, 2001 During this book’s revision for publication, 10 hijackers flew two airliners into the World Trade Center Towers in New York City, five others steered an airliner into the Pentagon building in Washington, D.C., and four more crashed a fourth passenger plane into a field in rural Pennsylvania apparently before the aircraft could reach another target. All within 90 minutes. As did so many elsewhere in the United States, Hawai‘i policy makers responded. Many of those responses make economic sense. A few appear to repeat or perpetuate the errors of past policy choices. The economic fallout from the terrorist attacks, the response by the United States and other countries, and the credible threat of further attacks in the United States, are still being assessed. Many believe that the U.S. economy unavoidably slid into recession and that Japan’s economy will remain in recession longer than it would have otherwise. Hawai‘i passenger counts fell dramatically immediately after the attack, then settled into a range about 20% below 2000 levels. Initial weekly unemployment claims jumped as much as five-fold immediately after the crisis. While it is tempting to compare this with the Gulf War experience, there are important differences. First, the target of U.S. military action today is not necessarily confined to a specific geographic area—terrorists with ties to Osama Bin Laden are widely dispersed. Second, the coalition military target is not a state or government but a collection of dangerous and disaffected persons. Third, the attacks on U.S. soil and the technology behind those attacks present formidable defense issues; the threat of further attacks seems credible. Thus, whether the 9-11 effects prove as transitory as the Gulf War will depend to a great extent on the success of the military response and defense against further terrorist actions. As discussed in Chapter 3, the Gulf War served as one of three proximate causes of Hawai‘i’s sustained economic slowdown. The deeper causes lay with the economic policies adopted during the high growth years through 1980s. While the three proximate causes triggered stagnation, our econo-

Lessons and Conclusions




113

my remained stagnant because we needed to put our economic house in order. In some ways, Hawai‘i is in a better position after September 11 than it was during the Gulf War. We had only begun to enjoy real recovery before September 11. After two years of relatively strong growth in 1999 and 2000, Hawai‘i had begun to feel the effects of a weakening economy on the mainland in 2001. As discussed in Chapter 8, ill-advised policies had already begun to reappear as a result of the improvement in Hawai‘i’s economic fortunes, but Hawai‘i officials had not yet piled year after year of such policies on to the economic infrastructure. If the terrorist attacks remind Hawai‘i leaders of the importance of getting economic institutions and incentives right, then perhaps some good will have been salvaged from the tragedy. Much of the legislation adopted in the wake of the September 11 attacks made sense. The Hawai‘i state legislature met in special session in late October and early November 2001 to respond to the gathering economic storm. The legislation providing for temporary food and housing assistance, health insurance coverage, and extended unemployment benefits for those who lost jobs after September 11 offered an appropriate, limited response to an immediate need. Legislation authorizing additional debt to repair public schools and appropriations to improve security at airports, harbors, and highways accelerated spending on existing needs and stimulated the economy. Even the $10 million appropriation for additional tourism promotion made sense since it was funded from the tourism special fund rather than the general fund.2 Yet some of the provisions passed during the special session perpetuate problematic economic policies of the past. In particular, the provisions that gave a preference to local companies for construction contracts, that raised the hotel construction tax credit to 10%, and that authorized the use of tobacco fund settlement monies to build a new medical center are of dubious economic merit.3 The first of these provisions attempts to create or preserve local jobs at the expense of higher-cost contracts. The second magnifies the economic inefficiencies of the hotel construction subsidies discussed in Chapter 8. The third substitutes the government’s assessment of whether a new medical school makes economic sense for the judgment of direct market participants. The medical school is yet another attempt to pick a winner when the government should instead create an economic framework that allows winners to identify themselves. Hawai‘i will weather the economic repercussions of September 11. Whether the lull proves as long and enduring as that of the 1990s will

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depend in part on the economic sense of Hawai‘i policy makers’ choices. At this point the evidence on the quality of those choices is mixed.

Notes 1. See, for example, Noel J. Kent, Hawai‘i: Islands Under the Influence, 2nd ed. (Honolulu: University of Hawai‘i Press, 1993). 2. Twenty-First Legislature, 2001, Third Special Session, Act 001 (food and housing assistance), Act 006 (health insurance coverage), Act 007 (unemployment insurance), Act 003 (public school improvements), Act 012 (security at airports, harbors, and highways), Act 002 (tourism marketing). 3. Twenty-First Legislature, 2001, Third Special Session, Act 005 (local construction preferences), Act 010 (hotel construction credit), Act 014 (medical center).

Appendix 1


Economic Revitalization Task Force Proposals

Bills

Act1

Lower top marginal tax rate to 7%; after 3 years lower to 6%. All other rates lowered proportionally.

H.B. 2749

157

Replace food tax credit with refundable low-income credit.

H.B. 2749

157

Nonrefundable low-income tax credit.

H.B. 2568 S.B. 2215

Reduce pyramiding of general excise tax (GET).

H.B. 2568 S.B. 2215

Cut corporate income and franchise tax rates in half.

H.B. 2568 S.B. 2215

Raise GET rate from 4% to 5.35%.

H.B. 2568 S.B. 2215

Exempt exported services from GET. Impose GET on imported services.

H.B. 2568 S.B. 2215

70, 1999 SLH

Provide $60 million for tourism promotion.

S.B. 2259

156

Raise transient accommodations tax (TAT) from 6% to 7%. Dedicate three percentage points to tourism marketing. Impose TAT on timeshares.

S.B. 2259

156

Establish executive board to oversee tourism marketing. No more than 10% of budget for administration.

S.B. 2259

156

Proposal 1. Restructure Tax System

71, 1999 SLH

2. Strengthen Tourism Industry

continues

115

116


Appendix 1 Bills

Act1

Place all tourism promotion activity under purview of board. Tourism research functions to be transferred to DBEDT.

S.B. 2259

156

Establish joint city/state analysis group to revitalize Waikiki.

H.B. 2556 S.B. 2203

Set 10-year goal of attracting major league sports franchise.

HCR/SCR 09

Proposal

3. Improve Regulatory Process Require all permits, approvals, and licenses to have maximum timeframe for review and approval. Approval or denial must be granted within the time frame or approval is automatic. Appeal process with specific time limits to be established at appropriate level (city of state).

S.B. 2204

164

Eliminate State Land Use Commission and transfer functions to Board of Land and Natural Resources and counties.

H.B. 2558 S.B. 2205

Prohibit workers’ compensation claims related to stress from appropriate disciplinary actions.

H.B. 2648

224

H.B. 2560

115

4. Improve University of Hawai‘i Provide university autonomy to set priorities, own and manage lands, funds, and resources, and hire own legal counsel. Establish advisory Board of Visitors to consist of distinguished individuals around the world. Ensure the survival of the East-West Center.

HCR/SCR 10

5. Improve Hawai‘i Schools Adopt county school boards appointed by governor subject to confirmation. Statewide superintendent, appointed by governor, to appoint county superintendents with concurrence of county boards.

H.B. 2561 S.B. 2208

Appendix 1 Proposal

Bills

Act1

Employ school-based budgeting.

H.B. 2563 S.B. 2210

Establish goal of second language competency for all high school graduates by 2004.

S.B. 2211

309

Establish computer literacy for all eighth-grade students by 2000; private sector commits $10 million to provide computer/network technology.

S.B. 2211

309

Establish principal/vice principal compensation based on identified performance measures. Establish flexibility in assigning principals to schools to match school needs.

H.B. 2565 S.B. 2212

Establish low tolerance policy for discipline issues in public schools. Encourage parental participation in day-to-day education. Continue School-to-Work Opportunities program after federal funding expires in 1999.

HCR/SCR 08

6. Strengthen Efficient Delivery of Government Services Create a generally accepted accounting S.B. 2213 principles (GAAP) accounting and budgeting system. Adopt an accrual, rather than cash, accounting system. Change budget system from input-based to output-based.

230

Eliminate duplication of services between state and counties.

223

H.B. 2567

Enable state and county governments S.B. 2213 to implement public-private competition for the provision of government services. Ensure that civil service laws and merit principles not violated. 7. Resolve Hawaiian Claims and Self-Determination Issues 1Unless

otherwise indicated, all acts in 1998 SLH.

230




117

Appendix 2


The Lingle Plan and Detailed Potential Response

Lingle Proposal

Response

Detail

Addressed

DBEDT business advocate reviews new or changing state regulations for their impact on business.

1. Improve the Business Climate Eliminate unnecessary regulations

Small Business Task Force on Regulatory Relief began meeting November 1996 to identify inappropriate regulations and to recommend changes. 1997 consolidation of state business forms reduced 12 separate forms and applications into one. 1998 Hawai‘i Small Business Regulatory Flexibility Act (Act 168, 1998 SLH) requires consultation with small businesses affected by any proposed state rules and regulations. Legislation (Act 164, 1998 SLH) requiring state agencies to specify maximum time period in which action must be taken on permits, applications, and licenses. continues

119

120


Appendix 2

Lingle Proposal

Response

Detail

Zero tolerance for favoritism

Addressed

Since 1993, and as subsequently amended, Hawai‘i has had a rigorous competitive sealed bid and competitive sealed proposal statute for procurement (Chapter 103D, HRS).

Selective privatization and performance-based budgeting

Addressed

Act 230, 1998 SLH, established a process for reforming government accounting and developing a privatization plan.

Small business preference program Addressed

Parts X and XI of Chapter 103D, HRS, devoted to assisting small business in bidding for government contracts and giving preferences to Hawai‘ibased products and services.

2. Tax Reform Cash rebate for Hawai‘i businesses that increase payroll

Addressed

Enterprise Zone Program provides tax incentives tied to employment gains.

Reduce 4% GET on commercial leases to 1%

Addressed

Existing sublease deduction reduces the GET rate to 0.5% when fully phased in.

Eliminate GET on exported professional services

Addressed

The Cayetano administration has submitted measures to exempt all exported services from the GET, thereby treating them the same as exported goods.

Fight attempts to tax pensions

Rejected

The demographic changes facing Hawai‘i in the next 15 to 20 years require reevaluation of the tax-free treatment of pensions.

Appendix 2 Lingle Proposal Return counties’ share of TAT




121

Response

Detail

Rejected

After several years a dedicated source of funding for tourism promotion that comes largely from the visitor industry was achieved in Act 156, 1998 SLH. Returning the TAT to counties would reverse this accomplishment.

Addressed

Secured dedicated source of tourism promotion funding.

3. Economic Diversification Never take military or tourism for granted

Completed Convention Center. Participated in siting USS Missouri in Hawai‘i. Develop health and wellness industry

Addressed

Led several efforts to attract facilities to Hawai‘i: Mayo Clinic, M.D. Anderson, etc. Encouraged development of telemedicine facilities.

Establish a Hawai‘i film school

Not Addressed

Develop technology partnerships

Addressed

State has been focusing on developing high-tech businesses and capabilities for some time. This began to pay off with the arrival in Hawai‘i of Uniden and Square USA. During Cayetano’s administration, Hawai‘i moved from being one of the lagging states in telecommunications development to being at the forefront via deregulation.

continues

122


Appendix 2

Lingle Proposal

Response

Detail Such partnerships already exist. For example, DBEDT/ Kaua‘i Economic Development Board and Pacific Missile Range Facility, and the Departments of Defense (state and federal), the Maui super computer and the Research and Technology Park operating the Pacific Disaster Center.

Encourage agriculture, biotechnology, and marine research

Addressed

Biotechnology actively promoted and developed. Resolution of issues surrounding water uses important to developing diversified agriculture in leeward O‘ahu.

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State of Hawai‘i, Department of Budget and Finance. The Multi-Year Program and Financial Plan and Executive Budget. Vol. 1. December 1994. ———The Executive Budget Supplemental. Vol. 1. January 1996. State of Hawai‘i, Department of Business, Economic Development, and Tourism. A Listing of Foreign Investments in Hawai‘i. 1995. ———Foreign Investment Activities in Hawai‘i and the United States, 1954 Through 1998, by Country. 1999. ———Hawai‘i Gross State Product Accounts, 1958–1985. June 1989. ———Quarterly Statistical and Economic Report. Various issues. ———“A Reconsideration of Council on Revenues Projections.” 21 March 1997. ———Restoring Hawai‘i’s Economic Momentum. January 1996. ———The State of Hawai‘i Data Book. Various years. State of Hawai‘i, Proceedings of the Constitutional Convention of Hawai‘i 1978. Vol. 1. Honolulu, 1980. ———Report of the Tax Review Commission.1 December 1989. ———Report of the 1995–1997 Tax Review Commission. 16 December 1996. Stevenson, Richard W. “Two Economic Policy Captains Working with Different Tools; Greenspan Is Determined to Avoid Repeating the Mistake of 1990.” New York Times, 5 January 2001. Stiglitz, Joseph. “The Insider: What I Learned at the World Economic Crisis.” The New Republic, 17 April 2000. “Survey: Business in Japan.” The Economist, 25 November 1999. Tax Foundation of Hawai‘i, Government in Hawai‘i. Various years. “Thaied Up in Knots.” The Economist, 3 July 1997. “Thailand’s Economy: Feeling the Heat.” The Economist, 15 May 1997. Tulip, Peter. “Do Minimum Wages Raise the NAIRU?” Federal Reserve Board Working Paper, August 2000. Woodward, Bob. Maestro, Greenspan’s Fed and the American Boom. New York: Simon and Schuster, 2000. Yamamura, Kozo. “LDP Dominance and High Land Price in Japan: A Study in Positive Political Economy.” In Land Issues in Japan: A Policy Failure? Edited by John O. Haley and Kozo Yamamura. Seattle: Society of Japanese Studies, 1992.

Index Adler, Peter, 66 affordable housing, 19 Ala Moana Shopping Center, 15 Aloha Tower Development Corporation, 50 American Hawai‘i Cruises, 57n. 10, 90 Anzai, Earl, 47 A+ after school program, 19, 45 Arakaki, Dennis, 32n. 11 Asian crisis, 5, 6, 32, 59, 71–74, 75, 88, 93, 99, 106 Baker, Rosalind, 69 balanced budget. See budget, balance requirement Bank of Hawai‘i, 42, 65 becalmed, 1, 82 Big Island. See Hawai‘i County Board of Education, 67, 70, 116 Bonham, Carl, 53, 54 brain drain, 109 bubble, Hawai‘i, 16, 21, 23, 26, 41; Japan, 2, 3, 6, 9, 13, 21, 30, 41, 104, 105. See also economic growth in Hawai‘i budget, 17, 60; balance requirement, 35–36, 47, 48; federal, 27; Hawai‘i state, 4, 17, 35, 36, 45, 46–47, 87; positive balance, 17, 36, 37, 46, 47, 78, 105; revenue, 26, 57n. 9, 59, 60; special funds, 36; surplus, 36, 78 Bush, George H. W., 29–30 Buyers, J. W. A. “Doc,” 65 California, 3, 53, 98 Card, David, 98 Cayetano, Benjamin J.: governor, ix, 4, 5, 45, 46, 54, 56, 63, 68–69,

76–82, 84, 86, 87, 91, 95–96, 99, 101, 105, 106; lieutenant governor, 45, 76, 77, 105 CIP (capital improvement project), 63 Clapes, Anthony Lawrence, 102n. 7 Clarke, Robert, 65 Clinton, Bill, 29, 46, 82, 86, 96–97, 98, 99, 102 construction. See economic growth in Hawai‘i, construction consumer price index, 62, 82–84, 85n. 7, 96, 99. See also inflation convention center, 81, 121 Coppa, Bruce, 65 COR (Council on Revenues), 4, 25–26, 43, 46, 57n. 5, 59–63, 75, 106 cost of living, 18, 97, 108 Couch, John, 65 Council on Revenues. See COR currencies, 71–72; yen, 14, 54, 73, 74 DBEDT (Department of Business, Economic Development, and Tourism), ix, x, 26, 43, 50, 52, 53, 54, 59, 61–63, 63–64, 75, 80, 92, 106, 116, 119 deficit. See budget Department of Budget and Finance, 60 Department of Business, Economic Development, and Tourism. See DBEDT Department of Education, 91 Department of Labor and Industrial Relations, 91 Department of Taxation, 60, 61, 64, 70 dependence. See external effects diversification, 23, 30, 109–110, 121 Docket 7702, 49 Dods, Walter, 65, 68

127

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earned income tax credit, 99 economic growth in Hawai‘i, 3, 6, 9, 34; in 1980s, 3, 9, 20, 23, 37, 101, 104, 108; in 1990s, 1, 3, 6, 34–35, 40, 42, 43, 52, 54, 56, 62, 74, 76, 82, 99, 101–102, 105; and construction, 16, 18, 21, 40, 41; gross state product, 9, 10, 99; jobs, 6, 40, 54, 56, 82; personal income, 6, 26, 43, 45, 54, 56, 62, 63, 82, 99; unemployment, 17, 41, 54, 56, 63, 99, 105, 112 economic policy, 23, 32, 41, 48, 49, 50, 51, 52, 54, 55, 56–57, 63–64, 65–66, 67–68, 69–71, 72, 75, 76, 79, 81–82, 84–85, 86, 94, 95, 97, 98, 101, 106–110, 112–114; asymmetry of, 2, 76, 102, 104, 107, 111–112; and economists’ role, 7; tradeoff with economic growth, 1, 6, 19, 86, 101, 104, 106, 107, 108–109. See also high-tech incentives; hotel tax credit; minimum wage Economic Revitalization Task Force. See ERTF Eisner, Robert, 27 election, 5, 45, 76–85, 86, 106 electricity prices, 24 Employees Retirement System, 92 environmental protection, 1, 18, 19, 51, 104, 110 ERTF (Economic Revitalization Task Force), 4–5, 59, 63–71, 75, 79, 81, 95, 99, 105, 115–117 Ethics Commission, 92 expenditure ceiling, 24, 47–48 exports, 2, 19–20, 22n. 29, 106–109; Japanese, 11, 21n. 3, 30, 73–74 external effects, 2, 8n. 1, 20, 23, 74, 76, 102, 104, 105, 106–107, 111 Fasi, Frank, 45, 56n. 1 Federal Coastal Zone Management Act, 51 Federal Reserve Board, 18, 26, 28, 29, 33n. 17, 34, 44n. 5, 74, 91

Federal Telecommunications Act of 1996, 49 film school, 80, 81, 121 First Hawaiian Bank, 42, 43, 65 Fukunaga, Carol, 69 Fuller, Lawrence, 65 gambling, 110 gasoline prices, 24, 110 general excise tax. See GET general fund. See budget GET (general excise tax), 17, 39, 57n. 9, 60, 66, 67–69, 79, 80, 81, 89, 110, 115, 120; contracting tax base, 15–16 government, size of, 4, 38, 40, 43–44, 76, 77, 78, 105 governor. See Cayetano, Benjamin J.; Waihe‘e, John Great Depression, 26, 28 Greenspan, Alan, 28, 44n. 5, 91 gross state product (GSP). See economic growth in Hawai‘i Gulf War, 2–3, 6, 23–26, 36, 99, 105, 112–113 Halekulani hotel, 15 Hanbo Steel, 71 Harbors Division (Department of Transportation), 50 Hawaiian Airlines, 24 Hawai‘i Community Development Authority, 50 Hawai‘i County, 87 Hawai‘i Maritime Industry Policy Advisory Task Force, 50, 51 Hawai‘i Strategic Development Corporation, 92 Hawai‘i Tourism Authority. See HTA Hawai‘i Visitors and Convention Bureau. See HVB Hawai‘i Visitors Bureau. See HVB health care, 18, 19, 104 Heen, Walter, 65 high-tech incentives, 5, 6, 79, 81, 86, 91–95, 101, 110, 121; tax credits, 91–95, 106, 109

Index High Technology Development Corporation, 92 Hilton Hawaiian Village, 89 Hirono, Mazie, 97 Hong Kong, 33n. 18, 72, 93 Hong, Stanley, 65 Honolulu city council, 39 Honolulu Symphony, 19 hotel rooms. See visitor units hotel tax credit, 5, 6, 86, 87–90, 101, 102n. 4, 106, 109, 113 housing prices. See property values HTA (Hawai‘i Tourism Authority), 70, 71, 92, 106, 115–116 HVB (Hawai‘i Visitors Bureau), 24, 25, 52, 53, 70 HVCB. See HVB Imada Iboshi, Pearl, ix, x IMF (International Monetary Fund), 71, 72 income tax, 57n. 9, 60, 62, 67–69, 79, 81, 85n. 3, 89, 95, 106, 115, 120 Independence, SS, 50 Indonesia, 72, 73, 93 inflation, 18, 26, 62, 96, 97, 99. See also consumer price index Iniki, 23, 40 Inouye, Daniel, 57n. 10 interest rate, 26, 28–29, 72, 74 International Monetary Fund. See IMF Iraq, 23, 25 Iwase, Randy, 69 Japan, 10, 20, 30, 33n. 18, 73, 112; economic policy, 11–12, 19; economy in 1980s, 2, 9, 12–13, 14; economy in 1990s, 3, 13, 23, 30–32, 54, 56, 59, 99, 105; investment from, 3, 10, 15; visitor arrivals from, see tourism, Japan Japan-America Institute of Management Science, 66 jobs. See economic growth in Hawai‘i Johnson, Lawrence, 65, 68 Jones Act, 50. See also Passenger Services Act




129

Kaua‘i, 15, 23, 24, 87 Keith, Kent, 58n. 13 Kelley, Richard, 65 Kennan, John, 98 Kent, Noel J., 8n. 1 Keynesian fiscal policy, 27, 36–37, 38, 39, 44n. 5 King, Charles, 65 Koki, Stan, 82, 84 Krueger, Alan, 98 Krugman, Paul, 30–31, 33n. 18 Kuwait, 23 La Croix, Sumner, ix, x Laffer curve, 26 Land Use Commission. See LUC land use regulation, 1, 4, 18, 48, 51–52, 79, 104, 105 Laney, Leroy, 43 Leppert, Thomas, 66 lessons of 1990s, 7, 101, 104, 108–110 Lingle, Linda, 5, 77, 79–81, 82, 84–85, 106, 119–122 Long-Term Capital Management, 74 Loui, Patricia, 65 low-income tax credit, 67, 99, 115 LUC (Land Use Commission), 18, 51, 52, 58n. 13, 67, 70, 116 Lucas, Robert, 102n. 8 mainland economy, 30, 34, 56, 74, 82, 91, 96, 99; recession, 3, 6, 23, 26–30, 33n. 17, 36, 105, 112–113; unemployment, 26, 30, 41, 56, 99 Mak, James, ix, x, 53, 54 Malaysia, 33n. 18, 71, 72, 73, 93 Malcolm, Donald, 65 maritime regulation, 48, 50–51, 79, 105, 111 mass transit. See rail transit Maui, 15, 77, 87 Mayo Clinic, 81, 121 M. D. Anderson, 81, 121 medical center, 113 minimum wage, 5, 6, 19, 86, 95–99, 101, 106 Mizuguchi, Norman, 65

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Index

Mortimer, Kenneth, 65 motor carrier regulation, 79, 111 NAFTA (North American Free Trade Agreement), 97 Naya, Seiji, ix, x Neumark, David, 103n. 15 new growth theory, 93 New Jersey, 98 Norwegian Cruise Lines, 58n. 10 O‘ahu, 87 Office of Space Industry, 19 Office of State Planning. See OSP oil prices, 24 Okata, Russell, 65, 68 OSP (Office of State Planning), 52 Passenger Services Act, 50, 57n. 10. See also Jones Act performance-based budgeting, 70, 77, 79, 117, 120 personal income. See economic growth in Hawai‘i; expenditure ceiling pineapple, 9, 40, 51, 54, 104, 106, 109 Plotts, Diane, 65 port authority, Pratt, Dick, x, 85n. 2 Price of Paradise, 22n. 15 productivity, 31 property tax, 17 property values, 17, 40 public education, 111 public goods, 89, 90, 93–94, 111 public service company tax, 89, 90 Public Utilities Commission. See PUC PUC (Public Utilities Commission), 49 rail transit, 3, 39, 45, 78 rainy day fund, 37, 47, 48 Reagan, Ronald, 26, 27 reduction in force. See RIF Reed, John, 65 Restoring Hawai‘i’s Economic Momentum, 54, 55 RIF (reduction in force), 4, 46, 57n. 6, 78

Rodrigues, Gary, 65, 68 Romer, Paul, 102n. 8 Rose, Lou, ix Roth, Randall W., 22n. 15 Roumasset, Jim, ix Route 128, 93 Saiki, Pat, 45, 56n. 1 September 11 (2001), 8, 99, 112–114 Sheraton Moana Surfrider, 15 Silicon Valley, 93 Singapore, 33n. 18, 72, 93 Sofos, Stephany, 65 Souki, Joseph, 65 South Korea, 33n. 18, 71, 72, 73 special funds. See budget, special funds standard of living, 20, 23, 93, 94, 106–107, 109, 111 state workers. See government, size of; RIF stock market, 13, 28, 30, 56, 71, 74, 93, 96 subsidies. See economic policy; high-tech incentives; hotel tax credits sugar, 9, 40, 51, 54, 104, 106, 109 Taiwan, 33n. 18, 72 Takahashi, Stanley, 65 Taniguchi, Barry, 65 TAT (transient accommodations tax), 67, 70, 79, 87, 88, 106, 115, 121 tax breaks, 19, 22n. 27, 86, 90, 94, 104; individual credit, 17. See also hightech incentives; hotel tax credit tax cuts, 26, 27, 63, 67–70, 79, 95, 106, 115 Tax Foundation of Hawai‘i, 21n. 12, 44n. 1 tax revenue. See budget, revenue; COR Tax Review Commission, 81, 90, 102n. 5 technological change, 31, 50, 91, 93, 94 telecommunications, 4, 48–50, 79, 81, 105, 121 terrorism, 23–24. See also September 11 Texas, 93, 98 Thailand, 5, 33n. 18, 71. See also currencies

Index Thumbs Up!, 42–43, 44, 44n. 9, 105 Tokujo, Roy, 65 tourism, 6, 9, 10, 23–24, 25, 40, 55, 63, 74, 82, 109, 112; eastbound, 13–14, 25, 30, 40–41, 54, 82, 88; Japan, 3, 14, 24, 74, 99; promotion, 24, 25, 48, 52–54, 58n. 14, 63, 67, 81, 105, 109, 113, 115, 121; U.S. mainland, 24, 99; westbound, 3, 25, 29, 30, 40, 56, 74, 88 transient accommodations tax. See TAT Tulip, Peter, 103n. 16 unemployment rate, 98. See also economic growth in Hawai‘i, unemployment; mainland economy, unemployment




131

United States economy. See mainland economy University of Hawai‘i, 67, 70, 91, 116 visitors. See tourism visitor units, 87 Volcker, Paul, 26, 28 voucher, 111 Waihe‘e, John, 36, 45, 46, 77, 78, 105 Waikiki, 87, 88, 89, 90, 116 Wailea Resort, 15 Wascher, William, 103n. 15 Westin hotels, 15, 24 Wright, Chatt, 65 yen. See currencies, yen