Supply and demand ping-pong meltdown

Wasn’t seven years warning enough?

Evidently not. While the Commonwealth was telling the world it was going to replace Japanese package tourists with “Free Independent Travelers,” was going to mine the “tremendous opportunities in the Russian tourism industry,” and was going to build a choo-choo train route on Saipan (while money was lacking to promote tourism in Japan)…I warned Saipan Tribune readers, as well as my clients, back in 1998 that such fuzzy thinking from econocrats and plain old bureaucrats was going to eventually result in the loss of tourists and then a major airline here…which has implications worth reviewing now.

After all, JAL has had enough of it. Continental is scaling back. And Pacific Island Aviation is just a memory.

In economics-talk, we’re up against a long-run contraction in supply. That’s “long run” because it resulted from a reduction in demand. More on that in a second.

But first, a word from the statistics realm. As of fiscal year 2005, visitor arrivals have fallen fully 27 percent (yikes!) since peaking at 726,690 in fiscal year 1997.

Twenty-seven percent. Read it and weep.

OK, back to this whole supply-and-demand gig. When an industry faces a reduction in demand, there is sort of a self-righting mechanism that does kick in: All else being equal, prices will slump, and at some point the falling prices can attract some (not all, but some) buyers back into the market. Business owners know this intuitively. Economists know it formally.

Econocrats never figured it out.

Anyway, that’s the short-run realm, where a change in demand is met with no changes in supply. However, if demand falls down sharp enough for long enough, we run into something else: A contraction in the supply side. In other words, businesses in the industry in question close down, or otherwise reduce their output. This puts upwards, not downwards, pressure on prices, which isn’t to say that prices will necessarily go up, but they will necessarily be higher than they would have been if no businesses closed…

That’s a “long run” gig. Which means that the “self-righting” mechanism slips away. When lower demand results in lower supply, you wind up with firmer prices that don’t dip down as far to seduce buyers back.

Result: An industry that is fundamentally smaller than it was before. This is what had guys like me horrified all those years ago in 1998; once you start killing the demand side to the point where it will impact supply, it is a long, long way back out of that hole.

My hairy eyeball is on the airline context for this, but the hotel industry is governed by the same economic laws. The hotel side of things is slower to catch up, of course, since hotels and airlines are two different things. Yes, room rates are lower now than they were in the good times, but if the tourism industry remains sick, hotel rooms will eventually be taken off the market, thereby reducing the supply of rooms, and thereby putting upwards pressure on prices from what they would have been if no rooms were taken off the market.

OK, now let’s look at yet another cycle in the death spiral: when the reduction in supply results in a further reduction in demand. That’s what the CNMI faces now. When JAL’s pullout induces some tour agents in Japan to drop the CNMI from their catalogs, the CNMI is losing out on that valuable marketing tool, which results in a further reduction in demand.

In other words, the initial reduction in demand (due to incompetence here) results in a reduction in supply (due to airlines running away) which results in a further reduction in demand (do to a lower CNMI profile with Japanese consumers)…and you can see where this leads: Economic ping pong, where the latest reduction in demand can induce yet more reductions in supply.

Which is your basic “meltdown.”

The CNMI’s tourism meltdown has been an elegantly clean case of textbook microeconomics; easy to predict, easy to see, and easy to understand. Talk about an easy way to start the New Year.

(Ed Stephens Jr. is an economist and columnist for the Saipan Tribune. E-mail him at Ed@SaipanEconomist.com.)