December 18, 2001

CPB REPORT: Public spending cushions economic downturn

Because of the worsened international economic situation, the Dutch economy is slowing down significantly. The GDP growth forecast of 1% for 2001 contrasts sharply with the average of nearly 4% posted over the last four years. Next year growth is expected to recover only modestly, coming out at 1.25%.

The lower GDP growth compared to past years can be attributed in most part to the performance of exports, in particular that of domestically produced goods exports. Whereas between 1997 and 2000 exports were by far the most important growth engine for the economy, this year and next public spending keeps the Dutch economy going. In 2001 public spending will contribute most to GDP growth: 0.75%. Although public spending will still contribute considerably in 2002, by 0.5%, private consumption will then actually make the largest contribution to GDP-growth, 0.75%-point according to the latest CPB projections.
In line with the government's budget rules, lower than expected interest and social security payments are being used for additional outlays in health, education, police, justice and infrastructure. This has given a considerable boost to public spending this year, thus cushioning the economic downturn considerably. This year the general government financial balance is expected to come to 0.9% of GDP. The EMU balance will be smaller next year than this year, but at 0.4% of GDP it will still be positive. In the current projection the gross general government debt will fall further to 49.4% of GDP in 2002.

Labour hoarding pushes down labour productivity; labour share in enterprise income rises considerably
Since public spending will develop relatively favourably this year and next, the growth deceleration compared to the recent past will be concentrated in the market sector. In the current projection, output growth in the market sector will be limited to 0.5% this year, while a modest upswing (to 1%) is foreseen for next year. Despite the sharp decline in output growth, employment in the market sector is still holding up, with an expected growth rate of 1.75% in 2001. Usually employment responds to an economic downswing after a certain time lag. Because of the tight labour market, characterised by a large number of job vacancies, there is much evidence of what is known as 'labour hoarding': businesses which have had to put great effort into recruiting their employees are not likely to make them redundant as soon as the economy slows down. The upshot of this is that labour productivity in the market sector is developing particularly unfavourably this year. In fact, it is expected to decline by 1.25%. Such a sharp fall in market-sector labour productivity is unprecedented in the post-1945 period. Similar trends are evident in other countries with relatively tight labour markets, such as Denmark, Ireland and Luxembourg.
Next year the economic downturn will also be reflected in employment growth in the market sector. The estimated decline (-0.25%) contrasts sharply with an average growth of nearly 3% per year between 1995 and 2000. The sharp fall in employment growth in the market sector is caused not only by the economic downturn and deteriorating profitability levels, but also by the hike in real labour costs. Consequently, unemployment is expected to rise by 0,75 %-point to 4% of the labour force in 2002.
The labour share in enterprise income is expected to rise by 2.25 percentage points to 85.5% this year. This would imply a cumulated rise over a three-year period of 4.5 percentage points, which puts profitability under considerable strain. Next year the labour share in enterprise income is not expected to rise any further.

Also in CPB Report 2001/4
The forecasts as presented above, are published in the December 2001 issue of CPB Report. CPB Report is a quarterly, English language magazine, that reviews the most recent forecasts on the national and international economy and highlights research activities. This issue contains articles on various subjects, including: Economic outlook 2003-2006; Polish-Dutch economic relations; Reexports and the Dutch market position; and Improving effectiveness and efficiency of Dutch housing associations.

Medium-term economic outlook 2003-2006
In anticipation of the next general elections in May 2002, CPB Netherlands' Bureau for Economic Policy Analysis has prepared a medium-term outlook for the period 2003-2006. The report contains two scenarios-- one cautious and one optimistic. The scenarios are centred around an analysis of potential growth, and assume that the economy will move towards a cyclically neutral level in 2006. The resulting GDP growth rates for the cautious and optimistic scenarios are 2.5% and 3% per year. The cautious scenario will be used as a baseline for the analysis of the economic effects of policy proposals for the next cabinet period.
What kind of policies can be used to promote further economic growth? Demand-side policies appear to be risky. The labour market is projected to be tight throughout the scenario period. Policies that stimulate demand may well put further pressure on wages, prevent the recovery of profitability, and further worsen the competitive position. As a result, economic recovery in the market sector may be jeopardised and unemployment may end up overshooting its equilibrium.
It would seem better that policies concentrate on stimulating the supply side. This would mean focussing on labour supply, equilibrium unemployment and structural productivity growth. There are already policies in place that aim to reduce inactivity, and more proposals are currently being formulated. It stands to reason that their chances for success are greatly improved by a tight labour market. This is another reason why continued wage moderation is important. Further reduction of taxes and replacement rates are other policy options that stimulate labour supply, reduce equilibrium unemployment and moderate wage growth.
Finally, careful thought must be given to the negative budgetary effects of the aging of the population, which have been the subject of several recent studies. Reacting to these studies, a high-level committee on fiscal affairs has advised bringing down the public debt to zero by the year 2025. To achieve that goal, the committee recommended that future cabinets maintain annual public surpluses of 1.25% to 1.75% of GDP until 2010. Given the projected average annual surplus of 0.7% of GDP in the cautious scenario, acting on this advice would limit the budgetary room for manoeuvre of the next cabinet.

Polish-Dutch economic relations
Although the Dutch position in certain product categories may be threatened by the fiercer competition arising from the accession of Poland to the internal market, the majority of Dutch industries will remain unaffected. The export specialisation of Poland differs substantially from that of the Netherlands. Both Poland and the Netherlands specialise in exports of agriculture, food products, and textiles. Nevertheless, there are substantial underlying differences within these broadly defined sectors. The overlap in export patterns is relatively small. Poland's accession may create opportunities for Dutch exporters. Indeed, we find that the export potential seems particularly large in some specific sectors, such as luxury foods, flowers and cheese. Polish exports of furniture, motor vehicles and some other products may face a favourable reception on the Dutch market.

Reexports and the Dutch market position
Domestically produced exports have steadily lost market share since the mid 1980s. But this poor performance has been masked by the strong growth in reexports, so that total exports have still been moving in line with export market growth. The reexport of goods by the Netherlands has grown explosively since the mid 1980s, and now accounts for more than 40% of total goods exports. Although reexports are certainly not insignificant for the Dutch economy, domestically produced exports are most relevant for the assessment of the Dutch market position and competitiveness. For domestically produced exports, exchange rate fluctuations and labour cost and productivity developments have a major impact on the battle with international competitors. But the Netherlands' competitive position as a reexporting country is determined primarily by other factors, such as the quality of the infrastructure and the presence of high-quality mainports.


Johan Verbruggen
Dick Morks