July 1, 2002

CPB REPORT 2002/2: Exports main driving force behind the Dutch economic recovery in 2003

The Dutch economy should be able to benefit from the upturn in the world economy in the course of this year. In the second half of 2002 the Dutch economy is expected to grow by almost 2%, compared to the same period of last year. Thus, for 2002 as a whole growth will probably come out at 1%.

For next year CPB Netherlands' Bureau for Economic Policy Analysis forecasts a growth of GDP of 2.75%.
The main reason for the recovery is the upturn of Dutch exports, from 2.25% in 2002 to 7% next year, thanks to the pick-up in world demand. Nevertheless, the growth of domestically produced exports, which by now account for less than 60% of total goods exports, will still lag behind world trade growth, which means that Dutch firms will continue to lose market share to foreign competitors. The main cause of this decrease in market share is the deteriorating price competitiveness of Dutch firms, due to the relatively strong growth of labour costs compared to foreign competitors and the recent strength of the euro.
Thanks to a substantial rise in labour productivity, Dutch labour costs will increase less in 2003, which will decrease inflation and influence the profitability of Dutch firms positively.

World trade in the lift
The volume of world trade started to recover in the beginning of 2002 after declining continuously in the course of last year. Particularly demand in the US and Southeast Asia bounced back. Leading indicators for the OECD area point to a further increase of industrial production and therefore international trade in the remaining part of this year. Due to the low starting level, world trade growth in 2002 remains limited to some 4%, but is projected to exceed 10% in 2003.
Based on the unexpected first-quarter growth in the US and on leading indicators and structural factors, CPB foresees an average GDP growth rate for the US of 3 to 4% until the end of next year. Employment is expected to pick up in the second half of 2002, after which unemployment should decline again. However, the current account balance will deteriorate further, exerting downward pressure on the US dollar. The consequences of a relatively steep dollar decline are presented in a separate box in this issue of CPB Report (see below).
GDP growth in the euro area turned positive in the first quarter of this year, but the recovery fell short of expectations. Monetary easing has been much less aggressive than in the US, and fiscal impulses have been nearly absent, but euro countries took advantage of their improved competitiveness due to the strong dollar. Though European growth is expected to strengthen over the forecast horizon, it is unlikely to reach US rates, also because private consumption and investment growth are rather flat.

Lacking confidence depresses private consumption path
Private consumption has been an important driving force behind economic growth in the Netherlands in the past period of booming growth. This year and next, this will probably not be the case. Consumer confidence is declining and willingness-to-buy is on a historically low level, so that private consumption growth in 2002 will be modest, only 1.75%. Last year the savings ratio increased strongly and this year this ratio will probably grow even further to 3.75%: the unfavourable developments on the housing market and on the stock market have led to cautiousness. The savings ratio is forecast to stay at this higher level next year. Private consumption growth is then expected to come out at 2.5%.

Exports lead the way to recovery
In 2003 exports will probably be the driving force behind economic growth. Expanding world trade is expected to boost foreign demand for Dutch products and services. In spite of that, Dutch export growth of respectively 2.25% in 2002 and 7% next year will lag behind world trade growth, which means that Dutch firms will lose market share. The prospects for the exports of domestically produced goods are even less favourable; in 2002 only 0.5% and in 2003 3.25%. The competitive position of Dutch firms has been under pressure for a number of years and will worsen this and next year even further, mainly caused by the strong increase of labour costs compared to other countries. A continuing rise of the euro in relation to the dollar as shown in the last month, may affect this competitive position even further. After all, a stronger euro makes the exports of the euro countries more expensive.

Moderating wage growth keeps down the inflation rate
This year’s inflation is expected to come out at 3.5%, while for next year 2.75% is forecast. These estimates are moderate in view of the high inflation of nearly 4% in the first couple of months of this year. One of the reasons for this persistent high inflation in the beginning of 2002 is the increase in import prices of oil, fresh fruit and vegetables; possibly the introduction of the euro also has pushed up inflation. Contractual wages are expected to grow by 3.75% this year and by 3.25% in 2003. Especially the lower growth of labour costs in 2003, mainly due to an expected strong increase of labour productivity, has a moderating effect on inflation. The profitability of Dutch firms will also be positively affected by the lower growth of labour costs.

Unemployment rising
The economic slowdown that started in 2001 will have a clear impact on the labour market this year and next. Earlier this year registered unemployment rose for the first time in eight years. Employment (in persons) is expected to grow by only 0.5% in both years, the major part in the health care and the public sector. The employment in the market sector will even decline slightly in both years. Coupled with a growth of the labour supply of around 1% per year, the unemployment rate will rise in both years and end up at 4.5% of the labour force next year.

EMU deficit will return in 2002 and 2003
After three years with a positive general government financial balance, this year the EMU balance is expected to turn negative again by 0.3% of GDP. The slow economic growth causes diminishing tax receipts; increasing unemployment is accompanied by higher unemployment benefits. Despite the expected economic recovery, the EMU deficit will further increase to 0.7% of GDP in 2003, because tax receipts and unemployment benefits lag behind the recovering economy.

Risks and uncertainties
A separate box in this CPB Report outlines an uncertainty variant concerning the euro/dollar exchange rate. A higher euro (2 dollar cents in 2002 and 5 cents in 2003) has a negative effect on Dutch price competitiveness and hence a negative effect on GDP growth, but it also leads to a lower inflation rate and a lower wage rise, especially in the next year.

Also in CPB Report 2002/2
The forecasts as presented above, are published in the July 2002 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. The Economic Outlook section of this issue also features an analysis of the economic effects of eight election platforms. For more information regarding this topic see CPB press release number 28 of May 15, 2002 on CPB's website (www.cpb.nl). The Articles section of this issue is centered around the theme of Knowledge Economics. The Articles section contains the following articles: The Dutch education system: Options for institutional reform; Financing academic research; Innovation policy; The future of fixed book prices; and The location of R&D in the Netherlands.

The Dutch education system: Options for institutional reform
There are some persistent problems in the Dutch education system which may create bottlenecks in the near future. This article pays particular attention to the performance of pupils at risk, teacher shortages, the quality of higher education, and lifelong learning. The educational performance of pupils at risk is structurally lagging behind, despite major policy efforts; primary and secondary education are encountering considerable teacher shortages; the quality of higher education is threatened by the growing exposure to (foreign) competition; and Dutch policy in the field of lifelong learning has reached a standstill and may miss the challenges posed by the knowledge economy. The article shows that more experiments with interventions for pupils at risk are needed, and rigorous evaluations are essential. Other promising policy options include further deregulation with respect to compensation of teachers, determination of tuition fees, and selection of students in higher education.

Financing academic research
Indicators of current academic performance yield an ambiguous picture of how much room there is for improvement.
Current scientific output seems to be relatively strong, which would suggest that stronger explicit incentives are unnecessary. The available indicators for utilisation do give some reason for concern, but these indicators are clearly very partial. Absence of evidence of room for improvement, however, is not the same as evidence of absence of room for improvement. However, the absence of evidence may stimulate policymakers to simply stick to the status quo. This may be a dangerous strategy. The preference of at least some top researchers for a tighter relationship between funding and scientific performance, combined with the trends of ageing and increasing international competition for top researchers, suggests one realistic way in which doing nothing may go seriously awry.
So what should be done? Current knowledge does not suggest institutional changes that will be unambiguously favourable. Hence, the best way forward is to experiment with several of the options sketched in this article, and to evaluate the effects. This may provide the necessary knowledge for better science policy.

Innovation policy
Innovation indicators for the Dutch private sector offer a mixed message: R&D intensity is relatively low, but other indicators sketch a more positive picture. The evidence suggests that ample opportunities exist for innovation policy. But there is a trade-off: policy instruments may be ineffective and inefficient, and may crowd-out market-based solutions. Furthermore, policymakers have to choose between generic and specific policy measures: generic innovation policy is inevitably redundant for some of the markets addressed, but specific policies may require levels of information not available to policymakers.
However, little is known about the precise impact and efficiency of innovation policy instruments. Well-designed, small-scale experiments offer opportunities for policy learning, and so do analyses of natural experiments in current innovation policy.

The future of fixed book prices
Fixed book prices may be an effective way to reach two cultural objectives. First, the instrument could improve the availability of books through an extensive network of booksellers. Second, it could stimulate the production of books by publishers. However, the fixed book price can lead to higher average retail prices for books, and thus have a negative impact on the 'consumption' of books. It reduces the incentive for booksellers to gear their stocks and services to demand and also discourages incentives for innovation. Moreover, there is no guarantee that publishers and booksellers will use the instrument in favour of cultural goals.
This article also presents three alternatives for the fixed book price: i) a slimmed-down version of the fixed book price, in which resale price maintenance is retained, but a number of disadvantageous aspects of the design are eliminated; ii) an alternative without intervention, in which the fixed book price is abolished without replacing it with another policy instrument.; and iii) scrapping the fixed book price and replacing it with subsidies aimed at promoting the achievement of cultural policy objectives.
In the future the market may be able to reach desired cultural objectives without a fixed book price. Therefore, from an economic perspective (i.e. the Competition law), the analysis shows that there is no good reason to keep the instrument. Technological developments reduce the need to intervene in the market and it is uncertain to what extent the fixed book price contributes to the cultural objectives.
Abolishing the fixed book price would bring many uncertainties. Whether or not this poses a problem, depends on the exact cultural objectives. Are the number of titles published and the number of booksellers sufficient at the moment? Can the Internet be regarded as a good substitute for a network of booksellers? Before any decisions can be made on the future of fixed book prices, these questions must be answered.


Dick Morks
Johan Verbruggen