CPB Report 2002/3
However, the world trade volume which is relevant for the Netherlands, is expected to increase strongly by 7.75% next year. The Dutch private sector might benefit from the upward trend in global trade, but the sharply increasing labour costs since 1998, and the strong position of the euro against the dollar put pressure on the Dutch competitiveness, causing a loss of market share for the private sector. The government expenditures, which contribute significantly to growth this year, will barely increase in 2003 as a result of the planned spending cuts. As a consequence, the EMU deficit in 2002, forecast at 0.5% of GDP, will not grow further next year probably.
- Dutch economic recovery delayed
- Private sector loses market share
- Unemployment 150 000 higher in two years
- EMU deficit in 2002 and 2003
Recovery in industrial countries less powerful than previously expected
The economic growth in the United States is expected to come out at 2.25% in 2002. At first, the US economy recovered strongly from the September 2001 terrorist attacks. In the first quarter of 2002 the American economy grew by 5% on a yearly basis. In the second quarter sentiment deteriorated dramatically. Influenced by falling business profits and the unreliable financial information of enterprises, the stock market collapsed. Because of this and of the weak growth of domestic consumption, GDP grew by only1% on a yearly basis in the second quarter. As it is now, the turmoil on financial markets is not expected to obstruct the further economic recovery in the second half of this year. Supported by low interest rates and a cheaper dollar, productivity gains and profitability of the US economy will be able to increase. US growth is forecast at 3.25% in 2003.
The European recovery struggles to gain momentum. On average economic growth in the EU will not exceed 1.25% this year. For 2003 a moderate recovery to 2.5% is estimated. Unemployment that is expanding since the fall of 2001, tumbling share prices and strongly increasing inflation in the first months of this year, caused a dramatic fall in consumer confidence in the euro area. This will influence household spending in a negative way. The expectations on the longer term, however, are favourable. The inflation is decreasing and the strong euro/dollar exchange rate affects the real disposable household income, and thus the purchasing power, positively. Without new incidents the fall of private non-residential investment will probably come to an end. All together, the near future for the world economy looks favourable. World trade, modestly growing by 3.75% this year, is expected to rebound powerfully by 10% in 2003.
Uncertainties
The main uncertainties about the forecasts of the Dutch economy are due to a number of unstable factors that may disturb the projections sooner or later. It is possible that the downturn of financial markets is holding longer, for instance caused by new financial scandals, or changing profitability expectations. This could undermine confidence and spending worldwide.
A next risk factor is the exchange rate of the dollar. A cheaper dollar compared to the euro might undermine the competitive position of the euro zone and thus delay the cyclical recovery in this area. But a stronger dollar on the short term is also possible.
Political tensions in and around the Middle-East may influence the Dutch economy negatively by causing higher oil prices. If these tensions lead to a situation of war, consequences will even be more serious.
On the opposite, a more powerful recovery in the industrial countries is also possible, as the international recovery, implied in the projection, is moderate, compared to previous periods of cyclical recovery.
Dutch economic growth in 2002 very modest; picking up moderately in 2003
The Dutch economy is expected to grow mildly by 0.5% this year, mainly caused by decreasing residential and non-residential investments and disappointing growth figures for consumption and exports. Government spending, still expected to increase this year because of higher expenditures on health care and education, will contribute most to economic growth in 2002. The production in the private sector will probably decrease slightly. In the second half of this year the economy will recover somewhat compared to the past four quarters, in which quarterly economic growth fluctuated around zero. The tightening world trade will then provide strong impulses for the private sector.
Next year the expected international revival of the world economy entails a higher increase of exports, which will then be the driving force behind the Dutch economic growth again. Next year economic growth is expected to accelerate to 1.5%. Consumer spending will grow slightly more than this year, the fall of non-residential investment expenditures will probably come to an end and residential investment will rise again. These developments are expected to lead to 1.5% higher production in the private sector. The planned spending cuts of the cabinet will result in an exceptional low growth of government expenditure in 2003.
Private consumption under pressure
Since the beginning of 2002 consumer confidence has fallen dramatically. The willingness-to-buy, a part of the consumer confidence, has never been lower since 1985, and also the appraisal of the economic climate strongly deteriorated. Persisting high inflation, strongly rising unemployment and the dramatic fall of share prices did not do any good to consumer confidence. This year private consumption will only grow by 1.25%, next year the growth of 1.5% will be only slightly higher. Under the assumption that share prices have reached the bottom, the effect of the capital stock on private consumption growth will be less negative next year. However, the real disposable household income growth is expected to slow down in 2003, compared to this year. The slackening inflation has a positive effect on real disposable household income, but lower wage raises, lower employment growth and an additional financial burden of almost 3.5 billion euro affect the household income in a negative way. In the projection is implied that the negative effect on private consumption of the abolition of salary savings schemes will be limited, because households will have more liquidities at their disposal. Because deposits for salary saving schemes are no longer withheld and previously saved amounts will become available, employees will be able to dispose of approximately 4.5 billion euro (about 1% of GDP) in 2003. A small part of this amount is expected to be applied for consumption. The rest will shift to other forms of saving, among which the new course-of-life scheme, upon which the government will pay out a bonus of 30% if used, to finance the unpaid leave.
Deterioration of profitability and disappointing economic growth push down investment
Non-residential investment is expected to decrease by 2.25% in 2002. Causes for this fall are twofold. Disappointing production growth and the matching capacity utilisation rate limit the urgency to invest in extra production capacity. Also, last years' deterioration of profitability hampered the financing of investments. The profitability rate and the productivity of equity capital have never been as low since 1982-1983. As to this gloomy climate, next year investments are not likely to grow.
Shrinking market share of Dutch export
The export of goods, excluding energy, will probably show a modest growth of 1.25% this year. The domestically produced part of exports decreased by 0.75% in 2002, as in 2001. For next year a sharp recovery of Dutch export growth is projected, influenced by a high relevant world trade growth. However, Dutch export will strongly lag behind relevant world trade growth. The main reason for the bad performance of Dutch exporters on the global market is the worsening price competitiveness: Dutch products have become more expensive in relation to euro competitors, because the considerably higher wage movements are not at all compensated for by higher growth of labour productivity. In relation to competitors outside the euro zone the unfavourable position has even deteriorated by the high euro/dollar exchange rate. Because Dutch producers price themselves out of the market, extra import will follow: foreign alternatives will become less expensive, thus more attractive to consumers and companies.
Unemployment rises steeply
The tension on the labour market decreases very fast because of the cyclical downturn that started last year. Since the beginning of 2002 employment has been growing less than labour supply, resulting in sharply increasing unemployment. The number of vacancies has been diminishing for some time and will continue to do so. Employment in the market sector will probably decrease this year by 0.5%, for next year even a fall of 1% is foreseen. As the employment in the public sector is still growing strongly this year, total employment will grow moderately in 2002. Next year, however, employment in the public sector will decrease sharply, and as labour supply keeps on growing in both years, unemployment will increase by a total of 150 000 persons in two years. This means that, for the first time since 1995, the unemployment rate will rise. In 2002 the dependency ratio, this is the number of recipients of a benefit as a percentage of the working population, will increase for the first time since 1994. This is partly due to a higher appeal to unemployment benefits, partly to a lower working population.
Wage increases slow down
Due to the unfavourable cyclical situation and particularly the increase in the unemployment rate, the expected contractual wage growth in the market sector will decrease to 3.75% this year and 3.25% in 2003. The quickness of reaction of wages is limited, due to the validity of the contracts of one to two years. Besides, many contracts are negotiated in spring, at which moment inflation is above the yearly average and unemployment just below. The expected contractual wage growth in the market sector is relatively strong compared to the inflation, especially seen to the background of the sharply increasing unemployment and the low profitability. The additional financial burden in 2003, however, will partly be shifted by higher wages.
Inflation declines, purchasing power goes down
This year the Consumer Price Index (CPI) will grow by 3.5%. Thus, the inflation remains high, especially due to the strong increase of unit labour costs. It is plausible that companies have seized the opportunity of the introduction of the euro to raise their margins, but this effect has probably not been large, in view of the cost increases and consumer prices as they are known by now. Next year inflation will decline to around 2.5%. The rise of unit labour costs will diminish, owing to the tightening labour productivity.
Despite the 0.75%-point higher growth of contractual wages compared to inflation, purchasing power of working people will still fall by an average of 1%. The additional financial burdens of approximately 3.5 billion euro mainly ends up with working people, especially due to the abolition of salary savings schemes. Besides, the strong increases of both pension premiums and premiums for health care insurances play an important role.
EMU-deficit in 2002 and 2003
Influenced by the cyclical growth delay, the general government financial balance will turn into a deficit of 0.5% in 2002. Without additional policy the EMU balance in 2003 would even be twice as deep in deficit, but by spending cuts and tax increases the EMU deficit will improve slightly to 0.4% of GDP next year.
Also in CPB Report 2002/3
The forecasts as presented above, are published in the September 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. This issue contains articles on various subjects, including: The new cabinet's plans, Liberalising the European natural gas market, Business services and the Baumol disease, ICT potential for the Netherlands, Economic effects of e-commerce, and Evaluating government investment plans.
The new cabinet's plans
In July, a new coalition cabinet started their term of government in the Netherlands. The new Cabinet's policy proposals have been written down in a coalition agreement, which was the result of extensive negotiations, especially concerning fiscal policy and the budget. CPB assisted in this process by assessing the economic effects of the proposals under consideration and of the final coalition agreement. The article describes the fiscal and budgetary aspects of the agreement, the macroeconomic background against which it was assessed, and the assessment itself.
The coalition agreement anticipates net spending cuts in public spending of 3.25 billion euro in 2006. Spending on public administration and social security will each be cut by 5 billion euro. The agreement allocates extra spending growth to health care, education and security.
On balance the new government's plans do not change the overall tax burden. There will, however, be shifts over time. In the first two years the tax burden for citizens and companies will rise, to drop again starting in 2005. Furthermore, shifts will take place between various taxes and contributions. Important themes of the new government's tax plans include the introduction of new financing for health care insurance, tackling the poverty trap, tax relief for families with children and a partial reversal of environmental orientation of the tax system.
As a result of the measures to be implemented, economic growth (GDP volume) in 2003-2006 will on average be 0.1 percentage points lower per year than under the conservative scenario. This is the net effect of higher growth in the private sector and lower growth in the public sector. Higher production in the private sector is related to lower labour costs and capital costs. Lower public sector production is the direct consequence of cutbacks.
Liberalising the European natural gas market
Europe's natural gas market is changing radically. The several national markets dominated by monopolistic suppliers are integrating into one European market in which production and trade are subject to competition, while transport through the networks will be unbundled and placed under regulatory influence.
As a result, gas prices will probably decline this decade. At the end of that period, prices could rise again due to the growing scarcity, when British fields will have become depleted and supply originates from (far) more distant regions.
Gas supply security remains a compelling issue - with the currently inadequate investment infrastructure in the main production country (Russia), the effects of volatile spot market prices on investments and the growing EU gas import dependence. The security of future gas supply will thus enjoy the continuing spotlight of energy policy.
The environmental effects of liberalisation seem to be less worrisome. These effects will probably be positive, in the sense that emissions will be reduced, due to an induced change in the fuel mix of power generators, which will replace the high emission energy carrier coal by the relatively clean fuel natural gas.
Evaluating government investment plans
CPB, in cooperation with four other institutes, carried out a quick-scan analysis for the Dutch government of some 300 investment proposals in the Netherlands in several policy areas, including transport, physical planning, the environment and information technology. The projects amount to a total investment sum of nearly 100 billion euros. The analysis classified only 10% of the plans as robust, 45% as upgradeable, and the rest as 'weak'. In the analysis projects that could not be analysed because of insufficient information, are classified in the category 'weak'.
Examples of robust plans are road pricing to alleviate congestion, a road-safety programme, and some investments in environmental planning on riverbanks and improvements in school buildings.
Sometimes people think that if a goal is worthwhile, every proposed project to pursue this goal is worthwhile too. This is only true if the project is effective and efficient in reaching the target.
In some policy areas - such as environmental protection - other policy instruments like regulation seem to be more effective and efficient than investments.
In some cases it would appear that policy goals are pursued with measures that do not seem to be appropriate. An example is trying to guide spatial planning with investments in public transport. This would call for re-adjusting the policy strategies.
Improvements can also be made by being more selective in designing a total policy strategy. More emphasis should be placed on the quality of individual projects that are used to implement the strategy. Projects for the construction of parks in or around some towns may illustrate this point. If thirty 'park projects' are to be carried out, it is imaginable that some will yield more effects in relation to the euros invested than others. A more selective process--'picking the winners'-- may result in a more efficient policy strategy.
Furthermore, the scale of projects should match the problems at hand. In many cases the costs of solving a given problem appear to be too high.
Finally, the timing of projects, the phasing of projects and the definition of a coherent strategy can contribute to more effective policies in most areas. Postponing the restoration of monumental buildings can lead to a dramatic rise in the costs and hence jeopardise the efficiency of a project. These cases clearly call for immediate action. The same holds true for some nature projects: for example, when an animal becomes extinct as a result of the postponement of appropriate measures. In contrast to this, there are also cases in which efficiency may improve by delaying or phasing a project. Examples include infrastructural projects, in cases where capacity problems are to be expected only in the medium- or long run.