CPB Report: Continued weakness of Dutch economy

• Dutch economy shrinks by 0.75 this year and will pick up by just 1% next year
• Average growth in 2001-2004 at less than 0.5 % per year comparable with the recession of the early eighties.
• Recovery is export led, notwithstanding continued decline of market shares due to deteriorating competitiveness.
• Due to low production growth and low profitability, investments by enterprises continue to decline, while unemployment will rise to 7% in 2004.
• Inflation expected to slow to 1.5% next year, and the average growth of contractual wages to 1.25%
• Weak activity is reflected in a rising public sector deficit to 3.25 % of GDP in 2004

World economy is recovering
The global economy has picked up strongly in the third quarter of this year. Production of G3 (United States, euro area and Japan) grew at an estimated 4.8% annual rate, which is twice as fast as in the previous quarter. US real GDP rose by 8.2%, the steepest increase in nearly twenty years. Growth in the euro area was at 1.6% relatively weak, but it was the first rise since the third quarter of 2002. Leading indicators suggest a continuation of the global recovery next year. Economic growth of G3 is expected to average 3%, a full percentage point higher than in the present year. This is reflected in a doubling of growth of world trade to more than 9%. Because economic activity in Europe remains relatively weak, Dutch export market growth lags behind world trade growth, at 7%.
Recent economic developments in China are breathtaking. In the third quarter, real GDP was up 9.1% compared to one year earlier; while in the second quarter the rise was 'only' 6.7% due to the Sars epidemic. In 2003 about one-third of the increase in the global export volume will have China as destination, which means that this country is the real driver of world economic growth.

Dutch economy slowly perking up
Whereas outside the euro area recovery is increasingly evident, this is hardly the case for the euro countries. The slight recovery that was foreseen for the Dutch economy has not manifested itself thus far, albeit that the third quarter showed a minimal 0.1% growth instead of a further contraction. The projected growth of GDP for this year has been revised downwards by 0.75 percentage point compared to three months ago. This adjustment is mainly due to the disappointing development of private consumption and exports of energy and services. The current projection assumes a further modest recovery of the Dutch economy in the fourth quarter, in the wake of the international recovery, resulting in a forecasted 0.75% decline for this year as a whole. In the post-war period, only 1958 and 1982 showed a sharper decline.

Recovery in 2004 originating abroad
This year, public spending will be the only expenditure category to make a positive (0.25%) contribution to GDP growth. The increase is wholly attributable to the surge in health care spending. Employment and net material consumption in the public sector are increasing far less than in previous years, while the volume of public investment is falling. The contribution to GDP growth of both private non-residential investment and domestically produced exports is expected to be -0.25%, and the contribution of private consumption even -0.5%. As a result, the economy will shrink by 0.75% this year. Next year, public spending will no more contribute positively to GDP growth. Then the strongest economic impulse will be provided by exports. Economic growth is expected to come out at 1% next year, which is low by historical standards for a recovery year.

Output gap reaches record level
GDP volume is expected to expand by less than 0.5% per year in the period 2001-2004. Because of the persistent low GDP growth, the output gap, i.e. the difference between actual and estimated potential output volume, has widened sharply from 3% in 2000 to an estimated -3% this year. A further deterioration is expected for next year, reflecting the loose situation on the labour market and the very low capacity utilisation in the market sector.

Weakest consumption growth in two decades
Dutch consumers remain in a sombre mood. Private consumption declined in the second and third quarter by 1.4%, compared to the corresponding periods of last year. Growth is expected to be less negative in the fourth quarter. For the year as a whole, a fall of the volume of consumption by 0.75% will result, the worst figure since 1983.The major cause is the decline of real disposable income of households, due to strongly rising pension contributions and health care premiums. Next year, consumption is expected to increase by 0.75%, which can be almost fully attributed to higher fixed expenses, i.e. consumption of residential services and health care. Growth in so-called 'free' consumption will probably be very weak next year.

Further contraction of private non-residential investment
Dutch investors are hesitant to invest at the moment. This year the volume of private non-residential investment is expected to decline by 4.75%. The past two years also showed a decrease. The main reason of this decline is the unfavourable output development in the market sector, which means that there is more than enough production capacity to meet demand. Last October, the capacity utilisation rate in industry was only slightly higher than in the recession year 1993. Moreover, profits have been under pressure for a number of years already, especially owing to rising labour costs. Output growth in the market sector is expected to be very modest next year (only 1%), while profitability will remain low. Under the circumstances, investments will continue to decline also in 2004, albeit less sharply than this year.

Persistent deterioration in Dutch price competitiveness
Non-energy exports are expected to contract slightly this year. Re-exports will post modest growth (1%), but domestically produced exports are expected to contract by 1%. The poor export performance is caused by the dramatic deterioration in price competitiveness of Dutch exporters in recent years, partly owing to rising labour costs and partly to the appreciation of the euro. Next year, the period of market share losses will not yet be over. Then, Dutch export market growth will be 7%, whereas the growth of domestically produced exports is expected to be only 2.5%. The deterioration in competitiveness, however, is expected to be considerably less than in previous years.

Contractual pay rise and inflation dip below 2%
Contractual pay increases are expected to moderate further next year, partly thanks to the recent Social Accord. Given the already negotiated pay settlements, contractual pay rates in the market sector will still increase by 1.25% in 2004. After the sharp rise in employers' social security contributions this year, a further rise is in the offing next year, largely accounted for by higher pension contributions.
Inflation, which has been declining from a high of more than 4% in 2001, should dip below 2% next year. The fall is related above all to favourable developments in unit labour costs and import prices. Inflation is pushed slightly upwards by increases in excise duties on tobacco and fuel.

Labour share in enterprise income shooting up
This year, the labour share in enterprise income is expected to increase sharply by 2.25 percentage point, to a level of 87.25% This marks a hike of no less than 6.25 percentage points over a five-year period. The weak growth of labour productivity in the market sector coupled with a considerable increase in compensation per employee are pushing unit labour costs sharply upwards, which is only partly compensated by higher selling prices. Next year, the labour share in enterprise income is expected to come out 1.5 percentage points lower than this year, mainly thanks to the cyclical recovery of labour productivity growth and the moderating contractual pay increases.

Unemployment continues to rise
Since early last year employment has been lagging behind labour supply, so that unemployment has been rising. Employment in the health care sector will continue to rise this and next year, albeit at a slower rate than in the previous years. Employment in the government sector is not expected to rise appreciably. Taken together, the rise in the number of jobs in the medical services and in the government sector will only partly compensate the decline in employment in the market sector. As a result total employment will fall by 50 000 persons and unemployment is expected to rise further to around 5.75 % of the labour force. Although growth in labour supply will remain in bounds next year, unemployment is expected to rise further to 7% of the labour force. The main reason is the 2% decline in employment in the market sector in 2004, mainly caused by the low output growth and the sharp deterioration in profitability in 2001-2003.

Budget deficit just above 3% EMU ceiling next year
The present year forecast for the budget deficit is 3% of GDP. To prevent the deficit from largely exceeding the 3% ceiling of the Growth and Stability Pact, the two Balkenende administrations gave priority to spending cuts and revenue-generating measures. That the present forecast is higher than in the Macroeconomic Outlook of last September is mainly due to the further deterioration in the economic situation, reflected not least in lower than expected tax and premium receipts, and overruns in health care spending. Despite substantial budget cuts and tax increases, the budget deficit is expected to deteriorate somewhat further next year, to 3.25% of GDP. This does not automatically imply that Brussels will qualify this deficit as excessive, because the Netherlands could plea exceptional circumstances, being shrinkage of GDP by 0.75% this year and a far below-potential growth rate during a number of years.

Uncertainties
The projections are surrounded by considerable political and economic uncertainties. Geopolitical tensions in the Middle East are still present, as is the threat of large-scale terrorist attacks. Uncertainties in the economic sphere lie in the case of the open Dutch economy in particular in international economic developments. A downside risk arises from the ultimately unsustainable US current-account deficit, which could lead to a sharp depreciation of the dollar. But there is also the upward risk that next year's recovery of world trade will come out stronger than assumed in the current projection. The Dutch economy will grow 0.4 percentage point less in 2004 if the value of the euro turns out 10 dollar cents higher, whereas 1%-point more world trade could yield 0.4 percentage point stronger GDP growth.