CPB REPORT: ECONOMIC UPTURN CONTINUES

CPB Netherlands Bureau for Economic Policy Analysis (CPB) is expecting a GDP growth of 4% in 2001, slightly less than in 2000.
Exports will probably increase by 9.5% this year and by 9% in 2001. Private consumption will not lose momentum. CPB expects consumption to grow by 4.25% in 2000. Although the wealth effects on consumption get weaker in 2001, consumption growth will expand to 4.5% next year, thanks to the strong increase of real disposable income in the projection for 2001, caused by the 2001 tax reform.
The rise in employment will abate to 2% next year. Yet, this rise in employment is projected to be strong enough to lower unemployment to 3% of the labour force in 2001.

World economy
The expansion of the world economy is showing continued strength and is expected to decelerate only slightly next year. World trade growth has accelerated in the first half of 2000 to almost 12%. This pace is expected to be maintained in the second half of this year, but to slow down in 2001, due to weaker production growth, particularly in the US. Thus, for 2000 and 2001 average growth rates of 11.75% and 9.25% are forecasted. The American economy shows signs of a slowdown, in particular with respect to private consumption and residential investment. US GDP is projected to increase this year and next by 5.25% and 3.25% respectively. The expansion in the euro zone is mainly export driven, based on strong foreign demand and a very competitive euro. The expected growth of the Japanese economy is quite modest, but the recovery is clearly there. The highest GDP growth rates are expected in the non-industrial countries, 5.5% in 2000 and in 2001.
This year, Dutch export markets will grow 2%-points less than total world trade, as European imports are growing less strongly, but next year's geographical disadvantage will be substantially smaller. This implies that world demand relevant for Dutch export market growth will only weaken from 9.75% to 8.75% in 2000 and 2001 respectively.

Investment and the labour market
This year domestic investment remains very dynamic: it is expected to increase by 7%. The tightness of the labour market causes problems in recruiting staff. This encourages firms to make long-term investments that raise the capital intensity of their output. For next year, the projection shows a modest slowing of investment growth to 5.5%, caused by a deterioration in profitability in 2000.
After a significant increase in employment in recent years, employment growth is expected to decline to 2.25% and 2% in 2000 and 2001 respectively. This is related to the further tightening of the labour market, which urges employers to raise their employee's productivity by making long-term investments.

Consumption, wages and inflation
Consumption is expected to rise by 4.25% this year, even though wealth effects on consumption growth, due to capital gains, are waning. In the first six months of 2000 consumption once more showed strong growth and indicators, such as consumer willingness to buy, suggest that this will remain the case in the second half of this year. Next year consumer spending is expected to rise slightly more, by 4.5%, thanks to the sharply increasing purchasing power as a result of the major tax reform in 2001.
Due to the further fall of unemployment and the higher projected growth of labour productivity, contractual wages will probably rise by 3.5% this year, as well as in 2001.
This year the consumer price index (CPI) is expected to rise by 2.5%, fractionally higher than in 1999. This higher level is due to the surge in import prices and the much higher natural gas prices. Next year inflation will accelerate to 3.5%. This can be explained by the hike in indirect taxes within the framework of the tax reform, most notably the VAT rate hike. In terms of purchasing power this effect will be more than compensated by a cut in direct taxes.
A higher oil price or a higher dollar exchange rate than in the central projection will result in a higher export growth, but also in a stronger increase in prices of imports and, hence, in higher inflation.

The government budget
Thanks to favourable economic conditions and strict budgetary policy, the level of general government spending is expected to fall from 47.8% of GDP in 1998 to 44.9% in 2001. Decreasing interest payments (from 4.7% of GDP in 1998 to 3.6% in 2001) and falling spending on social security (from 12.4% of GDP in 1998 to 10.8% in 2001) are the main causes for this reduction of government spending.
The favourable economic growth has also led to a buoyant increase of the tax revenues between 1998 and 2001. Revenues from VAT and other taxes - in particular the transfer tax on real estate, environmental taxes and inheritance tax - show a marked growth. The tax reform of 2001 will have a large effect on tax and social security revenues, leading to a strong increase of VAT and environmental taxes as a percentage of GDP, whereas taxes and social security contributions are expected to lag behind GDP growth. All in all, taxes and social security contributions as a percentage of GDP are expected to drop from 40.5% in 1998, to 39.6% in 2001.
The policy of consolidating public finances has succeeded in turning public deficits into a surplus: in 1999, for the first time in 25 years, the fiscal balance showed a surplus of 1% of GDP. In spite of the major tax reform, the surplus will probably still be at the same level in 2001.
The favourable evolution of the fiscal balance has contributed to a steady decline of the debt/GDP ratio. The general government gross debt is expected to drop to 52.6% of GDP in 2001.

Also in CPB Report 2000/3
The forecasts, as presented above, are published in the September 2000 issue of CPB Report and are in accordance with CPB's Macro Economic Outlook 2001 (only in Dutch), published simultaneously. CPB Report is a quarterly, English language magazine, that reviews the most recent forecasts on the national and the international economy and highlights research activities. This issue contains articles on various subjects, including ageing in the Netherlands; transparency of the Dutch pension market; and different pay practices.

Ageing in the Netherlands
Increasing pensions and medical expenditures due to the ageing of the Dutch population in upcoming decades will have huge implications for public finances. This makes current budgetary arrangements unsustainable in the long run. To restore sustainability, the government must increase the budget surplus to reduce the public debt. A relatively small adjustment suffices. This can either be a small tax increase of 0.7% GDP or by an equivalent expenditure reduction.

Transparency of the Dutch pension market
There is an increasing demand for choice possibilities within the Dutch pension system. On the trade-off spectrum between solidarity and individual choice possibilities, the Dutch pension system currently assigns much weight to solidarity. Participation in occupational pension funds is mandatory for most employees, and in many industries firms are obliged to take part in the sectoral pension funds. The unregulated part of the pension system is relatively small: individual life insurance payments comprise only 10% of the income of the retired.
Market transparency is an important precondition to ensure that the increased freedom of choice results in better choices. The transparency of the pensions market is limited, among other reasons due to the uncertain outcome; few repeat purchases; and high switching costs. More choice will have to go hand-in-hand with improved transparency. Solid opportunities to improve transparency abound.
One opportunity to improve transparency is to ensure that the pension advisor has no direct financial interest regarding the consumer's ultimate product choice.
The market for individual life insurance can also become more transparent by stimulating better information provision by insurance firms. This enlarges the comparability of insurance products and thus lowers search costs for consumers.

Why different pay practises?
In spite of union resistance pay methods that relate wages to performance are widespread in the Netherlands. About 38% of all employees get a part of their wage as individual remuneration (IR). Why do employers use this kind of pay arrangements? The main reason for employers is increasing labour productivity. Performance-related pay arrangements have three effects. First, they enable employers to provide workers with incentives, and hence to make them more productive. Second, employers can pay wages more in line with the marginal productivity of the individual worker. Third, this approach may lead to self-selection of employees: workers with different abilities will choose different types of wage contracts.
Labour unions dislike individual remuneration, because they have to take care of all their members, with high or low abilities. Low-ability workers will in general be worse off when working at an IR firm and in the long run they will probably choose for working at a salary firm. High-ability workers will benefit from individual remuneration because they will earn a higher wage than workers without IR.