March 22, 2005

Central Economic Plan (CEP) 2005

Central Economic Plan 2005

Press release
After a year of robust economic growth, diminishing unemployment, and low inflation, the world economywill fall back somewhat in 2005. Due to the high price of oil and a less expansionary macroeconomic policy, global economic growth will decrease to some extent, from 5% in 2004 to probably 4% this year.

In 2006, global economic growth may increase again to 4.5%.

In the Netherlands, the enduring and severe cyclical downturn of the Dutch economy may end late 2005. For this year, a small relapse of Dutch economic growth to 1% is foreseen, but in 2006, economic growth is expected to accelerate to 2.25%. After the recession in 2003, the Dutch economy was revitalised by extra exports, but growth of domestic expenditure dropped behind. Better prospects are on the horizon, however, for the domestic expenditure categories consumption and investment.

Although private consumption will probably decrease somewhat this year, prospects for next year are more positive. Moreover, investment and employment are expected to increase, thanks to higher production growth and improved profitability of firms. Unemployment will most likely peak in 2005 (6.75% of the labour force), followed by a decrease to 6.25% in 2006.

Inflation, at 1.25%, is not expected to change this year. In 2006, it may decrease to 0.25%, partly due to the abolition of the users' part of property taxes. The purchasing power of households will decline in 2005 by 1.25% on average. For next year, however, an increase of 0.5% is projected. Based on current policy measures, the general government financial deficit is expected to fall back steadily, from 3.2% of gross domestic product (GDP) in 2003, to 1.7% of GDP in 2006.

The analysis above was extracted from the summary chapter of the Central Economic Plan 2005 (CEP 2005), published today by CPB Netherlands Bureau for Economic Policy Analysis (CPB). The entire publication will appear on Wednesday April 6, 2005. The CEP 2005 contains a special feature about the direct consequences in 2006 of three fundamental institutional changes, in health insurance, disability insurance and early retirement/pre-pension/life-cycle schemes.

Euro area will join the favourable development of the world economy in 2006
While global economic growth increased to almost 5% in 2004 - the highest growth in twenty years - the high oil price (of the projected average of 40.25 dollar per barrel) will in all likelihood push the world economy down slightly, to 4% in 2005. The oil price thus hinders output growth in the euro area, which will furthermore experience diminished growth due to the worsening of the price competitive position as a result of the stronger euro and weak consumer and producer confidence. For the euro area, this will result in somewhat declining growth, from 2% in 2004 to 1.75% in 2005

For next year, CPB expects the oil price to drop to an average of 35 dollars per barrel. Production growth and world trade will probably increase again. In the euro area, economic growth accelerates in 2006 to 2.5% due to, among other things, more investment as a result of high profitability and the improved financial position of companies.

Dutch economic growth will relapse in 2005…
Economic growth in the Netherlands is expected to relapse to 1% in 2005, a slowdown of the rate of growth that started already last year. Provisional data of Statistics Netherlands indicate that production in the fourth quarter even fell by 0.1%, compared to the previous quarter. Over the entire year, however, economic growth was still 1.4% in 2004. In 2005, Dutch exporters will experience the consequences of the delay of the international cyclical situation, and are also troubled by the more expensive euro. Households will have less to spend this year, mainly because of the moderate wage development and the increases in the tax burden.

… but will rebound in 2006
Economic growth, as projected for next year, will accelerate to 2.25%, thereby ending a period of five meagre years. Dutch business will benefit from the upswing of the international cyclical situation. In addition, domestic expenditure is also expected to contribute to economic growth. For the first time in years, the purchasing power of households is projected to rise, enabling people to spend more. The foreseen increased profitability of companies will contribute to a considerable increase of investments.

Large uncertainties
The projected decline of economic growth in 2005 and the acceleration of growth next year are subject to considerable uncertainties rooted in the international situation. The euro/dollar exchange rate, for example, may rise or fall. If the oil price remains at the high level of (on average) 45 dollars per barrel this year and next, economic growth in the Netherlands will end up about 0.3% lower in both years.
Another uncertainty: the development of the long-term interest rates, which are strikingly low at the moment. If the long-term interest rate comes out 0.5%-point higher in 2005 than projected and 1%-point higher in 2006, then the expected recovery will be nipped in the bud. In that case, economic growth in 2006 will be 1%-point lower.
But it is also possible that economic growth, especially in Europe, has been underestimated. If consumer and producer confidence will recover faster than expected, this might give an important impulse to the economy.

The Netherlands catches up to the euro area
In recent years, Dutch economic growth clearly lagged behind growth in the euro area, but next year the Netherlands can catch up. Labour costs in the Netherlands will probably develop more favourably in 2005 and 2006 than labour costs in the euro area on average, leading to some improvement in the competitive position. As of next year, moreover, an end will come to the Cabinet's extensive cutbacks. Another factor: the capital positions of pension funds have improved in such a way that further increases in pension premiums, which affect labour costs and purchasing power negatively, are not likely. In the period 2000-2006, the Dutch economy grew altogether probably 3.5% less than the entire euro area. This means that the extra Dutch economic growth (8.5% more than average in the euro area in the period 1993-1999) will thus be counterbalanced for about 40%.

Exports growth is the main engine of the economy
Because of the worldwide growth delay, export growth declines from 8.2% in 2004 to 4.5% this year. With the pick-up of foreign demand, export growth will rebound next year, by 7.25%. Especially re-exports will increase forcefully in both years. Due to the price competitiveness position, which has strongly worsened in recent years as a result of greatly increased labour costs and the strong euro, growth of 'made in Holland' exports lags behind the relevant world trade. Last year, things took a favourable turn concerning the competitiveness position. Unit labour costs decreased just as strongly as they did in the competitive euro area countries. This year and next they will develop even more favourably. With a constant exchange rate of 1.30 dollars per euro and the projected moderate wage development, unit labour costs will also decrease more in 2006 than they will in competitive countries outsidethe euro area. In that case, Dutch exporters can set their prices more sharply than their competitors, benefiting the Dutch price competitive position. In 2004, export was responsible for 80% of the economic recovery. This year and next, exports remain the main engine of the Dutch economy, although their relative importance for economic growth will decrease.

Cautious recovery of private consumption
For this year, CPB projects a slight decrease of private consumption of 0.5%, mainly due to falling real disposable household income. In 2006, household expenditure will recuperate. Private consumption will indeed fall by 2.7% next year, but this is completely the result of a financial shift caused by the introduction of the new health care system in 2006 and therefore purely statistical. Adjusted for this statistical effect, therefore, private consumption will increase by 1% - due to rising real wages, some tax burden reductions and lower unemployment. Discretionary household savings will diminish somewhat in 2005, as households will compensate for the unfavourable income development by saving less money. In 2006, however, discretionary household savings will grow strongly. Fiscal compensation of collective pre-pension arrangements will be abolished, and the individual life-course scheme will be introduced; this will probably lead to a shift from collective pension savings to individual savings.

Investment growth accelerates, profitability improves
In this year and next, investment growth will accelerate thanks to the acceleration of production growth and a firm recovery of companies' profitability. In the period 2004-2006, the labour share in enterprise income will probably decline by 3%-points to 83.75 in 2006, after having increased in the period 1999-2003 by 6%-points to 86.9. The recovery of profitability is facilitated by the moderate wage development and the strong growth of labour productivity. This year, especially exporting companies will be able to improve their margins; in 2006, however, also companies oriented toward the domestic market will experience growing margins.

Falling unemployment in 2006
The decline of employment may come to an end this year, after employment measured in persons dropped in 2004 by 70,000 (or almost 1%) - the largest job loss since the early eighties. The labour market showed two faces last year. While employment actually decreased, the early signs of recovery were also visible: greater numbers of vacancies, a slower rise of unemployment, fewer bankruptcies and an increased number of hours worked by temporary employees. Unemployment is expected to rise somewhat in 2005, to 6.75% of the working population, but this rise is smaller than that of last year. Next year, the recovery of production growth and the improvement of profitability will probably lead to rising employment. This is likely to exceed the rise of the labour supply, so that unemployment is expected to fall somewhat, to 6.25%.

Low inflation
Inflation continues to fall, due to lower labour costs and appreciation of the euro, making the import of products cheaper. Compared to last year, when consumer prices increased by 1.2% on average, monetary depreciation in the first months of 2005 has slightly increased, to 1.6% in February. The high price of oil and increases in energy taxes led to higher energy expenses in recent months. In coming months, however, inflation may diminish somewhat, because the rise of last year's tobacco taxes will no longer be included in the inflation figure, and the rent increase on July 1 will be lower than last year's. For 2005 as a whole, the inflation of 1.25% (on average) will be equally high as in 2004. Next year, inflation is expected to come out at only 0.25%, also due to the abolition of the users' part of property taxes, which will have a downward effect on inflation of almost 0.5%-point.

Moderate wage development
CPB expects wage rises to further diminish to 0.75%, a continuation of the development in recent years. Due to low inflation and the rise of unemployment, the increase of contractual wages in the market sector has continued to slow, from 4.2% in 2001 to 1.5% in 2004. The Social Agreement regarding early retirement, pre-pension and life-cycle arrangements was long in coming, resulting up to now in hardly any collective labour agreements concluded for this year and next. In the Social Agreement, social partners agreed upon an extremely remote wage development. In 2006, contractual wage rises in the market sector are expected to come out somewhat higher, at 1%. With a very low projection of inflation of 0.25%, this means that employees can once again face a real rise in wages.

Budget deficit drops
This year and next, the general government financial balance is expected to improve even more, after the budget deficit of 2.5% of the gross domestic product came out below the 3% standard of the Stability and Growth Pact in 2004 (after only once exceeding this standard in 2003). This year the EMU deficit is expected to be 2.0%, next year decreasing to 1.7%. In 2005, further cutbacks and tax burden increases by this Cabinet, in particular, will improve the EMU deficit; in 2006, the pick-up of economic growth will have the same effect. The cyclically adjusted or structural deficit will thus further improve strongly to 0.6% of GDP this year, remaining at that level in 2006. The Netherlands will then almost be in compliance with the structural deficit of 0.5% of GDP (Gross Domestic Product), as permitted by Brussels.

CPB Newsletter 2005/1
Together with the first chapter of the Central Economic Plan 2005, CPB publishes a new edition of the CPB Newsletter. This magazine contains, among other things, an article about the effect of a larger police force, a review of CPB's recent English language publications and the table 'Main Economic Indicators', containing the figures of CPB's most recent forecast.


Dick Morks
Johan Verbruggen

Read also the accompanying press release and Newsletter 2005-1.


Dick Morks
Johan Verbruggen

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