September 21, 2004

Macro Economic Outlook 2005

Macro-economic Outlook 2005

Press release
The world economy is in top gear. Because of the worsening price competitive position in recent years, the Dutch economy has not been able to fully capitalise the international revival. This year, Dutch economic growth is expected to come out at 1.25% (1.5% in 2005).

Due to the unfavourable development of real disposable income and of social benefit remittance, private consumption is not expected (or hardly expected) to grow. The government and the business community, moreover, are unlikely to provide an expenditure impulse in the projection period. Although strongly diminishing employment and sharply rising unemployment in the labour market paint a gloomy picture this year, the market will probably tighten in early 2005. The growth of employment will be too small, however, to prevent a further rise of unemployment (to an average of 7% of the labour population). Labour productivity shows the usual cyclical recovery and contributes to further delay of inflation speed to 1.2% in both forecasting years. Also, the development of contractual wages will probably ease, to 0.75% on average in 2005. In the recession year 2003, the EMU deficit came out at 3.2% of the Gross Domestic Product (GDP). Extensive cutbacks and financial burden increases are expected to reduce this deficit to 2.9% of GDP in 2004 and to 2.6% next year.

  • Dutch economic growth projected at 1.25% in 2004 and at 1.5% in 2005
  • Exports the engine of economic recovery, domestic expenditure develops weakly
  • Labour market shows a slight recovery, but unemployment continues to grow
  • Cutbacks, together with financial burden increases, bring EMU deficit into compliance with European budget standards

These are some of the headlines of the Macroeconomic Outlook(MEV) 2005 as published today. In this outlook, CPB presents analyses and forecasts of the Dutch and the world economy in 2004 and 2005. A number of text boxes explore important developments such as longer working hours, past interest rate increases in the US, oil-price dependency, competition with low-wage countries, international comparison of working hours, and the no-claim restitution in health care. Also, the MEV presents an extensive special issue on 'labour productivity and participation'. More information about this subject is given at the end of this press release.

World economy growing vigorously
In the first half of 2004, the world economy continued to develop strongly. The healthiest growth was shown in the upcoming economies, with China presenting a spectacular 10% growth on a yearly basis. On average, world economic growth in 2004 has been the highest in the last twenty years. Next year, worldwide economic growth is likely to slow down somewhat, although it will remain above the expected trend and will be sufficient to cause a drop in unemployment. In the US, the rising economic climate continued in the first half of 2004. It is positive that economic growth has been accompanied by noticeably increasing employment. US growth is expected to come out at 4.5% this year and will dwindle slightly to 3.5% in 2005. The expansive US budgetary policy has not only contributed to the cyclical recovery in recent years, but has also caused a strongly increasing budgetary deficit- to probably 4.75% of GDP in 2004.
In the first half of 2004, economic growth in Japan was higher than it has been in the past decade- even higher than US growth. Not only exports performed well, due to the explosive growth in China, but also domestic expenditure increased sharply. Japanese GDP growth is now projected to come out at 4.5% in 2004. In 2005, economic growth will slow somewhat to 2.25%, mainly because of diminishing demand from China.

Euro area to gain some dynamics
In the euro area, economic growth increased modestly in the first half of this year, mainly due to expanding foreign demand. The recovery is still fragile, however. GDP growth lags behind US growth, partly due to the negative effects of the stronger euro on exports, and partly due to less stimulation from government budgets. Recovery in the euro area is expected to gain some strength in the projection period. GDP growth is forecasted at 2% in 2004, and 2.25% in 2005. Because of a moderate development of wages and a projected decline of the oil price, inflation will drop to below 2%. For next year, a slight drop of the average budget deficit in the euro area is expected, although in some euro countries, this deficit will probably stay above 3% of GDP.

Dutch economy getting back on its feet
With a projected economic growth of 1.25% for this year, the Dutch economy has performed considerably better than in the recession year 2003, when GDP volume fell by almost 1%. Nevertheless, economic recovery runs by fits and starts. According to provisional figures from Statistics Netherlands, production declined by 0.2% in the second quarter of this year, after two preceding quarters of strong growth. Although occasional circumstances (such as a mild winter, for example) will surely have played a role, figures show that a robust and extensive economic growth is still not expected. In the first half of 2004, GDP was 1% higher than in the first half of last year. Growth speed is expected to tighten slowly to an average of 1.5% in 2005.
From a historical and international perspective, the presumed recovery is modest, and its composition one-sided. Economic growth mainly stems from exports in both years. Exporting companies take advantage of the powerful growth of the world economy, although they still lose market share as a result of high labour costs and an expensive euro. Private consumption, non-residential investment and government expenditure perform very weakly.

Exports on the way up
Since the European economy tightened at the end of 2003, exports are strongly on the rise. Exuberant increases are expected in re-exports (i.e. imported products leaving the country after only little manufacturing), in particular, with growth figures of about 10%. Also, the export of domestically produced goods is likely to increase, although this growth will strongly lag behind world trade growth. This means that Dutch business will still lose market share in 2004 and 2005.
The competitive position of Dutch trade and industry has worsened in recent years because of rising labour costs and appreciation of the euro. Due to the wage moderation already underway, and the strong recovery of labour productivity, labour costs will increase less this year and in 2005 compared to our euro competitors. The euro is assumed not to appreciate further in 2005. This enables Dutch exporters to improve their competitive position compared to competitors outside the euro area, both this year and next. The effects on foreign sales lag behind, however, and will therefore hardly be noticed in next year's production growth.

Consumer remains penny-wise
Private consumption will increase only slightly this year, due to the package reduction of health care insurance (causing households to finance their own physiotherapy treatments, for instance). Next year, private consumption is not expected to increase at all, mainly because of the unfavourable development of real disposable household income. In addition, positive impulses on private consumption from the housing market and the stock market are not foreseen, mainly due to the fact that prices of houses are projected to rise less than inflation for the first time since 1984.
In 2005, as a consequence of cutbacks and financial burden increases, purchasing power will be under pressure. Total real disposable household income will decrease because of the purchasing power decline. This has resulted from certain social security policy measures that have curtailed inflow into the Disablement Insurance Act and the Unemployment Insurance Act. A simultaneous decrease of labour income and social security income-in real disposable terms-occurred only once in the last thirty years, in 1991.
Zero-growth of private consumption is still more than the projected decrease of real disposable household income by 0.75%. Thus, despite the stagnating growth of private consumption, household savings are expected to diminish somewhat in 2005. The projection assumes that consumers have become gradually more optimistic and are now prepared to spend part of their accumulated savings.

An end to falling investment
After three years of strong declines, investments are expected to rise in 2004 and 2005. However, the projected investment growth of 1% per year on average is very modest. Due to meagre production growth, the capacity utilisation rate remains low, making investments less necessary. Profitability recovers only sparsely, due to companies wrestling with passing on high pension premiums and strong price increases of oil and other manufactures in their market prices. On the domestic market, entrepreneurs are confronted with poor demand. On the more dynamic foreign markets, however, some space arises for improving margins, but entrepreneurs will use part of this to improve their competitive position.
The investment projection takes into account the anticipation behaviour of entrepreneurs in response to Cabinet proposals to abolish taxes on passenger cars and motorcycles within three years. This is expected to lead to extra replacement of delivery vans this year, and consequently to extra investment.

Unemployment growth eases
The labour market situation seems to improve gradually, with slight rises in the number of vacancies, fewer bankruptcies and an easing in the rising pace of unemployment. Employment is expected to decline strongly this year, however. Companies have been forced to reduce the number of employees, due to weak profitability and declining production in 2003. In addition, job growth in the public sector is smoothing off because of cutbacks. Next year, employment in persons is expected to expand sparsely, mainly thanks to recovering production growth. Moreover, a statistically upward effect on employment development can be attributed to the introduction of a law (VLZ) forcing employers to pay the wages of sick employees in their second year of illness (from January 1st 2005). Growth of employment still lags behind growth of the labour population. Unemployment will thus continue to grow next year, albeit at a slower rate than this year. In the projection, unemployment rises from 6.5% of the labour population in 2004, to an average of 7% in 2005.

Low inflation…
The inflation in July and August decreased to 1.1%, and is now more than 1%-point below the average of the euro area. In the beginning of 2003, inflation in the Netherlands was well above this average. The faster drop of inflation can be attributed, first of all, to the fact that in our open economy the appreciation of the euro manifests itself rather quickly in lower inflation (compared to most euro countries); a second explanation can be found in the relatively bad cyclical situation in the Netherlands. Due to poor domestic demand, companies have less manoeuvring room to raise their prices, leading to greater pressure to moderate the wage development. Inflation is expected to grow next year by the same percentage (1.25%) as this year. This year's inflation being below the rate of inflation in recent years can mainly be attributed to the smaller rise of unit labour costs.

… and moderate wage increases
Because of diminishing inflation and rising unemployment, wage demands by trade unions abate still further. At the moment, collective labour agreements have been negotiated for half of the employees in the market sector, and the rise of contractual wages seems to be heading toward an average of 1.5% for this year. Due to the failure of spring deliberations between the Cabinet and social partners about the course-of-life arrangement and pre-pension, collective arrangements for 2005 are still rather uncertain. Contractual wages are expected to diminish further in the next year, to an average of 0.75%, amounting to a wage rise of around inflation level in new collective labour agreements. Because of the failure of the deliberations, trade unions no longer consider themselves committed to the zero-line.

Purchasing power under pressure
Moderate real wage rises, financial burden increases, and higher pension premiums put purchasing power under pressure in 2004 and 2005. After declining by 1.3% in 2003, purchasing power will probably fall by 0.25% this year and by 1% next year. In 2005, purchasing power trends are least favourable for social welfare recipients without children and for employees in the public sector. This is a consequence of de-linking social security contributions and the zero-line for wages in health care and in the public sector. Income reductions of the elderly and the low-income households will be most moderate, due to measures taken by the Cabinet to counteract the purchasing power decline of these groups.

EMU deficit meets with EMU standards
In 2003, the Dutch EMU deficit exceeded the 3% standard of the Stability and Growth Pact. This was mainly due to modest economic growth, but also to setbacks in health care expenditure and the local government. Thanks to complementary cutbacks and financial burden increases by the Cabinet, the deficit is expected to stay below the 3% standard in 2004 and 2005. The structural EMU deficit, adjusted for cyclical influences, is projected to improve in both forecasting years by at least 0.5%, which means that this deficit will also meet with European budget agreements.

Uncertainties in the projection
Although various research centres fairly agree about the international picture, major uncertainties exist-with regard to the euro-dollar exchange rate and the oil price, for instance. It cannot be excluded, for example, that the oil price remains at the current level of 45 dollars per barrel. In that case, inflation for next year will come out 0.5% higher and economic growth 0.25% lower than foreseen in this projection.
Finally, although international tensions and possible terrorist attacks remain a real downward risk for the world economy, we cannot rule out the possibility that they might be counteracted by economic growth in the euro area tightening more strongly than projected.

Special issue: Labour productivity and participation
This special issue investigates the importance of human capital (education and experience) for the development of Dutch labour productivity. More specifically, how has increased participation affected labour productivity in recent years? The level of labour productivity per hour in the Netherlands is one of the highest in the EU, but growth has lagged behind the European average in recent years. This moderate growth could be explained by the strongly increased participation of low-skilled workers. In this view, the strong increase of employment may have led to lower labour productivity growth, because entering employees are less productive than current employees.

What do the figures say? The trend for bringing more highly qualified workers into action persevered further in the nineties. Also, the average age of workers (an approximation of experience) increased substantially. Both shifts probably contributed positively to Dutch productivity development in the nineties. Only a small part of this contribution was counterbalanced by the strongly increased participation of low-skilled workers. This tempering effect on labour productivity development does not supply a valid argument for higher participation of this group.

First, higher participation has a positive effect on welfare: income per head increases. Second, participation in the production process keeps skills and knowledge in shape, or may even increase them, which is favourable for welfare in later years. The question remains why labour productivity in the Netherlands has delayed further. This puzzle still demands an answer because of the importance of productivity growth for welfare in the long term. Two issues are thus at centre stage. First, given the high level of Dutch labour productivity per hour, possibilities for growth by absorption of already existing knowledge and techniques are relatively small. Second, for a small open economy like the Netherlands, the increase of labour productivity is mostly defined in other parts of the world. The most important source of ongoing welfare growth is situated in keeping up-to-date with global technological development. This calls for continuous efforts, also in the area of human capital, to ensure the capacity of the Dutch workforce to absorb and apply new techniques in the future.


Dick Morks
Johan Verbruggen

Read also the accompanying press release.

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