Macro Economic Outlook 2006

For 2006, a global recovery of economic growth is foreseen, because macroeconomic policies will - on balance - still be stimulating; the financial position of firms is good; and the oil price does not increase any further in the projection.

For the Dutch economy, a temporary slowdown of the economic growth is expected, from 1.7% in 2004 to 0.5% in 2005, caused by the slower growth rate of the world economy and the unfavourable development of real disposable income. Next year, growth is expected to pick up to 2.5%. Domestic expenditures will probably develop much more positively than this year, in part because of the more advantageous development of purchasing power. The competitive position of Dutch firms on the world market is still weakening, but at a slower pace than in previous years.

In 2006, the labour market situation will also be rosier, with more employment and falling unemployment. Wage and price developments are moderate in the projections for this year and next.The purchasing power of households in 2005 is expected to fall by 1.5% on average. In contrast, purchasing power can rise by 1% on average in 2006. Partly due to the introduction of a new system of medical insurance, differences in real net income growth between households will be large next year.
The expected recovery of the Dutch economy next year is surrounded by considerable uncertainty. For example, if the oil price remains high at (on average) $65 per barrel (Brent), economic growth will be 0.5%-point lower next year and the projected gain in purchasing power will evaporate.
The Dutch EMU deficit is expected to decrease steadily from 3.1% of Gross Domestic Product (GDP) in 2003, to 1.7% in 2006. In 2004 and 2005, years with only modest economic growth, this favourable development has been caused by the substantial cutbacks in government expenditure and the increases in the tax and premium burden. For next year, the Cabinet has chosen a slightly expansive budgetary policy. The projected improvement of the EMU deficit in 2006 is a result of the expected cyclical upturn.

These are some of the headlines of CPB's Macroeconomic Outlook (MEV) 2006, published today. In this outlook, CPB Netherlands Bureau for Economic Policy Analysis presents analyses and forecasts of the Dutch and the world economy in 2005 and 2006. A number of text boxes explore specific themes of topical interest, such as the effects of higher oil prices, the changes in European budgetary rules, the way in which OPEC countries spend their extra oil revenues, internet as a shopping channel for consumers, the labour market participation of the elderly, waiting lists and waiting time in healthcare and the financing system for childcare. The MEV also features an extensive special topic: 'Europe: financial perspectives in perspective'. More information about this subject is given at the end of this press release.

Economic growth in the US persists
In the first half of 2005, US economic growth remained high, at about 3.5%, mainly thanks to private consumption. In the second half of 2005 and in 2006 the present growth pace is expected to persist, despite the negative effects of Hurricane Katrina. This will enable employment to rise and the budget deficit to diminish. The very large deficit on the balance of payments is unlikely to decrease, because imports will increase substantially as a result of the growth in domestic expenditure.

Growth in the euro area is picking up
In the euro area, economic growth in the first half of this year was again disappointingly slow. This was the result of the appreciation of the euro in recent years, the large increase in the oil price, and the lack of confidence shown by consumers and producers. The growth rate is expected to increase from 1.25% GDP in 2005 to 2.25% in 2006. If realised, this will be the strongest growth since 2000. The expected recovery is mainly caused by a more favourable development of the dollar-euro exchange rate, the positive economic development outside the euro area, accommodative monetary policies and the fact that in the projections purchasing power is no longer weakened by an increasing oil price.

Oil price: decreasing but still high
Due to the devastating effect of Hurricane Katrina, the oil price reached a record of more than $67 per barrel (Brent) in August. Next to temporary disturbances and, possibly, speculative elements, the cause of the present high oil prices may be ascribed especially to the large increase in demand during recent years combined with a relatively small increase in supply. The reserve capacity for the extraction of oil has been strongly diminished in the OPEC member states. On the basis of the planned increase in the number of oil drilling installations, oil production can be expected to expand further in the years ahead. However, the now foreseen expansion of production capacity is needed to meet the expected rise in demand. As a result, the price of crude oil is projected to decrease only slightly, from an average of $52 per barrel this year to $50 per barrel in 2006.

Dutch economy moving forward after a bad start in 2005
After a decrease in Dutch GDP in the first quarter of 2005, the economy recovered strongly in the second quarter. Adjusted for seasonal influences and differences in the number of working days, economic growth mounted to 0.25% in the first half of this year. For the second half of the year, CPB expects a somewhat higher economic growth, but for the whole year 2005 not more than 0.5%. This is a considerable relapse compared to 2004, when the growth rate amounted to 1.7%. This relapse is mainly correlated with the worldwide deceleration in economic growth -- partly caused by the strong increase in oil prices -- and with the unfavourable development of real disposable household income.

Growth acceleration is on the way up
This year's deceleration in economic growth is probably a temporary interruption on the way up. CPB expects a growth of 2.5% next year. One important reason is the anticipated recovery of the European economy, the most important trade market for Dutch products. In addition, the competitive position of firms will suffer less in 2006, thanks to the projected depreciation of the euro and the moderate wage development. Also, domestic expenditures are likely to be on the way up again, among other things thanks to the favourable development of purchasing power. In addition, after two years of strong cutbacks, the Cabinet will increase government spending next year.

Large uncertainties
The projected upturn of the Dutch economy is, however, surrounded by considerable uncertainties. Next to the dollar/euro exchange rate and the interest rate, especially the developments on the oil market are a source of uncertainty. For example, if the oil price (Brent) does not decrease to $50 per barrel on average in 2006, but remains high at $65 per barrel on average, then economic growth will be 0.5%-point lower next year. Contrary to this downward risk, there is also the possibility that the economic growth in the euro area will pick up more than projected. Given the relatively high profitability, firm investments could boost a stronger cyclical upturn than projected.

Exports growth gains momentum in 2006
Last year, the Netherlands fully lived up to its reputation as a trade and distribution nation. The strong export growth was almost completely the result of the booming growth of re-exports: +20%. Although export growth falls this year due to the slowdown of the world economy, exports next year can probably gain momentum again when the expected European recovery materialises. Domestically produced exports mainly stem from the manufacturing industry, where the unit labour costs have been rising more than with the competitors inside the euro area. Unit labour costs were increasing at an equal pace in 2004, however, and also this year and next labour costs will show a development comparable to that in the rest of the euro area. Compared to competitorsoutsidethe euro area, labour costs - measured in euros - develop more favourably in the Netherlands. Outside the euro area wages increase more rapidly, and a small depreciation of the euro is also projected. After five consecutive years of deterioration, the Dutch competitive position can improve next year by a modest 0.5% on balance.

Consumers can see light at the end of the tunnel
Consumers are in a difficult position. In recent years it has been far from easy for them to keep their expenditure at levels to which they were more or less accustomed. The latest figures of Statistics Netherlands (SN) - including the recent revision and re-adjustments - show that the decrease in disposable income has been so strong that - excluding 'compulsory' pension savings - households have even dis-saved since 2003. Disposable income is under pressure in 2005 because of the negative real wage development and the financial burden increases. Private consumption will probably decrease by 0.75% this year. Next year, private consumption will show a sharp decline, but this is caused by the introduction of a new national health insurance system. SN will then count the health care expenditure for people who now have a private insurance as government consumption, and no longer as private consumption. Adjusted for this system change, household expenditure will increase by 1% next year, thanks in particular to the expected rises in both purchasing power and employment.

Recovery of profits and investments
New SN-figures (including the recent revision and the latest re-adjustments) show a remarkable picture of the profitability of Dutch firms. Despite the meagre economic growth in recent years, profitability -- which has been relatively low already since 2001 -- has not diminished any further in these years. In reaction to the recession, firms have apparently rationalised their production. Labour productivity has consequently increased by 2.3% per annum, on average, during the last three years. For comparison: average productivity growth in the nineties amounted to 1.5%. Although the high oil price is responsible for the somewhat lower profit margins this year, the upturn of the economy next year will probably lead to a considerable rise in profits.
Private non-residential investment hardly increases this year due to the low capacity utilisation. In 2006 investments are expected to show a robust revival, thanks to the improving production growth and profitability. Investments can expand by 8.25% next year. One should bear in mind that these private investments were shrinking earlier, by more than 13% in the period 2001-2003.

More prosperous prospects for the labour market
For the fourth year in a row, employment is decreasing in 2005, albeit less than in the two preceding years. Notwithstanding the loss of jobs, unemployment will rise this year by only 25,000 persons, to a peak of 6.75% of the labour force. This can be explained by the stagnation of labour supply. Due to the relatively small chance of finding a job in the present unfavourable labour market situation, some people simply do not (yet) enter the labour force (or leave it for some time); they may decide to enter another training programme, for example. Next year the number of jobs will probably rise, thanks to the recovery of production growth, and this will allow unemployment to decline somewhat.

Low inflation and moderate wage development
Inflation ended up at 1.8% in August. In view of the much higher energy bills and petrol price this is a low figure. Inflation is expected to come out at 1.5% this year, decreasing to 1% next year. The projected depreciation of the euro and the bloated oil price push up inflation. On the other hand, firms will pass on the decrease in unit labour costs, so that they can moderate prices next year, and the user part of real property taxes will then be abolished.
The low inflation and the high unemployment contribute to moderate wage demands by the labour unions. The average increase in contractual wages is expected to diminish further to only 1% this year. A somewhat higher wage increase of 1.5%, on average, is anticipated for 2006. This picture also springs from the collective labour agreements that have been concluded thus far.

Purchasing power goes down in 2005, up again in 2006
As in the last two years, purchasing power is decreasing in 2005. Next year, many households will experience an improvement in real net income thanks to the higher wage increase, the health-care allowance (the 'Zorgtoeslag'), and the restoration of the linking of social security to wages in the public sector. However, partly due to the transition to the new medical insurance system, differences in real net income growth between households are large. The median purchasing power is projected to rise by 1%. This means that half of the households will experience a larger rise than 1%, and the other half less than 1%. Purchasing power will develop favourably next year, for elderly people and families with children in particular.

Modest improvement of EMU deficit
In 2004, the budget deficit turned out to be considerably below the 3% limit of the Stability and Growth Pact. Although there are again substantial cutbacks this year, the disappointing economic growth results in only a minor improvement of the EMU deficit. Also in 2006 the deficit barely decreases: from 1.8% of GDP in 2005 to 1.7% of GDP. The expected higher tax revenues and lower unemployment expenditure (thanks to the pick up in the business cycle) will be countered largely by the rise in public expenditure (among which the introduction of an allowance for health-care insurance costs).

Special topic: Financial perspectives of Europe
This chapter places the financial perspectives of Europe in perspective. The welfare effects of the European Union reach much further than the net payments position of a member state. Thanks to European integration, every European earns on average approximately 10% more than what would have been the case without integration. It is therefore in the interest of all member states to pay the costs of European integration together, provided the EU expenditures pay due regard to the Subsidiarity Principle. However, the CPB analysis shows that application of this principle calls for reforms of the common agricultural policy and the European cohesion policy.