September 18, 2007

Macro Economic Outlook 2008

MEV 2008: Economic outlook is favourable but uncertain

Press release
With economic growth projected at 2.75% this year and 2.5% next year, the Dutch economy is performing above trend for three years in a row. Economic developments in the Netherlands are in step with those in Europe. The recent turmoil in the financial markets is a clear downward risk to the projection.

The Dutch labour market is tightening, causing upward pressure on contractual wage increases. Next year, consumer purchasing power will hardly rise on average, but differentials between households will be substantial. The general government budget balance swings from a deficit of 0.3% of GDP in 2007 to a surplus of 0.8% of GDP in 2008, which reflects the favourable cyclical situation and increasing gas revenues.

These are the headlines in CPB's Macro Economic Outlook 2008, published today. This Outlook (in short: MEV) contains analyses and projections for the Dutch economy and the world economy in the years 2007 and 2008. The current issue also contains two special topics: 'Happiness and economics' and 'Labour market participation of women'.

Dutch economy in step with Europe
With a projected economic growth of 2.75% this year and 2.5% next year, the Dutch economy is completely in line with European developments. This has been the case since 2004. Before that, in the period 1995-2003, there was less similarity between Dutch and European economic developments, and the Dutch economy often had a diverging pattern. Dutch-specific factors, such as a catching-up in labour market participation, the relatively strong impact of positive and negative wealth effects stemming from house and share prices, as well as the extremely tight labour market at the beginning of this century, all played a role in those years.

Financial market turmoil adds to uncertainty
The projected stable economic development, with only a mild softening of economic growth this year and next, is subject to considerable uncertainty. The projection published today does not yet take into account the recent turmoil in financial markets. The transmission mechanisms and the extent to which the unrest will affect the Dutch real economy are highly uncertain. Based on a model simulation, we review the possible effects on the Dutch economy of a simultaneous global rise in the interest rate differential between corporate and government bonds, a drop in share prices, lower world trade and a fall in the oil price and other commodity prices. The consequences would be limited in 2007, but in this simulation Dutch GDP growth falls back to 1.75% in 2008.

Rising labour market tensions
In response to the favourable production development and strong profitability, employment is expected to rise by 2.25% (140,000 labour years) this year. This makes the labour market even tighter, which shows up in high vacancy rates. The increase this year in the number of self-employed is remarkable. Last year already, the number of self-employed rose by 4%, the strongest rise in fifty years, while for this year an even bigger hike of 5¾% is expected. Although the favourable labour market situation is encouraging entrance into the labour market, the rise in labour supply is lagging the rise in labour demand. As a consequence, unemployment is falling to 4.25% of the labour force in 2007. Next year, employment growth is decelerating to 1%. This growth, however, remains stronger than the rise in labour supply. Unemployment is therefore projected to drop to 310,000 persons (4% of the labour force).

Wage increases and inflation veer up, purchasing power unchanged
The contractual wage increase is projected to strengthen, from 1.75% this year to 3.25% next year. This acceleration is caused partly by a pick-up in inflation but even more so by swelling labour market tensions. Apart from higher contractual wage rises, higher employers' contributions to health care also play a substantial role in the sharp rise in total labour costs. Total compensation per employee is projected to increase by 4.5% next year, substantially above the rise of 2.25% this year. Inflation is projected to pick up to 2%, stemming from higher labour costs, higher energy prices and a rise in some indirect taxes. The purchasing power of households improves this year by 0.75% on average. Next year, some households will gain and others lose. Purchasing power will be unchanged next year on average, as the positive impact of the rise in real wages is offset by higher health care premiums and rises in the tax burden.

Government balance swings from red into black next year
Despite the favourable cyclical situation, the general government balance is projected to deteriorate from +0.6% of GDP in 2006 to 0.3% of GDP in 2007- mainly as a result of a drop in gas revenues and expenditure overruns. Assessing the government budget in the longer term can best be done using the so-called robust budget balance (the structural primary budget balance excluding gas revenues), which corrects for temporary cyclical fluctuations, changes in net interest payments and variations in gas revenues. This robust government balance is projected to deteriorate from 0.1% of GDP in 2006 to around 1.0% of GDP in 2007 and 2008.

The outlook for the world economy is positive
In the first half of 2007 the favourable economic development continued in the euro area, although the German tax hike has caused some softening in economic growth. Unemployment in the euro area has dropped to the lowest rate in more than a quarter century. As in the second half of last year, US economic growth in the first half of 2007 was weak, due to a severe drop in residential investment. With healthy profitability and strong balance sheets of non-financial and financial enterprises, the global economic outlook is positive. Based on a normalisation of the housing market in the course of next year, US economic growth is projected to rebound from 2% in 2007 to 2.75% in 2008. However, this projection does not yet take into account the recent turmoil in financial markets and its negative consequences for the US housing market.

Happiness and economics
Survey-based data on happiness show that above a certain income people hardly become happier when income rises. According to some economists, this result should have consequences for the way in which the welfare concept is applied in economic analysis. The emphasis should not be on the absolute level of income but more on the relative level: how are income positions relative to each other? Until now, according to some economists, economic policy has not taken into account the fact that the achievements of one person can be a source of unhappiness for others. Moreover, policy may have to take on board the fact that people make systematic assessment failures: they make choices that are detrimental to their happiness. Can and must the government paternalistically try to influence behaviour? Partly because of doubts about the reliability of survey-based data on happiness, it is concluded in this special topic in the Economic Outlook that much more theoretical and empirical research is needed before it is clear what the impact of research into happiness should be on economic policy.

Even younger Dutch women decide to work part time
The current discussion on female labour market participation focuses on the effect of average hours worked on emancipation as well as the possible contribution of higher participation and less part-time work on the sustainability of the welfare state. Labour market participation of women has risen sharply, from 32% in 1975 to 62% in 2005. All generations have shown a rise in participation that has boosted economic growth. This boost would have been stronger if women had started to work more hours. The Netherlands is not the only country with rising female participation, but it is peculiar in the pervasive choice to work part-time. The current average number of hours worked by younger generations is no higher than the hours previously worked by older generations when they were of the same age. It is expected that women will not work substantially more hours in the future. Research findings show that working part-time is a deliberate choice. Government policy can affect the decision whether or not to enter the labour market, but can only to a minor extent increase the number of hours worked. Some policy measures may have only a limited effect on the sustainability of the Dutch welfare state, as tax increases are necessary to finance those measures, which will have a negative impact on the participation of others.


Dick Morks
Johan Verbruggen

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