CPB: Dutch growth falls back

Economic prospects December 2004:

• Dutch economy expected to grow by 1.5% in 2004, dropping to 1% in 2005.
• Main causes of the decline in growth: Slowdown of international business cycle, more expensive euro and higher oil prices.
• In 2005, the number of unemployed persons will continue to increase to an average of 6.75% of the labour force.
• Especially next year, diminishing real wages and higher taxes and premiums will put pressure on real disposable household income.
• EMU deficit expected to come out at 3% of GDP in 2004; for next year, a drop to 2.25% is expected.

These are some of the headlines from CPB's short-term forecast published today. The economic prospects are published in the December 2004 issue of the quarterly CPB Newsletter.

THE WORLD ECONOMY

High growth outside of Europe
Economic growth outside the euro area will probably end up at around 5% in 2004, half a percentage point higher than in 2003, and the strongest growth figure in the last 25 years. The most important explanations for this strong increase are the continuous strong expansion of the Chinese economy and the stronger growth of US domestic spending enabled by a generous monetary policy. In the second half of this year, growth outside Europe weakened somewhat, due, among other things, to additional increases in the price of oil, the absence of further tax cuts in the US, and measures taken in China to prevent overheating of the economy.

Development in euro area disappointing
For the euro area, economic growth in 2004 is estimated at 2%. Although somewhat better than 2003's growth of 0.5%, this figure is rather low for an upswing. Some data suggest that growth in the euro area on a yearly basis even diminished in the third quarter of 2004-probably caused mainly by the unremitting rise of the oil price. Leading indicators suggest that economic growth will remain weak in the short term. Besides the further oil-price rise, the erosion of the competitive position by the recent further appreciation of the euro plays an important role.

The present poor economic development is probably a growth break in the current, rising, business cycle. Economic growth is expected to tighten in the second half of 2005, spurred on by oil prices, which are expected to decrease next year. The projected economic growth in the euro area will only stick at 1.75% in 2005, 0.25% less than this year. This calculation was made using a euro/dollar exchange rate of 1.30 in 2005.

THE DUTCH ECONOMY

Economic growth getting stuck
The firm economic growth at the start of 2004 has lost much ground in the last six months. The recovery of the economy, which had only just begun, has already stumbled. According to the 'flash-projection' of Statistics Netherlands, growth on a yearly basis was 0.8% in the third quarter of this year, compared to the second quarter. In the first three quarters of 2004, growth amounted to 1.3%, compared to the year before, but for the entire year, close on 1.5% may be feasible. The fact is that the last quarter has two extra workdays, because Christmas 2004 falls in a weekend.

Fallback of economic growth in 2005
As is the case in the US and Europe, economic growth in the Netherlands is expected to fall back somewhat in 2005. Not only will the worldwide growth break hamper foreign demand for Dutch products, but the recent appreciation of the euro also means an extra setback for the exporting companies. Nevertheless, exports will still be the greatest contributor to Dutch production growth in 2005. The other important pillar of the economy- private consumption- will remain under pressure because of the decrease of average purchasing power. With growth expected to fall back to 1% in 2005, the Dutch economic achievement will be worse than the average for the entire euro area for the sixth time in a row, and just like this year, the Netherlands will be at the bottom of the list of all euro countries.

Price competitive position worsens even more
After three meagre years, export growth in 2004 is strong once more. Credit for this increase must be given mainly to re-exports, which have grown explosively by 13%. Domestic exports show a much more moderate recovery. In 2005, exports are expected to rise somewhat less dramatically, due to the deceleration of the world economy and further worsening of the price competitive position. While it is true that Dutch labour costs in 2004 will increase less compared to the competitors in the euro area, the unit labour costs measured in dollars will grow stronger compared to the competitors outside the euro area because of the ongoing appreciation of the euro. The result: further worsening of the overall competitive position in 2004 and 2005.

Private consumption still declining
Household consumer confidence is still extremely low. After slowly picking up for a year, however, it decreased somewhat this year in September and October, which were marked by demonstrations and increasing tensions regarding the policies of the Dutch Cabinet. In November, the consumer confidence index was roughly stable. For the time being, private consumption spending is developing rather moderately. Minor real wage rises and tax increases will diminish household purchasing power, however. In 2004, private consumption is expected to increase only by 0.5%; in 2005, it will even decrease by 0.25%. Nevertheless, projected private consumption growth is still higher than the growth of real disposable income (-1.25% in 2005). This implies that consumers will save somewhat less in 2005.

Investment rises slightly
Due to the recovery of production growth, non-residential investment will probably increase, after dropping for three years. Also in 2005, an increase of investment is projected, but this growth will be moderate. Not only will the capacity utilisation rate remain low, due to the meagre production growth rendering investments less necessary, but also a recovery of profitability is almost absent in 2004 and 2005. Despite the declining growth of labour costs, profitability will languish as a consequence of rising oil prices and price pressure on domestic and foreign markets.

The acceleration of investment growth in 2005 is mainly due to anticipation effects concerning the proposed policy measure to discourage the abuse of the 'grey license plate' by households mid 2005. As Statistics Netherlands considers all purchases of delivery vans to be investments, this will have an upward effect on investment figures in 2005.

Rise in unemployment flattens
The labour market situation is likely to improve. The average monthly rise of unemployment in the last six months is smaller than at the start of this year, and the number of vacancies is again increasing. Also the share of the work done by temporary employment agencies is growing once more, traditionally marking a more favourable labour market. Employers expanding their workforce after a recession usually begin by hiring temporary workers first. Since employment often responds to production growth with a nine-month delay, employment may grow slightly in 2005. The growth of jobs, however, still lags behind the growth of the labour force, so that unemployment continues to rise, to an average of 6.75% of the labour force in 2005.

Low inflation
After inflation amounted to only about 1% during the summer months, it increased to 1.4% on a yearly basis in October. The main cause was the high oil price, leading to steeper gasoline prices. Next year, the higher oil price will still affect the natural gas price for households: energy companies have already announced hefty tariff increases. Also the downward effect of the 'war on prices in supermarkets' will slowly fade away from the inflation rate. Conversely, the appreciation of the euro makes imported products cheaper. Since entrepreneurs will adjust their prices to the decreased growth in labour costs, inflation is expected to equal the 2004 figure of 1.25% in 2005.

Moderate wage development
Wage rises continue their downward trend, due to rising unemployment and lower inflation. This year, the contractual wage rise in the market sector is expected to decelerate to an average of 1.5%. For next year, hardly any collective labour agreements have yet been made. The rise of contractual wages in the market sector will probably come out at 0.75% in 2005, corresponding to a wage rise of 1% in new collective labour agreements. The 'social agreement' of November 6th 2004 no longer mentions wage rises 'approaching zero'. Instead, it calls for an 'utmost reserved' wage development.

EMU deficit well under 3% in 2005
The EMU deficit that exceeded the 3% standard of the 'Stability and Growth Pact' in 2003, is likely to meet that standard by a small margin in 2004. Despite a record amount of cutbacks and tax increases, the 2004 deficit is still in the danger area, however, as a result of limited economic growth, high health care expenditures and local government deficits. Thanks to the Cabinet measures aimed at limitation of the deficit, the budget deficit in 2005 will probably come out well under the 3% standard, at 2.25% of GDP.