Central Economic Plan 2004: modest growth of the Dutch economy

• Modest growth of Dutch economy in 2004 and 2005 in spite of strong international recovery
• Labour market in minor key: unemployment rises sharply to 7% in 2005
• Without additional policy measures government deficit expected to rise to 3.3% of GDP in 2004

The upswing of the world economy in 2003 will probably continue in 2004 and 2005. Although the Dutch economy is thus likely to struggle out of the recession, the recovery is still fragile and uncertain, however. This year, Dutch economic growth is expected to come out at 1.25%, picking up slightly to 1.5% in 2005. The forecasts show an economy that performs rather poorly (compared to other highly developed countries), with a modest economic recovery in 2004 and 2005. This is mainly due to the further deterioration of the Dutch competitive position, which will cause the increase of exports produced in the Netherlands to lag behind world trade growth. Another reason is the expected poor development of all categories of domestic spending: consumption, investment and government expenditure.

Particularly this year, the labour market presents an extremely gloomy picture: a substantial loss of employment and strongly rising unemployment from 5.1% in 2003 to 6.5% in this year, and even 7% in 2005. The rising unemployment and the strongly diminishing inflation to 1.25% in 2004 and 0.75% in 2005 contribute to moderation of contractual pay rises in the market sector. Also as a result of the Autumn Agreement between the trade unions and employers' associations, contractual pay rises in 2005 are forecasted at only 0.25%.

Without additional policy measures, the government deficit in 2004 is forecasted at 3.3% of the Gross Domestic Product (GDP) and at 2.9% in 2005. These deficits, together with the poor economic growth, are causing the gross debt of the general government to rise rapidly, and the limit for the government debt of 60% of GDP to loom ahead.

These are some of the headlines from the summarising chapter I of the Central Economic Plan 2004, published today by CPB Netherlands Bureau for Economic Policy Analysis (CPB). The complete Central Economic Plan will be made public on Wednesday, 7 April 2004.

Euro area lags behind substantial international recovery
Because of waning international political tensions, the expansive budget policy mainly in the US, and low interest rates, the economic growth outside the euro area tightened last year. The favourable global cyclical situation is expected to continue in 2004 and 2005. US economic growth is expected to rise to 4.5% in 2004, followed by a weaker 3.5% next year. At the moment, China's economy is developing sensationally, and is the main driving force behind global economic growth.

The growth forecasts for the euro area, amounting to 1.75% in 2004 and 2.25% in 2005, are lagging far behind the average growth of the highly developed economies. This is mainly due to the competitive position of the euro countries suffering from the strong euro, especially the euro-dollar exchange rate. Exports in the euro area thus cannot keep up with the growth pace of world trade. Little fiscal stimulus of the economy may also contribute to slower economic growth, mainly compared to the United States.

Worsened competitive position keeps Dutch economic recovery modest
This year, economic growth in the Netherlands will probably come out at 1.25%, picking up slightly to 1.5% in 2005. This recovery is slow in all respects. While economic growth in the entire euro area is projected to lag behind the growth of the world economy, the situation in the Netherlands is even less favourable than in other euro countries. Compared to the three former years of recovery (1976, 1983 and 1994), projected growth recovery is modest, due mainly to the considerable deterioration of the Dutch competitive position in recent years. This deterioration was caused not only by the appreciation of the euro, but also by unit labour costs that have increased rather strongly as a consequence of the tight labour market in the booming nineties. In 2004, this deterioration of Dutch price competitiveness will probably continue, and Dutch exporters will consequently be unable to profit fully from the international recovery.
Domestic spending is also developing modestly. Households and entrepreneurs are trying to improve their financial balances; this hampers private consumption and private non-residential investment. After years of government expenditures bolstering GDP growth, in this and next year the contribution of government spending to GDP growth will be very small. Economic recovery will consequently rest completely on the shoulders of the market sector.

Dutch economy cannot keep up with modest euro area growth
Together with the modest growth in the last three years, the actual forecast implies that, in the period 2001-2005, economic growth in the Netherlands will lag behind that in the euro area by 0.75% per year on average, and even 1.75% behind growth in the other highly developed economies. The main reason for lagging growth is the relatively unfavourable export performance. This year, the volume of domestically produced exports is expected to come out 1.75% higher than last year, and for 2005, an increase of 2.25% is foreseen. These growth figures are a far cry from those of world trade (7.5% in 2004 and 6.75% in the next year). The market loss in these years will probably amount to about 5% per year: a considerable loss, in historical perspective.

Belt-tightening in the private sector
Last year, private consumption decreased by 1.3%, due to stagnation of real disposable household income, caused mainly by the loss of employment, and higher pension and health-care premiums, and to negative wealth effects. In spite of the rising real disposable household income, private consumption is expected to grow only sparsely by 0.75% this year. That explains why the discretionary household saving rate (individual savings as a percentage of disposable income) will increase for the fourth year in a row to approximately 4%. Households will thus take a major step forward in restoring their financial position. The growth of private consumption, forecasted for 2005 at 1.25%, implies a small decrease of the discretionary household saving rate.
In 2004 and 2005, private health-care consumption is expected to grow sharply. In 2004, this increase is mainly due to reductions in the package of collective health care insurances; next year, greater household expenditures will follow the introduction of a no claim refunding system in the National Health Service. In both years, private consumption is upwardly affected by about 0.5%-point due to these shifts from collective to private funding of health care spending. On balance, therefore, the private sector will hardly experience any private consumption growth, both this year and next.

Slight pick-up in non-residential private investment
Companies are also scrambling to reinforce their financial balances, and will be unable to invest much in the short run. This year, private non-residential investment will probably decline for the fourth year in a row, by 2%. The poor capacity utilisation rate and profitability do nothing to stimulate investment. On the one hand, investment in computers is rising; on the other hand, both private investment in non-residential buildings and means of transport are still declining. The volume of private non-residential investment is expected to grow only modestly by 1.25% in 2005.

Gloomy prospects for the labour market
The labour market presents an extremely gloomy picture. All together, 240,000 jobs will disappear in the market sector in the years 2002-2004, 100,000 of which in 2004. Labour demand has reacted slowly to the unfavourable developments in recent years of production volume, prosperity, and real labour costs. Together with the recovery of production growth in the market sector (foreseen for 2004), labour productivity rises strongly by 3.75%. Unemployment will probably rise rapidly to 6.5% of the labour force.
The tide is expected to turn in the course of 2005, and the rise of unemployment will come to a halt. The yearly unemployment average will be 35,000 persons more than in 2004. Thus, 7% of the labour force, on average,
will be unemployed in 2005. Employment in the market sector will probably rise by 25,000 labour years. However, the major part of this increase can be attributed to statistical effects as a consequence of the introduction (on January 1, 2004) of a law compelling employers to continue paying wages also in the second year of illness.

Strong smoothing of wage and price rises
Wages and prices mutually affect each other. High inflation leads to higher salary demands, and higher wage increases contribute to higher inflation. This year and next, the opposite of this wage-price spiral will arise. Because of the strong increase of unemployment and the lower inflation, the average rise of contractual wages in the market sector is expected to diminish from 2.7% in 2003 to 1.25% in 2004. The projection makes the assumption that the Cabinet and social partners will come to an agreement this spring on policy issues such as early retirement, pre-pension saving schemes, and the life-cycle saving scheme, to which the very slow development of wages is connected. An historically slight contractual wage decrease of 0.25% is thus foreseen for 2005.
Influenced by low labour costs and low import costs, also inflation will probably smoothen, from 1.25% in 2004, to 0.75% in 2005. The 'price war' in Dutch supermarkets will dampen this year's inflation by an estimated 0.3%.

Purchasing power under pressure
Household purchasing power, which stood at -1.25% in 2003, will be close to zero this year and is estimated to be -0.5% in 2005 on current policies. Especially low-income employees in the market sector, with children, are expected to have greater purchasing power, while high-income employees and those in the public sector will experience a setback. In 2005, most households will experience lower real wages and social security benefits. Under current policies, social security recipients will encounter the strongest decline in purchasing power.

Imminent violation of the EMU deficit limit
Without further policy measures, the general government financial deficit will probably increase to 3.3% of GDP in 2004, declining to 2.9% in 2005. Because of this 2004 figure, the Netherlands could exceed the EMU deficit limit of 3% of GDP as laid down in the Maastricht Agreement. The impending overrun can be attributed to a considerable budgetary widening in 2001 and 2002 and to poor economic growth since 2001. The adjustments and increases in tax burdens of the previous and the current Cabinet will lead to a considerable improvement of the structural (i.e. corrected for cyclical influences) deficit in 2004 and 2005.
Because of the unfavourable development of the general government financial balance, the gross debt of the general government is expected to rise to 58% of GDP in 2005, bringing the EMU debt limit of 60% of GDP into sight.

Uncertainties
The projections are surrounded by considerable uncertainties. The recent events in Madrid underline that terrorist attacks remain a considerable risk to the world economy. Furthermore an ongoing appreciation of the euro could negatively influence the short-term projections of the Dutch economy. On the other hand, a lower euro-dollar exchange rate and a more powerful short-term cyclical recovery, especially in Asia, can by no means be ruled out within the foreseeable future.
Finally, economic growth will depend upon developments in budgetary policy. The Cabinet has announced additional measures to prevent the deficit from exceeding the 3% limit. This may reduce economic growth in the short run, but will contribute to the sustainability of the government finances in the long run.