Growth remains high, but is slackening

The government budget in 2007 is in balance, while a surplus of 0.5% of the gross domestic product (GDP) is foreseen for 2008.
The uncertainty of this forecast is larger than usual, however, due to the turmoil on the international financial markets. On the one hand, recent realisations appeared to be surprisingly favourable; on the other hand, the financial crisis may have a larger effect on Dutch economic development than was earlier expected.

These are some of the headlines from the short-term forecast as published today by CPB Netherlands Bureau for Economic Policy Analysis (CPB). The economic prospects were presented in the CPB Newsletter 2007/4.

International economic growth slowing down
The rise in the US GDP growth came out amply above the estimated potential growth in the second and third quarters of this year, despite a sharp fall of residential investment. Economic growth will probably fall back substantially in the quarters to come. US residential investments are expected to diminish even more steeply, while private consumption growth will feel the negative influence of decreasing house prices, the persistently high oil price and the low development of employment. As expected, US economic growth will be limited to only 2% next year.

In the euro area, the economy will grow by 2¾% in 2007. After the outbreak of the financial crisis, producer confidence has deteriorated and the euro has appreciated substantially compared to the US dollar. This forecast assumes the average exchange rate to amount to 1.44 dollars per euro in 2008 and the oil price to come out at 82 dollars per barrel Brent, on average. The headwind of the financial crisis, the strong euro and the high oil price will lead to flagging growth in the euro area, coming out at an estimated 2% next year.

Dutch economic growth falls back in 2008
Dutch economic growth is expected to fall from 3% this year to 2¼% in 2008. Investment and government expenditure will contribute less to economic growth in 2008 than they have this year. This also holds to a lesser degree for private consumption and domestically produced exports, while the development of re-exports actually has an upward effect on economic growth.

Private consumption develops steadily
Due to rising contractual wages, employment and house prices, private consumption in 2007 and 2008 will probably grow by 2% per year. The healthcare reform, in which the no-claim bonus has been replaced by a liability to pay the first 150 euro, distorts the private consumption growth in 2008. Adjusted for this healthcare reform, private consumption growth will come out about ½% lower. The 2008 forecast reckons on a modest upward anticipation effect regarding the indicated VAT rate increase in January 2009. Also due to this increase, the individual savings rate will fall by ¾%-point to -2¾%. This means that also in 2008 households will spend more than their disposable income, a situation that has occurred since 2003.

Fierce growth of re-exports persists
In 2007, as well as in 2008, exports make the largest contribution to economic growth, despite the expensive euro. Re-exports, which increase by more than 10% for the fifth year in a row, are the driving force behind the growth of total exports. For next year, CPB even expects a somewhat larger increase of re-exports than for 2007, due to stable world trade growth and strongly increasing trade in ICT products. ICT products take an active part in Dutch re-exports. The growth of domestically produced exports is expected to fall back as a consequence of the expensive euro, so that total exports will probably increase a little less in 2008 than they have this year.

Entrepreneurs still confident
Although private non-residential investment is still expected to grow in 2007 and 2008, it is not likely to equal the growth figures of 2006. Entrepreneurs are still confident, however, and the capacity utilisation rate is still increasing- although profitability is expected to diminish next year. The relatively strong fall in investment growth in 2007 is mainly due to incidental circumstances such as the development of investments in planes, royalties and licenses. Adjusted for these incidental investments, an acceleration of cyclically sensitive investments occurs in 2007, while in 2008 investment growth lags behind.

Labour market continues to tighten
The number of vacancies reached an all-time high in the third quarter of 2007, while unemployment steadily decreased. In short, labour market tensions have further increased in 2007; this trend is expected to continue next year. Although an increasing number of people are entering the labour market, influenced by the favourable cyclical circumstances, employment is growing even faster. This year, employment will probably increase by 2½%, the highest figure in nine years. Partly due to a less favourable profitability, employment growth will probably fall back to 1¼%. On average, employment will come out at 4% of the labour force, or 310,000 persons- amply short of the estimated level of equilibrium unemployment.

Tightness results in higher contractual wage rise
The tightness on the labour market clearly manifests itself in the contractual wage rise in 2008. In 2007, this was the case to a lesser degree, due to the fact that a large part of the collective labour agreements for 2007 had already been effected when the cyclical situation was less favourable. Higher social security contributions lead to higher rises in total labour costs in 2008, compared to contractual wage rises. In addition to the tightness on the labour market, also rising inflation contributes to an accelerating wage increase. Although inflation was only 1.1% in 2006, for 2007 it is forecasted at 1½%, and for 2008 even at 2¼%. Despite the more expensive euro- making the exports from non-euro area countries cheaper- inflation is rising due to higher unit labour costs and to increasing energy prices.

Government budget shows a surplus again in 2008
Despite the favourable cyclical situation, the general government financial balance worsens from 0.6% GDP in 2006 to 0% in 2007 due to lower natural gas revenues (a consequence of decreasing sales) and to financial setbacks in government expenditure. The government financial balance, however, will probably improve to a surplus of 0.5% GDP in 2008. This positive development is the balanced result of increasing natural gas revenues in 2008, the still-favourable cyclical situation, burden relief measures and rising government expenditure.