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Dutch economy gets boost from reduction in taxation

Economic Quarterly Report

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  • The Dutch economy is expected to grow by 2¼% in 2015, with growth accelerating to 2¾% in 2016
  • Exports and domestic demand are ensuring that growth is broad-based
  • Reductions in taxation in 2016 will give economy additional boost
  • Unemployment is falling steadily but there is still a long way to go

Modest growth in second quarter due to scaling back of gas extraction

Real Gross Domestic Product (GDP) increased by 0.1% quarter-on-quarter in the second quarter. The main reason for this low growth is the substantial contraction in the mining sector (figure 1). This took 0.5%-points off GDP growth in the second quarter. The contraction was caused by a reduction in the production ceiling for gas extraction in 2015 compared with last year. It looks as if the impact of this restriction was concentrated in the second quarter. This means that the underlying economic recovery was stronger in the second quarter than the GDP figure suggests.

Figure 1: Lower growth due to restriction on gas production
Figure 1: Lower growth due to restriction on gas productionSource: Statistics Netherlands (CBS)

On the expenditure side, the effect of the fall in gas extraction was evident mainly in the negative contribution to growth from net international trade, as imports rose steeply whereas the growth in exports fell slightly. That GDP volume still increased slightly is primarily due to the strong growth in investment in housing. Growth was recorded too in private consumption and business investment but in both cases this was somewhat less than in previous quarters.

There is a broader base for economic growth this year compared with last year; as well as higher exports, private investment and private consumption are also making positive contributions to growth. The stronger growth in domestic expenditure will compensate for the negative effect from gas extraction. As a result, we expect GDP to grow by 2¼% this year. Growth in exports will improve further in 2016 due to increased growth in the eurozone. The growth in private consumption will accelerate next year due to a further increase in disposable household income as a result of improving employment and the Cabinet’s plans to reduce taxation by EUR 5 billion. Investment, on the other hand, will increase at a slightly slower rate due to lower growth in housing investment. We expect the negative effect of reduced levels of gas extraction to disappear next year, assuming the production ceiling remains unchanged. As a result the economy will grow by ½%-point more than in 2015. The rate of GDP growth is therefore expected to increase to 2¾% next year.

In the second quarter, real GDP was virtually back up at the previous peak in 2008 (figure 2). This brings to an end an unusually long period in which there was a failure to make up for the loss of production from two recessions. What is more, GDP per capita is still 2.7% less than its peak in 2008. The number of bankruptcies has fallen sharply in recent months but is still relatively high. Unemployment, another good indicator of the state of the economy, is still far above the level before the Great Recession. Indeed, in that regard there is still a long way to go before all the damage has been repaired.

Figure 2: GDP volume back up at previous peak
Figure 2: GDP volume back up at previous peakSource: Statistics Netherlands (CBS), Rabobank
Table 1: Key data for the Netherlands
Table 1: Key data for the NetherlandsSource: Statistics Netherlands (CBS), Rabobank

Weak euro helps exports

We expect the growth in exports to be 4½% this year, slightly up on last year. Next year, export growth will improve further to 5% as the recovery in the eurozone boosts demand. The volume of exports grew by 1% on a quarterly basis in the second quarter of this year, which is roughly in line with the growth in exports in the first quarter. The earlier fall in the value of the euro against the US dollar and the British pound is helping Dutch exports. The euro is expected to weaken further in the course of this year due to impending interest rate increases in the US and the UK. Exports will benefit during the rest of this year and in 2016 from further improvements in the growth of the eurozone. The slowdown in growth in the emerging markets on the other hand will have a retarding effect (see Global economic outlook).

There are still downside risks, however. An unexpected downturn in the growth of the Chinese economy could affect Dutch exports. In addition, a number of emerging markets are struggling with the combined impact of lower commodity prices and the outflow of foreign capital (see Global economic outlook). Furthermore, the risk of a Greek exit from the eurozone has not been eliminated entirely.

Recovery in the housing market continues to drive private investment

Private investment is expected to increase by 9¼% this year. Next year, private investment will grow by only 4½% because of lower growth in housing investment. Business investment increased by 0.9% quarter-on-quarter in the second quarter, somewhat down on the growth of 1.8% recorded in the first quarter. Business investment has now recorded an increase in four consecutive quarters. It is being supported by higher levels of consumption and growth in exports. Producer confidence and capacity utilisation in the manufacturing industry have both increased in the past few quarters (figure 3). In addition, investment expectations for 2015 have improved in almost all sectors since the start of the year. We are expecting the growth in business investment to continue due to greater domestic momentum and further improvements in exports during the rest of this year and in 2016.

Figure 3: Capacity utilisation and producer confidence rise further
Figure 3: Capacity utilisation and producer confidence rise furtherSource: Statistics Netherlands (CBS)

Investment in housing grew by 7% in the second quarter on a quarterly basis, compared with 4.5% in the first quarter of this year and 15.8% in the fourth quarter of 2014. The exceptionally high growth rate at the end of last year was due to a substantial number of homes being sold before the expiry of the temporary increase in the tax break for gifts. The slowdown we had expected to see at the start of 2015 failed to materialise as the owner-occupied housing market continued to perform relatively well, there was an upturn in activity in the new-build market and the number of renovations increased because of the temporary reduction in the VAT rate. The investment in housing will therefore make a substantial contribution to the growth in private investment this year. Although the production of new builds will accelerate somewhat next year, the growth in sales of existing homes will slacken. As a result, growth in housing investment will be slightly less than in the past few quarters[1].

Inflation will increase

Inflation — measured using the year-on-year change in the European harmonised index of consumer prices (HICP) — will probably be ¼% this year. This is largely due to weak core inflation excluding rent (HICP excluding food, energy and fuel, and rent) and the negative effect of changes in fuel and food prices (figure 4). Core inflation is expected to rise further in 2016 as domestic expenditure improves and the slack in capacity is taken up. Furthermore, there will no longer be a downward effect on inflation from fuel prices. As a result, average price levels are expected to rise by 1¼% in 2016.

Figure 4: Inflation will increase
Figure 4: Inflation will increaseSource: Statistics Netherlands (CBS)

Inflation was negative for several consecutive months at the end of last year and start of this year, mainly due to the negative contribution from fuel prices and the very low core inflation rate. However, inflation was positive again in the past few months. Core inflation was responsible for an increase of 1.2%-points in the rate of inflation since the start of 2015; the clothing and footwear, hospitality sector and airline ticket categories were the main factors behind this increase. In addition to core inflation, food, energy and fuel contributed another 0.5%-points. Rent made less of a contribution to inflation as of July (-0.2%-points ) as rent increases in the rent-controlled sector were less this year than last year. Given this increase in inflation in recent months, it seems as if the threat has been averted for the time being of the deflation seen at the start of the year becoming incorporated in consumers’ expectations. The higher inflation is having a negative effect on real wage growth. 

Faster growth in consumption thanks to reduction in taxation

Various factors are causing consumers to cautiously start spending more again this year. Private consumption is expected to grow this year by 1¾%. The growth in consumption will rise to 2% next year.

The growth in real wages will slow down slightly due to rising inflation. There will be compensating effects, however, as rising employment and the planned reduction in taxation will contribute to an increased growth in household incomes this year. Furthermore, the substantial improvement in consumer confidence and the large number of house sales will boost growth in consumption, and increasing numbers of households will come out of savings mode. The positive factors are strong enough this year to enable household consumption to make a significant contribution to economic growth.

Unemployment is falling steadily

Unemployment is expected to fall steadily over the next few quarters. This year, unemployment is forecast to average 7% of the labour force, and it is expected to fall further in 2016 to 6¼%. 

Figure 5: Growth in employment
Figure 5: Growth in employmentSource: Statistics Netherlands (CBS)
Figure 6: Upturn in private sector labour productivity
Figure 6: Upturn in private sector labour productivitySource: Statistics Netherlands (CBS)

The number of people in work increased by 16,000 in the second quarter compared with the first quarter. This growth was almost entirely confined to the trade, transport & hospitality and commercial services sectors (figure 5). Within commercial services, the temporary staffing agencies are benefiting in particular from the economic recovery. Employment in non-commercial services (governmental authorities and health care) fell by 6,000 persons in the second quarter. Despite changes to the law on dismissal coming into effect on 1 July, there were no signs of a substantial increase in the number of applications for dismissal except in June (see box 1).

Various indicators point to continued growth in employment in the private sector. To begin with, leading indicators such as the number of job vacancies and temping hours are continuing to rise. Furthermore, growth in employment in the private sector is currently lagging behind production growth, causing labour productivity to increase (figure 6). In some sectors it will be possible to deliver these higher levels of production without increasing capacity, but more and more employers will want to expand their workforce in response to the upturn in demand. Given the cutbacks in health care, it will probably take somewhat longer before a recovery is seen in employment levels in non-commercial services.

Box 1: No wave of dismissals
Although the Work Security Act (Wet Werk en Zekerheid, or WWZ) and the changes to dismissal law came into effect on 1 July, this has not as yet led to a significant increase in the number of applications for dismissal. Under the amended legislation the route an employer should take in a given dismissal case (via the Employee Insurance Agency (UWV) or via the subdistrict court) is pre-determined. Some employers wanted to make use of the old rules while they still could before the WWZ came into effect. This was principally the case for the termination of relatively short employment contracts where employers would have to make transitional payments under the new rules. The result was nearly twice as many applications for dismissal in June compared with the previous month. The rise in numbers is too small however to have a visible effect on unemployment. Also, dismissal applications actually decreased in the months preceding June. It should become clear in the next few months how the number of dismissal applications will change under the new rules but there are no signs as yet pointing to a big increase.

Government takes brake off the economy

The government’s budget deficit will remain comfortably below the 3% limit agreed in the Stability and Growth Pact both this year and next year thanks to austerity measures taken previously and better than expected economic growth. The deficit for this year is estimated to be 1¾% of GDP. In 2016 the deficit will fall further to 1¼% of GDP.

As said, we are assuming there will be a net reduction in taxation of €5 billion in 2016. The key measures in the package as presented so far are an increase in the employed person’s tax credit for middle incomes and a reduction of 2%-points in the tax rates for the second and third tax brackets. According to the Netherlands Bureau for Economic Policy Analysis (the CPB), household purchasing power will rise by an average of 1.1% next year as a result. The employed will benefit most whereas retired people will see a decline in purchasing power. Incidentally, this is merely the start of a series of decisions on purchasing power next year. Lodewijk Asscher, the Minister of Social Affairs and Employment, has already said that the Cabinet will consider how to prevent a loss of purchasing power for the retired. Although the reduction in taxation is a very welcome shot in the arm for the economic recovery, we do feel the Cabinet has missed an opportunity in going only for a reduction in taxes rather than structural reform of the tax system. The net effect in 2016 of the €5 billion reduction in taxation that the Cabinet wishes to implement will be to offset the negative impact of the austerity measures that had already been planned for that year (figure 7 [2]).

Figure 7: Reduction in taxation offsets negative effect of austerity measures
Figure 7: Reduction in taxation offsets negative effect of austerity measuresSource: CPB, Rabobank

The planned reduction in taxation does mean that the Netherlands will no longer meet the Medium-Term Budgetary Objective (MTO) next year for the structural budgetary position. This structural position is the budgetary position adjusted to take account of business cycle swings and one-off effects. The rules set by Brussels state that the deficit must not be more than 0.5% of GDP in the medium term (Giesbergen, 2015). But it seems that the Cabinet is prepared to take this step as no sanctions are incurred in the short term by a failure to meet this Medium-Term Budgetary Objective.

 

Footnote
[1]The number of transactions involving existing homes becomes an investment in housing via the transfer costs (fees for estate agents and civil-law notaries, and transfer tax).

[2] This figure illustrates the effect of the measures designed to reduce the deficit that the CPB knew about on 17 September 2013. A number of measures that were announced on Budget Day 2014 are not incorporated. They include the smaller increase in the tax rate for the first tax bracket and the increase in the employed person’s tax credit in 2015.

Colophon

The Economic Quarterly is a publication of Economic Research (KEO) of Rabobank and a co-production with Financial Markets Research.

The views presented in this publication are based on data from sources we consider to be reliable. Among others, these include Macrobond. The economic growth forecasts are generated from the NiGEM global econometric structure models.

This data has been carefully incorporated into our analyses. Rabobank accepts, however, no liability whatsoever should the data or prognoses presented in this publication contain any errors. The information concerned is of a general nature and is subject to change.

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Abbreviations for sources: CBS: Statistics Netherlands, ONS: Office of National Statistics, OECD: Organisation for Economic Co-operation and Development, CPB: Economic Policy Analysis,  IMF: International Monetary Fund.

Abbreviations used for countries: VK: Great Britain (UK), IE: Ireland, US: United States, DE: Germany, IT: Italy, NL: Netherlands, ES: Spain, AT: Austria, FR: France, GR: Greece, BE: Belgium, FI: Finland, EZ: Euro zone, PT: Portugal.

Abbreviations used for currencies: CNY: Chinese yuan, IDR: Indonesian roepia, INR: Indian roepie, MYR: Malasian ringgit, KRW: South Korean won.

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For more information, please call the KEO secretariat on tel. +31 (0)30 – 216 2666 or send an email to economics@rn.rabobank.nl

Editors-in-chief: 
Allard Bruinshoofd, head of International Research, Economic Research
Tim Legierse, head of National Research, Economic Research

Graphics: Selma Heijnekamp and Reinier Meijer

Production coordinator: Christel Frentz

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