The Netherlands: strong domestic growth amid international uncertainty
Economic Quarterly Report
- The Dutch economy will grow by 2% in 2016 and 2017
- Domestic demand helped this year by temporary factors
- Slight fall in export growth in 2016, recovery in 2017
- The labour market recovery is gaining strength
- Increased international uncertainties the main risk to economic growth
Real Gross Domestic Product (GDP) in the Netherlands was up 1.9% In 2015. This is the highest level of growth measured since 2007, and follows growth of 1.0% in 2014. It shows that the Dutch economy has embarked on the road to economic recovery in the past two years. The relatively high economic growth in 2015 was possible because domestic demand finally made a contribution as well as exports (figure 1). This year, we expect domestic demand to increase further, as this is boosted by temporary factors. These temporary factors are expected to disappear in 2017 and therefore growth in domestic demand will be somewhat lower. Higher growth in exports will however offset this in 2017, leading to our forecast of 2% GDP growth in both 2016 and 2017 (table 1). International uncertainties however have increased in the past period, meaning there is a real possibility that economic growth will turn out to be lower.
The broad base of the economic recovery last year is clearly shown in figure 2: virtually all sectors made positive contributions to growth. The only sector to make a clear negative contribution to growth was minerals extraction. This was completely due to lower gas extraction as a result of the reduced gas ceiling in Groningen. The underlying picture therefore is that the economic recovery in 2015 was more powerful than the GDP figures would suggest: without the decline in gas extraction GDP would have risen by 2.3%.
We expect the economic recovery to continue both this year and next year. The internal dynamics are strong: the housing market is improving, employment is rising and consumer confidence is much stronger. There are also a number of temporary factors boosting private consumption this year. Low inflation and the five billion euro tax reduction package have led to rising purchasing power, which is supporting private consumption. The effect of these temporary factors will largely disappear in 2017, so we expect private consumption to grow less strongly in that year.
Our international view is much less certain. We expect export growth to be lower this year than in 2015, because global growth is faltering somewhat and exports will get less support from the weaker euro. Next year, growth in the Netherlands’ most important trading partners will pick up again, so Dutch export growth will be higher. One caveat to these forecasts is that the international picture is highly uncertain (see also the section Global Economic Outlook). If the fears of many investors turn out to be justified and a sharp global slowdown occurs, with its open economy the Netherlands will be affected. Export growth in this case would be significantly lower than our current forecast.
International uncertainties a potential threat to economic recovery
The increase in the volume of exports of Dutch goods and services has been the most important driver of economic growth in past years. We expect exports to continue to be an important driver of economic growth in 2016 and 2017. Export growth will be slightly lower in 2016 than it was in 2015, since the Netherlands’ most important trading partners are experiencing slightly lower economic growth this year. The positive effect of the cheaper euro is also now considerably less important. Global growth is expected to recover again in 2017, so Dutch exports will increase faster next year.
Our international view is however surrounded with many uncertainties, since the number of downside risks has risen significantly recently. The Chinese yuan for instance is under increased pressure. If the Chinese central bank is unable to avoid a heavy depreciation, world trade growth could slow and the euro could appreciate. This would pressure exports from the Netherlands and the rest of the eurozone. Internal European risks could also affect Dutch exports. It is possible that the refugee problem could lead to a (temporary) suspension of the Schengen Treaty, which would have a negative effect on the trade of goods and services within the EU. There is also the risk that the United Kingdom will leave the EU. Lastly, there are general concerns regarding the monetary policy of the central banks and the financial markets are currently extremely nervous. If this nervousness continues, it could affect the economic growth of our trade partners.
The aggregation of all these risks makes it quite possible that at least one of these negative scenarios will become reality. In this case, it is very possible that export growth in the Netherlands will be lower this year and next, meaning that economic growth will also be lower.
Lower commodity prices good for purchasing power …
Commodity prices (amongst which gas and oil prices are the most relevant for the Netherlands) have fallen significantly over the last year. The effects of this for the Netherlands are double-edged. On the one hand, lower commodity prices mean lower inflation, which increases real disposable household income and stimulates higher private consumption. On the other, lower gas prices mean much lower government income, which increases the government deficit and makes future austerity measures more likely.
As we have said, lower commodity prices mean low inflation. According to the harmonised European measure HICP, inflation in 2015 stood at 0.2%, the lowest level since this measure was introduced in 1997. The main reason for the decline in inflation is the decline in the prices of gas and oil. Lower oil prices have led to lower fuel prices, while lower gas prices have led to lower energy bills. This is positive for household purchasing power. The increases in collectively negotiated wages are well above inflation, meaning that wages have risen in real terms (figure 3). Together with higher employment and increased consumer confidence, this made a significant boost to private consumption last year.
Gas and oil prices have fallen further recently, meaning that inflation will remain low this year and real wages will rise further. Besides the rise in real wages, the five billion euro tax cut package and rising employment are also contributing to the significant increase in disposable household income in 2016. We accordingly expect private consumption to rise further this year and grow by 2%.
Some of these supportive factors will disappear in 2017. Inflation will rise next year, partly because there will no longer be downward pressure from commodity prices. We do not expect wages to increase by as much as inflation, so that wages will rise by less in real terms in 2017. The temporary boost to consumption from the tax cuts will also not be repeated in 2017. Growth in private consumption will therefore fall slightly next year, to 1½%.
… but is leading to headaches in The Hague
As already stated, lower commodity prices are good for households. Lower gas prices are however less of a boon to government finances. The government has sharply reduced production of natural gas in recent years, which has cut government income by around five billion euros between 2013 and 2015. Because gas prices have also fallen sharply in the meantime, government income has contracted by a further five billion, meaning that the government is receiving 10 billion euros less in income from natural gas compared to 2013 (figure 4).
This has led to a serious deterioration in the government’s finances, so that if prices remain unchanged the structural government deficit will be much higher than the level permitted under the European budgetary rules. It is therefore also likely that on the basis of its spring estimate the European Commission will ask the Dutch government to take new austerity measures. If the government follows this advice, after this year’s generosity the next budget day will introduce a sour note. In this case, economic growth could be lower than our forecast.
Low interest rates are supporting the housing market …
Another factor currently affecting the Dutch economy is the extremely low level of interest rates. This, which is partly due to the accommodative monetary policy of the European Central Bank (ECB), is making housing more affordable and providing strong support to the housing market (see our recent Dutch Housing Market Quarterly). There has already been a strong increase in home sales in 2014 and 2015 (figure 5).
The average house price has now been rising for quite some time, although it is still 15% below the peak reached in 2008. We expect house prices to show a relatively strong recovery in the coming years, while the increase in the number of transactions will be more moderate. The recovery in the housing market is leading to improved confidence and reducing the number of households facing a situation of negative equity, which provides further support to private consumption.
Investment in housing is also benefiting from the recovery in the housing market, rising by an unprecedented amount last year. Growth will be more moderate this year, however we still expect investment in housing to show an 8% increase on last year. Investment growth in housing will decline somewhat next year.
… but is increasing concerns regarding the monetary climate and the pension funds
Low interest rates are thus supporting the internal dynamics in the Netherlands in the short term. At the same time, low interest rates are also causing structural problems in the Dutch economy. First of all, a long period of low interest rates could diminish the profitability of banks and insurers. If this causes further financial turmoil, it could harm the economic outlook.
Secondly, low interest rates are a problem for the pension funds. Low interest rates have caused pension fund coverage ratios to fall below the required level, especially now that returns on invested assets are also under pressure due to the turmoil in the financial markets. If this situation continues, it is very likely that the entitlements accrued by those in work and pension benefits will not only not rise by enough to compensate for inflation, they may have to be curtailed again. Another possibility is that contributions will rise. Both these developments could mean lower growth in disposable household income, which would be bad for growth of consumption. Uncertainty with respect to pensions could also lead to an increased propensity to save, which would also be negative for consumption growth.
Recovery in the labour market is gaining strength
The recovery of economic growth can also be seen in the labour market. For the first time in years, there were more people in work on average in 2015 than in the preceding year. The last quarter of 2015, in which employment increased by 40,000 employed persons, was actually the best quarter for this measure since 2008.
Looking at the sectors, we see that the sector commercial services has been doing well for some time and certainly showed a strong increase in the latter quarters of 2015 (figure 6). Many of these jobs are temporary agency jobs, which is a sign of an early-cyclical recovery, but also suggests there is a structural shift to flexible workers. Employment has also been rising for some time in the trade, transport and hospitality sectors. In addition, it is good to see that the decline in employment in the construction sector since 2011 came to an end in the last quarter of 2015. Lastly, the fact that there was little or no decline in employment in the government sector in the latter quarters of last year is an important development. Employment fell sharply in the public sector in the preceding years due to austerity measures, especially in health care, which exacerbated the general decline in employment. This was in sharp contrast to the period between 2000 and 2008, in which the public sector accounted for more than three quarters of employment growth.
The outlook for the labour market in 2016 and 2017 is positive. The Dutch economy has now been growing for some time and the recovery is expected to continue both this year and next year. This will enable a cyclical recovery in the labour market. The improved outlook is also visible in the early-cyclical indicators such as the number of vacancies, which has been rising for some considerable time. Another factor contributing to the recovery of employment is the public sector, which is no longer expected to reduce employment growth in the coming years, meaning that employment growth will be on a higher trajectory this year and next year.
The recovery in the labour market is also expressed in lower unemployment. In 2015, unemployment fell to 6.9% compared to 7.4% in 2014. The strong recovery in employment will also lead to lower unemployment in 2016 and 2017. Higher labour supply as a result of higher labour participation will however slow the fall in unemployment. Nevertheless, we are forecasting unemployment to fall to 6¼% in 2016 and 6% in 2017.
The Economic Quarterly is a publication of Economic Research 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.
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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.
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