The Netherlands: between technology and deglobalisation
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- The future is uncertain. That’s why we outline three possible scenarios for the period 2018-2023: Muddling Through, The Fourth Industrial Revolution and Deglobalisation
- In the Muddling Through scenario, no visionary policy is adopted and structural problems are not addressed, meaning that economic growth in the 2018-2023 period will only be 1.4%
- In the Fourth Industrial Revolution scenario, it will emerge that we have underestimated the productivity gains from today’s technological developments and the government will take measures to encourage innovation and entrepreneurship. Growth will in this case amount to 2.3% in the 2018-2023 period
- In the Deglobalisation scenario, there will be a sharp increase in protectionism and there will be no willingness to engage in international cooperation. World trade will slump, and economic growth in the Netherlands will be only 0.3% in the 2018-2023 period
The Dutch economy is expected to perform relatively well next year. The biggest contribution to this growth will come from domestic expenditures. Economic growth of 1.8% is higher than what is deemed sustainable for the Dutch economy in the long term.
Just like the global economy, the Dutch economy is at a crossroads. There are unmistakeable signs of recovery in the real economy, but private debt is still high and monetary policy is looser than it has ever been.
There are, broadly speaking, three views of future economic developments. The first concerns ‘lengthy stagnation’, mainly due to problems in the demand side of the economy. In the article ‘Recovery at last?’ we discuss the questions of whether we are now in a situation of permanent underspending, what is the status of household finances and what are the causes of a demand-driven recovery or the absence of this.
The second view envisages a ‘Fourth Industrial Revolution’. This implies that the supply side of the economy will undergo an acceleration, especially with respect to technological progress. Our article ‘The unknown potential of the Dutch economy’ deals with the factors underlying structural growth in the Netherlands. Both these analyses present a picture of great uncertainty: technological progress and the effects of this on economic growth are extremely difficult to estimate.
The third view is that the economy will continue to muddle through. The international economic challenges and uncertainties on financial markets both play part in this. They will bring about neither huge disasters nor real solutions.
We have taken these elements and constructed three scenarios. If nothing is done to deal with the structural imbalances and there is no policy to raise the potential strength of the economy in the coming years, we will probably see lower growth in the 2018-2023 period than we expect to see this year and in 2017. Under this scenario, which we have called Muddling through, growth will average 1.4% in this period. This is a lower rate of growth than before the crisis, and also means that the purchasing power of employees will not rise.
However, it is quite possible that the structural growth rate will be higher than it currently is. In the Fourth Industrial Revolution scenario, a visionary policy will be adopted in the western world to structurally strengthen the economy. If this scenario occurs, we will have underestimated the contribution of today’s technological developments to economic growth. Growth will average 2.3% in 2018-2023, bringing us gradually back to the trend growth rate seen before the crisis.
In today’s political climate however, it is very possible that countries will increasingly drift apart due to rising protectionism. In the Deglobalisation scenario world trade will slump, leading to low growth of exports in the Netherlands in the 2018-2023 period. This would bring average economic growth in this period to 0.3%, and mean that we fail to realise our growth potential due to falling demand.
How the economy will actually develop in the coming years remains anyone’s guess. But we see these scenarios as setting the bandwidths for the risks and opportunities facing the Dutch economy.
Scenario I: Muddling Through
The Western world will not succeed in coming up with a collective answer to the problems that present themselves. New problems will be addressed with half measures whereby the sharp edges will be blunted but nothing will really be solved. Europe will see stronger cooperation or coordination in some areas (external border security), while it will continue to slacken in others (budgetary policy, agricultural policy). There will be no further substantial integration. As a result, huge tensions will remain under the surface. These tensions and half solutions will lead to new hotbeds and turmoil, resulting in high volatility in both the financial markets and confidence. This is not a sustainable situation in the long term, but it could very well continue in the coming years (see Outlook 2017: The Global economy in the Trump era).
The Dutch government will also not take decisive action, and will not take any measures to structurally strengthen the economy. It will invest in innovation and entrepreneurship, but not enough and without any clear vision. Structural economic growth will therefore continue at 1.2 per cent in the 2018-2023 period. There will also not be any additional government policy. A budget deficit of 0.6 per cent in 2017 will thus be converted into an average surplus of 0.5 per cent in the 2018-2023 period. This will lead in particular to higher collective costs as a result of rising costs of health care. This is due to demographic developments and an intensification of health care, and will be reflected in higher premiums. Partly as a result, there will be hardly any increase in household purchasing power in the coming years.
In this scenario, Dutch export volume will rise by an average of 4.0 per cent in the 2018-2023 period. This would mean growth in the export sector of approximately the same rate as we have seen on average since the crisis in 2008, but this is a significantly lower rate than the average before the crisis (figure 1). This has everything to do with the continuing weaknesses in the global economy (ie Outlook 2017: The Global economy in the Trump era). Growth among the Netherlands’ major trading partners is moderate, while trade and other treaties that would lead to further international integration are still on the shelf. The climate of uncertainty and volatility also does not help international trade.
The volume growth of household consumption will be modest in this scenario at an average of 0.7 per cent per year in the 2018-2023 period. This is mainly because there will be hardly any increase in household disposable income. One important reason for this is that rising inflation will not be accompanied by a similar increase in wages, so that any real increase in wages will remain limited (figure 2). The rise in employment will also be moderate in the 2018-2023 period, and rising health care premiums will negatively impact household disposable income.
There will be two effects on consumption from the continuing relatively low level of interest rates. Firstly, low interest rates will stabilise housing prices in real terms. This will have a limited positive effect on household assets. Secondly, continuing low interest rates will be a problem for the pension funds, whose coverage ratios will remain below the required level. This will lead to an increase in pension contributions and pensions will be curtailed. This will diminish disposable household income, and the continuing uncertainty will lead to lower consumer confidence, especially among older people. There will be a high level of uncertainty due to the sharp increase in health care costs, and there will be a debate as to who should pick up the bill. The effect of low interest rates in the long term will therefore on balance be negative for domestic consumption, due to the large amounts of pension capital in the Netherlands. The fact that real household disposable income will still rise is because more people will find work and wages will rise slightly in real terms in the coming years.
In the Muddling Through scenario, private investment will grow by an average of only 1.5 per cent per year in the 2018-2023 period. Investment in housing will no longer be encouraged by an increase in transaction volume in the housing market. This means that investment in housing will grow at a significantly lower rate in this period. At the same time, continuing uncertainty and volatility in the financial markets will create an uncertain climate for investment, and businesses will see little reason to invest in expansion.
The labour market
The labour market will continue to recover in the coming years. There will be an increase in the labour supply in the 2018-2023 period, but this growth will increasingly slow as a result of the further ageing of the population, despite the increase in the age of entitlement to state retirement pension. Employment will increase by more than the labour supply in this period, meaning that unemployment will slowly decline. We expect unemployment to approach its equilibrium level of 4.5 per cent at the end of the period, which in fact means that the output gap will have closed (figure 3).
 The growth of 1.4 per cent we can expect in this period is due to the fact that we are currently below the structural economic level. In this scenario, we expect the output gap to be closed at the end of this period in 2023.
Scenario II: The Fourth Industrial Revolution
Artificial intelligence, robotics, smart phones, 3D printers, nanotechnology. These disruptive technological developments have followed each other at dizzying speed in recent years. Many economists and writers expect to see a significant increase in productivity growth as a result of the new technological breakthroughs, among whom the economists Brynjolfsson and McAfee (2014) are perhaps the best known. But also the World Economic Forum in 2016 believes that today’s technological developments are happening at a historically unprecedented speed. The perception is that after the three major breakthrough technologies - the steam engine, electricity and ICT - we now have to prepare ourselves for a fourth industrial revolution. The blending of various technologies is blurring the divisions between the physical, digital and biological domains (figure 4).
This is affecting every country and every business. Due to the speed and universality of these processes, it is quite possible that the fourth industrial revolution began ten years ago without us noticing it. It has however taken more than ten years for these technologies to be reflected in higher productivity growth, so that we will only be aware of the consequences in 2018.
This process will also be aided by an international political drive to structurally strengthen productivity growth. Governments including the German government and certainly also the Dutch will recognise the potential offered by low interest rates and healthy government finances. They will also see the need for a vigorous approach and a clear economic vision, and therefore will invest from 2018 onwards with conviction and focus in areas such as R&D, innovation and entrepreneurship.
The resulting innovation gain that will initially occur in the more developed economies - the eurozone, the US and the UK - will translate into additional annual growth of Total Factor Productivity (TFP) of around 1 per cent (See: The unknown potential of the Dutch economy). The additional government spending in the Netherlands and Germany will further increase the capital stock of the Netherlands, nearly doubling the growth potential in the Netherlands in comparison to the Muddling Through scenario to 2.3 per cent.
If the Netherlands is the only country able to achieve significant technological progress and increase TFP, this will not lead directly to much higher GDP growth. This has everything to do with the open nature of the Dutch economy. A technological shock that happens only in the Netherlands will bring about higher growth of investment and consumption, but a large part of the effect of this will go abroad as a result of imports. Exports will also not increase much due to such a boost, since there will be no additional demand from abroad.
The Fourth Industrial Revolution scenario will however be a global phenomenon, meaning that we will see higher TFP growth in other countries as well. This will lead to an annual additional increase in Dutch GDP in the 2018-2023 period. The rising activity in foreign economies will create additional demand for Dutch goods and services, so that export growth will be significantly higher (table 2). At the same time, higher government spending will provide an additional boost to demand. The higher effective demand will also work through to other components of consumption, such as private investment, which will grow much faster than in the Muddling Through scenario.
Despite the boost to demand from abroad and the government, the demand side will not be in a position to grow at the same rate as the supply side of the economy in the short term. Technological progress will provide greater production capacity. But if there is no equivalent demand for this, the output gap will on average widen to some extent in the 2018-2023 period, meaning that inflation in this period will remain low. Interest rates will also remain low, which is good for the housing market but not so good for the funding ratios of the pension funds. The output gap will however close over the longer term (after 2023).
The rapid development of new technologies in the Fourth Industrial Revolution will have a dual effect on the labour market. Firstly, a relatively large number of current jobs will disappear as a result of the introduction of new production processes and techniques, especially among the workforce with an average level of qualification (Erken et al., 2016). Secondly, many new jobs will be created, mainly among the low educated and the highly educated workforce. The net effect will be positive for employment, so that unemployment in this scenario will be lower than in the Muddling Through scenario.
Consumption will rise by an average of 1 per cent the 2018-2023 period in this scenario. Disposable household income will rise on average considerably faster than in the Muddling Through scenario. Wages in real terms will increase, because inflation will be low while pressure in the labour market will push nominal wages higher. The increasing level of employment will generate an increase in higher disposable income. At the same time, interest rates will remain low, so that the funding ratios of the pension funds will also remain low. The concerns resulting from this will mean that households remain cautious and will not use all their additional income for spending.
Private investment will increase more strongly in this scenario, after slightly weakening in 2017. Most of the growth will be seen in business investment, since the recovery in the housing market will be somewhat more moderate in the 2018-2023 period than previously. The increased demand for goods and services from abroad and from the government will lead to demand-driven investment, while the new technological advances will also lead to additional investment.
Government finances will develop less favourably in this scenario. Tax revenues will rise as a result of the increased economic activity, the rise in employment and higher wages, but on average there will still be deficits in the 2018-2023 period. Partly due to the technological progress, health care costs will rise in this scenario, so that higher revenues will not all be reflected in a more favourable balance. In addition, the extra boost from the government will cause a further deterioration in the balance. Ultimately however, the government’s financial position will remain neatly within the European barrier of 3 per cent.
Scenario III: Deglobalisation
The result of the Brexit referendum, Donald Trump’s victory and the vote in Wallonia on the CETA treaty look as though they may mark the end of a long period of globalisation. After decades of economic and political integration, we are now at the start of a turning point with widespread geopolitical turmoil. Protectionism and nationalism are coming to the fore, since a significant part of society feels like it has lost out as a result of these developments. The economic historian Jan Luiten van Zanden (2016) sees clear parallels between today and the end of globalisation at the beginning of the 20th century. The global economy underwent a period of rapid integration at the end of the 19th century, so much so that by some measures the world was more globalised than it is today. There were significant groups that lost out at that time as well, mainly farmers and large industries in continental Europe. This led to strong resistance against globalisation and further economic and political integration, and provided a fertile breeding ground for protectionism and nationalism, with these forces ultimately coming together in the outbreak of the First World War in 1914 and forming the prelude to the Second World War.
We do not expect such an outcome in this scenario this time. But there are clear economic losers as a result of globalisation today, such as factory workers in manufacturing industries in the US. At the same time, large parts of the population have hardly benefited at all in recent decades in terms of disposable income. The disadvantages of globalisation are now widely cited while the benefits are no longer mentioned and the real dangers of economic and political disintegration have been forgotten. This is providing the conditions for the ever stronger rise of nationalist and protectionist political movements. An increasing number of countries will turn inwards: old trade treaties will be suspended and there will be no readiness to engage in international economic and political cooperation. Trading blocs will fall apart and strict trade barriers will be introduced. Volatility in the financial markets will be much higher, and the outlook for businesses will be highly uncertain.
In the Deglobalisation scenario, world trade will grow by nearly 2 percentage points less in the 2018-2023 period than in the Muddling Through scenario, in which trade growth would already be weaker than before the crisis. As an open economy, the impact for the Netherlands will be severe: the volume of growth in exports in the 2018-2023 period will grow by only 1.5 per cent per year. This will also be reflected in lower growth in other consumption components. There will be a huge drop in demand, which ultimately will lead to the Netherlands experiencing economic growth of close to nil. GDP volume will increase on average by 0.3 per cent in the 2018-2023 period.
The drop in demand will make the difference between actual GDP and potential GDP ever greater, so that in this scenario the output gap will become increasingly negative. This will result in very low inflation of on average 0.8 per cent, well below the ECB’s target level of around 2 per cent. All this will mean that interest rates will remain low in the 2018-2023 period.
Private investment will also stagnate. The recovery in the housing market will come to an end (with house prices actually falling in real terms), while businesses will suspend their investment due to the fall in demand from abroad and the high level of uncertainty. Growth of the stock of capital goods will also weaken to some extent, thus reducing the potential for growth as well.
The volume growth of private consumption will be lower than in the Muddling Through scenario. The main reason for this is that disposable income will not rise in this scenario. At the same time, the growth in employment will not be enough to absorb the increase in the labour supply. Unemployment will be higher than in the Muddling Through scenario. The growth in nominal wages will weaken to the extent that wages will decline in real terms despite the moderate level of inflation. The weak development of disposable income will also cause house prices to decline in real terms, despite the low level of interest rates. The pension funds will also increasingly experience difficulties. The continuing low level of interest rates will damage funding ratios, while low global growth will lead to lower returns from instruments such as equities. All this will contribute to a weak development of private consumption.
Contrary to the Muddling Through scenario, the Deglobalisation scenario will involve a budget deficit of 0.3 per cent on average in the 2018-2023 period. The main reason for this is that household income will be much lower than in the Muddling Through scenario, so that income tax revenues will be lower. The growth of nominal GDP will also be lower. The higher deficit and the lower nominal GDP growth will also mean that debt in comparison to GDP will be higher on average than in the Muddling Through scenario.
The future is uncertain. And it certainly cannot be made. Today, we cannot be sure whether we are in a situation of underspending, limited technological progress, or indeed an economy that will grow in the years to come. Three scenarios for the future of the Netherlands present very different outcomes with respect to economic variables such as growth, unemployment, the government deficit and inflation. What do these scenarios tell us about the potential future policy for the Netherlands?
No dilemmas in The Hague
In the Deglobalisation scenario, growth will average 0.3% per year over six years. This is low, but still 0.1 of a percentage point higher than the average in the past seven years. In the Fourth Industrial Revolution scenario, we see growth averaging 2.3% over the coming six years. This may seem high, but the average growth rate in the period before 2008 was 2.5%. The bandwidth of the scenarios is thus more limited than what the Netherlands managed to achieve in the not so distant past.
This bandwidth of uncertainty does not however appear to have penetrated the alternate reality of The Hague. In its medium to long term forecasts the CPB (the Netherlands Bureau for Economic Policy Analysis) is expecting economic growth of 1.7%. This is accompanied by the comforting message that the government finances will return to safe ground without additional policy measures, with a budget surplus of nearly 1 percentage point in 2021. This calculation is the basis for the calculation of the election programmes that are most likely occupying the Ministry of Economic Affairs’ full attention at the moment.
Of course, the CPB’s scenario may materialise. But it is certainly more optimistic than the picture we see in our Muddling Through scenario. The difference is mainly in the growth of labour productivity, where we have a rather less positive view. Never mind, these are just details. The big problem with the CPB figures is that the politicians see them as confirming that there are no dilemmas: real austerity is not necessary, there will be no crisis in the Netherlands and we also do not have to prepare ourselves for a world that may be completely different as a result of either innovation or protectionism. And this raises the threat of stagnation, certainly if the upcoming elections to the House of Representatives lead to a situation in which four or five parties are needed to form a government.
An uncertain world calls for a steadfast policy
There are however dilemmas with respect to the future of the economy. The condition of the economy is highly uncertain. Monetary policy is still looser than it has ever been. Private debt is still high. And with Brexit, the election of Trump and upcoming elections in many European countries, this uncertainty will surely not diminish in the coming period. It would therefore be wise to prepare our country to some extent for this uncertainty.
Of course, it is not policy that will decide what the world will actually look like. But we can prepare ourselves as well as we can for the various possible scenarios. There are therefore a number of things that we can learn from our deliberations.
First of all, we do not have to worry too much about a rapid rise in unemployment. Even in a scenario of lower economic growth, the damage to the Dutch labour market will be acceptable. One important reason for this is of course the ageing of the population. This does not mean that everything is fine in the labour market. The big difference between the self-employed and ‘permanent’ employees will indeed continue to be a problem without policy. And in The Fourth Industrial Revolution scenario, this also means that people’s ability to adapt will be inadequate, so that some groups will likely face long-term unemployment.
Second, the development of disposable income is not a positive factor. Even in the Fourth Industrial Revolution scenario there will be only a limited increase in purchasing power. This has everything to do with how we have collectively arranged our affairs in the Netherlands. Dutch households have limited liquidity, because firstly a significant amount of household assets are locked up in property and pensions, and secondly because much of our spending, for example on health care, is mostly funded collectively. In each scenario, making changes to the Dutch institutions associated with pensions, health care and home ownership would be a ‘no regret’option.
The third point is that investing in innovation, knowledge and entrepreneurship pays in all scenarios. This could lead to extra growth relatively quickly. We assume this will happen in the Fourth Industrial Revolution scenario, but it would deliver economic growth, purchasing power and jobs in the other scenarios as well.
The final point concerns finding the right balance between motivation and security. An open and uncertain economy demands that people are given the opportunity to keep their skills up to date. This means that social security must be generous enough to allow people the time to train or retrain. And the policy also has to be sufficiently motivational: people will really have to do this. This is the only way to prepare people against globalisation and an uncertain world.
Filling the hairline cracks
The scenarios we present do not provide an exhaustive overview of the potential developments in the Dutch economy in the coming years. But they do show that the Netherlands is not prepared in all respects to face various economic situations. And while if we leave things to the politicians the muddling through scenario is the most likely, it would be very advisable to further address the structural flaws in the Dutch economy - pensions, the labour market, health care and the housing market - and to make these areas ready for whatever scenario may actually occur. Because what are just hairline cracks now could become gaping holes if the economy turns down, leading to the collapse of the building. And it is much more efficient to repair the hairline cracks before that happens.
Brynjolfsson, E. and A. McAfee (2014), The Second Machine Age: Work, Progress and Prosperity in a Time of Brilliant Technologies, New York: W.W. Norton & Company.
Erken, H., Smid, T. and Versteegh, E. (2016). ICT-impuls zorgt tot 2020 voor 120 duizend extra banen (Dutch). Rabobank Economic Report.
World Economic Forum (2016). The Fourth Industrial Revolution: what it means, how to respond. Blog at www.weforum.org, calculated on 3 March 2016.
Zanden, Jan Luiten van (2016). Het einde van de globalisering (Dutch). MeJudice.
The Outlook 2017 is a publication of RaboResearch of Rabobank and a co-production with Financial Markets Research. The date of completion is the 28th of November 2016.
The views presented in this publication are based on data from sources we consider to be reliable. Among others, these include Macrobond. These data have been carefully incorporated into our analyses. The economic growth forecasts and scenarios are generated from the NiGEM global econometric structure models.
The use of this publication in whole or in part is permitted only if accompanied by an acknowledgement of the source. RaboResearch accepts, however, no liability whatsoever should the data or prognoses presented in this publication contain any errors.
Abbreviations for sources: CBS: Statistics Netherlands, OECD: Organisation for Economic Co-operation and Development, CPB: Economic Policy Analysis Netherlands, IMF: International Monetary Fund, ECB: European Central Bank, Fed: Federal Reserve.
© 2016 - Coöperatieve Rabobank U.A., Nederland