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Outlook 2018: New coalition adds fuel to the fire of the Dutch economy

Economic Quarterly Report

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  • After years of growth, the Dutch economy has finally fully recovered from the crisis
  • In 2018 and 2019 GDP will grow by respectively 2.8 and 2.2 percent
  • Household consumption is strongly contributing to economic growth and export growth remains high
  • The additional government spending from the coalition agreement will push economic growth even higher. Given the current phase of the economy this is undesirable
  • Unemployment will decline strongly because of rising employment: we expect the unemployment rate to be only 3.8 percent in 2019
  • Inflation will increase further because of the economic upturn
  • International risks remain high; especially a ‘hard’ Brexit would hurt Dutch economic growth

In 2017 the volume of the economy is expected to grow by 3.2 percent, the highest growth in ten years. This means the period of catch-up growth after the crisis has finally come to an end and a new phase is unfolding: a phase were the economy is approaching the top of the cycle. This means growth above potential growth, lower unemployment and increasing inflation.

The broad based recovery will continue in the coming years: household consumption will increase because of rising disposable income and higher confidence, while the strong growth of world trade will continue to support export growth (figure 1). The rise of residential investment, which has been an important contributor to economic growth in the past few years, will be more moderate in the coming years because of lower transaction levels and limited growth in the number of newly constructed homes. However, because of the economic upswing business investment will stay strong in the coming years.

The new coalition agreement will lead to significantly higher government spending, which will further boost economic growth in the coming years. In addition, lower taxes on labour will positively affect economic growth, but households will have to wait till 2020 before they actually experience a net reduction of their taxes. We don’t believe the additional government stimulus is desirable at the moment, because the economy would already be growing above potential without the additional government spending. The government does not seem to learn from past mistakes and keeps on amplifying the economic cycle.

All in all we expect GDP growth of 2.8 percent in 2018 and 2.2 percent in 2019 (table 1). This is well above our estimated potential growth rate of 1.2 percent, which means the possibility of economic overheating is increasing. This is also visible in our estimates for unemployment and inflation: unemployment will decline to 3.8 percent in 2019 and inflation will increase to 2.6 in 2019, partly because of the increase of the value added tax.

There are, however, large international risks which could negatively affect our growth estimates. Especially the outcome of the Brexit-negotiations remains a large unknown. Were an uncontrolled or ‘hard’ Brexit to be the outcome of the negotiations then there wouldn’t be much left of our positive economic forecasts. In addition, there are other geopolitical risks which could reduce economic growth. 

Figure 1: Government spending boosts growth in 2018 and 2019
Figure 1: Government spending boosts growth in 2018 and 2019Source: Statistics Netherlands (CBS) and estimates Rabobank
Table 1: Key figures the Netherlands
Table 1: Key figures the NetherlandsSource: Statistics Netherlands (CBS) and estimates Rabobank

Government is stimulating the economy at the top of the cycle

The new coalition wants to increase spending and reduce taxes, reversing some of the austerity measures that defined the post-crisis period. Government expenditures will increase because the new coalition will spend more on defense, education and infrastructure (figure 2).The additional government expenditure will come on top of government spending plans by the previous coalition, which will cause government expenditure to increase with 3.8 percent in 2018 and 2.8 percent in 2019. It should be noted, however, that the plans from the coalition agreement have yet to be implemented in law or executed. This means that especially the 2018 government spending plans could be delayed, which would reduce government spending and consequently economic growth.

Figure 2: Coalition agreement lead to additional government spending
Figure 2: Coalition agreement lead to additional government spendingSource: CPB MLT (effects coalition agreement included)

The new coalition agreement will also reduce taxes on households in the coming years. A two-bracket income tax system will be implemented, which will reduce taxes on labour. But because the new government will compensate lower income households with adjusted deductions, the system as a whole won’t get any less complicated. This is a missed opportunity to increase the efficiency of the tax system and to boost the potential growth rate of the Dutch economy. In addition, the additional tax reduction on labour will be much lower in the long run, because such tax cuts had already been passed by the previous government.

In the short term the tax burden of households will decline, but only from 2020 onwards will there be a net reduction in the tax rate (figure 3). The tax burden won’t decline in 2019 because the increase in the value added tax will be fully implemented in 2019, while the income tax reduction will be spread out over multiple years. We believe the increase of the value added tax will lead to higher inflation and reduce real disposable household income. The positive effect of the tax reduction on the economy will therefore be barely visible in 2018 and 2019.

Figure 3: Households have to wait until 2020 to get a reduction in their tax burden
Figure 3: Households have to wait until 2020 to get a reduction in their tax burdenSource: CPB MLT (effects coalition agreement included)

Taken together, the government will stimulate the economy in the coming four years. It is doubtful the economy needs extra stimulus at this point in time. As previously mentioned, the Netherlands is entering a phase where the economy will approach the top of the cycle, with growth above the potential rate. This is in stark contrast to the years after the crisis, when the government, in an effort to improve state finances, pursued austerity policies that hurt growth. Now that the economy is finally recovered, the government plans to stimulate the economy even further. It’s this kind of policy that amplifies the volatile economic cycle of the Netherlands. 

Export growth remains on track despite upcoming Brexit

Exports will remain an important contributor to economic growth in coming years. We expect the growth of Dutch trading partners to remain on track, which should see Dutch export growth in 2018 and 2019 remain around the long term average (figure 4).

Figure 4: Export growth to remain around long term average despite upcoming Brexit
Figure 4: Export growth to remain around long term average despite upcoming BrexitSource: Statistics Netherlands (CBS) and forecast Rabobank

While exports are doing well, we do expect the upcoming Brexit to start having a negative effect on Dutch trade from 2019 onwards. We expect that there will be a transition period of two years from 2019 onwards, after which a free trade agreement between the UK and the EU will be implemented. The free trade agreement will mean more trade restrictions compared to the current situation, which will negatively affect trade. Because companies will already take this into account in 2019, British imports will already start declining in 2019. The UK is one of the most important trading partners of the Netherlands, which means that lower imports from the UK will hit the Dutch export sector relatively hard. However, the negative effect of lower imports from the UK in 2019 will be compensated by stronger import growth from Germany and the US, which are the other two most important trade partners of the Netherlands. The net result will be that Dutch export growth will remain on track in the coming years.[1]

However, were there to be an uncontrolled or ‘hard’ Brexit then the effects for the Dutch economy will be much stronger. In that case not much will be left of our economic outlook of strong Dutch GDP growth.

Footnote
[1] Relevant world trade for the Netherlands is calculated by taking the sum of imports of all other countries weighted by importance to Dutch trade.

Households spend more due to higher income and strong confidence levels

The strong volume growth of household consumption will continue over the next two years (figure 5). Consumption growth now lies well above the long term average. The strong increase of household disposable income can explain a large part of the consumption growth. The labour market recovery boosts household income in two ways. First of all, it leads to a direct substantial increase in income for the people who find a job. Secondly, it will lead to labour market scarcity, which gives upward pressure on wages (see the labour market section below). Aside from the increase in disposable income, the high consumer confidence levels also help to boost consumption growth along with a wealth effect from high house prices (figure 6). In 2018 we expect a reduction of the household saving rate, which is common when the economy is near the top of the cycle.

Figure 5: Strong consumption growth
Figure 5: Strong consumption growthSource: Statistics Netherlands (CBS) and Rabobank forecast
Figure 6: Confidence of households remains very high
Figure 6: Confidence of households remains very highSource: Statistics Netherlands (CBS)

Strong decline in unemployment but labour market flexibility keeps increasing

The labour market is recovering at an extraordinary pace. Since 2015 employment has increased by around 100,000 persons per year. In 2017 we estimate an increase of employment of nearly 200,000 persons. In 2018 and 2019 the strong employment growth will continue, which will lead to over 600,000 more employed persons in 2019 compared to 2014.

Since 2014 more than half of the employment growth was through temp agencies (figure 7). Growth of employment in the temp agency sector is characteristic of the early part of an economic recovery. In this phase it’s too risky for employers to offer a fixed contract to employees, which means the temp agency sector can play a role in increasing employment. However, the phase of early labour market recovery is behind us, which makes it somewhat surprising that in 2017Q3 almost half of the employment increase was still through temp agencies.

Strong employment growth will lead to a reduction of the unemployment rate. Due to the increasing labour scarcity, discouraged workers will now start looking for a job, which increases the labour supply thus moderating the decline in unemployment. Still, the unemployment rate will likely decline to 4.2 percent in 2018 and 3.8 percent in 2019. This is well below our estimated structural unemployment rate of 4.5 percent, which shows once more that we are entering a more mature phase in the economic recovery.

Figure 7: Employment growth compared to the previous quarter
Figure 7: Employment growth compared to the previous quarterSource: Statistics Netherlands (CBS)

The ongoing economic upturn will also be visible in wage and inflation developments. Labour scarcity will not only lead to higher sectoral wage agreements, but also lead to additional wage growth because employers will try to lure employees by offering better pay. In 2018 and especially 2019 this will lead to strong growth in nominal wages. However, because of increasing inflation, real wage growth will remain subdued. We expect HICP inflation will increase to 1.8 percent in 2018, which fits the ECB inflation target of ‘close, but near 2 percent’. In 2019 the increase of the value added tax will make companies raise their prices, which means inflation will further increase to 2.6 percent. Labour scarcity is not (yet) strong enough to lead to a full wage compensation of the value added tax increase, because there are still a lot of people who are without a job. In addition, the position of employees has become weaker over the past few decades, which has led to structural decline in labour’s share of income.

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