Netherlands: growth continues, wages still lag
Economic Quarterly Report
- The Dutch economy will generate strong growth in the coming period, expected to amount to 3.3 per cent in 2017 and 2.4 per cent in 2018
- The growth is broad-based. Despite international uncertainties, exports continue to increase and domestically, investment (including investment in housing) and consumption are holding up well
- The labour market is not as tight as the official figures suggest. Wages will therefore increase only marginally in the short term
- To maintain economic growth after 2018, the Netherlands has to invest in education and innovation, help the middle bracket of business progress and reduce absenteeism
- Free disposable income also has to increase. This could be achieved by reducing taxes on employment, settling the divisions between pension and housing equity and pay close attention to rising costs of health care
- In addition, climate legislation is essential for future sustainable growth
The Dutch economy is going through a phase of strong cyclical recovery. Last year, growth in gross domestic product (GDP) in real terms came to 2.2 per cent. This year, the economy has picked up and growth is expected to hit 3.3 per cent. The production capacity of the Dutch economy will return to full utilisation in the course of 2018, and there will be no further catch-up growth. We expect growth of 2.4 per cent in 2018. There is also further recovery visible in the labour market, with unemployment falling from 5 per cent in 2017 to 4.5 per cent in 2018.
The economic growth is broad-based. Exports, investment and investment in housing and consumption are all contributing to the economic upturn (figure 1). Exports continue to perform well as a result of the growth at several major trading partners and the strong competitive position of the Netherlands. And, in line with the rapid growth of transactions in the housing market in 2017, investment in housing is increasing strongly this year. The number of transactions is expected to decline next year and the growth of investment in housing will also therefore subside somewhat. Household consumption is up by 2.2 per cent in 2017. Although some sectors are having difficulty finding qualified personnel, there is still more room in the labour market than the official unemployment figures suggest. We thus expect it to take a little longer before growth in real wages accelerates and inflation rises. Consumption growth will be slightly lower in 2018, at 1.9 per cent. This is still a substantial increase, but not as large as in 2017. The output gap will close in the course of 2018 and the economic potential of the Netherlands will be fully utilised. If economic growth remains steady after that, a larger increase in wages is likely after 2018.
Of course such strong economic growth in the Netherlands is a good thing, but how can we keep it going after 2018? How can we ensure that everyone benefits? And how can we ensure that the growth is sustainable?
How can we keep the current economic growth in the Netherlands going after 2018?
As a result of the strong growth in 2017 and 2018, the economy will soon reach its potential level of production. This is good news, however it also means that the years of high catch-up growth are behind us. The economy may temporarily grow above its potential, most likely with high inflation as a result, but ultimately the structural growth potential of the economy will be the determining factor. This is estimated at a modest 1.2 per cent per year. If we want to boost the structural growth trajectory of the Netherlands, new measures will be needed from the new cabinet and from society at large.
There are two ways in which an economy can grow faster sustainably: higher productivity or a larger supply of labour. Looking at the first factor, we see that structural productivity is expected to increase by only 1.0 per cent a year after 2018. The proportion of this attributable to working more intelligently, the use of new technologies and a more highly educated workforce is known as the growth of total factor productivity (TFP). This comes to only 0.6 per cent per year. By comparison, this measure was on average 1.4 per cent per year between 1980 and 2008 (figure 2).
Heavy investment in education and innovation is therefore essential. The potential gains are significant: if the total population aged over 25 spends one month longer in education, this will deliver € 3.5 billion in additional economic growth. One euro extra spent on R&D at businesses delivers 2.3 euros in added value. There is therefore a clear task for the next cabinet.
Encouraging the middle bracket of business to increase productivity, for instance by improving management, is a second way of increasing average productivity. The best-performing businesses have a high added value per employee and so far are performing excellently. But the middle bracket is lagging, while this is where there is much potential (figure 3).
Improving productivity among the (large) middle bracket of companies would significantly raise average productivity. If companies in the fourth quartile were to work towards raising their productivity to the average level of the third quartile, and companies in the third quartile were to increase their productivity to the level of the second quartile, this would mean an increase of the total average labour productivity of 14 per cent! One way of achieving this is to focus on continued training of business owners. International research shows that management quality is a co-determinant of labour productivity at companies (Bloom and Van Reenen, 2015).
The other determining factor for structural economic growth is labour supply. There is little potential for increasing this over the long term. The Dutch working population is ageing, and even after taking account of increasing the age of entitlement to state retirement pension (AOW), the structural growth in employment between 2018 and 2022 will only contribute 0.2 per cent to total structural growth.
Nonetheless, there are ways in which the labour supply could be increased in future.
Internationally, the Netherlands scores relatively high when it comes to absenteeism. Reducing absenteeism would help to increase the labour supply. How exactly? This high average score conceals differences in absenteeism between sectors, companies and employees. Small businesses generally experience lower absenteeism than large ones. Self-employed persons are less likely to take sick leave than employees, and there is less absenteeism in the hospitality industry than in the government sector (figure 4). There is also less absenteeism in times of crisis than when the economy is doing well. This variation in the absenteeism figures suggests that some companies deal with absenteeism better than others. By sharing best practices, companies can learn from one another and the average level of absenteeism could be reduced.
How can we ensure that everyone benefits from economic growth?
Despite the recent good figures, the economic growth has not led to a noticeable difference in everyone’s disposable income. First of all, this is because wages have not yet increased fully in proportion to the positive economic developments (figure 5). This is partly because the broader unemployment is still relatively high: employers can still look for potential employees that are not as yet offering themselves in the labour market before the official unemployment figures fall faster and there is upward pressure on wages across the board.
Apart from the development of wages, the government could help to increase disposable income by reducing the marginal pressure on labour and reducing the difference between the wage costs for the employer and the net pay received by the employee. Working would become more rewarding and it would be more attractive to employ people.
As a result of the institutional structure of the Dutch pensions system and the housing market, Dutch households have relatively little free disposable income: a high level of saving is obligatory. Providing more flexibility here would mean that households would have more money to spend or could decide to save in a different way, such as repaying their mortgages.
Lastly, the government could do something about the rising costs of health care. After a gap, these are poised to rise significantly in the coming years. It is of course a political choice as to whether this is desirable, but one important consideration is that rising costs of health care could significantly pressure free disposable income.
How can we ensure that the growth is sustainable?
Climate change could have a significant impact on the world, and therefore also on the Dutch economy. Nonetheless, the Netherlands is lagging far behind when it comes to meeting the agreed European targets with respect to sustainability (figure 6).
Politicians have difficulty in embracing long-term targets, since these relate to periods far longer than a single term of office. Uncertainty regarding future sustainability policy means that businesses and households are reluctant to commit to measures to achieve greater sustainability. Why invest in insulation or solar panels if the future benefits are doubtful?
Climate legislation could be a solution. The details of the exact measures needed to meet the climate targets would not have to be defined in the legislation. But because climate legislation would bind current and future administrations to clear climate targets, this would provide clarity to businesses and households. They could have more confidence that a continuing transition towards a more sustainable economy is occurring.
Increasing the potential for economic growth, reforming the tax and pensions system so that people have more free disposable income and making the economy more sustainable require investment and political will. It is in times such as the current period of economic recovery that there is more room for such an approach, which would give the Netherlands the chance of working today towards more sustainable growth in the widest sense of the word.
 This is partly because employees in the hospitality industry are generally younger and healthier than in other sectors. Controlling for such effects will reduce the differences, but it will not remove them.
 One example of this is to devote attention to prevention: for example, consider providing standing desks for office workers.