Domestic demand is a stabilizing factor for the Dutch economy

The external environment has not become more stable in recent months: President Trump is exerting pressure on China in the trade conflict; in the UK, a new prime minister will pursue a new Brexit strategy with an uncertain outcome; and the Italian government will resume its dispute with ‘Brussels’ over its budget deficits, with a risk of rising tensions in the eurozone. Meanwhile, growth of global trade is declining sharply, and export-oriented industries in many countries are feeling the pinch. Despite all these uncertainties, the economic outlook for the Netherlands continues to be relatively stable, at least for the time being. This is due mainly to the very low level of unemployment and a boost from higher government spending, both of which are supporting domestic demand (figure 1). A healthy domestic dynamic in most of the other eurozone countries also means that exports are still at a reasonably good level. It is certainly important to keep an eye on international tensions (and trade tensions), as any escalation would be bad news for the Dutch economy as well.

There were only 300,000 people officially out of work in April 2019, just 3.3 percent of the working population (figure 2), the lowest level since the crisis. Previously we have noted that the pool of workers available to employers is drying up. This situation has become more acute, now that the agreement in principle on pension reforms (Principeakkoord pensioenhervormingen) plans to freeze the age of entitlement to state retirement pension (AOW) for this and next year, and to increase this age less rapidly thereafter. This will slow the growth of the labor supply. The record low in unemployment however seems to have been reached. Therefore, in the coming years we expect unemployment to rise slightly and slowly, to 3.4 percent in 2019 and 3.6 percent in 2020.

Despite the record low in unemployment, real wage growth is lagging, and this is having a dampening effect on purchasing power and private consumption of Dutch households. The wage increases in the collective labor agreements in the early months of 2019 were indeed less than the high level of inflation (figure 3). Low unemployment does however appear to have caused a slight increase in permanent contracts and a decline in flexible contracts in recent months (figure 4). Employers are also attempting to deal with the tightness by starting new employees in a higher scale, as shown by a survey by employers’ organization AWVN. This has a positive effect on non-recurring wage growth. It is less clear what the effects of the recently adopted Balanced Labor Market Act (Wet Arbeidsmarkt in balans) could be. This Act states that the maximum term for temporary contracts will be increased again from two to three years. This will allow employers to more frequently scale employees at the same - lower - level with a new contract rather than assigning them a step higher in the salary scale within their existing contract. Nonetheless we think that non-recurring wage growth is substantial, and that there will still be an increase in real wages of just over nil for the average Dutch worker in 2019 and 2020. And because employees will on average pay less income tax, they will also have a slight net gain in purchasing power in 2019.

The limited growth in wages means that the development of Dutch household consumption is far from exuberant. On the other hand, low unemployment leads to financial security and thus continued spending. House prices are also still rising, which also usually supports consumption.

We expect private consumption to increase by 1.3 percent this year, which is just short of half the growth in 2018. One important reason for this is the high level of inflation, which we expect to hit 2.7 percent in 2019. Higher prices clearly affected Dutch household finances in the first quarter: inflation in the Netherlands was the highest in the entire Eurozone. This was due to the increase in sales tax, which is still pushing consumer prices higher and denting consumer confidence (figure 5). Energy bills have also risen sharply due to higher taxes and rates. This could change, as two of the large energy suppliers have announced that they will reduce their rates with effect from 1 July. The Cabinet has also stated that it will reduce the energy bill for citizens from 2020, by shifting more of the costs to business. Accordingly, we expect inflation to decline in 2020, leading to slightly stronger growth in consumer spending of 1.6 percent.

Business investment grew strongly last year, but the outlook now is less favorable. Producers have become less optimistic, mainly with respect to the outlook for business activity and their order books (figure 6). Producer confidence is at its lowest level since the end of 2016, although it is still above its historical average. The decline in confidence appears to be due to the international trade tensions, and is happening mainly in industrial daily production, which has hardly grown since the end of 2018 (figure 7). This fits with the impression that export-oriented industry is experiencing difficulties elsewhere as well. Despite the high levels of capacity utilization in industry, it is therefore to be expected that the pace of private investment will slow. In 2019 we expect to see growth of 4.6 percent, followed by a decline in the growth rate to 1.6 percent in 2020.

Investment in housing is a positive surprise. Despite the sharp fall in sales of owner-occupied homes and serious capacity shortages in the construction sector, this type of investment rose 0.9 percent quarter-on-quarter in the first quarter of 2019, which was more than we had expected. In view of the fall in sales of owner-occupied homes, we still expect housing investment to stabilize, albeit a bit later than we had expected. We look for growth of 3.7 percent in 2019 and 0.8 percent in 2020.

The government is also investing, among other things in infrastructure. It will of course have to deal with the same shortage of workers as businesses and private citizens. This raises the question of whether the government can achieve all its plans in this area in the coming period. In his Spring Memorandum, Minister Hoekstra tellingly spoke of ‘an underspend this year’ in the infrastructure budget. Nonetheless, the figures for government investment in the past two quarters have shown impressive growth. So we still expect government spending over the whole of 2019 to be 4 percentage points higher than in 2018. We are also seeing a stronger (2.4 percent) increase in government consumption compared to last year, mainly due to higher spending on health care. The government is therefore providing a boost to economic growth through higher consumption and investment. And this is welcome, since as we showed in our last Economic Quarterly Report, economic growth this year and in 2020 will depend on government spending much more than in previous years (see also figure 1).

The strong growth of the Dutch economy in 2017 and 2018 is now behind us, and the economy will develop at a more modest rate. A further slowing of growth is likely if the US economy enters a mild recession at the end of next year, as we currently expect. In the short term, there is a significant chance that the trade conflict between China and the US will escalate further. For a discussion of this point, see our Global Economic Outlook accompanying this Quarterly Report. This would also be bad news for the Dutch economy: we currently estimate the direct and indirect negative effects of lower trade on Dutch GDP growth to be several tenths of a percentage point per year. This estimate does not take account of the effect of such a political escalation on the financial markets and on the sentiment of consumers and producers, and is therefore a minimum estimate. A hard Brexit, if it happens, would also cause significant damage to the Dutch economy.