Dutch economy: two years of muddling through expected

16 December 2022 14:00 RaboResearch

Two years of moderate growth are expected to follow impressive recovery growth in 2021 and 2022.

Rear view of a group of cyclists crossing a junction in central Amsterdam during the morning commute on a very wet day with torrential rain.

Due to a particularly rapid recovery from the corona pandemic, the Dutch economy has been practically bursting at the seams since this spring. Staff shortages, material scarcity, high utilization rates: they leave little room for further growth. Meanwhile, high energy costs and increased interest rates are weighing increasingly heavily on consumer and business spending, both in the Netherlands and for important trading partners.

The Dutch economy already contracted slightly in the summer and was 0.2 percent smaller than in the previous quarter. We also foresee a slight contraction for the last three months of the year. Due to the strong growth in the first half of the year, the economic growth rate for 2022 is still expected to be 4.2 percent. But for 2023 and 2024, we assume a significantly lower growth rate. Scarcity and rising prices continue to plague the Netherlands and key trading partners, while the government wants to stimulate the economy. In our view, this situation pushes the economy into a "muddling through" mode: neither strong contraction nor strong growth. We therefore expect the Dutch economy to grow by only 0.6 percent in 2023, followed by 1.0 percent in 2024.

Figure 1: Economic expectations

Source: RaboResearch

Figure 2: Growth will come from government in years ahead

Source: CBS, RaboResearch

Consumer prices continue to rise in 2023 and 2024

Inflation has declined slightly in recent months, but that cannot prevent average inflation for all of 2022 from ending in the double digits. We assume 11.6 percent, followed by 4.2 percent in 2023. This means that consumer prices will remain high and are also expected to keep rising relatively hard. By instituting an energy price cap, that price increase will no longer come from making home energy more expensive, but from price increases in other products and services, such as daily groceries. In the last six months we already saw that consumer prices outside of energy are rising sharply (see Figure 3). This is partly because producers of other items have also seen their energy costs rise, and they are passing on these costs to a greater or lesser extent. We also see rising labor costs and the prices of raw materials increasing. This trend is likely to continue next year. On top of that, the government will be providing considerable stimulus to the already overheated economy, which is expected to maintain upward pressure on prices.

For 2024, we assume that the price cap on energy will continue in slimmed-down form. As a result, inflation due to rising energy prices will make a comeback. We therefore expect inflation to be higher again in 2024, at 5.9 percent. Of course, much depends on the actual development of oil, gas and electricity prices and the cabinet's policy response to them. We assume in our estimate that these prices will remain relatively high in the coming years, in part because the main alternative to natural gas from Russia, LNG, involves higher costs than natural gas from a pipeline.

Figure 3: Not only energy has become more expensive

Source: CBS, RaboResearch

Unemployment rises but remains relatively low

After dropping to a low of 3.2 percent last April, unemployment rose to 3.7 percent in October. We expect unemployment to rise further over the next two years, reaching an average of 4.1 percent in 2023. For 2024, we assume 4.5 percent unemployment.

The slowdown in economic growth contributes to this. Furthermore, we also believe that frictional unemployment will again play a more prominent role in the labor market. Frictional unemployment – short-term unemployment because job seekers and employers do not find each other overnight – is linked to economic dynamics. This momentum is expected to swell again next year after having been at a low ebb for the past two years due to the corona support packages (see Figure 4). Indeed, government support during the pandemic not only prevented viable companies from going under, but also kept afloat companies that offer products or services for which there is not, or no longer, sufficient demand. In normal times, these companies would have already had to cease operations, freeing up money, business space and personnel for other entrepreneurs. This process is a much-needed part of a healthy economy, but the trade-off is a somewhat higher level of unemployment.

Figure 4: Slow return of business dynamics

Source: CBS, RaboResearch

Aging population expected to keep labor scarce

Still, unemployment is likely to remain well below the long-term average in the coming years. So we are not assuming that employers will soon have their choice of candidates again, like in 2014, when there were more than eight job seekers for every job opening. By comparison, in the third quarter of this year, there was less than one job seeker for every vacancy.

The Netherlands will age at an unprecedented rate over the next two decades. In 2030, according to the latest population projections by PBL and CBS, the Netherlands will have about 220,000 more 23- to 66-year-olds than this year. And there will be as many as 640,000 more 67-year-olds by then. Thus, despite raising the state pensionable age, the number of people of employment age per Dutch pensioner will reduce (see Figure 5). Relatively speaking, the Netherlands will consist of more and more consumers of labor, but fewer and fewer providers of it. We therefore expect that there will still be cyclical peaks and troughs of unemployment in the future, but presumably from a structurally lower point. As a result, it will remain challenging for employers to find enough people. Especially since the public sector, particularly healthcare, will grow strongly and thus compete with companies for staff more than it does today.

Figure 5: Fewer employed people per retiree

Note: For 2000 and 2010: concerns the ratio of over-65s to the number of 22- to 64-year-olds. For 2022 and beyond: refers to the ratio of 67-year-olds to the number of 23- to 66-year-olds, due to the raising of the state retirement age and the greater educational participation of people in their early twenties. Source: CBS, RaboResearch

Consumption: small plus expected to turn into a minus

Rising retail prices and rising energy costs were still outweighed by the fading corona pandemic in the first half of this year. Consumer spending rose hard in the first and second quarters, by +1.2 percent and 0.8 percent quarter-on-quarter (QOQ), respectively. But in the third quarter, high inflation seems to have clearly taken hold of households appetite for buying, and in purchasing power: consumption rose only marginally that summer quarter with a plus of 0.1 percent QOQ.

Next quarter, this is expected to turn to a contraction, and for all of 2023 we foresee consumer spending to be 0.2 percent lower than in 2022. More and more Dutch people are facing higher energy bills. And as high energy costs feed through to the prices of other consumer goods and services, the gap between collective wages and non-energy prices is also widening, further undermining household purchasing power (see Figure 3).

Figure 6: More often in permanent employment

Source: CBS, RaboResearch

A boost to household consumption – accounting for more than 40 percent of gross domestic product (see Figure 10) – is that labor force participation is at a very high level, and there appears to be an increase in the share of employed people on permanent contracts (see Figure 6). This may boost willingness to buy. Moreover, while consumer confidence may be at historically low levels, the Dutch are less pessimistic about unemployment for the time being: only a small majority expect it to increase over the next 12 months (see Figure 7). Therefore, we do not expect consumers to take extra precautionary saving measures for that reason. Furthermore, we assume that wages will continue to rise in the coming years to partially make up for the loss of purchasing power.

For 2024, therefore, we assume that consumers will again spend 0.8 percent more. There is of course a downside risk if unemployment rises faster than currently anticipated, or if purchasing power is undermined more than we currently assume. A possible boost to consumption in the next two years could lie in the aging population: proportionately fewer Dutch people are dependent on work for their income, which may make household spending less sensitive to the state of unemployment. Pensioners also increasingly have more purchasing power. This is in part due to the increased labor participation of women within the household – households increasingly receive two supplementary pension benefits on top of an AOW benefit. Moreover, that state pension benefit, like many supplementary pensions, will also be greatly increased next year.

Figure 7: Moderate unemployment expectations

Source: European Commission

Companies are keeping their hand on the purse strings

After an unusually strong 8.6 percent QOQ increase in the second quarter thanks to large spending on transportation equipment, business investment actually fell slightly again in the third quarter with an estimated -1.4 percent QOQ. While business investment overall will still be much higher this year than in 2021, we are assuming a 0.3 percent contraction for 2023, with business investment contributing negatively to economic growth next year. Indeed, high energy prices not only erode consumers' purchasing power but also weigh heavily on businesses. As consumers buy less stuff and services from businesses, businesses earn less. That leaves less room to invest, which had in fact already become less attractive due to higher interest rates and economic uncertainty.

Moreover, the energy crisis – in addition to being a downside risk – can also be an upside risk: it may entice entrepreneurs to put more money into sustainability more quickly, which can be a boost to business investment. Labor market tightness can also be ambiguous for business investment: on the one hand, it is an incentive to invest in productivity in order to meet demand with the same workforce. But on the other hand, that same labor shortage can actually hinder short-term investment. For now, we assume that business investment will recover only modestly from the second half of 2023 and will be 0.8 percent higher in 2024 than the previous year.

Figure 8: Economy grown significantly in last three years

Note: *Corporate and government investment are an estimate, the breakdown of which is not available until CBS' second calculation of GDP. Source: Macrobond, RaboResearch

Government wants to keep spending

Due in part to additional spending due to the corona pandemic, government consumption swelled to 6.7 percent more than just before the pandemic (see Figure 8). A small dip of 0.1 percent QOQ in the third quarter notwithstanding, the government plans to continue expanding in coming years. We therefore expect government consumption, a sizeable item that includes healthcare, defense and civil servants' pay, to increase 2.3 percent in 2023, followed by 2.6 percent in 2024.

Public investments, such as public spending on infrastructure, are actually lower than before the pandemic. There are also extensive plans for this, including in the area of sustainability. We expect a year-on-year increase in public investment of 2.0 percent in 2023. For 2024, we assume an increase of 3.1 percent. Government consumption and investment together account for just under 30 percent of gross domestic product (see Figure 10), and planned government plans are therefore expected to be the main driver of economic growth over the next two years.

However, there are clear downside risks for these two items, starting with the staff shortage. Partly due to tightness in the labor market, the government has been unable to fully implement its plans for several years. In the coming years, although unemployment is rising slightly, finding sufficient personnel is expected to remain challenging. For specific infrastructure projects, the protracted nitrogen problems also remains an obstacle. The question is therefore whether governments will succeed in (fully) executing their plans. Finally, the government's interest costs have risen sharply, placing a heavier burden on public finances and possibly leaving less room than expected for the planned additional expenditures and investments.

Housing investments down due to cooling housing market

Residential investments fell 2.4 percent in the third quarter compared to the previous quarter, contributing largely to the economic contraction in the third quarter. Housing investments, typically accounting for about 5 percent of the economy, is a sum of new construction, remodeling of existing homes and transaction costs (think transfer tax, notary fees and brokerage services), among other things. With increased interest rates, declining home sales and falling house prices, we expect housing investments to continue to act as a drag on the economy in coming years. For 2023, we foresee a decline 5.5 percent for housing investments, followed by a further decline of 4.5 percent in 2024.

Figure 9: 12 percent fewer licenses than last year

Source: CBS, RaboResearch

There was already limited upward room to move in housing construction due to labor shortages, site disputes and nitrogen issues. And so the drop in building permits this year (see Figure 9) suggests that the trend in new construction over the next 18 months is downward rather than upward. That picture is reinforced by the sharp decline in the number of yet to be built homes sold in recent months.

The number of existing owner-occupied houses changing hands has also declined sharply. It is a trend that is expected to continue in 2023 and recover only slightly in 2024. With this, not only is spending on transaction costs decreasing, but presumably demand for new kitchens and bathrooms, for example, is also falling. Anyway, due to increased interest rates, we foresee less demand for building work. While there is an increased demand for sustainability measures, the higher interest rate makes large and expensive renovations less attractive for those who would normally borrow money for this purpose.

An upside risk to housing investment lies in the phasing out of the landlord levy paid by housing associations. This may provide additional impetus for renovation and sustainability by housing associations over the next two years. A downside risk is a sharper drop than currently anticipated in new construction, due to the cooling owner-occupied housing market.

International trade suffers from global cooling

We also expect a short-term economic downturn in major trading partners, such as Germany, the US and France, in many cases somewhat larger than ours. High inflation there also limits consumer and business spending, which impacts their demand for Dutch goods and services. Dutch exports are therefore expected to grow less rapidly in the next two years than in recent years. For 2023, we assume a plus of 1.4 percent in exports, for 2024 – when the global economy is expected to recover a bit – we forecast a growth of 2.4 percent in exports.

On the other hand, lower consumer spending and business investments in the Netherlands also mean slower import growth. For 2023, we assume import growth of 1.2 percent, followed by an acceleration to 2.8 percent in 2024 when consumption and investments also increase again. Combined, the added value of international trade for the Dutch economy thus continues to grow in the coming years, but less rapidly than in 2021 and 2022 (see Figure 2).

Figure 10: Expenditure side of GDP

Note: Relates to value added in constant prices. Source: CBS, RaboResearch

Table 1: Economic expectations for the Netherlands

Source: CBS, RaboResearch