Dutch economy: Moderate growth follows a bumpy growth path

The Dutch economy is on a roll. Statistics Netherlands (CBS) surprised us a few weeks ago with their first estimate of economic growth in Q2 2024. According to their calculations, the gross domestic product (GDP) increased by a significant 1.0% compared to Q1.

The Dutch economy is stagnating. Growth of only 0.1% in 2023 was followed by moderate growth of 0.6% is expected for 2024 as a whole. In Q1 2024, the economy still contracted by 0.3%. Exports have shrunk for two years in a row and investments, especially in housing, have slumped.

These are two opposing messages about the Dutch economy, and both are true, depending on the perspective. Recent quarters have shown a bumpy pattern: Growth and contraction have alternated with significant swings.

This volatility is mainly due to international trade and household consumption. Exports, for example, grew strongly last quarter (+1.3%), after a sharp contraction (-1.4%) in Q1. The opposite was true for household consumption.

In the past, large fluctuations were also common – even apart from the effects of the Covid-19 and energy crises. There were often good reasons for these swings, such as tax measures that cause companies to bring forward or postpone certain investments, or mild or very cold winters that affect gas consumption. However, this does not seem to be the case now, as Statistics Netherlands makes no mention of this in its reporting. Therefore, the underlying causes remain somewhat of a guess.

Growth estimates for 2024 and 2025 revised upward

Due to a surprisingly strong Q2, we are revising our GDP growth estimates upward for this year from 0.4% to 0.6%, and for 2025 from 1.3% to 1.4% (see table 1). This is mainly due to better – or less poor – prospects for exports and private investments.

At the same time, inflation remains stubbornly high. In August inflation stood at 3.3%. For all of 2024, we now expect an inflation rate of 3.1%. In 2025, inflation is expected to fall only slightly to 2.8%.

The 1.0% GDP growth in Q2 was the highest in two years (see figure 1). In the spring of 2022, all Covid restrictions ended, leading to a strong economic recovery. However, since then, growth has been low, and the economy contracted in five of the six quarters between Q4 2022 and Q1 2024.

In Q1 of this year, contraction was mainly due to falling exports (-1.4%). These recovered strongly in the following quarter, with a growth of 1.3% compared to the previous quarter. Housing investments and government spending also rebounded after a poor Q1. Conversely, household consumption, which was strong in Q1, contracted in the most recent quarter.

The production side also shows a remarkable shift

The volatile export figures are reflected in the manufacturing sector. This sector is heavily focused on foreign trade and accounts for a large share of Dutch exports. In Q2, the added value in the manufacturing sector grew by 3.3% compared to the previous quarter, following a 3.3% contraction a quarter earlier (see figure 2).

However, the manufacturing sector alone is not large enough to explain the entire turnaround in GDP growth. Many other sectors also experienced a relatively strong Q2 after a weak Q1. For example, business services grew 1.5%, and a 3.0% contraction in the construction sector turned into 0.9% growth. A further analysis and an outlook for the various sectors (including the relationship between exports and manufacturing) can be found in our most recent sector forecast (in Dutch).

While the recent high economic growth and the 1.4% growth forecast for 2025 sound promising, they don’t tell the whole story about future growth potential. The labor market has been extremely tight for years, and productivity growth has stagnated. This stagnation is also a key reason why inflation remains stubbornly high.

No end in sight for workforce scarcity

Since the end of the financial crisis and the euro crisis, the labor market become increasingly tight, interrupted only briefly by the Covid pandemic. Job vacancies still outnumber the number of unemployed, which is historically exceptional. Although labor market tightness has eased slightly over the past two years, it remains significant. This cautious relief is mainly due to fewer job openings as unemployment levels have barely shifted.

In the somewhat longer term, there is some easing in sight. We anticipate the number of bankruptcies to rise in the coming years (see figure 3). The increase is due in part to high inflation, lagging growth, high interest rates, and repayment of Covid-related debt. We expect the number of bankruptcies to peak in 2027, so the impact in 2024 and 2025 will still be limited. Moreover, the anticipated wave of bankruptcies is not expected to return labor market tightness to pre-2020 levels.

Job market pressure also remains high because productivity is barely rising, and even declined in 2023. This increases the demand for labor. Finally, the new administration has lower labor migration high on its agenda. This also keeps the strain in place, especially in the short term. While there are measures possible to counter the tightness, many of these are not expected to provide relief in the coming years.

We expect unemployment to rise slightly in the coming quarters, averaging 4.0% in 2025. Historically and internationally, this is a relatively low level.

Long-term constraints and low productivity growth inhibit future welfare growth

Persistent labor market tightness is good news for workers: The risk of job loss is low despite mounting bankruptcies, and bargaining power in wage negotiations is strong. However, this tightness also has a downside. New, innovative companies that could drive productivity growth in the Netherlands are facing growth constraints due to the scarcity of personnel. Ultimately, this is bad news for future economic growth and the quality and affordability of public services.

This is not the only cause of faltering productivity. Employment is also shifting from high- to low-productivity sectors. Without government intervention, this trend is expected to continue. The government could, for example, simplify the tax system (including the regulations for the self-employed) or provide more guidance to students on their educational decisions could help.

Finally, underinvestment, in areas such as research & development, and education is a major reason for lagging productivity growth. Earlier this year, we demonstrated that both increased investment and austerity measures significantly influence on our economic prosperity.

Food prices and high wage growth are driving up inflation

In July, inflation (HICP) unexpectedly rose to 3.5%, exceeding our expectations and those of other economists. In August, it slightly decreased to 3.3%. Factors such as rent increases and increased food prices are keeping inflation elevated. Meanwhile, wages are rising sharply, which boosts purchasing power for employees but also increases costs for companies (especially in the service sector).

We expect inflation to average 3.1% this year and 2.8% in 2025 (see figure 4). While the rise in energy prices appears to be largely behind us, food prices and prices for other goods and services (core inflation) continue to rise. Average wages are expected to increase by 6.1% this year and 5.0% next year, mainly due to severe labor market constraints and catch-up growth following high inflation in 2022 and 2023. A detailed explanation of our inflation estimate can be found in our most recent Inflation monitor.

In recent quarters, the various spending components have had both positive and negative impacts on economic growth (see figure 1). Looking ahead, we expect that growth will primarily be driven by household and government consumption (see figure 5). On the other hand, investment and net trade are expected to negatively impact overall growth. Below, we discuss each spending component in more detail.

Catching-up on wages boosts consumption

High inflation in 2022 and 2023 put a big dent in household purchasing power, as wage growth lagged behind price increases. To mitigate socially undesirable outcomes, the government did take measures, such as reducing energy bills and providing income support for low-income households. Despite these efforts, household incomes remained under considerable pressure, resulting in minimal consumption growth (see figure 1).

With inflation now substantially lower, wages are catching up (see figure 6). We expect that by 2025, the entire loss since 2022 will be recovered. Additionally, the newly formed government has announced tax relief measures. As a result, according to the CPB, median purchasing power is projected to increase by 2.5% this year and 1.1% next year.

As employment is also expected to remain strong, there is ample room for consumption growth. We therefore expect household consumption will be the largest contributor to economic growth in the coming quarters.

The downside is that substantial income increases can further fuel inflation. After all, when production reaches its limits, higher disposable income quickly leads to higher prices. This is one of the reasons why we estimate that inflation will remain relatively high. There is even a risk that the effect could be even greater than anticipated. Importing more goods and services may help mitigate this inflationary effect.

The government is running into limits

Everyone is awaiting with keen anticipation the details of the outline agreement (‘Hoofdlijnenakkoord’) that was reached in May by the new Dutch coalition parties PVV (Party for Freedom), VVD (Liberal Party), NSC (New Social Contract, centre party) and BBB (Farmer’s Party). It is expected to be published before Prinsjesdag (the opening of the parliamentary year on September 17). The broad outlines are already clear: The new cabinet will continue the generous budget policy of Rutte-IV, pushing the limits of European budget rules. Ambitions are high in various policy areas, including climate, healthcare, infrastructure, and housing.

However, implementing these plans is anything but easy. The previous administration aimed to strengthen the public sector and stimulate investment in the Dutch economy but did not achieve all its goals. This was partly due to staff shortages and slow decision-making. The so-called under-spending is most significant in defense and infrastructure.

According to the CPB, the underspend is projected to be as high as 0.8% of GDP in 2024, much higher than in recent years (see figure 7). While it is expected to decline gradually, it will still remain relatively high in 2028.

Because of this gradual decline and the government's continued high ambitions, we foresee steady growth in government spending in the coming quarters, contributing substantially to overall economic growth.

Ambitions cannot all be achieved at once

While the large under-expenditure is good news for public finances – resulting in a budget deficit of only 0.4% of GDP in 2023 – it complicates addressing societal challenges. For example, a shortage of personnel delays the energy transition, and the desired strengthening of national defense, and hinders necessary investments in infrastructure.

The significant underspend signals that not everything can be accomplished, or at least not at the desired pace. It urges the government to make sharper choices.

Generous fiscal policies, such as household purchasing power gains, have the side effect of extending high inflation. Tension on the labor market, for example, can hardly ease if job losses in the private sector are offset by job growth in the public sector. Regardless of the limits of the European fiscal rules, it may be wise to pursue a slightly less expansionary fiscal policy for this reason as well.

Business investment suffers from high interest rates, low GDP growth and increase in bankruptcies

Dutch producers have been predominantly pessimistic about the economy for over a year (see figure 8). Manufacturers’ opinions about their order positions have deteriorated significantly, and opinions about stocks have been negative for a long time. Meanwhile, central banks have raised interest rates substantially. The European Central bank’s (ECB) policy rate, which was -0.5% at the beginning of 2022, rose to 4.0% at the end of 2023. Although gradual declines in ECB policy rates are expected, financing costs for companies will remain higher than they have been for years.

These high interest rates and weak growth prospects mean that companies are reluctant to invest. On top of this, we expect the number of bankruptcies to increase in the coming years. Therefore, business investment is projected to contract by 0.6% this year and grow at the same rate next year.

Housing investments strained by staff shortages; and sustainability constraints

After four consecutive quarters of contraction, housing investment surprisingly rose by 1.2% in the most recent quarter compared to the previous one. However, we do not think this is a lasting recovery, partly due to the tight labor market. New construction prospects are subdued because of a significant drop in building permits over the past two years (see figure 9). Yet, the rapid rise of house prices somewhat offsets this effect, making more projects profitable.

Home sales have remained at a decent level so far this year, positively effecting housing investment through home remodeling and transfer taxes.[1] However, the high number of sales is also causing supply to dry up faster, leading to expected declines in transaction numbers in the future.

In recent years, a growing proportion of housing investments have focused on sustainability measures. However, this trend seems to have stalled, partly due to the announced dismantling of the net-metering scheme for solar panels and the cancellation of the (hybrid) heat pump obligation for households.

Overall, housing investment is expected to shrink by -4.1% this year and by -1.5% next year, continuing to negatively impact economic growth as it did in 2023.

[1] Housing investments are a sum of various factors, including new construction, remodeling of existing homes, and transaction costs (such as property transfer tax, notary fees and brokerage fees).

International trade suffers from geopolitical tensions

Despite strong export growth in Q2 2024 (+1.3%), Dutch international trade is faltering. Exports had already contracted throughout 2023, and we expect a similar trend for 2024. Imports from major trading partners such as Germany and the UK have been under pressure for over a year, and this is unlikely to change due to their limited economic growth.

On top of this, Dutch exports seem to be losing momentum. Before the Covid pandemic, Dutch exports often grew faster than the weighted imports from trading partners. However, since 2021, this growth has been consistently lower (see figure 10). We expect this trend to continue in the current year and the next.

The reasons for this deterioration are unclear, but it may be linked to low productivity growth and a generally deteriorating business environment, as recently highlighted by PwC.

US presidential election: Bad news for Dutch exports

The US economy, another major trading partner for the Netherlands, remains strong, keeping exports at full speed. However, this export momentum engine is expected to slow down in the coming years.

Firstly, we expect a slight recession in the US during the second half of this year, which will also reduce its demand for Dutch goods and services.

Secondly, we are still assuming a Donald Trump victory in the November presidential election, although uncertainty has increased since Kamala Harris' Democratic nomination. Trump has already announced plans to increase existing import tariffs and introduce new ones, including those targeting Europe. This would negatively impact Dutch trade with the US.

Even if Kamala Harris wins, Dutch trade won’t be entirely unaffected. While she does not directly advocate for import tariffs on Europe, her stance on China, for example, is not fundamentally different from Trump’s. This means that a Harris victory would still put pressure on global trade, and consequently, Dutch exports, albeit to a lesser extent.