The Danish Economy

Denmark entered 1997 with favourable economic fundamentals, although wage development was relatively strong compared to abroad.

More serious prospects thus loom at the start of 1998, since the economy is now close to full capacity utilization. In this situation it is difficult to maintain a current-account surplus and to dampen wage growth. A particular factor of uncertainty is whether the unrest on the financial markets in Southeast Asia will affect the industrialized countries, and thus have an impact on the Danish economy.

Development in 1997

Since the autumn of 1993 Denmark has experienced a prolonged cyclical upswing. After dampening temporarily in 1995 output regained momentum in 1996, and this strong growth continued in 1997, cf. Chart 1.

The international cyclical development reflects that the upswing has spread only slowly among the industrialized countries. Considering these countries as one, growth is gradually rising, but with variations in the cyclical positions of the individual countries. At one end of the range is a group of countries such as the USA, the UK, the Netherlands, Norway and Denmark. They have experienced strong growth and declining unemployment for a number of years. At the other end is Japan where the upswing has not yet begun. Between them lie several continental European countries, including Germany and France, where as yet the upswing is moderate.

In Japan growth declined in 1997 after making good progress in 1996, which was attributable primarily to domestic demand. Both private consumption and investments fell as a consequence of a tightening of fiscal policy which took effect in 1997. Output measured as growth in the gross domestic product, GDP, rose by 1/2 per cent in 1997, stimulated by net exports

up to the 3rd quarter. Japan is the industrialized country most severely affected by the crisis which began with foreign-exchange unrest in Thailand in July 1997. This turbulence spread to other countries in Southeast Asia and in the autumn to the share markets, causing prices to plummet, cf. p. 46ff. on the economic development in the region and p. 85ff. on assistance programmes initiated by the International Monetary Fund, IMF.

Despite the unrest on the financial markets the real economic development in the USA does not yet appear to be particularly affected. In 1997 growth in GDP was 33/4 per cent. The sustained cyclical upswing, with falling unemployment and continued low inflation, is driven particularly by private consumption and investments. Unemployment is now below the level normally considered compatible with stable inflation. The absence of any inflationary pressure can be viewed against the background of a flexible US labour market with rising employment in the service sectors especially. In view of the sustained favourable growth the Federal Reserve in March 1997 raised the benchmark official interest rate. Since then monetary policy has remained unchanged as a result of the stable development in prices. The dollar's strengthening against the European currencies and the Japanese yen has helped to keep import prices down, but may reduce export opportunities in the long term.

In Germany growth has so far stabilized at just over 2 per cent after the economic revival in 1996. The primary growth factor is exports, which have increased as a consequence of the weakening of the D-mark against the dollar and the slowdown in German wage growth. The latter fell to below 2 per cent on an annual basis during 1997. Unemployment averaging 111/2 per cent of the labour force in 1997 was the highest in decades and contributed to dampening the development in private consumption. Investments also showed weak development, and domestic demand is thus not strong enough for the upswing to be self-sustained. An inflationary tendency due to rising import prices was the background to the Bundesbank's raising of the repo rate in October.

In France too exports were the principal contributor to growth in 1997. There were no clear indications of greater domestic demand, despite slightly higher wage increases than in Germany.

In the UK the upswing entered its fifth year in 1997 and GDP rose by 31/2  per cent. Growth was stimulated by domestic demand, as rising property prices and declining unemployment caused private consumption to increase. Indications that the economy was overheating led the Bank of England to raise its central official interest rate on several occasions in 1997.

In Italy GDP rose by around 1 per cent in 1997, primarily driven by growth in domestic demand.

In recent years both Norway and Finland have enjoyed strong growth, with GDP increases of between 4 and 5 per cent. In Finland the upswing is broadly based, whereas in Norway it is related primarily to rising domestic demand based on the substantial North Sea oil revenues.

In contrast to the other Nordic countries the economic upswing has not yet gained a firm hold in Sweden. Exports increased, but the moderate growth was related particularly to private consumption. Wages increased by almost 5 per cent in 1997.

Growth in the overall EU area is estimated at just over 21/2 per cent in 1997. Efforts to comply with the convergence criteria of the Maastricht Treaty resulted in further movement towards low inflation and low long-term interest rates. This stimulates economic activity and tends to offset any adverse impact of fiscal-policy tightenings in the EU member states. Furthermore, the low interest rates contribute to achieving budget improvements, making the convergence process self-sustaining, cf. p. 32f. on the development in interest rates and p. 76f. on the convergence situation within the EU.

Table 1 Key figures for the Danish economy

Preliminary statistics indicate growth in Danish GDP of 3 per cent in 1997. The important trading partners, Sweden, Germany and France, have now drawn closer to Denmark's growth rate. However, Denmark still stands out among these countries with stronger growth which is based on exports and private consumption as well as investments, cf. Table 1.

Total domestic demand rose by 5 per cent, compared to just over 2 per cent in Denmark's trading-partner countries.

The savings ratio fell by approximately 2 percentage points in 1997, while private consumption rose by 31/2 per cent. In the light of the development in private consumption the Folketing (Parliament) in May and October adopted extraordinary measures to tighten fiscal policy. In May these were adjustments of tariffs and taxes in the areas of transport and the environment, and land registration fees were raised. In October the measures were supplemented with a number of temporary steps. With effect from October 1997 the stamp duty on supplementary mortgage loans was raised from 1.5 per cent to 5 per cent, excluding for supplementary mortgage loans for new buildings, conversions or extensions and in connection with

change of ownership. In 1998 an extraordinary contribution to the Labour Market Supplementary Pension Fund (ATP) amounting to 1 per cent of gross salaries is being levied.

The increase in consumption must be viewed in conjunction with the strongly rising prices for owner-occupied homes, which has increased the value of the housing stock, cf. Chart 2. Since mid-1993 prices have risen by 50 per cent, and by 12 per cent in 1997 alone. The rise in property prices is both attributable to growth in disposable incomes and to general confidence in the economic situation and declining long-term interest rates.

The rising property prices have also stimulated residential investments which continued to increase in 1997. Growth in business investments was higher in 1997 than in 1996. The expansion of the capital stock in recent years reflects adjustment to the higher demand.

In 1997 total government demand increased by 3 per cent, which was primarily related to rising employment in the public sector. According to Ministry of Finance estimates from December 1997 fiscal policy was moderately contractive in 1997, but not as tight as planned when the Finance Act for 1997 was adopted. In 1996 the end-result of a planned tightening was an expansion.

In Denmark fiscal policy is the most important instrument used to manage economic activity. Monetary policy is based on the sole objective of maintaining a stable krone rate vis-ā-vis the other core currencies. Therefore the impact on economic activity of financial conditions, viz. the development in interest rates and the effective exchange rate of the krone, is to a high degree determined by the development abroad.

Model computations of the effects of respectively financial conditions and fiscal policy on GDP are shown in Chart 3. The financial index is described in more detail in the Monetary Review - May 1997, while the effects of fiscal policy on GDP are described in the Budget Review of December 1997 from the Ministry of Finance. An increase in either the financial index or the fiscal-policy index indicates a relaxation, whereas a decrease corresponds to a tightening. A decline in the fiscal-policy index thus represents a contractive fiscal policy.

In the period from mid-1995 financial conditions, measured by the financial index, have had an expansive effect on the Danish economy with no counteracting contractive effect from fiscal policy.

In 1997 the effective krone rate continued to weaken in both nominal and real terms, cf. Chart 4. The nominal depreciation was a good 2 per cent

and is related particularly to the strengthening of the dollar and the pound sterling. One consequence of the weakening was rising import prices throughout the year. The Southeast Asian currencies, which depreciated substantially in 1997, are not included in the calculation of the effective krone rate. Taking this into account, at end-1997 the effective krone rate was by and large unchanged from one year previously.

Total exports of goods and services increased by 31/2 per cent in 1997. Export growth in the other European countries was generally stronger than in Denmark. Manufactured exports appear to have lost market shares in 1997. The growth in exports was more than offset by the increase in imports, which was three times the rate of GDP growth. The far stronger growth in imports than in exports is related to relatively high capacity utilization in the manufacturing industry.

During the last four years unemployment has declined sharply. The background is the strong upswing in the economy and the development in leave schemes and transitional allowance schemes, as well as a series of measures designed to improve structures in the labour market. Despite the

Table 2 The Danish labour market

structural-policy-related improvements reports from the labour-market councils show that the labour market has become tighter in 1997.

In 1997 total employment increased by approximately 60,000, cf. Table 2. Around 35 per cent were employed in the public sector, primarily local government. In step with rising turnover in the manufacturing sector the employment level also increased and is now back at the 1993-94 level.

Recorded unemployment is now down to the same level as in 1980. Compared to other EU member states Denmark's unemployment is low.

(to be continued)