The Danish Economy

The strong growth in the Danish economy since the autumn of 1993 continued into 1998 with rising employment and high capacity utilisation. Meanwhile the balance problems in the economy have become more serious. Recent years' deterioration in the balance of payments escalated in 1998 and for the year as a whole there was a deficit of kr. 16 billion. This is the first current-account deficit since 1989. In addition, capacity problems have led to wage increases considerably in excess of those seen abroad.

At the close of the year industrial and consumer-confidence indicators show that the pressure on the economy is subsiding and that Danish growth is gearing down. A clear cyclical dampening and a period of lower growth than abroad in consumption and investments, irrespective of any weakening in activity abroad, are prerequisites for regaining competitiveness and achieving a sound current-account surplus.

International Background

Growth in the gross domestic product, GDP, of Denmark's trading- partner countries is estimated at 2.6 per cent in 1998. This is close to the growth rate in 1997. In those countries domestic demand rose by 3.0 per cent in 1998, against 2.2 per cent in 1997. The effects of the economic crises in Russia and Southeast Asia on the economies of the USA and the euro area in 1998 were only moderate. The effect may becomestrongerin1999,however,andtheOECD'slatestforecastpredictsdeclininggrowthinDenmark'strading-partnercountriesin 1999.

The sustained cyclical upswing in the USA entered its 7th year. This is the longest uninterrupted boom in the USA since World War II. Preliminary statistics indicate that GDP rose by 3.9 per cent in 1998. Growth was driven primarily by private consumption, which was stimulated by low unemployment. Low savings, together with substantial investments, led to a growing current-account deficit. Although the boom in the USA has been characterised by low inflation, the rate of increase in hourly wage costs is beginning to pick up.

Since 1992 Japan has faced a serious recession, interrupted only by a short period of growth in 1996. The recession is aggravated by the financial crisis in Southeast Asia. Preliminary statistics show a drop in real output of 2.6 per cent in 1998, while during the year unemployment rose from 3.5 per cent to 4.3 per cent. Especially domestic demand was weak, despite falling bond yields over the year to a historic low of less than 1 per cent in the autumn of 1998. The Japanese crisis can be attributed among other things to a financial sector burdened by defaulting loans and facing major solvency problems, cf. Box 2. As a result of the crisis a reconstruction plan for the financial sector was adopted, together with measures to ease fiscal policy.

For the euro area as a whole the economic upswing was increasingly driven by consumption and investments. According to the preliminary statistics real output grew by close to 3 per cent in 1998. Inflation was still subdued, with an increase in the Harmonised Index of Consumer Prices (HICP) of around 1 per cent against 1997. The rate of wage increases was about 2 per cent in 1998.

In Germany GDP growth was approximately 2.6 per cent in 1998, against 2.3 per cent in 1997. Domestic demand was the primary factor for growth, including considerable stockbuilding. Unemployment fell to 10.7 per cent at year-end from 11.7 per cent at end-1997. This was primarily a consequence of job-creation measures. Wage increases in Germany have been moderate in recent years. The annual rate of increase was just over 1 per cent in the 3rd quarter of 1998. At the end of the year the rate of increase in consumer prices was approximately 0.5 per cent, the lowest level for more than 10 years.

Preliminary statistics for France indicate growth of 3.1 per cent in 1998, compared to 2.3 per cent in 1997. Growth was driven primarily by private consumption.

In recent years Finland has achieved one of the strongest growth rates in the euro area and GDP growth for 1998 is estimated at around 5 per cent.

After a number of high-growth years in the UK the picture has changed and consumer and industrial confidence is weak. The preliminary statistics for 1998 indicate an increase in output of 2.7 per cent after 3.5 per cent in 1997. The growth in 1998 can be attributed to consumption and investments, while exports were hit by rising costs and sterling's strength, although the currency weakened during the year.

GDP growth in Sweden is estimated at just below 3 per cent in 1998. Unemployment fell to 6.5 per cent from 8.0 per cent in 1997. This improvement is mainly attributable to domestic demand, although exports also contributed, as a consequence of the weak Swedish krona. In 1998 Swedish inflation was moderate.

Chart 1 Gross domestic product, GDP

Note: Constant prices, seasonally adjusted.
Source: National statistics and own calculations.

Growth in Norway has been high for some years. The main factor is a surge in domestic demand. There have been signs of overheating of the economy, creating a risk of higher inflation. In 1998 Norway was affected by falling oil prices and the balance of payments deteriorated significantly.

Russia was burdened by serious financial and real-economic problems in 1998. Output fell and export earnings declined. Low oil prices were one of the factors involved. Inflation in Russia was considerable.

Economic Activity in Denmark

The strong upswing in activity which has characterised the Danish economy since the autumn of 1993 continued into 1998 with high capacity utilisation and falling unemployment.

Preliminary statistics indicate an increase in Danish GDP of 2.8 per cent in 1998. The primary growth factor is domestic demand, which rose by 4.2 per cent overall. Stockbuilding accounts for a considerable proportion, cf. Table 1.

Private consumption increased by 3.1 per cent and the savings ratio fell. At the same time business investments rose strongly. The total savings deficit of the private sector was 2.4 per cent of GDP, compared to a small surplus in 1997.

In view of the growth in private consumption the Folketing (Parliament) on 26 June 1998 adopted the Whitsun package of fiscal-tightening measures, cf. Box 1. The purpose was to stimulate private savings by e.g. reducing the tax deductibility of interest payments in order to dampen rising prices for owner-occupied homes, which have a great impact on private consumption. Most of the Whitsun-package measures do not take effect until 1999. In 1998 the package's dampening effect on property prices was offset by falling interest rates. Although statistics for prices for one-family homes up to the 4th quarter do not indicate any slowdown in the growth rate, sales have stagnated.

Preliminary statistics point to a neutral fiscal policy for 1998 with a fiscal effect of -0.1 per cent of GDP. This is clearly less tight than the -0.5 per cent planned when the Finance Act was adopted. In recent years it has generally been difficult to maintain the planned degree of tightness in government finances, and public consumption has grown more than laid down in the Finance Act and in local-government budgets. This makes it all the more important that the adopted fiscal tightening in 1999 is achieved and is maintained in 2000.

Box 1 THE WHITSUN PACKAGE OF ECONOMIC MEASURES

The Whitsun package entails adjustments to both corporate and personal taxation. The amendments will enter into force gradually up to 2002. Personal taxes The tax deductibility of interest payments is lowered gradually from 46.4 per cent in 1998 to 32.6 per cent in 2002. The base tax rate is lowered gradually from 8 per cent in 1998 to 5.5 per cent in 2002. The maximum marginal tax rate is raised from 58 per cent to 59 per cent. The basic deduction on calculation of intermediate tax is raised by kr. 32,000. The deductibility of transport expenses is raised for taxpayers in low-income brackets. The tax rates for company cars are raised. Property taxes The tax on imputed rent of owner-occupied homes is replaced by a local-government tax of 1 per cent of the property value, but 3 per cent of the proportion exceeding kr. 2,150,000. Pensions The temporary extra contribution to the ATP (Danish Labour Market Supplementary Pension Fund) pension savings scheme becomes permanent. The real-interest tax is converted to a tax rate of 26 per cent on returns. A tax on equity returns of 5 per cent is introduced and the ceiling for equity investments is raised to 50 per cent. Other measures A number of energy taxes are raised. VAT credit periods are amended and depreciation rules adjusted.

The objective of Denmark's monetary policy is to stabilise the krone, and the effects on the economy of monetary conditions therefore to a great extent stem from abroad. Since 1995 monetary factors as a whole have had a clear expansive effect on the domestic economy, among other things due to the international drop in long-term yields. This makes a tight fiscal policy all the more imperative.

Total exports of goods and services stagnated in 1998. In volume terms they were unchanged from the 1997 level. The dampening of exports must be viewed in the light of the deterioration in competitiveness. An additional factor was the labour-market dispute in April and May, which generally blurs the economic indicators. In volume terms imports increased by 3.7 per cent and domestic market shares were lost.

Chart 2 Nominal and real effective krone rates

Note: Real effective krone rate based on hourly earnings in manufacturing industry. The real effective krone rate denotes the development in Danish wages compared to abroad in a common currency.
Source: Statistics Denmark, OECD, the Danish Employers' Confederation and own calculations.

Throughout the cyclical upswing Danish manufactured exports have grown at a slower rate than exports from competing countries. Since 1993 Denmark has lost market shares. Denmark's competitiveness deteriorated as a result of higher wage increases than in competing countries and an increase in the effective krone rate. Moreover, the Danish economy was characterised by high capacity utilisation and exports have thus generally lagged behind the trends in export markets.

The Danish krone strengthened in both nominal and real terms in 1998, cf. Chart 2. At the close of the year the nominal effective krone rate was approximately 2 per cent higher than at end-1997. This is mainly attributable to the development in the Swedish krona, the dollar and the pound sterling. A stronger increase was seen in the real exchange rate based on an hourly wage index for manufacturing industry, which illustrates Danish wage growth compared to abroad in a common currency. This reflects more vigorous wage growth in Denmark than abroad.

Total employment rose by around 60,000 in 1998. This matches the increase in 1997, cf. Table 2. Employment in the private sector improved by 50,000, while public-sector employment increased by 10,000, including service-related jobs at local-government level.

Unemployment has fallen substantially in recent years, to the lowest level since 1980. Recorded seasonally-adjusted unemployment was 6 per cent at year-end, while unemployment compiled by Eurostat according to international guidelines was 4.6 per cent. In contrast to the statistics of Statistics Denmark, Eurostat's statistics are e.g. based on the number of people available for and actively seeking employment. For comparison, the Eurostat statistics show a rate of unemployment of 10.8 per cent in the euro area.

A precondition for sustained growth in employment without accelerating wages is a growing supply of labour. As an element of the Finance Act agreement for 1999 the Folketing (Parliament) adopted a package of labour-market reforms. It includes a reduction of the period of entitlement to unemployment benefit from 5 to 4 years, a tightening of the rules on availability for work, and enhanced activation measures. Moreover, the rules of the early-retirement scheme were changed in order to raise the average age of retirement.

Economic indicators show that towards the end of the year particularly activity in the manufacturing industry was dampened. Capacity utilisation and new orders received from both domestic and export markets declined, while sales of manufactures stagnated.

The industrial confidence indicator averages businesses' assessment of output expectations, order books and stocks of finished goods. Chart 3 shows that industrial confidence decreased significantly in the 2nd half-year and was exceptionally low at year-end.

Chart 3 Consumer confidence and industrial confidence indicators

Note: Seasonally adjusted. The composite confidence indicator reflects business enterprises' expectations of the following three months. The indicator includes data on output expectations, overall order books and stocks of finished products.
Source: Statistics Denmark.

Consumer confidence also declined in the 2nd half-year and at end-1998 was at the same low level as before the upswing began in 1993, cf. Chart 3. Falling consumer confidence was particularly affected by the evaluation of the economy in general. However, retail sales and car sales still show high growth and no dampening of consumption is indicated.

The decline in these indicators must be viewed in the light of the tougher conditions for exports and the Whitsun package of economic measures. This may be a forewarning of a slowdown in economic activity in 1999, although it is uncertain whether the intended dampening of domestic demand will be achieved.

"to be continued on next page"