The Danish Economy
Growth in the Danish economy was moderate in 2002, and mainly attributable to increasing private consumption and business investments. The balance of payments showed a large surplus. Imports rose, and even though the global economy weakened, exports continued to expand. Unemployment remained low, and the labour market is still tight, with wage increases exceeding those abroad. The rate of price increase rose and was on average slightly higher than in the euro area. In the longer term a higher rate ofwageincreasethanabroad may be to the detriment of competitiveness.
The economic situation does not warrant any change in the medium-term fiscal-policy stance that is aimed at reducing the government debt significantly over the next decade. It is important to have a long-term perspective for economic policy, taking into account the future demographic development of an ageing population.
International background
The global economy was still subdued in 2002. In the first months of the year there was growing confidence in the US economy's ability to rapidly resume growth after the downturn in 2001. At the same time it was hoped that increasing exports would lead to higher investments and employment in the euro area, and thereby generate higher growth during the year. The positive predictions were not fulfilled on either side of the Atlantic. Growth was moderate in the USA, and weak in the euro area, cf. Chart1. The dollar weakened vis-à-vis the euro throughout 2002 and the beginning of 2003. The greater part of the dollar's strengthening in 1999-2000 has thus been eliminated.
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Chart 1 |
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| Note: Constant prices. | |
| Source: National statistics and own calculations. | |
Against the background of the weak US economy the monetary and fiscal policies were eased considerably in 2001, and at the beginning of 2002 the economy was improving. There were growing expectations of a sound upswing, but in the course of the summer optimism was replaced by increasing concern about the future development. As a result of e.g. accounting scandals in several large US corporations the stock markets were hit by significant stock-price drops, cf. p. 39. Both consumer and business confidence declined during the summer. GDP growth was 2.4 per cent in 2002, but the labour market remained weak. Private consumption increased moderately, and the expected upswing in business investments did not materialise.
The Federal Reserve cut the federal funds target rate by 0.5 per cent to 1.25 per cent in November in view of the weak development in demand, output and employment. In 2002 inflation was 1.6 per cent, against 2.8 per cent in 2001.
The government budget balance deteriorated considerably during 2002 in the light of tax cuts, increased expenditure for e.g. military and security measures, and weaker economic activity. The deficit in 2002 was 3.1 per cent of GDP, against 0.5 per cent in 2001.[1] Deficits are now also expected in the coming years.
At the beginning of 2003 the prospects for the US economy were subject to considerable uncertainty. This was not least related to concern about the effect of the lower stock prices on the real economy, and how a possible war in Iraq would impact oil prices. Despite lower business investments, the balance-of-payments deficit increased to almost 5 per cent of GDP in 2002, cf. Box 1. This deficit, reflecting increased indebtedness in both the private and public sectors, is not sustainable in the long term.
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Box 1
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The US balance of payments has deteriorated gradually since 1991 and was almost 5 per cent of GDP in 2002. During the sustained upswing up to the year 2000, the growing US balance-of-payments deficit reflected a combination of increasing investments and reduced savings in the private sector. Consequently, the private savings surplus in the early 1990s was replaced by a considerable deficit in the years up to 2000. The continued increase in the US balance-of-payments deficit in the last two years should be seen against the background of deteriorating public finances and only a minor increase in private savings. The deterioration in public finances is especially attributable to an expansionary fiscal policy in the form of tax cuts and high growth in public spending. The balance of government finances has thus been reversed from a surplus of more than 1 per cent of GDP in 2000 to a deficit of more than 3 per cent of GDP in 2002. At the beginning of 2003 the President proposed further tax cuts. Against this background a further increase must be expected in the deficit on government finances and thereby a sustained high balance-of-payments deficit. In the euro area the balance of payments has been close to equilibrium since 1990. The 1990s saw a private savings surplus, which gradually declined up to the year 2000. After a significant improvement in the 1990s government finances have weakened in the last few years. This weakening has been far less pronounced than in the USA, and in 2002 the euro area's government budget deficit was lower than that of the USA. |
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| Balances of payments and government balances in the USA and the euro area | |
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Note: In the euro area proceeds from the sale of UMTS licences amounted to 1.1 per cent of GDP in 2000. This income is included in the government balance. |
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The dollar's weakening against the euro is offset by its strengthening vis-à-vis a number of Latin American currencies. The overall impact of the exchange rate on the US economic activity and balance of payments will therefore be limited in 2003.
Following a strong downturn in 2001, the economic development in Japan improved in 2002. Exports rose, and growth in private consumption resumed. Investments continued to decline, however, and the fundamental structural problems, especially the bad loans in the banking sector, remained unsolved. There was a sound rate of growth throughout 2002, but GDP for the year as a whole was only 0.3 per cent higher than in 2001. The government deficit rose to 8 per cent of GDP in 2002, e.g. driven by higher public consumption, and the debt was 140 per cent of GDP.[2] The monetary-policy interest rate is close to zero, and the scope for further relaxation of monetary policy is limited. However, since prices are declining, the real interest rate is higher than in the USA and the euro area.
In the euro area the expected upswing did not emerge, and growth is estimated at 0.8 per cent in 2002 against 1.5 per cent in 2001.[3] The low growth is a result of weak development in both consumption and investments, while the upturn in exports was too small to counter the subdued domestic demand. Unemployment rose slightly in 2002. Growth in the euro area is impeded by e.g. rigid labour-market structures and political reluctance in a number of member states to reform labour-market legislation.
Despite the weak economic activity and stronger euro, inflation was above 2 per cent for most of the year, and thereby above the medium-term target of less than 2 per cent set by the European Central Bank, ECB. Overall inflation has mainly been under pressure from higher prices for services. This reflects a relatively strong increase in wage costs. The changeover to the euro has only affected overall inflation to a limited extent, cf. p. 72.
The ECB operates within a narrower monetary-policy framework than the Federal Reserve. While price stability is a treaty-bound objective of the ECB, monetary policy furthermore supports the general economic policy to the extent that this does not jeopardise the prospects for price stability. In December 2002 the ECB lowered the interest rate by 0.5 per cent in view of the expected reduced inflationary pressure in the future as a consequence of the weak economic activity in the euro area.
Government finances deteriorated in 2002. For the overall euro area, a deficit of 2.3 per cent of GDP is expected, against 1.5 per cent in 2001.[3] This is partly due to the weak economic activity, but also to unfinanced taxcutsinsome member states. A deficit significantly exceeding 3 per cent of GDP was seen in Portugal in 2001, and is expected for Germany in 2002. As a consequence, the EU Treaty's procedure on excessive budget deficits has been initiated, with a requirement for rapid budget improvements, cf. p. 78.f. Government finances in France and Italy also present challenges. The problems seen in these four member states are a result of insufficient consolidation of government finances in the preceding years of stronger growth.
Low and declining business and consumer confidence indicate that investment and consumption activity will remain low in the first months of the year. An upswing in the euro area is not expected before the 2nd half of 2003 at the earliest. In view of among other things the strengthened euro it will presumably be moderate.
In the UK, Sweden and Norway GDP growth was 1.5-2 per cent in 2002, and thereby a little higher than in the euro area. In all three countries growth was driven especially by fair growth in private consumption. Consumption growth in the UK was affected by rapidly rising housing prices, while consumption in Sweden was stimulated by tax cuts, and in Norway by large wage increases.
Labour markets in the three countries continued to be tight – particularly in Norway, although rising unemployment during the year made the tendency for a shortage of labour less pronounced.
At the end of 2002 the monetary-policy interest rates in the three countries were unchanged from the year before. Sveriges Riksbank and Norges Bank both raised the interest rate in mid-year, but lowered it again towards the end of the year, in view of the less favourable economic outlook. At the end of the year inflation rates in the UK and Sweden were close to the inflation targets of 2.5 per cent and 2 per cent of the Bank of England and Sveriges Riksbank respectively. In Norway the krone's strengthening dampened the price development during the year. In the last months of 2002 inflation (exclusive of energy and taxes) was approximately 2 per cent and thereby below Norges Bank's target of 2.5 per cent.
At the beginning of 2003 Norges Bank and the Bank of England lowered their interest rates by respectively 0.5 per cent and 0.25 per cent.
Economic activity in Denmark and the balance of payments
During the last two years the Danish economy has been fairly robust despite the subdued international economy, although there were some signs of a slowdown in the 2nd half of 2002. Unemployment was low and employment high in 2002. There was a surplus on the balance of payments and government finances. GDP growth was 1.6 per cent in 2002, against 1.4 per cent the year before, cf. Table 1. GDP growth was relatively strong in the 1st half of the year, but weakened in the 2nd half.
Private consumption was one of the principal factors contributing to growth, cf. Chart 2. In 2002 private consumption rose by 2.2 per cent after remaining virtually unchanged since the Whitsun package of incentives to stimulate savings in 1998. The increase in private consumption reflected higher real incomes, a low level of interest rates, and lower interest expenditure following loan conversions in view of falling interest rates. The overall financial conditions thus continued to be expansionary. The low interest rates furthermore buoyed up housing prices, although the rate of increase diminished. The development in housing prices concealed varying tendencies related to geographical location and type of housing. The highest price increases were seen for flats in or near Greater Copenhagen.
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Chart 2
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| Note: Private investments comprise business and residential investments. | |
| Source: Statistics Denmark and own calculations. | |
In overall terms private investments increased by 1.4 per cent in 2002, after increasing by almost one half per cent in 2001. Despite the international economy's dampening, investments in machinery and transport equipment rose. Private building and construction investments fell in 2002, reflecting a small increase in housing construction and a decline in business construction activities.
In 2002 the private savings balance improved to 1.1 per cent of GDP, cf. Table 1. This primarily reflects that the reclassification of the special pension contribution of 1 per cent of income formally moved 0.5 per cent of GDP from public to private savings.
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Table 1
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| Real growth against the previous year, per cent |
1998
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1999
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2000
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2001
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2002
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| Gross domestic product, GDP |
2.5
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2.6
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2.8
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1.4
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1.6
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| Private consumption |
2.3
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0.7
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-1.9
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0.4
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2.2
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| Government demand |
2.7
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2.1
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1.3
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2.8
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0.7
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| Business investments |
13.5
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1.9
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9.4
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4.1
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1.6
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| Residential investments |
4.2
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-1.0
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9.9
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-14.2
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0.9
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| Domestic demand, excluding |
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| stockbuilding |
4.2
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1.2
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1.3
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1.0
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1.6
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| Stockbuilding1 |
-0.1
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-1.1
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0.6
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-0.3
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-0.5
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| Domestic demand, total |
4.0
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0.1
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2.0
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0.8
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1.1
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| Exports |
4.3
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12.3
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13.1
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3.2
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3.2
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| Imports |
8.9
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5.5
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11.9
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1.8
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2.3
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| Net exports1 |
-1.4
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2.6
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0.9
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0.7
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0.5
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| Unemployment, per cent of the labour force |
6.6
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5.7
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5.4
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5.2
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5.2
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| Consumer-price index2, percentage growth |
1.3
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2.1
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2.7
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2.3
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2.4
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| Current account, per cent of GDP |
-0.9
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1.8
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1.6
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3.1
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2.9
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| Government balance, per cent of GDP |
1.1
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3.2
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2.5
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2.8
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1.8
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| Private savings balance3, per cent of GDP |
-2.0
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-1.5
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-0.9
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0.3
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1.1
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| Source: Statistics Denmark. 1 Contribution to growth in GDP at constant prices. 2 The Harmonised Index of Consumer Prices (HICP). 3 Current account minus government balance. |
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Growth in overall government demand, i.e. government consumption and investments, was dampened in 2002, but at the same time government revenue as a ratio of GDP fell. The lower revenue is attributable to slightly lower corporate taxes, the tax freeze, the low proceeds from taxation of pension yields, and not least the reclassification of the special pension savings scheme. The surplus on the government budget balance receded from 2.8 per cent of GDP in 2001 to 1.8 per cent of GDP in 2002. Measured in terms of the effect on public finances, the fiscal policy was marginally expansive. Growth in government consumption fell to 1 per cent after a few years with growth in excess of the intermediate target of 1 per cent per annum.
Growth in exports continued in 2002, and there was no sign of lost market shares, although for some years competitiveness has deteriorated due to relatively high wage increases in Denmark, and in 2002 also the lower dollar rate. The real effective krone rate thus increased by 2.2 per cent in 2002, cf. Chart 3. Danish exports are, however, relatively insensitive to cyclical developments and normally gain market shares in periods of low international growth. Import growth increased in view of the development in domestic demand.
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Chart 3 |
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| Note: The real effective krone rate based on hourly earnings in manufacturing industry. The real effective krone rate denotes the trend for Danish wages compared to abroad in a common currency. For hourly wages partial estimate for 2002. Source: OECD, Danish Employers' Confederation and own calculations. |
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The current-account surplus was kr. 39 billion in 2002, equivalent to 2.9 per cent of GDP. This was slightly lower than in 2001, cf. Chart 4. It is related to a lower surplus on the balance of services. The balance of goods and services reflects the relationship between Danish and foreign demand and was also influenced by price developments in 2002. Lower prices thus contributed to reducing the value of agricultural exports, while declining freight rates had a negative effect on the balance of services. Total net transfers improved slightly, reflecting reduced interest expenditure. The external debt was almost 20 per cent of GDP at the end of the 3rd quarter of 2002, against 17 per cent at the end of 2001. The increase in the external debt despite the balance-of-payments surplus is mainly attributable to value adjustments as a consequence of falling stock prices and rising bond prices.
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Chart 4 |
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| Note: 4-quarter moving average. Source: Statistics Denmark. |
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Average unemployment for the full year was 5.2 per cent. Unemployment rose from 5.0 per cent in January to 5.4 per cent in December. After several years' growth the overall level of employment fell in the 2nd half of 2002, cf. Table 2. Cost adjustments by business enterprises led to lower employment in the private sector and contributed to higher productivity increases in 2002 than the year before. The decrease in private-sector employment was partly offset by higher employment in the public sector. In addition, the number of recipients of early retirement benefit increased by 9,000 in 2002. This figure is higher than for the two previous years where the reform of the early retirement scheme in 1999 reduced the influx of new recipients.
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Table 2 |
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| 1,000 persons, annual average |
1998
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1999
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2000
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2001
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2002
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| Wage and salary earners |
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| Private sector |
1,669
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1,698
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1,722
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1,722
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1,697
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| Public sector |
812
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820
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825
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824
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831
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| Self-employed |
199
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197
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196
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194
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193
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| Total employment |
2,680
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2,716
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2,743
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2,739
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2,720
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| Unemployed |
183
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158
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150
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145
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145
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| Labour force |
2,863
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2,873
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2,893
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2,884
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2,865
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| Transitional allowance |
36
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31
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25
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20
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15
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| Recipients of early retirement benefit |
140
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149
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156
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160
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169
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| Recipients of leave benefits |
43
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34
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28
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24
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19
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| Unemployment, per cent of labour force |
6.6
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5.7
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5.4
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5.2
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5.2
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| Unemployment, EU definition, |
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| Per cent of the labour force1 |
4.9
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4.8
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4.4
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4.3
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4.5
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| Sources: Statistics Danmark, the Directorate of Labour, Eurostat and own calculations. 1 Eurostat statistics. |
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Credit expansion
Growth in lending by mortgage-credit institutes and banks was by and large unchanged in 2002, cf. Chart 5. Growth in lending to households rose as a result of increased growth in lending by mortgage-credit institutes. At the end of 2002 home financing via adjustable-rate loans accounted for almost 28 per cent of total mortgage-credit lending, against 21 per cent the year before. Growth in business lending fell throughout 2002. Due to their favourable level of earnings business enterprises can finance a good proportion of their investments themselves.
The money stock, M2, primarily consisting of the deposits with banks of private individuals and business enterprises, together with their holdings of banknotes and coins, grew by 4.6 per cent in 2002. The money stock thus increased slightly more than the transaction requirement measured as the value of domestic demand. M3, which besides M2 comprises short-term mortgage-credit bonds, increased by 11.1 per cent in 2002. The M3 growth rate is highly dependent on the extent to which mortgage-credit institutes' adjustable-rate loans are financed by bonds that are included in M3. The development in M3 should therefore be interpreted with caution.
Wage and price development
Wage increases in 2002 were at around the same level as in 2001. The full-year rate of wage increase in the private sector was 4.0 per cent. Most areas of the central-government and health-care sectors saw higher wage increases than the private sector.
In the last seven years the rate of wage increase in Denmark has exceeded that of the euro area, cf. Chart 6, and the labour market is still closer to its capacity limit in Denmark than in the euro area. At the close of the year the EU-harmonised unemployment rate was 4.7 per cent in Denmark and 8.5 per cent in the euro area.
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Chart 6 |
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| Note: Abroad, total is the countries included in the effective krone rate index. The wage increases are weighted together using the weights of the index. Wage increases are wage increases in the manufacturing sector. Partial estimates for 2002. Source: OECD, Danish Employers' Confederation and own calculations. |
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A prerequisite for improvement in employment is that Danish wage costs must increase at a rate which is in accordance with the requirements of the fixed-exchange-rate policy. This also means that over a number of years Danish wage costs should increase in line with wage costs in the euro area. If not, Denmark will find it difficult to maintain its competitiveness in relation to the anchor currency. Wage increases in recent years have been at the high end, and in the longer term this can make it more difficult to maintain the low level of unemployment, unless Danish productivity increases permanently exceed those abroad.
Measured in HICP terms, inflation was 2.4 per cent in Denmark and 2.3 per cent in the euro area in 2002. In the 1st half of the year the rate of price increase declined in both Denmark and the euro area as a result of lower rates of increase for food prices.
Inflation was at almost the same level in Denmark and the euro area at the beginning of the year, but in the 2nd half-year price increases in Denmark exceeded those of the euro area, cf. Chart 7, partly because the energy price index, especially including residential heating costs, rose more in Denmark than in the euro area.
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Chart 7 |
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| Note: Underlying inflation is a measure of the domestic market-determined price increases and has an overweight of services. Source: Statistics Denmark, Eurostat and own calculations. |
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Domestic market-determined inflation rose to 3.2 per cent in 2002 from 2.1 per cent in 2001. This reflects that the subdued development in import prices has not immediately affected consumer prices.
Economic prospects
At the start of 2003 there are no significant imbalances in the Danish economy. Unemployment is still low, and both the balance of payments and public finances show surpluses.
The risks faced by the Danish economy include the international political situation, which contributes to greater uncertainty in the global economy. Danish exports are relatively insensitive to cyclical fluctuations, but nonetheless continued weak development for our trading partners will have a negative impact on exports. The global economy is, however, expected to pick up during 2003.
The very low interest rates entail that the financial conditions are highly expansionary and thereby stimulate consumption and investment significantly in the immediate future. Taxes and duties, as well as transfer incomes, are strongly dependent on economic growth, and there is scope to allow these automatic stabilisers to come into play should the cyclical situation weaken. The economic outlook does not warrant any change in the medium-term fiscal-policy stance, which is aimed at reducing the government debt significantly before the ageing of the population becomes seriously apparent.
The demographic development, especially after the year 2010, points to a reduced workforce and higher government expenditure in relation to the tax base. It is therefore important that the government's target of higher employment in the private sector and reduction of the government debt up to the year 2010 be maintained. Government finances will only be sufficient to bear the costs of the increased proportion of elderly citizens without introducing tax increases or cutting public benefits if the required increase in private-sector employment is achieved in the coming years. The economic policy must thus be targeted at increasing the workforce. The sustained influx to the early retirement scheme has the opposite effect, since it lowers the actual age of retirement and reduces the total workforce.