The Swedish Economy August 2005 Published by The National Institute of Economic Research (NIER) Stockholm 2005 The National Institute of Economic Research (NIER) prepares analyses and forecasts of the Swedish and international economy and conducts related research. The NIER is a government agency accountable to the Ministry of Finance and is funded largely by the Swedish government. Like other government agencies, the NIER has an independent status and is responsible for the assessments that it publishes. The Swedish Economy contains analyses and forecasts of the Swedish and international economy. The report is published four times a year, in March, June, August and December. The Statistical Appendix is issued together with The Swedish Economy and Wage Formation – Economic Conditions in Sweden. The Swedish Economy and Statistical Appendix are English translations of the corresponding reports in Swedish, Konjunkturläget and Analysunderlag, respectively. The Statistical Appendix in connection with the June report of The Swedish Economy and with Wage Formation is published only on the NIER’s home page. Wage Formation – Economic Conditions in Sweden is a report published annually by the NIER that provides analyses of the economic conditions for wage formation in Sweden. It is the English translation of the report in Swedish, Lönebildningen – Samhällsekonomiska förutsättningar i Sverige. In the Special Studies series, the NIER publishes reports based on studies or other assignments commissioned by outside parties. Research findings are published in the Working Paper series. Some of these working papers appear in international scholarly journals and are then reissued under the heading of Reprints. Reports in these three series can be ordered at no charge. Most publications can also be downloaded directly from the NIER’s home page, www.konj.se. NIER Kungsgatan 12–14 Box 3116 SE-103 62 Stockholm Sweden Phone: +46-8-453 59 00 Fax: +46-8-453 59 80 E-mail: email@example.com Home page: www.konj.se ISSN 0023–3463 ISBN 91-89226-62-3 Preface The Swedish Economy, August 2005 provides an economic forecast for the years 2005–2007. The forecast covers both the Swedish and international economies. In a special section, the new forecast is compared with the assessments presented in June 2005. The work of preparing The Swedish Economy was led by Mats Dillén, Director of Forecasting. The calculations were completed on August 19, 2005. Ingemar Hansson Director General Diagram 1 Purchasing Manager Index, Manufacturing – US, Euro Zone, Japan and Summary Sweden Index, monthly values 65 65 Economic recovery is continuing after a temporary 60 60 slowdown around the start of this year. Sweden’s GDP 55 55 will increase by 2.4 percent this year and by 2.9 percent each year in 2006 and 2007. The number of 50 50 hours worked has begun rising after dropping for 45 45 three years in a row. Inflationary pressure remains 40 40 low. The repo rate should be left unchanged in 02 04 US anticipation of the budget bill. Euro zone Japan Sweden Sources: Institute for Supply Management, NTC Sweden’s living standards are not rising as fast as its Research Ltd, Silf and FöreningsSparbanken. GDP. Real GNI per capita is a better measure of living standards than GDP growth and will be up by Diagram 2 GDP Growth – Worldwide, OECD and selected economies only 0.4 percent this year, partly because of rising oil Annual percentage change 10 10 prices. 8 8 6 6 Global Recovery Picking Up Again Worldwide growth is vigorous again after slowing around the 4 4 end of last year. Leading indicators show that confidence in the 2 2 future has recently been increasing at manufacturing firms, making them more willing to invest and to hire more personnel 0 0 (see Diagram 1). Global recovery is being driven mainly by 00 World 01 02 03 04 OECD 05 06 07 investment, which is in a strong cyclical upswing. However, India China New EU-countries households and firms are cautious, and their propensity for Sources: IMF, OECD, national sources and NIER. saving is high, contributing to extremely low interest rates on bonds. Recovery is expected to continue, and worldwide GDP is forecast to increase by 4.3 percent this year and by 4.2 percent annually in 2006 and 2007 (see Diagram 2). These growth rates Diagram 3 Price of Oil Brent USD/barrel and SEK/barrel, respectively, may be compared with the average worldwide growth of 3.5 monthly values percent since 1985. The reason for the relatively high growth 70 700 rate in the current period is that there are spare resources in the 65 650 60 600 world economy which are gradually being put to use – for 55 550 example, in the current rapid structural transformation in Asia, 50 500 particularly China and India. 45 450 The surge in oil prices in the past two years is a result of high 40 400 worldwide growth, but has also worked against it (see Diagram 35 350 3). Over the summer the price of oil has continued to soar, 30 300 25 250 rising above 60 dollars a barrel in mid-August. However, 20 200 production capacity will expand in the next few years, and the 15 150 00 02 04 06 currently strong inventory build-up is anticipated to slacken Oilprice in USD during the same period. As a combined effect of these factors, Oilprice in SEK (right) the price of oil is expected to drop back to 47 dollars a barrel by Note: North Sea Oil. Sources: EcoWin, International Petroleum Exchange the end of 2007. But there is considerable uncertainty about the and NIER. 6 Summary Diagram 4 Official Interest Rates continued development of oil prices. Substantially higher oil Percent, monthly values prices could bring global recovery to a halt. But an increase in oil 5 5 prices would not affect all countries and regions equally. For 4 4 example, the OECD area would be hit harder than the world economy as a whole since the OECD countries account for a 3 3 much larger share of oil consumption than of oil output. In spite of surging oil prices, the US economy has shown 2 2 remained strong. One positive tendency is that the macroeconomic imbalances, which have been gradually 1 1 worsening for a number of years, are now diminishing. The US 0 0 trade deficit is not growing as fast as before; the deficit in the 02 04 06 Sweden federal budget is diminishing, and unemployment has receded. Euro zone US Household saving, however, has continued dropping from a level that was low to begin with. Sources: National sources and NIER. The US economy is well ahead in the business cycle. The labour market has been strengthening for almost two years. For some time now, the economy has been in a phase of slackening productivity growth and more rapidly rising unit labour costs. To prevent excessive inflation, the Federal Reserve has raised the federal funds rate by 2.50 percentage points since the summer of 2004 to 3.50 percent this August (see Diagram 4). But monetary policy is still expansionary, reflecting continued presence of spare resources in the economy. As resource utilization rises, the Fed will go on raising the federal funds rate, contributing to a gradual increase in household saving and thus to reduction of the imbalances in the household sector as well. All factors considered, GDP growth will slow from 3.6 percent this year to 3.3 percent in 2006 and 3.1 percent in 2007. After four quarters of lacklustre growth, there are now signs that recovery in the euro zone, which began at the end of 2003, is resuming. According to a number of studies, confidence in the future at business firms has been increasing recently. The reasons may be that the euro has weakened this year and that the global economy has strengthened. Household consumption has shown a very weak tendency over the past five years despite favourable household finances. A slack labour market and pessimism in the household sector are two principal explanations for the caution of households and for their high propensity to save. For the past year, however, the labour market has been improving. Unemployment is down somewhat, and employment is up. Consumption is also being encouraged by extremely low interest rates. For these reasons, household consumption will be increasing somewhat faster in the period ahead. Inflationary pressure is modest, and the European Central Bank is expected to wait until the summer of 2006 before beginning a period of cautious increases in the policy interest rate. GDP growth will be limited to 1.4 percent this year but accelerate to 1.9 percent in 2006 and 2.2 percent in 2007. Summary 7 The Swedish Economy – Upswing to Continue Diagram 5 GDP Billions of SEK, constant prices and percent, seasonally adjusted quarterly values After a brief slowdown in the fourth quarter of last year and the 760 2.4 first quarter of this year, recovery resumed in the second quarter (see Diagram 5). For the past two years, investment has been in 720 2.0 a strong cyclical upswing phase. Even as growth slumped 680 1.6 around the end of last year, investment continued its surge (see 640 1.2 Diagram 6). This year the upswing in investment will be reinforced by a strong increase of investment in manufacturing. 600 0.8 But the fastest increase is in housing investment, which rose by 560 0.4 more than 16 percent last year and will do so by almost 20 520 0.0 percent this year. A combination of factors – highly expansionary monetary conditions, with low interest rates and a 480 97 99 01 03 05 07 -0.4 relatively weak krona, as well as healthy profitability and a Billions of SEK Percentage change (right) favourable economic outlook both for Sweden and for the Sources: Statistics Sweden and NIER. world as a whole – will mean rising investment in 2006 and 2007 as well. However, growth in investment will peak this year and then recede somewhat. Household consumption was up by a strong 0.8 percent in Diagram 6 Gross Fixed Capital Formation Billions of SEK, constant prices and percent, the second quarter and has also been revised upward for the first seasonally adjusted quarterly values quarter. Its tendency has thus been quite robust during the first 126 8 half of this year. Conditions favour a continued rise in 119 6 consumption. Interest rates are low, the net wealth position of 112 4 households is strong, disposable income is expected to increase at a healthy rate and saving is high. The anticipated 105 2 improvement of the labour market situation will also stimulate 98 0 consumption. More positive household sentiment is already 91 -2 evident from the NIER’s Consumer Survey (HIP), where the so- called Micro Index reached its highest level since 1993 (see 84 -4 Diagram 7). So far this year, the tendency in general government 77 -6 consumption has been weak, but it will strengthen next year as 97 99 Billions of SEK 01 03 05 07 local governments take advantage of the margin for expansion Percentage change (right) permitted by their healthy finances. Sources: Statistics Sweden and NIER. After three quarters of stagnation, exports of goods were up by a full 1.5 percent in the second quarter. This outcome was surprisingly strong in view of the lacklustre tendency in new Diagram 7 Household Expectations for orders for exports and the gradual slowdown in manufacturing Personal Finances According to Micro Index Balances, monthly values indicated in the Business Tendency Survey during the first half- 20 20 year. As noted at the beginning of this report, the latest indicators show that the international economic outlook has brightened somewhat. An upturn in the Purchasing Manager 10 10 Index and in the NIER’s latest Business Tendency Survey reflect a similar improvement in the outlook for manufacturing in 0 0 Sweden (see Diagram 8). All factors considered, exports of goods will increase less strongly in the third quarter than in the -10 -10 second, but much more than in the three preceding quarters. In a longer-term perspective, exports of goods will benefit from -20 -20 continuing international economic recovery and from the relative weakness of the krona, which however is expected to -30 -30 strengthen slightly in the period ahead. In 2007 the 93 95 97 99 01 03 05 Source: NIER. 8 Summary Diagram 8 Confidence Indicator – telecommunication products industry is expected to be in a Manufacturing Balances, seasonally adjusted monthly values phase of strong growth, reinforcing the increase in exports. 15 15 Overall, GDP is forecast to grow by 2.4 percent this year and 2.9 percent annually in 2006 and 2007. Domestic demand is 10 10 driving growth this year, but the composition of domestic 5 5 demand is changing. Investment will play a diminishing role in 0 0 growth, while consumption in the household and general -5 -5 government sectors will be driving growth to an increasing -10 -10 extent. In 2006 strengthening exports are expected to help -15 -15 broaden the base of GDP growth. Adjusted for variations -20 -20 between years in the number of working days, GDP growth will be 2.4 percent this year, 3.2 percent in 2006 and 3.0 percent -25 -25 00 02 04 2007. Confidence indicator (seasonally adjusted) Historical average 1964-2004 Note: Assessment of orders on hand – assessment Table 1 Selected Indicators of finished goods inventory + expected output. Source: NIER. Annual percentage change and percent, respectively 2003 2004 2005 2006 2007 GDP at market prices 1.5 3.6 2.4 2.9 2.9 GDP, calendar-adjusted 1.6 3.0 2.4 3.2 3.0 Real GNI per capita 1.1 3.9 0.4 1.7 2.5 1 Current account 5.9 7.8 5.9 4.9 5.3 2 Employment rate 77.6 77.0 76.5 76.5 76.9 1 General government net lending –0.1 1.0 0.8 0.6 0.9 3 Unemployment 5.3 6.0 5.8 5.4 5.2 Hourly earnings, economy as a whole (Short-term Wage and Salary 4 Statistics) 3.5 3.3 3.3 3.6 3.9 Labour costs, business sector (National 4 Accounts) 3.5 2.9 2.5 3.7 4.0 4 Productivity, business sector 3.6 4.3 2.5 3.0 2.8 CPI, Dec.-Dec. 1.3 0.4 0.7 1.5 2.3 UND1X, Dec.-Dec. 1.6 0.7 1.1 1.2 1.6 5 Repo rate 2.75 2.00 1.50 2.25 3.50 Interest rate, 10-year government 5 bonds 4.9 3.9 3.4 4.3 4.7 5 Index for the Swedish krona (KIX) 113.1 111.0 118.1 117.1 116.1 1Percentage of GDP. 2 Regular employment, percentage of population aged 20–64. 3 Percentage of the labour force according to the new LFS. 4 Calendar- adjusted. 5 At year-end. Sources: Statistics Sweden, Labour Market Board, the Riksbank and NIER GDP in constant prices reflects aggregate output and is therefore a natural measure for taking the pulse of the economy. But for analyzing a population’s living standards over time or comparing living standards between countries, real gross national income (GNI) per capita is a more relevant measure. Growth in real GNI per capita may deviate from GDP growth for three reasons: First, to determine the change in living standards, the change in population must be taken into account. Second, incomes in a country normally develop differently than the value of output. Third, changes in the terms of trade affect living standards and GDP differently. A current example is the rapid rise in oil prices this year, which contributes to the Summary 9 substantial difference between GDP growth and growth in real Diagram 9 GDP and Real GNI per Capita Annual percentage change GNI per capita this year (see Diagram 9). In real GNI per capita 5 5 consideration has been given to the necessity for a higher volume of exports in order to “finance” the purchase of a given 4 4 quantity of oil. Consequently, a smaller share of output is left for consumption or investment, so that living standards decrease 3 3 (see the analysis in the box captioned “Real GNI per Capita Better Than GDP as a Measure of Living Standards”). 2 2 1 1 Upturn in Number of Hours Worked 0 0 00 02 04 06 After peaking in the fourth quarter of 2001, the number of GDP, constant price Real GNI per capita hours worked dropped 2.9 percent to a low point in the first quarter of 2005, but has now begun rising (see Diagram 10). Sources: Statistics Sweden and NIER. Leading indicators, such as newly reported vacancies and layoff notices, also suggest that the labour market has begun to pick up. Diagram 10 Hours Worked and Newly To judge by the subdued tendency in wages, the low level of Reported Vacancies inflationary pressure and the small proportion of firms reporting Millions and thousands. Monthly and quarterly values problems in recruiting personnel, there are still considerable 1800 60 spare resources on the labour market and thus a large number of persons who are unemployed for cyclical reasons. The so-called 1750 50 labour market gap, or the difference between the actual and potential number of hours worked, is estimated at –1.2 percent 1700 40 for the second quarter. This estimate is very uncertain (see Diagram 11). One underlying reason for the cyclical weakness of 1650 30 the labour market is that productivity growth in 2002–2004 later proved to have been much stronger than expected. 1600 20 Consequently, inflationary pressure was overestimated, and the margin for decreasing the repo rate has thus been 1550 93 95 97 99 01 03 05 07 10 underestimated. The cyclical reduction in the number of hours Hours worked Newly reported vacancies, seasonally adj. (right) worked has therefore been more prolonged than it would have Sources: Labour Market Board, Statistics Sweden been if the rapid productivity growth had been foreseen. and NIER. With a robust investment tendency, rising local government employment and an expansionary monetary policy, including a Diagram 11 Labour Market Gap relatively weak krona, cyclical recovery of the labour market will Percent of potential number of hours worked, seasonally adjusted quarterly values continue. Clearly productivity growth has already slackened 2 2 compared to 2002–2004, a natural development in the current phase of the business cycle. Therefore, to meet rising demand, 1 1 firms must increase their input of labour. The number of hours worked is consequently expected to continue rising, reducing the 0 0 labour market gap and entailing relatively satisfactory growth in -1 -1 employment in 2006 and 2007. However, in view of the changeover in the Labour Force -2 -2 Surveys (LFS) this past spring, the development of the labour market is not easy to interpret. It is especially difficult to -3 -3 determine the degree to which employment and unemployment as measured only reflect the change in the LFS and the degree to -4 90 92 94 96 98 00 02 04 06 -4 which they actually show what has happened (see the analysis in Note: The labour market gap is calculated as the the box captioned “Changeover in LFS Complicates difference between the number of hours worked and its potential level. Source: NIER. 10 Summary Diagram 12 Hourly Earning – Business Sector Interpretation of the Labour Market Situation”). As measured in Annual percentage change the new LFS, the unemployment rate this year will be 5.8 6.0 6.0 percent. The changeover in the LFS is estimated by Statistics 5.5 5.5 Sweden to have raised the reported unemployment rate by 0.4 5.0 5.0 percentage point. With the recovery of the labour market, the unemployment rate will drop to 5.1 percent in the fourth quarter 4.5 4.5 of 2007. The forecast is based on labour market policy according 4.0 4.0 to the spring budget bill. Recently the Government and its allied 3.5 3.5 political parties have begun to consider certain amendments, including a change in the number of participants in labour 3.0 3.0 market programmes. Modifications of this kind have not been 2.5 2.5 considered in the present forecast. 2.0 2.0 In 2007 the regular employment rate for persons aged 20–64 93 95 97 99 01 03 05 07 will be about 77 percent, 3 percent below the Government’s Sources: National Mediation Office and NIER. targeted regular unemployment rate of 80 percent. Despite some margin for labour market to continue recovering after 2007, only a minor portion of the shortfall in relation to the target will be cyclically related. Achieving the Government’s employment Diagram 13 Unit Labour Cost – Business Sector target will thus require structural measures that increase labour Annual percentage change, calendar-adjusted supply and decrease the equilibrium unemployment rate. 8 8 6 6 Riksbank Should Wait Despite Inflation Below Target 4 4 2 2 Inflationary pressure in the Swedish economy remains low. The underlying inflation rate as measured by the UND1X was 0.7 0 0 percent in July. The main reason for the low inflation rate is that -2 -2 unexpectedly strong productivity growth in recent years has led to a cyclically weak labour market and limited wage increases. -4 -4 01 03 05 07 Last year, wages in the business sector rose by 3.0 percent, the Labour cost per hour Productivity lowest rate of increase in 10 years (see Diagram 12). For this Unit labour cost reason, unit labour costs in the business sector have decreased in Sources: Statistics Sweden and NIER. the past three years by a total of 1.5 percent (see Diagram 13). Employment will be up in the period ahead, and wages will accelerate as the labour market gradually tightens. Wages in the Diagram 14 UND1X business sector are forecast to rise in 2007 by 3.9 percent, or Annual percentage change, monthly values slightly less than the long-term rate of wage increases, estimated 3.5 3.5 at about 4 percent. The modest rate anticipated reflects the 3.0 3.0 assessment that the labour market in 2007 will still be somewhat 2.5 2.5 weaker than is compatible with inflation of 2 percent. 2.0 2.0 The acceleration of wage increases will contribute to higher 1.5 1.5 underlying inflationary pressure. UND1X inflation will gradually climb to 1.6 percent at the end of 2007 (see Diagram 14). The 1.0 1.0 Riksbank’s guideline is that the repo rate should be lowered 0.5 0.5 (raised) if the inflation rate is expected to be below (above) the 0.0 0.0 target in one to two years. As shown in Diagram 14, UND1X is -0.5 00 02 04 06 -0.5 expected to be considerably less than 2 percent in this time UND1X frame. Mechanically following the guideline would mean UND1X excl. energy reducing the repo rate, given this assessment of inflation. Note: Shaded area refers to inflation rate expected in one to two years time-horizon. However, the impact on UND1X inflation will be relatively Sources: Statistics Sweden and NIER. great if the price of oil recedes to 47 dollars a barrel at the end of Summary 11 2007. With oil prices following that path, their inflationary effect is expected to be only temporary. In the NIER’s opinion, therefore, monetary policy should be guided in the current situation by UND1X with energy prices excluded. As can be seen in Diagram 14, UND1X inflation excluding energy prices is higher than UND1X inflation without this adjustment, but will still be less than 2 percent in one to two years. Thus, even with inflation unaffected by oil prices, the repo rate should be reduced, though the argument for doing so is weaker than if the decision is guided just by UND1X inflation. The present forecast is based, however, on current provisions of fiscal and labour market policy. Probably fiscal policy will become more expansionary, with unfinanced increases in expenditure or reductions in taxes. Moreover, inflation can be affected by changes in labour market policy. It is therefore appropriate to postpone monetary policy decisions until the impact of forthcoming fiscal and labour market policy decisions can be determined with greater certainty. For this reason, the NIER Diagram 15 Cyclically Adjusted Net Lending recommends that the repo rate be left unchanged for the time Percent of potential GDP being. 2.5 2.5 2.0 2.0 More Restrictive Fiscal Policy Desirable 1.5 1.5 This year, general government net lending will be 0.8 percent of 1.0 1.0 GDP. Under the provisions currently in effect, net lending will rise to 0.9 percent of GDP in 2007. The NIER recommends 0.5 0.5 that fiscal policy be brought more in line with the 2-percent target in the next few years even though such action is not really 0.0 04 06 0.0 desirable from the standpoint of economic stabilization. An 2-percent target Cyclically adjusted net lending appropriately balanced approach, in the NIER’s opinion, would Cyclically adjusted net lending, NIER recommendation be to strengthen net lending by SEK 5 billion in 2006 and a Sources: Statistics Sweden and NIER. further 10 billion in 2007. Cyclically adjusted net lending would then increase from 1.1 percent of GDP to 1.6 percent of GDP in 2007 (see Diagram 15). This more contractionary fiscal policy – by comparison with the forecast – should be balanced as much as possible by a more expansionary monetary policy. The effect on growth would then be relatively limited, while general government finances would be better prepared for the next economic downturn and the demographic trend of an aging population. Contents Development of the International Economy...........................15 Financial Markets..........................................................................39 GDP and Demand in Sweden ....................................................49 Household Consumption........................................................50 General Government Consumption .....................................53 Gross Fixed Capital Formation .............................................54 Stockbuilding.............................................................................57 Exports.......................................................................................58 Imports ......................................................................................61 Terms of Trade, Current Account and Gross National Income .......................................................................................63 Output and Labour Market.........................................................73 Output, Productivity and Hours Worked ............................74 Demand for Labour.................................................................77 Labour Supply and Unemployment ......................................85 Resource Utilization.................................................................87 Wages, Profits and Prices ............................................................91 Wages and Labour Costs.........................................................92 Competitive Situation and Profitability ................................96 Inflation .....................................................................................99 Public Finances .......................................................................... 105 Targets and Stance of Economic Policy............................ 106 Issues Relating to Taxes and Benefits................................ 110 Revenue and Expenditure of the General Government Sector....................................................................................... 117 Finances in Subsectors of General Government ............. 121 Comparison of Forecasts ............................................................. 127 The International Tendency ................................................ 128 The Tendency in Sweden..................................................... 129 Boxes and Analyses US Savings Imbalances.....................................................................22 China’s Growth and Challenges......................................................28 The NIER’s Repo Rate Assessment ..............................................46 Real GNI per Capita Better than GDP as a Measure of Living Standards.............................................................................................67 Changeover in LFS Complicates Interpretation of the Labour Market Situation.................................................................................80 Principles of the 1991 Tax Reform ............................................. 112 More Jobs Through Cheaper Household Services ................... 114 15 Development of the International Diagram 16 Purchasing Manager Index, Manufacturing – US, Euro Zone, Japan and Economy Sweden Index, monthly values 65 65 60 60 Global Economic Recovery With High Oil Prices 55 55 The international economy is continuing its recovery even though its strong growth has contributed to extremely high oil 50 50 prices. The slump in growth in late 2004 and early 2005 appears to be largely over. Monthly data indicate that worldwide 45 45 industrial activity has recovered after weakening early this year. 40 40 Business surveys and statistics on new orders, for example, show 02 04 US that confidence has been rising at business firms (see Diagram Euro zone 16), making them more inclined to invest, increase output and Japan Sweden hire new personnel. Sources: Institute for Supply Management, NTC The outlook is also relatively favourable for the somewhat Research Ltd, Silf and FöreningsSparbanken. longer term. The investment-driven international economic upswing is continuing, supported by an expansionary monetary Diagram 17 GDP and Gross Fixed Capital Formation – OECD policy and very low long-term interest rates (see Diagram 17). Percentage change, seasonally adjusted quarterly Business profits are high, while financing costs are limited by values low real rates of interest and rising share prices on stock 3 3 exchanges. To a large extent, business firms have put their 2 2 balance sheets in order again after the ICT-bubble bursted. These factors provide a favourable climate for new investment 1 1 (see Diagram 17). By contrast, the prospects for household consumption are 0 0 not quite so encouraging, despite low interest rates. With a fairly slack tendency in incomes and limited optimism about the -1 -1 future, the upturn in consumption will be sluggish in the euro zone. In the US, households are expected to increase their -2 01 03 05 07 -2 saving, thus curtailing growth in consumption. In Japan, the GDP upswing in consumption will be dampened by a more Gross fixed capital formation contractionary fiscal policy. Moreover, in most of the growth Sources: IMF, OECD, national sources and NIER. economies of Asia, Latin America, and Central- and Eastern Europe, growth will be driven by investment in fixed capital, Diagram 18 Exports – Worldwide whereas growth in consumption will be more modest. Annual percentage change, quarterly values Growth in world trade was up substantially last year (see 20 20 Diagram 18), and although it has been slack recently compared to the end of 2004, it is forecast to be relatively high in 2005– 15 15 2007. The market for Swedish exports expanded by almost 9 10 10 percent last year. This year its growth will slacken to 5.7 percent, partly because of a very weak tendency in the first quarter. In 5 5 2006 and 2007, the market for Swedish exports will grow by 6.5 and 6.1 percent, respectively. 0 0 In short, the international economy is continuing to recover, but with some moderation in worldwide growth as resource -5 -5 utilization rises and economic policy becomes less expansionary. Worldwide GDP grew last year by a full 4.9 percent. Growth -10 96 98 00 02 04 -10 will fall off to 4.3 percent this year and 4.2 percent each year in Source: IMF. 16 Development of the International Economy 2006 and 2007 (see Diagram 17). These figures may be Diagram 19 GDP and Inflation – OECD Annual percentage change compared to the average growth rate of 3.5 percent since 1985. 6 6 For the entire OECD area as well, GDP growth will slacken (see Diagram 17) from 3.3 percent in 2004 to 2.7 percent 5 5 annually in 2005–2007 (see Diagram 19). Since this growth rate 4 4 is considered to be slightly higher than its potential level, resource utilization is expected to continue increasing. 3 3 Inflation in the OECD area has been subdued despite rising 2 2 resource utilization and continually rising oil prices. One reason is the relatively modest increase in unit labour costs. Although 1 1 unit labour costs have begun to increase somewhat faster, costs 0 0 are not expected to accelerate significantly. Moreover, since oil 85 87 89 91 93 95 97 99 01 03 05 07 CPI prices are expected to recede somewhat in the period ahead, GDP inflation will be limited to about 2 percent for the rest of the Note: CPI figures are for the OECD countries excl. forecast period (see Diagram 19). Australia, the Czech Republic, Hungary, Iceland, Korea, Mexico, New Zealand, Poland, Slovakia and The UK and the US are ahead of other countries in the Turkey. For EU countries, the harmonized CPI, or HICP. business cycle. In the UK, the output gap had already closed in Sources: OECD and NIER. 2004, and in the US it is expected to close during 2006. The euro zone lags well behind in the business cycle, and despite gradual Diagram 20 GDP – US, Euro Zone and UK Percentage change, seasonally adjusted quarterly economic recovery, there will still be some unutilized resources values at the end of 2007 (see Diagram 20). 2.0 2.0 The world’s central banks are expected to continue shifting 1.5 1.5 to a less expansionary monetary policy in order to prevent excessive inflation. The Bank of England is an exception; having 1.0 1.0 already completed its cycle of increasing interest rates, it lowered its policy interest rate in August. The US central bank (the Fed) 0.5 0.5 has continued to tighten monetary policy; so far, it has raised its policy interest rate from 1.00 percent in June 2004 to 3.50 0.0 0.0 percent at the end of August. The federal funds rate is expected -0.5 -0.5 to reach 4.75 percent by the end of 2006 and to remain at that 03 05 07 level during 2007. In view of the soft economy in the euro zone, US Euro zone the European Central Bank (ECB) is expected to wait until well UK into next year before beginning to raise its policy interest rate. Sources: National sources, Statistics Sweden and NIER. The outlook for the global economy is accompanied by several elements of uncertainty. A rapid correction of international savings imbalances, including the massive current- account deficit of the US, could stifle worldwide growth through an increase in savings in the US and/or through turbulence on financial markets, e.g. with a sharply depreciating dollar. The situation in the euro zone is difficult to judge, one reason being the structural transformation under way in response to increasing competition from Asian as well as Central and Eastern European countries. There is a risk that recovery will be more sluggish than forecast. Perhaps the greatest risk factor is the development of oil prices. If instead of gradually decreasing as assumed to 47 dollars a barrel at the end of 2007, the price of oil remained substantially higher, the expected effect would be to curb global growth. In countries that are net importers of oil, the costs of business firms would increase, with a negative short-term impact on their inclination to invest and hire new personnel. The real Development of the International Economy 17 incomes of households would be weakened by higher prices of oil-based products. On the other hand, the increased revenue received by oil-exporting countries would strengthen their growth. Overall, the development of global demand would be slowed because of greater uncertainty and a higher average short-term propensity to save in oil-exporting countries than in oil-importing countries. For the OECD area, which accounts for 60 percent of world oil consumption but only 25 percent of world oil output, the negative effects would predominate, at least in the short run. Simulations with the NiGEM 1 model of the world economy indicate that GDP in the OECD area would be 0.7 percent lower at the end of 2007 if the price of oil remained above 60 dollars. The impact on the world economy, according to the model, would be of about half that magnitude. 2 Table 2 GDP and the CPI in Other Countries Annual percentage change GDP CPI 2004 2005 2006 2007 2004 2005 2006 2007 United States 4.2 3.6 3.3 3.1 2.7 2.9 2.5 2.5 Japan 2.6 1.7 1.5 1.5 0.0 -0.2 0.3 0.3 EU 2.5 1.9 2.3 2.6 2.2 2.0 1.8 1.9 Euro zone 1.7 1.4 1.9 2.2 2.1 2.0 1.6 1.8 Germany 1.1 1.0 1.4 1.9 1.8 1.4 1.4 1.3 France 2.1 1.5 1.8 2.3 2.3 1.8 1.6 1.8 UK 3.2 2.0 2.4 2.4 1.3 2.0 2.2 2.1 New EU 5.0 4.4 4.5 4.5 4.1 2.6 2.7 2.8 countries 1 OECD 3.3 2.7 2.7 2.7 2.0 2.1 1.9 2.0 China 9.5 9.0 8.5 8.0 3.9 2.2 2.5 2.4 Latin America 5.7 4.1 3.8 3.3 6.5 6.0 5.2 5.2 World 4.9 4.3 4.2 4.2 1The GDP figures are calendar-adjusted. The CPI figures are for the OECD except Australia, the Czech Republic, Hungary, Iceland, Korea, Mexico, New Zealand, Poland, Slovakia and Turkey. The CPI figures for the EU countries show the harmonized CPI, or HICP. Sources: IMF, OECD and NIER. Oil Prices Boosted by Strong Inventory Build-up Oil prices have continued to increase over the summer. The price of oil has almost doubled since beginning to rise at the outset of 2004. The average price of Brent oil in June was 54 dollars a barrel. In July the price rose further to an average of 57.6 dollars a barrel, and the upsurge continued upward in August. In Swedish currency, the increase in the price of oil this 1 NiGEM stands for National Institute Global Econometric Model. The model was developed by the NIESR, i.e. National Institute of Economic and Social Research, London. 2 For details about the oil-price simulations in the NiGEM, see the box captioned ” Oil Prices and the Global Economic Upswing” in the Swedish Economy, June 2004. 18 Development of the International Economy Diagram 21 Price of Oil year has been even stronger, since the krona has depreciated Brent USD/barrel and SEK/barrel, respectively, monthly values against the dollar. In July the price of oil in Swedish currency 70 700 had soared nearly 70 percent above its level at the start of the 65 650 year (see Diagram 21). 60 600 Today’s oil prices are high in real terms as well (see Diagram 55 550 22). In current prices, the real price of oil averaged 28 dollars a 50 500 45 450 barrel during the period 1986–2004. Thus, the real price of oil in 40 400 July was twice as high as this historical average. 35 350 The surge in prices over the last few months coincides with a 30 300 strong build-up of inventories (see Diagram 23). There is 25 250 normally an inventory build-up just before the fourth quarter, 20 200 when there is a sharp seasonal increase in consumption. But this 15 150 00 02 04 06 year the inventory build-up has been stronger than usual. Oilprice in USD Oilprice in SEK (right) The primary reason for the high and volatile price of oil is Note: North Sea Oil. last year’s strong increase in oil consumption, which is due in Sources: EcoWin, International Petroleum Exchange turn to the high rate of global GDP growth. The resulting and NIER. increase in oil production severely depleted the world’s reserve Diagram 22 Real Oil Price at Today’s Price Level capacity, or the difference between production capacity and Index 2005-07-01=57,6, monthly values actual production. Only the OPEC countries still have unused 100 100 production capacity. In the second quarter of this year, reserve capacity was estimated at barely more than 2 percent of total 75 75 output (see Diagram 24). In the same quarter of 2002, the proportion was 10 percent. Moreover, there are limitations in regard to refinery capacity. 50 50 China and North America accounted for almost 60 percent of last year’s increase in oil consumption. This year and in 25 25 coming years, the increase of consumption in China and North America will fall off considerably. Total consumption of oil is forecast to rise this year by 1.9 percent, a marginal downward 0 0 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 adjustment compared to last spring. Next year the increase in Real oil price consumption is expected to be more than 2 percent (see Table Note: WTI oil price deflated by consumption- weighted CPI for 14 OECD countries in a common 3). currency. Deflator equal to 1 in July 2005. Sources: EcoWin, International Petroleum Exchange, OECD, national sources and NIER. Table 3 Demand for Oil by Region Millions of barrels per day and annual percentage change, Diagram 23 OECD’s Commercial Crude Oil respectively Stocks Millions of barrel 2004 2004 2005 2006 2.70 2.70 North America 25.4 3.4 1.1 1.4 Europe 16.3 1.0 0.3 0.2 2.60 2.60 China 6.4 15.2 5.0 7.6 Rest of world 34.0 3.2 2.7 2.6 Total consumption 82.1 3.6 1.9 2.2 2.50 2.50 Change in inventories1 1.2 0.0 0.0 1 Percentage of total oil consumption. Since changes in inventories are heavily 2.40 2.40 influenced by speculation, no forecasts are made for this item. Sources: International Energy Agency (IEA) and NIER. 2.30 2.30 00 02 04 Maximum 2000-2004 Minimum 2000-2004 Countries outside OPEC account for some 60 percent of total Total commercial crude oil stock of OECD world supply of oil. A steady increase in the supply of these Note: Shaded interval represents the difference countries is expected in the next few years, while growth in oil between minimum, and maximum oil stocks in each month 2000-2004. consumption will slacken. This means that the need for oil from Sources: EcoWin, International Energy Agency (IEA) and NIER. Development of the International Economy 19 OPEC will be somewhat less that the anticipated expansion of Diagram 24 Price of Oil and OPEC’s Spare production capacity in OPEC countries in 2005 and 2006. Production Capacity Dollar/barrel and percent of total production, Reserve capacity is therefore expected to increase somewhat this respectively year and next year (see Table 4). 80 12 Table 4 Oil Production 60 9 Millions of barrels per day and annual percentage change, respectively 40 6 2004 2004 2005 2006 Non-OPEC 50.1 2.3 1.3 2.5 20 3 OPEC1 33.0 7.4 -0.1 1.7 Total output 83.1 4.2 0.8 2.2 0 0 Reserve capacity (percent of 02 04 total output) 2.4 -1.4 1.1 1.0 Price of oil Reserve capacity (right) 1This item includes not only crude oil but also so-called Natural Gas Liquids Note: Reserve capacity is defined as the quantity of (NGL’s). OPEC’s output in 2005 and 2006 is calculated as total consumption oil that can be extracted within 30 days and where less non-OPEC supply, based on the assumption of no change in inventories. output can be maintained for at least 90 days. The IEA makes no forecasts for the development of inventories. Sources: EcoWin, International Energy Agency (IEA) and NIER. Sources: International Energy Agency (IEA) and NIER. Diagram 25 GDP and Demand – US NIER’s oil forecast is based on a medium-term assessment of oil Percentage change, seasonally adjusted quarterly values prices. In summary, with the brightening outlook for inventories 4 4 and reserve capacity slightly increasing, the price of oil is 3 3 expected to recede to 47 dollars a barrel by December 2007. On the assumption that this adjustment will be gradual, the price in 2 2 the same month this year and next year will be 59 and 53 dollars 1 1 a barrel, respectively. 0 0 -1 -1 -2 -2 United States Approaching Full Resource Utilization -3 -3 01 03 05 07 According to preliminary statistics, the US economy grew by GDP more than 0.8 percent in the second quarter of this year (see Gross fixed capital formation Household consumption Diagram 25). That was the ninth quarter in a row when Sources: Bureau of Economic Analysis and NIER. economic growth exceeded its potential rate, which is estimated at just below 0.8 percent per quarter. Growth in investment Diagram 26 Purchasing Manager Index – US picked up to 2.3 percent (see Diagram 25). A decrease in Index, monthly values 70 70 stockbuilding lowered GDP growth by almost 0.6 percentage points. There is much to indicate that the inventory depletion in 65 65 the second quarter was due largely to strong growth in demand, 60 60 leading to renewed build-up of inventories in the third quarter. 55 55 Net exports provided a positive contribution of 0.4 percentage point to GDP growth. Growth in household consumption 50 50 expenditure slowed to just above 0.8 percent, a level in line with 45 45 its historical average. 40 40 Indicators point to continued strong growth in the third quarter. The Purchasing Manager Index for manufacturing has 35 98 00 02 04 35 been rising since May, a sign of a stronger tendency in Manufacturing Service sector manufacturing (see Diagram 26). For the services sector, the Purchasing Manager Index remains at a high level, though it Source: Institute for Supply Management. dipped slightly in July (see Diagram 26). 20 Development of the International Economy Diagram 27 Labour Market – US The house market remains strong. Prices of existing houses Annual percentage change and percent, respectively, seasonally adjusted monthly values were up by nearly 15 percent from the corresponding period last 4 8 year. Sales of both new and existing houses are at a very high level. One factor contributing to the strength of the real estate 3 7 market is that long-term interest rates are still low. 2 6 The labour market has continued to improve. In July, the number of persons employed was 1.7 percent higher than in July 1 5 of last year, and the unemployment rate dropped to 5.0 percent 0 4 (see Diagram 27). Labour productivity rose by more than 2 percent in the -1 3 second quarter of this year compared to the same period last year (see Diagram 28). Productivity growth has slowed -2 2 85 87 89 91 93 95 97 99 01 03 05 compared to the last few years, a natural development in the Change in employment Unemployment (right) current mature phase of the US business cycle. The slower Sources: U.S. Department of Labor and Bureau of growth in productivity has contributed to sharply rising unit Labor Statistics. labour costs (see Diagram 28) Household consumption expenditure is expected to grow by just above 3 percent annually during the forecast period, a rate Diagram 28 Labour Productivity and Unit Labour Cost – US consistent with the historical average. Higher disposable income Annual percentage change, quarterly values due to rising employment will stimulate consumption. 6 6 Household saving has been decreasing recently and is currently zero (see Diagram 29) It will increase somewhat during the 4 4 forecast period, in part because of higher interest rates. Consumption will also be curbed by adjustment to high oil 2 2 prices. With high capacity utilization and healthy profits continuing, growth in investment will still be relatively rapid during the 0 0 forecast period, though somewhat less so than in recent years. All factors considered, GDP growth is forecast to be 3.6 -2 85 87 89 91 93 95 97 99 01 03 05 -2 percent this year, 3.3 percent in 2006 and 3.1 percent in 2007 Productivity (see Table 5). Unutilized resources in the economy will therefore Unit labour cost be decreasing, and the output gap will close during 2006. Source: Bureau of Labor Statistics. Core inflation (the CPI excluding energy and food) has been dropping since the spring and was 2.1 percent in July (see Diagram 30). The lower rate of productivity growth in the last Diagram 29 Household Savings – US few quarters has contributed to rising unit labour costs and thus Percent, 5-month centred moving average to higher inflationary pressure. 8 8 Monetary policy is still expansionary even though the Fed has raised the federal funds rate since June of last year by a total 6 6 of 2.50 percentage points to 3.50 percent. With the output gap closing in 2006 and unit labour costs rapidly increasing, the Fed will continue to raise interest rates in the period ahead. The 4 4 federal funds rate is forecast to be 4.00 percent toward the end of this year and 4.75 percent toward the end of 2006. It will 2 2 remain at 4.75 percent during 2007 in view of lower GDP growth. Long-term interest rates are also expected to rise during 0 0 the forecast period. 90 92 94 96 98 00 02 04 With substantially higher tax revenue from households as Net-lending ratio (savings/disposable income) well as firms, the federal budget deficit is forecast to decrease Source: Bureau of Economic Analysis. from 3.6 percent of GDP in 2004 to 2.7 percent of GDP in 2005, then somewhat further in the next few years. The deficit in Development of the International Economy 21 the balance of trade is at an historically high level, reaching 5.5 Diagram 30 Inflation – US Annual percentage change, monthly values percent of GDP in the second quarter. As an after-effect of a 4.0 4.0 weaker dollar in recent years, net exports are expected to contribute positively to GDP growth at the outset of 2007, 3.5 3.5 though only modestly. The contribution will be very small, 3.0 3.0 however, and the improvement will not be enough to reduce the 2.5 2.5 deficit in the current account appreciably. For a more thorough analysis of the deficit in the US current account, see the box 2.0 2.0 captioned “US Savings Imbalances”. 1.5 1.5 1.0 1.0 0.5 0.5 Table 5 Selected Indicators – United States 95 97 99 01 03 05 Consumer prices (CPI) Billions of dollars, current prices, and annual percentage change, CPI excluding food and energy constant prices Source: U.S. Department of Labour. 2003 2004 2005 2006 2007 Household consumption 7 710 3.9 3.6 3.2 3.2 expenditure General-government 1 737 2.1 1.5 1.1 0.8 consumption expenditure Gross fixed-capital formation 2 010 8.4 6.9 4.3 3.5 1 Stockbuilding 15 0.4 –0.2 0.0 0.0 1 Net exports –501 –0.8 –0.2 –0.1 0.0 GDP 10 971 4.2 3.6 3.3 3.1 CPI 2.7 2.9 2.5 2.5 Unemployment 5.5 5.1 5.0 5.0 2, 3 Policy interest rate 2.25 4.00 4.75 4.75 2, 4 Long-term interest rate 4.2 4.8 5.4 5.4 2 Yen/Dollar 104 110 107 104 2 Dollar/Euro 1.34 1.23 1.24 1.25 1 Billionsof dollars and contribution to GDP growth, respectively. 2 At the end of each year. 3 Federal Funds target rate. 4 Rate on 10-year government bonds. Sources: Bureau of Economic Analysis and NIER. 22 Development of the International Economy US Savings Imbalances investment, or its so-called net lending. For a country’s current account to improve by 4 percent Already back in the late 1990’s, there were warnings of GDP, for example, its net lending must therefore that the growing deficit in the US current account increase by the same amount. was unsustainable in the long run. Since then, the international savings imbalances have grown. Even (1) Current account = balance of trade and though the dollar has weakened by about 25 percent services + net factor income = net in effective terms since early 2002, the deficit in the lending = - (financial balance) current account reached a record high of 666 billion dollars, or 5.7 percent of GDP, in 2004. Since then the deficit has grown even larger. The current trend Changed Composition of Capital Flows cannot go on indefinitely, and the danger of a sudden correction of the deficit in the US current Thus, a deficit in the current account means that the account is a major element of uncertainty for the country in question shows negative net lending. The development of the global economy. The purpose domestic net-lending deficit is matched by a net- of the analysis in this box is to illustrate the lending surplus in other countries. The net lending mechanisms that could trigger a correction of this of other countries, however, may take various deficit. The analysis concludes with a conceivable forms. During the second half of the 1990’s, the US scenario for adjusting the deficit to a more deficit on current account was financed primarily by sustainable level. private foreign investors who were attracted by expectations of a high return on investments in the US. In 2000, for example, the net inflow of foreign A Country’s Current Account direct investment was 162 billion dollars, and the net inflow of portfolio investment in the form of The balance of a country’s current account normally purchases of securities was 93 billion dollars. After consists of the difference between the country’s the ICT collapse in 2000, however, the financing of exports and imports of goods and services (the so- the current-account deficit changed. In 2004, for called balance of trade and services), and the example, there was a net outflow of 133 billion difference between factor incomes from abroad and dollars in foreign direct investment and a net the return received by foreign investors on assets in outflow of 28 billion dollars in stock purchases. the country. 3 The current account (with a negative In recent years, the deficit in the US current sign) is matched by the financial balance, or the account has instead been financed mainly through difference between the net acquisition of assets purchases of US government bonds by foreign abroad and the net acquisition by foreigners of (especially Asian) central banks. Official US assets in the country concerned. In the United statistics show an increase in such purchases from States, the persistent deficits in the current account 43 billion dollars in 2000 to 355 billion dollars in have led to deterioration of the country’s net 2004. The amount has probably been financial position against other countries from zero underestimated. Dollar purchases of this kind are to minus 25 percent of GDP in little more than 15 made primarily to keep the purchasing country’s years. This development has reduced net factor currency from appreciating against the dollar. incomes, contributing in turn to a larger deficit than The domestic forces underlying the deficit in the otherwise in the current account (see Equation 1). 4 current account have also changed. In the second The current account also equivalent to the half of the 1990’s, the inflow of capital was largely difference between a country’s saving and its for purposes of investment. Between 2001 and 2003, however, investment in the US dropped 3 Normally items such as transfers are included in the current sharply, a development that would have reduced the account. current-account deficit, all else being equal. But at 4 Since the return on US investments abroad in recent years has the same time, national savings or the difference greatly exceeded the return on the investments of foreigners in the US, the net factor income of the US against other countries between GDP and total consumption, decreased in has been about zero. Were it not for the vast US indebtedness the US. The principal reason was that general to other countries, positive net factor incomes would have government net lending had dropped from 1.5 helped to strenthen the current account. Development of the International Economy 23 percent of GDP in 2000 to –4.3 percent of GDP in needed if the US current-account deficit is to be 2004. At the same time, the saving ratio of reduced in time to a sustainable level. 7 , 8 households had fallen to zero, a historic low. Thus, The macroeconomic effects of an adjustment the current-account deficits in the US were caused toward this level, however, differ depending on the mainly by high investment in the late 1990’s, but factor that initiates the correction. Moreover, it is largely by a low level of savings in more recent difficult to specify the timing of the correction. years. Many analysts are concerned by this development, and by the fact that today the inflow Different Factors May Initiate a Correction of capital to the US is used to a large extent for of the US Current Account Deficit household and government consumption instead of investment. 5 This situation may make it more A correction of the US current account deficit may difficult in the long run to finance the country’s be prompted by both external and internal factors. growing foreign debt. 6 For example, foreign The principal external factor is demand in other investors could begin to require a higher risk countries for US goods and services as well as premium on their holdings in the United States. securities, while the main internal factor is US demand for goods and services. Since changes in current account deficits are The Dollar and the Deficit in the US associated with changes in exchange rates, it is Current Account sometimes argued in debates on the subject that a correction of the US current account deficit is to be If the deficit in a country’s current account is accomplished through an adjustment of the unsustainable in the long run, the exchange rate will exchange rate of the dollar. In principle, such an adjust sooner or later to bring about a reduction of adjustment of the exchange rate could take place the deficit. The sustainability of a deficit can vary through an autonomous revaluation of Asian over time and be affected, for instance, by currencies like China’s renminbin. Here, though, the demographic trends. According to most analysts, exchange-rate adjustment in question would be the deficit sustainable in the long run is currently much greater than the Chinese revaluation of 2.1 between 0 and 3 percent of GDP, much less than percent in July. Since trade with China constitutes the present deficit of nearly 6 percent of GDP. less than 10 percent of total US trade, even a major Since US imports exceed US exports by about 50 revaluation of the Chinese currency would have a percent, and since the US economy is also relatively rather limited direct effect on the US current closed (exports constitute roughly 10 percent of account. GDP and imports roughly 15 percent), a fairly large A weakening of the dollar can also be due to adjustment of the exchange rate is necessary to decreased demand for US securities. Such a change, achieve a given change in the current account. In a in turn, could result from a higher risk premium on paper by Obstfeld & Rogoff,” Global Current investment in the US or expectations of a more Account Imbalances and Exchange Rate expansionary monetary policy in the US relative to Adjustments” (2005, se.www. other countries. In simulations with the NiGEM 9 economics.harvard.edu/faculty/rogoff/papers) och model for the world economy, these factors provide Blanchard, Giavazzi & Sa ”The US Current only a limited improvement in the US current Account and the Dollar” (2005. MIT Working account unless they amount to a massive shock. Paper 05-02,), the authors conclude that a depreciation of the dollar by 35-50 percent is 7 In the simulations in Obstfeld & Rogoff and in Blanchard, Giavazzi & Sa, the current account improves by about 5 percent of GDP. 8 In the analysis in the box captioned ”Dollar Overvalued in a 5 Since 1995 the proportion of foreign ownership of the Long Term Perspective” in The Swedish Economy, August 2004, (growing) government debt in the US has increased from 22 the assessment was that the dollar needed to depreciate by percent to almost 45 percent in 2004. some 30 percent. 6 Recently investment has gone up again. Since the national net 9 NiGEM stands for National Institute Global Econometric lending of the US is still low, however, the need to borrow Model. The model was developed by NIESR, the National from other countries has increased further. Institute of Economic and Social Research, in London. 24 Development of the International Economy Diagram 31 Higher Savings in US: Real Short-Term Interest Rates in US and Euro Zone, Deviation from A weakening of the dollar, all else being equal, Base Scenario Percentage points, quarterly values would increase foreign demand for US goods and 1.5 1.5 services. An autonomous increase of demand in 1.0 1.0 other countries could also lead to improvement in the US balance of trade and services and thus to an 0.5 0.5 improved current account as well. Such a 0.0 0.0 development cannot be ruled out, but in scenarios that are currently considered realistic, the effect on -0.5 -0.5 the US current account deficit would be limited. -1.0 -1.0 -1.5 -1.5 05 07 09 11 US Euro zone Effects of Changed US Saving Behaviour Sources: National Institute of Economic and Social Research on the Current Account Deficit and NIER. According to many analysts, the low propensity to Diagram 32 Higher Savings in US: GDP in US and Euro save in the US is the principal explanation for the Zone, Deviation from Base Scenario international savings imbalances. Thus, a shift in the Percent, quarterly values saving behaviour of US households and/or the net 4 4 lending behaviour of the country’s general government sector could be a critical factor that 2 2 would trigger a correction of the imbalances in net lending. A return to a less expansionary fiscal policy 0 0 and an increase in the propensity of households to save (because of a change in the economic climate, -2 -2 for example), or new rules to encourage saving (such as a tax reduction for personal saving) are -4 05 07 09 11 -4 conceivable causes of such a shift. US Euro zone An increase in general government net lending Sources: National Institute of Economic and Social Research and equivalent to 5 percent of GDP, all else being equal, NIER. could roughly restore balance in general government finances; at the same time, the current account would be around zero. However, an the saving ratio rises initially by over 1 percentage increase in general government net lending is usually point. It is assumed, however, that households react associated with a decrease in household net lending. to the higher level of general government net This mechanism is powerful in equilibrium models lending and that the saving ratio drops back like the NiGEM, where households react to an relatively quickly. increase in general government net lending by The increase in net lending has relatively reducing their saving ratio. This means in turn that substantial effects on the US economy. Even an increase in general government net lending must though the US central bank (the Fed) tries to be relatively sizable if it is to bring about by itself a counteract the weaker tendency in demand by substantial correction of the current account. lowering interest rates (see Diagram 31), In the current situation, however, a scenario unemployment rises and resource utilization falls. where both the general government sector and After five years GDP is almost 3 percent less than households increase their net lending/saving may be in the base scenario (see Diagram 32). Thereafter, realistic since both general government net lending GDP gradually rises again to its level in the base and household saving are extremely low to begin scenario. with. Such a scenario has been simulated in the NiGEM model. In the experiment, general government net lending increases permanently by the equivalent of some 3 percent of GDP. In addition, households first increase their saving, and Development of the International Economy 25 Diagram 33 Higher Savings in US: Effective Exchange Rates, Dollar and Euro, Deviation from change is due largely to the fact that the real rate of Base Scenario Percent, quarterly values interest is lower than in the base scenario). As for 10 10 the results of the simulation, however, it is primarily the first years of cyclical adjustment to the new 5 5 equilibrium that are of interest. Other countries are also affected in real terms by 0 0 the increase of net lending in the US. For example, with decreased demand in the US and consequent -5 -5 strengthening of the euro by about 2 percent in effective terms, exports of the euro zone decrease -10 05 07 09 11 -10 and its current account deteriorates (see Diagram US 34). The ECB attempts to counter the decrease in Euro zone demand by lowering interest rates. But GDP drops Sources: National Institute of Economic and Social Research and NIER. initially by almost 1 percent compared to the base scenario (see Diagram 32). Since most forecasters D iagam 34 Higher Savings in US: Current A ccount in US and Euro Zone, Deviation from are expecting GDP growth of 1.0-1.5 percent in the Base Scenario euro zone this year, an effect of this nature would Percent of GDP, quarterly values 2.0 2.0 lead to stagnation, and the recovery currently in progress would be considerably delayed. 1.0 1.0 0.0 0.0 Summary -1.0 -1.0 The present tendency of the US current account is not sustainable in the long run. A correction will -2.0 05 07 09 11 -2.0 occur sooner or later and will entail a sizable US Euro zone adjustment of the exchange rate. Simulations in the Sources: National Institute of Economic and Social NiGEM model of the world economy suggest that Research and NIER. external factors, such as a continued revaluation of The decrease in demand and a weakening of the China’s currency or a higher risk premium for dollar by almost 10 percent in effective terms (see foreign investments in the US, must be of Diagram 33) leads to a sharp drop in imports, while considerable magnitude to bring about a substantial exports rise somewhat. Together with a substantial change in the US current account. Another reduction in net US foreign indebtedness, this conceivable factor that could trigger a process of contributes to improvement of the current account adjustment is an increase in the propensity to save after five years by about 1 percent of GDP (see in the US. In the simulation above, an increase in Diagram 34). In the long run the deficit is about 2 the propensity for saving in the household sector percentage point less than in the base scenario. 10 and for net lending in the general government sector results in a weaker dollar and a clearly The period when GDP is below its level in the base stronger current account. Previous studies have scenario is prolonged. One interpretation is that often focused on what finally happens to the time is required for the structural transformation exchange rate with the level of output unchanged. when aggregate demand consists to a lesser degree This study shows that without an extremely of household and general government efficacious economic policy the impact of the consumption, and to a correspondingly higher adjustment would be clearly felt. During the process extent of exports and private investment (the latter of adjustment toward a new equilibrium, resource utilization would decrease appreciably in the US, 10 In the long run, the relationship between the adjustment in and with the reduction in demand for imports, there the dollar and the change in the current account is much the would be a risk of stagnation in the euro zone and same as in Obstfeld & Rogoff, where the dollar weakens by 35 would also lead to a significant decrease in global percent and the current account strengthens by the equivalent GDP. of 5 percent of GDP. 26 Development of the International Economy Domestic Demand Stabilizing in Japan GDP rose by 1.3 percent in the first quarter of 2005 after stagnating in the last three quarters of 2004. There were substantial increases both in household consumption and in investment in machinery and equipment. Exports, by contrast, decreased slightly, in part because many countries were making downward adjustments in inventories of items like IT products. In the second quarter, GDP growth slackened to 0.3 percent. Household consumption and investment in machinery and equipment continued to rise relatively rapidly, while exports picked up again. GDP growth was dampened by decreases in inventories and in construction investment as well as a fairly substantial increase in imports. Indicators show that business confidence about the third quarter has improved somewhat. GDP growth will thus be Diagram 35 Operating Surplus - Japan Thousands of billions of yen, quarterly values slightly higher beginning with the third quarter of this year. Both 40 40 domestic demand and exports are expected to grow at a rather healthy rate. Growth in exports will be stimulated by a weaker exchange rate for the yen and the strengthening of worldwide 20 20 demand for Japanese products following the adjustments in inventory, among other factors. Japanese firms have shown a very favourable profit tendency 0 0 in the last few years (see Diagram 35). The improved financial situation of firms has recently led to higher employment and -20 -20 rising wages. Hence, household income has strengthened. Higher growth in exports will help to sustain the relatively favourable profit tendency in 2006 and 2007 as well. This will -40 98 00 02 04 -40 stimulate household consumption, which will grow at a Sources: Ministry of Finance, Japan. respectable rate in the period ahead. A more restrictive fiscal policy, however, will dampen the rise in consumption. A healthy profit tendency and higher capacity utilization will also contribute to increasing investment in machinery and Diagram 36 GDP and Inflation – Japan equipment. GDP will grow by 1.7 percent this year (see Diagram Annual percentage change 36). Tighter fiscal policy and the high price of oil are expected to 4 4 limit growth to 1.5 percent per year during 2006–2007. 3 3 Consumer prices continued to fall during the second quarter of this year, and in June the annual rate of inflation was –0.5 2 2 percent. The higher level of resource utilization will contribute 1 1 to some increase in prices in the next two years. It thus appears that the seven-year period of deflation will end. But since 0 0 inflation will be very low, monetary policy will remain -1 -1 expansionary next year and in 2007. -2 -2 95 97 99 01 03 05 07 CPI GDP Continued High Growth in Asia Sources: Cabinet Office, Management and Coordination Agency, Japan and NIER. China’s economy is continuing its rapid expansion. In the first two quarters of this year, GDP rose by about 9.5 percent in Development of the International Economy 27 constant prices compared to the same period in 2004. However, Diagram 37 Fixed Investment – China Annual percentage change, current prices, quarterly the availability of data in constant prices is limited. In current values prices, by comparison, GDP rose at an annual rate of some 15 70 70 percent during the same period, while household consumption increased by about 13 percent. The rate of increase in total 60 60 investment was approximately 25 percent in current prices (see 50 50 Diagram 37). This rate of growth in investment, however, was considerably 40 40 lower than in 2004 owing to a subdued rate of increase in 30 30 construction investment. The slowdown was the result of previous steps by the Government to contain the overheated 20 20 real estate market. These steps included credit limitations, 10 10 requirements of higher reserves for banks and an increase in the policy interest rate. Other restrictive action was taken in March 0 97 99 01 03 0 of this year, with an increase in the rate of interest on real estate Source: National Bureau of Statistics, China. mortgages. The overall effect was to curb the rise in real estate prices during the first half of this year. In addition, the rate of investment has increased in sectors with capacity problems (such as coal, electricity and transport). The slowdown in construction investment contributed to the decrease of growth in imports to around 15 percent in current prices. Exports, on the other hand, continued to grow rapidly and were up about 30 percent. The surge is explainable partly by higher exports of textiles early this year after the US, the euro zone and other countries lifted import quotas as of January 1, 2005, in accordance with the WTO agreement. Since the spring, however, the US and the EU have reinstated import quotas for textiles from China. On July 21 of this year, China’s currency, the yuan, was revalued by 2.1 percent against the US dollar after having been linked to the dollar at a fixed exchange rate for ten years. The new foreign-exchange policy is described by the Chinese central bank as one of a managed float, which in this case means being linked to a basket of currencies. Since the revaluation was so limited, it is not expected to have significant effects on foreign trade and thus not on GDP, either. Diagram 38 GDP and Inflation – China Annual percentage change Overall GDP growth will slow from 9.0 percent this year to 12 4 8.5 percent in 2006 and 8.0 percent in 2007 (see Diagram 38). The slackening growth rate will be due primarily to a lower rate 10 3 of increase in construction investment. 8 2 Many countries in Southeast Asia are continuing to grow at a relatively robust rate because of the rapid expansion in China. 6 1 For Malaysia, Thailand and Indonesia, GDP is forecast to increase by 5.0 to 6.0 percent annually in 2005–2007. 4 0 In India growth has accelerated in recent years. GDP growth, 2 -1 which was 7.3 percent last year, will ease off to 6.7 percent this year and to 6.4 and 6.5 percent, respectively, in 2006 and 2007. 0 97 99 01 03 05 07 -2 Growth is being driven mainly by the dynamic services sector, GDP CPI (right) particularly in ICT. Sources: IMF, National Bureau of Statistics, China and NIER. 28 Development of the International Economy China’s Growth and contributed to surging wages. During 1982-2004 employment grew at an annual average rate of about Challenges 2.5 percent, and the number of persons employed increased from some 450 million to approximately China is often cited as a quite rapidly growing 750 million. In the same period, consumer prices economy and is expected to play an important role rose by an annual average of about 6 percent. in future global development. Despite evident successes, however, the country’s rapid transformation has posed a number of problems that burden the country and its economy in various Different Demand Structure ways. Compared to many industrialized countries, China has extremely high investment and relatively limited consumption in proportion to GDP. Rapid Economic Growth With investment rapidly growing, its share of GDP rose from 28 percent in 1982 to 45 percent in Economic growth has been very strong since the 2004 (see Table 6). During this same period, early 1980’s. During 1982–2004, GDP rose in consumption decreased as a share of GDP from 54 constant prices by an annual average of 9.8 percent, to 43 percent. Net exports of goods and services, and the GDP deflator rose by 5.5 percent. which were negative for most of the 1980’s, have In current prices, GDP per capita increased been positive since 1990, except in 1993. Net from about 300 dollars in 1982 to 1300 dollars in exports in proportion to GDP were 2.6 percent in 2004, and China’s share of the world’s PPP-adjusted 2004, somewhat above the average of 2.2 percent GDP rose from about 4 percent in 1984 to some 13 since the outset of the 1990’s. percent in 2004. Table 6 GDP and Demand in China Average Annual Percentage Change and Percent of Foundation for Growth GDP, respectively Laid by Investment and Exports Percentage Percent of Percent of change GDP in 1982 GDP in 2004 China’s strong growth has been confined largely to 1982–2004 economic zones along the coasts and adjacent areas. GDP 16 100 100 Growth has been driven by exports and investment. Investment 19 28 45 Surging investment in the exporting industries and a Household 15 54 43 massive expansion of infrastructure set the stage for consumption Exports 25 8 35 rapid growth in exports. During the period 1982- Imports 25 7 33 2004 exports surged by an average of some 25 Source: National Bureau of Statistics, China. percent per year in current prices (see Table 6). The investment of exporting industries has been financed largely by foreign capital. Foreign direct investment in China, about 430 million dollars in High Household Saving in China 1982, skyrocketed to some 60 billion dollars, or The extremely high investment has entailed a almost 4 percent of GDP, by 2004. The cumulative considerable need for financing, which has been inflow for the period 1982-2004 was roughly 560 met largely through high domestic household billion dollars. saving. According to estimates, households save some 30 to 35 percent of their total income. Most of their savings are deposited in government banks Rise in Household Consumption at very low interest. One reason for the high rate of saving is the In addition, household consumption has risen by an lack of a social safety net or a public pension annual average of some 15 percent in current prices system. during 1982-2004 (see Table 6). The vigorous growth of GDP has stimulated employment and Development of the International Economy 29 Rapid Growth a Source of Social Tension the first half of 2004 to about 25 percent in the first half of 2005. China’s rapid growth is causing problems in several areas. Uneven regional distribution of growth is generating great differences in living standards, Inefficient Use of Resources particularly between urban and rural areas, leading to social tension. There are still some regulations that contribute to Consequently, the major aims of the inefficient use of resources in the Chinese economy. Government include broader-based growth and For example, prices of water and energy are higher living standards for a majority of the controlled. With the subsidies for oil and petrol, for population, particularly in rural areas. This calls for instance, recent increases in oil prices have not been millions of new jobs. There is a need to absorb reflected sufficiently in prices to consumers. This surplus labour from state companies and the has probably contributed to the increase in the use countryside and to develop jobs with higher value of petroleum products in China. added. Improvements in the functioning of the labour market and increased education are essential components of any successful policy for absorbing Weak Banking Sector this surplus labour. The Government’s policy has focused on The banking sector in China is having difficulty in creating new jobs in the private sector, particularly meeting the borrowing requirements of soaring in services. In addition, the so-called Hukou system, investment. This is one reason why foreign direct which restricts migration between cities and rural investment has been so important. Risk areas, is being relaxed. management at banks is inadequate, and deposit insurance is lacking. The sector is burdened by a massive stock of doubtful loans, which were High Growth Means Problems of estimated to account for some 20 percent of total Overheating bank lending at the end of March 2005. The highest proportion of doubtful loans is The rapid growth in China has led to certain found at the four major state banks. The problems of overheating in recent years. With the accumulation of the enormous stock of doubtful high rate of investment, demand for primary loans at these banks is due partly to the increase in products (steel, aluminium and cement) as well as lending as government control of investment energy has soared. As a consequence, prices of these decisions and financial transactions has been items have risen appreciably in recent years, both in relaxed. China and on the world market. The real-estate market in coastal cities has also shown signs of overheating, with surging property Continued Reform of the Financial Sector prices in cities such as Shanghai. Vigorous expansion of exporting industries and increased However, reform of China’s banking sector has lending by banks to private borrowers, together been in progress for several years. One step has with higher investment from abroad, have fuelled been to reform risk management, with tighter rules demand for real estate, driving up prices. for lending. In addition, the Chinese central bank However, the authorities have taken steps to has provided substantial additional capital to bolster cool off the economy. Credit restrictions have been the financial strength of the banking sector. imposed on energy-intensive industries. Availability Many more reforms of the financial system must of land for industrial buildings has been limited to be implemented, however, by December 2006, slow the pace of investment. In addition, the one- when China will be required by the WTO year base rate for loans has been raised. These agreement to open its financial sector to foreign measures have helped to bring down the annual rate competition. At that time foreign banks will be able of growth in investment from some 60 percent in to compete with Chinese banks within China, where 30 Development of the International Economy only a handful of banks are currently permitted to Property Rights of Farmers Unclear operate. Capital markets are also in need of reform as A number of problems in China are due to the fact they are underdeveloped and not sufficiently that the country’s economic and political systems capable of efficiently providing a supply of capital. are ill adapted to rapid growth. This is true, for Moreover, the role of the stock market as a source example, of the banking system and the energy of financing is still marginal. sector. In addition, China’s economic and political However, the banking system is heavily system is afflicted by fundamental problems that dependent on the progress of reform in state can hamper growth without arising from it. companies. Probably the structural transformation The majority of China’s population still lives in of these firms will be implemented rather gradually rural areas, where the planned economy still prevails to avoid an overly large increase in unemployment. in agriculture. Even today, farmers do not own the land that they cultivate. Thus, they can easily lose it without receiving any compensation, for example if the local government decides to make farmland Inflexible Foreign Exchange Policy available for industrial activity or residential A weak banking sector, without a well-developed construction. This situation is a hindrance to foreign exchange market, has also been one of the investment and production in rural areas. main reasons why China maintained its policy of a fixed exchange rate for so long. The Chinese currency, the yuan, was held at a fixed exchange rate Social Insurance Sector Underfinanced against the US dollar from 1995 until July 21, 2005, when it was revalued by 2.1 percent against the The current pension system is inadequately financed dollar. It was also announced then that the and for this reason, among others, it must be exchange rate would no longer be fixed. The new reformed. The pension system is not funded, foreign exchange policy, the details of which have meaning that current pension disbursements are not yet been disclosed publicly, has been described financed with pension premiums paid by future by the Chinese central bank as a managed float, pensioners. The system is unsustainable in the long which in this case means being linked to a basket of run because of the rising proportion of elderly other currencies. persons in relation to the working-age population. The underlying reason for the revaluation was The country’s skewed age distribution is due both probably the increasingly insistent demand of other to the previous ”one-child” policy and to the countries, especially the United States, that this step increased life expectancy of the population. be taken. For years many analysts had held that the yuan was undervalued against the US dollar. Despite China’s many problems, the impression Through large trade surpluses and policy of a fixed remains that the country is in a period when exchange rate, China has accumulated a vast reserve extremely high growth will raise living standards for of some 610 billion US dollars. the population and give China an increasingly It is the Government’s long-run aim to make the important role in the world economy. yuan a freely convertible currency. In the near future, for example, it will be easier for private firms Sources: and institutions to take money out of the country National Bureau of Statistics, China. and for foreign institutions to issue bonds in China. IMF, World Economic Outlook, April 2005. A prerequisite for the possible introduction of a Prasad, E. (red), China’s Growth and Integration into the floating exchange rate is modernization and World Economy, Occasional Paper 232, IMF, 2004. capitalization of China’s banking sector. Kiesow, I. and K. Sandklef, ”Kina inför framtiden – Några viktiga trender i Mittens Rike” (China’s Outlook for the Future – Some Important Trends in the Middle Kingdom), FOI (Swedish Defence Research Agency), http://www.asia.foi.se/pdf/kina-rapport.pdf, 2004. Development of the International Economy 31 Ministry for Foreign Affairs, Swedish embassy in Bejing, http://www.oecd.org/dataoecd/1/23/33930229.pdf. various reports. “Asia’s subsidised oil”, Financial Times, 2005–08–18. Jiliang, S., Development and Trend of Banking Risk Management in China”, China Banking Regulatory Commission, 2004, 32 Development of the International Economy Diagram 39 GDP and Demand – Euro Zone Percentage change, seasonally adjusted quarterly values 1.5 1.5 Euro Zone – Light at the End of the Tunnel? 1.0 1.0 At the end of 2003, an export-driven economic recovery 0.5 0.5 commenced in the euro zone. Surging oil prices and an appreciating euro during 2002 and 2004, however, brought 0.0 0.0 recovery to a halt by mid-2004. Although GDP accelerated -0.5 -0.5 somewhat in the first quarter of this year (see Diagram 39). domestic demand remains slack. GDP growth rose to 0.5 -1.0 -1.0 percent in part because of extreme calendar adjustment, which -1.5 02 04 06 -1.5 meant that GDP growth for the fourth quarter of 2004 was GDP underestimated. Gross fixed capital formation Household consumption There are no such calculation effects for the second quarter. Unlike the first quarter, moreover, net exports are not expected Sources: Eurostat and NIER. to provide any positive contribution to growth, and GDP growth will drop back to 0.3 percent. Monthly statistics indicate that the lacklustre development of household consumption in Diagram 40 Purchasing Manager Index – Euro Zone the second quarter will continue. However, fixed capital Index, monthly values formation, which was slowed by a weather-related drop in 65 65 construction investment in the previous quarter, is expected to be up again (see Diagram 39). 60 60 New information, such as evidence of rising optimism in most business surveys (see Diagram 40) suggests that growth in 55 55 the euro zone has strengthened somewhat in the initial weeks of 50 50 the third quarter. For example, the outlook in manufacturing appears to be improving after the downturn in the spring. The 45 45 increase in growth is being driven primarily by developments in other countries, but domestic demand also appears to be 40 40 increasing somewhat faster. 98 00 02 04 Manufacturing Higher oil prices are curbing GDP growth in the euro zone. Service sector But low interest rates and buoyant demand from other countries Source: NTC Research Ltd. will lead to gradually rising growth in the period ahead. With the depreciation of the euro in the spring and the recovery of the global economy, exports will soon be rising again. In addition, the improvement in the balance sheets of firms, low financing and labour costs and high profits will continue to strengthen the investment tendency. The upswing in investment, however, is relatively slow by historical standards. One explanation for the cautiousness of firms is the increased competition from countries outside the OECD as well as uncertainty about the reform measures that will be taken in response to this competition. Another explanation is the uncertainty created by high oil prices. However, oil prices will gradually decrease in the period ahead; together with the depreciation of the euro, this factor will favourably affect profits and thus investment. Household consumption slackened again in the first half of this year, one reason being a lacklustre tendency in real incomes. At the same time, however, household saving remains high. Uncertainty about the labour market and about the reform process under way in several member countries is still a source Development of the International Economy 33 of concern, and household confidence has been dropping in Diagram 41 Consumer Confidence – Euro recent months (see Diagram 41). On the other hand, Zone Balances, monthly values consumption is being stimulated by low interest rates, and as the 10 10 labour market situation improves, consumption is expected to 5 5 begin rising somewhat faster (see Diagram 39). There are signs of a brightening labour market, with some increase in 0 0 employment and a decrease in unemployment (see Diagram 42). -5 -5 However, there is no expectation of rapid recovery in household -10 -10 consumption, and the high level of household saving will -15 -15 decrease only marginally this year and in the next two years. Households cannot count on any fiscal policy stimulus. -20 -20 Although the provisions of the Stability and Growth Pact have -25 96 98 00 02 04 -25 been softened, weak general government finances in many Euro zone countries leave little margin for discretionary action to stimulate Germany Historical average, Euro zone the economy. With the measures taken to achieve balance in Source: EU-commission. general government finances in certain countries, such as France, the Netherlands and Germany, fiscal policy for the euro Diagram 42 Unemployment Rate – Euro Zone zone as a whole will be somewhat restrictive this year. Percent of labour force, monthly values Thereafter, fiscal policy is expected to be neutral. 11.0 11.0 All factors considered, GDP growth will decrease somewhat 10.5 10.5 from 1.7 percent last year to 1.4 percent this year. In 2006 and 2007, growth will accelerate to 1.9 and 2.2 percent, respectively. 10.0 10.0 Despite high oil prices, inflation in the euro zone has been 9.5 9.5 fairly stable recently. The inflation rate rose from 2.1 percent in June to 2.2 percent in July, mainly because of rising energy prices 9.0 9.0 (see Diagram 43). However, no secondary effects of the high 8.5 8.5 price of oil are yet apparent. So-called core inflation (HICP excluding energy, food, alcohol and tobacco) gradually receded 8.0 8.0 during the spring and was 1.3 percent in July. With the relatively modest inflationary pressure and the low 7.5 96 98 00 02 04 7.5 level of resource utilization, the ECB can wait before raising the Source: Eurostat. refi rate. However, as growth picks up and resource utilization rises, the ECB is expected to shift monetary policy in a less expansionary direction. The first increase in the refi rate, from 2.00 to 2.25 percent, will come next summer. Thereafter, the refi rate will be raised gradually to 3.25 percent by the end of 2007. Diagram 43 Inflation – Euro Zone Annual percentage change, monthly values 3.5 3.5 3.0 3.0 2.5 2.5 2.0 2.0 1.5 1.5 1.0 1.0 0.5 0.5 99 01 03 05 Consumer prices (HICP) HICP excluding energy, food, alcohol and tobacco Source: Eurostat. 34 Development of the International Economy Table 7 Selected Indicators – Euro Zone Billions of euros, current prices, and annual percentage change, constant prices 2003 2004 2005 2006 2007 Household consumption 4 294 1.2 1.5 1.7 2.1 expenditure General-government 1 548 2.6 1.1 1.9 1.6 consumption expenditure Fixed-capital formation 1 507 1.3 1.4 3.0 2.9 1 Stockbuilding 39 0.1 0.0 -0.1 0.0 1 Net exports 158 0.1 0.1 0.0 0.1 GDP 7 547 1.7 1.4 1.9 2.2 HICP 2.1 2.0 1.6 1.8 Unemployment 8.9 8.8 8.6 8.4 2, 3 Policy interest rate 2.00 2.00 2.50 3.25 2, 4 Long-term interest rate 3.6 3.5 4.2 4.5 2 Dollar/Euro 1.34 1.23 1.24 1.25 1 Billionsof euros and contribution to GDP growth, respectively 2 At the end of each year Diagram 44 GDP and Inflation – UK 3 Refi rate Annual percentage change 4 Rate on 10-year government bonds 8 8 Sources: Eurostat and NIER. 6 6 More Expansionary Monetary Policy in the UK 4 4 GDP growth in the United Kingdom was 3.2 percent in 2004 2 2 (see Diagram 44). Consumption and investment both increased fairly rapidly in both the household and general government 0 0 sectors. Demand was stimulated by an expansionary fiscal policy -2 -2 and low real rates of interest. Fiscal policy also contributed to a 91 93 95 97 99 01 03 05 07 stronger employment and wage tendency in the construction HICP GDP industry and in general government than in other sectors. Sources: Office of National Statistics and NIER. However, GDP growth slowed to only 0.4 percent in the first quarter of this year. The increase in household consumption was insignificant, and investment decreased somewhat, though general government consumption continued rising at an Diagram 45 House Prices and Base Interest undiminished rate. Exports also decreased. Rate – UK According to preliminary data, GDP rose by 0.4 percent in Annual percentage change and percent, respectively, monthly values the second quarter of this year as well. The components of 32 8 demand in GDP have not yet been reported. But retail trade statistics indicate that the lacklustre tendency in household 24 7 consumption has continued. Moreover, employment and the rate of wage increases have weakened recently. On the other 16 6 hand, exports and imports have risen somewhat. 8 5 The slowdown in domestic demand is due partly to previous interest rate hikes totalling 1.25 percentage points between 0 4 November 2003 and August 2004. One purpose of the Bank of England’s tighter monetary policy is to dampen the rate of -8 3 increase in house prices and thereby also counter the surge in 95 97 99 01 03 05 House prices household consumption (see Diagram 45). The increases in Base rate (right) interest rates have helped considerably to reduce inflation in Sources: Halifax and Bank of England. house prices, which slowed to only about 1.5 percent in July of Development of the International Economy 35 this year. The more modest increase in net wealth, and thus in the margin for lending, have probably contributed to the significantly slower rise in household consumption in the first two quarters of this year. The inflation rate has been rising since the autumn of 2004, partly because of rising resource utilization. In June of this year, HICP inflation was 2.0 percent, the target rate of the Bank of England. With growth slowing in the first two quarters of this year, the risk of inflation has lessened. In view of this development, the Bank of England has lowered the base rate from 4.75 percent to 4.50 percent this August. Lower interest rates are expected to compensate for the drop in demand following the terrorist attacks in the third quarter of this year. GDP growth will be increasing again during the forecast period. The more expansionary monetary policy will contribute to a slightly faster increase in domestic demand than otherwise. Exports will be strengthened by somewhat higher growth in demand in the euro zone and in other major export markets. The labour market, where the unemployment rate was 4.8 percent in April of this year, will thus remain strong. After growing by only 2.0 percent this year, GDP will accelerate to 2.4 percent annually in 2006 and 2007, in line with its potential growth rate. HICP inflation will thus remain around 2.0 percent during the forecast years (see Diagram 44). Domestic Demand Sustaining Growth in the Nordic Region GDP growth in Finland will be curbed this year by the labour dispute in the paper industry in May and June. According to preliminary statistics, GDP dropped by 1.3 percent in the second quarter. The conflict is judged to have limited primarily exports, and it was one reason why manufacturing output was three percent lower in the first half of this year than in the same period in 2004. Diagram 46 GDP and Inflation – Finland The largest contribution to GDP growth this year will come Annual percentage change from household consumption. The reasons include a steady 8 8 increase in real wages, high dividends on profits and continued 6 6 strengthening of the labour market. In the first half of 2005, the 4 4 number of persons employed was 1.6 percent higher on average 2 2 than in the same period in 2004. Growth in employment has 0 0 been concentrated mainly in the private services and the -2 -2 construction sectors. The unemployment rate in June was 8.7 percent, compared to 8.9 percent in June 2004. -4 -4 GDP in Finland will grow by 1.0 percent this year. Next year -6 -6 growth will be 3.1 percent, in 2007 it will be 2.7 percent (see -8 91 93 95 97 99 01 03 05 07 -8 Diagram 46). HICP HICP inflation will be 1.2 percent this year. Thus, inflation GDP in Finland will be lower than the euro zone average for the Sources: Statistics Finland and NIER. 36 Development of the International Economy fourth year in a row. Inflation will be 1.6 percent in 2006 and 1.8 percent in 2007, closer to the average for the euro zone. According to preliminary statistics, GDP growth in Norway slackened slightly in the first quarter of this year. Both household consumption and oil-related investment were down. By most indications, however, GDP growth in Norway will be relatively healthy in the period ahead. With oil prices currently high, oil-related investment will surge this year as well, but it is expected to decline thereafter. According to the latest business tendency survey by Statistics Norway, firms outside the oil sector are also planning to increase their investment during the rest of the year. Stimulated by rising asset prices and employment, household consumption is expected to increase by more than 3 percent per year in 2005 and 2006. Unemployment is therefore anticipated to decrease marginally to 4.0 percent during the forecast period. All these factors considered, GDP growth will increase from 2.8 percent last year to 3.1 percent this year, then slacken Diagram 47 GDP and Inflation – Norway Annual percentage change somewhat in 2006 and 2007 to 2.5 and 2.0 percent, respectively 6 6 (see Diagram 47). GDP growth will be curbed in the next two years not only by lower oil investment, but also by a tighter 5 5 monetary policy, leading to a slowdown in household 4 4 consumption and in other investment. The inflation rate rose to 1.7 percent in June. The Central 3 3 Bank of Norway raised its policy interest rate from 1.75 percent 2 2 to 2.00 percent effective June 30. This rate hike was the first in three years and was made primarily in response to rising 1 1 resource utilization, which has been leading to higher 0 0 inflationary pressure. Norway’s budget surplus will increase to 91 93 95 97 99 01 03 05 07 15.6 percent of GDP this year. High oil prices are generating CPI GDP substantial tax revenue for the Norwegian government. Sources: Statistics Norway and NIER. GDP growth in Denmark will slacken this year to 2.3 percent (see Diagram 48), primarily because of temporarily weak domestic demand in the first quarter, when there was a drop in both household consumption and investment. On the other Diagram 48 GDP and Inflation – Denmark hand, the tendency was strong in exports as well as in general Annual percentage change government consumption. For the rest of the year, growth will 6 6 be driven by household consumption, which is being 5 5 encouraged by low interest rates, rising asset prices and last year’s tax cuts. A weaker tendency in household consumption is 4 4 anticipated for next year, when the effects of the fiscal policy 3 3 stimulus have subsided. For some time the unemployment rate has held steady between 5.0 and 6.0 percent, and it is estimated 2 2 to be 5.0 percent for the forecast period. 1 1 Rising demand in Europe will favour GDP growth, which will be 2.2 and 2.0 percent, respectively, in 2006 and 2007. 0 91 93 95 97 99 01 03 05 07 0 Consumer prices in Denmark rose by only 0.9 percent in HICP 2004 owing to declining prices of imports, reduction of the VAT GDP and high productivity growth. Inflation accelerated this June to Sources: Statistics Denmark and NIER. 1.8 percent and will continue upward to around 2.0 percent during the forecast period because of rising resource utilization. Development of the International Economy 37 Robust Growth in the New EU Countries Diagram 49 Gross Fixed Capital Formation in New EU-countries The new EU countries 11 are continuing to show robust growth. Annual percentage change Gross fixed capital formation rose by 7.1 percent last year and 14 14 will go on increasing by about 8.5 percent annually during the 12 12 period 2005–2007 (see Diagram 49). The continuing upswing in 10 10 the international economy will further strengthen exports of the new EU countries, which will increase by some 10 percent per 8 8 year during the forecast period. 6 6 High unemployment persists despite strong growth. In Poland and Slovakia, for example, the unemployment rate has 4 4 been almost 20 percent for some time. 2 2 GDP growth in the new EU countries was 5.0 percent last 0 0 year and will be about 4.5 percent per year during the period 2005–2007 (see Diagram 50). -2 95 97 99 01 03 05 07 -2 Inflation will recede from 4.1 percent last year to about 2.5 Note: The new EU countries are Poland, Hungary, the Czech Republic, Cyprus, Estonia, Latvia, percent annually in 2005–2007 (see Diagram 50). Lithuania, Malta, Slovakia and Slovenia. Sources: Eurostat and NIER. Diagram 50 GDP and Inflation in New EU- countries Annual percentage change 10 10 8 8 6 6 4 4 2 2 0 0 99 01 03 05 07 HICP GDP Sources: National sources and NIER. 11 The new EU countries are Poland, Hungary, the Czech Republic, Cyprus, Estonia, Latvia, Lithuania, Malta, the Slovak Republic and Slovenia. 39 Diagram 51 Stock Market – US Index, 5-days centred moving average Financial Markets 5000 2000 With the Riksbanks’s latest reduction of the repo rate to 1.50 4000 1600 percent in late June, as well as continued low interest rates on bonds and a weaker krona, monetary conditions are highly 3000 1200 expansionary. This situation is reinforcing the economic upswing, leading to rising employment and a gradually tighter 2000 800 labour market. To keep this development from generating excessive inflation, monetary conditions should be made less 1000 400 expansionary in the period ahead. This shift would be 0 0 accomplished through a gradually higher repo rate, rising interest 97 99 01 03 05 rates on bonds and a somewhat stronger krona. Nasdaq Composite Standard and Poor's 500 (right) Source: EcWin. Positive Stock Market Tendency as Profits Rise Since 2003, the US stock markets have shown an upward trend Diagram 52 Stock Market – Sweden after the stock market decline that began in 2000 (see Diagram Index, 5-days centred moving average 51). Even after rising more than 30 percent since 2003, stock 450 2000 markets are far below their peak levels in 2000. Since the start of this year, however, stock markets have shown virtually no 360 1600 increase, which may be explainable by rising oil prices. Uncertainty about the strength of the US economic recovery has 270 1200 diminished over the summer, and listed US companies are 180 800 reported steadily higher profits despite decreasing productivity growth that raises the unit labour costs of firms. 90 400 Like US stock markets, the Swedish stock market has risen substantially since 2003. On the whole, it is still well below its 0 0 peak in 2000, though certain industries are not far from it. The 97 99 01 03 05 Stockholm All-Share Index (SAX) stock market has shown a positive tendency this year, with the OMX (right) broad-based SAX index up by about 17 percent (see Diagram Source: EcoWin. 52). This summer a number of Swedish listed companies have presented favourable reports for the first half-year, showing a steady, robust tendency in profits. The rise in profits is due to a healthy increase in demand and the high productivity growth Diagram 53 Official Interest Rates Percent, daily values due in part to extensive cost cutting in recent years. 5 5 4 4 Inflationary Pressure Forcing Fed to Continue Raising Interest Rates 3 3 The US central bank (the Fed) has continued to raise its policy 2 2 interest rate (the federal funds rate) over the summer. Since June 2004, when the federal funds rate was 1.00 percent, it has been 1 1 increased ten times, reaching 3.50 percent this August (see Diagram 53). Despite these repeated increases, the federal funds 0 02 04 06 0 rate is not at all high by historical standards, either in nominal or Euro zone US in real terms. Sources: National sources and NIER. The current tightening of monetary policy in the US is necessary to keep the economy from overheating. The 40 Financial Markets tightening effect on monetary conditions, however, has been limited, as longer-term market rates of interest have remained low despite increasingly high short-term market rates. Even though the federal funds rate has been raised by 2.50 percentage points in little more than one year, this phase of rate increases is by no means unique compared with previous interest-rate cycles. The US is well ahead of other countries in its business cycle. Productivity growth has slackened somewhat, and with the tightening labour market, unit labour costs have begun rising. As the remaining spare resources are put to use, inflationary pressure will intensify. The Fed will therefore continue to raise the federal funds rate, which will reach 4.00 percent at the end of 2005 and 4.75 percent during 2006. There will be no change in the federal funds rate in 2007 (see Diagram 53). In the euro zone, growth has remained low despite global economic Diagram 54 Short-Term Real Interest Rates Percent, monthly values, 5-month centred moving recovery in recent years. The prospects for growth have average brightened somewhat, however, and growth is expected to pick 4 4 up during the forecast period and to exceed its potential rate. To 3 3 avoid an increase in inflationary pressure, the ECB is expected 2 2 to raise its policy interest rate (the refi rate) in the second quarter of 2006. By the end of 2007, the refi rate will be 3.25 percent 1 1 (see Diagram 53). 0 0 -1 -1 -2 -2 Monetary Policy in an International Perspective -3 02 03 04 05 06 07 -3 To form a picture of the stance of monetary policy, it is relevant Sweden Euro zone to study real short-term market rates of interest. Real short-term US interest rates have differed fairly substantially between the US, Note: Inflation is calculated as the inflation rate in Sweden and the euro zone in recent years (see Diagram 54). Real the current three-month period, expressed as an annual rate. The interest rate is a nominal three- rates of interest have been appreciably higher in Sweden than in month rate. The period in the diagram is shorter either the euro zone or the US, reflecting Sweden’s tighter than the forecast period for reasons pertaining to calculation procedure. monetary policy stance. Sources: National sources and NIER. Real short-term interest rates are expected to rise during the Diagram 55 Inflation and One Year Inflation forecast period – somewhat more in the US than in Sweden and Expectations the euro zone – because of higher resource utilization and the Percent, quarterly values 3 3 consequent increase in policy interest rates. 2 2 Inflation Expectations Remain Low in Sweden 1 1 For both households and firms, the inflation rate expected in 0 0 one year has decreased in recent years and is currently below the -1 -1 Riksbank’s inflation target, though some increase may be noted for households in the latest quarter (see Diagram 55). This -2 -2 development has coincided with a decreasing tendency in the 98 00 02 04 06 CPI current rate of inflation. Households Business Tendency Survey Market expectations of future inflation can be measured indirectly through so-called break-even inflation, or the difference Note: Expectations are shown in the diagram with one year’s lead. between the nominal rate of interest on a government bond and Sources: Statistics Sweden and NIER. Financial Markets 41 the rate of interest on a so-called index-linked bond, which Diagram 56 Real Interest Rate and Break- provides a return that is guaranteed against future inflation. even Inflation – Sweden Percent, 5-days centred moving average Although inflation expectations determined in this way should 3.0 3.0 be interpreted with some caution, it may be noted that for some time they have been appreciably less than the inflation target (see 2.5 2.5 Diagram 56). Market operators were somewhat surprised when the Riksbank lowered the repo rate by 0.50 percentage point at the 2.0 2.0 end of June (see Diagram 57). After the relatively strong outcome for GDP in the second quarter, together with a 1.5 1.5 number of other favourable indications for the state of the economy, there are no longer any market expectations of a 1.0 1.0 further reduction in the repo rate. Market operators now expect 03 04 05 Index-linked bond yield the repo rate to remain at today’s level until the spring of 2006. Break-even inflation Note: Break-even inflation is the difference between the yields on a nominal long-term bond and an index-linked bond with similar maturities. Maturity approximately 10 years. Riksbank Should Wait Despite Inflation Below Target Sources: EcoWin and NIER. Diagram 57 Expected Repo Rate in Sweden The Riksbank’s latest reduction of the repo rate to 1.50 percent According to Implicit Forward Interest Rates has made monetary conditions highly expansionary. The Percent, monthly values reduction was welcome since it is stimulating the increase in 2.8 2.8 demand and thus helped bring inflation closer to the target rate 2.6 2.6 of 2 percent, primarily by speeding up cyclical improvement of 2.4 2.4 the labour market. Productivity growth will be lower during the forecast period 2.2 2.2 than in 2004. This will contribute to greater demand for labour, 2.0 2.0 and as the labour market tightens, to rising inflationary pressure. 1.8 1.8 There has been no change in the currently modest inflationary pressure in the Swedish economy. The low rate of inflation is 1.6 1.6 due primarily to the unexpectedly strong productivity growth in 1.4 2006 2007 1.4 recent years, which has led to a cyclically weak labour market 19/8 2005 and limited wage increases. Last year wages in the business 7/6 2005 sector rose by 3.0 percent, the lowest rate of increase in ten years Sources: Reuters and NIER. (see Diagram 58). For these reasons, unit labour costs in the business sector have decreased by a total of 1.5 percent in the last three years (see Diagram 59). Diagram 58 Hourly Earning – Business Sector Employment will be increasing in the period ahead, and with Annual percentage change the labour market gradually tightening somewhat, the rate of 6.0 6.0 wage increases will rise. In 2007 wages in the business sector are 5.5 5.5 forecast to increase by 3.9 percent, slightly less than the rate 5.0 5.0 considered compatible with 2-percent inflation. The higher wage increases will contribute to higher underlying inflationary 4.5 4.5 pressure. UND1X inflation will gradually increase to 1.6 percent 4.0 4.0 by the end of 2007 (see Diagram 60) 3.5 3.5 Based on the Riksbank’s guideline for taking action, the repo rate should be reduced; otherwise the inflation rate will be well 3.0 3.0 below the target in one to two years’ time (see Diagram 60). The 2.5 2.5 forecast for UND1X inflation is influenced, however, by the 2.0 2.0 assumption that today’s high oil prices will recede during the 93 95 97 99 01 03 05 07 forecast period. Therefore, in the NIER’s opinion, monetary Sources: National Mediation Office and NIER. policy should be guided in the current situation by UND1X 42 Financial Markets Diagram 59 Unit Labour Cost – Business excluding energy prices. This measure provides a more accurate Sector Annual percentage change, calendar-adjusted picture of underlying inflationary pressure. UND1X excluding 8 8 energy is higher than UND1X inflation but will still much less than 2 percent in one to two years (see Diagram 60). 6 6 One strong argument for reducing the repo rate is that this 4 4 step, given the current forecast, would speed cyclical recovery of the labour market without jeopardizing the inflation target. 2 2 However, the forecast is based on current provisions of fiscal 0 0 and labour market policy. In fact, fiscal policy will probably be more expansionary by virtue of the proposals in the budget bill -2 -2 for 2006. Moreover, inflationary pressure may be influenced -4 01 03 05 07 -4 upward or downward by changes in labour market policy. These Labour cost per hour are persuasive arguments against lowering the repo rate at this Productivity Unit labour cost point. If the budget bill proves to contain no measures that Sources: Statistics Sweden and NIER. increase inflationary pressure, it may well be appropriate to lower the repo rate later on. Another relatively strong reason not to reduce the repo rate is that the risk assessment for growth and thus for inflationary Diagram 60 UND1X Annual percentage change, monthly values pressure is asymmetrical. In the NIER’s opinion, it is more 3.5 3.5 probable that growth will be higher, rather than lower, than in 3.0 3.0 the forecast. Continued improvement of the labour market may 2.5 2.5 well lead to even faster growth in consumption, which in turn would speed improvement of the labour market, stimulating 2.0 2.0 consumption further. 1.5 1.5 An additional argument against reducing the repo rate is 1.0 1.0 based on the fact that prices of single-family homes, like 0.5 0.5 household indebtedness, are rising rapidly. This tendency entails 0.0 0.0 a risk, however slight, of such a sharp drop in house prices later -0.5 -0.5 on that demand cannot be maintained at a reasonable level even 00 02 04 06 by combining a zero repo rate and an expansionary fiscal policy. UND1X UND1X excl. energy In the NIER’s opinion, however, this possibility need not be Note: Shaded area refers to inflation rate expected taken too seriously at present. in one to two years time-horizon. Sources: Statistics Sweden and NIER. All factors considered, the NIER recommends that the repo rate be left unchanged for the time being. Given the current assessment, as resource utilization and inflationary pressure Diagram 61 Repo Rate – Sweden increase, the repo rate can subsequently be raised gradually to Percent, daily values 3.50 percent by end of 2007 (see Diagram 61). For further 4.5 4.5 discussion of this monetary policy recommendation, see the box 4.0 4.0 captioned ”The NIER’s Repo Rate Assessment”. 3.5 3.5 3.0 3.0 2.5 2.5 Monetary Policy in a Rear-View Mirror 2.0 2.0 With hindsight it is now apparent that monetary policy has not 1.5 1.5 been sufficiently expansionary in the past three years; in other 1.0 1.0 words, the repo rate has been too high. This conclusion is 02 03 04 05 06 07 Repo rate evident from the fact that in the last two years the inflation rate Implicit forward repo rate, August 19, 2005 Implicit forward repo rate, June 7, 2005 has not only been below the 2-percent target, but has even averaged less than the lower tolerance limit of 1 percent (see Note: Expectations according to yield curve. Sources: The Riksbank, Reuters and NIER. Diagram 60). Low wage increases, low percentages of firms reporting shortages and many other indicators as well show that Financial Markets 43 the labour market is cyclically weak, with too little demand for labour. The number of hours worked has decreased by nearly 3 percent between the peak in the fourth quarter of 2001 and the trough in the first quarter of 2005 (see the ”Output and Labour Market” section). That is a relatively long period for the labour market to be cyclically weakening. But this conclusion, which is based on hindsight, says nothing about whether goal-achievement could have been better given the information available at the time when the monetary policy decisions were taken. Most economic forecasters, including the NIER, the Government and the Riksbank, have underestimated productivity growth in recent years, thereby also underestimating the stimulus to demand, primarily through a more expansionary monetary policy, that would have been needed to halt the cyclical weakening of the labour market Diagram 62 Long-term Interest Rates, 10- Year Government Bonds earlier on. Between the low point in the first quarter of 2005 and Percent, weekly values the final quarter of 2007, the number of hours worked will have 6.0 6.0 increased by 2.6 percent. One of the principal driving forces 5.5 5.5 behind this cyclical improvement of the labour market will be 5.0 5.0 monetary policy, which is currently quite expansionary. 4.5 4.5 4.0 4.0 Rising Interest Rates on Bonds 3.5 3.5 3.0 3.0 Interest rates on long-term bonds, in Sweden as well as internationally, have shown a declining trend in the last few 2.5 02 03 04 05 2.5 years but have recently risen somewhat (see Diagram 62). Real Sweden Germany rates of interest on bonds have generally followed a similar trend US (see Diagram 63). The tendency of these trends is difficult to Source: The Riksbank. reconcile with the increasingly bright picture of the economy in the latest period. The remarkably low bond rates are treated in greater detail in a special analysis in The Swedish Economy, March 2005. Among the reasons for the trend, special attention was called to the high Diagram 63 Interest Rate on Index-Linked profit level of firms in relation to their investment, a factor Bonds Percent, weekly values limiting the demand for financial capital. Moreover, the high rate 4.0 4.0 of household saving may be due to demographic factors. A large proportion of the population in the western world will retire in 3.5 3.5 the next ten years, a factor that may explain a high level of 3.0 3.0 pension saving by households. Another explanation, which also 2.5 2.5 may be related to future pensions, is that pension managers have 2.0 2.0 increased – or are expected to increase – the demand for long- 1.5 1.5 term bonds in order to make their asset portfolios more consistent with long-term pension commitments. In the EU this 1.0 1.0 development has resulted from on-going changes in applicable 0.5 02 03 04 05 0.5 rules. High demand for long-term bonds raises their prices, thus USA lowering interest rates on bonds. Sweden Euro zone Over the summer the US economy has continued to show Note: Maturity is close to 10 years. The yield on a strength. This has led to rising bond rates in the US as well as in French index-linked bond has been used for the Euro zone. the euro zone and Sweden. However, Sweden’s lower policy Source: EcoWin. interest rate, together with continued low inflation expectations, 44 Financial Markets has kept Swedish long-term interest rates below the corresponding German rates. This has previously been the case for brief periods, but it is unusual. With global resource utilization and inflationary pressure increasing, short- and long-term market rates of interest are expected to continue rising in the US, Sweden and the euro zone. The US interest rates are expected to increase more than the Swedish interest rates, and the Swedish interest rates will increase more than the German. It is therefore anticipated that the negative interest rate differential in relation to Germany will gradually decrease and will turn positive during 2006–2007. Revaluation of Chinese Currency Having Modest Effects China’s central bank revalued the country’s currency by slightly more than 2 percent in late July. At the same time, China Diagram 64 Nominal Exchange Rates 5-days centred moving average abandoned its policy of a fixed exchange rate against the US 1.40 100 dollar, shifting to a system where the Chinese currency would be linked to a basket of other currencies. Modification of China’s 1.32 105 exchange rate policy was expected, but its nature and timing 1.25 110 were not known. Since the revaluation was relatively limited, so 1.17 115 were the reactions of financial markets. 1.10 120 The US dollar has strengthened during the year, appreciating 1.02 125 by some 9 percent in relation to the euro (see Diagram 64). High 0.95 130 economic growth, together with repeated increases in interest rates, and a cautious economic outlook elsewhere – as in the 0.88 135 euro zone – have contributed to this development. 0.80 01 03 05 140 The deficits of the US economy in trade with other countries Dollar/Euro Yen/Dollar (right) and in the deficit in the federal budget are major elements of uncertainty about the future development of the dollar. The US Source: EcoWin. must attract considerable amount of capital in order to finance its deficits. During the spring, however, the deficits in foreign trade were less massive than many feared, and the government deficit is decreasing as the US economy maintains its momentum. This may have contributed to a stronger dollar this year. The continuing strength of the US economy, with further increases in interest rates in 2005–2006, is expected to help prevent the exchange rate of the dollar from changing appreciably during the forecast period, in spite of factors tending to weaken the dollar in the long run. At the end of 2007, a euro is expected to cost USD 1.25. Krona Weakened by Lower Repo Rate The Swedish krona has gradually weakened during the year against most major currencies. Among the factors affecting the exchange rate of the krona are the increases in policy interest Financial Markets 45 rates by the central banks of the US and Norway. The slowdown Diagram 65 Nominal Exchange Rates 5-days centred moving average in the Swedish economy this past spring raised expectations of a 11 11 lower repo rate, increasing interest rate differentials against other countries and putting downward pressure on the krona. During 10 10 the year, the Swedish currency has weakened by about 5 percent in effective terms, largely through its depreciation against the 9 9 dollar. In mid-August a dollar cost about SEK 7.60, and a euro about SEK 9.30 (see Diagram 65). 8 8 In a long-term perspective, the krona is expected to strengthen in effective terms. This will depend in part on the 7 7 large surpluses in the current account which continue to improve Sweden’s net financial position against other countries. 6 01 03 05 6 The strengthening of the krona is expected, however, to be Krona/Euro Krona/Dollar relatively limited. The effective exchange rate index for the Source: EcoWin. krona, the KIX, is forecast to be about 116 at the end of 2007, which means that it will appreciated annually by slightly less than 1 percent in 2006–2007 (see Diagram 66). At the end of 2007, a euro is expected to cost SEK 9.20 and a dollar, about SEK 7.40. Diagram 66 Effective Exchange Rate Indices Index 1992-11-18=100, monthly values 145 145 Table 8 Interest Rates and Exchange Rates at the End of Each Year 140 140 2003 2004 2005 2006 2007 135 135 Policy interest rates 130 130 Riksbank’s repo rate 2.75 2.00 1.50 2.25 3.50 125 125 ECB’s refi rate 2.00 2.00 2.00 2.50 3.25 Federal funds target rate 1.00 2.25 4.00 4.75 4.75 120 120 1 Long-term interest rates 115 115 Sweden 4.9 3.9 3.4 4.3 4.7 110 110 Germany 4.3 3.6 3.5 4.2 4.5 105 105 United States 4.3 4.2 4.8 5.4 5.4 95 97 99 01 03 05 07 Exchange rates TCW KIX Krona/Dollar 7.36 6.70 7.56 7.46 7.36 Krona/Euro 9.02 8.98 9.31 9.26 9.20 Note: An increasing index indicates a weaker krona. Sources: The Riksbank and NIER. Dollar/Euro 1.22 1.34 1.23 1.24 1.25 TCW index 124.4 122.4 129.0 128.0 127.0 KIX 113.1 111.0 118.1 117.1 116.1 1Interest rates on 10-year government bonds. Sources: The Riksbank and NIER. 46 Financial Markets Diagram 67 Repo Rate Percent, daily values The NIER’s Repo Rate Assessment 4.0 4.0 The development of the repo rate presented in The Swedish 3.5 3.5 Economy is based initially on the Riksbank’s inflation target but is determined by the NIER’s assessment of inflation. Properly 3.0 3.0 speaking, there is thus no forecast of the Riksbank’s monetary 2.5 2.5 policy; presented instead is a path of development for the repo rate that the NIER considers appropriate (see Diagram 67). 2.0 2.0 The Riksbank’s latest reduction of the repo rate, to 1.50 1.5 1.5 percent in late June, was welcome in view of the limited inflationary pressure. The low repo rate, low interest rates on 1.0 03 05 07 1.0 bonds and the weakening of the krona, partly in connection with With NIER's repo-rate assessment the reduction of the repo rate, have contributed to monetary With repo rate unchanged at 1.50 percent conditions that are currently quite expansionary. These Sources: The Riksbank and NIER. conditions are stimulating growth in demand, leading to cyclical improvement of the labour market. As discussed above, the NIER recommends that the repo rate be kept unchanged for the time being, with the first increase Diagram 68 Nominal Exchange Rate KIX, quarterly values in June 2006, provided the economy develops according to the 120 120 current forecast. With rising resource utilization and increasing inflationary pressure, the repo rate, based on the current 118 118 assessment, should be raised step-by-step to 3.50 percent by the end of 2007 (see Diagram 67). The gradual increase in the repo 116 116 rate will help to keep the economy from overheating after the forecast period. The forecast in the present report is based on 114 114 this recommended course for the repo rate. 112 112 One way to illustrate the considerations underlying the repo rate assessment is to compare the NIER’s forecast with a 110 110 scenario of an unchanged repo rate for the entire forecast 03 05 With NIER's repo-rate assessment 07 period. This approach also enhances comparability with the With repo rate unchanged at 1.50 percent Riksbank’s forecast, in which that assumption is made; however, Sources: The Riksbank and NIER. it does not provide an alternative forecast. Compared with the NIER’s assessment, an unchanged repo rate of 1.50 percent would mean a more expansionary monetary policy beginning in the third quarter of 2006 (see Diagram 67). Diagram 69 Output Gap Such a monetary policy would lead to lower market rates of Percent, quarterly values interest and to a weaker exchange rate for much of the forecast 1.0 1.0 period (see Diagram 68). As a consequence of these more 0.5 0.5 expansionary monetary conditions, GDP would grow more rapidly than in the NIER’s forecast. The initial abundance of 0.0 0.0 spare resources – as illustrated by the negative output gap – would be eliminated more quickly, and the output gap would -0.5 -0.5 close at the end of 2006 (see Diagram 69). Resource utilization would then become increasingly strained during 2007. An -1.0 -1.0 unsustainably tight labour market, like the strain on utilization of other resources, would give rise to so-called bottlenecks in the -1.5 03 05 07 -1.5 economy, thus increasing inflationary pressure. It is judged that With NIER's repo-rate assessment with an unchanged repo rate, underlying inflationary pressure, With repo rate unchanged at 1.50 percent with energy prices excluded, would exceed 2.0 percent at the end Source: NIER. of 2007 (see Diagram 70). Financial Markets 47 In summary, an unchanged repo rate would lead to excessive Diagram 70 UND1X-Inflation Annual percentage change, quarterly values inflation and a positive output gap at the end of 2007. In order 3.0 3.0 to bring inflation back down to 2 percent, it would be necessary to adopt a monetary policy that would sharply inhibit growth. 2.5 2.5 Given that the economy develops according to the present 2.0 2.0 forecast, it will be appropriate to begin raising the repo rate in June 2006 so as to prevent this kind of overheating. 1.5 1.5 The NIER’s forecast is based on the fiscal policy provisions 1.0 1.0 currently in effect. The conditions for monetary policy would change if the measures proposed by the NIER to strengthen the 0.5 0.5 budget in 2006 and 2007 were implemented (see the “Public 0.0 0.0 Finances” chapter). A more contractionary fiscal policy of this 03 05 07 With NIER's repo-rate assessment nature should be balanced as much as possible by a more Excl energy, with NIER's repo-rate assessment Excl energy, with repo rate unchanged at 1.50 % expansionary monetary policy. The effects on growth would Sources: Statistics Sweden and NIER. then be relatively limited, while general government finances would be better prepared for the next economic downturn and the demographic trend of an aging population. 49 Diagram 71 GDP Billions of SEK, constant prices and percent, seasonally adjusted quarterly values 760 2.4 GDP and Demand in Sweden 720 2.0 680 1.6 After a brief slowdown, growth picked up again in the second quarter of this year (see Diagram 71). There was a strong 640 1.2 increase mainly in household consumption and in investment, 600 0.8 though the tendency in exports was also better than at the outset 560 0.4 of the year (see Diagram 72). But the increase in imports was even stronger, and the contribution of foreign trade to GDP was 520 0.0 negative. Domestic demand has thus become the principal 480 -0.4 driving force in the economy, unlike last year, when growth was 97 99 Billions of SEK 01 03 05 07 export-driven to a large extent. Domestic demand will Percentage change (right) strengthen further during the rest of the year with local Sources: Statistics Sweden and NIER. government consumption increasing more vigorously. However, growth in exports will slacken somewhat in the third quarter. In the fourth quarter, with a relatively weak krona and stronger Diagram 72 Demand demand, exports will accelerate again. Although GDP will be Change as a percentage of GDP for the previous quarter, seasonally adjusted quarterly values increasing at a quarterly rate of 0.8 percent beginning with the 3 3 second quarter, the lacklustre tendency around the start of this year will limit GDP growth for this year to 2.4 percent (see 2 2 Table 9). 1 1 Table 9 Supply and Demand 0 0 Billions of SEK, current prices, and percentage change, constant prices -1 -1 2004 2004 2005 2006 2007 -2 -2 GDP 2 546 3.6 2.4 2.9 2.9 01 03 05 07 GDP, calendar-adjusted 3.0 2.4 3.2 3.0 Total consumption Gross fixed capital formation Household consumption 1 224 1.8 2.1 2.8 3.2 Exports expenditure Sources: Statistics Sweden and NIER. General government consumption 706 0.3 0.0 0.8 0.5 expenditure Gross fixed-capital formation 407 5.5 9.0 6.9 4.3 1 Stockbuilding 4 –0.3 0.0 0.2 –0.1 Exports of goods and services 1 178 10.5 3.1 5.6 6.5 Imports of goods and services 974 6.9 4.0 6.9 6.5 Total domestic demand 2 341 1.7 2.7 3.2 2.6 1 Net exports 204 2.0 –0.1 –0.1 0.5 2 Bytesbalans 199 7.8 5.9 4.9 5.3 1Contribution to GDP growth 2Percentage of GDP, current prices Sources: Statistics Sweden and NIER. Demand will be increasing relatively fast in both 2006 and 2007. Resource utilization is still low, and GDP can maintain a rather strong growth rate in the next few years without unsustainably high increases in wages or prices. GDP will therefore continue rising, with a quarterly growth rate of 0.8 percent in 2006 and somewhat less in 2007 (see Diagram 71). Thus, the 50 GDP and Demand in Sweden improvement in the economy will be greatest in 2006, when calendar-adjusted GDP will be up by 3.2 percent. In 2006 growth will be driven to a roughly equal degree by domestic demand and demand from abroad. But in 2007 exports will once again be providing the largest contribution to GDP growth. Since there is one less working day in 2007 than in 2006, actual GDP will increase by 2.9 percent each year. Household and general government consumption will be rising faster in 2006 and 2007 than in recent years, primarily because of rising incomes and an improving labour market. With strong growth in investment since mid-2004, capacity will expand, and capacity utilization will drop back to more normal levels. This normalization of capacity utilization, together with rising interest rates, will contribute to gradually slower growth of investment in 2006 and 2007. Exports will pick up again, and in 2007 Swedish exporters will be gaining market share, in part because of a strengthening market for telecommunication products. With domestic demand increasing vigorously, imports will rise faster than exports next year and the contribution of net exports to GDP growth will be negative. However, the contribution will turn positive again in 2007 as Swedish exporters gain market share while total domestic demand slackens somewhat (see Table 9). The high price of oil is forecast to recede in the next few years (see the chapter ”Development of the International Economy”); its effect on GDP and employment is therefore expected to be relatively modest in 2005–2007. Instead, the effect will be temporary slackening in the total net lending of the economy when higher oil prices place an added burden on households and firms through higher prices on items like petrol and heating oil. The most relevant measure of living standards – real GNI per capita – takes account of these effects, and during the forecast period its annual rate of increase will average 1.2 percentage points less than the rate of GDP growth. The difference will be due primarily to population increase and to Diagram 73 Household Disposable Income deterioration in the terms of trade (see the box captioned ”Real Annual percentage change, constant prices GNI per Capita Better Than GDP as a Measure of Living 8 8 Standards”). 6 6 4 4 Household Consumption 2 2 0 0 Rising Household Income -2 -2 Real household disposable income will increase by 2.4 percent this year and by 3.2 and 2.5 percent, respectively, in 2006 and -4 80 82 84 86 88 90 92 94 96 98 00 02 04 06 -4 2007 (see Table 10 and Diagram 73). Sources: Statistics Sweden and NIER. The higher disposable income this year will be due mainly to greater total earnings compared with last year, but also to lower taxes. Income taxes have been cut by raising the tax reduction GDP and Demand in Sweden 51 for the individual social security contribution from 75.0 to 87.5 percent. In addition, the net wealth tax has been reduced, and the inheritance and gift tax has been abolished. Compared with 2005, hourly earnings and the number of hours worked will be rising even more strongly, contributing to relatively sizable growth in income. An increase in transfers in the form of a higher ceiling in the parental insurance system, higher child allowances and higher supplements for families with several children will also contribute to a relatively rapid increase in household income next year. Table 10 Household Income Billions of SEK, current prices, and percentage change 2004 2004 2005 2006 2007 Total earnings 1042 2.7 3.4 4.6 4.8 Hourly earnings according to 1 National Accounts (NA) 3.2 3.1 3.6 4.0 1 Hours worked -0.3 0.3 0.9 0.8 Other factor incomes 224 4.6 3.4 5.2 4.6 Transfers from the general government sector 477 3.3 1.7 2.8 2.8 Transfers from the household sector 56 3.0 1.1 4.7 2.9 Taxes and contributions –517 4.0 1.6 4.4 5.4 Disposable income 1282 2.7 3.3 4.1 3.7 2 Consumer prices 1.2 0.9 0.9 1.2 Real disposable income 1.5 2.4 3.2 2.5 1Adjusted for differences between years in the number of working days 2Implicit price index for household consumption expenditure Sources: Statistics Sweden and NIER. Steady Increase in Household Consumption When the National Accounts published the preliminary data for the second quarter, household consumption was revised upward at the same time by 0.25 percentage point for the first quarter. Diagram 74 Household Consumption Billions of SEK, constant prices and percent, The overall picture that now emerges is different in some seasonally adjusted quarterly values respects from the previous one. After last summer, consumption 400 3.6 increased by about 0.5 percent per quarter for three quarters in a 380 3.0 row (see Diagram 74), then by 0.8 percent in the second quarter 360 2.4 this year. The outcome for the second quarter was probably 340 1.8 affected by certain temporary factors, and the tendency since last 320 1.2 summer is not considered to have changed appreciably. The principal temporary factor is that a portion of the tax refund for 300 0.6 2005 was paid out in June, earlier than usual. Households 280 -0.0 received more than SEK 8 billion at this time, and retail sales 260 -0.6 were up from May by a strong 3.7 percent. 240 -1.2 97 99 01 03 05 07 Billions of SEK Percentage change (right) Sources: Statistics Sweden and NIER. 52 GDP and Demand in Sweden Table 11 Household Consumption Expenditure Billions of SEK, current prices, and percentage change, constant prices 2004 2004 2005 2006 2007 Consumption expenditure 1,224 1.8 2.1 2.8 3.2 of which: Durable goods 236 6.3 6.5 4.7 4.9 Automobiles 42 1.3 2.0 5.3 6.0 Everyday commodities 191 1.3 2.6 2.0 1.9 Consumption abroad 51 11.6 6.3 5.8 5.3 Services excl. housing 324 1.0 1.4 4.2 5.1 1 Saving ratio 112 8.4 8.3 8.5 8.3 Saving ratio excl. negotiated 1 pensions 58 4.5 4.7 5.2 4.6 1Saving in billions of SEK, current prices, and saving as a percentage of disposable income. Sources: Statistics Sweden and NIER. Diagram 75 Household Savings Percent of disposable income, current prices 15 15 Increasingly Important Role of Household Demand 10 10 Since the economy peaked in 2000, the household saving ratio 5 5 has risen from 3.1 percent to over 8 percent (see Table 11 and Diagram 75). The tendency in consumption has been relatively 0 0 weak despite a monetary policy that is currently quite expansionary. But low interest rates have still influenced -5 -5 consumption. Their effect is apparent, for instance, from the fact that consumption of durable goods has increased by more -10 80 82 84 86 88 90 92 94 96 98 00 02 04 06 -10 than 6.5 percent annually in the past two years, whereas Saving ratio consumption of services (which is not stimulated to the same Saving ratio, excl. negotiated pensions degree by low interest rates) rose by only 0.5 percent per year. If Sources: Statistics Sweden and NIER. household consumption is once again to be a dynamic driving force in the development of the economy, it is especially important that consumption of services, not just total consumption, rise faster. Increased consumption of services Diagram 76 Household Net Wealth Percent of disposable income, current prices, generates much more employment in the short run than quarterly values increased consumption of goods, since the import content of 300 300 services is lower and their labour intensity is higher. For the most part, conditions favour relatively vigorous 250 250 growth in consumption. The net wealth position of households 200 200 is strong (see Diagram 76), interest rates are low and real disposable income is rising at a healthy rate. On the other hand, 150 150 the labour market is still cyclically weak so far; it is probably this factor that has recently been dampening the propensity of 100 100 households to consume. In August 2005, household expectations for personal finances, as measured by the Micro 50 80 82 84 86 88 90 92 94 96 98 00 02 04 50 Index in the NIER’s Consumer Survey (HIP), reached their Financial assets highest level since 1993, when the study was first conducted in Value of single fam. houses & tenant ownership flats its present form. On the other hand, household expectations Sources: Statistics Sweden and NIER. about the tendency of the Swedish economy, as measured by the GDP and Demand in Sweden 53 Macro Index in the same survey, has not yet really recovered Diagram 77 Micro- and Macroindex Index, monthly values from its sharp drop late in 2000 (see Diagram 77). In the period 60 60 ahead, however, the labour market will gradually strengthen, probably bolstering household optimism and thus stimulating 40 40 consumption. With real household income up by 2.4 percent in 2005, 20 20 households are expected to increase their consumption by 0.7 percent in both the third and fourth quarters this year. As a 0 0 result, growth in consumption will be 2.1 percent this year. In 2006 and 2007, income will rise by 3.2 and 2.5 percent, -20 -20 respectively, primarily on account of higher household earnings. The labour market will strengthen, favouring consumption. All -40 97 99 01 03 05 -40 factors considered, household consumption will increase by 2.8 Micro index Macro index percent in 2006 and 3.2 percent in 2007. Source: NIER. General Government Consumption Diagram 78 General Government Consumption Annual percentage change, constant prices and General Government Consumption Steady in percent of GDP, current prices Proportion to GDP 6 30 General government consumption will be unchanged this year 4 28 compared to 2004 (see Diagram 78 and Table 12). In the next two years, consumption will be increasing. During the period 2005–2007, general government consumption as a share of 2 26 GDP will be about 28 percent, roughly the same level as in the past ten years. 0 24 Table 12 General Government Consumption Expenditure -2 22 93 95 97 99 01 03 05 07 Billions of SEK, current prices, and annual percentage change, Percentage change constant prices Percent of GDP (right) 2004 2004 2005 2006 2007 Sources: Statistics Sweden and NIER. General government consumption expenditure 706 0,3 0,0 0,8 0,5 Percent of GDP 27.7 27.6 27.8 27.7 Central government consumption 197 –0.3 –0.4 –0.1 0.3 Percent of GDP 7.7 7.6 7.6 7.5 Local government consumption 509 0.5 0.2 1.2 0.6 Percent of GDP 20.0 20.0 20.2 20.2 Sources: Statistics Sweden and NIER. Central government consumption decreased in 2004 and will continue to do so in 2005 and 2006 as well. The main reason for the decrease this year will be the prohibition against using appropriations saved by public authorities from previous years, combined with a cutback of 0.6 percent in this year’s appropriations. The reduction in appropriations will remain effective in 2006 and 2007. In 2006, however, public authorities will again be allowed to use appropriations that they have saved, 54 GDP and Demand in Sweden Diagram 79 Gross Fixed Capital Formation thus increasing consumption. But the development of Billions of SEK, constant prices and percent, seasonally adjusted quarterly values consumption will be limited by lower expenditure on national 126 8 defence. In summary, general government consumption is expected to decrease slightly in 2006. In 2007 central 119 6 government consumption will be up by a modest 0.3 percent. 112 4 The consumption of the local government sector will increase this 105 2 year by 0.2 percent. The sector as a whole reported a surplus for 2004, but a third of municipalities and half of the county council 98 0 districts showed negative results. The local government sector is 91 -2 therefore expected to be restrictive about consumption in 2005. 84 -4 In 2006, consumption will pick up, increasing by 1.2 percent. The improved labour market will also contribute through higher 77 -6 97 99 01 03 05 07 tax revenue. The rate of increase will slow somewhat in 2007, Billions of SEK Percentage change (right) when consumption will be up by 0.6 percent. 12 The local Sources: Statistics Sweden and NIER. government sector as a whole is expected to show a surplus in all years of the period 2005–2007. Diagram 80 Investment Index fourth quarter 2002=100, constant prices, seasonally adjusted quarterly values Gross Fixed Capital Formation 140 140 120 120 Growth in Investment to Peak This Year The investment tendency remains robust (see Diagram 79), and 100 100 the upswing in investment is broader-based this year than last year. The strong rise in investment is due to high capacity 80 80 utilization combined with very good profitability, as well as favourable financing conditions in the form of low interest rates 60 60 and rising stock prices. In the business sector, investment is 95 97 99 01 03 05 07 Machinery surging in machinery and equipment, software and housing, Buildings and structures excl. housing Software etc. whereas other investment in buildings and structures is slack (see Sources: Statistics Sweden and NIER. Diagram 80). The investment of public authorities is accelerating with rising investment in infrastructure and relatively strong local government finances. The increase in investment for the economy as a whole will Diagram 81 Gross Fixed Capital Formation Percent of GDP, current prices be strongest this year. The relatively high level of investment in 25 25 the forecast period will bring capacity utilization down to more normal levels. The normalization of capacity utilization, together 20 20 with rising interest rates, will contribute to gradual slackening of the growth in investment during 2006 and 2007. 15 15 With investment rising strongly, its share of GDP will 10 10 increase to 18 percent in 2007 (see Diagram 81). That share is still considerably lower than in the 1980’s, when it averaged 21 5 5 12 The NIER’s forecasts are normally based on the policy rules and other 0 0 80 82 84 86 88 90 92 94 96 98 00 02 04 06 provisions currently in effect. Thus, the central government subsidy to the Total investments local government sector would be unchanged in nominal terms between 2006 Business sector excl. housing Housing and 2007, a departure from previous patterns. In order to improve the Public authorities accuracy of the forecast, it is assumed that the local government sector will receive a supplement of SEK 5 billion in 2007, even though such a supplement Sources: Statistics Sweden and NIER. has not yet been legislated. That amount is equivalent to the average annual supplement received by the local government sector during the period 2000– 2005. See also The Swedish Economy, December 2004, Table 44, page 102. GDP and Demand in Sweden 55 percent. The main reason is that housing investment is currently Diagram 82 Investment – Service Industries Billions of SEK, constant prices and percent, lower than in the 1980’s. For the business sector aside from seasonally adjusted quarterly values housing, the investment share of GDP will be 12 percent in 52 8 2007, only marginally less than its average of 13 percent in the 48 6 1980’s. 44 4 Table 13 Gross Fixed Capital Formation 40 2 Billions of SEK, current prices, and percentage change, constant 36 0 prices 32 -2 2004 2004 2005 2006 2007 28 -4 Manufacturing 69 1.6 16.0 9.0 3.9 Other goods industries 40 –1.2 12.7 5.8 2.7 24 -6 97 99 01 03 05 07 Service industries excl. housing 161 7.7 4.0 5.7 5.1 Billions of SEK Housing 64 16.1 19.1 10.0 4.8 Percentage change (right) Total, business sector 334 6.7 10.4 7.3 4.5 Note: Excl. housing, ships and aircrafts. Public authorities 73 0.3 2.5 4.7 3.8 Sources: Statistics Sweden and NIER. Total investment 407 5.5 9.0 6.9 4.3 Sources: Statistics Sweden and NIER. Diagram 83 Investment – Manufacturing Billions of SEK, constant prices and percent, seasonally adjusted quarterly values 24 8 Business Sector Investment More Broadly Based Last year investment in the business sector was increasing again 22 4 after having decreased for three years. The recovery began with a broadly based upturn in service industries (see Diagram 82). 20 0 According to the Business Tendency Survey, confidence in the future is high in service industries, and output is expected to show a relatively strong increase in the period ahead. The rise in 18 -4 investment will thus continue, though more slowly than last year. 13 In service industries, investment will increase by 5-6 16 -8 97 99 01 03 05 07 percent annually in 2006 and 2007, meaning that growth in the Billions of SEK stock of capital will keep up with output. Percentage change (right) The increase in investment came somewhat later in Sources: Statistics Sweden and NIER. manufacturing industries (see Diagram 83) than in service industries and was largely confined to a few industries, particularly pulp and paper. Capacity utilization thus continued Diagram 84 Capacity Utilization – rising in large portions of manufacturing and had reached very Manufacturing Percent, seasonally adjusted quarterly values high levels by the end of last year (see Diagram 84). Although 92 92 there has been some slackening of the tendency in manufacturing , and capacity utilization has receded somewhat, 90 90 firms have highly expansionary investment plans for this year in 88 88 a number of industries, including the energy sector and the pulp and paper, transport-vehicle and mining industries. Decisions on 86 86 large investments have long-term consequences, and the slackening tendency in manufacturing industries is expected to 84 84 be short-lived. It is therefore anticipated that manufacturing 82 82 80 80 91 93 95 97 99 01 03 05 Statistics Sweden 13In the second quarter, the investment of the service industries dropped NIER sharply, but this was due entirely to an increase in exports of aircraft, which are Source: Statistics Sweden and NIER. registered as a negative investment. This registration is neutral in its effect on GDP. Excluding aircraft, investment in service industries increased. 56 GDP and Demand in Sweden Diagram 85 Housing Investment investment will continue to increase in the period ahead, though Billions of SEK, constant prices and percent, seasonally adjusted quarterly values at a gradually diminishing rate. 24 8 22 6 20 4 Strong Increase in Residential Construction 18 2 Housing investment was up by 16.1 percent last year and even a 16 0 little more in the first two quarters of this year (see Diagram 85). 14 -2 In the second quarter, housing investment (seasonally adjusted) 12 -4 rose by more than 7.5 percent compared to the first quarter. 10 -6 This surging growth is explainable largely by new construction of multiple-unit housing. The Business Tendency Survey 8 -8 97 99 01 03 05 07 confirms the impression of a persistent strong tendency in Billions of SEK Percentage change (right) residential construction, which is expected to increase in the Sources: Statistics Sweden and NIER. period ahead, though at a somewhat slower rate. There is a very ample stock of orders on hand, and construction firms plan further increases in personnel. The National Board of Housing, Building and Planning Diagram 86 Investment in Housing Billions of SEK, constant prices (Boverket) reports the ratios between the cost of buying an 140 140 existing single-family home and the cost of building a new one (so-called q-values) for all municipalities in the country. By this 120 120 measure, it was advantageous last year to build new single-family homes in 84 municipalities, 13 more than in 2003. This tendency 100 100 is considered to have strengthened further this year as prices of existing homes, according to the Småhusbarometern survey on 80 80 single-family houses, have gone up by more than 7 percent since 60 60 the start of this year. Furthermore, 60 percent of municipalities reported a housing shortage in 2004, compared to 10 percent in 40 40 1998. Housing investment is thus favoured by increases in both the 20 80 82 84 86 88 90 92 94 96 98 00 02 04 06 20 profitability of new construction and the demand for housing. In Sources: Statistics Sweden and NIER. summary, housing investment will continue upward during the forecast period. In 2005 housing investment will soar by 19.1 percent, and in 2006 and 2007 the rate of increase will be 10.0 percent and 4.8 percent, respectively. Despite this vigorous, tendency, however, housing construction will still be considerably less in 2007 than in 1980–1992 (see Diagram 86). General Government Investment to Increase The investment of public authorities will be rising in all years of the period 2005–2007 (see Table 13table 13). Both local and central government authorities will contribute to the increase. Relatively strong finances in the local government sector will create a margin for increasing local government investment. For central government authorities, investment in infrastructure and in administration of the correctional care system will contribute substantially to the increase. GDP and Demand in Sweden 57 Stockbuilding Diagram 87 Inventories, Assessment of Current Situation – Manufacturing Balances, quarterly values 35 35 Stockbuilding to Contribute to GDP Growth This 30 30 Year 25 25 In the first half-year this year, inventories decreased on an overall basis. Industrial firms continued to draw down their 20 20 inventories of input goods. Inventories of work in progress were 15 15 also reduced. In trade, on the other hand, inventories increased in the first half-year. With the large quantity of trees felled last 10 10 January by the storm in southern Sweden, inventories of the 5 5 forest sector were depleted much less than normally. 14 97 99 01 03 05 Input-goods inventories According to the Business Tendency Survey, the Finished-goods inventories dissatisfaction of industrial-sector firms with their inventories Note: Higher balances mean that more firms are generally increased in the first half of this year despite the dissatisfied about excessive inventories. Source: NIER. reductions made. Trade inventories are also considered somewhat too large, particularly at automobile dealers. Diagram 88 Inventories, Assessment of Increasingly, inventories of wholesalers are also viewed as Current Situation – Trade excessive (see Diagram 87 and 88). Balances, quarterly values It is assumed that in the second half of 2005 the level of 70 70 inventories in the manufacturing industries will remain largely 60 60 unchanged even if output increases. Moreover, to respond to 50 50 higher consumption, firms will only have to expand their trade 40 40 inventories marginally. 30 30 Inventories will thus decrease in manufacturing this year with 20 20 the reductions in the first half-year. In trade, on the other hand, 10 10 inventories will go up in 2005. Overall, inventories will continue 0 0 to increase in 2005 because of the normal inventory build-up of -10 -10 the forest sector in the second half-year 15 . 97 99 01 03 05 Trade in motor vehicles In 2006 and to a lesser extent in 2007 as well, manufacturing Wholesale trade is expected to build up inventories of input goods to avoid Retail trade in durable goods disruption of production when demand rises. Inventories of Note: Higher balances mean that more firms are dissatisfied about excessive inventories. work in progress are also expected to increase to a certain extent Source: NIER. as the rate of output rises, whereas finished-goods inventories will be depleted somewhat to more desirable levels, particularly Diagram 89 Change of Inventories Billions of SEK, constant prices and percent of in 2007. It is assumed that inventories in trade will already be GDP, respectively large enough to meet the increase in consumption in 2006 as 12 0.40 well as 2007. For 2006, in addition, the tendency of forest inventories is expected to normalize after the massive changes in 9 0.20 2005 ensuing from the storm that felled so many trees. In summary, inventories will increase in 2005 as much as they did last year and, in consequence, the contribution to 6 0.00 growth in demand will be zero (see Diagram 89). Next year, 3 -0.20 14 See the box in The Swedish Economy, March 2005, captioned ”Natural 0 -0.40 Disasters and Their Impact on GDP”. 02 04 06 15 In the National Accounts, growing timber stands, or the increase in the Change country’s total timber stand after logging, are classified as an item of inventory. Contribution to demand in percent of GDP (right) This item normally increases each year by an appreciable amount. Since the Sources: Statistics Sweden and NIER. growth is largely constant over time, however, the contribution to GDP is every small. 58 GDP and Demand in Sweden Diagram 90 Exports of Goods and Services inventories will increase more than this year, contributing 0.2 Billions of SEK, constant prices and percent, seasonally adjusted quarterly values percent to growth in demand. In 2007, by contrast, the increase 360 10 in inventories will be less than in 2006, with a restraining effect on the development of demand. 330 8 300 6 270 4 Exports 240 2 210 0 Tendency of Exports Subdued This Year Before 180 -2 Strengthening Again 150 97 99 01 03 05 07 -4 Exports stagnated in the third quarter of 2004 and then Billions of SEK remained virtually unchanged at that level for another two Percentage change (right) quarters (see Diagram 90). At the outset, demand from North Sources: Statistics Sweden and NIER. America and Asia weakened, whereas exports to Europe continued to increase until the first quarter of this year, when they also slackened. According to the latest preliminary National Diagram 91 Exports of Goods Accounts, exports rose more strongly in the second quarter. Billions of SEK, constant prices, seasonally adjusted monthly values This increase, though, is considered to be partly the result of 80 80 temporarily large deliveries of goods in June (see Diagram 91). The underlying demand of the market for exports was still weak, 75 75 as is indicated, for example, by the order statistics of Statistics Sweden (see Diagram 92). The Business Tendency Survey confirms this picture, as a majority of industrial firms indicate 70 70 that new orders for exports decreased somewhat in the second quarter. During the spring, firms responded increasingly that 65 65 their stocks of orders on hand were too small. Internationally, however, there are signs that the world 60 60 economy is strengthening again, and in the longer term as well, the prospects for a relatively strong international economic 55 00 02 04 55 tendency are promising. The market for Swedish exports is Sources: Statistics Sweden and NIER. therefore expected to grow faster in each of the next two years after relatively low growth this year (see the chapter ”Development of the International Economy”). In the latest Business Tendency Survey, it was also indicated that a more Diagram 92 New Export Orders – Manufacturing positive demand tendency of this kind may be under way, as Annual percentage change and percentage change, mothly values, trend firms were reporting a slight increase in new orders over the 20 4 summer. Some improve in the stock of orders was also noted (see Diagram 93). Moreover, the Purchasing Manager Index 15 3 suggests that the inflow of new orders for exports may have 10 2 increased in July. The gradual weakening of the krona in the first 5 1 half-year is also favouring growth in Swedish exports. Consequently, the rate of increase in exports is forecast to go up 0 0 from 3.1 percent this year to 5.6 percent in 2006 and 6.5 percent -5 -1 in 2007 (see Table 14). -10 -2 -15 -3 97 99 01 03 05 Compared with the same per. in the preciding year Compared with the previous period (right) Sources: Statistics Sweden and NIER. GDP and Demand in Sweden 59 Table 14 Exports of Goods and Services Diagram 93 Export Orders on Hand, Billions of SEK, current prices, and percentage change, constant Assessment of Current Situation – Manufacturing prices Balances, seasonally adjusted monthly values 2004 2004 2005 2006 2007 40 40 Exports of goods 899 9.8 2.9 5.3 6.4 of which: Manufactured products 765 9.7 2.8 6.1 7.2 20 20 Primary products 131 11.4 3.8 1.0 1.8 Exports of services 279 13.0 3.8 6.4 6.9 0 0 Total exports 1 178 10.5 3.1 5.6 6.5 Sources: Statistics Sweden and NIER. -20 -20 Gradual Improvement in Exports -40 -40 of Manufactured Products -60 -60 After decreasing in the first quarter this year, exports of 97 99 01 03 05 Source: NIER. manufactured products were up again in the second quarter (see Diagram 94). The main increase was in exports of the machinery industry. Complete statistics on exports are not yet available, but Diagram 94 Exports exports of pharmaceuticals, telecommunication products and Index 1999=100, constant prices, seasonally adjusted quarterly values metal products are also estimated to have risen. For large 180 180 portions of other exports, however, the tendency has remained slack. Exports of the electrical products and instrument 160 160 industries probably decreased. Demand for passenger cars has also been sluggish. In Europe, new car registrations were down 140 140 by about 1 percent in the first half-year compared with the 120 120 previous year, and in the US demand for larger, “gas-guzzling” vehicles is currently dropping. In addition, exports of lorries 100 100 appear to have flattened out after their previously surge. According to most indicators, growth in exports will be slack 80 99 01 03 05 07 80 in the third quarter. But conditions for a coming upturn on the Manufactured goods market for Swedish exports are favourable. In each of the next Primary products Services two years, the market is expected to grow by more than 6 Sources: Statistics Sweden and NIER. percent. After this year’s lacklustre tendency, Swedish exports of manufactured products will increase in 2006 almost as rapidly as the market for exports, and somewhat faster in 2007 (see Table Diagram 95 Manufactured Goods, World 14 and Diagram 95). Market and Swedish Exports Manufacturers of telecommunication products in the US as Annual percentage change, constant prices well as Asia appear to be entering a phase of stronger 15 15 investment, while operators in Europe continue to expand their capacity. A gradually stronger upswing of investment in Europe 10 10 will generate higher exports of other investment goods as well. It is also assumed that exports of pharmaceuticals will show a 5 5 more robust tendency. The development of passenger car exports, on the other hand, is expected be weaker in the period ahead before demand picks up again when the consumption 0 0 tendency strengthens in Europe and oil prices drop back to more normal levels. After haulers rapidly renewed their fleets -5 -5 97 99 01 03 05 07 last year, exports of lorries are also anticipated to be sluggish World Market until demand gradually begins to accelerate again. Exports Note: World market estimated with weights of Swedish exports. Sources: Statistics Sweden and NIER. 60 GDP and Demand in Sweden Diagram 96 Exports of the Three Largest Exports of Primary Products Increasing More Slowly Groups of Primary Produtcts This Year Index 1999=100, constant prices, seasonally adjusted quarterly values 220 220 Exports of primary products are increasing much more slowly 200 200 this year than last year (see Table 14 and Diagram 94 and 96). This year, exports of primary products will be up by an average 180 180 of 3.8 percent. Growth is being curbed by lower exports of 160 160 petroleum products after last year’s temporary high. In addition, 140 140 growing international supply is contributing to stagnation in 120 120 Swedish exports of wood pulp. However, a weaker krona is 100 100 stimulating Swedish exports of primary products. The rise in 80 80 exports of primary products is due primarily to a continuing 60 99 01 03 05 07 60 increase in exports of foodstuffs, electric power and sawnwood. Petroleum products Exports of foodstuffs are expected to expand further this year Food-stuffs Sawn and planed goods since demand remains favourable on the important European Sources: Statistics Sweden and NIER. market. Exports of electricity rose sharply in the first half of this year but are anticipated to resume a lower level for the rest of the year. Considerably stepped-up output in the sawmill industry, in combination with favourable demand from other countries, will lead to a substantial increase in exports of wood products this year, primarily to markets outside Europe. Exports of forest products will also be up sharply this year owing to the large number of trees felled by the storm in southern Sweden last January. 16 In addition, exports of paper and paperboard will increase further this year. Swedish exports of iron ore will rise as much as output capacity allows. At the end of last year, purchasers of steel were stockpiling. Demand for steel was therefore down early in 2005, and exports have decreased. In the second half-year, on the other hand, demand is expected to pick up, enabling the steel industry to increase its exports somewhat further this year. Exports of nonferrous metals, which have been favoured by rapid growth of the Chinese economy together with increased US demand, may rise somewhat this year as demand remains vigorous. Global growth will also be relatively high in 2006 and 2007. Swedish exports of primary products, however, will slow down. With the increasing competition on international markets, producers of pulp and nonferrous metal products will lose market share and will be able to achieve only a slight increase in exports in 2006 and 2007. Exports of iron ore will be curtailed by lack of capacity and an increase in domestic deliveries. In addition, exports of forest products will drop sharply after the substantial increase following the storm that felled so many trees. However, exports of Swedish wood products will be favoured by decreased supply from other countries and can therefore increase somewhat further. Exports of foodstuffs are expected to rise at about the same rate as in 2005. See the box in The Swedish Economy, March 2005, captioned ”Natural 16 Disasters and Their Impact on GDP”. GDP and Demand in Sweden 61 Lower Level of Exports in Services Last year exports of services were up by 13 percent because of a strong increase in exports of freight services and so-called other services, that is, consultancy, licences, patents, banking services and so-called merchanting. This year the growth will slacken considerably. World trade is developing more slowly, with the result that the demand for freight services will also show a more subdued tendency. The weakening in exports of goods is part of the reason why exports of other services will also be growing more slowly. Preliminary statistics indicate, however, that consumption by foreigners in Sweden will be up sharply this year. With the stronger tendency of the world economy in 2006 and 2007, exports of services are also anticipated to show a relatively robust rise in these years. Thus, demand for various business services will be growing faster, and freight volumes are also expected to be increasing more rapidly (see Diagram 94). Diagram 97 Imports of Goods and Services Billions of SEK, constant prices and percent, seasonally adjusted quarterly values 300 9 Imports Imports rose rapidly in the second and third quarters of last year 270 6 but slowed in the fourth quarter and decreased in the first 240 3 quarter of this year (see Diagram 97). In the second quarter, imports picked up again. This development is explainable 210 0 primarily by the tendency in exports. Beginning with the second quarter of this year, imports will again be rising at a fairly healthy 180 -3 pace, primarily as a result of high investment and stronger household consumption, but also of more vigorous exports in 150 -6 97 99 01 03 05 07 the second quarter. Imports will show a fairly robust increase Billions of SEK during the forecast period, but in contrast with 2004, demand Percentage change (right) for imports will be driven to a higher degree by domestic Sources: Statistics Sweden and NIER. demand. Table 15 Imports of Goods and Services Billions of SEK, current prices, and percentage change, constant prices 2004 2004 2005 2006 2007 Imports of goods 722 7.7 4.7 7.0 6.8 of which: Manufactured 557 9.4 6.8 7.8 7.9 products Primary products 170 2.6 0.0 3.4 2.8 Imports of services 251 4.9 2.1 6.4 5.5 Summa import 974 6.9 4.0 6.9 6.5 Sources: Statistics Sweden and NIER. 62 GDP and Demand in Sweden Diagram 98 Imports High Investment Contributing to Increased Imports Index 1999=100, constant prices, seasonally of Manufactured Products adjusted quarterly values 160 160 Imports of manufactured products weakened around the end of 150 150 2004, one reason being lower imports of telecommunication 140 140 products and input goods. The decline in imports of goods in 130 130 these categories continued in the first quarter of this year, particularly for imports of telecommunication products. The 120 120 outcome data for the second quarter showed that the slackening 110 110 tendency of imports had ceased and that imports of 100 100 manufactured products were increasing. The weaker exchange 90 90 rate of the krona will curb demand for imports, but only 99 01 03 05 07 marginally. Next year, major investments in machinery, together Manufactured goods Primary products with rising household consumption and gradually stronger Services exports, will lead to further acceleration of growth in imports. In Sources: Statistics Sweden and NIER. 2007, the contribution of investment will be less, while exports will contribute increasingly to demand for imports. Despite the smaller contribution of domestic demand, imports of manufactures will be up by 7.9 percent in 2007 (see Diagram 98 and Table 15). Imports of Primary Products Stagnating This Year Imports of primary products rose by 2.6 percent in 2004 (see Table 15 and Diagram 98). This year, the weaker exchange rate of the krona will raise the price of imports and limit their development. Imports of crude oil decreased at the outset of this year, but for the remainder of 2005, they are expected to resume more normal levels in relation to exports of petroleum. In adjusting to rising output, imports of petroleum are again on the rise after having fallen in the first quarter of this year. Imports of foodstuffs, after levelling out late in 2004 and early in 2005, will increase for the rest of this year. Imports of forest products will be sharply reduced this year on account of the larger supply of timber in Sweden from trees felled by the storm last January. Overall, imports of primary products will stagnate this year. In 2006 and 2007, they will increase somewhat faster. Imports of forest products will also be rising again. Growing Imports of Services After two lacklustre years, imports of services picked up more substantially last year, with a particularly strong increase in foreign travel by households, but also in imports of freight services. This year, imports of services are expected to show a somewhat weaker tendency again. Foreign travel by households will not increase to the same extent, while imports of freight services will be less vigorous with slower growth of trade in goods. GDP and Demand in Sweden 63 In 2006 and 2007, imports of services will accelerate once more. Imports of other services are anticipated to show a stronger tendency as the economy improves. There will be faster growth in household consumption, which includes travel abroad. Terms of Trade, Current Account and Gross National Income Strong Increase This Year in Prices of Exports and Imports This year prices of exports and imports are expected to show appreciable increases of 2.6 and 4.8 percent, respectively (see Diagram 99 and 100 and Table 16). One of the main reasons for these price increases is the weakening of the krona. The Diagram 99 Export Price increases also reflect sharply higher prices of iron ore, metals Index 2004=100 120 120 and oil. During the course of 2006, the krona will strengthen, but on 110 110 average it will be somewhat weaker than in 2005. Prices of primary products will decrease over the year, but for the year as 100 100 a whole, they will still be slightly higher compared to this year. The principal factor limiting the development of prices in 90 90 exports will be the declining prices of telecommunication 80 80 products, whereas prices of imports will rise by almost 1 percent. In 2007, the krona will appreciate, while crude oil and 70 70 petroleum prices in particular will continue to decrease. There 99 01 03 05 07 Manufactured goods will be a drop in prices of both exports and imports. Primary products Services Sources: Statistics Sweden and NIER. Table 16 Prices of Exports and Imports Annual percentage change 2004 2005 2006 2007 Prices of exports, total –0.2 2.6 0.1 –1.0 Diagram 100 Import Price Index 2004=100 Manufactured products –1.0 1.0 -0.6 –0.8 130 130 Primary products 4.7 10.7 1.9 –5.3 Services -0.4 3.1 1.5 0.6 120 120 Prices of imports, total 0.8 4.8 0.9 –1.5 110 110 Manufactured products –1.1 1.6 0.8 –0.5 100 100 Primary products 7.5 18.9 0.2 –7.2 Services 0.8 2.9 1.9 0.8 90 90 Sources: Statistics Sweden and NIER. 80 80 70 70 60 60 99 01 03 05 07 Continuing Decline in Terms of Trade Manufactured goods Primary products The terms of trade, or the ratio between prices of exports and Services prices of imports, have shown a deteriorating trend since the Sources: Statistics Sweden and NIER. early 1990’s. This year the trend will continue, with the terms of 64 GDP and Demand in Sweden Diagram 101 Terms of trade trade declining by over 2 percent (see Diagram 101), primarily Index 2004=100 because of soaring oil prices. The terms of trade will also worsen 150 150 in 2006, but then strengthen somewhat in 2007 as prices of 140 140 crude oil and petroleum products recede (see Table 16 and Table 17). 130 130 120 120 Table 17 Terms of Trade 110 110 Annual percentage change 100 100 2004 2005 2006 2007 Manufactured products 0.1 -0.6 –1.5 –0.3 90 90 80 82 84 86 88 90 92 94 96 98 00 02 04 06 Primary products –2.6 –6.9 1.7 2.0 Total Services –1.2 0.2 –0.4 –0.3 Goods Services Total –1.0 –2.1 –0.7 0.4 Sources: Statistics Sweden and NIER. Sources: Statistics Sweden and NIER. The main reason for the deteriorating trend in the terms of trade in the last ten years is the sharp drop in prices of exported Diagram 102 Terms of trade Index 2004=100 telecommunication products. Other major factors contributing 114 114 to this trend are the relatively weaker tendency in prices of 112 112 exported motor vehicles and the surge in oil prices (see Diagram 102). 110 110 When prices of exports rise more slowly than prices of 108 108 imports, the margin for consumption does not increase as much 106 106 as GDP. In the period 1995-2004, the terms of trade declined by 104 104 an annual average of 1.3 percent, creating a differential of 0.5 102 102 percentage point between annual growth in GDP and growth in 100 100 the margin for consumption (see also the box captioned ”Real GNI per Capita Better Than GDP as a Measure of Living 98 98 95 97 99 01 03 Standards”). Goods Goods excl telecom.prod, motor vehicles and oil Sources: Statistics Sweden and NIER. Continuing Surplus in Current Account The current account strengthened further in 2004 to 7.8 percent Diagram 103 Current Account of GDP (see Diagram 103 and Table 18). The current account is Percent of GDP, current prices the total of household saving and the net lending of firms and 8 8 the general government sector 17 . General government net lending will decrease this year, and it will continue to do so next 6 6 year, in part because of tax reductions. With business sector 4 4 investment increasing, the net lending of firms will decrease this year and next year, but will remain positive. Households will 2 2 save more this year and in 2006. However, household saving will decrease as a share of GDP, though this share will still be 0 0 slightly higher than 3 percent (see Diagram 104). The high saving and net lending in the economy mean that -2 -2 exports will considerably exceed imports; in other words, Sweden has a very sizable surplus in its balance of trade (see -4 -4 50 55 60 65 70 75 80 85 90 95 00 05 Table 18). In 2005 and 2006, the balance of trade will deteriorate Sources: The Riksbank 1950–1992, Statistics Sweden 1993–2004 and NIER. 17 Except for transfers of capital, normally a minor item (see Table17). GDP and Demand in Sweden 65 slightly, as imports will be increasing faster than exports, but it Diagram 104 Net Lending Percent of GDP, current prices will strengthen once more in 2007. The balance of services was 10 10 also positive last year, in part because of an increase in merchanting, 18 and this improvement will continue during the 5 5 forecast period. In addition, the net return on capital improved in 2004, mainly because of a sharply higher return on Swedish 0 0 assets abroad (securities and directly owned subsidiaries). This year the surplus in the current account will decrease owing to a -5 -5 smaller surplus in the balance of trade and a considerably lower -10 -10 net return on capital. But the surplus in the current account will remain remarkably large and will be 5.3 percent of GDP in 2007 -15 -15 (see Diagram 103). 80 82 84 86 88 90 92 94 96 98 00 02 04 06 Households Public sector Business sector Table 18 Current Account, Saving and Net Lending Sources: Statistics Sweden and NIER. Billions of SEK, current prices 2004 2005 2006 2007 Balance of trade 177 150 137 146 Balance of services 28 35 36 42 Wages and salaries, net –2 –2 –2 –2 Return on capital, net 30 11 5 8 Transfers etc., net –33 –38 –41 –42 Current account 199 155 136 152 Percent of GDP 7.8 5.9 4.9 5.3 Transfers of capital 1 0 0 0 Saving and net lending 199 156 135 151 General government net lending 26 22 16 24 Household saving 93 96 100 98 Net lending by firms 80 38 20 29 Sources: Statistics Sweden and NIER. Gross National Income Higher Than GDP Gross national income (GNI) is obtained by adding (net) primary income from abroad – i.e. net Swedish income from Diagram 105 Gross National Income abroad, such as wages and salaries, interest, dividends on shares Bilions of SEK, current prices and the return on direct investment abroad – to GDP. The 3000 80 surplus in the current account since 1994 has reduced Sweden’s 60 2500 indebtedness to foreign lenders. This has improved net primary 40 income by lowering interest expenditure and increasing the 2000 20 return on Swedish assets abroad. With these improvements, 1500 0 primary incomes began to exceed expenditure in 2004; in other -20 words, GNI is now greater than GDP (see Diagram 105). 1000 -40 Primary income will decrease this year and next year, primarily 500 because of substantial increases in dividends on Swedish shares, -60 which will mean a higher return on capital for foreign 0 80 82 84 86 88 90 92 94 96 98 00 02 04 06 -80 GDP GNI 18 Merchanting primarily involves producing and selling products abroad, often Primary income, net (right) by subsidiaries of Swedish firms, and invoicing them from Sweden. A portion Sources: Statistics Sweden and NIER. of the revenue from such sales is categorized as export of services and is included in business-sector output. These revenues can be viewed as compensation for previous costs of marketing, research and development. 66 GDP and Demand in Sweden shareholders. However, net primary income will still be positive, and GNI will exceed GDP during the forecast period, 2005– 2007. Table 19 Gross National Income Billions of SEK, current prices 2004 2005 2006 2007 GDP 2546 2625 2740 2877 1 Primary income, net 30 10 4 7 GNI 2575 2635 2744 2883 Percent of GDP 101.2 100.4 100.1 100.2 1Wages and salaries, return on capital, and foreign-related subsidies and taxes. Sources: Statistics Sweden and NIER. GDP and Demand in Sweden 67 Real GNI per Capita Better than GDP Diagram 106 GDP and GNI per Capita Index 1980 = 100 as a Measure of Living Standards 180 180 In analyses and forecasts on the state of the economy, a natural 160 160 measure to use is GDP growth, i.e. the change in the volume of output. For example, when the mass media report the economic 140 140 growth of a country, they normally refer to the increase in GDP. On the other hand, in analyses and comparisons of living 120 120 standards between countries and over time, it is more relevant to 100 100 study gross national income (GNI) in relation to the price of final domestic demand, i.e. consumption and investment. 80 80 Moreover, GNI must be related to the population, that is, 80 82 84 86 88 90 92 94 96 98 00 02 04 06 GDP measured per inhabitant. Obviously, in comparing Real BNI per capita living standards between countries, but also growth, it is Sources: Statistics Sweden and NIER. important to adjust for different rates of population growth. The measure in this case is real GNI per capita, and it is the relevant one to use for analyzing the development of living standards, both over time and between countries. On average, GDP increased by 2.1 percent per year, whereas real GNI per capita increased by 1.6 percent per year during the period 1981–2004 (see Diagram 106). Calculation of Real GNI Gross national income (GNI) is defined as follows: GNI = GDP + net primary income from abroad Primary income consists of interest, dividends on shares, the return on direct investment abroad, wages and salaries and certain taxes and subsidies. GDP measures the output (equal to the income) within a country, whereas GNI measures the income received by residents of the country (Sweden in this case). Since net primary income is a relatively small item in Sweden, the development of GNI and GDP in current prices is similar. When GDP is adjusted for the development of prices, i.e. calculated in constant prices, each individual product included in output, as well as each individual product included in use, is deflated by its own separate price index so as to reflect the development of output by volume as accurately as possible. For measures of income such as GNI and household disposable income, there is no unambiguous underlying measure of volume. 19 The “volume” of income is dependent, of course, on the use to which the income is put. Since it is assumed that household disposable income is used for consumption, real disposable income is calculated by deflating for the change in 19 See also Sveriges ekonomi statistiskt perspektiv – första kvartalet 2005 (Sweden’s Economy, a Statistical Perspective – Quarter 1, 2005), Statistics Sweden. 68 GDP and Demand in Sweden Diagram 107 GDP per Capita and Real GNI prices of household consumption. When real GNI is calculated, per capita Annual percentage change it is natural to deflate by the change in prices of final domestic 6 6 use, i.e. the total of household consumption and general government consumption, gross fixed capital formation and 4 4 stockbuilding. 20 2 2 One of the main reasons why real GNI per capita has been growing more slowly than GDP is the change in the population, 0 0 which has increased by an annual average of 0.3 percent since 1981. Another important difference arises from changes in the -2 -2 terms of trade. Deterioration in the terms of trade, when prices -4 -4 of imports rise faster than prices of exports, means that real purchasing power increases more slowly than GDP. For -6 -6 81 83 85 87 89 91 93 95 97 99 01 03 05 07 example, if oil prices rise, Swedish households are affected GDP per capita Real BNI per capita through the higher price of oil as well as the possible impact on Sources: Statistics Sweden and NIER. GDP growth. The margin for consumption and real GNI per capita have thus been increasing more slowly than GDP. Sweden’s terms of trade have been deteriorating since 1981 (see Diagram 101). This tendency is the main reason why real GNI per capita has not increased as strongly as GDP per capita (see Diagram 107). Strong Increase in Real GNI per Capita Last Year Table 20 GDP and GNI Annual percentage change 2003 2004 2005 2006 2007 GDP, current prices 3.6 4.4 3.1 4.4 5.0 Deflator, GDP 2.1 0.8 0.7 1.5 2.0 GDP, constant prices 1.5 3.6 2.4 2.9 2.9 Population 0.4 0.4 0.4 0.4 0.4 GDP per capita, constant prices 1.1 3.2 1.9 2.4 2.4 GNI, current prices 3.9 5.6 2.3 4.1 5.1 1 Deflator, domestic use 2.4 1.3 1.5 1.9 2.1 Real GNI 1.5 4.3 0.8 2.1 2.9 Population 0.4 0.4 0.4 0.4 0.4 Real GNI per capita 1.1 3.9 0.4 1.7 2.5 1 Implicit development of prices for household and general government consumption expenditure and for gross fixed capital formation and stockbuilding. Sources: Statistics Sweden and NIER. Last year GDP rose by 3.6 percent, whereas real GNI per capita – a more relevant measure for development of living standards – increased by 3.9 percent (see Table 20). That year the population grew by 0.4 percent, as it also will throughout the forecast period. The stronger increase in real GNI per capita, despite population growth, was due to substantial improvement in net 20 In a measure of living standards, it is actually better to deflate only by the change in prices of consumption, but then depriciation must also be considered. GDP and Demand in Sweden 69 primary income to and from other countries. Incomes in this category fluctuate considerably, as profits and dividends on shares of major Swedish companies, for example, vary from year to year. A factor working in the opposite direction was that the terms of trade deteriorated last year as well. This year, by contrast, growth in GNI per capita will be much less than in GDP. Aside from population growth, the difference will be due to sharply worsening terms of trade for reasons that include rising oil prices. In addition, net primary income is expected to decrease substantially (see the section ”Gross National Income Higher Than GDP”). Next year as well, real GNI per capita will increase more slowly than GDP, but the difference will be smaller than this year since the terms of trade will not be deteriorating as much. In 2007, the difference between the increase in real GNI per capita and in GDP will be 0.4 percentage point and explainable entirely by population growth. At that time, decreasing oil prices will offset other factors like the continued deterioration in the terms of trade for Diagram 108 GDP and GNI , Sweden in manufactured products. Relation to US Index 1994=100 106 106 Living Standards Increasing as Rapidly in Sweden 104 104 as in the United States 102 102 100 100 Table 21 GNI and GDP in Sweden, the US and the EU15 Annual percentage change, average1995–2004 98 98 1 Sweden US EU15 96 96 GDP, constant prices 2.8 3.3 2.3 GDP per capita, constant prices 2.6 2.2 2.0 94 94 94 96 98 00 02 04 Real GNI 2.7 3.6 2.4 GDP GDP per capita Real GNI per capita 2.5 2.5 2.0 Real GNI per capita 1Data on real GNI are lacking for Spain, Portugal and Luxembourg. In the Sources: OECD, Statistics Sweden and NIER. aggregate for the EU15, where these countries are assigned a total weight of 11 percent, real GNI growth is approximated by GDP growth Sources: OECD, Statistics Sweden and NIER. GDP growth was lower in Sweden than in the US during the period 1995–2004 (see Table 21). From 1994 to 2004, GDP increased over 4 percent more slowly in Sweden than in the US (see Diagram 108 ) However, since population growth has been higher in the US, GDP per capita has increased faster in Sweden (see Table 21 and Diagram 108). At the same time, however, Sweden’s terms of trade have deteriorated, largely eliminating the difference between Sweden and the United States in the average increase of real GNI over the past 10 years (see Table 21 and Diagram 108). This comparison with the US illustrates the importance of measuring the development of living standards in different countries using real GNI per capita rather than GDP. Compared with the EU15, on the other hand, Sweden has shown higher average growth in both GDP and real GNI per capita. In the past 10 years, GDP has increased 5 percent faster 70 GDP and Demand in Sweden Diagram 109 GDP and GNI Sweden in in Sweden than in the EU15, and real GNI per capita has risen Relation to EU15 Index 1994=100 4 percent faster (see Diagram 109). 107 107 106 106 105 105 Living Standards Roughly the Same in Sweden as in 104 104 Other EU Countries 103 103 It is also interesting to compare living standards in different 102 102 countries. This is normally done by comparison of GDP per 101 101 capita adjusted for differences in purchasing power; these data 100 100 are published by the OECD in the form of statistics on the so- 99 99 called “Prosperity League”. In GDP adjusted for purchasing 94 96 98 00 02 04 GDP power, consideration is given to changes in the terms of trade. GDP per capita Mainly for this reason, Sweden, despite comparatively high GDP Real GNI per capita growth, is not substantially wealthier than the rest of the OECD Note: Data unavailable for Spain, Portugal and Luxembourg. In the aggregate for the EU15, where in terms of GDP adjusted for purchasing power. To simplify these countries habe a combined weight of 11 percent, real growth in GNI is approximated by somewhat, adjustment for purchasing power can be described as growth in GDP. using relative prices instead of actual exchange rates when Sources: OECD, Statistics Sweden and NIER. nominal GDP is compared between countries. 21 Since GNI per capita is a better measure of consumption potential than GDP per capita, GNI per capita, adjusted for purchasing power, is reported in Diagram 110 GNI per capita adjusted for purchasing power. For most OECD countries, the difference between GNI and GDP is relatively minor. In the case of Ireland and Luxembourg, however, GNI is much lower than GDP. Ireland’s GNI is limited by extensive foreign ownership of large portions of its business sector, which are included instead in the GNI of the country’s of ownership. In Luxembourg, many foreign nationals are employed; their earnings are reported in their home countries. Comparisons of levels between countries are difficult since the OECD calculations of purchasing power are surrounded by considerable uncertainty. Moreover, the National Accounts data are not precise, either for nominal GDP or for population. This means that only large differences between countries in terms of Diagram 110 GNI Per Capita, OECD, 2003, purchasing-power-adjusted GNI per capita are statistically Adjusted for Purchasing Power significant. The OECD indicate that the interval of uncertainty Index OECD=100 200 200 is about 5 percent. In 2003 the index for Sweden was 107 (see Diagram 110); in other words, living standards are roughly 7 percent higher in Sweden than in the OECD on average. Within 150 150 an interval of plus/minus 5 percentage points, there are 11 other countries. The UK tops the list with an index of 112; Finland is lowest with 104. Most countries in the EU15 are at roughly the 100 100 21 Start, for example, with Sweden’s GDP in current prices and in Swedish 50 50 currency. Convert final domestic demand (consumption and investment) into a common currency by dividing the relative prices of these products in Sweden and the OECD. Foreign trade, like net primary income in GNI, is converted into a common currency through dividing it by the actual exchange rate. 0 0 USA CHE DNK BEL CAN SWE JPN FIN IRL ESP GRC PRT TUR LUX NOR GBR AUT NLD AUS ISL FRA DEU ITA NZL KOR MEX Deterioration in the terms of trade, due for example to rising oil prices, reduces GDP in current prices, whereas price ratios and exchange rates are Sources: OECD and NIER. affected only to a lesser degree. Purchasing-power-adjusted GDP thus decreases. GDP and Demand in Sweden 71 same level. Only Luxembourg, the US, Norway and Switzerland have substantially higher living standards. Within the EU15, Spain, Portugal and Greece have living standards below the OECD average. Living Standards Have Not Kept Pace With GDP In summary, GDP shows output, whereas the relevant measure of living standards is real GNI per capita. This measure indicates the development of real purchasing power per inhabitant. Since 1981, real GNI per capita has been increasing 0.5 percentage point more slowly per year than GDP. The weaker tendency in recent years is due to an increasing population in combination with a declining trend in the terms of trade. A force in the opposite direction is the strengthening of net income from abroad. 73 Diagram 111 Output and Employment Annual percentage change, calandar-adjusted Output and Labour Market 4 4 After a mild slump this year, GDP will grow at an average 3 3 annual rate of more than 3 percent in 2006 and 2007, in 2 2 calendar-adjusted terms. Previously strong growth in 1 1 productivity will slacken to just more than 2 percent during the 0 0 forecast period. The number of hours worked has been decreasing for three years in a row because of lacklustre growth -1 -1 in demand. This year there will be a slight upturn in hours -2 -2 01 03 05 07 worked, which will rise thereafter by almost one percentage Output point a year. Average hours worked will increase somewhat, Productivity Hours worked limiting growth in employment (see Diagram 111). Average hours worked Employment Because of the changes in the LFS surveys, the latest labour Sources: Statistics Sweden and NIER. market statistics are particularly difficult to interpret. The actual development of employment may have been overstated in the data published by Statistics Sweden. The development of unemployment is also less certain than usual (see the captioned Diagram 112 Number Employed, Hours and ”Changeover in LFS Complicates Interpretation of the Labour Unemployment Market Situation”). Index 1994=100 and percent, respectively, seasonally adjusted quarterly values Employment is expected to increase at an annual rate of 0.7 110 14 percent in 2006–2007. In 2007, the regular employment rate will be just below 77 percent of the population aged 20–64, well 108 12 short of the Government’s and Parliament’s targeted 106 10 employment rate of 80 percent. Although in 2007 there will still 104 8 be some margin for cyclical improvement of the labour market with no threat to the inflation target, most of the remaining 102 6 difference is regarded as structural. Consequently, achieving the 100 4 employment target will call for structural measures that increase labour supply and reduce the equilibrium unemployment rate. 98 94 96 98 00 02 04 06 2 Even though the increase in the population of working age Employed Hours worked (16–64) will contribute 0.9 percentage point annually in 2005 Unemployment (right) and 2006, the labour force will increase by only 0.3 percent per Sources: Statistics Sweden and NIER. year. The main reason is the growing number of persons expected to pursue studies in the next few years. An additional reason is that labour supply will be curtailed by a continued increase in the number of persons receiving sickness and activity compensation (previously termed “disability pensions”). Unemployment is down slightly since last summer, primarily because of expansion in labour market programmes. The level of cyclical unemployment is currently high but will drop in 2006 and 2007 as rising employment contributes to a gradual decrease in the unemployment rate to 5.2 percent in 2007 (see Diagram 112). Even at the end of 2007, however, there will still be some cyclical unemployment. Thus, at that time the labour market will still be somewhat weaker than is required to maintain a stable inflation rate of 2 percent. 74 Output and Labour Market Diagram 113 Output Index 1999=100, constant prices, seasonally adjusted quarterly values 135 135 130 130 Output, Productivity and Hours Worked 125 125 120 120 Growth This Year Dampened by Weaker Tendency in 115 115 in Manufacturing 110 110 105 105 Growth in output was relatively strong toward the end of 2003 100 100 and early in 2004, but it slowed in the same period a year later 95 95 (see Table 22 and Diagram 113). Business sector output was 99 01 03 05 07 limited mainly by slackening demand for exports of industrial GDP (basic prices) Public authorities firms. In the second quarter of this year, the situation in Business sector manufacturing stabilized, and in the second half-year growth in Sources: Statistics Sweden and NIER. industrial output will begin to recover (see Diagram 114). In most service industries the favourable tendency has continued. Growth in the business sector as a whole is expected to be fairly Diagram 114 Output – Business Sector vigorous in 2006–2007 (see Table 22), with demand developing Index 1999=100, constant prices, seasonally adjusted quarterly values as reported in the previous chapter. 150 150 140 140 Table 22 Output Billions of SEK, current prices, and percentage change, constant 130 130 prices 120 120 2004 2004 2005 2006 2007 Calendar-adjusted 110 110 Goods industries 680 6.6 3.2 4.4 4.5 100 100 of which: Manufacturing 474 8.5 3.1 5.0 5.3 Construction 102 2.9 6.0 4.3 3.9 90 90 Service industries 1 083 1.8 2.8 3.3 3.1 99 01 03 05 07 Manufacturing of which: Trade 234 3.5 4.3 4.6 4.5 Construction Business services 218 3.2 4.3 4.0 3.8 Services 1 Total, business sector 1 712 4.0 3.2 3.8 3.7 Sources: Statistics Sweden and NIER. Public authorities 481 0.4 -0.5 1.1 0.7 2 Total output (basic prices) 2 227 3.1 2.4 3.2 3.0 Product taxes/subsidies 319 2.2 2.0 3.2 3.0 2 GDP (market prices) 2 546 3.0 2.4 3.2 3.0 Diagram 115 Confidence Indicator – Manufacturing Not calendar-adjusted Balances, seasonally adjusted monthly values Business sector1 1 708 4.4 3.2 3.5 3.6 20 20 Public authorities 479 1.5 -0.5 0.5 0.4 2 GDP (market prices) 2 539 3.6 2.4 2.9 2.9 10 10 1 Consumption of financial services not allocated by industry has been subtracted. 2 Including output of nonprofit institutions serving households 0 0 Note: Output refers to value added. Sources: Statistics Sweden and NIER. -10 -10 The Business Tendency Survey’s confidence indicator for -20 -20 manufacturing stabilized in the second quarter of this year (see Diagram 115). The inflow of new orders was largely unchanged, -30 96 98 00 02 04 -30 and the proportion of firms dissatisfied with their order situation Note: Assessment of orders on hand – assessment was unchanged from the first quarter. The tendency was slack in of finished goods inventory + expected output. Mean the steel and motor vehicle industries, but firmer in the metal 1996–2004=0. Source: NIER. Output and Labour Market 75 products and machinery industries. The tendency in the forest products industry was unexpectedly favourable in the second quarter. According to the preliminary output data of the National Accounts, there was already some recovery in industrial output in the second quarter. These preliminary calculations, however, are fairly uncertain since they are based partly on forecasts. The Business Tendency Survey indicates that growth in output remained weak in the second quarter. Moreover, the expectations of industrial firms for the third quarter are cautious. It is anticipated that growth in export orders will recover somewhat, but that orders from the domestic market will increase only marginally. However, new orders in the motor vehicle industry, from both export and domestic markets, will recover. Growth in output is forecast to be generally modest in the third quarter. Thus, overall industrial output should not be expected to increase substantially until shortly before the end of the year, when demand will have strengthened. The order situation in the construction industry improved Diagram 116 Confidence Indicator – further in the second quarter of this year, and almost 90 percent Construction of firms are satisfied with the size of their stock of orders (see Balances, seasonally adjusted monthly values Diagram 116). Output was up considerably. Construction firms 60 60 are expecting a further increase in new orders as well as in 40 40 construction activity in the buildings and structures sector in the third quarter. Firms are also optimistic about the next year. 20 20 For most service industries, the situation continued to improve in the second quarter of this year. As before, however, the 0 0 tendency in trade was varied. In wholesaling and infrequently purchased commodities, sales were up substantially, whereas -20 -20 they were virtually unchanged in food distribution and for motor vehicle dealers. Demand for transport services was better than -40 -40 expected. And in business services and in computer and related -60 -60 activities, demand continued increasing, with further 96 98 00 02 04 improvement in the order situation. For other business activities Note: Assessment of orders on hand + expected change in number employed. Mean 1996–2004=0. related to the construction industry, such as the services of Source: NIER. architects and building consultants, the tendency was especially favourable. In service industries, optimism about the future generally continues to prevail. The Business Tendency Survey for July indicates that developments will continue along the lines described above. In summary, a recovery phase will commence in manufacturing during the second half of 2005, and the upswing will gradually gain momentum as demand from abroad improves. At the same time, domestic demand is expected to increase significantly and to stimulate output, primarily in services. This means that business sector output will show a relatively strong tendency in 2006–2007 (see Table 22). There will also be some increase in the output of the general government sector. 76 Output and Labour Market Diagram 117 Output and Hours Worked – Increase in Productivity to Slacken Business Sector Percentage change, seasonally adjusted quarterly values Business sector productivity continued to surge last year (see 3 3 Table 23 and Diagram 117 and Diagram 118). One reason is the strong increase in so-called merchanting 22 . Productivity growth 2 2 will be lower this year. The explanation will be the temporary slowdown in manufacturing and the expectation that 1 1 merchanting, which is highly cyclical, will provide a substantially 0 smaller contribution to growth. Thus, the productivity increase 0 in 2005 will be somewhat less than the trend rate (see Diagram -1 -1 119). With the gradual recovery in manufacturing, productivity growth in the business sector will also pick up somewhat. It is -2 99 01 03 05 07 -2 estimated that the increase in productivity will be close to the Output trend rate in 2006 and 2007, though decreasing slightly in 2007 Hours worked Productivity as the business cycle enters a more mature phase. Sources: Statistics Sweden and NIER. Table 23 Productivity SEK per hour and annual percentage change, constant prices Diagram 118 Productivity – Business Sector Annual percentage change, calendar-adjusted 2004 2004 2005 2006 2007 12 12 Calendar-adjusted 10 10 Goods industries 360.3 6.8 3.1 3.8 4.1 8 8 of which: Manufacturing 397.2 9.6 4.4 4.9 5.4 Construction 236.7 2.1 1.6 1.9 1.8 6 6 Service industries 383.8 2.1 1.7 2.4 1.9 4 4 of which: Trade 252.6 3.0 3.3 3.5 2.9 2 2 Business services 347.6 2.5 1.5 3.0 2.3 0 0 Business sector 363.7 4.3 2.5 3.0 2.8 -2 -2 Public authorities 245.5 0.6 0.3 -0.1 0.0 Total1 325.6 3.4 2.1 2.3 2.2 -4 -4 81 83 85 87 89 91 93 95 97 99 01 03 05 07 Not calendar-adjusted Business sector Business sector 362.9 3.7 2.5 3.2 3.0 Manufacturing Services Public authorities 245.8 0.2 0.3 0.1 0.1 Sources: Statistics Sweden and NIER. Total1 325.1 2.8 2.1 2.5 2.4 1Including nonprofit institutions serving households Sources: Statistics Sweden and NIER. Diagram 119 Productivity – Business Sector Annual percentage change, calendar-adjusted Upturn in Number of Hours Worked 5 5 In the business sector, the number of hours worked, calendar- 4 4 adjusted, decreased somewhat further last year (see Table 24table 24 and Diagram 120 and Diagram 121). This was also 3 3 the case for public authorities. Actual hours worked, however, increased both in the business sector and at public authorities 2 2 because of the larger number of working days. 1 1 According to the preliminary outcome data of the National Accounts, the total number of hours worked began to pick up in 0 0 81 83 85 87 89 91 93 95 97 99 01 03 05 07 22 Merchanting primarily involves producing and selling products abroad, often Business sector Business sector, trend by subsidiaries of Swedish firms, and invoicing them from Sweden. A portion of the revenue from such sales is categorized as export of services and is Sources: Statistics Sweden and NIER. included in business-sector output. These revenues can be viewed as compensation for previous costs of marketing, research and development. Output and Labour Market 77 the second quarter of this year. In certain service industries, like Diagram 120 Number of Hours Worked Index 1999=100, seasonally adjusted quarterly trade and business services, the increase was substantial, and the values number of hours worked soared in the construction industry. In 106 106 manufacturing as well, there was some increase in hours worked. For the period 2006–2007, hours worked are expected to go 104 104 up in the construction and service industries, but to remain largely unchanged in manufacturing. On an overall basis, 102 102 calendar-adjusted hours worked will increase by 0.9 percent in 100 100 2006 and 0.8 percent in 2007. The number of hours worked will thus have passed a trough 98 98 in the first quarter of this year after 13 quarters of cyclical weakening following the peak in the fourth quarter of 2001. 96 99 01 03 05 07 96 During that prolonged cyclical decline, the number of hours Total Public authorities worked dropped by a total of 2.9 percent. From the trough, the Business sector number of hours worked is forecast to have risen by 2.6 percent Note: The number of hours worked at public in the fourth quarter of 2007. Since this increase is well above authorities dropped sharply in the first quarter of 2000, when the ecclesiastical districts of the Church the trend rate, it means that the labour market will be tightening. of Sweden were reclassified as nonprofit organizations serving households (NPISH). During the forecast period, the construction and service Sources: Statistics Sweden and NIER. industries will increase their share of the number of hours Diagram 121 Number of Hours Worked – worked in the economy as a whole, whereas the share of Business Sector manufacturing will decrease. Index 1999=100, seasonally adjusted quarterly values 120 120 Table 24 Number of Hours Worked 115 115 Millions of hours and annual percentage change 110 110 2004 2004 2005 2006 2007 Calendar-adjusted 105 105 Goods industries 1 884 –0.2 0.1 0.6 0.4 100 100 of which: Manufacturing 1 189 –1.1 -1.2 0.1 -0.1 Construction 432 0.7 4.3 2.4 2.0 95 95 Service industries 2 816 –0.3 1.1 1.0 1.1 of which: Trade 924 0.5 1.0 1.1 1.5 90 90 99 01 03 05 07 Business services 626 0.8 2.8 1.0 1.5 Manufacturing Construction Business sector 4 700 –0.3 0.7 0.8 0.8 Services Public authorities 1 950 –0.2 -0.7 1.2 0.7 Sources: Statistics Sweden and NIER. Total1 6 824 –0.3 0.3 0.9 0.8 Not calendar-adjusted Business sector 4 717 0.7 0.7 0.3 0.6 Public authorities 1 959 1.3 -0.7 0.5 0.3 1 Totalt 6 849 0.9 0.3 0.4 0.5 1Including hours worked at nonprofit institutions serving households Sources: Statistics Sweden and NIER. Demand for Labour Increase in Number of Hours Worked As noted above, the number of hours worked reached a low point in the first quarter of this year before increasing in the second quarter (see Diagram 122). Output also rose in the 78 Output and Labour Market Diagram 122 Number Employed, Hours and second quarter after slackening late in 2004 and early in 2005. At Average Hours Worked Index 1994=100, seasonally adjusted quarterly the same time, the increase in productivity has come to a halt. values In addition, average hours worked were up in the second 110 110 quarter. Average hours worked normally rise in an economic 108 108 upswing when output accelerates but firms have not yet started 106 106 to hire additional personnel. Instead, they make greater use of existing personnel. Average hours worked are also affected, 104 104 however, by factors that do not primarily depend on the 102 102 business cycle. For example, last year’s increase in average hours 100 100 worked was due largely to a decrease in sickness absence. The 98 98 preceding rise in sickness absence reduced average hours worked and is thus one of the main reasons why employment declined 96 96 94 96 98 00 02 04 06 much less than the number of hours worked after the economy Employed Hours worked peaked in 2000–2001 (see Diagram 122). Average hours worked Because of the rise in average hours worked, higher demand Sources: Statistics Sweden and NIER. has not yet generated an appreciable increase in employment (see Digram 122). According to the Labour Force Surveys (LFS), employment rose slightly during the second quarter of this year. But this result is based on data from the new, EU-harmonized Labour Force Surveys, which differ from earlier surveys and are thus not directly comparable over time (the uncertainty in the Labour Force Surveys is discussed further in the box captioned ”Changeover in LFS Complicates Interpretation of the Labour Market Situation”). Output and Labour Market 79 Figure 1 Composition of the Labour Market in 2004 According to the LFS In thousands and as a percentage of the population (aged 16–64) in parentheses Population (16–64) 5 736 In labour force Not in labour force 4 459 (77,7) 1 277 (22,3) Employed Unemployed 4 213 (73,4) 246 (4,3) Primary activity Willingness and ability At work Absent Full-time study Willing to work Unwilling to work 3 508 (61,2) 705 (12,3) 521 (9,1) 592 (10,3) 685 (11,9) of which: Absent for of which: Absent for Sickness Able to work Unable to work part of week because entire week because 415 (7,2) (Latent seekers of work) 452 (7,9) sick sick 140 (2,4) 114 (2,0) 156 (2,7) Negotiated pension 70 (1,2) Full-time students. Others who have not Have looked for work looked for work 53 (0,9) 87 (1,5) Other 271 (4,7) Source: Statistics Sweden. 8 Changeover in LFS a job; now the respondent is first asked whether he/she has performed work during the week of Complicates Interpretation of reference. Another central element in the new LFS the Labour Market Situation is having looked for work. In the previous LFS, respondent was first asked whether he/she wanted to The Labour Force Surveys (LFS) are central to work. analyzing what is happening on the Swedish labour market, and they are an important source of statistics in the National Accounts. Beginning in How Have Statistics Sweden Estimated April 2005, the survey is presented in accordance the Effects of the Changeover in the LFS? with a new, EU-harmonized LFS. 23 The switchover involves the use of a new interview form with The total sample in the LFS has gradually been different definitions and a change in the order of reduced since January 2004, making the results less the questions. These changes create a break in the certain even before the changeover in the statistics. time series for the LFS since the surveys are no During the period from October 2004 through longer comparable over time. Statistics Sweden March 2005, parallel surveys were conducted with intends to publish time series that are linked, i.e. the new and old LFS for the purpose of estimating adjusted for the break in the time series, as well as the effects of the changeover and thus for linking seasonally adjusted series, but not until the end of the principal variables in the LFS. The existing 2005. sample was distributed so that in the fourth quarter 20 percent of respondents were interviewed according to the new questionnaire and the Changes in Definitions and in the Order of remaining 80 percent according to the previous one. Questions In the first quarter of this year, the new form was used for 30 percent of the sample and the previous Expanded definitions have affected critical variables one for the remaining 70 percent. 24 Thus, the in the LFS like employment and unemployment. sample used for calculating the effects of the In the new LFS, work abroad is treated the same changeover is clearly limited, with high statistical as work in Sweden. Formerly persons registered as uncertainty. living in Sweden but working abroad were Based on the average of the differences for the categorized as “outside the labour force”. This fourth quarter of 2004 and the first quarter of 2005, change also applies to persons seeking employment Statistics Sweden have calculated the effects of the and located abroad. changeover for certain central variables. These have Unemployed persons are now defined as those then been used for linking, in other words for who are able to work and are actively looking for recalculating the levels of previously reported data work. Previously it was also necessary for a person so as to make them comparable with the data after to have been willing to work during the week of the statistical changeover. The previous data have reference. In addition, merely examining job been adjusted upward by adding some 14 000 to the advertisements for the purpose of finding a job is number of persons employed and some 21 000 to regarded as actively looking for work. Moreover, the number of persons unemployed, or a total of persons waiting to begin a new job within three about 35 000 more persons to the labour force as a months are now regarded as unemployed. The whole. previous time limit was one month. The result can also be affected by the changed order of the questions. In the previous LFS, a Results for the Second Quarter respondent was first asked whether he/she has According to the LFS, employment rose by an average of about 0.3 percent in the second quarter 23 For a more thorough description of the changes, se the box captioned ” The New LFS – a Break in the Time Series, with Temporarily Higher Uncertainty” in The Swedish Economy, June 24 The LFS data reported during the period are based solely on 2005, as well as information on the home page of Statistics the questionnaire previously used and thus on a highly limited Sweden. sample. Output and Labour Market 81 of this year compared to the second quarter of last new questionnaire, would mean upward revision of year. At the same time, unemployment was up by the level of employment in 2004 by 33 000. Using 0.1 percentage point from the second quarter of last only the results from the parallel study for the year. fourth quarter of 2004, by contrast, would mean that the level would not be raised at all. Diagram 123 shows the range of the difference in the Problems in Interpreting the Results reported development of employment depending on the which variant of linking is chosen. Several factors now make it more complicated to interpret the results of the survey. Even for periods Diagram 123 Employment, LFS With Different with no break in the time series, there is uncertainty Methods of Linking Thousands of persons, actual quarterly values in the statistics because of random error. Estimates 4030 4030 of effects of the changeover are even more uncertain owing to the relatively limited samples on 4020 4020 which the surveys are based. Nevertheless, the level 4010 4010 of the adjustment chosen in linking is critical to the 4000 4000 picture presented for the development of the labour 3990 3990 market from 2004 to 2005. If the effects of the changeover are underestimated, the actual 3980 3980 development of employment and unemployment 3970 kv2 -04 kv3 -04 kv4 -04 kv1 -05 kv2 -05 3970 from 2004 to 2005 will be overstated. If the effects Old LFS are overestimated, there will be an analogous Linking based on fourth quarter 2004 Linking based on first quarter 2004 understatement of the actual development. Linking based on average of 4th and 1st quarters New LFS In the summer months, there are sharp seasonal Sources: Statistics Sweden and NIER. variations in employment and unemployment. Since the parallel surveys were conducted in the fourth and first quarters, it is difficult to determine whether The NIER makes use of SCB’s linking but the changeover in the statistics has also entailed a considers that its upward revision of the number change in seasonal effects. It may not be possible to employed in 2004 may be too low, thus leading to discern any new seasonal pattern until after several overstatement of the change in employment in years. A changed seasonal pattern may also mean 2005. that the effects of the changeover were measured incorrectly. Did Unemployment Rise? Was There a Rise in Employment? For relative unemployment, 25 the results of the parallel surveys showed a changeover effect of 0.3 Under the new criteria for classification as percentage point for the fourth quarter of 2004 and employed, persons residing in Sweden but working 0.5 percentage point for the first quarter of 2005. abroad are included in this category. According to That finding corresponds to an upward revision of the LFS, the number of such persons averaged previous unemployment statistics by approximately about 29 000 on an annual basis in 2004 and about 14 000 and 28 000 persons, respectively, for the two 34 000 in the second quarter of this year. But quarters used in the parallel surveys. Thus, for Statistics Sweden raised the number employed last unemployment the difference between the quarters year by 14 000, less than half of these levels, based is not as large as for employment. With linking on the average of the differences from the parallel based on the first quarter alone, the number of surveys. persons unemployed in 2004 would be adjusted The uncertainty in this calculation can be upward by 7 000 compared to the linking used by illustrated by an example. Linking based only on the results of the parallel survey for the first quarter of 25 Number of unemployed persons as a percentage of the 2005, when the sample was 50 percent larger for the labour force. Statistics Sweden. With this higher level of Diagram 125 Unemployment, LFS and AMS unemployment in 2004, there would be a smaller (Labour Market Board) Percent of labour force, seasonally adjusted change in unemployment from 2004 to 2005, quarterly values equivalent to 0.1 percentage point in terms of 6.5 6.5 relative unemployment. 6.0 6.0 For unemployment, the new method of measurement appears to affect the seasonal pattern 5.5 5.5 considerably. In Diagram 124 the actual monthly 5.0 5.0 development of relative unemployment is shown 4.5 4.5 for 2004 according to the previous LFS and for 2005 according to the new LFS. 4.0 4.0 3.5 3.5 00 02 04 Diagram 124 Unemployment Unemployment, LFS Percent of labour force, actual monthly values Unemployment, AMS 7.5 7.5 Sources: Statistics Sweden, Labour Market Board and NIER. 7.0 7.0 6.5 6.5 The NIER uses the linking of Statistics Sweden but 6.0 6.0 considers the rise in unemployment in the past month to be due primarily to a changed seasonal 5.5 5.5 pattern, which means that unemployment is 5.0 5.0 expected to recede. On the other hand, if unemployment remained at a relatively high level 4.5 JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC 4.5 for several of the next few months, the level of 2005 unemployment for the full year 2005 would be 2004 higher than in the present forecast. Sources: Statistics Sweden and NIER. For purposes of being considered unemployed, the Conclusions in Summary extension (from one month to three months) of the The uncertainty of the LFS data in regard to the period that a person can wait before starting a job change between 2004 and 2005 is especially high as means that relatively more young persons are now a consequence of the statistical changeover. registered as unemployed, particularly in the Statistics Sweden’s assessment of the effects of the summer months. The LFS for June this year changeover determine the extent to which the showed a relative unemployment rate of 7.1 official statistics on employment and percent, 0.8 percentage point higher than for June unemployment through 2004 are to be adjusted. of last year. The entire increase in unemployment The NIER reports the outcome data and makes consisted of young persons. But other analyses of forecasts for these official statistics. There is reason the unemployment tendency do not find any to believe, however, that with the adjustments in the correspondingly strong increase in recent months. levels of employment and unemployment for 2004 In Diagram 125, unemployment is shown according the actual changes in these variables are overstated to the Labour Market Board (AMS) and the LFS. in official statistics and thus in the present forecast as well. 83 Output and Labour Market Diagram 126 Employment, New LFS Percentage change, seasonally adjusted quarterly values Modest Increase in Employment Ahead 1.5 1.5 During the last four years, GDP growth has not been strong 1.0 1.0 enough to generate an appreciable increase in employment. Instead, firms have made more efficient use of their existing personnel, primarily through strong growth in productivity, but 0.5 0.5 also – in the second quarter of this year – by increasing the average number of hours worked. Employment was up slightly 0.0 0.0 in the first and second quarters of this year, while regular employment, or employment excluding participants in labour -0.5 -0.5 market employment programmes, showed a somewhat weaker 00 02 04 06 tendency and is not expected to pick up until the third quarter of Number employed Number employed excl participants in employm. prog this year (see Diagram 126). Note: The historical series has been linked The Business Tendency Survey indicates that the weak backward by the NIER. Sources: Statistics Sweden and NIER. tendency in manufacturing has stabilized somewhat. Employment in manufacturing, however, is expected to decrease Diagram 127 Shortage of Labour – Goods further, as only modest growth in orders and output is Industries anticipated. On the other hand, firms in the construction and Proportion of firms in percent, quarterly values services industries are optimistic about the tendency for the rest 50 50 of this year. Over 30 percent of construction firms are reporting a shortage of labour; the corresponding proportion in 40 40 manufacturing is about 10 percent (see Diagram 127). In service 30 30 industries there was a decrease in the proportion of firms reporting labour shortages in the second quarter, a natural 20 20 development when firms have begun hiring new personnel (see Diagram 128) 10 10 The number of newly reported vacancies 26 was up in the second quarter. The increase was primarily in service industries 0 0 91 93 95 97 99 01 03 05 and the local government sector. Over 31 000 persons were Manufacturing affected by layoff notices in the first half of this year, but 3 000 Construction fewer than in the corresponding period last year. Most of the Source: NIER. decrease took place in the second quarter (see Diagram 129). The number of hours worked reached a trough in the first quarter, then began to rise in the second. The year 2005 will be Diagram 128 Shortage of Labour – Service the first since 2001 when the number of hours worked has gone Industries Proportion of firms in percent, quarterly values up for the year as a whole. Particularly this year, but also in 2006 100 100 and 2007, the increase in productivity will slacken compared to 2004. GDP growth will thus be sufficiently high to generate an 80 80 increase in the number of hours worked. At the same time, 60 60 average hours worked will begin rising, even if only slightly, for the forecast period, resulting in a somewhat smaller increase in 40 40 employment (see Table 25). Underlying the increase in average hours worked will be a continuing decline in sickness absence, 20 20 among other factors. The so-called Career Break Programme, 0 0 will have the opposite effect on average hours worked. That 91 93 95 97 99 01 03 05 Computer and related activities programme makes it possible for an employee to take a leave of Other business activities absence for 3 to 12 months with an income equivalent to 85 Durable goods trade Wholesale trade Source: NIER. 26 Vacancies reported to the country’s employment offices. 84 Output and Labour Market Diagram 129 Layoff Notices and Vacancies percent of what the employee would receive in unemployment Thousands, 3-month moving average compensation. A requirement for participation in the 50 20 programme is that an unemployed person be hired as a temporary replacement for the individual on leave. As is the case 38 15 with other forms of absence from work, both the person on leave and the temporary replacement are classified as 25 10 employed. 27 Employment is forecast to increase by 0.2 percent this year and by 0.7 percent in 2006 and 2007 (see Table 25). In 2007, the regular employment rate for persons aged 20-64 13 5 will be 76.9 percent, short of the Government’s and Parliament’s target of 80 percent by 3.1 percentage points, or about 166 000 0 93 95 97 99 01 03 05 0 persons (see Diagram 130) 28 . Although there will still be some Newly reported vacancies, seasonally adjusted margin for cyclical improvement in the employment ratio after Layoff notices (right) 2007, most of the difference between the regular employment Source: Labour Market Board. rate and the target is considered to be structural. Therefore, in the opinion of the NIER, sustainable achievement of the employment target will not be possible without structural reforms that increase labour supply or reduce equilibrium Diagram 130 Regular Employment Ratio Percent of population aged 20-64, seasonally unemployment. adjusted quarterly values 80 80 Table 25 Key Numbers for the Labour Market 79 79 Level in thousands of persons according to the old LFS, annual 78 78 percentage change according to the new LFS 77 77 2004 2004 2005 2006 2007 1 Total output (basic prices) 2 227 3.1 2.4 3.2 3.0 76 76 2 Productivity 325 3.4 2.1 2.2 2.2 3 75 75 Number of hours worked 6 849 -0.3 0.3 0.9 0.8 74 74 Number of persons at work 3 508 -0.1 0.3 0.9 0.8 73 73 Number of persons absent 705 -2.4 -0.6 0.0 0.2 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 Average hours worked for employed Regularly employed, aged 20-64 4 Employment target persons 31 0.2 0.1 0.2 0.1 Number of persons employed 4 213 -0.5 0.2 0.7 0.7 Note: Regular employment ratio, old LFS. Sources: Statistics Sweden and NIER. 5 Unemployment 246 6.0 5.8 5.4 5.2 6 Expanded unemployment 386 9.0 8.5 8.1 7.7 Number of persons in labour-market 5 programmes 106 2.4 2.7 2.7 2.4 7 Regular-employment rate 4 072 77.0 76.5 76.5 76.9 1 Billions of SEK, calendar-adjusted. 2 SEK per hour, calendar-adjusted. 3 Millions of hours, calendar-adjusted. 4 Hours per week, calendar-adjusted. 5 Level and percent of labour force according to the new LFS. 6 Officially unemployed plus latent seekers of employment, level and percent of expanded labour force according to the new LFS. 7 Number of persons aged 20-64 and percentage of population in this age group with regular employment, excl. persons in labour-market employment programmes. Sources: Statistics Sweden, Labour Market Board and NIER 27 In July there were 11 158 persons in the Career Break Programme. 28 Regular employment according to the old LFS. Output and Labour Market 85 Labour Supply and Unemployment No Change in Labour Supply This Year The labour force showed a relatively weak tendency in 2004 despite high growth in the population aged 20–64. The main explanation was an increase in the number of students and sick persons outside the labour force. In the second quarter of this year, labour supply increased slightly after remaining unchanged in the first quarter. However, since there are no second-quarter outcome data from the LFS for the various groups outside the labour force, it is not possible to determine which of these groups have decreased. In the next few years the working-age population will be rising by an average of almost 40 000 persons per year. The increase will contribute about 0.9 percentage point annually to the labour force (see Table 26). But growth in the labour force will be curbed during the period by a decreasing proportion of persons in age group 25-54, where the rate of labour force participation is relatively high. Table 26 Net Contribution to Labour Force Level in thousands of persons according to the old LFS, annual percentage change and net contribution in percentage points according to the new LFS 2004 2004 2005 2006 2007 Labour force 4 459 0.2 0.0 0.3 0.4 of which net contribution from: Population aged 16–64 5 735 0.8 0.8 1.0 0.8 1 Sick persons 415 -0.4 -0.3 -0.2 -0.1 2 Persons with negotiated pensions 70 0.1 0.0 0.0 0.0 Full-time students 520 -0.3 -0.4 -0.3 -0.3 of whom: 3 In training programmes 80 -0.2 0.0 0.2 0.2 In regular education 441 -0.1 -0.4 -0.4 -0.4 4 Other 271 0.0 0.0 -0.1 -0.1 1 The category of sick persons outside the labour force includes individuals receiving disability pensions for health-related reasons. 2 Old-age pensions, retirement pensions and sickness and activity compensation for reasons related to the labour market 3 Training programme participants outside the labour force, according to the Labour Market Board 4 The category designated ”Other” consists of homemakers, persons on leave, persons residing abroad etc. Sources: Statistics Sweden, Labour Market Board and NIER. The surge of recent years in the number of persons receiving sickness and activity compensation 29 has limited the development of labour supply. This year and in the next few years, the number of sick persons outside the labour force will continue to increase, though at a declining rate (for a discussion 29 Previously designated “disability pensions”. 86 Output and Labour Market Diagram 131 Full-time Students and Number on the tendency in ill health and its effect on the labour force, of Sick-Listed Persons Outside the Labour see also the box in The Swedish Economy – March 2005, captioned Force Thousands, seasonally adjusted quarterly values ”Fewer Sick-Days, but Total Ill Health Increasing”). In addition, 700 700 the number of full-time students is continuing to rise, curbing growth in the labour force (see Diagram 131 and Table 26). 600 600 The estimated number of participants in labour market programmes in 2005 and 2006 will average about 121 000, equal 500 500 to the volume of programmes recently announced. 30 It is estimated that by 2007 the number will decrease to 107 000. 400 400 This year there will be a substantially higher number of 300 300 participants in employment programmes as the Career Break Programme is extended to the entire country and the volume of 200 200 employment support is increased. 31 At the same time, the 93 95 97 99 01 03 05 07 Sick persons outside the labour force number in training programmes will decrease (see Diagram 132). Full-time students Most labour market programmes, however, are for training Sources: Statistics Sweden and NIER. purposes, with participants considered as full-time students and therefore not included in the labour force. The number of students in regular education will continue to increase during the Diagram 132 Labour Market Programmes Thousands, seasonally adjusted quarterly values next two years, the reason being that as the younger age groups 250 250 grow larger, more persons will be enrolled in basic education. Overall, no change in the size of the labour force is expected 200 200 this year. The labour force will increase by 0.3 percent next year and by 0.4 percent in 2007 (see Table 26). 150 150 100 100 Unemployment Decreasing to 5.1 Percent 50 50 In 2003 there was a sharp rise in unemployment as employment 0 93 95 97 99 01 03 05 07 0 decreased while labour supply increased. Unemployment Labour-market programmes climbed further in the early months of 2004, but stabilized over Employment programmes Training programmes the summer and fell slightly in the second half-year (see Diagram Sources: Labour Market Board and NIER. 133) The decrease was due primarily to the expansion in labour market programmes. In the first quarter of 2005, the unemployment rate was unchanged at 5.3 percent, adjusted for normal seasonal variations. Owing to the changeover in the Diagram 133 Unemployment Rate statistics, there is no seasonally adjusted measure of the Percent of labour force, seasonally adjusted quarterly values unemployment rate for the second quarter. But the outcome for 10 10 June, according to the new, EU-harmonized Labour Force Survey (LFS), was 7.1 percent (actual rate). While unemployment 9 9 normally increases in the summer, the change from May to June 8 8 is unusually large this year, possibly indicating that the unemployment rate according to the new Labour Force Surveys 7 7 will show a different seasonal pattern. The new methods and 6 6 definitions also mean that the measured level of unemployment 5 5 has increased by 0.4 percentage point according to the 4 4 30 The Government has announced that there will be so-called ”plus jobs” in 3 3 93 95 97 99 01 03 05 07 the general government sector, traineeships, training replacements and other Linked according to new definition measures that would mean a lower unemployment rate according to the present forecast.. Note:The historical series has been linked beckward 31 Participants in labour market programmes for employment purposes are by the NIER with an estimated effect of 0.4 percentage change. included in the labor force. Sources: Statistics Sweden and NIER. Output and Labour Market 87 calculations on which the official statistics are based (see also the box captioned ”Changeover in LFS Complicates Interpretation of the Labour Market Situation” for further discussion of the uncertainty in the LFS). Thus, the first-quarter unemployment rate of 5.3 percent according to the previous LFS corresponds to 5.7 percent according to the new LFS. Measured in the new way, the unemployment rate is forecast to be 5.8 percent for 2005. Thereafter, employment will continue to rise, bringing the unemployment rate down to 5.1 percent by the fourth quarter of 2007. The concept of expanded unemployment includes not only persons officially unemployed, but also latent seekers of employment, i.e. persons outside the labour force who are willing and able to work but have not looked for work, as well as full-time students who have looked for work. 32 Since there are no second-quarter LFS data for the various categories outside the labour force, the development in the second quarter of the number of latently unemployed and of unemployment measured according to the ILO 33 -definition 34 is not known. The number of latent seekers of employment, however, is expected to decrease when the labour market situation improves during the forecast period as more persons seek to enter the labour market, thereby becoming either employed or officially unemployed. The expanded unemployment rate will be 8.5 percent this year, dropping to 7.7 percent in 2007. Resource Utilization Resource utilization in the Swedish economy has risen but is still relatively low. This situation is reflected, for example, in the questions of the Business Tendency Survey on labour shortages. Firms report no major problems in recruiting the personnel that they need. Despite a certain increase since the end of 2003, only 15.8 percent of business-sector firms indicate a shortage of labour (see Diagram 134), a very low figure by historical Diagram 134 Shortage of Labour – Business Sector standards. Of manufacturing firms, 65 percent report also that Proportion of firms, percent, quarterly values slack demand is the main limitation on increasing output. Only 50 50 24 percent state that the supply of labour or other production factors is the principal bottleneck. 40 40 The labour market remains weak. The expanded unemployment rate is estimated to have been 8.5 percent in the 30 30 second quarter of this year. After the changeover in the LFS statistics, the expanded unemployment rate is roughly 0.3 20 20 percentage point higher than with the previous method of measurement (see also the box captioned ”Changeover in LFS Complicates Interpretation of the Labour Market Situation”). 10 10 32 For the different categories of persons on the labour market, see Figure 1. 0 0 93 95 97 99 01 03 05 33 International Labour Organisation. 34 This defiinition of unemployment includes full-time students who have Note: Weighted average of industries in the Business Tendency Survey. looked for work during the week of the survey. Source: NIER. 88 Output and Labour Market The rate of wage increases in the business sector last year was the lowest in over 10 years, and the latest outcome data indicate that wage increases are modest. Together with the high growth in productivity, this means that unit labour costs have decreased in recent years. The inflation rate has been well below the target of 2 percent, and according to the latest data, it is among the lowest in the entire EU. The NIER’s view of resource utilization can be summarized by the output gap. A central element in the concept of the output gap is so-called equilibrium unemployment, which is the level of unemployment compatible with a stable inflation rate of 2 percent. Equilibrium unemployment is a nonobservable quantity and can only be estimated by indirect methods. In the preceding issue of The Swedish Economy, the expanded unemployment rate was revised upward by 0.3 percentage point because of the changeover in the LFS statistics. Since actual unemployment was revised upward to an equal extent, the upward revision does not mean that the view of resource utilization has changed. The latest data on the proportion of firms reporting shortages and on wage and price increases, for example, do not call for any change in the assessment of equilibrium unemployment. The expanded equilibrium unemployment rate is currently estimated at 7.4 percent, or 1.1 percent less than the actual expanded unemployment rate. Table 27 Output Gap Level, in millions, percent and annual percentage change 2004 2004 2005 2006 2006 Equilibrium expanded 7.3 7.4 7.3 7.2 unemployment rate Expanded unemployment rate 8.7 8.5 8.1 7.7 Potential hours worked 6 913 0.2 0.2 0.4 0.5 Actual hours worked 6 824 –0.3 –0.3 0.9 0.8 1 Labour market gap –1.3 –1.2 –0.6 –0.3 Diagram 135 Labour Market and Productivity Potential output 2 550 2.4 2.5 2.8 2.9 Gaps Actual output (GDP) 2 539 2.9 2.4 3.2 3.0 Potential number of hours worked and percent of 2 Output gap –0.5 –0.6 –0.2 –0.1 potential productitity, seasonally adjusted quarterly values 1Percentage deviation of actual hours worked from potential hours worked. 3 3 2Percentage deviation of actual output from potential output (potential GDP). Note: The calculations are adjusted for differences between years in the 2 2 number of working days. 1 1 Sources: Statistics Sweden and NIER. 0 0 The output gap is the sum of the labour market gap and the -1 -1 productivity gap. The labour market gap is estimated at -2 -2 –1,2 percent for this year (see Diagram 135). The productivity -3 -3 gap is currently positive because of the surge in productivity in -4 -4 the last few years. In the period ahead, productivity is expected 90 92 94 96 98 00 02 04 06 to increase somewhat more slowly than its trend rate of Labour-market gap Productivity gap development, and the productivity gap will gradually decrease. Note: The labour market gap is calculated as the The total output gap, which indicates how much GDP can grow difference between the number of hours worked and its potential level. Source: NIER. Output and Labour Market 89 above its potential growth rate without giving rise to demand Diagram 136 Output Gap Percent of potential GDP, seasonally adjusted pressure that threatens the inflation target, is estimated to quarterly values average -0.6 percent for this year (see Diagram 136). 2 2 During the forecast period, demand for labour will increase more than supply; thus, the labour market gap will gradually 1 1 become smaller. Economic recovery is proceeding so slowly, however, that even at the end of 2007 there will still be spare 0 0 resources in the Swedish economy. Consequently, demand -1 -1 pressure on wages and prices will be low, though rising, during the entire forecast period. -2 -2 -3 -3 -4 -4 90 92 94 96 98 00 02 04 06 Source: NIER. 91 Wages, Profits and Prices Diagram 137 Labour Market Gap, Hourly Earnings and UND1X-Inflation Percent of potential number of hours worked and Hourly earnings in the business sector rose by 3.0 percent in annual percentage change, respectively, quarterly values 2004, the lowest rate of increase in 10 years. The rate of wage 7 3 increases will remain modest throughout the forecast period, 6 2 primarily because of the soft labour market. However, as the labour market improves and more spare resources are put to 5 1 use, growth in wages will gradually accelerate (see Diagram 137). 4 0 But even for 2007, wages are forecast to rise by somewhat less 3 -1 than 4 percent, the rate of wage increases considered compatible 2 -2 in the long run with the inflation target. With the low rate of wage increases and strong growth in 1 -3 productivity, unit labour costs decreased in 2004. Unit labour 0 -4 93 95 97 99 01 03 05 07 costs will rise little by little but still be relatively modest UND1X throughout the forecast period, contributing to low, though Hourly earning, business sector Labour market gap (right) rising, inflationary pressure. Sources. Statistics Sweden, National Mediation The profit share in the business sector has risen rather Office and NIER. substantially in recent years, despite relatively little increase in prices, as a consequence of limited increases in labour costs and high growth in productivity. The profit share will continue to rise slightly during the forecast period even though unit labour costs will then be going up at a more normal rate. The cost situation has improved in recent years and will be maintained in 2004–2006. Sweden’s competitive position is expected to remain favourable. Mainly because of low resource utilization, there is very little inflation this year. As measured by the UND1X, the inflation rate has been less than the Riksbank’s target since October 2003, and most of the time it has even been under the lower tolerance limit. The inflation rate in Sweden, as measured by the harmonized HICP index, is presently lower than in all of the other 24 countries in the EU. In both the EU and the OECD, the inflation rate has remained at about 2 percent in the past three years. This show that Sweden’s extremely low inflation in 2004 and 2005 has been due to Swedish conditions and thus not to a particularly low rate of international inflation. In 2006 and 2007, resource utilization will gradually rise. As a result, wages and unit labour costs will be increasing somewhat faster, and the inflation rate will therefore be slightly higher (see Diagram 137). The UND1X excluding energy is expected to be increasing by 2 percent by the end of 2007. 92 Wages, Profits and Prices Diagram 138 Hourly Earnings – Business Sector Annual percentage change, 3-months moving aver- age Wages and Labour Costs 7 7 6 6 Upturn in Wage Increases This Year 5 5 Hourly earnings in the business sector increased in 2004 by an average of 3.0 percent, the lowest rate of nominal wage increases 4 4 since 1994 (see Diagram 138). This lacklustre tendency is due mainly to the slack labour market. 3 3 The statistics for particular months have varied substantially 2 2 depending on the days of the week for public holidays; this variation has primarily affected wages in industries with ongoing 1 1 production, such as manufacturing and certain service 93 95 97 99 01 03 Source: National Mediation Office. industries. 35 In the period from January through May of this year, wages have increased by an average of 3.0 percent compared to the same period last year (see Diagram 138). The Diagram 139 Hours Worked and Hourly statistics will probably be adjusted upward because of retroactive Earnings – Business Sector Annual percentage change, quarterly values wage payments in connection with local revisions of wages. The 12 7 final rate of wage increases for January through May is forecast to be 3.3 percent compared with the same period last year. This 6 8 indicates that there will be an upturn in wage increases this year 5 for the business sector as a whole. 4 4 3 -1 Wage Increases Gradually Accelerating 2 -5 1 The labour market has stabilized. The number of hours worked for the economy as a whole, which has gradually been -9 0 93 95 97 99 01 03 05 07 decreasing for several years, has taken an upturn and will be Hours worked Hourly earning (right) increasing as from the second quarter of this year (see Diagram Sources: Statistics Sweden and NIER. 139). This picture is supported by the Business Tendency Survey, which indicates that there has been a growing shortage of labour in the business sector for some time, even though the percentages of firms reporting shortages are still relatively low Diagram 140 Labour Shortage and Hourly Earnings – Business Sector by historical standards (see Diagram 140). In addition, there has Proportion of firms, percent and annual percentage been a strong profit tendency in the business sector (see also the change, respectively, quarterly values 50 7 section ”Competitive Situation and Profitability”). The rate of wage increases through May of this year reflects that 40 6 development and suggests that wages in the business sector will accelerate this year. With growing utilization of labour resources, 30 5 the rate of wage increases will gradually rise during the forecast period. Despite successive improvement, the labour market will 20 4 still be cyclically weak even in 2007, as reflected in a continuing 10 3 35 Holidays increase the amount of compensation for overtime, thus raising average hourly earnings. An early Easter thus contributed to a relatively high 0 2 93 95 97 99 01 03 05 07 rate of wage increases in March and a low rate in April. And in May, when the Labour shortage, business sector Monday following Whitsunday, or Pentecost, was no longer a legal holiday Hourly earnings, business sector (right) after losing that status in favour of Sweden’s national day (June 6), the rate was Note: Weighted measure based on industries in the unusually low. But correspondingly higher wage increases in June are expected Business Tendency Survey. to make up for May. Source: NIER. Wages, Profits and Prices 93 negative labour market gap. Consequently, the rate of wage Diagram 141 Hourly Earnings and Labour increases will not reach the level of 4 percent considered Market Gap – Business Sector Annual percentage change and percent of GDP, compatible in the long run with 2 percent inflation (see respectively Diagram 141 and Table 28). 36 4 8 Table 28 Hourly Earnings According to the Short-Term 2 6 Wage and Salary Statistics Annual percentage change 0 4 2004 2005 2006 2007 Manufacturing 3.1 3.4 3.4 3.6 -2 2 Construction 2.6 3.7 4.1 4.2 Service industries 3.0 3.2 3.5 3.9 -4 0 Business sector 3.0 3.3 3.6 3.9 93 95 97 99 01 03 05 07 Labour-market gap Local government 4.2 3.6 3.8 3.9 Hourly earning (right) Central government 2.7 3.1 3.5 3.7 Sources: National Mediation Office and NIER. Total 3.3 3.3 3.6 3.9 Sources: National Mediation Office and NIER. Diagram 142 Hourly Earnings – Business Sector The tendency of productivity in manufacturing was strong in Annual percentage change, quarterly values 2004. Thus, industrial output rose while at the same time the 6.0 6.0 number of hours worked decreased. According to the National Accounts data for the first half of the year, the development in 5.0 5.0 manufacturing stagnated. This is reflected in the Business Tendency Survey, where industrial firms are expecting a limited 4.0 4.0 inflow of new orders and continuing cutbacks in personnel. During the forecast period, the number of hours worked will be 3.0 3.0 increasing more slowly in manufacturing than in the business sector as a whole (see the section under “Productivity, Output 2.0 2.0 and Hours Worked”). Consequently, demand for labour will 01 03 05 07 Manufacturing remain weak in manufacturing, where wages will be increasing Construction more slowly in 2006 and 2007 than in the business sector as a Service industries whole (see Diagram 142 and Table 28). Sources: National Mediation Office and NIER. Construction began accelerating last year and has continued to do so this year, according to both the National Accounts and the Business Tendency Survey. Increased demand for construction workers is reflected in higher wage increases for the construction industry in January through May this year than for the business sector as a whole. The robust tendency in construction will persist during the forecast period; as a result, wages will be rising faster in the construction industry than in the business sector as a whole during 2006 and 2007 (see Diagram 142 and Table 28). From January through May of this year, wages have gone up somewhat more slowly in service industries than in manufacturing. In service industries, which lag somewhat behind manufacturing in the business cycle, wages will be increasing somewhat more slowly this year than in the business sector as a 36 See ”Productivity and Wages Through 2015”, Special Study No. 6, NIER, 2005. 94 Wages, Profits and Prices Diagram 143 Hourly Earnings – Business whole. Demand has been rising for some time, however, Sector, Local Government Sector and Central according to the Business Tendency Survey, although demand Government Annual percentage change, quarterly values varies between different service industries (see also the section 6 6 headed “Demand for Labour”). In business-related service 5 5 industries, there is sharply higher demand for other business and consultancy services, whereas the picture in trade is more varied. 4 4 In trade in infrequently purchased commodities and in 3 3 wholesaling, firms have a positive outlook on the future, whereas the food distribution trade, for instance, is expecting a 2 2 reduction in employment. The gradually accelerating demand for 1 1 services will mean higher wage increases in service industries in the period ahead, and in 2007 wages will be rising at the same 0 01 03 05 07 0 rate as in the business sector as a whole (see Diagram 142 and Business sector Local government sector Table 28). Central government This year’s labour negotiations in the local government sector Sources: National Mediation Office and NIER. resulted in a lower wage settlements in the central agreements for 2005–2006 than in the corresponding agreements for 2001– 2004. 37 Actual wages will also rise somewhat more slowly in local government than in 2001-2004, though faster than in the business sector this year and in 2006. But the difference between the two sectors in the rate of wage increases will gradually diminish as the labour market gap becomes less and less negative. This development will have a greater impact on business-sector wages, and in 2007 wages will be increasing at the same rate in business and local government sectors (see Diagram 143 and Table 28). In the central government sector, central agreements were reached in October last year, but because of substantial delays in reaching a number of local agreements, wage increases were limited last year. The rate of wage increases was also low in the period from January to May this year compared to the corresponding period last year. 38 But as a growing number of local agreements are concluded, the data will be revised upward. Even so, wages are expected to increase more slowly in the central government sector than in the business sector this year, a development connected with the limited appropriations to central government authorities. Although the rate of wage and salary increases in central government will gradually rise, it will still be somewhat lower than in the business sector during the forecast period (see Diagram 143 and Table 28). 37 See the box captioned ”Negotiated Settlements and Actual Wage Increases in the Local Government Sector” in The Swedish Economy, Mars 2005. 38 The average rate of wage increases for the central government sector in the period January-May is currently 1.2 percent compared to the same period last year. Wages, Profits and Prices 95 Labour Costs Increasing More Slowly Than Hourly Diagram 144 Hourly Wage and Labour Costs Earnings This Year According to National Accounts – Business Sector Annual percentage change, calendar-adjusted As from January 1 this year, new rules for sickness-related 7 7 benefits are in effect. Employers now stand to gain more financially by decreasing the number of persons sick-listed on a 6 6 full-time basis. The new rules stipulate that the employer must 5 5 pay 15 percent of the sickness benefit for the period when an 4 4 employee is sick-listed full-time. In compensation, the legislated 3 3 employer contribution was lowered by 0.24 percentage point. For employers on the whole, the cost of sick-listing is thereby 2 2 unchanged. In the business and central government sectors, 1 1 however, the overall cost is effectively reduced, as sick-listings in 0 0 these sectors are somewhat below the average. Municipalities 01 03 05 07 and county council districts, on the other hand, face higher Hourly wage Labour cost per hour costs. Another change is that the period for which the employer Sources: Statistics Sweden and NIER. provides sick-pay has been shortened from three to two weeks, reducing costs for all employers. Furthermore, negotiated employer contributions in the business sector are somewhat less this year than last year, according to the Confederation of Swedish Enterprise (Svenskt Näringsliv). For these reasons, labour costs in the business sector will increase more slowly than hourly earnings this year (see Diagram 144 and Table 29). Table 29 Labour Costs and Hourly Earnings per Unit of Output – Business Sector SEK per hour and annual percentage change, calendar-adjusted 2004 2004 2005 2006 2007 Hourly earnings (STWS) 3.0 3.3 3.6 3.9 Hourly earnings (NA) 169 2.9 3.3 3.7 4.1 Employer contributions (NA) 74 2.8 0.6 3.7 4.0 Labour costs (NA) 243 2.9 2.5 3.7 4.0 Productivity 4.6 2.6 3.0 2.8 Unit labour costs -1.7 -0.1 0.7 1.2 Note: Employer contributions include social security contributions and payroll taxes. STWS (KL) stands for Short Term Wage and Salary Statistics and NA Diagram 145 Unit Labour Cost – Business for the National Accounts. Sector Annual percentage change, calendar-adjusted Sources: Statistics Sweden, National Mediation Office and NIER. 8 8 Unit labour costs in the business sector, or the cost of labour 6 6 per unit of output, decreased by 1.7 percent last year because of slowly rising labour costs and strong growth in productivity. As 4 4 labour costs increase while productivity growth slackens, unit 2 2 labour costs will gradually accelerate during the forecast period. 0 0 Even in 2007, however, unit labour costs will be rising more slowly that their long-term rate of increase, 1.6 percent, -2 -2 considered compatible with inflation of 2 percent (see Diagram -4 -4 145 and Table 29). 39 With this low rate of increase in unit labour 97 99 01 03 05 07 Labour cost per hour Productivity Unit labour cost Sources: Statistics Sweden and NIER. 39See ”Productivity and Wages Through 2015”, Special Study No. 6, NIER, 2005. 96 Wages, Profits and Prices Diagram 146 Cost of Labour According to costs, inflationary pressure on Swedish output will remain Labour Cost Index (LCI) – Business Sector Index 1997=100 relatively limited. 135 135 130 130 125 125 Competitive Situation and Profitability 120 120 115 115 Relative Unit Labour Costs Increasing, 110 110 But Competitive Strength Maintained 105 105 100 100 According to the Labour Cost Index (LCI), labour costs 95 95 increased in Sweden last year by 3.7 percent, and in the euro 97 99 01 03 zone by 2.6 percent. In the first quarter of this year, on the other Euro zone Sweden hand, labour costs rose by 3.0 percent in Sweden and by 3.1 Note: Excl. health and other care, study, social and percent in the euro zone, compared to the same quarter the year personal services. Source: Eurostat. before. 40 This is not the first time that labour costs have risen faster in Sweden than in the euro zone (see Diagram 146) The Diagram 147 Unit Labour Cost in Relation to more rapid increase in costs has been offset, though, by a the Euro Zone – Business Sector stronger rise in productivity. Consequently, relative unit labour Index 1997=100 costs in national currency are currently at the same level as in the 110 110 late 1990’s (see Diagram 147). Measured in a common currency – that is, when changes in exchange rates are also considered – 105 105 relative unit labour costs are considerably lower than in the late 1990’s, the krona having weakened against the euro. By this 100 100 measure, though, Sweden’s competitive position tends to be somewhat overestimated, because of the declining trend in prices of Swedish exports compared to prices of other countries’ 95 95 exports, measured in a common currency (see the section headed ”Terms of Trade, Current Account and Gross National 90 97 99 01 03 05 07 90 Income”). The explanation is that telecommunication products, Common currency the prices of which have been dropping sharply in the past ten National currency years, are overrepresented in Swedish exports. Relative unit Note: In the comparison, Swedish unit labour costs are calculated excluding payroll taxes as defined by labour costs are forecast to remain at this rather low level, as the OECD. Sources: OECD and NIER. unit labour costs have been increasing at roughly the same slow rate in Sweden and the euro zone and no major changes in the exchange rate are anticipated (see Diagram 147). Diagram 148 Profit Share – Business Sector excl. Finance and Real Estate Percent 38 38 Profitability Stabilizing 36 36 The profit share 41 in the business sector rose strongly last year 34 34 from a comparatively low level (see Table 30 and Diagram 148). 32 32 The increase is explainable mainly by the continued upsurge in 30 30 productivity, which has also contributed to persistent cyclical weakness in the labour market and thus to low wage increases. 28 28 The profit share will rise somewhat further in 2005–2007 26 26 24 24 80 82 84 86 88 90 92 94 96 98 00 02 04 06 40 The figures for both the full year 2004 and the first quarter of 2005 are Profit share preliminary. Profit share, calendar-adjusted 41 Gross profit as a share of value added at factor prices. The profit share Sources: Statistics Sweden and NIER. normally rises if value-added prices increase faster than unit labour costs. Wages, Profits and Prices 97 Table 30 Prices, Costs of Output and Diagram 149 Profit Shares – Manufacturing Profit Shares – Business Sector Percent Annual percentage change 70 70 2003 2004 2005 2006 2007 60 60 Not calendar-adjusted Value-added price1 1.0 0.4 0.2 1.0 1.6 50 50 Product price 0.8 1.5 3.0 0.9 0.2 40 40 Input price 0.5 2.4 5.1 0.9 -0.9 Unit labour cost (ULC) 0.3 -2.1 -0.1 1.0 1.3 30 30 Hourly labour costs 3.8 1.9 2.4 4.2 4.3 Productivity2 3.5 4.1 2.5 3.2 3.0 20 20 Profit share3 0.4 1.5 0.2 0.0 0.2 10 10 Calendar-adjusted 80 82 84 86 88 90 92 94 96 98 00 02 04 06 Total manufacturing Unit labour cost (ULC) 0.1 -1.7 -0.1 0.7 1.2 Manufacturing, primary products Hourly cost of labour 3.5 2.9 2.5 3.7 4.0 Manufacturing, investment goods Productivity2 3.4 4.6 2.6 3.0 2.8 Sources: Statistics Sweden and NIER. Profit share3 0.5 1.3 0.1 0.2 0.3 1 The value-added price is calculated by deducting the average price of inputs consumed (input price) from the average price of the output produced (product price). 2 The development of productivity in this table has been calculated only for Diagram 150 Procuct Price and Input Price – Business Sector employees; in other words, hours worked by business proprietors are not Annual percentage change included. 3 Gross profit divided by value added at factor prices, with consideration given 6 6 to taxes and subsidies on output. The change is expressed in percentage points. Source: NIER 4 4 Last year’s increase in profits (see Table 30) was substantial 2 2 despite a stronger exchange rate that curbed prices of exports. Product prices, but above all prices of inputs, still increased 0 0 considerably as prices of petroleum and metals soared (see Diagram 150). At the same time, costs were held in check by the continued strong increase in productivity together with modest -2 97 99 01 03 05 07 -2 increases in hourly earnings (see Diagram 152). To some degree, Product price Input price the robust increase in profits was due to the calendar effect, as Sources: Statistics Sweden and NIER. there were more working days than normal last year (see Table 30 and Diagram 148). The profit share rose in both the industrial and service sectors (see Diagrams 149 and 151). Growth in international demand will slacken somewhat this Diagram 151 Profit Shares – Service Industries excl. Finance and Real Estate year, whereas domestic demand will accelerate. With a weaker Percent exchange rate for the krona, fairly good productivity growth and 40 40 relatively low unit labour costs, the profit share in the business 35 35 sector will increase somewhat further this year. The profit share 30 30 will decrease slightly in manufacturing, except for the basic industries, but continue rising in services. Within manufacturing, 25 25 there will be some redistribution of profits to basic industries 20 20 from other manufactured products owing to surging prices of 15 15 metals. 10 10 In 2006–2007 labour costs in the business sector will be rising somewhat faster, and the exchange rate of the krona will 5 80 82 84 86 88 90 92 94 96 98 00 02 04 06 5 strengthen. The increases in unit costs, however, will be offset Service industries Wholesale and retail trade by somewhat faster-rising productivity and a considerably Business services weaker tendency in prices of imported inputs. Sources: Statistics Sweden and NIER. 98 Wages, Profits and Prices Diagram 152 Value Added Price and Unit The profit share in manufacturing will increase slightly Labour Cost – Business Sector Annual percentage change despite weakening in the basic industries, where it will be 8 8 lowered because of falling prices of metals. In services, the profit share will be down somewhat. The overall effect will be that the 6 6 profit share in the business sector as a whole will be largely 4 4 unchanged in 2006 and be up slightly in 2007. Calendar- adjusted, it will increase a little more. Thus, in 2007 the profit 2 2 share in the business sector will be on a par with the average for 0 0 the 1990’s (see Diagram 148). In view of the rather low and stable relative unit labour costs -2 -2 and the forecast for the profit share in the business sector as -4 97 99 01 03 05 07 -4 presented above, Sweden’s competitive situation is expected to Value added price remain favourable in the next few years. Unit labour cost Change in profit share (percentage points) Sources: Statistics Sweden and NIER. Wages, Profits and Prices 99 Diagram 153 Inflation Annual percentage change, quarterly values 3.5 3.5 Inflation 3.0 3.0 2.5 2.5 2.0 2.0 Low Inflation in 2005 1.5 1.5 Inflation has been somewhat modest during 2004 and 2005 and 1.0 1.0 it has been on historically low level. The Riksbank reduced the 0.5 0.5 repo rate in late June, decreasing the mortgage interest cost in 0.0 0.0 the CPI, and in July CPI inflation was only 0.3 percent. -0.5 -0.5 The rate of underlying inflation as measured by the 00 02 04 UND1X 42 , which excludes mortgage interest cost and changes CPI UND1X in taxes and subsidies, was 0.7 percent in July. The UND1X is Note: The shaded area represents the Riksbank’s normally used as a guidepost for the Riksbank’s decisions on inflation target of 2 percent, with a tolerance interval of plus/minus 1 percentagae point. monetary policy. UND1X inflation has generally been less than Source: Statistics Sweden. the lower tolerance limit for the inflation target since February 2004 (see Diagram 153). For most of 2005, Sweden’s inflation, Diagram 154 Inflation, HICP in Sweden and according to the HICP, has been the lowest for any country in EU15 Annual percentage change, july 2005 the EU15 as well as the EU25. 43 . Thus, the unusually low rate of 4.0 4.0 Swedish inflation is due not to low international inflation, but to Swedish conditions (see Diagram 155). Imported inflation as measured by the UNDIMPX is 3.0 3.0 normally much lower than domestic inflation according to the UNDINHX (see Diagram 156). One reason is that the UNDIMPX includes a large proportion of goods with prices 2.0 2.0 which are increasing relatively slowly because of strong productivity growth. The UNDINHX, on the other hand, 1.0 1.0 includes a high proportion of services, the price of which normally increases somewhat faster. In the years 1995–2004, the UNDIMPX rose by an annual average just below 0.4 percent, 0.0 0.0 whereas the UNDINHX increased by over 2.2 percent annually. LU EL ES BE UK IT IE AT DE DK PT FR NL FI SE Source: Statistics Sweden. During the same period, however, the UND1X averaged 0.4 percentage point less than the Riksbank’s inflation target. According to the NIER’s calculations UND1X inflation of Diagram 155 Inflation, HICP 2 percent would mean imported inflation of about 0.6 percent Annual percentage change, quarterly values and domestic inflation of some 2.7 percent. These long-term 3.5 3.5 levels can therefore be used as reference values in analyses and 3.0 3.0 forecasts of the UNDIMPX and UNDINHX. 2.5 2.5 2.0 2.0 1.5 1.5 1.0 1.0 0.5 0.5 0.0 0.0 00 02 04 Sweden Euro zone 42See Figure 3 above for different measures of inflation. Source: Statistics Sweden. 43The EU15 consists of the EU’s member countries before the latest expansion in May 2004, while the EU 25 consists of the EU’s current members. 100 Wages, Profits and Prices Diagram 156 Underlying Inflation Figure 2 Measures of Inflation Annual percentage change, quarterly values 5 5 4 4 3 3 CPI (100.0) 2 2 1 1 0 0 Changes in UND1X Mortgage Interest Cost -1 -1 indirect taxes and (94.4) (5.6) subsidies -2 -2 -3 -3 00 02 04 UNDINHX UNDINHX UNDIMPX UNDIMPX UND1X (63.8) (30.6) UND1X excl. Sources: Statistics Sweden and NIER. energy (84.9) Diagram 157 Underlying Inflation excl. energy Electricity Domestically Import-intensive Fuel and Annual percentage change, quarterly values (4.8) produced goods goods and heating oil and services excl. services excl. oil (4.8) 5 5 electricity products (59,.) (25.8) 4 4 3 3 Note: Figures in parentheses indicate the weighting percentage for the item in the CPI. Changes in indirect taxes and subsidies have no explicit weight. 2 2 1 1 Source: Statistics Sweden 0 0 -1 -1 -2 -2 -3 -3 00 02 04 UNDINHX excl. energy UNDIMPX excl. energy UND1X excl. energy Costs of heating oil and fuel have soared in 2004 and 2005. If Sources: Statistics Sweden and NIER. energy prices are excluded from the various measures of underlying inflation, the weak inflation rate becomes even more apparent (see Diagram 157). Diagram 158 Inflation and One Year Inflation Inflation expectations one year ahead, as measured in Expectations Percent, quarterly values surveys, have receded during 2004 and 2005. This indicates that 3 3 inflation will continue to be low, though at a higher level than at present (see Diagram 158). 2 2 1 1 Inflation Higher in Two Years 0 0 Inflation according to the UND1X will remain low in 2005, but -1 -1 gradually rise during the forecast period because of increasing cost pressure as the labour market gradually tightens. The -2 -2 inflation rate according to the UND1X will rise by an average of 98 00 02 04 06 CPI 1.2 percent in 2006 and 1.4 percent in 2007. Since the repo rate Households Business Tendency Survey will be raised step-by-step beginning in the second half of 2006; the CPI will be rising faster than the UND1X (see Diagram Note: Expectations are shown in the diagram with one year’s lead. 159). CPI inflation will average 1.0 percent in 2006 and 2.0 Sources: Statistics Sweden and NIER. Wages, Profits and Prices 101 percent in 2007. The rate of inflation as measured by the Diagram 159 Inflation Annual percentage change, quarterly values UND1X excluding energy will reach 2.0 percent toward the end 3.5 3.5 of 2007 (see Diagram 160). 3.0 3.0 2.5 2.5 The strong upturn in the inflation rate during the spring of 2006 is explainable principally by relatively substantial price decreases 2.0 2.0 the year before, i.e. 2005, in several components of the inflation 1.5 1.5 indices. Since the inflation rate is calculated as the change in 1.0 1.0 prices over the latest 12 months, these price reductions will keep 0.5 0.5 inflation down in the next 12 months, but thereafter that effect 0.0 0.0 will disappear. There will then be a relatively large increase in the -0.5 -0.5 inflation rate. 00 02 04 06 CPI UND1X Table 31 Consumer Prices Sources: Statistics Sweden and NIER. Annual percentage change Weight in Dec. CPI 2005 2006 2007 2007 Diagram 160 Underlying Inflation CPI 100.0 0.4 1.0 2.0 2.3 Annual percentage change, quarterly values Cost of interest 5.6 –0.5 –0.2 0.8 1.0 3.5 3.5 (contribution to CPI) 3.0 3.0 UND1X 94.4 0.7 1.2 1.4 1.6 UNDINHX 63.8 1.0 1.9 2.3 2.5 2.5 2.5 UNDIMPX 30.6 0.0 –0.3 -0.5 -0.4 2.0 2.0 HICP 0.8 1.3 1.4 1.6 1.5 1.5 Sources: Statistics Sweden and NIER. 1.0 1.0 0.5 0.5 0.0 0.0 Domestic Inflation to Increase in 2006 and 2007 -0.5 -0.5 00 02 04 06 Resource utilization will be rising during the forecast period, and UND1X UND1X excl. energy the output gap will be successively closing, though not Sources: Statistics Sweden and NIER. completely. With unit labour costs gradually accelerating, domestic inflation will be rising in 2006 and 2007 (see Diagram 161). This tendency will be due to a combination of slackening productivity growth and a rising rate of wage increases during Diagram 161 Domestic Inflation and Cost 2006–2007. Pressure The upward tendency in inflation will be reinforced by rising Annual percentage change, quarterly and calendar- adjusted yearly values, respectively costs of housing, which will be affected by increases, for 7 7 example, in prices of electricity, real-estate taxes and rents. 6 6 Overall, the rate of domestic inflation according to the UNDINHX will climb from 1.0 percent this year to 2.3 percent 5 5 in 2006. At this level it will be 0.4 percentage point below its 4 4 trend value. 3 3 2 2 1 1 0 0 -1 -1 98 00 02 04 06 UNDINHX Unit labour costs in service sectors Sources: Statistics Sweden and NIER. 102 Wages, Profits and Prices Diagram 162 UNDINHX Table 32 Domestic Inflation (UNDINHX) Annual percentage change, quarterly values 5 5 Annual percentage change and percent Weight in CPI 2004 2005 2006 2007 4 4 Indicators 1 3 3 GDP 3.0 2.4 3.2 3.0 2 Output gap -0.5 –0.6 –0.2 –0.1 3 2 2 Unit labour costs –1.7 -0.1 0.7 1.2 Consumer prices 1 1 UNDINHX 63.8 1.6 1.0 1.9 2.3 of which contribution from: 0 0 00 02 04 06 Electricity and gas 4.8 0.0 –0.2 0.0 0.0 UNDINHX Housing excl electricity, gas UNDINHX excl. energy and costs of interest 18.5 0.8 0.7 0.8 0.9 Sources: Statistics Sweden and NIER. Rents 14.1 0.7 0.5 0.6 0.6 UNDINHX excl. housing 40.5 1.0 0.5 1.1 1.3 1 Adjusted for difference between years in number of working days. 2 Percent of potential output. 3 Business sector. Adjusted for difference between years in number of working Diagram 163 Imported Inflation and Prices of days. Imports Sources: Statistics Sweden och NIER. Annual percentage change, quarterly values 8 8 6 6 Imported Inflation to Remain Low 4 4 Imported inflation will remain low during the forecast period. 2 2 The weakening of the exchange rate in 2005 will provide a positive contribution to prices of imported goods except 0 0 petroleum products. But the full impact of the depreciation will -2 -2 not be felt, partly because the exchange rate will strengthen again in the next few years. The price tendency, as measured by the -4 00 02 04 06 -4 UNDIMPX excl. petroleum products, will be increasing in 2007 Imported inflation excl. fuel and heating oil by an average of 0.3 percent (see Diagram 163). Manufactured goods, producer prices So far in 2005, prices of heating oil and fuel to consumers are Sources: Statistics Sweden and NIER. up by more than 14 percent. This relatively strong increase has contributed to an inflation rate, as measured by the UNDIMPX, considerably higher than the UNDIMPX without petroleum Diagram 164 Imported Inflation excl. Fuel and products (see Diagram 164). The price of crude oil is expected Heating Oil Annual percentage change, quarterly values to recede during the forecast period to 47 dollars a barrel, thus 3 3 limiting inflation in 2006 and 2007. Imported inflation according to the UNDIMPX will average –0.5 percent in 2007, nearly 2 2 1.0 percentage point higher than its long-term reference value. 1 1 0 0 -1 -1 -2 -2 -3 -3 00 02 04 06 UNDIMPX UNDIMPX excl. fuel and heating oil Sources: Statistics Sweden and NIER. Wages, Profits and Prices 103 Table 33 Imported Inflation (UNDIMPX) Annual percentage change and percent Weight in CPI 2004 2005 2006 2007 Indicators Exchange rate (KIX) –2.1 1.7 0.9 –0.8 Producer prices of imports –0.7 1.2 1.1 0.1 Consumer prices UNDIMPX 30.6 –0.7 0.0 –0.3 -0.5 of which contribution from petroleum products 4.8 0.7 1.6 0.1 –0.7 UNDIMPX excl. petroleum products 25.8 –1.3 –1.6 -0.3 0.3 Sources: Statistics Sweden and NIER 105 Public Finances Diagram 165 Net Lending – General Government Sector Percent of GDP, current prices In 2005, general government net lending is forecast to be 0.8 10 10 percent of GDP. Under current rules 44 net lending will drop to 0.6 percent in 2006, rising again to 0.9 percent of GDP in 2007 5 5 (see Table 34, Diagram 165 and Diagram 167). Cyclically adjusted net lending will be 1.1 percent this year and 0.8 and 1.1 0 0 percent, respectively, in 2006 and 2007. Average annual net lending for the years 2000–2004 was 1.6, -5 -5 whereas the average for the years 2005–2007 will be 0.8 percent. In combination with the low level of cyclically adjusted net lending, this may be interpreted to mean that net lending will not -10 -10 reach Parliament’s target of 2-percent net lending on average over a business cycle. -15 80 82 84 86 88 90 92 94 96 98 00 02 04 06 -15 The NIER recommends that fiscal policy focus on achieving Sources: Statistics Sweden and NIER. the 2-percent target. However, the timing of the necessary budget-strengthening measures should be chosen with due regard for the cyclical development of the economy. Diagram 166 Fiscal Policy Alignment Appropriate timing in the NIER’s opinion would entail Percent of GDP, current prices accepting a somewhat more contractionary fiscal policy in 2006 2 2 and 2007, with additional measures to strengthen the budget by Tightening fiscal policy SEK 5 billion in 2006 and a further 10 billion in 2007, in order 1 1 to come closer to the 2-percent target. Fiscal policy would then be contractionary to the extent of 0.7 percent in 2007 (see 0 0 Diagram 166), then cyclically adjusted net lending would be 1.6 -1 -1 percent instead of the 1.1 percent currently forecast. A tighter fiscal policy of this nature should be countered as much as -2 -2 possible by a more expansionary monetary policy. In this Expansionary fiscal policy recommendation, it is assumed that the economy develops in -3 -3 00 02 04 06 accordance with the current forecast. Policy-dependent change in net lending Policy-dependent change, NIER:s recommendation Source: NIER. Table 34 Finances of the General Government Sector Billions of SEK and percent of GDP, current prices 2003 2004 2005 2006 2007 1 Revenue 1 360 1 414 1 452 1 506 1 578 Diagram 167 Revenue and Expenditure – Percent of GDP 55.8 55.6 55.3 55.0 54.9 General Government Sector of which taxes 1 238 1 287 1 319 1 374 1 439 Percent of GDP, current prices Percent of GDP 50.8 50.6 50.3 50.1 50.0 75 75 Expenditure 1 362 1 388 1 430 1 490 1 554 70 70 Percent of GDP 55.9 54.5 54.5 54.4 54.0 Net lending –2 26 22 16 25 65 65 Percent of GDP –0.1 1.0 0.8 0.6 0.9 60 60 1Including tax to EU. Sources: Statistics Sweden and NIER. 55 55 50 50 44 The calculations are based on the rules currently in effect for the respective 45 45 80 82 84 86 88 90 92 94 96 98 00 02 04 06 years. There is an exception for central government subsidies to local Revenue governments in 2007, on which no decision has yet been made. In the Taxes and duties meantime, it is assumed that these subsidies will increase in line with their Expenditure historical trend. For 2007 it is assumed that the additional subsidy will be SEK Sources: Statistics Sweden and NIER. 5 billion. Thus, the forecast does not take account of the changes in rules being considered in the preparation of the budget bill for 2006. 106 Public Finances Targets and Stance of Economic Policy The following section describes the development of public finances in relation to fiscal- and budget-policy targets for general government net lending, the expenditure ceiling and the balanced-budget requirement for local governments. Also included is an overall assessment of fiscal and monetary policy. The Targeted Surplus – Over a Business Cycle and for Individual Years The Swedish Parliament has set a target for general government net lending of 2 percent of GDP on average over a business cycle. One of the reasons given for adopting this overall target for general government finances is the need to strengthen public finances in preparation for the strain resulting from future demographic developments. In addition to this overall target, Parliament sets targets for individual years based on the overall target and the current state of the economy. General Government Net Lending Far Below the Target of 2 Percent Net lending averaged 1.6 percent in 2000–2004, years for which actual data are available, whereas the average for the years 2000– 2007 is estimated at 1.3 percent. The NIER also calculates cyclically adjusted net lending, or the net lending that would result with normal resource utilization and a normal composition of GDP. Cyclically adjusted net lending is calculated by adjusting actual net lending for the effects of low or high resource utilization and for effects due to the composition of GDP. Diagram 168 Actual and Cyclically Adjusted Table 35 Cyclically Adjusted Net Lending Net Lending Percent of GDP and percent of potential GDP, Percent of GDP, current prices current prices, respectively 2002 2003 2004 2005 2006 2007 10 10 Net lending –0.5 –0.1 1.0 0.8 0.6 0.9 Cyclically adjusted net lending 0.0 0.5 1.3 1.1 0.8 1.1 5 5 Output gap –0.5 –0.9 –0.5 –0.6 –0.2 –0.1 2 2 Sources: Statistics Sweden and NIER. 0 0 -5 -5 Cyclically adjusted net lending was 1.3 percent in 2004 but will deteriorate to 1.1 percent in 2007 (see Table 35 and Diagram -10 -10 168). Cyclically adjusted net lending will then be short of the 2- percent target by 0.9 percentage point, equivalent to about SEK -15 -15 91 93 95 97 99 01 03 05 07 25 billion. The calculation of both cyclically adjusted net lending Actual net lending Cyclically adjusted net lending and the indicator of fiscal policy excludes the temporary tax Sources: Statistics Sweden and NIER. revenues arising in 2004 and 2005 from charging interest on the Public Finances 107 periodization funds of firms. Cyclically adjusted net lending will Diagram 169 Difference Between Actual and be higher than actual net lending throughout the forecast period, Cyclically Adjusted Net Lending Percent of GDP, current prices primarily because of persistently low resource utilization (see 0.6 0.6 Diagram 169). 0.4 0.4 The cumulative cyclically adjusted net lending for the period 2000–2007 will be almost SEK 140 billion less than the 0.2 0.2 2-percent target (see Diagram 170). 0.0 0.0 -0.2 -0.2 -0.4 -0.4 Net Lending in Line With Target for 2005 -0.6 -0.6 The target for general government net lending has been set for -0.8 -0.8 2005 at 0.5 percent of GDP. According to the current forecast, 00 02 04 06 net lending will be 0.8 percent, or 0.3 percentage point above Composition effect Resource utilization this target. Source: NIER. By parliamentary decision, however, the state of the economy is to be considered in evaluating goal-achievement. If the economy develops differently than foreseen when the target for Diagram 170 Cyclically Adjusted Lending and the surplus was set, net lending may justifiably deviate from the Cumulative Targeted Surplus, 2000–2007 target. An unexpectedly strong (weak) economic tendency would Billions of SEK be an acceptable reason for an outcome that exceeded (fell short 500 500 of) 0.5 percent to a corresponding degree. The proposed target for the surplus in 2005 was presented by 400 400 the Government in that year’s budget bill, which was submitted 300 300 to Parliament in September of last year. The NIER’s forecast for the output gap for 2005 is currently the same as a year ago. 200 200 Consequently, there is no need for revision of the surplus target based on a change in the economic outlook. In view of the 100 100 uncertainty in the forecasts of net lending as well as the output gap, the assessment is that the net lending target for 2005 will be 0 0 00 02 04 06 achieved. Even excluding the temporary revenue from charging 2 percent of potential GDP, cumulative interest on the periodization funds of firms, net lending will Cyclically adjusted lending, cumulative exceed 0.5 percent this year. Source: NIER. Stance of Fiscal Policy Diagram 171 Fiscal Policy Alignment Percent of GDP, current prices The stance of fiscal policy is measured by the so-called policy- 2 2 dependent change in general government net lending (see Table 1 1 36 and Diagram 171). In 2004 fiscal policy was contractionary as a result of central 0 0 government cutbacks to avoid exceeding the expenditure ceiling. For example, expenditure for national defence was lowered -1 -1 substantially. In addition, local governments squeezed their costs in 2004 for the purpose of achieving a balanced result. -2 -2 -3 -3 00 02 04 06 Policy-dependent change in net lending Output gap Source: NIER. 108 Public Finances Table 36 Stance of Fiscal Policy Percent of GDP, current prices 2002 2003 2004 2005 2006 2007 Net lending, level –0.5 –0.1 1.0 0.8 0.6 0.9 Change, percentage points –3.1 0.4 1.1 –0.2 –0.3 0.3 of which policy-dependent change –2.0 0.0 0.8 0.3 –0.3 0.4 Source: NIER. Under current provisions, fiscal policy by this indicator will be slightly contractionary this year, expansionary next year and contractionary again in 2007. Thus, despite expansionary features this year like reductions in income taxes and the abolition of the inheritance and gift tax, the contractionary measures predominate. Examples include the downward adjustment of 0.6 percent in appropriations to central government authorities and higher net lending in the local government sector. To some degree, the lower expenditure on Diagram 172 Fiscal and Monetary Policy sickness benefits will also be contractionary. 3 3 Policy-dep. change of general governm. net lending Expansionary monetary policy, Tightening monetary policy, tightening fiscal policy tightening fiscal policy 2 2 Overall Economic Policy 1 2004 1 2005 2007 Monetary policy has now been expansionary for several years 0 2003 0 (see Diagram 172). As discussed in the ”Financial Markets” 2006 2001 section, the NIER recommends that the repo rate is raised -1 -1 beginning in 2006 so that it will reach 3.50 percent by the end of -2 2002 -2 2007. The present forecast is based on this development of the Expansionary monetary policy, expansionary fiscal policy Tightening monetary policy, expansionary fiscal policy repo rate, as well as the current provisions of fiscal policy. -3 -3 The NIER recommends that fiscal policy focus on achieving -3 -2 -1 0 1 2 3 Difference between the repo rate and the equilibrium interest rate the 2-percent target. Changed provisions that cause net lending Note: The equilibrium repo rate is assumed here to deviate from the target are recommended only if the economy to be 4.5 percent. Source: NIER. begins to show substantial cyclical imbalance. If the targets are not achieved under current rules, the timing of the measures needed to correct the budget should be chosen in view of the state of the economy. If the measures to bolster the budget were strong enough to increase cyclically adjusted net lending to 2.0 percent by 2006 – equivalent to 1.2 percent of GDP, or SEK 32 billion – there would be a risk of substantially prolonging the cyclical weakness of the labour market. This would be true even if a more contractionary fiscal policy of this nature were offset by a more expansionary monetary policy. A well-balanced approach, in the NIER’s opinion, would be to adopt a somewhat tighter fiscal policy in 2006 and 2007, with additional measures that would strengthen the budget by SEK 5 billion in 2006 and a further 10 billion in 2007, thus bringing net lending closer to the target of 2 percent. Fiscal policy would then be contractionary by 0.7 percent in 2007, and cyclically adjusted net lending would be 1.6 percent instead of 1.1 percent as in the current forecast. A somewhat tighter fiscal policy of this kind should be balanced as much as possible by a more expansionary Public Finances 109 monetary policy. In this recommendation, it is assumed that the Diagram 173 Central Government Budgeting economy develops in accordance with the current forecast. Margin Billions of SEK, current prices 25 25 Central Government Expenditure to Remain Below 20 20 the Ceiling In the absence of new measures, central government 15 15 expenditure will be below the expenditure ceiling in 2005 and 2006, but in relation to the prevailing uncertainty, the margins 10 10 are slim (see Table 37 and Diagram 173). Expenditure subject to the ceiling will stay below it partly 5 5 because declining sickness absence is curbing expenditure on sickness benefits. The expenditure tendency will also be 0 0 dampened by cutbacks of 0.6 percent in appropriations to all 97 99 01 03 05 07 central government authorities. Expenditure for unemployment, Sources: National Financial Management Authority and NIER. however, will still be high, and the number of persons receiving sickness or activity compensation (formerly termed ”disability pensions”) is rising. Certain forms of support, including employment subsidies to local governments and for chronically unemployed persons, have been designed so that in the central government budget they will be categorized as tax reductions instead of expenditure subject to the ceiling. In the National Accounts, such subsidies are reported as expenditure for transfers to local governments and firms, respectively. These tax reductions will be more than SEK 16 billion this year and SEK 13 billion in 2006. If this kind of support had been designed as expenditure subject to the ceiling, the ceiling would be exceeded both in 2005 and in 2006. Table 37 Ceiling on Central Government Expenditure Billions of SEK, current prices 2003 2004 2005 2006 2007 Total expenditure subject to ceiling 819 856 866 897 935 Ceiling on central-government 822 858 870 907 943 expenditure Budgeting Margin 3 2 4 10 8 Sources: National Financial Management Authority and NIER In the budget bill for 2005, the expenditure ceiling proposed for 2007 was expressed in the form of a rule for calculation: the ceiling would be equivalent to the same share of potential GDP that was used in setting the 2006 ceiling. By this method of calculation, the expenditure ceiling for 2007 would be SEK 943 billion. Under current provisions and in the central government subsidy of SEK 5 billion to the local government sector assumed in the forecast, the ceiling would still be observed despite the fact that previous tax reductions have been replaced by a general central government subsidy to the local government sector. 110 Public Finances Diagram 174 Net Income Excluding The Balanced Budget Requirement for the Local Nonrecurring Revenues and Costs – Local Government Sector Government Billions of SEK, current prices 8 8 The Local Government Act prohibits municipalities and county council districts from budgeting a deficit for coming years. Any 6 6 deficit that nevertheless occurs must be offset by an equivalent 4 4 budgeted surplus within three years. Through expenditure 2 2 cutbacks and tax increases, municipalities in the aggregate met 0 0 the balanced-budget requirement in 2004 (see Diagram 174). -2 -2 The result for county council districts also improved and was -4 -4 very nearly balanced. Financial conditions for the local government sector will -6 -6 improve in 2005–2007. Tax revenue will be growing faster than -8 -8 00 02 04 06 in 2004, while the subsidies enacted and the assumed Municipalities County-council districts supplement of SEK 5 billion in 2007 will lead to relatively Sources: Statistics Sweden and NIER. favourable development of local government finances. Local government tax rates are forecast to remain the same in 2006 and 2007 as in 2005. Issues Relating to Taxes and Benefits This section is devoted to structural factors of central importance like the functioning of the system of benefits, and also to current tax issues. Financial Incentives to Work To follow how the financial incentives to work develop over time, and would be affected by the changed provisions under consideration, the NIER publishes current indicators of the financial incentive to work in terms of the so-called net compensation rate for an additional input of work. The net compensation rate is defined as the share of the increase in labour costs received by a person who provides an additional input of work, after the resulting increase in taxes and contributions and the decrease in benefits. 45 One advantage of this method is that the effects of employer contributions and indirect taxes are also considered. 46 The calculations are performed with the aid of Statistics Sweden’s Fasit model, using data on household income in 2003. The net compensation rate is affected not only by the development of the economy, but also by changes in the provisions of the systems of taxation and benefits in 1997–2006. 45 The mirror image of the net compensation rate is the marginal effect, which is thus defined as 100 percent minus the net compensation rate. 46 The NIER’s method of calculating the net compensation rate was explained in the box captioned ”NIER Spotlights Incentives to Work,” in The Swedish Economy, August 2004. Public Finances 111 The mean net compensation rate for all working Swedes will be Diagram 175 Net Compensation Rate for 40.4 percent this year (see Table 38 and Diagram 175). Additional Labour Input Percent 42 42 Table 38 Net Compensation Rate 2003–2007 41 41 Percent 40 40 2003 2004 2005 2006 2007 Compensation rate excl. employer 59.6 59.1 59.0 58.9 58.8 39 39 contributions and indirect taxes Net compensation rate 41.2 40.6 40.4 40.4 40.2 38 38 Source: NIER. 37 37 At the end of the 1990’s, the net compensation rate decreased, 36 36 partly because of higher employer contributions. Thereafter, the 35 35 97 99 01 03 05 07 net compensation rate increased until 2003, primarily as a result Source: NIER. of the three steps taken to provide compensation for the individual social security contribution. The increases in local government taxes and changes in taxation provided in the budget bill for 2005 lowered the net compensation rate in 2004 Diagram 176 Distribution of Income and Net Compensation Rate and 2005. The net compensation rate will decrease somewhat in Percent the next few years, chiefly because more people will be paying 41,5 central government income taxes. For individuals with higher 2002 41,0 earned income, the net compensation rate is lower since their 40,5 Higher compensation for work marginal tax rate is higher. 2004 40,0 The changes in distribution of income and in the net 39,5 2007 compensation rate in recent years are shown in Diagram 176. 2000 1998 39,0 The distribution of income is measured by the so-called Gini 38,5 coefficient, which is a generally accepted measure of the degree to 38,0 which the distribution of income is uneven. 47 The distribution of 37,5 income was most uneven in 2000, since capital gains, which are 37,0 often realized by persons with high incomes, were temporarily 0,29 0,28 0,27 0,26 0,25 0,24 0,23 More even distribution of income very large that year. After 2000, the distribution of income has become more even, and the net compensation rate for working Source: NIER. has increased slightly. Current Tax Issues In the spring budget bill for 2005, the Government raised the question whether the entire tax system should be reviewed. In a number of areas, exceptions have been made to the principles of the 1991 tax reform. Preparations are in progress for beginning such a review in 2006. 47 The coefficient varies between 0 and 1, with 0 indicating a totally even distribution of income and 1 a maximally uneven distribution. 112 Public Finances Principles of the 1991 Tax Reform Nearly fifteen years have passed since the 1991 tax reform, and during this time more than 250 changes have been made in its provisions. Many of these changes have deviated from the principles of the reform. One example is greater differentiation of the Value Added Tax (VAT). The primary aim of the tax reform was to lessen the distortions generated by the tax system without diminishing its overall equalizing effect. The view prevailing at the time was that the previous system of high marginal tax rates and asymmetrical taxation of capital tended to inhibit productive activity and led to misallocation of the resources of the economy. With the income tax reform, the tax base was broadened through fewer deductions and exemptions from taxation, a smaller number of different tax rates and a maximum marginal tax rate of 50 percent with a local government taxrate of 30 percent. The corporate income taxrate was lowered from 57 to 30 percent, its tax base was also broadened by limiting the number of possible tax deductions and by establishing greater tax neutrality among different forms of investment. The VAT was extended to more areas and was set at a uniform rate of 23.46 percent. The present tax system is based on several fundamental tax principles, including horizontal fairness and tax neutrality. Horizontal fairness means, among other things, similar tax treatment in similar situations. For example, persons with the same actual earned income are to pay the same tax, regardless of the form of compensation received (cash wages or other types of wage benefits). Similarly, incomes from capital are subject to the same taxation regardless of the manner in which they arise. The principle of tax neutrality means that taxation is to be so designed that it is neutral in regard to alternative courses of action, such as equal treatment of different ways to arrange purchases, production and distribution, as well as different forms of investment and financing. In the nearly 15 years that have passed since the tax reform, there have been changes, both in society at large and in tax policy. For example, Sweden has joined the EU, and globalization is now much more pervasive than 15 years ago. The challenge for the future lies primarily in the adjustment to demographic changes, where there is a risk of stagnation in labour supply that could undermine the financial foundation of the welfare system. A more uniform level of taxation, according to the principles of the tax reform, could be achieved with the proposal of the VAT Commission in its interim report, ”Enhetlig eller differentierad mervärdesskatt?” (Uniform or Differentiated VAT, (SOU 2005:57). The aim of the VAT Commission’s study is to limit the problems of drawing boundaries in the application Public Finances 113 of today’s differentiated tax rates. The study proposes that the present differentiation of VAT with three tax rates (6, 12 and 25 percent) be abolished in favour of a single tax rate of 21.7 percent. The change would have a neutral impact on central government finances and would not affect the average standard of living for households. 114 Public Finances More Jobs Through Cheaper compensation (formerly termed “disability pension”) would find work to a greater extent. Household Services The NIER has analyzed the general economic To quantify these effects, calculations are provided effects of tax relief for household services 48 , 49 The for three different cases: a main case, an alternative analysis concerns the long-term impact of tax relief, case of less beneficial effects and another alternative not the possible short-term cyclical consequences. case of greater beneficial effects. By the calculations in The changes in applicable rules are designed so that these three examples, white-market employment general government finances will not be affected in would increase in the long run by 2 945–18 823 the long run. A tax reduction for household persons as a consequence of a tax reduction for services would be financed through reducing household services. This is equivalent to 0.07-0.45 expenditure on transfers and through changing percent of employment. taxes on other goods and services sufficiently for The calculations are based in part on the Finnish the effect on general government finances to be evaluation of a tax reduction for household services zero. The reform thus entails a redistribution of in Finland. However, the results rest on a number taxes. of uncertain assumptions and should therefore be The results show that a tax reduction of 50 regarded only as examples of possible effects, not as percent of the labour cost of household services an estimate of the most probable effects. could lead to somewhat higher employment on the “white,” or legitimate, market in the long run. Effects on General Government Finances With the requirement of a zero overall effect on Effects on Employment general government finances, the changes in taxes In the short run, lower taxes on household services on other goods and services differ in the three may have cyclical effects on employment, but these cases. In the main case, taxes on other goods and are less relevant for evaluating permanent changes services are unchanged. Thus, the tax reduction for in applicable rules. In the long run, employment household services need not be financed by higher would increase on the white market for three taxes on other goods and services. This outcome of reasons: the tax relief results from the combination of the additional tax revenue from household services and the decrease in expenditure on transfers. When • Black-market work would be replaced to some individuals who are unemployed, studying or extent by white-market work. receiving sickness or activity compensation (or • Households that purchase more household working on the black market while receiving services would increase their contribution to the transfers at the same time) switch to white-market labour supply, leading to correspondingly higher employment, the result is not only higher tax employment in the long run. revenue, but also lower expenditure on transfers like • There would be better matching between labour unemployment compensation, income support, supply and demand for labour Thus, persons student allowances, sickness or activity who otherwise would have been unemployed, compensation (formerly termed “disability students or recipients of sickness or activity pension”) and AMU allowances 50 . In the main case, the reduction of SEK 1 017 million in tax revenue from other goods and services, due to diminished 48 The services concerned relate to household tasks and child consumption of these goods and services, is exactly care at home (for example, cooking, cleaning, laundry and baby- offset by an increase of SEK 604 million in tax sitting) as well as gardening. 49 The report ”Samhällsekonomiska effekter av skattelättnader för hushållsnära tjänster” (General Economic Effects of Tax Relief for Household Services) was published (in Swedish only) on June 28 as a NIER Special Study. The study may be read 50 AMU allowances are the benefits received by participants in and downloaded on the NIER’s home page: www.konj.se. labour market programmes. Public Finances 115 revenue from household services and by a decrease of SEK 413 million in transfers (see Table 39). In the alternative case of less beneficial effects, a tax increase of 0.1 percentage point (equivalent to SEK 2 037 million) on other goods and services would be required, whereas in the alternative case of greater beneficial effects there would be a decrease of 0.1 percentage point (equivalent to SEK 1 758 million) in taxes when the tax reduction is implemented. 51 Table 39 Effects on General Government Finances Millions of SEK Effects Main Less Greater case beneficial beneficial effects effects Changes in: Tax revenue –413 –79 –815 Other goods and services –1 017 –646 –1 460 Household services 604 567 645 Expenditure on transfers –413 –79 –815 Source: NIER. Generally it is difficult to determine specifically how tax changes affect general economic welfare. Tax relief for household services would increase welfare if the gain in the form of additional legitimate market labour or less black-market labour were sufficient to offset the distortion between household services and other goods and services. Tax relief for household services would also mean higher costs for the public authorities and firms that administer and control the system. However, the results of the calculations in this study suggest that welfare is enhanced. In two of the three cases studied (the main case and the case of greater beneficial effects), the budget of each individual would be strengthened since there would be no need to finance the tax reduction for household services by higher taxes on other goods and services. In the alternative case of less beneficial effects, the welfare effect would be harder to determine since taxes on other goods and services would then have to be raised. 51 The marginal tax rate (i. e. the percentage of gross compensation taken by VAT and employer contributions) thereby changes from 59.80 percent to 59.92 and 59.67 percent, respectively. 116 Public Finances Diagram 177 Social Benefits, Ages 20–64 Less Need for Social Welfare Benefits in 2006 and Thousands, full-year equivalents 2007 1200 1200 Since the mid-1990’s, the number of persons supported by social 1000 1000 welfare benefits has exceeded 1 million (see Diagram 177), 800 800 equivalent to one person out of five in age group 20–64. The 600 600 previous increase will level off this year and be followed by some decrease in 2006 and 2007. 400 400 Total benefits related to ill health, i.e. sickness benefits, 200 200 rehabilitation days, and sickness and activity compensation, were sharply rising until 2002, but have subsequently decreased 0 90 92 94 96 98 00 02 04 06 0 somewhat and will continue to do so in the period ahead (see Social benefits, total Ill health benefits Table 40 and Diagram 178). The number of sickness-benefit Labour-market benefits and welfare payments days will continue decreasing rather rapidly in 2005-2007 despite Sources: Statistics Sweden and NIER. reduction in the duration of employer responsibility for sick-pay effective January 1, 2005. This may be due to improved efficiency in the sick-listing process and the obligation of employers to pay 15 percent of the cost of sickness benefits in Diagram 178 Social Benefits in Different cases of full-time sick-listing. Systems, Ages 20–64 Thousands, full-year equivalents In the overhauled the sick-listing process, the social 500 500 insurance office must decide on the form of compensation within one year of the first sick-listing day. This means that 400 400 many chronically sick-listed persons will begin to receive 300 300 sickness and activity compensation, which will thus increase and by 2007 account for almost half of total social welfare benefits 200 200 (see Diagram 178). 100 100 0 0 Table 40 Persons Supported by Social Welfare Benefits 90 92 94 96 98 00 02 04 06 Number of full-year equivalents,1 persons aged 20–64, thousands Sickness and rehabilitation benefits Disability pensions 2002 2003 2004 2005 2006 2007 Unemployment compensation Labour-market programmes Ill health 677 668 663 659 653 649 Income support payments of which: Sickness benefits 270 260 228 201 180 170 Sources: Statistics Sweden and NIER. and rehabilitation allowances Sickness and activity 407 408 435 459 473 479 compensation Labour-market benefits 273 280 320 329 316 293 of which: Unemployment 160 191 217 211 198 189 compensation Labour-market 113 89 103 118 118 104 programmes Income support 86 85 87 85 84 83 Total 1 036 1 033 1 070 1 073 1 053 1 026 Change from preceding year 32 –3 36 4 –20 –28 Percentage change 3.2 –0.3 3.5 0.4 –1.9 –2.6 1A full-year equivalent refers to one person who is supported with full benefits for one year. In other words, two persons who have been unemployed for a half-year each together constitute one full-year equivalent. A full-year equivalent is thus a statistical construction, and the number of full-year equivalents is calculated to permit measuring the unutilized labour force in a way that is comparable over time. Sources: Statistics Sweden and NIER. Public Finances 117 As the labour market gradually improves, expenditure on Diagram 179 Tax Ratio Percent of GDP, current prices unemployment compensation will go down. However, the 54 54 number of participants in labour market programmes will be high in 2005 and 2006 before decreasing somewhat in 2007. 53 53 Another consequence of an improving labour market will be a decrease in the number of persons receiving income support. 52 52 But the Government’s target of reducing the number of income support recipients by half between 1999 and 2004, or by 57 600 51 51 persons, will not be achieved during the forecast period. 50 50 49 49 Revenue and Expenditure of the General Government Sector 48 93 95 97 99 01 03 05 07 48 Sources: Statistics Sweden and NIER. Tax Ratio to Decrease This Year The tax ratio, i.e. taxes and social security contributions in Diagram 180 Principal Tax Bases Percent of GDP, current prices proportion to GDP, is down substantially from its peak in 2000, 62 62 and this trend will continue (see Diagram 179 and Table 41table 41). The decrease this year will be due primarily to changed 60 60 provisions like the reductions in income and net-wealth taxes, 58 58 abolition of the inheritance and gift tax and lower employer 56 56 contributions. With the local government tax rate forecast to 54 54 remain at 31.60 percent, the decrease in the period ahead will 52 52 depend solely on the development of the tax bases. 52 Two of the 50 50 principal tax bases – household income (earnings and transfer payments) and consumption expenditure – will decrease in 48 48 proportion to GDP in both 2006 and 2007 (see Diagram 180). 46 93 95 97 99 01 03 05 07 46 Total earnings and transfer payments Household consumption expenditure Sources: Statistics Sweden and NIER. 52 In the calculations it is assumed that there will be no changes in tax provisions. 118 Public Finances Table 41 Taxes and Contributions Percent of GDP, current prices 2003 2004 2005 2006 2007 Tax ratio 50,8 50,6 50,3 50,1 50,0 of which: 19.5 19.4 19.1 19.2 19.2 Household taxes and 1 contributions 1 Direct business taxes 2.4 2.7 2.9 2.8 2.8 Employer contributions 14.4 14.1 13.9 14.0 13.9 Value added tax (VAT) 9.2 9.1 9.2 9.2 9.2 Real estate tax 1.0 1.0 0.9 0.9 1.0 2 Taxes on energy 2.5 2.5 2.5 2.4 2.3 Taxes on alcohol and tobacco 0.8 0.7 0.7 0.7 0.6 Other indirect taxes 1.0 1.0 1.0 1.0 1.0 of which to: Local governments 16.5 16.5 16.5 16.5 16.4 National pension system 5.9 5.8 5.7 5.7 5.7 Central government 28.0 28.0 27.7 27.6 27.6 EU 0.4 0.3 0.3 0.3 0.3 1 Household taxes and direct business taxes in 2004 according to preliminary Diagram 181 Revenue – General Government calculations in the NA (National Accounts). It is expected that these items will Sector be revised later on. Percent of GDP, current prices 2 Only the enacted tax shift of SEK 3.4 billion in 2005 is considered in the 70 70 calculations. 60 60 Sources: Statistics Sweden and NIER. 50 50 40 40 The total revenue of the general government sector will drop 30 30 from 60.1 percent of GDP in 1998 to 54.9 percent of GDP in 2007, of which taxes and contributions will account for 49.7 20 20 percentage points 53 (see Diagram 181). 10 10 0 0 93 95 97 99 01 03 05 07 Direct taxes Indirect taxes Business Taxes Social security contributions Other revenue With profits rising in the business sector, revenue from business Sources: Statistics Sweden and NIER. taxes will remain high in the period ahead, but it will still be lower than in the late 1990’s (see Table 41table 41 and Diagram 182). As from January 1, 2005, interest is charged on profits set Diagram 182 Business Taxes aside by firms (corporations and similar legal entities) in Percent of GDP, current prices periodization funds. The interest charged is expected to provide 4.0 4.0 about SEK 2 billion in annual revenue. Certain firms have changed their use of these funds now that interest is charged on 3.5 3.5 them. The firms that have dissolved their funds are found primarily in the financial sector, where low-cost credit is 3.0 3.0 available to them. This new provision is expected to add SEK 5 billion in business income taxes in 2005. 2.5 2.5 2.0 2.0 1.5 1.5 93 95 97 99 01 03 05 07 Sources: Statistics Sweden and NIER. 53 Tax excluding VAT to the EU and customs duties. Public Finances 119 Real Estate Tax and Stamp Duty Diagram 183 Real Estate Tax and Stamp Duty Percent of GDP, current prices For single-family houses, the average assessed value for tax 1.00 1.00 purposes will increase by 23 percent next year. A tax-moderation rule (dämpningsregeln), however, will mean that only a third of 0.80 0.80 the increase will be reflected in the real estate tax for 2006. 54 The 0.60 0.60 effect has been considered in the forecast, where the real estate tax is expected to account for about 1.0 percentage point of the 0.40 0.40 tax ratio in the period ahead; 0.6 percentage point will be provided by households (private individuals) and 0.4 percentage 0.20 0.20 point by firms (corporations and other legal entities). The real 0.00 0.00 estate tax provided its highest contribution to the tax ratio, 1.4 93 95 97 99 01 03 05 07 percentage points, in 1997. Subsequent changes in provisions Household real estate tax Company real estate tax have resulted in less revenue (see Table 41 and Diagram 183). Stamp duty This year the real estate tax is expected to provide a total Sources: Statistics Sweden and NIER. revenue of SEK 24.7 billion. In addition to the real estate tax, there is the so-called stamp duty, which is imposed when real estate and leaseholds change ownership and when mortgages are officially recorded. The Diagram 184 Expenditure Ratio Percent of GDP, current prices stamp duty will contribute 0.3 percentage point to the tax ratio 75 75 in the period ahead and is expected to provide SEK 7.3 billion in revenue this year (see Diagram 183). 70 70 65 65 Lowest Expenditure Ratio in 30 Years 60 60 As a share of GDP, total general government expenditure will 55 55 be the same in 2005 as in 2004 (see Table 42, Diagram 184 and 50 50 Diagram 185). In 2006 and 2007, the proportion will be less, primarily because of a decrease in transfers to households. In 45 80 82 84 86 88 90 92 94 96 98 00 02 04 06 45 2007, the proportion is forecast to be 54.0; at no time since 1976 General government expenditure General government expenditure excl interest expend. has the expenditure ratio been so low. In the 1970’s, the Sources: Statistics Sweden and NIER. expenditure ratio rose from about 43 percent to 60 percent. Table 42 Expenditure of the General Government Sector Diagram 185 Expenditure – General Government Sector Percent of GDP, current prices Percent of GDP, current prices 2003 2004 2005 2006 2007 80 80 Expenditure 55.9 54.5 54.5 54.4 54.0 General government consumption 28.3 27.7 27.6 27.8 27.7 60 60 General government investment 3.1 3.1 3.1 3.1 3.2 Transfers to households 19.1 18.9 18.7 18.4 18.0 40 40 Transfers to firms 1.8 1.6 1.6 1.6 1.5 Transfers abroad 1.3 1.4 1.6 1.7 1.6 20 20 Interest expenditure 2.4 2.0 2.0 2.0 2.1 Sources: Statistics Sweden and NIER. 0 0 93 95 97 99 01 03 05 07 Transfer payments to households General government consumption Other expenditure Interest expenditure 54 In principle, the tax-limitation rule provides that the real estate tax may not Sources: Statistics Sweden and NIER. exceed 5 percent of a household’s taxable income. 120 Public Finances General government consumption accounts for more than half of total general government expenditure. In the past ten years, general government consumption expenditure as a share of GDP has been about 28 percent. In 2004, this proportion decreased slightly with the expenditure cutbacks in the central and local government sectors. The proportion will remain at this level in 2005–2007. Transfers by the general government sector to households constitute the next largest item of general government expenditure. This proportion will decrease in each year of the period 2005–2007 (see Diagram 185). Pensions account for nearly half of general government transfers to households and are received by more than 18 percent of Sweden’s population. Labour-market-related transfers to households will decrease in proportion to GDP as the labour market situation gradually improves in the next few years (see Table 43). General government expenditure related to ill health will increased somewhat as a share of GDP in 2005, then decrease in 2006 and 2007. Expenditure related to ill health includes sickness and rehabilitation allowances (sjuk- och rehabiliteringspenning) and sickness and activity compensation (sjuk- och aktivitetsersättning). The number of persons receiving these benefits will decrease in each year of the forecast period. The reason why this tendency will not be clearly reflected in expenditure related to ill health is that as from January 1, 2005, the housing supplement to persons receiving sickness and activity compensation has been reclassified as a benefit related to ill health, rather than to old age as before. In recent years, there has also been a trend of reclassifying recipients of sickness or rehabilitation allowances as recipients of sickness or activity compensation. This has tended to slow the increase in expenditure, as sickness and activity compensation is lower than sickness and rehabilitation allowances. In the longer run, this reclassification tendency may have an unfavourable effect on the economy in general as well as general government finances, since it is easier for sick-listed persons to return to the labour market than for recipients of sickness and activity compensation to do so. General government transfers related to children and study will be higher, one reason being the increase in child allowances as from January 2006. Transfers abroad are increasing as a share of GDP because of a higher contribution to the EU and a rise in expenditure on international assistance. The interest expenditure of the general government sector as a share of GDP will remain at the same level as in 2004 both this year and next year before increasing slightly in 2007. The main reason will be continued low interest rates and relatively little change in the proportion of central government debt to GDP. Public Finances 121 Table 43 General Government Transfers to Households Percent of GDP, current prices 2003 2004 2005 2006 2007 Transfers to households 19.1 18.9 18.7 18.4 18.0 Old age 9.1 9.0 8.8 8.7 8.6 Labour market 1.6 1.7 1.6 1.5 1.4 Ill health 3.8 3.6 3.7 3.5 3.3 Handicap 0.8 0.9 0.9 1.0 1.0 Children/study 2.4 2.3 2.3 2.5 2.4 Income support 0.4 0.4 0.4 0.4 0.3 Other 1.0 1.0 1.0 0.8 1.0 Note: Old age = persons receiving old-age pensions, negotiated pensions and housing allowances to pensioners. . Labour market = unemployment compensation, benefits from labour-market programmes and wage guarantee. Ill health = sickness and rehabilitation allowances, sickness and activity compensation and as from January 1, 2005, housing supplements to persons receiving such compensation.. Handicap = occupational-injury, assistance allowances etc. Children/study = child allowances, parental insurance, maintenance support and study allowances. Sources: Statistics Sweden and NIER. Diagram 186 Central Government Budget Balance and Net Lending Billions of SEK, current prices Finances in Subsectors of General 200 200 Government 150 150 100 100 Deficits in Central Government Finances, 50 50 Central Government Debt Increasing 0 0 For central government net lending, which has been negative -50 -50 ever since 2002, forecasts point to continuing deficits in 2005– 2007 (see Table 44 and Diagram 186). -100 -100 97 99 01 03 05 07 The budget balance, equal to borrowing requirements but Budget balance with the opposite sign, is negative as well. The budget balance is Net lending often less favourable than net lending, since borrowing to Sources: National Debt Office, Statistics Sweden and NIER. finance student loans, for instance, has a negative impact on the budget balance but not on net lending. But items that improve the budget balance but not net lending can offset this effect. In Diagram 187 Government Debt 2005, the budget balance will be somewhat better than net Percent of GDP and billions of SEK, current prices lending. One reason is that with the appreciation of the krona in 100 1500 recent years, exchange-rate gains have been realized in servicing 80 1200 central government debt. Another reason is the repurchase of shares by TeliaSonera and Nordea. To maintain its proportion 60 900 of the equity in these companies, the central government is selling shares for a total of SEK 6.3 billion in 2005 and 4.5 40 600 billion in both 2006 and 2007. The proceeds received by the central government are reported as revenue from the sale of 20 300 property and thus affect the budget balance but not net lending. As a consequence of the budget deficits, central government 0 80 82 84 86 88 90 92 94 96 98 00 02 04 06 0 debt will increase, though decreasing slightly in proportion to Percent of GDP Billions of SEK (right) GDP in 2005–2007 (see Diagram 187). Sources: Statistics Sweden and NIER. 122 Public Finances Table 44 Central Government Net Lending and Budget Balance Billions of SEK, current prices, and percent of GDP 2003 2004 2005 2006 2007 Net lending –43 –23 –41 –43 –35 Percent of GDP –1.7 –0.9 –1.5 –1.6 –1.2 Adjustments Privatization of corporations 0 0 6 5 5 Transfer from National 13 4 2 0 0 Pension Fund Lending, repayment, net –10 –15 –18 –15 –17 Foreign-exchange and debt- –8 –19 1 –8 –1 service losses/gains Interperiod adjustments, other 2 0 13 14 10 Budget balance –46 -53 –37 –47 –38 Percent of GDP –1.9 –2.1 –1.4 –1.7 –1.3 Change in value, other –18 24 2 3 –4 Central-government debt, change 64 28 35 44 42 Central-government debt 1 186 1 213 1 248 1 292 1 334 (consolidated) Percent of GDP 48.6 47.7 47.5 47.1 46.4 Maastricht debt 1 268 1 301 1 285 1 317 1 344 Percent of GDP 52.0 51.1 48.9 48.1 46.7 Note: New definition of central-government debt in 2003. Sources: Statistics Sweden, National Debt Office and NIER. Surplus in Pension System Despite Higher Pensions The pension system consists of the pay-as-you-go system, where the National Pension Funds serve as a buffer, and the Premium Pension Authority (PPM), which invests pension contributions with fund managers chosen by the individual. The pension contributions paid to the two parts of the system are 16 and 2.5 percent, respectively, of the pension base. 55 The revenue of the pension system is currently greater than its pension disbursements, which means that the net lending of both the National Pension Funds and the PPM is positive. The total net lending of the pension system is close to 2 percent of GDP. The net lending target of 2 percent for the general government sector as a whole thus entails net lending around zero for the central and local government sectors taken together. 55 Calculated as the contribution base excluding the individual pension contribution. Public Finances 123 Table 45 Net Lending, Old Age Pension System Billions of SEK, current prices, percent of GDP 2003 2004 2005 2006 2007 Revenue 205 216 221 230 241 Percent of GDP 8.4 8.5 8.4 8.4 8.4 Pension contributions 166 173 177 183 191 Premium pension moneys 20 22 23 24 25 Return on capital 19 21 21 23 25 Expenditure 159 168 173 180 191 Percent of GDP 6.5 6.6 6.6 6.6 6.6 Pensions 155 163 169 177 187 Other 3 5 4 4 4 Net lending 47 48 49 50 50 Percent of GDP 1.9 1.9 1.9 1.8 1.7 of which: National Pension Funds 1.0 1.0 0.9 0.8 0.7 PPM 0.9 0.9 0.9 1.0 1.0 Sources: Statistics Sweden and NIER. EU’s statistics organization, Eurostat, has made a decision of principle that in the National Accounts funded pension systems with a substantial element of individual choice are not to be included in the general government sector. Beginning in 2007, therefore, the PPM will belong to the household sector, and its accounts will be adjusted for the period subsequent to 2004. This change will mean that the net lending of the general government sector as measured will be adjusted downward by about 1 percentage point. Leaving the surplus target is at 2 percent of GDP after this accounting change would effectively raise the level of ambition and thus require higher taxes or lower expenditure in the next few years. However, it would also provide a margin for reducing taxes or increasing expenditure somewhat in the long run when demographic conditions are less favourable than at present. In the NIER’s recommendation for the stance of fiscal policy, as presented above, it is assumed that the surplus target is adjusted to about 1 percent of GDP. This means that the level of ambition would remain unchanged. 124 Public Finances Diagram 188 Pension Levels Table 46 Indexation of Pensions and Pension Capital Index 2001=100 Annual percentage change and index 114 114 2003 2004 2005 2006 2007 112 112 Pensions (adjustment 3.6 1.8 0.8 1.0 2.1 index) 110 110 1 of which: Real incomes 3.4 1.8 2.0 2.0 2.7 108 108 2 Norm –1.6 –1.6 –1.6 –1.6 –1.6 3 CPI 1.8 1.6 0.4 0.6 1.0 106 106 Pension capital 5.3 3.4 2.4 2.6 3.8 104 104 Income index 111.79 115.64 118.41 121.49 126.06 102 102 Income-related base 40 900 42 300 43 300 44 400 46 100 4 amount 100 100 Price-related base 01 03 05 07 amount 38 600 39 300 39 400 39 700 40 000 New method of indexation (adjustment index) Former method (price basic amount) 1 Average change in real incomes in the three preceding years for all persons Source: NIER. aged 16–64 with pension-qualifying income 2 In the calculation of the initial amount of a pension, a growth rate of 1.6 percent, termed the norm, is taken into account; this feature of the pension system is disregarded here. 3 CPI inflation in June of the preceding year 4 Used in calculating the ceiling on pension-qualifying income. Diagram 189 Net Lending – Local Government Percent of GDP, current prices Source: NIER 0.4 0.4 In the new pension system, pensions are revalued by a so-called 0.2 0.2 adjustment index (see Table 46). The magnitude of the adjustment is determined by the development of prices in the 0.0 0.0 preceding year and by the development of the real incomes of the working population in the three preceding years. Since prices -0.2 -0.2 have been rising very slowly in 2004 and 2005, pensions will be indexed upward by only 0.8 percent in 2005 and by 1.0 percent in 2006. With the combination of somewhat higher inflation in -0.4 -0.4 93 95 97 99 01 03 05 07 2006 and surging real incomes, it is forecast that pensions will be Municipalities County council districts raised by 2.1 percent in 2007. Sources: Statistics Sweden and NIER. With adjustment indexation, the relatively robust growth in real incomes in recent years will mean that pensions increase more in 2005-2007 than they would have under the old system of indexation by the price-related base amount (see Diagram Diagram 190 Revenue and Expenditure – 188). With the new method of indexation, pension levels in 2007 Municipalities will be almost 5 percent higher than with the old method. Percent of GDP, current prices 18 18 Healthy Municipal Finances 17 17 The net lending of municipalities has improved after reaching a 16 16 trough in 2002. This development is due to increases in local government taxes in 2003 and 2004 as well as expenditure cutbacks (see Diagram 189 and Diagram 190). Healthy finances 15 15 are forecast for municipalities in 2005 as revenues will be rising more strongly than consumption. Next year, however, the net 14 93 95 97 99 01 03 05 07 14 lending of municipalities is expected to enter another downturn Revenue because of a fairly substantial increase in local government Expenditure consumption. Sources: Statistics Sweden and NIER. Public Finances 125 Diagram 191 Revenue and Expenditure – County Council Districts Percent of GDP, current prices 9 9 Stronger Net Lending in County Council Districts In 2004, the net lending of county council districts turned 8 8 positive for the first time since 1998. This year, net lending will improve further with increasing revenue, primarily in the form 7 7 of central government subsidies, and steadier expenditure in proportion to GDP (see Diagram 191). Expenditure will be 6 6 limited by a decrease in temporary hiring of personnel and the fact that the costs of pharmaceuticals are no longer increasing. 5 5 In the period ahead, both revenue and expenditure are expected 93 95 97 99 01 03 05 07 to increase at about the same rate as GDP; net lending will Revenue Expenditure therefore remain positive in both 2006 and 2007. Sources: Statistics Sweden and NIER. Comparison of Forecasts 128 Comparison of Forecasts In this section, the new forecast is compared with the forecast published by the NIER in June 2005. The purpose is to highlight the principal changes in the forecast presented in The Swedish Economy, June 2005, and generally to explain the underlying reasons for these revisions. The International Tendency The picture of the international tendency presented in the June report remains essentially the same. There are still spare resources in the world economy, and international economic recovery is continuing. One exception is the United Kingdom, where unexpectedly weak growth in the first half of this year signals that domestic demand is slackening (see Table 1). For the euro zone as well, the growth prospects have been revised downward somewhat because of higher oil prices. Other areas of the world, however, are expected to develop roughly in line with the previous forecast. For example, the tendency of the economy remains strong in the United States and in China. Over the summer, the price of oil has continued to soar. At the end of August, a barrel of oil cost over 60 dollars, much more than was forecast in June. As in the June report, however, it is assumed that the price of oil will recede during the forecast period. Around the end of 2007, the price of oil is expected to have dropped back to 47 dollars a barrel, 4 dollars more than in the preceding forecast (see Table 1). Growth Remains Strong in the United States Growth in the United States has been high for a number of years, and the labour market has continued to improve during 2005. Inflationary pressure has risen as the economy has entered a more mature phase of the business cycle, with rising resource utilization, lower productivity growth and increasing unit labour costs. To contain these inflationary tendencies as the economy approaches full resource utilization, the Fed is expected to raise its policy interest rate (the federal funds rate) to 4.00 percent toward the end of 2005. Compared with the June report, the forecast for GDP growth has been raised slightly, in part because of a stronger investment tendency (see Table 1). Comparison of Forecasts 129 Table 1 Current Forecasts for Other Countries Compared to the Forecast in June 2005 Annual percentage change except where otherwise indicated 2005 2006 2007 Aug –05 Diff. Aug –05 Diff. Aug –05 Diff. GDP US 3.6 0.1 3.3 0.0 3.1 –0.1 Japan 1.7 0.2 1.5 –0.1 1.5 –0.1 EU 1.9 –0.1 2.3 -0.1 2.6 0.0 Euro zone 1.4 0.0 1.9 –0.2 2.2 –0.1 Germany 1.0 –0.2 1.4 –0.3 1.9 –0.1 France 1.5 –0.1 1.8 –0.4 2.3 0.0 UK 2.0 –0.4 2.4 0.0 2.4 0.0 New EU 4.4 0.0 4.5 0.0 4.5 0.0 countries OECD 2.7 0.0 2.7 –0.1 2.7 –0.1 China 9.0 0.0 8.5 0.0 8.0 0.0 World 4.3 0.0 4.2 –0.1 4.2 0.0 Federal funds 4.00 0.25 4.75 0.25 4.75 0.00 1 target rate 1 ECB’s refi rate 2.00 0.00 2.50 –0.25 3.25 –0.25 1,2 Dollar/Euro 1.23 –0.01 1.24 –0.02 1.25 –0.03 2,3 Price of oil 59 12 53 8 47 4 1 Percent at year-end. 2 Level at year-end. 3 Dollars per barrel. Note: The difference is between the current forecast and the forecast in June 2005. A positive value denotes an upward revision. Sources: OECD and NIER. Higher Oil Prices Curbing Growth in Euro Zone Growth in the euro zone will increase during the forecast period, but the upswing is expected to be somewhat weaker in 2006 and 2007 than in the June report. The principal explanation for the revision is the unexpectedly high price of oil. With this weaker growth, the ECB will raise the refi rate somewhat more slowly than was forecast in June (see Table 1). The Tendency in Sweden Despite record-high oil prices, the upswing in the Swedish economy is continuing, and the apparent slump at the end of last year proved to be only a brief slowdown. Bolstering the economic upswing are very low interest rates and a weakening krona after the Riksbank’s reduced the repo rate to 1.50 percent in late June. Thus, monetary conditions are highly expansionary and will stimulate domestic demand, which is expected to show relatively rapid growth during the forecast period. Compared to the June forecast, GDP has been adjusted upward somewhat because of a stronger tendency in investment and consumption. 130 Comparison of Forecasts With more robust growth in demand, inflation has also been revised upward slightly from the previous forecast (see Table 2). Construction Has Picked Up Considerably Investment has been surging since mid-2004. The lacklustre tendency in 2001–2003 is evidence that the need for investment has been neglected, implying that the current upswing will continue. Moreover, firms are showing very healthy profitability, and financial conditions are favourable in other respects as well. In the business sector, investment is surging in machinery and equipment, software and housing, whereas investment in other buildings and structures is showing a weaker tendency. The investment of public authorities is also strengthening with the increase in infrastructure investment and strong local government finances. Housing investment was up last year by more than 15 percent, and for the first half of this year, residential construction exceeded the June forecast. The strong increase is particularly noticeable in new construction of multi-unit dwellings. The Business Tendency Survey confirms this picture of a very vigorous development in housing investment. In summary, given the stronger investment tendency, particularly in construction, growth in investment has been revised upward by 1.2 percentage points for this year and by 0.9 percentage point for next year (see Table 2). Slackening Growth in Exports In 2004 Sweden’s growth was led primarily by exports, whereas the tendency in domestic demand was slack. Around the end of last year, though, growth in exports fell off, and domestic demand has now become the principal driving force behind Sweden´s economic growth. The weak tendency in exports continued in the first quarter of this year. But according to preliminary National Accounts, exports showed a relatively strong increase in the second quarter. That increase, however, is considered partly due to temporarily large deliveries in June; consequently, growth in exports is forecast to slacken again in the third quarter of this year. This picture is confirmed by Statistics Sweden’s data on orders and by the Business Tendency Survey, where a majority of industrial sector firms report a diminished inflow of new orders in the second quarter. In general, therefore, the picture of the tendency in exports is the same as in the June report, with exports showing little development this year but picking up again in 2006 and 2007. Imports are also expected to develop in line with the June report. For 2006, however, the forecast for imports has been Comparison of Forecasts 131 adjusted upward by 0.5 percentage point because of stronger domestic demand. Upward Revision of Household Consumption In connection with the publication of the preliminary second- quarter data in the National Accounts, household consumption was revised upward by 0.25 percentage point for the first quarter. A somewhat different overall picture is now emerging. Since last summer, consumption increased for three quarters in a row at a steady quarterly rate of about 0.5 percent, speeding up to 0.8 percent in the second quarter of this year. Partly because of the unexpectedly strong tendency in the first half-year, the forecast for growth in consumption this year has been revised upward by 0.4 percentage point. The tendency in consumption has been bolstered by certain temporary factors like the disbursement of part of the tax refund in June, and the underlying tendency is not considered to have strengthened as much as the strong outcome for the second quarter might suggest. Consequently, the development of consumption in 2006 and 2007 is expected to be only marginally robust than in the June report. All factors considered, the stronger tendency in investment and consumption has led to an upward revision of GDP growth by 0.3 percentage point for this year. For 2006 and 2007, growth in GDP has been revised marginally upward, partly because of somewhat stronger domestic demand (see Table 2). Labour Market Still Slack The Swedish labour market has been slack so far this year. This tendency will persist through autumn, and the labour market is not expected to pick up until 2006. The reason for the weakness is that growth in output has not been strong enough to generate a substantial increase in demand for labour. Instead of hiring more employees, firms have been using existing personnel more efficiently. Compared with the June forecast, however, GDP growth has been adjusted upward, while productivity growth has been reduced, entailing an upward revision in the total number of hours worked (see Table 2). Nevertheless, the forecast for employment has been revised downward for this year since average hours worked have been increased. Consequently, unemployment is largely unchanged compared to the June forecast. Following the change of method in the Labour Force Surveys (LFS), however, the labour market forecast is highly uncertain (see the box captioned ”Changeover in LFS Complicates Interpretation of the Labour Market Situation”). 132 Comparison of Forecasts With the forecast raised for GDP growth, resource utilization will be somewhat higher than was forecast in the June report. The upward revision of the output gap suggests in turn that wage and inflationary pressure will be higher. The underlying rate of inflation, as measured by the UND1X, has been increased by 0.2 percentage point for 2005 and by 0.1 percentage point for 2006. The upward adjustment has been somewhat less in the CPI than in the UND1X since costs of interest in 2005 and 2006 are less than in the June forecast, owing to a lower level of interest rates (see Table 2). Higher General Government Net Lending The expenditure of the general government sector has been revised downward for the entire forecast period compared with the June report. The reasons for the change include downward revision of central government interest expenditure and a decrease in transfers to households after a reduction in forecast expenditure related to ill health. At the same time, general government revenue will be higher than in the June report. Part of the explanation is stronger development of major tax bases. For example, both household consumption and earnings are somewhat higher than in the June report. All factors considered, lower expenditure and somewhat higher revenue have led to an upward revision of general government net lending for the entire forecast period 2005–2007. For 2005, general government net lending is now forecast to be 0.8 percent of GDP. With the provisions currently in effect, 56 net lending will drop to 0.6 percent of GDP in 2006 before rising to 0.9 percent in 2007 ( se Table 2). 56 The calculations are based on the provisions currently in effect, with the exception of central government subsidies to local governments in 2007. In the absence of a decision, it is assumed that these subsidies will increase in line with their historic rate of development. For 2007 it is assumed that the additional subsidies will amount to SEK 5 billion. Comparison of Forecasts 133 Table 2 The Current Forecast for Sweden Compared to the Forecast in June 2005. Annual percentage change except where otherwise indicated 2005 2006 2007 Aug.-05 Diff. Aug.-05 Diff. Aug.-05 Diff. GDP 2.4 0.3 2.9 0.1 2.9 0.1 Household consumption 2.1 0.4 2.8 0.1 3.2 0.1 General government 0.0 -0.1 0.8 -0.1 0.5 0.0 consumption Gross fixed capital 9.0 1.2 6.9 0.9 4.3 –0.5 formation 1 Stockbuilding 0.0 –0.1 0.2 0.1 -0.1 0.1 Exports 3.1 0.1 5.6 0.0 6.5 –0.1 Imports 4.0 –0.1 6.9 0.5 6.5 –0.2 2 Number of hours worked 0.3 0.5 0.9 0.0 0.8 0.0 Business sector 2.5 -0.3 3.0 0.1 2.8 0.0 2 productivity 3 Output gap –0.6 0.0 –0.2 0.1 -0.1 0.1 Employment 0.2 –0.1 0.7 0.1 0.7 0.0 4 Unemployment 5.8 –0.2 5.4 0.0 5.2 0.0 Hourly earnings 3.3 0.0 3.6 0.0 3.9 0.1 CPI, annual average 0.4 0.2 1.0 0.0 2.0 0.0 UND1X, annual average 0.7 0.2 1.2 0.1 1.4 –0.1 5 TCW index 129 2.2 128 1.6 127 1.0 6 Repo rate 1.50 0.00 2.25 0.00 3.50 0.25 Interest rate on 10-year 6 government bonds 3.4 0.0 4.3 –0.1 4.7 0.0 7 Current account 5.9 –0.2 4.9 –0.4 5.3 –0.1 General government net 7 lending 0.8 0.6 0.6 0.7 0.9 0.6 1 Change in percent of GDP for the previous year 2 Calendar-adjusted 3 Percent of potential GDP 4 Percent of the labour force. 5 Level at year-end 6 Percent, at year-end. 7 Percent of GDP. Note: The difference is between the current forecast and the forecast in June 2005. A positive value denotes an upward revision. Source: NIER.