Two cats in a corner, as long as it goes well

We will have a new government of PVV, VVD, NSC and BBB. From an economic perspective, I am pleased that the outline agreement so emphatically states that we must think about our revenue model. It literally says: "A healthy economy and flourishing companies are necessary for prosperity in the Netherlands. Without a stable economy and a strong SME, there are no jobs and no money for public facilities. Entrepreneurs are needed to invest and are of great importance. value to our society." That is a very different tone than we have heard from previous governments.

If the sustainability of public finances is at stake, the new team intends to focus more on limiting expenditures than on increasing the burden. Also quite a change. Now paper is patient and we'll see how it all turns out. Quite a few savings are planned that are probably not easy to achieve. For example, €1 billion must be saved within the government itself, including by reducing the number of government civil servants after the explosive growth between 2018 and 2022. I suspect that this will not be without a struggle.

Various tax increases for entrepreneurs are being reversed. That seems like a good thing to me. An additional income tax bracket will be introduced, which should improve the income position of middle-income earners. I am also pleased with the intention to no longer let the Netherlands take the lead everywhere with measures that make life more expensive and worsen the competitive position of companies. And I am also pleased that the agreement states that energy costs for families and companies may not be significantly out of step with neighboring countries. It is not yet immediately clear to me how exactly we are going to achieve this. We will see.

Our economy is shrinking again
Our economy shrank by 0,1% in the first quarter compared to the previous quarter. That did not go well. Last year, our economy shrank for three quarters in a row, but showed recovery in the fourth quarter, although the growth figure for that quarter was adjusted this week from 0,4% to 0,3%. Then you hope that the recovery will continue, but that was not the case.

The volume of consumer spending grew by 0,7% quarter-on-quarter, following growth of 2,0% in the fourth quarter of last year. This was due to the payment of the energy surcharge. I therefore expected a decline in consumption in the first quarter, but that was not too bad. We probably see the effect of the improvement in purchasing power here.

I was pleasantly surprised by the increase in investments in fixed assets. These had fallen sharply in the second half of last year, but improved somewhat in the first quarter this year: +0,4%. Hopefully that recovery will continue in the coming months.

Industry was the main culprit in the first quarter. The added value of production fell by as much as 3,8% quarter-on-quarter. That's big. In fact, you usually only see that kind of shrinkage during recessions. On the expenditure side, the decline in production manifests itself in a decline in the export of goods. Because the export of services did grow, the volume of exports of goods and services together only fell by 0,1%. Statistics Netherlands also publishes monthly figures on the volume of goods exports. The figures for the first quarter do not make me happy. In the first quarter, the volume of goods exports was 5,6% lower than a year earlier. Compared to the fourth quarter, the volume was even more than 10% lower, with the caveat that these figures have not been adjusted for season. The first quarter is always weak, but not as weak as this year.

Inventory building also made a strong negative contribution to growth. Stockpiling reduced GDP growth by as much as 0,7%.

I am definitely optimistic for the rest of the year. Companies do not continue to draw on inventories and when the drawdown stops, it usually turns into an increase. Then the negative growth contribution changes into a positive one. That makes a difference. I also expect positive developments in industry and exports in the foreseeable future. The NEVI purchasing managers' index, which measures the confidence of industrial entrepreneurs, has been improving for several months and reached a level of above 50 in April. International indicators also suggest that world trade is picking up. It would be strange if we didn't benefit from that. Finally, I expect private consumption growth to pick up further now that wage growth is so significantly above inflation. Despite my optimism about the coming quarters, economic growth for the year as a whole will remain modest, just barely above 0,1's 2023%. But that is mainly due to the lack of statistical spillover and weak exports.

Knot makes more of an impression than Powell
This week, Fed boss Jay Powell was a guest in the Netherlands. He took part in a panel discussion with DNB President Klaas Knot at the Tropenmuseum in Amsterdam. I'm a fan of Powell, but to be honest I was more impressed by Knot's performance, although that may be because I follow what Powell says more closely than what Knot says in speeches. Powell didn't say anything I hadn't heard from him before.

Both gentlemen are convinced that inflation will turn out well. Powell made it clear that interest rates will be cut, but not in the very short term. Knot made it clear that the ECB will cut interest rates on June 6. He did not want to commit to what the path will be next, but influential ECB director Isabel Schnabel said this week that the economic data currently available does not justify a further rate cut in July. The ECB will probably follow a rhythm of cutting interest rates every second meeting, i.e. one interest rate cut per quarter.

I liked Knot's analysis on the consequences of the divergent responses to the pandemic, which may have led to much higher labor productivity growth in the US than in Europe, as now reflected in the statistics. When the pandemic broke out and large parts of the economy shut down, masses of people in the US were laid off. More than seventeen million Americans lost their jobs between February and April 2020. The unemployment rate rose by more than 10 percentage points. Those people did receive money from the government. Unemployment benefits were increased and made easier to access. All Americans also received an amount of $1.200 into their accounts from the government. European countries opted for a different strategy. We tried to protect jobs because the government actually paid part of the labor costs. In the Netherlands, including the NOW scheme. As a result, the increase in unemployment in our country was limited to just over 1 percentage point. As Knot said in the Tropenmuseum, the American labor market was completely shaken up. The vast majority of those 17 million unemployed have now found a job again and of course in the places where they are most productive. In economists' jargon: a very significant reallocation of labor took place. In our country, on the other hand, the supply side of the economy has been frozen, so that a reallocation of labor to the most productive places has not occurred. We are generally very satisfied with how measures such as the NOW have worked. But in the longer term, it might have been better for labor productivity if we had followed the American strategy.

US inflation is not disappointing in April
US consumer prices rose 0,3% in April compared to March and 3,4% compared to April last year. That was 3,5% in March. Excluding food and energy, so-called core inflation was also 0,3% month-on-month and 3,6% year-on-year. In March this was still 3,8%.

Financial markets breathed a sigh of relief. In the first three months of the year, inflation had consistently been higher than expected. Not this time. Yet the graph shows that core inflation is still well higher than before the pandemic and a monthly increase of 0,3% is slightly lower than in the previous four months, but such an increase is still too high.

Alternative measures of inflation illustrate the problem. The following graph shows two of them. 'Sticky price' inflation measures the price increase of items whose prices do not change very often. The '16%-trimmed' inflation excludes from the calculation the 8% that are rising fastest in price and the 8% that are rising least rapidly in price. The extremes can distort the average. These series are still very much above pre-pandemic levels. Moreover, the rate of decline appears to have decreased.

Chinese figures provide a good picture of the challenges for that economy
Industrial production in China was 6,7% higher in April than a year ago. That's an excellent figure, albeit not spectacular. It is very likely that production will benefit from government incentives.

Yet China is facing serious problems. House prices were 3,1% lower in April than in April last year, the lowest figure since 2015. Compared to March, prices were 0,6% lower. The decline in house prices is currently accelerating and that is a huge problem. Too much has been built in recent decades. Many Chinese have bought apartments as an investment. However, the vacancy rate is enormous. Some project developers have now collapsed. Construction cannot be expected to contribute to growth for the time being, while that sector has been a growth engine in recent decades. The fall in house prices can put pressure on the financial position of many homeowners.

Chinese retail sales were 2,3% higher in April than a year ago. That did not go well. Even in the Netherlands they are currently growing faster, even if the inflation difference is adjusted for.

China has been trying for years to switch to a growth strategy that depends less on exports and more on domestic spending, especially consumption. But it doesn't work this way. In fact, if the industry produces more, but consumers do not want to buy the more produced, then only exports remain. However, China is encountering a strong headwind there due to increasing protectionism.

This week Putin is visiting his good friend Xi. A cat in a corner makes strange jumps. What happens when you corner two cats and they meet?

Closing
There will be a different wind blowing in The Hague. There is of course a lot of criticism and consternation among the opposition to the new government. There is hope among those who voted for the four coalition parties. In terms of economics, I am pleased that the importance of our revenue model is being recognized. How much the new team can realize their plans remains to be seen. How relations between the coalition partners will develop is also exciting.

Our economy contracted slightly in the first quarter, but I think improvements are on the way.

The conversation with Powell and Knot in the Tropenmuseum this week was interesting. A great success for the organiser, the Foreign Bankers Association and in particular their driving force, my wonderful former colleague Arlette Koedam. I thought Powell was solid, but he didn't say anything new. I thought Knot's performance was strong. He came up with clear, understandable and convincing analyzes for everyone. Maybe they weren't new either, but he delivered it with verve.

US inflation in April was not disappointing. That was a relief for the financial markets. Of course I wish them that, but you can't call the figures very good either.

The Chinese economy is under great pressure. House prices are falling and consumers are taking it easy. That leaves export-led growth. A threatening tsunami of protectionist measures will put a stop to this. Then China will focus more on Russia. That economy is also affected by measures from Europe and the US, the sanctions. This is how we drive two cats into a corner and into each other's arms. Hope it turns out fine.

Hans de Jong

Han de Jong is a former chief economist at ABN Amro and now a resident economist at BNR Nieuwsradio, among others. His comments can also be found on Crystalcleareconomics.nl

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