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Nyheder
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Danish Economy, Autumn 2006
ENGLISH SUMMARY | - Chapter I: The Danish Economy and Policy Recommendations
- Chapter II: Poverty in Denmark
| | Chapter I: The Danish Economy | Danish economy has been characterized by strong domestic demand over the last year and a half. Private consumption has been growing fast, supported by a very strong housing market and improved labour market conditions. This year consumption is expected to grow by 4½ per cent, and growth is expected to remain above trend also in 2007. As house prices are expected to level out and employment is forecasted to stay more or less unchanged, growth in private consumption will gradually decline to more trend-like levels of 2½ per cent in 2008-09. Also investments have been growing rapidly – caused by strong growth in demand, low yields and increasing difficulties of hiring qualified labour. On top of a strong domestic demand, relatively high international growth rates have spurred Danish exports, and Danish exporters seem to have gained market shares despite having faced higher wage increases than their competitors.
On the labour market, employment has increased and unemployment has dropped. Over the last year and a half, unemployment has fallen by 60,000 persons, hence lowering the unemployment rate by almost 2 percentage points. Currently, the unemployment rate is just above 4 per cent, which is well below the estimated structural level of unemployment. Due to the outlook of a continued strong demand, unemployment rates are expected to remain low in the forecast period going to 2009. The labour force has so far only vaguely responded to the good business cycle conditions. Over the coming years a more pronounced impact on the labour supply is expected, but this will only just counteract the underlying demographic tendency to a gradual drop in the labour force. Hence, with both unemployment and labour force expected to be more or less constant, employment will stay mostly unchanged. Until now, the more pronounced labour market tightness has not given cause to any significant wage acceleration. However, the continued low level of unemployment is sooner or later expected to result in rising wage increases around 4½ per cent in 2007-09.
The strong demand has caused imports to rise much faster than production, which has reduced the surplus of the current account. This tendency is expected to continue, and the surplus of the current account is expected to fall from 3½ per cent of GDP last year towards 1½ per cent in 2009. On the other hand, the high level of economic activity has improved public sector finances. The public sector budget surplus is expected to exceed 3 per cent of GPD throughout the forecast horizon.
On this background GDP is expected to grow by more than 3 per cent in 2006, which is slightly faster than in 2005. Over the coming years, lower growth rates are expected as a consequence of supply-side constraints founded in the tight labour market situation. Therefore GDP growth is expected to be around 2 per cent in 2007, and just above 1½ per cent in 2008-09.
Table 1 Short-term outlook for the Danish economy |
| Current prices DKK bn. | Per cent of GDP | Percentage change, volume |
| 2005 | 2005 | 2005 | 2006 | 2007 | 2008 | 2009 | | Private consumption | 754.3 | 48.5 | 4.1 | 4.5 | 3.1 | 2.4 | 2.3 | | Public consumption | 402.0 | 25.9 | 1.3 | 072 | 1.3 | 1.1 | 1.1 | | Gross fixed capital formation | 324.1 | 20.9 | 9.4 | 11.4 | 4.2 | 2.5 | 2.1 | | consisting of: |
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| | Residential investments | 86.8 | 5.6 | 14.2 | 9.6 | 4.8 | 2.5 | 1.7 | | Business fixed investments | 209.7 | 12.8 | 8.1 | 13.8 | 4.3 | 2.5 | 2.4 | | Public investments | 27.6 | 1.8 | 4.4 | 2.0 | 2.0 | 2.0 | 2.0 | | Stockbuilding (a) | 1.2 | 0.1 | -0.3 | 0.0 | 0.0 | 0.0 | 0.0 | | Total domestic demand | 1,481.6 | 95.3 | 4.1 | 5.0 | 2.9 | 2.1 | 2.0 | | Exports | 753.5 | 48.5 | 8.5 | 11.9 | 4.6 | 3.5 | 3.5 | | Imports | 681.1 | 43.8 | 11.9 | 16.4 | 6.2 | 4.4 | 4.1 | | GDP | 1,554.0 | 100.0 | 3.0 | 3.3 | 2.1 | 1.6 | 1.6 | | Key indicators |
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| | Consumer prices, percentage change (b) | 2.0 | 2.3 | 1.8 | 2.1 | 2.2 | | Unemployment, per cent (c) | 5.5 | 4.3 | 4.0 | 4.1 | 4.1 | | Current account, DKK bn. | 56.3 | 39.8 | 28.1 | 26.2 | 26.0 | | Current account, per cent of GDP | 3.6 | 2.4 | 1.7 | 1.5 | 1.4 | | Gen. government financial balance, DKK bn. | 71.8 | 58.2 | 58.5 | 59.6 | 58.4 | | Gen. government fin. balance, per cent of GDP | 4.6 | 3.6 | 3.4 | 3.4 | 3.2 | | Hourly wage costs, percentage change | 2.7 | 3.3 | 4.3 | 4.6 | 4.5 | | Terms of trade, percentage change | 1.7 | -0.6 | 0.3 | 0.4 | 0.4 |
| a) | The percentage changes are calculated as the real changes in stock building relative to real GDP in the previous year. | | b) | Implicit private consumption deflator. | | c) | Percentage of the total labour force. National definition. | | d) | The DKK/USD exchange rate is taken as 6.00 in 2005, 5.96 in 2006 and 5.81 in 2007-09. | | Sources: | Statistics Denmark, National Accounts and own estimates. |
| Policy Recommendations | | The forecast predicts a “soft landing” after several years with high demand growth and great strain on the labour market. However, so far increases in wage rates have been moderate; strong growth in demand has to a large extent been covered by an increased level of imports, while foreign labour has contributed to an increase in the labour supply. Hence, there are many indications that the economy is considerably more capable of adjustment now than in, e.g., the mid-eighties.
Nevertheless, the labour market is now so tight that it is not a question whether wage rates accelerate, but rather to which extent and for how long. If wage acceleration leads to a shift upwards in expected inflation, there is a large risk that higher wage increases will become a longer term phenomenon. And if this persists for several years, the competitiveness of the Danish economy will decrease untenable. In that case, the economy will most likely have to go through a longer period of low growth and a relatively high level of unemployment to adjust wages and prices back to a sustainable level. Declining house prices would clearly deepen such a period with low growth.
In the current situation, with the risk of the economy overheating being considerably, fiscal policy should contribute to dampen the economic activity. However, over the coming year fiscal policy is expected to be expansionary and thereby increasing the risk of the economy being overheated. In a situation where the tax freeze (according to which the Government has committed itself not to raise any taxes) implies a reduction of the number of available instruments, expansive fiscal policy is particularly inappropriate.
A tax reform, where income tax is reduced and taxation of imputed rent of owner-occupied houses is raised, would in the current situation reduce the risk of the economy overheating. Lower income tax could increase the effective labour supply, and a higher taxation on houses would reduce the tax subsidies of investments in owner-occupied homes. At the same time the tax system would become more robust to globalisation. In the longer run the tax reform will improve public finances as a consequence of the derived positive effects on the labour supply.
Specifically, a revenue-neutral tax reform is recommended, where marginal taxes on labour income are reduced by 10 bn. DKK, and the taxation of houses is increased by a similar amount. Such an increase in the taxation of houses does not even amount to the revenue loss caused by various preferential rules and the erosion caused by the tax freeze since 2001. The analysis in part I.7 shows that the suggested tax reform in the short run will be able to reduce the strain on the labour market with 5-10,000 persons, partly as a consequence of the increased labour supply, and partly because the tax reform in the short run will dampen demand.
Obviously, this tax reform would be inconsistent with the tax freeze. However, it is difficult to find other fiscal initiatives that has both favourable structural effects, reduces the risk of overheating, and has limited distributive consequences.
If politicians are not willing to implement a tax reform, with reference to the tax freeze or for some other reason, they face an unpleasant choice: One option would be to implement a traditional fiscal policy tightening, which, however, will not only affect the business cycle, but also brings unintended side effects around. Alternatively, one could choose not to tighten. In that case, however, there is a substantial risk that the economy after a period of overheating will experience a prolonged period with high unemployment and low growth. Since this risk is considered significant, it is recommended, that a traditional fiscal tightening is made, if it is chosen not to implement the suggested tax reform.
In the spring a welfare reform was introduced in Denmark taking a significant step in the direction of ensuring the public finances in relation to the longer term demographic development. Even though the welfare reform contains a number of initiatives, which improve the public finances in the long run, the reform only solves approximately half of the initial fiscal sustainability problem; cf. figure 1 and part I.8.
Figure 1 Public balances with and without reform
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Source: Part I.8.
The long term projection of the public finances presented in part I.8 has been made on the assumption that the tax freeze will be abolished in 2011. Alternatively, if it is assumed that the “nominal principle” (meaning that taxes on housing is fixed in nominal terms) of the tax freeze is continued until 2040, the tax revenue will be eroded by inflation. This erosion will eliminate almost all of the improvement of the public finances entailed by the welfare reform. Correspondingly, the computations show that additional growth in public consumption by only 0.15 percentage points per year until 2040 will eliminate approximately half of the effects on the public finances from the welfare reform. These alternative scenarios show that there is a considerable risk of a poorer development in public finances than projected.
The projection shows that public earnings and expenditures in the period 2010-25 on average will be in balance and that public debt in 2025 will be unchanged compared to today. This illustrates that the deterioration of the public finances is a not a present, but a future, phenomenon. On this background, it does not seem imperative at the present time to make further distinctive tightening of the public finances solely justified out of consideration of long term sustainability. A scenario with higher surplus in an extended period would imply that the public sector builds up credit of a magnitude, which can be in conflict with the consideration of equally treatment of the current generations compared to the coming.
Even though there is no need for immediate tightening on the grounds of the long term sustainability, the projection clearly shows that there will be a need for initiatives that improve the public finances at some point in time. However, it will be natural, that the main part of the adjustment will take place at a time lying after the immediate horizon of the welfare reform that goes until around 2025.
However, to maintain the long term focus in the fiscal policy it is appropriate to set up new goals for the development in the public finances. A new medium term plan, as a replacement of the current 2010-plan, should contain goals that as a minimum targets structural public finances being close to balance towards 2020 or 2025. Such a goal would ensure that public debt is kept literally unchanged. This will not solve the long term sustainability problem, but it will assure that no new burdens are pushed on to future generations. A new medium term plan should contain an abolishment of the tax freeze so that the excise duties and taxation of houses are not eroded by inflation. In addition, the new plan should contain explicit targets for the development in public consumption. These targets should be stated for the nominal public consumption relative to nominal GDP.
Currently, the overall growth rate of expenditures of the local municipality is pinpointed by a combination of the tax freeze (which keeps average tax rates constant across municipalities) and an agreement between the central government and the municipalities. The current system implies a limited flexibility for the individual municipality and, judged by repeatedly overruns of the medium term goals for real growth in public consumption, the system can only be characterised as a limited success. This is likely to be connected with ambiguously sanctions and difficulties with getting the sum of the budget of the individual municipalities to abide by a centrally negotiated target.
A more flexible way of controlling total municipal expenditures and taxes would be to introduce tradable municipal “expenditure rights”. These expenditure rights can be allocated to individual municipalities each year on the basis of a centrally determined target. If an individual municipality wants to increase spending above the allocated rights, it has to buy additional expenditure rights from other municipalities. Municipalities wanting to buy will have to increase taxes, while municipalities willing to sell expenditure rights will have to cut spending, but can in turn also cut taxes. The price of the expenditure rights will in general reflect the tightness of the centrally determined target.
A system of tradable municipal expenditure rights will make it easier for individual municipalities to adjust the level of taxes and expenditures to the desired levels according to local preferences. At the same time the central government maintains full control over the total municipal expenditures (and average tax rates). It will also be easy to initiate individual sanctions if the centrally determined target is violated, as it is simple to identify municipalities exceeding their expenditure rights.
Chapter II: Poverty in Denmark
One of the purposes of the welfare state is to fight poverty. The public income compensating transfers act as a public insurance against poverty but income compensating transfers from the public is allocated only to persons who are unable to earn an income making it possible to reach an acceptable level of living. The chapter analyses economic poverty in Denmark.
In this chapter a person is defined a being poor if disposable income after income tax and public transfers is less than 50 per cent of the median of the population. This definition is commonly used in comparative analyses on poverty by the OECD and Luxembourg Income Study, see Förster and d’Ercole (2005) and Smeeding (2006). Income is calculated using an equivalence scale for households of different sizes. The equivalence scale is based on the observation, that the household cost of a child is less than the costs of an adult, and that there are economics of scale. (The equivalence factor is F=(na + 0.6*nc)^0.8 where the number of adults is denoted na, and the number of children is denoted nc The equivalence factor is based on analyses of the cost of living survey.)
Persons aged more than 19 years are included if they are not enrolled in education, and if they have been registered as living in the country from the beginning of the year. Others have been excluded from the analysis; this goes for adults enrolled in education and who are expected to receive a higher income later in their life and it goes for persons finishing an education during the year. An important point is that a person is treated as a separate household if he (she) is 19 years and not living together with a woman (man) at the same address.
The disposable income for a person on the poverty line in 2004 is 75,000 DKK, and the real value of the income on the poverty line has increased by 17 per cent from 1992 to 2004, while it was nearly constant from 1988 to 1992, when unemployment was increasing.
Calculations show that the share of the population living in poverty is relatively low at a level of 4.4 per cent in 2004, and that it has has been relatively stable for the last 12 years, cf. figure 2. If poverty instead had been defined as 60 per cent of the median income, 8.9 percent of the population would have been poor in 2004. The share of poor in Denmark is low in nearly all international comparative studies of poverty.
Figure 2 Share of persons living in poverty 1988-2004 | |
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Source: Calculations made by the secretariat using a 10 per cent sample of the population.
In 2004 165,000 persons are poor and poverty is relatively common among the youth, persons living alone or with a high number of dependent children and among immigrants, self-employed and people outside the labour force. Some of the poor young persons are living together with their parents or they are foreign students or trainees.
Special attention has been given to three groups of persons who are often considered as more exposed to live in poverty. The three groups are single parents, immigrants and persons who have a mental illness. Single parents are more exposed to poverty than persons living alone without dependent children, but a single parent with one child quit poverty relatively quickly, while single parents with more than one child usually stay poor for a longer period.
The share of persons living in poverty is above 10 per cent among immigrants from Western countries and above 20 per cent among immigrants from Non-western countries, while the share among Danes is less than 4 per cent. The share in poverty is especially high among those who have been in the country for only one to three years, but the differences between persons of different origin are remarkably large.
A separate analysis investigates poverty among persons who suffer from mental illness. We find large differences between persons with different diagnoses, and the incidence of poverty seems to be higher around the time when mental illness is diagnosed.
The welfare implications of living in poverty are much more severe, if the person lives in poverty for several years compared to just a single year. More than half the persons who experience poverty are only poor for one year. This can be due to exceptional circumstances such as divorce, childbirth or temporary income loss. For a year or two it is often possible to use savings, benefits from grants from family and friends or to borrow. As time spend in poverty increases the, level of living is affected more dramatically.
The duration of poverty is analyzed in a hazard rate model exploiting all spells of poverty starting from 1989 to 2003. Estimations show that hazard rates are decreasing in the time spent in poverty, and the probability of leaving poverty from the first to the second year is twice as large as the probability of leaving poverty from the fifth to the sixth year.
The duration of a spell of poverty is especially long for unskilled outside – or with only limited connection to – the labour market. Furthermore, self-employed and immigrants face longer spells as well as persons living in Copenhagen. Finally, persons with a relatively large number of dependent children stay in poverty for a longer period than single parents with only one child or couples with up to three children.
The generational income mobility is examined. This is done by comparing earnings in 2002-04 for persons born in 1962-64 with their parent’s earnings in 1980-82. The interest is focused on the lower tail of the earnings distribution. Hence, we use quantile regression to explore the effect of explanatory variables at different points in the conditional distribution of the dependent variables. The analysis reveals that the effect of parents’ earnings on the earnings of the offspring is modest. However, the effect on the lowest part of the distribution is a bit higher than the effect on average income. The probability of the children having zero income is however quite sensitive to parents’ income.
The prevention of poverty should start in early childhood. An important element is to give children and young people personal and educational skills to the labour market. Empirical findings support the theory that it is important with pre-emptive measures towards socially vulnerable children. However, no comprehensive survey of which measures are efficient to improve the development of socially vulnerable children exists. Therefore, a systematic quantitative evaluation of measures used to support and develop socially vulnerable children is needed.
It is important that initiatives to improve qualifications for the weakest group of children continue in the elementary school. The problems are concentrated around young people leaving school without adequate qualification to achieve an education on upper secondary and vocational training level. The goal ought to be that almost everybody should be able to complete an education.
Besides initiatives aiming at preventing poverty, there are two ways to reduce poverty. One is to increase income support to those who are below the poverty limit, while the second is to improve the possibility of leaving poverty by being self-supporting.
Hardly any full-time workers are poor. Therefore it is important to create good employment possibilities for people who have the largest risk to end up in poverty. It is also important that there is an economic gain from being employed. It is necessary that the level of public income transfers is balanced with wages.
Social assistance can lower the amount of poverty, but at the same time less cautious rules and higher compensation could reduce incentives to seek jobs. However economic incentives only affect persons who have a realistic possibility of getting a job. Some poor persons have so dismal qualifications or bad health that economic incentives will not improve their chances on the labour market. A reduction of income transfers for these groups will solely imply a reduction in income.
In Denmark social assistance is much lower for refugees, emigrants and Danes that return to Denmark after a longer period abroad than it is for native Danes. However, it is very difficult for refugees to find a job because of their lack of language abilities and qualifications toward the Danish labour market. Therefore economic incentives have only minor effects on this group. It is recommended that refugees receive social assistance at the same level as native Danes for tree years. After this period their qualifications are much better and their possibilities of becoming self-supporting have improved considerably. Hence, they should be equalised with emigrates and returning native Danes.
The average income for single parents is relatively low and the labour supply for this group is relative sensitive to changes in income. The economic gain is very small for single parents receiving social assistance if they find an unskilled job. Hence, it is recommended that the earned income tax credit specifically for single parents is increased since this improves the economic incentives to find a job for this group.
It is difficult for the persons that are most exposed to live in poverty to find and hold a job. A firm attachment to the ordinary labour market is the best way to deter people from marginalization. It is possible within the collective agreements to employ workers on special terms, e.g. lower wage rates or by reduced hours of work. However, this possibility is rarely used. In order to increase the use of employment on special terms, it is recommended that a temporary public subsidy is given to this type of employment. The specific terms are negotiated locally. An alternative is to prescribe a lower starting wage rate for new immigrants and persons on long term social assistance for a defined period.
A wage subsidy to people on social assistance is also a remedy to secure a more firm attachment to the labour market for this group. It is recommended that receivers of social assistance with modest qualifications are employed with a wage subsidy as fast as possible.
If it is possible to integrate the poor into the labour market, poverty is reduced and labour supply increased. Hence, society gains from preventing and reducing poverty. |
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