EX-99.C 2 a07-24743_1ex99dc.htm EX-99.C

Exhibit 99.c

 

Appendix 1

 

Sweden’s Economy

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2



 

 

Appendix 1

 

Sweden’s Economy

 

Contents

 

Preface

 

9

 

 

 

 

 

Summary

 

9

 

 

 

 

 

1

The global economy

 

11

 

1.1

United States

 

12

 

1.2

Euro area

 

14

 

1.3

Asia

 

16

 

1.4

Oil prices

 

18

 

 

 

 

 

2

Financial markets

 

19

 

2.1

Outside Sweden

 

19

 

2.2

Sweden

 

21

 

 

 

 

 

3

Swedish demand and output

 

24

 

3.1

Exports

 

25

 

3.2

Investment

 

27

 

3.3

Stockbuilding

 

30

 

3.4

Household consumption

 

31

 

3.5

General government consumption

 

34

 

3.6

Imports

 

35

 

3.7

Output

 

37

 

3.8

Current account

 

39

 

3.9

GNI

 

39

 

 

 

 

 

4

Labour market, wages, inflation and resource utilisation

 

43

 

4.1

Labour market

 

47

 

4.2

Wages

 

57

 

4.3

Inflation

 

61

 

 

 

 

 

5

General government sector

 

65

 

5.1

General government finances

 

65

 

5.2

Fiscal policy targets

 

70

 

5.3

Fiscal policy

 

74

 

5.4

Central government sector

 

76

 

5.5

Pension system

 

78

 

5.6

Local government

 

79

 

 

3



 

 

6

Alternative scenarios

 

82

 

6.1

Base scenario

 

82

 

6.2

High-growth scenario

 

82

 

6.3

Low-growth scenario

 

83

 

 

 

 

 

7

Forecast evaluation

 

85

 

7.1

Ministry of Finance forecasts

 

85

 

7.2

Comparison with other forecasters

 

87

 

7.3

Comparison with the preceding forecast

 

89

 

 

 

 

 

Tables Appendix

 

91

 

Tables Chapter 1 The global economy

 

91

 

Tables Chapter 2 Financial markets

 

92

 

Tables Chapter 3 Swedish demand and output

 

93

 

Tables Chapter 4 Labour market, wages, inflation and resource utilisation

 

97

 

Tables Chapter 5 General government sector

 

99

 

 

 

 

 

Explanatory boxes

 

 

 

Revised method for calculating the wallet version of household disposable income

 

32

 

Long-term impact of the government’s policies

 

40

 

Potential GDP and the output gap

 

46

 

Labour supply and employment

 

54

 

2007 wage round

 

58

 

4



 

Tables

 

Selected statistics

 

10

Table 1.1 GDP, inflation, unemployment and world market demand

 

11

Table 2.1 Interest and exchange rate assumptions

 

23

Table 3.1 Demand and output

 

24

Table 3.2 Exports of goods and services and change in export prices

 

26

Table 3.3 Investment

 

28

Table 3.4 Household disposable income

 

31

Table 3.5 Imports of goods and services and change in import prices

 

36

Table 3.6 Business sector output

 

37

Long-term impact of the government’s economic policies

 

42

Table 4.1 Selected statistics

 

43

Table 4.2 Employment trends by sector and contributions to total employment change in 2006

 

47

Table 4.3 Participants in labour market policy programmes

 

48

Table 4.4 New start jobs

 

49

Central agreements and wage outcomes 2001–2006

 

59

Table 4.5 Consumer prices

 

64

Table 5.1 General government net lending

 

65

Table 5.2 General government finances

 

65

Table 5.3 Taxes and charges

 

67

Table 5.4 Regulatory changes in the tax system; gross effects compared to preceding year

 

69

Table 5.5 General government expenditure

 

70

Table 5.6 Net lending in general governmnet

 

71

Table 5.7 Net lending: moving average for seven years excluding premium pension system

 

73

Table 5.8 Central government expenditure ceiling

 

74

Table 5.9 Indicators of stimulus to demand

 

75

Table 5.10 Central government finances

 

76

Table 5.11 Central government net lending and budget balance

 

76

Table 5.12 Budget balance and central government debt

 

78

Table 5.13 The old-age pension system

 

79

Table 5.14 Taxes and central government grants

 

79

Table 5.15 Central government grants according to the National Accounts

 

80

Table 5.16 Local government sector finances

 

80

Table 6.1 Selected statistics, base scenario

 

82

Table 6.2 Selected statistics, high-growth scenario

 

83

Table 6.3 Selected statistics, low-growth scenario

 

84

Table 7.1 Ministry of Finance forecasts and outcome for 2006

 

85

Table 7.2 Average absolute forecast error for GDP-growth

 

88

Table 7.3 Ministry of Finance forecasts for 2007 in the Budget Bill for 2007 and the 2007 Spring Fiscal Policy Bill

 

90

GDP

 

91

Unemployment

 

91

Inflation

 

91

Interest and exchange rate assumptions, year-end

 

92

Interest and exchange rate assumptions, annual average

 

92

Demand and output

 

93

Contribution to GDP growth

 

93

 

5



 

Exports and imports of goods and services and change in prices

 

94

Gross fixed capital formation

 

94

Household income and savings

 

95

Business sector output

 

95

General government output

 

96

Current account balance

 

96

Components of saving

 

96

Gross national income (GNI)

 

96

General government finances

 

99

Central government finances

 

100

The old-age pension system

 

100

Local government finances

 

101

 

6



 

Figures

 

Figure 1.1 GDP-growth in key countries

 

12

Figure 1.2 Housing starts and Housing Market Index (HMI)

 

12

Figure 1.3 Housing investment as a percentage of GDP

 

13

Figure 1.4 Industrial output and capacity utilisation

 

14

Figure 1.5 Inflation in the euro area

 

15

Figure 1.6 Unemployment and unit labour costs

 

16

Figure 1.7 Chinese GDP growth by quarter

 

17

Figure 1.8 Inflation in Japan

 

18

Figure 1.9 Price of Brent crude

 

18

Figure 2.1 Ten-year bond yields in Germany, the United States, Japan and Sweden

 

19

Figure 2.2 Key interest rates in the euro area, Sweden and the United States

 

20

Figure 2.3 U.S. dollar against the yen and euro

 

20

Figure 2.4 Equity market performance in the euro area, the United States, Japan and Sweden

 

21

Figure 2.5 Spread between ten-year bond yields in Sweden and Germany

 

21

Figure 2.6 Repo rate and uncertainty range

 

22

Figure 2.7 TCW exchange-rate index

 

22

Figure 3.1 GDP

 

24

Figure 3.2 World market growth and growth in Swedish exports

 

25

Figure 3.3 Unit labour cost in Swedish industry compared to 14 OECD countries

 

26

Figure 3.4 Investment

 

27

Figure 3.5 Investment as a percentage of GDP

 

27

Figure 3.6 Capacity utilisation in the industrial sector

 

27

Figure 3.7 Housing starts

 

29

Real disposable income – National Accounts vs. the wallet version

 

32

Figure 3.8 Household disposable income and consumption

 

33

Figure 3.9 Household debt

 

33

Figure 3.10 Household interest expenditure

 

33

Figure 3.11 Employment and household consumption

 

34

Figure 3.12 Household saving

 

34

Figure 3.13 Industrial output and exports of goods

 

37

Figure 3.14 Inflow of new orders from the export market to the manufacturing industry

 

37

Figure 3.15 Demand for private services

 

38

Figure 4.1 Output gap and employment gap

 

44

Figure 4.2 Employment gap, wage growth, inflation and repo rate

 

45

Figure 4.3 Participants in labour market policy programmes

 

48

Figure 4.4 Newly reported vacancies and employment

 

49

Figure 4.5 Employment and people in the labour force

 

50

Figure 4.6 Absence and employment

 

51

Figure 4.7 Labour participation by age group

 

52

Figure 4.8 Open and total unemployment

 

53

Demographic dependency ratio

 

54

Contributions to employment rate variations among selected OECD countries compared to Sweden, 2005

 

54

Figure 4.9 Employment gap and wage growth

 

57

Figure 4.10 Nominal and real wage growth

 

57

 

7



 

Figure 4.11 Consumer prices

 

61

Figure 4.12 Effects on CPI inflation of prices for various goods and services

 

61

Figure 4.13 Hourly wage and inflation

 

62

Figure 4.14 Exchange rate and imported inflation

 

62

Figure 4.15 Oil price in USD and SEK and petrol in the CPI

 

63

Figure 5.1 Net lending, revenue and expenditure

 

65

Figure 5.2 Consolidated gross debt

 

67

Figure 5.3 Central government debt 2000—2050, excluding proceeds from sales

 

71

Figure 5.4 Local government sector finances

 

81

Figure 7.1 Average absolute forecast errors for 2006

 

87

Figure 7.2 Average absolute forecast errors related to GDP

 

88

Figure 7.3 Average absolute errors and average errors for unemployment 1997–2006

 

89

 

8



 

Preface

 

This appendix to the 2007 Spring Fiscal Policy Bill presents the Ministry of Finance’s global and Swedish economic forecast for 2007 and 2008, as well as an estimate for 2009 and 2010 based on the assessed level of resource utilisation and potential economic growth.

 

The forecast is based on data from institutions such as Statistics Sweden (SCB), the European Commission and the Swedish National Institute of Economic Research (NIER). The Ministry of Finance has full responsibility for the assessments presented here. Henrik Braconier, director at the Ministry of Finance, is responsible for the calculations. The appendix proceeds from information available on 29 March 2007. The announced inquiry concerning repeal of the property tax has not been taken into consideration.

 

Summary

 

Fuelled by several years of expansionary monetary policy in the OECD area and historically low long-term interest rates, the global economy has grown rapidly in recent years. Although monetary policy has gradually tightened, the low rates are still contributing to rising demand. Global economic growth is expected to slow down in 2007 and 2008 but remain brisk. Continued labour market strength is setting the stage for rapid increases in household consumption. But global investment growth is likely to decelerate. Despite a long period of strong economic growth, global inflation has been modest and is expected to remain so in the next few years.

 

Rapidly rising demand in the United States over the past three years has accounted for a considerable share of global economic growth. While U.S. economic growth is set to taper off in 2007, steady ongoing growth in Asia and Europe should cushion the impact. But if the U.S. housing market declines further and has ripple effects, global economic growth may be less vigorous than anticipated by this forecast. The alternative scenario presented in Chapter 6 illustrates how a steeper economic downturn in the United States would affect the Swedish economy.

 

The Swedish economy is growing rapidly for the fourth consecutive year. Economic conditions are favourable, while both domestic and foreign demand for Swedish goods and services is rising steadily. In 2007 and 2008, the business cycle is expected to enter a more mature phase and exports are likely to increase more gradually. Owing partly to rapid expansion of output capacity over the past few years, investment growth is also set to slow down somewhat. Housing investment is projected to level out at a high plateau in the next few years.

 

Meanwhile, household consumption is set to increase very rapidly in the next few years as the result of a solid wealth position, rising real wages and robust employment growth, as well as the significant tax cuts that have been adopted and announced. Partly due to the fact that local government finances are sounder than they have been for a long time, general government consumption should also increase substantially in 2007 and 2008.

 

Given brisk demand growth and a stronger Swedish krona, imports are likely to increase at a steady pace in 2007 and 2008. GDP is forecast to rise by 3.7 per cent this year and 3.3 per cent next year. Calendar-adjusted GDP growth, which excludes the impact of the number of working days, is expected to be 3.9 per cent in 2007 and 3.2 per cent in 2008. Due to a high level of resource utilisation, actual GDP growth is projected to slow to 2.1 per cent in 2009 and 2.3 per cent in 2010.

 

Employment has been recovering steadily since Sweden’s robust economic growth caused a turnaround in the labour market in 2005. Continuation of rapid demand growth in Sweden will pave the way for rising employment in 2007 and 2008 as well. The cyclical labour market recovery has boosted labour supply. The measures that the government has already adopted to stimulate labour supply, combined with the reforms announced in this bill, should contribute to a steady expansion of supply during the period 2007–2008. Expanding labour supply is essential in order achieve a sustainable increase in the level of regular employment. The alternative scenario presented in Chapter 6 assumes that the reforms to increase labour supply will have a considerably greater impact than anticipated by this forecast. The scenario illustrates how structural reforms can generate economic growth, employment and stronger public finances.

 

 

9



 

 

Notwithstanding the forecast expansion of labour supply, brisk employment growth should lead to rapid resource utilisation increases in the total economy. Particularly in view of considerable uncertainty about the economic impact of the government’s supply-stimulating policies, projecting resource utilisation is a difficult task. If labour supply does not expand faster than this forecast anticipates and demand continues to exhibit strong growth, the economy may be in danger of overheating during the next few years. A number of indicators suggest that the Swedish business cycle is in a phase at which wage and price increases will begin to accelerate. The incipient manpower shortage makes it even more important to stimulate labour supply.

 

Despite the rapid expansion of labour supply, strong employment growth in 2006 led to lower unemployment. Open unemployment is expected to decline further in 2007 and 2008. Total unemployment, which also includes people participating in labour market policy programmes, is set to decrease substantially in both 2007 and 2008. Employment is expected to grow slower in 2009 and 2010 in the wake of a high level of resource utilisation, while open unemployment remains at just above 4 per cent. The regular employment rate is projected to rise throughout the forecast period and reach 75.6 per cent for the 16–64 age group in 2010.

 

General government finances have strengthened in the past few years. Excluding premium pension savings, general government net lending was 2.1 per cent of GDP in 2006. Steady economic growth provides the fiscal latitude to adopt tax cuts and other reforms without leaving public finances weaker than 2006. Tax cuts previously adopted and currently proposed will substantially reduce tax receipts as a percentage of GDP. Because expenditures will decrease by the same approximate percentage, general government net lending will remain virtually unchanged at just over 2 per cent of GDP in 2007–2008. In 2009–2010 general government net lending will strengthen gradually. The surpluses should continue to bolster the general government sector’s financial position. Moreover, gross debt will shrink as a result of the planned divestments of state shareholdings. Consolidated gross debt is projected at 27.0 per cent of GDP in 2010.

 

Selected statistics

 

Percentage change, unless otherwise stated

 

 

 

2006

 

2007

 

2008

 

2009

 

2010

 

GDP

 

4.4

 

3.7

 

3.3

 

2.1

 

2.3

 

GDP, calendar adjusted

 

4.7

 

3.9

 

3.2

 

2.1

 

2.0

 

Number of employed

 

1.8

 

2.3

 

0.9

 

0.1

 

-0.1

 

Regular employment rate, 16-64 years(1)

 

73.5

 

75.0

 

75.6

 

75.7

 

75.6

 

Regular employment rate, 20-64 years(1)

 

77.7

 

79.4

 

80.2

 

80.3

 

80.1

 

Open unemployment(2)

 

5.4

 

4.7

 

4.1

 

4.2

 

4.2

 

Total unemployment(2),(3)

 

8.4

 

6.7

 

6.2

 

6.1

 

6.2

 

Labour market policy programmes(4)

 

138

 

95

 

95

 

90

 

90

 

Wage growth(5)

 

3.1

 

4.0

 

4.3

 

4.5

 

4.4

 

UND1X, yearly average

 

1.2

 

0.8

 

1.5

 

2.2

 

2.2

 

CPI, yearly average

 

1.4

 

1.8

 

2.3

 

2.7

 

2.5

 

General government net lending(6),(7)

 

2.1

 

2.3

 

2.2

 

2.5

 

3.2

 

Taxes and charges(6),(8)

 

49.8

 

47.7

 

47.2

 

47.3

 

47.3

 

General government expenditure(6)

 

52.7

 

50.9

 

50.3

 

49.9

 

49.1

 

Consolidated gross debt(6)

 

46.9

 

40.9

 

36.6

 

32.2

 

27.0

 

 


(1)       Number of employed in the age group, excluding employed in labour market policy programmes, as per cent of population in the age group.

(2)       Per cent of labour force.

(3)       Number of people in open unemployment and in labour market policy programmes.

(4)       Number of people in labour market policy programmes, thousands.

(5)       Short-term wage statistics.

(6)       Per cent of GDP.

(7)       Excluding premium pension savings.

(8)       Including taxes to EU.

Sources: Statistics Sweden, National Labour Market Board, National Mediation Office and Ministry of Finance.

 

10



 

1         The global economy

 

Robust global growth

 

World GDP grew by an estimated 5.2 per cent in 2006. From an historical perspective, the global economy has grown very quickly for four consecutive years. While global growth is expected to weaken somewhat in the next two years, a number of indicators point to only a modest slowdown to 4.6 per cent in 2007 and 4.5 per cent in 2008. Due primarily to a recovery in the United States, global growth is likely to accelerate somewhat to 4.7 per cent in 2009, followed by 4.5 per cent in 2010.

 

Investment activity will taper off

 

The global economy is still exhibiting moderate inflation, high corporate profits and historically low bond yields. Modest inflation expectations and low interest rates are paving the way for investment activity to remain brisk. However, investment activity is expected to taper off somewhat after several years at a high level.

 

Table 1.1 GDP, inflation, unemployment and world market demand

 

Percentage change, unless otherwise stated

 

 

 

2006

 

2007

 

2008

 

2009

 

2010

 

GDP

 

 

 

 

 

 

 

 

 

 

 

World

 

5.2

 

4.6

 

4.5

 

4.7

 

4.5

 

United States

 

3.3

 

2.2

 

2.6

 

3.3

 

3.0

 

Japan

 

2.2

 

1.8

 

1.9

 

2.0

 

2.0

 

Euro area

 

2.6

 

2.2

 

2.1

 

2.0

 

2.0

 

CPI(1)

 

 

 

 

 

 

 

 

 

 

 

United States

 

3.2

 

1.8

 

2.6

 

2.8

 

2.9

 

Japan

 

0.2

 

0.6

 

0.9

 

1.2

 

1.5

 

Euro area

 

2.2

 

2.0

 

2.0

 

1.9

 

1.9

 

Unemployment, percentage of labour force(2)

 

 

 

 

 

 

 

 

 

 

 

United States

 

4.6

 

4.8

 

5.3

 

5.2

 

5.1

 

Japan

 

4.1

 

3.9

 

3.7

 

3.7

 

3.7

 

Euro area

 

7.9

 

7.4

 

7.4

 

7.5

 

7.5

 

World market demand(3)

 

9.8

 

6.3

 

6.4

 

7.0

 

6.9

 

 


(1)       HICP for the euro area and CPI for the United States and Japan.

(2)       Eurostat definition for euro area and national definition for the United States and Japan.

(3)       World market demand measures the weighted import demand in all countries to which Sweden exports.

Sources: National sources, Eurostat and Ministry of Finance.

 

Buoyed by a brighter outlook for the labour market, consumption is expected to grow steadily in 2007 and 2008. Unemployment in both the United States and the euro area is as low as it was around 2000. The oil price decline in autumn 2006 has provided additional latitude for household consumption.

 

Soft landing in the United States

 

The cooling U.S. housing market in autumn 2006 led to rapidly falling housing investments, significantly restraining GDP growth in the latter half of the year. But spurred by favourable labour market trends and falling oil prices, household consumption remains solid. Ripple effects from the housing market to other economic sectors have been limited so far.

 

As unemployment rises in the wake of lower gross fixed capital formation, the weaker housing market is likely to have a greater impact on household consumption. But the economic slowdown is forecast to be temporary. Most of the correction in the housing market should be over sometime in 2008. As the impact of lower gross capital formation in housing subsides in 2008, the U.S. economy is expected to recover.

 

Growth in the euro area and Asia will decelerate

 

The slowdown of the U.S. economy is likely to have relatively few repercussions on the rest of the world. As opposed to the global economic downturn around 2000, more modest growth in the United States is the result of specific domestic factors that have relatively little impact on imports. The danger of ripple effects in terms of reduced lending and rising risk premiums appears to be limited.

 

Both the euro area and Asia have been resistant so far – they are expected to grow above trend in both 2007 and 2008. But the slowdown in the United States and weaker investment activity are forecast to moderate growth, which will be fuelled more by domestic consumption, in those two regions. Lower household saving and a significantly better labour market are set to stimulate euro area consumption in both 2007 and 2008. While Asian growth has been largely driven by rapidly increasing exports, the trend

 

11



 

toward greater dependence on domestic demand is likely to continue in 2007 and 2008.

 

Figure 1.1 GDP-growth in key countries

 

Annual percentage charge

 

 

Sources: National sources, Eurostat and Ministry of Finance.

 

Global risk outlook

 

Although the base scenario is for a soft landing of the global economy, the downside risks are considerable. Among the primary risks in this forecast is the slowdown in the United States. If the correction in the housing market is more pronounced than anticipated, the ripple effects on the rest of the economy will be more evident as well. The result would be substantially slower growth in the United States and thereby the possibility of a palpable impact on the global economy.

 

Other risks are associated more with financial markets. Low nominal interest rates have led to a significant upswing in capital asset prices and rapidly expanding credit. A quick correction could have major repercussions on the real economy of every region.

 

Particularly in combination with rising oil prices, mounting labour costs in the wake of a tighter labour market and a higher level of resource utilisation could substantially increase inflationary pressure. A poorer economic growth outlook and the need for tighter monetary policies would result.

 

While the risk is small, an abrupt correction in the international trade and current account imbalances would significantly affect the global economy.

 

1.1      United States

 

Declining housing investment restraining economic growth

 

Thanks to strong ongoing consumption growth and solid increases in the machinery investment, U.S. GDP rose by 3.3 per cent in 2006. But the slowdown in the housing market gradually moderated GDP growth during the year. Housing investment made a negative contribution to GDP growth in 2006. The weak housing market and its ripple effects on other economic sectors are expected to persist throughout 2007 and early 2008. As a result, U.S. GDP growth is likely to be considerably less vigorous than 2006 in both 2007 and 2008.

 

Housing investment decelerated throughout 2006 and was 13 per cent lower in the fourth quarter than 12 months earlier. Demand for new housing has fallen considerably since mid-2005, while the number of completed, unsold units has risen. In February 2007, fewer new units were sold than at any time since 1997 and housing starts sank to their lowest level since 1991.

 

Figure 1.2 Housing starts and Housing Market Index (HMI)

 

 

Source: National Association of Home Builders.

 

The Housing Market Index (HMI) fell sharply in 2006. But more stable HMI trends in late 2006 and early 2007 suggest that the housing market has already started to adjust. The fact that the index is still far below 50 indicates that the residential construction market remains weak.

 

The number of completed, unsold units is expected to decrease as housing starts taper off. But the housing investment as a percentage of GDP is far above the historical average, and it will take at least a year for the housing surplus to

 

12



 

be offset. Thus, housing investment is forecast to decline by almost 14 per cent in 2007 and not start recovering until early 2008.

 

Figure 1.3 Housing investment as a percentage of GDP

 

 

Source: US Department of Commerce.

 

Recent, widely discussed problems in the sub-prime mortgage market have led to greater uncertainty about the magnitude of the U.S. economic slowdown in 2007. Because more and more people with subprime mortgages are having trouble making payments, many lenders have declared bankruptcy. Falling house prices and rising mortgage rates have probably caused these problems. It is not inconceivable that the impact on house prices will thereby increase and detrimentally affect household consumption even more than anticipated by the base scenario of this forecast.

 

Changes in the housing market will depress consumption

 

Given that household consumption accounts for approximately 70 per cent of U.S. GDP, it has a major impact on economic growth. Rising house prices, along with steady income and employment growth, have helped boost household consumption by an annual average of 3.5 per cent in the past three years. But partly due to the impact of the weak housing market, household consumption is expected to grow a good deal slower in 2007 and 2008.

 

The housing surplus has begun to moderate price increases for existing units, and house prices are even falling in some regions. Because household net worth and the latitude for debt-financed consumption decrease along with house values, household consumption is likely to taper off as well. The decrease in housing construction is also likely to weaken employment, thereby detrimentally affecting consumption in 2007 and 2008. As much as one third of employment growth over the past three years is estimated to have been associated with changes in the real estate market. Lower household saving could offset lower real net worth. But the saving ratio of U.S. households is already negative, and declining net worth points to higher saving instead. Weaker income trends as the result of slower employment and economic growth should also restrain increases in household consumption.

 

Lower industrial activity

 

The U.S. industrial sector is in a more fragile position than many other major industrialised nations. Sales have been low in relation to inventories since late 2006, and new orders have tapered off. Industrial output has slowed down as a result. Industrial activity is being squeezed by weak demand in sectors that are dependent on the housing market, competition problems in the auto industry and other developments. Thus, industrial activity is expected to remain less vigorous in 2007. But strong global demand and the cheaper dollar, factors that favour U.S. exporters, are set to counteract weak domestic demand. As a result, exports are expected to grow at a healthy pace in both 2007 and 2008, albeit not as fast as 2006. Meanwhile, import growth is likely to decelerate in the wake of poorer domestic demand. Thus, the contribution of net exports to GDP growth is forecast to be slightly positive in 2007.

 

As the economic outlook for the industrial sector dims, lower profits and decreasing capacity utilisation are likely to ensue. Thus, the machinery investment in the industrial sector is also expected to grow slower than 2006 in both 2007 and 2008.

 

13



 

Figure 1.4 Industrial output and capacity utilisation

 

 

Sources: Federal Reserve och Federal Reserve Board.

 

The weak housing market and industrial activity have already restrained service sub-sectors that depend on orders from them. Taking slower consumption growth into consideration as well, the result is likely to be persistence of the dimmer outlook for the service sector in 2007.

 

GDP growth below potential growth in both 2007 and 2008

 

The downturn in the U.S. housing market and the ripple effects it is expected to have on consumption and other factors are likely to considerably depress GDP growth in 2007 to well below the potential growth estimate of approximately 3 per cent. The correction in the housing market is projected to be over sometime in 2008, at which point housing investment should begin to gradually recover. Other economic sectors, including household consumption, would benefit. Monetary policy is also likely to stimulate the U.S. economy in 2008. Owing to the accelerating economic downturn, the Federal Reserve is expected to start lowering the federal funds rate in the latter half of the year. While GDP growth is thereby forecast to be somewhat stronger in 2008 than 2007, it is unlikely to match potential growth until 2009.

 

As employment growth wanes and demand rises slower, inflationary pressure is expected to ease in 2007. But given somewhat stronger economic growth, inflation should pick up speed in 2008.

 

1.2      Euro area

 

Growth finally increasing

 

Euro area GDP grew in 2006 by 2.6 per cent, the highest in six years. A large percentage of the improvement can be traced to the considerably stronger German economy.

 

Economic growth is expected to lose some momentum in 2007 and 2008 in the wake of weaker global demand, fiscal austerity and a less expansionary monetary policy. But the slowdown is forecast to be modest, leaving GDP growth at 2.2 per cent in 2007 and 2.1 per cent in 2008.

 

Germany strongest of the EU big three

 

Euro area GDP growth accelerated considerably in the fourth quarter of 2006. GDP was 0.9 per cent above the third quarter and 3.3 per cent above the fourth quarter of 2005. The increase was propelled in equal measure by rapid export growth late in the year and ongoing improvement in domestic demand. Foreign trade contributed 0.8 percentage points and domestic demand contributed 0.7 percentage points to GDP growth, while a substantial decrease in inventories made a negative contribution.

 

The biggest economies of Germany, France and Italy (EU big three) have averaged 1.7 per cent annual GDP growth over the past ten years, as opposed to 3.7 per cent for the other euro countries. France has enjoyed the most rapid growth of the EU big three during most of that time. But Germany has pulled into the lead since early 2005, while Italy is lagging further and further behind.

 

German investment activity tapered off in mid-2006 and is expected to continue doing so in 2007 as the result of weaker global demand and lower capacity utilisation. Closer trade relations with new EU Member States and Eastern Europe have favoured German exports. In contrast to most other euro countries, Germany’s share of world trade has increased in recent years. Several years of cost-cutting by the business sector have improved competitiveness and substantially lowered unit labour costs.

 

14



 

French GDP growth has been driven more by a rapid upturn in consumption, while industrial activity has moderated considerably. Favourable labour market trends are paving the way for a continuation of healthy economic growth in 2007 and 2008. But due to mounting competition problems and more feeble consumption, the deceleration of Italian GDP growth will be more evident during that period.

 

Common to virtually all euro countries is high business confidence in the manufacturing industry. Expectations for the future dimmed somewhat in autumn 2006 but remain optimistic. New orders are still brisk, while manpower requirements have decreased somewhat. All in all, the confidence indicators point to a modest slowdown in industrial output in 2007.

 

Consumption recovering

 

Greater household consumption is vital to the persistence of strong GDP growth in 2007 and 2008. Consumption has been one of the main drivers of economic expansion in countries such as Spain and France that experience favourable employment growth and rising housing prices. However, consumption has contributed only modestly to euro area GDP growth as a whole. But largely due to an increase in Germany as well, euro area consumption grew more rapidly in 2006 than at any time since 2001. The weaker global economy notwithstanding, a number of indications suggest that consumption growth in the euro area will persist in 2007 and 2008. The number of employed workers has increased significantly, and consumer confidence is at its highest point in five years. As public finances strengthen, precautionary saving by households is expected to decrease and provide additional latitude for consumption.

 

As a result of the VAT hike from 16 per cent to 19 per cent that took effect in January 2007, German consumption growth is forecast to slow down temporarily this year. The acceleration of consumption expected in 2006 barely manifested. Although retail sales (particularly new cars) were up substantially during the fourth quarter, the overall impact was small. Given a considerable improvement in the labour market and rising consumer confidence, the 2007 slowdown stemming from the VAT hike is expected to be short-lived and relatively modest in terms of both consumer prices and consumption.

 

Inflation more modest in 2007

 

Falling energy prices moderated inflation considerably in autumn 2006. But inflation speeded up again in early 2007. Measured as the Harmonised Consumer Price Index (HICP), inflation was up from 1.6 per cent in October 2006 to 1.8 per cent in February 2007.

 

Core inflation (HICP excluding energy and unprocessed food) has risen sharply since the end of 2006. As a result, the difference between aggregate HICP inflation and core inflation has evaporated. Core inflation was 1.9 per cent in February 2007.

 

Figure 1.5 Inflation in the euro area

 

 

Sources: Eurostat.

 

Much of the rate of growth in core inflation is due to the German VAT hike, as the result of which inflation (excluding energy prices) in Germany rose from 1.2 per cent in December 2006 to 1.8 per cent in February 2007.

 

Inflation of 2.2 per cent in 2006 was above the ECB inflation target for the seventh consecutive year. Because the impact of earlier oil price hikes will drop out of the 12-month comparisons this summer, the energy component of the consumer price index will hold down inflation until midyear. The combination of lower energy prices and tighter monetary policy is expected to push inflation down to 2.0 per cent in 2007 and 2008.

 

When will wage growth take off?

 

The 7.4 per cent unemployment rate at the beginning of 2007 was lower than the high-growth years around 2000. The decrease in the number of jobless workers is forecast to taper off, leaving

 

15



 

the unemployment rate at approximately 7.4 per cent in both 2007 and 2008.

 

A key difference between now and the period around 2000 is that a considerably improved labour market has not accelerated wage growth. One possible reason is that the labour market reforms adopted in recent years have held down equilibrium unemployment. A less auspicious explanation may be that there is a greater time lag between a tighter labour market and its impact on wages than was previously the case. If that is true, wage growth is likely to accelerate considerably in 2007 once the euro area business cycle enters a more mature phase. But global competition and the ECB’s interest rate policy are likely to restrain wage increases.

 

Figure 1.6 Unemployment and unit labour costs

 

 

Sources: Eurostat.

 

1.3      Asia

 

Increasingly integral to the global economy

 

Many years of very rapid growth, particularly in China and India, have gradually increased Asia’s share of world GDP. Measured as purchasing power parity (PPP)(1), Asia’s share rose to approximately 36 per cent in 2006, as opposed to 20 per cent for the United States and 15 per cent for the euro area. As GDP rises in Asia, global growth increasingly reflects developments in the region.

 

Whereas both the U.S. and euro area economies are set to slow down in 2007, Asia still faces bright prospects of continued rapid growth over the next few years. Domestic demand is an increasingly vital driver for the entire region. Intra-Asian trade has risen, while reliance on exports to the United States has decreased. Furthermore, low inflationary pressure has opened the door to a more expansionary monetary policy if necessary. Due to strengthening public finances, fiscal policy is also becoming an increasingly viable instrument of control. The exception is India, whose tight fiscal policy will remain hostage to large government budget deficits.

 

Asian GDP increases are expected to moderate over the next two years in the wake of somewhat slower growth in China and India, as well as the newly industrialised economies of South Korea, Taiwan, Hong Kong and Singapore that will be affected by less vigorous global export demand.

 

Chinese growth will taper off but remain very high

 

Exports have been fuelling growth in China. According to the IMF, China’s share of world exports rose from 1 per cent in the early 1980s to more than 8 per cent in 2006. The advances of the export industry have generated both higher corporate profits and rising employment in the urban regions. Gross capital formation, and to a lesser extent consumption, has grown very fast as a result. Rapid credit expansion has also spurred gross capital formation, thereby increasing the risk of overinvestment and bad loans. The persistence of strong gross capital formation and export growth in 2006 contributed to a 10.7 per cent increase in GDP.

 


(1)       Measuring GDP as PPP takes differences among the purchasing power of the various countries into consideration.

 

16



 

Figure 1.7 Chinese GDP growth by quarter

 

 

Source: National Bureau of Statistics.

 

China adopted austerity measures in late 2006 aimed at restraining rapid gross capital formation and credit growth. Consisting of a lending rate hike, stronger administrative controls and higher reserve requirements, the effort made an impact and checked growth of gross capital formation somewhat at the end of the year. The moderating effect on growth of gross capital formation is expected to continue in 2007 and 2008, thereby contributing to more deliberate (but still very rapid) GDP increases. Weaker export trends as a result of more sluggish global demand growth are also set to rein in Chinese economic expansion. The country’s currency strategy of a gradual appreciation of the yuan against the dollar in order to achieve greater exchange-rate flexibility is also expected to detrimentally affect exports at the margin.

 

Expectations that GDP will grow somewhat slower are in line with China’s current five-year economic plan, which targets a long-term, economically sustainable average of 7.5 per cent a year. The idea is also for consumption and innovation to drive growth more than before. But consumption growth is unlikely to speed up within the next four years. Given the flimsy social safety net, the saving ratio among Chinese households is forecast to remain high.

 

Indian economic growth will slow down

 

Domestic demand and household consumption have historically made the biggest contributions to Indian economic growth. Partly due to rising demand by China, which accounts for approximately half of Indian export trade in Asia, exports have become an increasingly important engine of economic growth in recent years. India’s share of world GDP has risen to more than 6 per cent. Measured as PPP, only the United States, China and Japan contribute more to world GDP.

 

Indian GDP grew by 9.3 per cent in 2006. Owing to a rising level of resource utilisation, thereby restraining output in both the industrial and service sectors, economic growth is projected to taper off in 2007 and 2008. Moreover, Indian monetary policy is likely to tighten in the wake of rising inflation and rapid credit expansion. Given large government budget deficits, fiscal policy is expected to be restrictive.

 

Japan back in the game

 

While Japan has played a more modest role during the arduous years of deflation, its importance should not be underestimated. GDP growth of 2.2 per cent in 2006 reinforced the view that Japan is once more a force to be reckoned with. The Japanese economy is expected to expand somewhat slower in 2007-2008 than 2006 but remain above OECD’s estimated potential growth of 1.4 per cent. One factor contributing to more modest GDP increases is likely to be weaker growth of gross capital formation in the next two years. The significant decline in machinery orders early in 2007 will probably restrain the Japanese industrial sector’s propensity to make capital expenditures. The incipient adjustment of output capacity to demand is also holding down the machinery component of gross capital formation. Furthermore, the Bank of Japan has dropped its zero interest policy and raised its key interest rate by 50 basis points. The probable result will be additional restraint on gross capital formation at the margin.

 

Although employment has risen and unemployment declined, household consumption is forecast to grow only modestly in 2007 and 2008. Inflation, which is struggling to stay above zero, is restraining the propensity to consume. Japan had zero inflation in February 2007, and prices are expected to rise only marginally for the rest of the year.

 

17



 

Figure 1.8 Inflation in Japan

 

 

Source: Ministry of Internal Affairs and Communications.

 

Owing partly to the large percentage of part-time employees and number of workers retiring, real wage growth has also been sluggish. Wage demands and levels are lower among young workers than those who are retiring. As the labour market tightens, real wage growth is expected to accelerate but not enough for consumption to take off in earnest. Exports, the main reason that the Japanese economy has steadily strengthened since 2000, are forecast to exhibit somewhat slower growth going forward as the result of weaker import demand by its most important trading partners of China and the United States. But due partly to weaker import growth, net exports are set to continue making a positive contribution to Japanese economic expansion.

 

1.4      Oil prices

 

Oil prices hit record highs in summer 2006. Brent crude peaked at close to USD 80 per barrel in early August. Due partially to unusually warm weather in the United States, oil prices retreated late in the year. Cold weather and reduced oil inventories contributed to renewed hikes in early 2007.

 

For a number of reasons, oil prices have risen substantially since 2002. Output capacity has expanded relatively slowly since 2000, while demand for oil has risen rapidly in recent years.

 

The strong global economy has contributed to greater demand for oil. The emergence of China and India as significant net consumers of oil has helped narrow the gap between potential supply and actual demand (reserve capacity). As a result, oil prices have become increasingly vulnerable to supply disruptions and geopolitical uncertainty in oil-producing regions.

 

Figure 1.9 Price of Brent crude

 

 

Source: Reuters.

 

Global reserve capacity is expected to be limited in the short term, while demand remains strong. Thus, relatively high oil prices are expected to persist.

 

There is much to suggest that global reserve capacity will increase over the longer term. The price hikes of recent years have boosted investment in both new and existing oil fields. In the wake of a less vigorous global economy, demand is likely to taper off toward the end of the forecast period. As a result, the supply of crude is projected to rise faster than demand in the long term and thereby increase reserve capacity. Refinery capacity is also expected to expand, especially after 2009 as the OPEC countries and Asia put new capacity to use.

 

Expanding reserve capacity is likely to reduce the risk premium and thereby oil prices as well. But the price decline should be limited by the risk of geopolitical unrest and future production disruptions, as well as higher costs of oil production. Oil is projected to cost USD 60 per barrel at the end of 2007, USD 60 at the end of 2008, USD 55 at the end of 2009 and USD 50 at the end of 2010.

 

Predicting future oil prices is still associated with a great deal of uncertainty. Politically unstable countries account for an increasing percentage of production. Changes in global growth, unexpected production disruptions, and geopolitical tensions retain the potential to significantly affect oil prices.

 

18



 

2         Financial markets

 

The financial markets have been haunted recently by uncertainty about the U.S. economy. Signs of a slowdown in the United States and uneasiness about the U.S. mortgage market have contributed to a decline in international bond yields. In the light of weaker economic growth, the Federal Reserve is expected to cut the federal funds rate in the latter half of 2007. Meanwhile, the ECB and Riksbank are likely to further tighten monetary policy. The Bank of Japan is also forecast to continue raising its key interest rate, albeit slowly.

 

Expectations of future interest rate differentials among various countries have set the tone for the foreign exchange market. The prospect of narrower differentials contributed to a depreciation of the dollar against both the euro and krona in 2006. As the differentials between Sweden and the other regions narrow, the krona is expected to appreciate further.

 

Higher interest rates and a stronger krona involve tighter monetary conditions in Sweden. But the change is from an expansionary level, and interest rates are set to remain low. All in all, Swedish monetary conditions are anticipated to remain relatively expansionary.

 

2.1      Outside Sweden

 

Lower bond yields due to less risk appetite

 

Owing largely to greater uncertainty about the U.S. economy, international bond yields fell after summer 2006. Strong economic indicators in late 2006 and early 2007 raised expectations for U.S. growth, thereby contributing to rising international bond yields. Most recently, uncertainty about the U.S. economy and uneasiness about U.S. mortgage lending institutions have dogged the financial markets. The greater risk aversion stemming from that uncertainty has caused capital flight from investment options with lower creditworthiness to government bonds, thereby helping to push down bond yields. Generally speaking, both Swedish and international bond yields are at historically low levels.

 

Figure 2.1 Ten-year bond yields in Germany, the United States, Japan and Sweden

 

 

Source: Reuters.

 

Flatter yield curve

 

As short-term bond yields have continued to climb while long-term yields have declined since the beginning of 2007, the yield curve(2) has flattened. The yield on the 10-year U.S. Treasury note is lower than on short-term bills. In the past, such conditions have often signalled an impending economic downturn.


(2)                     The yield curve describes the relationship between the yields on treasury bills and bonds of various maturities.

 

Given the various structural explanations for the low bond yields, whether that historical relationship still holds true today is a matter of speculation. One explanation stems from new rules for pension funds, leading to greater demand for long-term bonds. Increased confidence in the inflation targets of central banks has probably contributed to a decrease in the term premium – in other words, investors are demanding less compensation for holding long-term bonds because they believe that inflation is now less volatile. An increase in world net saving, particularly in the newly industrialised Asian economies and other emerging economies, has presumably helped depress bond yields as well.

 

Recent short-term interest rate hikes by the ECB and Bank of Japan also explain the flat shape of the yield curve.

 

European and Japanese bond yields are expected to increase in the wake of strong economic growth, greater resource utilisation, rising inflation and higher short-term interest rates. Because the U.S. curve is likely to acquire a positive slope, yields are predicted to increase

 

 

 

19



 

 

marginally in the United States as well. Several factors point to generally higher international interest rates in the longer term. Globalisation has contributed to an expansion of global labour supply. The higher gross capital formation required by such an expansion should add impetus to rising interest rates. Moreover, the high level of household saving in Asian countries is set to subside as incomes rise and social safety nets improve.

 

This forecast anticipates a yield of 4.80 per cent on the 10-year U.S. Treasury note and 4.30 per cent on its German counterpart at the end of both 2007 and 2008.

 

ECB will continue tightening while the Federal Reserve cuts federal funds rate

 

The Federal Reserve has left the federal funds rate at 5.25 per cent since summer 2006. Due to the strength of U.S. economic indicators at the end of 2006, prices of forward contracts indicated that the Federal Reserve would tighten monetary policy. But the slowdown in U.S. GDP growth during the first quarter of 2007 changed prices of forward contracts, which now point to a cut in the federal funds rate to 4.75 per cent by the end of 2007. This forecast anticipates that the signs of weaker economic growth will be pivotal to the Federal Reserve’s decisions. The prediction is that the federal funds rate will be cut this year and decrease from the 4.75 per cent figure in December 2007 to 4.5 per cent in December 2008.

 

The ECB has continued to tighten monetary policy, raising its key interest rate by 2 percentage points to 3.75 per cent since December 2005. The ECB’s moves have been motivated by the fact that inflation and money supply growth, the two pillars of its monetary policy strategy, have been above the target level. Rapid, persistent price increases can increase the inflation expectations of households and undermine their confidence in the target, thereby spurring wage growth. Due partly to strong growth in lending to households, money supply is continuing to expand rapidly. Meanwhile, the recent strengthening of the European economy points to additional hikes in the ECB’s key interest rate. The ECB has been signalling that it plans to gradually raise the rate toward a more neutral level – this forecast anticipates 4.0 per cent at the end of both 2007 and 2008.

 

Responding to the recent palpable strength of the real Japanese economy, the Bank of Japan has raised its key interest rate by 50 basis points since summer 2006. Core inflation has also risen, though remaining low. This forecast anticipates that the Bank of Japan will continue raising its key interest rate, albeit slowly.

 

Figure 2.2 Key interest rates in the euro area, Sweden and the United States

 

 

Sources: ECB, Riksbank and Federal reserve.

 

Dollar will weaken further

 

Strong U.S. economic indicators in late autumn 2006 temporarily shored up the dollar. Weaker indicators recently have raised expectations that the Federal Reserve will cut the federal funds rate during the course of 2007. The prospect of lower positive interest rate differentials vis-à-vis other currency areas has sapped the dollar’s strength once again.

 

Figure 2.3 U.S. dollar against the yen and euro

 

 

Source: Reuters.

 

The dollar is likely to depreciate further as growth and interest rate differentials narrow. This forecast anticipates that the dollar will fall

 

20



 

to 1.35 against the euro and 115 against the yen at the end of 2007, followed by 1.35 against the euro and 110 against the yen at the end of 2008.

 

Carry trades

 

Carry trades have had a major impact on the foreign exchange market in recent years. A carry trade involves borrowing in a low-interest currency to invest in higher yielding assets. A similar transaction is available in the currency futures market. The principle is the same – to take advantage of the interest rate differential between two countries. The theory posits that systematic generation of profits on interest rate arbitrage is impossible, but that the differentials should manifest in the simultaneous appreciation of low-interest currencies and depreciation of high-interest currencies. Nevertheless, such arbitrage trading has periodically generated profits and affected the foreign exchange market. The yen has gradually depreciated against the dollar and euro over the past two years. Traders have been borrowing in yen at low interest rates to invest in higher yielding dollar and euro assets. Low Japanese interest rates have further depressed the yen. A carry trade can be undermined by altered monetary conditions. Recent economic indicators suggest that Japanese growth has accelerated, and the Bank of Japan raised its key interest rate in February 2007. Changes in monetary policy can quickly affect currency flows and exchange rate levels. Nevertheless, the Bank of Japan is expected to raise its key interest rate at a deliberate pace.

 

Equity markets are more volatile

 

The major world stock indices have been more volatile recently. Uncertainty about U.S. economic growth and uneasiness about U.S. mortgage lending institutions have contributed to substantial movements on world equity markets. Whether a temporary correction or a more sustained bear market is under way after almost four years of a bull market remains to be seen.

 

Swedish firms reported generally higher profits for the fourth quarter of 2006 than analysts had predicted. However, the consensus estimate is that profits will decline somewhat going forward. Both the U.S. and European equity markets are undervalued in comparison with the bond market. But rising interest and labour costs may squeeze the margins of firms in the longer term.

 

Figure 2.4 Equity market performance in the euro area, the United States, Japan and Sweden

 

 

Source: Reuters.

 

2.2      Sweden

 

After the yield on 10-year Swedish government bonds rose in late 2006, long-term yields have retreated in line with international trends. But given the favourable economic conditions, bond yields are still low.

 

Figure 2.5 Spread between ten-year bond yields in Sweden and Germany

 

 

Source: Reuters.

 

Since May 2005, 10-year Swedish government bonds have been in the historically unusual position of yielding less than their German equivalent. The fact that the Riksbank’s repo rate has been lower than the ECB’s key interest rate during that period provides most of the explanation. In addition, new rules for pension funds

 

21



 

have stimulated demand for long-term Swedish bonds. Meanwhile Sweden’s shrinking, relatively small central government debt is limiting the supply of long-term government bonds.

 

This forecast anticipates that Swedish bond yields will rise in both 2007 and 2008 as available economic resources dwindle and monetary policy becomes less expansionary. Swedish bond yields are expected to increase somewhat more than their German equivalents in 2008 as the spread between the Riksbank’s repo rate and the ECB’s key interest rate narrows. The yield on 10-year Swedish government bonds is projected at 4.05 per cent in December 2007, 4.65 per cent in December 2008 and 4.85 per cent in December 2009.

 

Riksbank continuing to raise the repo rate

 

The Riksbank is continuing to tighten monetary policy. Its repo rate hikes from 1.5 per cent to 3.25 per cent since 2006 are likely to be followed by more. Despite strong economic growth, Swedish inflation is low. Thus, the spread between the repo rate and inflation has widened. Inflation remains below the Riksbank’s target. But underlying inflation, as measured by the Riksbank’s UND1X index, is expected to rise during the latter half of the year to 0.8 per cent at the end of 2007, 1.9 per cent at the end of 2008 and 2.4 per cent at the end of 2009 (see Section 4.3 on inflation).

 

Figure 2.6 Repo rate and uncertainty range

 

 

Sources: Riksbank and Ministry of Finance.

 

The Ministry of Finance issues its repo rate forecast with an uncertainty range based on its past forecast errors.(3) The present forecast anticipates gradual hikes in the repo rate over the next few years. Ongoing employment growth is expected to contribute to more rapid wage increases and higher resource utilisation. The forecast anticipates a repo rate of 3.5 per cent at the end of 2007, 4.5 per cent at the end of 2008, 4.75 per cent at the end of 2009 and 4.25 per cent at the end of 2010.


(3)                     The deviations are based on forecasts in the 1998-2006 Spring Fiscal Policy Bills.

 

Krona will appreciate

 

Due primarily to the prospect that the Riksbank would tighten monetary policy, the krona appreciated against both the euro and dollar in autumn 2006. But owing chiefly to changed expectations about interest rate differentials between Sweden and the other regions, the krona has depreciated against both currencies since the beginning of 2007.

 

Favourable underlying factors such as a current account surplus, stable public finances, solid economic growth and modest inflation are set to strengthen the krona. The trade-weighted (TCW) exchange-rate index is projected to be 124 at the end of 2007, 120 at the end of 2008, 121 at the end of 2009 and 121 at the end of 2010.

 

Figure 2.7 TCW exchange-rate index

 

 

Source: Reulers.

 

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Volatility on the Stockholm Stock Exchange

 

Owing primarily to rising corporate profits, the Swedish bull market charged ahead in autumn 2006. The stock market started off 2007 on a strong note. But uncertainty about the U.S. economy and mortgage market led to falling share prices around the world. At the moment, the equity markets appear to have stabilised.

 

At approximately 24 per cent, growth in corporate profits was somewhat higher than expected in the fourth quarter of 2006. The primary industries of forestry, steel and minerals reported the biggest increases, followed by the engineering and pharmaceutical industries. Analysts generally predict that earnings growth will continue but decelerate. The consensus estimate(4) is that the earnings of firms listed on the Stockholm Stock Exchange will rise by approximately 6 per cent in 2007, 9 per cent in 2008 and 5 per cent in 2009. By and large, slower earnings growth points to an impending period characterised by weaker growth of gross capital formation (see Section 3.2 on gross capital formation).


(4)                     Source: FactSet Consensus Estimates (JCF)

 

Outlook for the Swedish economy

 

Financial market factors such as interest and exchange rates affect the Swedish economy by influencing business strategies and consumer behaviour. Prices of capital assets such as equities and housing affect household net worth and ultimately consumption. Fiscal conditions are expected to stay relatively expansionary throughout the rest of 2007 but tighten as the Riksbank raises the repo rate throughout 2008. Short-term real interest rates have risen in the wake of the higher repo rate, while inflation has remained low. Household borrowing is still increasing rapidly, albeit more modestly. The borrowing trend, which is partly due to the continuation of expansionary monetary policy, is contributing to strong demand growth in the total economy. The relatively weak krona is expected to appreciate in late 2007 and 2008.

 

Table 2.1 Interest and exchange rate assumptions

 

Value at the end of each year

 

 

 

2006

 

2007

 

2008

 

2009

 

2010

 

Repo rate

 

3.00

 

3.50

 

4.50

 

4.75

 

4.25

 

6-month interest rate

 

3.07

 

3.60

 

4.55

 

4.70

 

4.30

 

5-year interest rate

 

3.70

 

3.95

 

4.60

 

4.80

 

4.50

 

10-year interest rate

 

3.65

 

4.05

 

4.65

 

4.85

 

4.55

 

Spread Swe-Ger 10 year

 

-0.15

 

-0.25

 

0.35

 

0.55

 

0.25

 

6-month EURIBOR

 

3.61

 

4.05

 

4.05

 

4.05

 

4.05

 

TCW index

 

123

 

124

 

120

 

121

 

121

 

EUR/SEK

 

9.04

 

9.10

 

8.80

 

8.90

 

8.90

 

USD/SEK

 

6.84

 

6.74

 

6.52

 

6.59

 

6.59

 

EUR/USD

 

1.32

 

1.35

 

1.35

 

1.35

 

1.35

 

 

Sources: Reuters and Ministry of Finance.

 

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3                            Swedish demand and output

 

Due largely to an increase in demand on a broad front, Swedish GDP growth was very strong at 4.4 per cent in 2006 (see Figure 3.1). Export growth has been rapid, the sustained upswing in gross fixed capital formation has persisted and household consumption has risen steadily.

 

Figure 3.1 GDP

 

 

Sources: Statistics Sweden and Ministry of Finance.

 

GDP growth will remain rapid in 2007 and 2008

 

In the wake of more modest growth of exports and gross fixed capital formation, GDP growth is set to be slower in 2007 and 2008 (see Table 3.1) but remain high. Given a cooling off of the global economy and a stronger krona, export growth is likely to be somewhat slower, though healthy from a historical perspective. The persistence of robust demand, high capacity utilisation and the financial strength of firms should help keep gross fixed capital formation in sectors such as industry and residential construction at a high level. But as demand tapers off somewhat and the output capacity that has been added in recent years is put to use, growth in gross fixed capital formation is likely to decelerate in 2007 and 2008.

 

Steady expansion of Swedish household consumption is expected to partially offset slower growth of exports and gross capital formation. Disposable income is rising quickly, employment is proceeding upward and household net worth is starting from a solid position. The cumulative impact should be high consumption growth in 2007 and 2008, particularly in 2007 as income tax cuts help boost household disposable income. Spurred by sound finances, local government is set to exhibit the most rapid consumption growth in the general government sector.

 

Table 3.1 Demand and output

 

 

 

SEK Billion

 

Percentage change in volume

 

 

 

2006

 

2006

 

2007

 

2008

 

2009

 

2010

 

Household consumption

 

1 339

 

2.8

 

4.2

 

3.8

 

2.4

 

2.6

 

General government consumption

 

759

 

1.8

 

1.4

 

1.4

 

0.5

 

0.6

 

Central govt.

 

207

 

1.0

 

0.5

 

0.4

 

0.1

 

0.1

 

Local govt.

 

552

 

2.0

 

1.8

 

1.7

 

0.7

 

0.7

 

Investment

 

509

 

8.2

 

5.6

 

3.4

 

2.3

 

2.7

 

Change in stocks(1)

 

0

 

0.0

 

0.0

 

0.1

 

0.0

 

0.2

 

Exports

 

1 456

 

9.1

 

7.0

 

6.3

 

6.3

 

6.0

 

Imports

 

1 224

 

7.8

 

7.6

 

6.7

 

6.7

 

6.7

 

GDP

 

2 838

 

4.4

 

3.7

 

3.3

 

2.1

 

2.3

 

GDP, calendar adjusted

 

 

4.7

 

3.9

 

3.2

 

2.1

 

2.0

 

 


(1)                     Contribution to GDP-growth, percentage points.

Sources: Statistics Sweden and Ministry of Finance.

 

More moderate GDP growth in 2009 and 2010

 

GDP growth forecasts for the years after 2008 are based on estimates of the size of potential supply, measured as potential GDP. As described by an explanatory box in Chapter 4, potential GDP is calculated on the basis of potential productivity and potential labour supply.

 

Due to a rapid expansion of GDP and employment in 2007-2008, the level of resource utilisation is forecast to be high. In other words, the output gap is expected to be positive. Given a positive output gap in 2008, wage and price increases are likely to accelerate while the Riks-bank raises the repo rate, thereby contributing to a stronger krona and weaker domestic demand. Both household and general government consumption, as well as gross fixed capital formation, are set to rise slower in 2009 and 2010 than 2008. Partly due to the appreciation of the krona, export growth should moderate somewhat.

 

Demand is likely to taper off somewhat in 2009 and 2010 while GDP increases approximately 1 percentage point slower than potential GDP.

 

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Risk outlook

 

The primary risk to the Swedish GDP forecast would be an unexpectedly abrupt downturn in the U.S. economy that restrains global (and thereby Swedish) growth. But as discussed in Section 1.1, the base scenario is a soft landing in the United States.

 

Certain risks are primarily associated with developments in the medium term. The magnitude and timing of the impact of the government’s economic policies are difficult to project. Assessing current resource utilisation and future growth in potential GDP is also fraught with uncertainty. Such factors are integral to the direction of the economy over the next few years. To illustrate the uncertainty of the assessments, Chapter 6 presents two alternative scenarios in which the Swedish economy takes a different course than in the base scenario.

 

3.1                  Exports

 

Swedish exports grew rapidly in 2006 and are expected to continue upward. The upswing in 2006 extended to most groups of products and virtually every region, with the exception of the United States. Increases to European countries were particularly rapid, and the strong German economy helped make it Sweden’s biggest export partner once again.

 

Given that the European economy has stabilised at a high level and global demand is still brisk, the prospects for Swedish export growth remain auspicious. Exports are likely to rise steadily throughout the forecast period but at a gradually slower pace as the krona appreciates and the global economy cools off. Export growth is expected to total 7.0 per cent in 2007 and 6.3 per cent in 2008, followed by a further modest deceleration in 2009-2010.

 

Outlook for Swedish exports remains bright

 

The prospects for ongoing robust export growth are good. Both the global economy and demand for Swedish exports in the world market remain strong. Exports are rising steadily to all major regions, particularly Europe by virtue of its vigorous economy, except the United States. The European economy is more stable now that it is transitioning from having been driven mainly by external demand to increasingly being driven by domestic demand. A total of 70 per cent of Swedish exports goes to European countries.

 

Figure 3.2 World market growth and growth in Swedish exports

 

 

Sources: Statistics Sweden and Ministry of Finance.

 

Given high sales and earnings in 2006, Swedish firms find themselves in a strong financial position. The high sustained level of industrial activity is particularly benefiting the industrial sector, and the engineering sector is especially optimistic.

 

The competitiveness of the industrial sector is strong. In both national and common currency, the sector’s unit labour cost has trended downward compared to other countries since the early 1990s (see Figure 3.3 below). The reason is that Sweden has enjoyed higher productivity growth and the krona has depreciated for a long time.

 

The NIER Investment and Intermediate Goods Survey points to persistence of strong export growth. The Purchasing Managers Index also suggests that industrial activity will remain brisk.

 

Exports of finished goods such as motor vehicles, telecom products and pharmaceuticals grew very rapidly, particularly in late 2006. The trend is expected to generally proceed in 2007, if somewhat more leisurely than in 2006.

 

Firms in the basic industries are also enjoying solid export growth, and survey statistics suggest that they will continue to do so. But exports of primary products are expected to slow down more than exports of finished goods in 2007. For instance, exports of petroleum products are

 

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set to taper off significantly in 2007 in the wake of supply restrictions following very rapid growth in 2006

 

Exports of goods are likely to grow steadily throughout the forecast period, though gradually decelerating due to a cooling down of the global economy and an appreciation of the krona. Exports of goods are forecast to rise by 6.9 per cent in 2007 and 6.1 per cent in 2008.

 

Figure 3.3 Unit labour cost in Swedish industry compared to 14 OECD countries

 

 

Sources: Statistics Sweden, NIER and Ministry of Finance.

 

Exports of services growing at a healthy clip

 

While exports of services grow in line with exports of goods, the trend for the past ten years has been a somewhat faster services growth. As a result, services accounted for 26 per cent of total exports in 2006 – up 6 percentage points since 1996.

 

Exports of services rose by 12 per cent in 2006, and the healthy increases are expected to continue in 2007. Brisk world trade has led to a rapid upturn in exports of transport services and to greater exports of business services. Export of travel and tourism (expenditures of foreign visitors in Sweden) has also benefited from the robust global economy, which is increasingly dependent on household consumption growth. Like exports of goods, exports of services are expected to grow more modestly in the next few years as the global economy cools off and the krona appreciates.

 

Net trade in services has been positive in recent years, and exports of services are projected to increase faster than imports of services during the forecast period. However, due to the appreciation of the krona, import of travel and tourism (foreign travel by Swedes and  associated expenditures abroad) is likely to rise a little faster than export of travel and tourism in 2008.

 

Exports of services are expected to grow by 7.4 per cent in 2007 and 6.9 per cent in 2008.

 

Table 3.2 Exports of goods and services and change in export prices

 

 

 

SEK billion

 

Percentage change in volume

 

 

 

2006

 

2006

 

2007

 

2008

 

2009

 

2010

 

Exports of goods

 

1 051

 

8.0

 

6.9

 

6.1

 

 

 

Processed goods

 

878

 

8.3

 

7.5

 

6.7

 

 

 

Exports of services

 

367

 

12.0

 

7.4

 

6.9

 

 

 

Total exports

 

1 418

 

9.1

 

7.0

 

6.3

 

6.3

 

6.0

 

Export prices

 

 

2.7

 

-0.7

 

-0.3

 

1.0

 

1.2

 

 

Sources: Statistics Sweden and Ministry of Finance.

 

Export prices to fall again

 

Due primarily to rising petrol and metal prices, along with the weaker krona, export prices have increased over the past two years. As primary product prices fall back and the krona appreciates, export prices are expected to retreat in 2007-2008.

 

After rising substantially in late 2006, metal prices are expected to decline during 2007. However, demand for metals remains robust, and the decline is not likely to be as steep as the increases in 2005-2006.

 

The expected appreciation of the krona during the forecast period should exert pressure on firms to hold down the prices of their products so as not to compromise competitiveness. But once again, the price cuts should be limited by the heavy demand that many firms are still encountering. Although primary product costs have risen considerably for a number of years and production costs are thereby higher, some firms are still able to pass part of the increase on to their customers by raising prices. For instance, big steel companies have announced hikes this spring. Export prices are expected to fall by 0.7 per cent in 2007 and 0.3 per cent in 2008. Partly due to the diminished impact of the stronger krona, export prices will probably recover somewhat in the medium term, rising by 1.0 per cent in 2009 and 1.2 per cent in 2010.

 

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3.2                  Investment

 

Robust growth of investment for the past three years

 

Investment has risen at an accelerating pace since 2003 (see Figure 3.4), and the brisk investment activity has spilled over to more and more of the total economy. Growth of investment averaged 7.6 per cent in 2004–2006, including 8.2 per cent in 2006. Not since the late 1980s has investment grown so rapidly for three consecutive years.

 

Figure 3.4 Investment

 

 

Sources: Statistics Sweden and Ministry of Finance.

 

Investment will grow steadily

 

Persistently high capacity utilisation and the financial strength of firms are set to spur growth of investment going forward. The government’s economic policies, which are expected to boost employment and thereby capital expenditure requirements by firms, should promote continuation of solid growth of investment. But a growing number of firms are likely to have expanded their output capacity over the next year while global demand tapers off. As a result, growth of investment is predicted to gradually decelerate in 2007 and 2008. Total investment is projected to increase by 5.6 per cent in 2007, 3.4 per cent in 2008 (see Table 3.3), 2.3 per cent in 2009 and 2.7 per cent in 2010. Investment is expected to account for 18.3 per cent of GDP, the highest percentage since 1991, at the end of 2010 (see Figure 3.5).

 

Figure 3.5 Investment as a percentage of GDP

 

 

Sources: Statistics Sweden and Ministry of Finance.

 

Investment by goods producers growing rapidly again

 

The upswing in exports that began in 2003 has claimed a growing share of industrial sector output capacity (see Figure 3.6), generating a need for greater investment – particularly on machinery. Investment in machinery in the industrial sector advanced vigorously during 2005, above all in the paper products industry. Once the paper products industry started up the machinery in autumn 2005, investment decreased sharply and moderated the increases for the industrial sector as a whole in 2006. Nevertheless, machinery investment continued to grow steadily in other sub-sectors during 2006 and brought the total figure for the industrial sector to 2.3 per cent.

 

Figure 3.6 Capacity utilisation in the industrial sector

 

 

Source: Statistics Sweden.

 

Despite the vigorous investment activity of recent years, persistently strong foreign demand and rising domestic demand has propelled capacity utilisation to a record high since measurements

 

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began in 1980. New orders to the industrial sector remain high, both foreign and domestic demand are strong, interest rates are relatively low and corporate profits are growing briskly. Thus, the prospects are bright for continuation of rapid growth in investment.

 

The Statistics Sweden Business Investments survey points to a sharp upswing in 2007. The majority of sectors, most notably the chemical and mining industries, are planning for increased investment. Investment in the paper products industry is also expected to increase somewhat, while the construction component of investment in the industrial sector should taper off.

 

The global economy is set to slow down in 2007–2008, and Swedish exports are likely to cool off. Thus, demand for Swedish-made goods will probably decline somewhat, as reflected in progressively lower expectations by the manufacturing industry for orders from the export market. The need for investment on machinery should also ebb in the longer term.

 

Investment in the industrial sector is expected to grow briskly in 2007 but slow down somewhat in 2008.

 

Particularly in view of major efforts by electricity suppliers to boost generation and improve supply, rapidly increasing investment in the energy sector over the past few years is likely to continue.

 

Table 3.3 Investment

 

Percentage change

 

 

 

2006

 

2007

 

2008

 

2009

 

2010

 

Business sector

 

6.1

 

4.8

 

4.6

 

 

 

Producers of goods

 

6.1

 

8.1

 

5.9

 

 

 

Producers of services

 

6.1

 

2.1

 

3.4

 

 

 

Housing

 

16.5

 

10.1

 

-1.5

 

 

 

General government

 

8.7

 

4.1

 

4.4

 

 

 

Central government

 

8.2

 

7.2

 

5.7

 

 

 

Local government

 

9.2

 

0.9

 

3.0

 

 

 

Total

 

8.2

 

5.6

 

3.4

 

2.3

 

2.7

 

 

Sources: Statistics Sweden and Ministry of Finance.

 

According to the NIER Business Tendency Survey, expectations in the construction industry have dimmed somewhat of late. While firms believe that new orders and construction will grow further, fewer and fewer anticipate an improvement in the construction market over the next 12 months. But investment in housing is expected to increase substantially in 2007, while  construction in the property management sub-sector and the general government sector has taken off. Given solid new orders and a broader-based upswing in construction activity, investment by the construction industry is thereby expected to rise steadily in 2007 and 2008.

 

Investment by goods producers is predicted to climb by 8.1 per cent in 2007 and 5.9 per cent in 2008 (see Table 3.3).

 

Investment by service producers will slow down

 

Investment in the service sector – particular financial services and property management, as well as post and telecommunications – rose steadily in 2006.

 

Investment in wholesale and retail trade also grew at a healthy pace in 2006, and robust consumption growth is likely to give it an additional boost in 2007–2008. For instance, new department stores are opening in several market segments, including building supplies and home furnishings. Investment in household services is also forecast to grow at a good clip in 2007 and 2008.

 

After declining for three years, investment in the property management sub-sector (excluding housing) rose in 2005 and took off even more in 2006. Rapidly expanding household consumption is fuelling most of the investment, including new construction and expansion of shopping centres, in this sector as well. As a result, investment in the property management sub-sector is expected to grow steadily in 2007 and 2008.

 

Due particularly to construction of 3G networks, investment in post and telecommunications rose sharply in 2006. The networks should be completed by 1 June 2007. Construction of networks in the 450 MHz band, which will improve mobile phone coverage in sparsely populated areas, is also likely to be completed this summer. Thus, investment in the sector is expected to taper off during the latter half of 2007 and 2008.

 

Excluding vessels and aircraft, investment in the transport sector declined somewhat in 2006. The NIER Business Tendency Survey reflects considerably weaker demand for transport services recently. Thus, investment activity is set to remain sluggish in 2007.

 

Investment by service producers is projected to increase by 2.1 per cent in 2007. Owing

 

28



 

particularly to strong employment growth in the service sector, the figure is expected to rise to 3.4 per cent in 2008.

 

General government investment rising steadily

 

Investment in central and local government rose sharply in 2006. The machinery component of investment grew the most in central government, while buildings were the largest component in the local government sector.

 

Major infrastructure improvements by the National Rail Administration and National Road Administration over the next few years will contribute to rapid growth in central government investment in both 2007 and 2008. Among the Rail Administration projects are the Bothnia Line, the Malmö City Tunnel and the tunnel through Hallandsås. Road Administration projects include the Northern Link and the extension of the E45 European motorway. Following a sharp upswing in local government investment during 2006, its growth is likely to decelerate somewhat in 2007.

 

General government investment is expected to increase by 5.1 per cent in 2007 and 5.3 per cent in 2008.

 

Investment in housing will remain strong

 

Largely due to an increase in housing construction, activity in the construction industry has risen steadily in recent years. Housing starts averaged 19 per cent annual growth in 2002–2005 (see Figure 3.7).

 

The Government Budget Bill for 2007 proposed the elimination of state interest subsidy and investment grant as of 1 January 2007. As a result, an estimated 7,000–8,500 housing starts were accelerated. Preliminary data from Statistics Sweden indicates that housing starts rose by approximately 40 per cent in 2006 to more than 44,500.

 

While construction activity remains brisk, longer-term expectations for the construction market are more cautious. One indicator of residential construction activity for the next six months is the number of building permits granted. Permits were granted for approximately 24,500 units in the latter half of 2006, an increase of more than 40 per cent from 12 months earlier. Even disregarding accelerated housing starts, the  rapid increase in permits points to persistent residential construction growth.

 

Figure 3.7 Housing starts

 

 

Sources: Statistics Sweden and Ministry of Finance.

 

Demand for housing is high. According to the National Board of Housing, Building and Planning Housing Market Survey for 2007, 42 per cent of municipalities report housing shortages, as opposed to 11 per cent in the late 1990s. Net influx to those municipalities totalled approximately 39,000 people in 2006, while overall population growth was approximately 57,000. Housing demand is also set to increase going forward. The Board predicts that demographic trends, particularly the entry of people born in the 1980s into the housing market, will ensure a rapid increase in the number of Swedish households until 2010. The size of the 20–24 year old population remained largely unchanged in 1999–2005. But the Statistics Sweden population forecast anticipates that its numbers will swell by almost 20,000 annually until 2010. Low interest rates, as well as healthy increases in household disposable income and financial assets, are also contributing to the growing demand for housing.

 

Robust demand is pushing up housing prices. For instance, prices of single-family dwellings were more than 9 per cent higher in February 2007 than 12 months earlier. Prices of owner-occupied flats are also up sharply over the past year. As reflected in higher Tobin’s q values, steep prices and lower relative costs are making it lucrative to build.(5)

 


(5)                     Tobin’s q measures the relationship between the price of a used single-family dwelling and the production cost of a new single-family dwelling of a similar standard. A Tobin’s q greater than 1 indicates that it is lucrative to build a new home. The national average for Tobin’s q was around 1 in 2006. But it was much higher in urban regions – close to 1.5 in Stockholm County.

 

29



 

Despite strong demand and solid profitability, rising interest rates and costs are expected to depress residential construction growth. Interest rates are likely to increase in 2007–2008, blunting the appetite of households to buy. The production costs of construction firms represent a pivotal factor. Production costs increased by just over 3 per cent annually in 2000–2005. But price hikes gradually accelerated in 2006, and production costs were 6.4 per cent higher in February 2007 than 12 months earlier. While building materials account for the greatest increases, costs for property developers(6) have also risen in the wake of higher interest costs. Rising interest rates should contribute to steadily higher costs for property developers. Accelerating wage growth should also contribute to mounting production costs. Wages in the construction industry are projected to increase by 4.4 per cent in the next few years, as opposed to 3 per cent annually in 2004–2006.

 

Housing starts are expected to decrease to 29,000 in 2007 in the wake of accelerated projects, followed by 36,000 in 2008.

 

Due largely to renovation of housing built as part of the Million Homes Programme, refurbishment is also expected to exhibit rapid growth.

 

Given increases in new construction and refurbishment, total investment in housing should rise by 10.1 per cent in 2007. Owing to accelerated housing starts, the figure is expected to decline by 1.5 per cent in 2008.(7)

 

3.3      Stockbuilding

 

Inventories did not affect GDP growth in 2006

 

GDP growth was not significantly affected by total stockbuilding in 2006. Heavy stockbuilding of standing timber offset large withdrawals from industrial sector inventories of intermediate goods, as well as inventories in wholesale and retail trade.

 

Industrial sector will replenish inventories in 2008

 

When foreign demand for Swedish goods recovered in the latter part of 2005, finished goods inventories in the industrial sector dwindled considerably. As a result, a growing number of firms regarded their inventories as insufficient. Industrial output speeded up in 2006 while withdrawals from finished goods inventories continued. As export growth tapers off in 2007 and 2008, the industrial sector is expected to replenish its finished goods inventories.

 

Industrial sector inventories of intermediate goods have shrunk since 2002. The ongoing trend toward application of the just-in-time concept, which dictates lower inventories of intermediate goods, provides some of the explanation. But the delivery times of suppliers have lengthened recently, and imports of primary products have been sluggish. Meanwhile, export demand has been brisk and industrial output has risen. As a result, firms consider inventories of intermediate goods to have reached a low level. As exports cool off, the decrease in inventories of intermediate goods is set to slow down in 2007. But the industrial sector is likely to replenish them in 2008.

 

Inventories in wholesale and retail trade, particularly primary products, fell sharply in 2006. Assessments of inventories in wholesale and retail trade are low now, suggesting a desire to replenish them. Given strong domestic demand going forward, inventories are likely to continue dwindling in 2007 and 2008 but at a somewhat slower pace.

 

Stockbuilding of standing and felled timber is returning to normal levels after the severe storm of January 2005. There were large withdrawals from felled timber in 2006, while inventories of standing timber began to increase. The trend is likely to continue, particularly when it comes to felled timber.

 

Inventories will boost GDP growth in 2008

 

A negative contribution to GDP growth by timber inventories is expected to offset a positive contribution by inventories in the industrial sector and wholesale and retail trade in 2007. In other words, the overall impact on GDP growth of 2007 inventory adjustments is forecast to be neutral. Stockbuilding in the two sectors is projected to contribute 0.1 percentage points to

 


(6)                     Interest, credit, planning and administrative costs.

 

(7)                     For housing, which often takes a long time to build, total investment value is distributed over time in the National Accounts. The amount of investment entered for a period corresponds to the percentage completed during the period. Given that housing starts are expected to be lower in 2007 due to the acceleration of certain projects and it takes an average of 1½ years to complete a block of flats, residential construction investment is likely to decrease in 2008.

 

30



 

GDP growth in 2008. Inventory adjustments are not likely to affect GDP growth in 2009 and 2010.

 

3.4      Household consumption

 

Stable consumption growth in 2006

 

Household consumption trends were very weak in 2001, but household consumption growth has accelerated year by year to 2.8 per cent in 2006. Rising disposable income, as well as increases in the value of real and financial assets, has fuelled the growth. The brightening outlook for the labour market since mid-2005 has contributed as well.

 

Consumption of goods, particularly food and home electronics, exhibited the most rapid growth in 2006. Meanwhile, consumption of electricity, gas and heating decreased significantly.

 

Excellent prospects for strong consumption

 

Real household disposable income rose by 2.0 per cent in 2006. In addition to substantially higher interest expenditure, rising capital gains from 2005 to 2006 moderated the growth. The reason is that the National Accounts include capital gains taxes, but not the gains themselves, in the definition of disposable income. The wallet version of disposable income (see explanatory box on next page) excludes capital gains taxes in order to provide a fairer assessment of how households experience changes in their income.

 

At 5.7 per cent in real terms, growth of household disposable income is expected to be sharply higher in 2007 than 2006. The strong labour market is set to contribute an equally robust increase in hours worked as 2006, while hourly wages are likely to rise more quickly. Thus, aggregate wage bill is forecast to grow more quickly than in 2006. However, social benefits from the general government sector to households should decrease in 2007. Given a strengthening labour market and a reduction in the level of unemployment benefits, unemployment-related social benefits are expected to shrink the most. Social benefits related to ill health are also set to decrease from 2006 to 2007. Growth of other income, such as from owner-occupied dwellings, is expected to be relatively vigorous in 2007.

 

Table 3.4 Household disposable income

 

Percentage change, current prices

 

 

 

 

SEK billion

 

 

 

 

 

 

 

 

 

 

 

 

 

2006

 

2006

 

2007

 

2008

 

2009

 

2010

 

Wage bill(1)

 

1 137

 

5.4

 

6.1

 

5.5

 

4.9

 

4.5

 

Number of hours worked

 

 

2.0

 

1.8

 

0.9

 

0.2

 

-0.1

 

Hourly wages(2)

 

 

3.3

 

4.3

 

4.6

 

4.7

 

4.6

 

General government transfers

 

497

 

1.7

 

-0.2

 

2.6

 

4.5

 

4.7

 

Other income

 

299

 

1.5

 

4.7

 

4.4

 

4.9

 

5.3

 

Taxes and charges

 

-556

 

4.9

 

-1.9

 

5.3

 

5.5

 

5.1

 

Nominal disposable income

 

1 377

 

3.3

 

6.8

 

4.3

 

4.6

 

4.5

 

Price index

 

 

1.3

 

0.9

 

1.6

 

2.2

 

2.4

 

Real disposable income

 

1 359

 

2.0

 

5.7

 

2.7

 

2.4

 

2.1

 

 


(1)                     The wage bill is defined as the number of hours worked multiplied by the hourly wages.

(2)                     According to the definition in the National Accounts.

Sources: Statistics Sweden and Ministry of Finance.

 

Tax cuts, primarily the earned income credit, are estimated to make the greatest contribution (SEK 40 billion) to the rapid growth of household disposable income in 2007. Other tax reforms will also help boost household disposable income. The hike in contributions to unemployment benefit funds partially offset the impact of tax cuts on household disposable income. The repeal of the wealth tax proposed by this bill boost household disposable income by an estimated SEK 5 billion.

 

Real disposable income in 2008 is expected to rise by 2.7 per cent, considerably more modest than 2007 but above the 1993–2006 average of 1.6 per cent. The relatively rapid growth projected for 2008 is primarily due to persistently strong labour market trends.

 

Nominal disposable income is forecast to  increase by 4.6 per cent in 2009 and 4.5 per cent  in 2010. But because the consumption deflator is  likely to rise fairly quickly both years, real disposable income growth is set to be a modest 2.4 per cent in 2009 and 2.1 per cent in 2010.

 

31



 

Revised method for calculating the wallet version of household disposable income

 

The Government Budget Bill for 2007 presented an initial method for calculating household disposable income that better reflects how households experience changes in their income. A revision to the calculation has now added the impact on household disposable income of financial intermediation services indirectly measured (FISIM) to the factors that are excluded.

 

The Government Budget Bill for 2007 explained the reasons for a wallet version of household disposable income. Certain adjustments to the concept of household disposable income as defined by the National Accounts are needed in order to better describe how households experience changes in their income. As opposed to the principles applied in the National Accounts, the wallet version excludes capital gains taxes, operating surplus from owner-occupied dwellings, interest for individual insurance policies and the yield tax. In addition to using differing measures of income, the National Accounts deflate disposable income with the implicit price index for household consumption, while the wallet version deflates it with the Riksbank’s index of underlying inflation (UND1X).

 

FISIM is the portion of the net interest income of banks that is reported as production. FISIM did not previously affect GDP, but a change to accounting principles in autumn 2005 led to an upward annual adjustment of approximately 1 percentage point. However, growth rates were not significantly affected. As a result of the change, household disposable income and consumption were adjusted by the same amount. In other words, FISIM did not affect the household saving ratio.

 

Nevertheless, the reporting of FISIM can render the very concept of disposable income misleading as an indicator of how households experience changes in their income. Interest income and expenditure affect that experience whether or not they are classified as FISIM. Thus, excluding the impact of FISIM on household disposable income in accordance with the National Accounts is an appropriate way of better assessing the experience.

 

Real disposable income – National Accounts vs. the wallet version

 

Percentage change

 

 

Sources: Statistics Sweden and Ministry of Finance.

 

The above figure shows changes to real disposable income in accordance with the National Accounts and the wallet version. The two methods may generate distinctly different results for a particular year. For instance, the wallet version grew a good deal faster in 2006 than the National Accounts definition suggests. The underlying reason was that capital gains increased substantially from 2005 to 2006, thereby reducing disposable income growth as defined by the National Accounts. In adjusting for that effect, the wallet version generates a higher rate of growth for household income. Because capital gains are expected to decrease from 2006 to 2007, the wallet version of disposable income rise slower this year than in the National Accounts definition.

 

 

32



 

 

Figure 3.8 Household disposable income and consumption

 

SEK billion, constant prices, reference year 2005

 

 

Note: From 2000 is the Church of Sweden included in the household sector. Sources: Statistics Sweden and Ministry of Finance.

 

Besides the fact that household disposable income has increased and is expected to continue upward at a healthy clip, consumption is benefiting from the rapid growth in the value of household financial assets over the past few years. Households realised some of the value growth in 2006 by selling equities and funds and depositing the proceeds in bank accounts.

 

Household assets are not simply financial, but include single-family dwellings and tenant ownership rights. The value of the housing assets appreciated by an estimated 12 per cent in 2006 to approximately SEK 3,700 billion at the end of the year. The prices of single-family dwellings have been rising for more than a decade. The very high rate of growth in early 2006 has subsequently decelerated somewhat. The value of tenant ownership rights has also increased in the past ten years. Recent interest rate hikes do not appear to have noticeably moderated housing prices yet.

 

Figure 3.9 Household debt

 

Per cent

 

 

Sources: Statistics Sweden, The Swedish Financial Supervisory Authority and Ministry of Finance.

 

Household debt has also continued upward. The tendency is closely related to the upturn in housing prices. Household debt rose by almost 11 per cent in 2006. Debt as a percentage of disposable income has risen to above the levels of the late 1980s and early 1990s (see Figure 3.9). Due to both higher housing prices and the bull market of the past few years, debt as a percentage of household real and financial assets has not increased to anywhere near the same degree.

 

Households have benefited for several years from low, albeit recently rising, interest rates. Although rates are expected to proceed upward during the forecast period, interest expenditure should remain relatively low (see Figure 3.10). The greater indebtedness of recent years and the large percentage of borrowing at variable rates have left households vulnerable to major interest rate fluctuations.

 

Figure 3.10 Household interest expenditure

 

Per cent of disposable income

 

 

Note: The interest expenditures are not adjusted for FISIM. (see explanatory box on the following page for further explanation of FISIM).

Sources: Statistics Sweden and Ministry of Finance.

 

Indicators point to strong consumption growth

 

Available indicators suggest relatively rapid consumption increases in the coming months. According to the NIER Household Survey, households expect that their own finances, the Swedish economy and the labour market will all do very well over the next year. The NIER Business Tendency Survey reports ongoing growth of retail sales and optimism about the future. Statistics Sweden and the Swedish Research Institute of Trade Retail Sales Index shows that growth has been particularly robust in consumer durables recently but considerable in consumer non-durables as well.

 

33



 

Rapid consumption growth during forecast period

 

The steady consumption growth of the past few years is likely to continue during the forecast period.

 

The substantial disposable income growth predicted for 2007, the second largest in 25 years, is the main reason that household consumption is set to increase so rapidly.

 

The state of the labour market is integral to the magnitude of consumption growth in the next few years (see Figure 3.11). Employment has been rising rapidly and is expected to continue sharply upward in 2007 and 2008. Apart from affecting household income, rising employment contributes substantially to consumer confidence and thereby their propensity to consume rather than save.

 

Figure 3.11 Employment and household consumption

 

Annual percentage change

 

 

Sources: Statistics Sweden and Ministry of Finance.

 

Household consumption is expected to rise by 4.2 per cent in 2007 and 3.8 per cent in 2008.

 

Given persistently healthy income increases, a strong wealth position and high initial saving, the outlook for strong consumption growth is also bright in the medium term. Household consumption is forecast to rise by 2.4 per cent in 2009 and 2.6 per cent in 2010, somewhat faster than the average since 1980.

 

Household savings

 

Household savings totalled SEK 38 billion, or 2.8 per cent of disposable income, in 2006.

 

An increase to SEK 62 billion, or 4.2 per cent of disposable income, is projected for household saving in 2007. Net saving in supplementary pension schemes (including savings in the premium pension system) is projected to be SEK 82 billion, generating a total saving ratio of 9.3 per cent.

 

Figure 3.12 Household saving

 

Per cent of disposable income

 

 

Note.: Own savings is household net savings excluding savings in supplementary pension schemes and the premium pension system.

Sources: Statistics Sweden and Ministry of Finance.

 

As the result of strong income growth, household saving is set to increase rather significantly from 2006. But the saving ratio is likely to decline steadily in 2008–2010.

 

3.5      General government consumption

 

General government consumption(8) averaged 0.8 per cent growth in 2000–2005. Preliminary figures for 2006 show general government consumption growth of 1.8 per cent, the lion’s share in the local government sector. In current prices, general government consumption in 2006 accounted for 27 per cent of GDP, 19 percentage points of which was attributable to the local government sector. General government consumption is expected to increase by 1.4 per cent in both 2007 and 2008, followed by an annual average of 0.5 per cent in 2009 and 2010.

 


(8)       As of 2000, the Church of Sweden was reclassified from the local government to household sector. To ensure comparability, it has been excluded from the statistics for previous years as well.

 

Local government consumption growing rapidly

 

Local government consumption averaged 1.3 per cent annual growth in 2000–2005. During the first three years, the sector averaged 1.8 per cent

 

 

 

34



 

increases and had a negative cumulative financial result(9) of SEK 4 billion. The local government sector adopted a cost-cutting plan in 2003 to curb its spiralling expenditures. The effort to consolidate finances made an impact in 2004, and the sector’s financial result was positive. The adoption of the balanced budget requirement in 2000, along with the demand for sound economic management, appears to have helped restrain local government consumption.

 

The local government sector’s financial result in 2005 was SEK 13 billion, a considerable improvement over previous years. Along with higher central government grants and a stronger tax base, the consolidation effort has firmed up local government sector finances. Preliminary figures for 2006 indicate a continued high financial result of SEK 15 billion for the sector as a whole.

 

According to preliminary figures, local government consumption rose by 2.0 per cent in 2006. Value added was up by 1.3 per cent. A 4.3 per cent increase in social transfers in kind made a major contribution to favourable consumption trends. Social transfers in kind are made up of general government purchases of goods and services (from market producers) that are provided to households with no further transformation in production within the general government sector.(10)

 

At 1.8 per cent, consumption growth in the local government sector is expected to be relatively strong again in 2007. The primary reason is that the sector’s incomes from taxes and central government grants are likely to continue growing at a healthy pace, thereby creating greater fiscal latitude for consumption (see section 5.6). As in 2006, social transfers in kind are projected to rise faster than total consumption. Thus, the trend for the local government sector to rely on market producers is set to continue accelerating.

 

Local government consumption is forecast to increase by 1.7 per cent in 2008. The migration policy measures announced in this bill will boost the consumption figure. Excluding those measures, consumption trends are expected to be somewhat weaker as the result of smaller income increases than 2007.

 

Given that the calculation assumes that central government grants will be nominally unchanged in 2009 and 2010, annual consumption growth should be limited to an average of 0.7 per cent during that period.

 

The bonus job scheme has boosted local government consumption in 2006 and 2007. The phase-out of the scheme in 2008 and 2009 will have the opposite effect. Bonus jobs affect hours worked in the sector, and thereby both output and consumption.

 

Modest growth of central government consumption

 

Average annual central government consumption remained essentially unchanged throughout 2000–2005. Consumption in constant prices rose by a slight 0.3 per cent from SEK 197 billion in 2000 to SEK 198 billion in 2005. But year-to-year variations, a significant percentage of which was attributable to defence, were relatively large – from a decrease of 3 per cent in 2000 to an increase of 3 per cent in 2002.

 

Preliminary figures for 2006 show central government consumption rising by 1.0 per cent in constant prices. Payroll expenses were up by a slight 0.1 per cent. Value added increased by 0.6 per cent. Social transfers in kind grew by a robust 6.0 per cent.

 

The appropriations announced in the Government Budget Bill for 2007 for purposes such as due process, international operations and research are set to boost central government consumption by 0.5 per cent in 2007. The dental care reform and the proposal in this bill for increased appropriations to the Migration Board, etc., should contribute to 0.4 per cent consumption growth in 2008. Consumption is forecast to increase by an average of 0.1 per cent in 2009 and 2010.

 

3.6      Imports

 

Imports of goods rose substantially in 2006

 

Imports of goods were up in 2006 by 7.6 per cent, or 1.5 percentage points above the average for the past ten years. Both rapid export growth, thereby increasing the need for imports, and

 


(9)       Excluding extraordinary items.

(10)     Such goods and services include privately owned old-age homes, prescription drugs and dental care, and privately owned or cooperative preschools.

 

35



 

robust domestic demand explain the strength of the trend. Excluding textiles, clothing and footwear, imports of capital and consumer goods rose sharply in 2006. Probably due in part to substantial price hikes in 2006, petroleum products and crude – which account for more than 10 per cent of the import of goods – were down by approximately 5 per cent. Despite rapid price increases, imports of metals averaged approximately 10 per cent growth.

 

Prices of imported goods expected to decline

 

The prices of finished goods such as textiles, wood products and metalware rose slightly in 2006. Meanwhile, the prices of telecom products, office machines and computers continued downward by almost 10 per cent. All in all, the prices of imported goods rose relatively much in the wake of substantial hikes on crude, petroleum products and other primary products such as metals. Although the prices of finished goods are up somewhat during the past two years, import prices have exhibited more modest increases than the prices of Swedish-made goods. As a result, importing finished goods has become a more lucrative venture despite the depreciation of the krona.

 

Appreciation of the krona over the next few years is expected to be accompanied by lower import prices in both 2007 and 2008. Along with a declining world market price of oil, a stronger krona against the dollar should lead to a pronounced turnaround for petroleum product and crude prices from 2006 to 2007. After having risen by approximately 20 per cent in 2006, they are forecast to retreat by almost the same percentage in 2007. The price of metals is projected to decline in the course of 2007 as global demand for them cools off somewhat and inventories are replenished. But the prediction is associated with a high degree of uncertainty.

 

Demand for imported goods will remain robust

 

Both exports and industrial output are expected to enjoy steady, albeit decelerating, growth in both 2007 and 2008. Household consumption is set to be vigorous both years. Inventories, which firms regard as insufficient to boost output enough to satisfy demand, will need replenishment. Such a shortage would help boost imports. Brisk economic activity in Sweden is expected to ensure persistently strong import growth over the next two years. Demand for imported goods is likely to be robust, due partly to the fact that a stronger krona will restrain their price hikes compared to Swedish-made goods.

 

Table 3.5 Imports of goods and services and change in import prices

 

 

 

SEK billion

 

Percentage change in volume

 

 

 

2005

 

2006

 

2007

 

2008

 

2009

 

2010

 

Imports of goods

 

827

 

7.6

 

7.9

 

7.3

 

 

 

Finished goods(1)

 

620

 

9.7

 

9.5

 

8.3

 

 

 

Imports of services

 

270

 

8.5

 

6.5

 

5.1

 

 

 

Total imports

 

1 097

 

7.8

 

7.6

 

6.7

 

6.7

 

6.7

 

Import prices

 

 

 

3.5

 

-2.1

 

-1.0

 

0.8

 

1.1

 

 


(1)       Classification according to SNI.

Sources: Statistics Sweden and Ministry of Finance.

 

Now that crude imports have fallen for three consecutive years, oil inventories are low. Meanwhile, import prices of crude are expected to decline sharply. As a result, refineries are likely to replenish their oil inventories, thereby boosting crude imports in 2007. Although crude does not account for a large percentage of imports of goods, it affects the total when there are major fluctuations in the rate of its import growth.

 

Imports of goods are expected to increase by a total of 7.9 per cent in 2007 and 7.3 per cent in 2008.

 

Imports of services continue to rise steadily

 

Imports of services were up by a robust 8.5 per cent in 2006. Business services exhibited the strongest growth, while transport services increased at a fast pace as well. Consisting of consultancy, banking, licenses and patents, business services account for almost half of imports of services. Both transport and business services correlate with goods imports.

 

Persistently strong domestic demand, solid growth of goods imports and an appreciation of the krona should ensure that imports of services continue to rise during the forecast period – though probably at a more deliberate pace in 2007-2008, given that that both business and

 

36



 

transport services correlate with world trade and the global economy is set to cool off. However, import of travel and tourism (foreign travel by Swedes and associated expenditures abroad) is projected to rise as the krona strengthens and household consumption expands.

 

Imports of services are expected to grow by 6.5 per cent in 2007 and 5.1 per cent in 2008.

 

3.7      Output

 

Industrial activity remains brisk

 

Swedish industrial activity speeded up in winter 2005/2006. The main driver was strong demand for Swedish products abroad, generating high export growth in the first quarter of 2006 (see Figure 3.13). After slowing down in the second quarter, industrial output growth got a second wind as exports of goods took off again. Industrial output grew by 5.6 per cent in 2006 (see Table 3.6).

 

Figure 3.13 Industrial output and exports of goods

 

Annual percentage change

 

 

Sources: Statistics Sweden and Ministry of Finance.

 

Industrial output has bright initial prospects of growing further in 2007 and 2008. The major gross capital formation of recent years – including mining and the pulp, paper and paper products industries – have boosted output capacity (see Section 3.2). Moreover, low relative unit labour costs indicate that the competitiveness of the Swedish industrial sector is good (see Section 3.1).

 

Table 3.6 Business sector output

 

 

 

SEK billion

 

Percentage change in volume

 

 

 

2006

 

2006

 

2007

 

2008

 

2009

 

2010

 

Producers of goods

 

756

 

5.2

 

4.7

 

3.8

 

 

 

of which: Industry

 

519

 

5.6

 

5.3

 

4.8

 

 

 

Construction

 

125

 

9.6

 

5.8

 

1.8

 

 

 

Producers of services

 

1 174

 

5.9

 

4.2

 

3.8

 

 

 

Total business sector

 

1 930

 

5.6

 

4.4

 

3.8

 

2.5

 

2.8

 

 

Note: Output refers to value added, i.e. gross output minus input goods.

Sources: Statistics Sweden and Ministry of Finance.

 

As the global economy cools off somewhat in 2007 and 2008, demand for Swedish goods is not expected to grow as fast as in 2006. The resulting slowdown in export growth should help moderate the expansion of industrial output. The NIER Business Tendency Survey corroborates that assessment. According to the survey, new orders from the export market have been high in early 2007 but not at the same level as during much of 2006 (see Figure 3.14). Expectations for both new orders and output also suggest that actual industrial output will cool off somewhat. Total industrial output is forecast to increase by 5.3 per cent in 2007 and 4.8 per cent in 2008.

 

Figure 3.14 Inflow of new orders from the export market to the manufacturing industry

 

Seasonaly adjusted values

 

 

Note: The graph shows the difference between the percentage of firms reporting increased and decreased flow of new orders.

Source: NIER.

 

Construction activity will gradually slow down

 

Construction output has grown rapidly since 2004, and the 9.6 per cent increase in 2006 was the highest for over 25 years. Among the reasons for the high rate of growth were an ongoing expansion of gross capital formation in housing, as well as a sharp upswing in local government

 

37



 

gross capital formation in buildings and construction of commercial premises.

 

The NIER Business Tendency Survey indicates that construction activity in early 2007 has been very brisk, characterised by continued increases in new orders, employment and construction alike. Although the survey has long pointed to a palpable manpower shortage in the construction industry, particularly residential construction, the impact on output growth appears to be limited so far. Thus, construction activity has remained vigorous despite insufficient resources. But the expectations of construction firms for the next 12 months indicate that activity will cool off in 2007. As residential construction rises and levels off, output growth in the construction industry is expected to slow down. In the medium term, higher interest rates should also contribute to the more deliberate pace. Construction output is forecast to increase by 5.8 per cent in 2007 and 1.8 per cent in 2008.

 

Households spurring production of services

 

Production in the service sector expanded by 5.9 per cent in 2007. The strength of the upswing was primarily due to rapid growth in the production of business services. Production of other services, such as financial services and wholesale and retail trade, also showed vigorous increases and contributed to the favourable trend for the sector as a whole.

 

The NIER Business Tendency Survey indicates that many private service sub-sectors have continued to enjoy rising demand in early 2007 but that the increases have not been as robust as during the latter part of 2006 (see Figure 3.15). The survey also suggests that retail sales are rising somewhat slower than 2006. Nevertheless, overall conditions remain propitious and the wholesale and retail confidence indicator is still comparatively high.

 

Figure 3.15 Demand for private services

 

Seasonally adjusted values

 

 

Note: The graph shows the difference between the percentage of firms reporting increased and decreased demand.

Source: NIER.

 

Given demand changes in the total economy, production growth in the service sector is expected to be somewhat less vigorous in 2007 and 2008 but remain high. Production of business services is likely to cool off. These services are being largely driven by domestic demand from the industrial sector, as well as the construction and contracting industry, not to mention demand for Swedish services abroad. Given slower growth in the industrial sector, construction activity and exports of services in 2007 and 2008, the production of associated businesses services is also expected to taper off. Rising household consumption should help ensure rapid ongoing production growth in wholesale and retail trade and household services, as well as other services such as hotel and restaurant. Production growth for the service sector as a whole is projected at 4.2 per cent in 2007. Demand is likely to slow further in 2008 and help push the growth in production of services down to 3.8 per cent.

 

Demand changes in the total economy should moderate business sector output but leave it comparatively high during the forecast period. Total business sector output is expected to increase by 4.4 per cent in 2007, 3.8 per cent in 2008, 2.5 per cent in 2009 and 2.8 per cent in 2010.

 

General government output

 

General government output consists mostly of total compensation of employees, the changes to which are due to employment measured as hours worked. Payroll expenses averaged 86 per cent of general government output in 2000–2006.

 

38



 

The business sector has taken over a growing share of the production of welfare services since the early 1990s. Publicly financed services have been contracted out and the number of temporary workers has increased, while hospitals and preschools have been privatised or corporatised. As a result of such structural changes, consumption has expanded faster than output. General government output averaged 0.6 per cent, while general government consumption averaged 0.9 per cent, growth in 2000–2006.(11) The trend is expected to continue in the next few years.


(11)     As of 2000, the Church of Sweden was reclassified from the local government to household sector. To ensure comparability, it has been excluded from the statistics for previous years as well.

 

Local government output rose by 1.3 per cent and consumption by 2.0 per cent in 2006. Consumption growth was driven by materials, services and social transfers in kind.(12) Output growth is projected at 1.6 per cent in both 2007 and 2008, followed by a cooling off period in 2009 and 2010 (see section 3.5). As a result, local government output is expected to average 0.5 per cent annual growth.


(12)     Social transfers in kind are made up of general government purchases of goods and services (from market producers) that are provided to households with no further transformation in production within the general government sector. Such goods and services include privately owned old-age homes, prescription drugs and dental care, and privately owned or cooperative preschools.

 

Central government output, which rose by 0.6 per cent in 2006, is expected to increase by 0.7 per cent in 2007 and 0.5 per cent in 2008, followed by an annual average of 0.2 per cent in 2009 and 2010.

 

General government output is forecast to increase by an average of 0.9 per cent in 2007–2010.

 

3.8      Current account

 

The trend of a growing current account surplus over the past few years is expected to continue during the forecast period. Due primarily to rapid growth in exports of goods, the surplus rose by SEK 20 billion to SEK 210 billion, or 7.2 per cent of GDP, in 2006. Given steady increases in the trade and services balance, the current account balance is expected to rise further to 7.8 per cent of GDP in 2007 and 2008. In addition to trade in goods and services, the current account balance consists of current transfers (Swedish development assistance and the contribution to EU funding) and factor income (wages and return on capital). Medium-term projections anticipate small additional increases in the current account surplus to 8.0 per cent of GDP in 2009 and 7.9 per cent in 2010.

 

3.9      GNI

 

Gross national income (GNI) differs from GDP in that it also includes primary income, which is the net of taxes, wages and property income – in other words, the net of Swedish income in the rest of the world and rest of the world income in Sweden. Given positive primary income, GNI is expected to be somewhat higher than GDP in 2007. GNI is forecast to increase by 6.4 per cent in 2007 and 5.6 per cent in 2008. In current prices, GNI and GDP in current prices are each expected to grow by 4.7 percent annually in 2009 and 2010.

 

 

 

39



 

Long-term impact of the government’s policies

 

Achieving high sustainable employment is vital to maintaining high economic growth and stable public finances, as well as ameliorating labour market exclusion. The government has adopted and announced a number of reforms that target sustainable employment growth. This bill proposes additional reforms. The purpose of this explanatory box is to describe how the government’s economic policies are seen as affecting the direction of the economy. The reforms that are being adopted and announced are expected to make a major impact on the economy in the next few years but not have their full effect for another 5-10 years. A more fundamental, detailed discussion of labour supply and employment appears in the explanatory box entitled “Labour supply and employment”.

 

Incentives to work strengthened

 

The government has adopted and announced reforms that will increase the incentives to work. Income taxes have been cut through adoption of the earned income tax credit, while benefit levels in several social insurance systems have been lowered. But the hike in contributions to unemployment benefit funds may have somewhat of an offsetting effect. Once it becomes more lucrative to work, more people will find their way into the labour market – in other words, the supply of labour will expand. In addition, unemployed workers are expected to more actively look for jobs, leading to improved matching between labour supply and demand. The likely overall impact of the stronger incentives is that labour supply will expand and equilibrium unemployment will decrease over the long term. As a result, the reforms should generate higher sustainable employment.

 

A number of studies can serve as a starting point for assessing the degree to which the strengthened incentives to work will affect labour supply, unemployment and employment.(13) An overall analysis of relevant studies suggests that the reforms will boost employment by 0.9 per cent and lower equilibrium unemployment by almost 0.5 percentage points in the long term. The impact until 2010 is expected to be somewhat less, given that it will probably take longer than that for the policies to have their full effect.


(13)              The research literature presents a series of estimates about how incentives to work, measured as the tax wedge, affect employment. One such study is Nickell, S & R. Layard (1999), “Labour Market Institutions and Economic Performance”, in the Handbook of Labor Economics. Its findings are in line with many of the most important studies in the area, as well as the Ministry of Finance’s assessment. But the estimated impact varies considerably from study to study. A number of studies also treat the impact on employment of changes in the level of unemployment benefits. The Ministry of Finance’s assessment is similar to the findings presented in Bassanini, A & R. Duval (2006), “Employment Patterns in OECD Countries: Reassessing the Role of Policies and Institutions”, OECD Economics Department Working Papers 486, OECD Economics Department.

 

 

Income tax reforms will also affect incentives for people with jobs to change their working hours. On the one hand, some people will probably work more once the marginal advantage of staying on the job for an extra hour is greater than before. On the other hand, some workers may prioritise more time off when tax cuts leave them with higher wages after tax. The net impact on average hours worked in the total economy is expected to be positive, and hours worked are expected to increase by 0.2 per cent more than employment.

 

Change in scope and direction of labour market policy programmes

 

The government has adopted a number of measures for a more effective labour market policy. Several programmes – including the bonus jobs, the sabbatical year, and certain employment subsidies – whose participants are defined as employed are being eliminated. Because many of the participants are expected to gain employment in the regular labour market, these changes will boost regular employment. But because not everyone will obtain a regular job, the impact on total employment will be negative.

 

The number of people in labour market policy programmes – such as work experience placements and vocational training – whose participants are by definition not counted among

 

 

40



 

 

the labour force will not noticeably change between 2006 and 2010. But the programmes will be modified so as to focus more on people who have particular difficulty gaining employment. Starting in 2008, virtually everyone participating in the programmes will participate in a job and development guarantee for long-term unemployed workers or job guarantee for youth. Participants in these programmes will be registered as outside the labour force, thereby lowering open unemployment, but they will nevertheless be actively seeking jobs so that the effective labour supply will increase. The labour market reforms will reduce the risk that people who actually would have good prospects for gaining regular employment will be trapped in a cycle of various policy programmes. The above reforms are expected to increase employment. But the magnitude of the impact is difficult to assess and is highly dependent on how successfully the employment offices implement the intentions of the reforms.

 

The introduction of new starts jobs and entry jobs (instegsjobb), as well as the appropriation of additional resources to Samhall (a state-owned company that offers sheltered employment to people with disabilities), is also intended to make it easier for those who have particular difficulty gaining employment to find work.

 

The changes in the labour market policy programmes are expected to boost employment by 0.4 per cent and reduce equilibrium unemployment, measured as open unemployment, by 0.4 percentage points by 2010. The long-term impact of the changes is projected to be the same. Some of the reduction in open unemployment will reflect the fact that people participating in the job and development guarantee for long-term unemployed workers and the job guarantee for youth will be statistically defined as outside the labour force even though they are part of the effective labour supply. Elimination of the sabbatical year scheme is expected to increase average hours worked by 0.2 per cent.

 

Targeted reductions of employer’s social contributions to boost employment

 

Because general reductions of employer’s social contributions have a long-term tendency to boost wages, their impact on employment is limited.(14) Targeted reductions are less likely to be passed on as higher wages. As a result, reductions that target specific sectors or worker categories can have a long-lasting impact on employment. A number of such targeted stimulus measures have been adopted. Among them are the re-entry job scheme mentioned above and tax cuts for household services. The main probable impact of such tax cuts is that services that currently go unreported will be reported. Thus, the effect on employment may not be particularly large.(15) However, tax receipts will definitely increase. The government has also proposed reduced employer’s social contributions for certain service sub-sectors. But because the shape of the reductions remains hazy, the present calculation assumes that the change will not have any significant impact on employment. The changes in employer’s social contributions, excluding new start jobs, are expected to boost employment by 0.1-0.2 per cent in the long term.


(14)               For a more detailed discussion, see the explanatory box entitled “Labour supply and employment”.

(15)               Some people whose services go unreported are probably already registered as employed in the Statistics Sweden Labour Force Survey. The National Accounts calculation of GDP and hours worked includes an estimate of unreported services, a percentage of which will probably become reported services.

 

Wage formation will improve

 

Increased labour supply in the wake of the reforms should moderate wage growth. Reduced subsidies to unemployment benefit funds may also have an impact. Greater self-financing of the funds will oblige members to bear a greater share of the costs for those who are jobless. The result may be restraint on wage demands. Thus, increasing self-financing may help wage formation work better, thereby contributing to lower equilibrium unemployment and higher sustainable employment. But the design of the fee, particularly its relationship with the cost of unemployment in each fund, can be structured better. The government plans to review the system and propose changes in its Budget Bill for 2008. As currently structured, self-financing of unemployment benefit funds is estimated to increase employment by 0.1 per cent.

 

 

 

41



 

Total employment will increase by 1.6 per cent

 

The government’s economic policies are expected to boost the total number of employed workers by 1.6 per cent over the long term. The regular employment rate – the total number of employed workers excluding those statistically defined as employed in labour market policy programmes – should increase by 1.9 percentage points. Equilibrium unemployment, measured as open unemployment, is expected to decrease by 1.1 percentage points in the long term.

 

As mentioned above, average hours worked are likely to increase once it is more lucrative to stay on the job longer. Elimination of the sabbatical year, as well as changes in sickness allowance calculations, should also favourably affect average hours worked. But much of the employment growth will reflect entry into the labour market of people who work fewer average hours. Because they are likely to work part-time more than other employees, they will restrain average hours worked. But the net impact on average hours worked will probably be positive so that the total number increases by 2.1 per cent (somewhat outstripping employment increase).

 

Given that additions to the labour force are assumed to have below average productivity, the impact on GDP is estimated at somewhat below 2.1 per cent.

 

Assessing when and how much the reforms that have been adopted and announced will have an impact is associated with considerable uncertainty. Chapter 6 of this appendix presents a calculation in which the reforms are assumed to make a substantially greater impact than anticipated by this forecast.

 

Important to keep in mind is that the government’s economic policies can affect growth and employment via other routes than described here. Educational policy and investments in infrastructure may contribute to more robust growth going forward. Changes with respect to the supply of venture capital and repeal of the wealth tax also have the potential to bolster economic growth. But because the effects of such measures are still far away or more poorly documented in the research literature, the calculations do not take them into consideration.

 

Long-term impact of the government’s economic policies

 

Change in per cent or percentage points

 

 

 

Employ-

 

Unemploy-

 

Hours

 

GDP, %

 

 

 

ment, %

 

ment, p.p.

 

worked, %

 

 

 

Strengthened incentives to work

 

0.9

 

-0.5

 

1.1

 

 

Change in labour market policy programmes

 

0.4

 

-0.4

 

0.6

 

 

Reductions of employer’s social contributions(1)

 

0.1

 

-0.1

 

0.1

 

 

Improved wage formation

 

0.1

 

-0.1

 

0.1

 

 

Change in sickness allowance

 

 

 

0.2

 

 

Total

 

1.6

 

-1.1

 

2.1

 

1.8

 

 


Note.: Due to rounding, the parts do not add up to the whole.

(1)                     Excluding new start jobs.

Source: Ministry of Finance.

 

42



 

4         Labour market, wages, inflation and resource utilisation

 

Sustained rise in employment

 

Labour market trends have been favourable since mid-2005. Employment and hours worked have risen and open unemployment has fallen. Robust growth in demand for labour is forecast for the next few years. GDP growth is high and indicators point to a sustained and significant rise in employment.

 

Increasing employment has not yet caused general problems for firms in finding suitable workers, but there are signs that recruiting is becoming more difficult and that wage growth is accelerating. Labour resource utilisation appears to be tightening. Employment and unemployment are consequently now at levels where wages and prices may rise faster than consistent with the Riksbank’s inflation target. Conditions for strong and sustainable employment growth over the next few years are nevertheless good, due to the assessed high net inflow of workers in the labour market, in part due to adopted and proposed measures to stimulate labour supply.

 

Changes in labour market policy programmes will affect the labour market

 

Except cyclical and structural changes in the labour market, employment and labour supply are influenced by changes to the scope and direction of labour market policy programmes. The number of programmes in which participants are defined as employed will decline relatively sharply in 2007 and 2008, subduing employment growth. However, regular employment (excluding participants in labour market policy programmes) will rise faster than total employment.

 

The number of places in programmes whose participants are defined as outside the labour force in 2010 will be about equal to the 2006 level, but programme orientation will change. As of 2008, most people participating in labour market programmes will participate in one of the new programmes to be introduced: the job and development guarantee for long-term unemployed workers or the job guarantee for youth. The programmes will be oriented more clearly towards eliminating labour market exclusion. The job and development guarantee is expected to encourage unemployed workers to look for  jobs more actively and efficiently or participate in a work experience programme. Although participants will be registered as outside the labour force, reducing the open unemployment rate, they will in fact be seeking jobs and will therefore increase the effective labour supply. Sharper focus on individuals who are less immediately employable will reduce the risk that people who actually would have good prospects for gaining regular employment will become trapped in an endless cycle of policy programmes. The new labour market policy is to raise the long-term employment level.

 

Table 4.1 Selected statistics

 

Percentage change unless otherwise stated

 

 

 

2006

 

2007

 

2008

 

2009

 

2010

 

GDP

 

4.4

 

3.7

 

3.3

 

2.1

 

2.3

 

Productivity

 

3.1

 

2.2

 

2.1

 

1.8

 

1.8

 

Hours worked

 

1.4

 

1.5

 

1.1

 

0.2

 

0.5

 

Average hours worked

 

-0.4

 

-0.8

 

0.2

 

0.1

 

0.6

 

Employed

 

1.8

 

2.3

 

0.9

 

0.1

 

-0.1

 

Regular employment rate, age group 16-64(1)

 

73.5

 

75.0

 

75.6

 

75.7

 

75.6

 

Regular employment rate, age group 20-64(1)

 

77.7

 

79.4

 

80.2

 

80.3

 

80.1

 

Labour force

 

1.2

 

1.5

 

0.3

 

0.2

 

-0.1

 

Open unemployment(2)

 

5.4

 

4.7

 

4.1

 

4.2

 

4.2

 

Labour market policy programmes(23)

 

3.0

 

2.0

 

2.0

 

1.9

 

1.9

 

Total unemployment(2)

 

8.4

 

6.7

 

6.2

 

6.1

 

6.2

 

Hourly wages(3)

 

3.1

 

4.0

 

4.3

 

4.5

 

4.4

 

CPI, year-on-year (4)

 

1.4

 

1.8

 

2.3

 

2.7

 

2.5

 

UND1X, year-on-year(4)

 

1.2

 

0.8

 

1.5

 

2.2

 

2.2

 

 


Note: Figures in the table refer to non-calendar-adjusted data. A more detailed table is available in the tables appendix.

(1)                    The number of people in regular employment for the specific age group; that is excluding people employed in labour market policy programmes, as a percentage of the population in the age group.

(2)                    As a percentage of the labour force.

(3)                    According to short-term wage statistics.

(4)                    Annual average.

Sources: Statistics Sweden, National Labour Market Board, National Institute of Economic Research and Ministry of Finance.

 

Labour supply will increase slower than employment

 

Relatively rapid labour supply growth is anticipated in 2007. Supply growth will be considerably lower in 2008, in part due to introduction of the job and development guarantee for long-term unemployed workers and the job guarantee for youth. The labour supply is set to increase in 2007 and 2008 more than demographic growth among the working age population would suggest,

 

43



 

as more people enter the labour market due to rising demand for labour. The demand momentum is also affecting outward flow from the labour force and fewer workers are likely to leave the labour market prematurely. The trend labour participation rate is also gathering momentum among certain age groups, which is expected to continue. Implemented and proposed reforms to increase labour supply are also promoting labour supply growth. Nevertheless, labour supply is growing at a slower rate than employment, leading to a decline in unemployment.

 

Resource utilisation will be progressively higher

 

Indications are that labour resource utilisation is rising. Unemployment has declined relatively quickly and there are signs of accelerating wage growth. The percentage of firms reporting labour shortages in surveys is rising and tendencies suggest it is getting more difficult to recruit suitable workers in some sectors. Consequently, unless there are structural changes in the labour market, employment cannot continue rising as rapidly as in the last year without triggering inflationary wage growth. In other words, the employment gap is around zero, meaning actual employment is close to potential employment. However, the assessed output gap, which includes employment as well as changes in average hours worked and productivity, is positive. The primary driver is productivity growth, which has risen in recent years above the level considered sustainable in the long term. (See explanatory box, “Potential GDP and the output gap”.)

 

Several reforms have been adopted and others announced to increase supply and demand in the labour market and improve both wage formation and matching between supply and demand for workers. The reforms are expected to help sustain favourable employment and GDP growth in future years. However, the expansionary economy and attendant high demand for labour is anyhow expected to cause actual employment to increase faster than potential employment. Consequently, the level of resource utilisation will be high and the employment gap will widen to nearly 1 per cent in 2008, meaning employment will be about 1 per cent higher than is sustainable long-term (see Figure 4.1).

 

Figure 4.1 Output gap and employment gap

 

Per Cent

 

 

Source: Ministry of Finance.

 

Rising wage growth and inflation

 

Wage growth has been low over the past few years, mainly due to high available labour supply competing for jobs, making it relatively easy for employers to recruit suitable workers. As employment rises in the future and resource utilisation becomes progressively higher, wage growth is anticipated to rise. The growing labour supply combined with factors including the reformed unemployment insurance system is expected to check wage growth to a certain extent.

 

Inflation has been low in recent years and remains relatively subdued. Moderate wage growth combined with strong productivity growth has kept the labour costs of firms down, contributing to controlling domestic inflation. The CPI has been increasing somewhat faster recently, due to higher energy prices, increased interest costs and rising import prices. Domestic inflationary pressure will increase when wage growth rises in parallel with more moderate productivity growth in the future. But a stronger krona and falling energy prices are expected to restrain inflation in upcoming years.

 

Economy will adjust towards normal resource utilisation in 2009 and 2010

 

The calculations for 2009 and 2010 are not based on an assessment of the business cycle. The calculations for those years are based on assessments of the level of resource utilisation in 2008 and the potential growth rate in the total economy. The economy is assumed to be

 

44



 

moving towards normal resource utilisation in 2010.

 

Potential GDP is estimated to rise by an average of 2.7 per cent(16) a year in 2009-2010 and potential employment by an average of 0.5 per cent a year, lower than for 2006-2008. The progressive moderation of potential growth is primarily attributable to flagging population growth. Estimated potential productivity growth is around 2.2 per cent per year.

 


(16)               The number of working days will be higher in 2010 than in 2009, which is assumed to augment GDP growth by 0.3 percentage points and average hours worked by 0.6 percentage points.

 

Labour resource utilisation is likely to be high in 2008, and wage growth will rise to a level inconsistent with a balanced economy. The forecast underlying inflation rate will be slightly higher than the Riksbank’s inflation target in 2009 and 2010. The Riksbank is expected to respond by raising the repo rate to a maximum of 4.75 per cent in 2009.

 

Relatively high wage growth and tighter monetary policy are expected to moderate eco-nomic growth and demand for labour. As a result, GDP growth should be below potential GDP in 2009 and 2010. Employment is also expected to show only sluggish growth in 2009, followed by a decline in 2010. Open unemployment is set to rise slightly. This triggers a decline in resource utilisation, which is expected to reach a long-term sustainable level in 2010.

 

Figure 4.2 Employment gap, wage growth, inflation and repo rate

 

Per cent, annual average

 

 

Sources: Statistics Sweden, Riksbank and Ministry of Finance.

 

Adjusted for the effect of the increase in working days between 2009 and 2010, average hours worked should remain unchanged in both years. Policy changes are expected to increase average hours worked, but the increase will be offset by the demographic trend.

 

Productivity growth should be weaker than growth in potential productivity for 2007-2010 due to high capacity utilisation and more limited scope for efficiency gains.

 

Overall, labour market trends in upcoming years are expected to stimulate a rise of 2 percentage points in the regular employment rate for workers age 16-64 between 2006 and 2010, when it will be 75.6 per cent. A decline in open unemployment is expected from 5.4 per cent to 4.2 per cent in the same period, and total unemployment (including participants in labour market policy programmes) should drop from 8.4 per cent to 6.2 per cent.

 

Uncertainty in assessments of resource utilisation and the impact of new proposals

 

The risks in labour market forecasts are mainly associated with uncertainty in assessments of the impact of government policy and how rapidly the effects will materialise. The current assessment is reported in the explanatory box “Long-term impact of the government’s economic policies”. Uncertainty is also considerable with respect to the level of resource utilisation in the total economy. There is often a lag before wages and inflation respond to changes in the labour market, which hampers the assessment. The alternative scenario presented in Chapter 6 assumes government policy will have considerably greater impact than stated in this forecast.

 

 

45



 

Potential GDP and the output gap

 

Overall economic output is determined by the number of workers employed, the average hours they work and their output per hour worked, or productivity. Output at a given point in time can theoretically be divided into two components: a structural component usually called potential output and a cyclical component that describes cyclical variations around the potential level. The Ministry of Finance’s calculations of potential GDP are based on an assessment of how high employment can rise without triggering wage and price growth inconsistent with the Riksbank’s inflation target, how many hours workers can normally work and the productivity trend. In other words, potential GDP is a measure of how much can be produced in the total economy at a level of resource utilisation consistent with stable inflation. Potential GDP is a concept that can be assessed and calculated in a variety of ways and the assessments are highly uncertain.

 

The output gap measures the difference, expressed as a percentage, between actual and potential GDP. A negative output gap means actual GDP is below potential and the opposite is true if the output gap is positive. As overall economic output is determined by the number of employed workers, their average hours worked and their productivity, the output gap can be divided into an employment gap, an hours worked gap and a productivity gap, all expressed as percentages of the potential levels.

 

The employment gap illustrates available resources in the labour market. A positive or negative gap means the actual employment rate differs from the potential employment rate; that is, the highest level of employment possible without triggering inflationary wage growth and without continual increases in the profit share of GDP. If the gap is closed, unit labour costs for firms(17) develop so that inflation is consistent with the Riksbank’s inflation target. The potential employment level is determined by population size, the assessed percentage of the population participating in the labour force in a normal economy and the percentage defined as outside the labour force (categories including students and people receiving sickness/activity compensation for instance) and the level of equilibrium unemployment, which is the level below which unemployment cannot fall without causing severe labour shortages.

 


(17)               Growth in unit labour cost is calculated as wage growth including social contributions per hour worked minus productivity growth.

 

The productivity gap illustrates the difference between actual productivity and an estimated trend.

 

The hours worked gap illustrates the difference between average hours worked and the estimated potential level in a normal economy.

 

All gaps are not always positive or negative in tandem. On the contrary, the productivity gap and hours worked gap tend to be positive when the employment gap is negative and vice versa. The reason is that productivity often rises rapidly early in an economic upturn when there is scope to use machinery and labour more efficiently. Once capacity utilisation has risen sufficiently, there is less scope for efficiency gains. Average hours worked often increase when the employment rate falls because various categories of absence tend to decline when employment growth is weak. Thus, a positive hours worked gap early in an economic upturn is often accompanied by a negative employment gap.

 

Because the components are correlated to GDP growth in various ways, the output gap (the total of the productivity gap, the hours worked gap and the employment gap) is on average less negative or positive than the employment gap.

 

 

46



 

4.1      Labour market

 

Strong trend continued in 2006

 

Following four years of weak growth, the employment trend began recovering in the second half of 2005 and employment growth has since remained positive. Unemployment was not affected because the labour force increased in parallel with employment until summer 2006. Indications are that many workers who gained employment during this period were former students and thus by definition previously outside the labour force. Employment increased faster than the labour force in autumn 2006 and winter 2007, pushing down unemployment. Total unemployment, including the open unemployment and participants in labour market policy programmes, has declined rapidly in the last six months.

 

The employment trend has been good in most sectors (see Table 4.2), particularly private services and construction. Employment growth has been strongest in the construction industry, but since the sector accounts for only about 6 per cent of all workers employed, the contribution to total employment growth was far below that of the private service sector. The main driver of growth in the latter has been a steep rise in business and household services. Relatively robust employment growth in the local government sector made a substantial contribution to total employment growth, but much of the increase in local government employment stemmed from the expansion of bonus jobs in 2006 and does not qualify as growth in regular employment.(18)

 


(18)               People defined as being in regular employment include all employed persons except those categorised as employed in labour market policy programmes (employment support, bonus jobs, sabbatical year, trainee replacement and business start-up grant).

 

Employment rose in 2006 for virtually all age groups. The increase was highest for the youngest (16–19) and the oldest (60–64) workers. The number of employed in the 16–19 age group increased by 14 per cent in 2006.

 

Table 4.2 Employment trends by sector and contributions to total employment change in 2006

 

 

 

Percentage
change

 

Contribution,
percentage points

 

Private service sector

 

2.9

 

1.2

 

Business services

 

4.9

 

0.5

 

Household services

 

4.0

 

0.3

 

Trade

 

1.5

 

0.2

 

Real estate services

 

5.5

 

0.1

 

Financial services

 

3.2

 

0.1

 

Other services

 

1.4

 

0.1

 

Construction

 

6.9

 

0.4

 

Industry

 

-0.6

 

-0.1

 

Local government

 

1.2

 

0.3

 

Central government

 

0.8

 

0.0

 

Total

 

1.8

 

1.8

 

 

Note: The figures are rounded off and the individual items do not add up to the total.

Source: Statistics Sweden.

 

Labour market policy programmes scaled back…

 

The number of participants in labour market policy programmes averaged 138,000 in 2006. The number of programme places was increased during the year successively through the end of October when the new government commenced the effort to change the direction of labour market policy, including restructuring the volume and content of labour market policy programmes. The Budget Bill for 2007 proposed the elimination of bonus jobs, general and extended employment supports, the sabbatical year scheme, the trainee replacement scheme and graduate internships. The National Labour Market Board also sharply scaled back the number of participants in other programmes in late autumn and winter (see Figure 4.3).

 

 

47



 

Figure 4.3 Participants in labour market policy programmes

 

Thousands of persons

 

 

Note: Seasonally adjusted data.

Source: National Labour Market Board.

 

In this bill, the government is proposing a job and development guarantee for long-term unemployed workers, to take effect 2 July 2007. It is possible to provide places to everyone covered by unemployment insurance who has used 300 benefit days. It will also be possible to extend the guarantee to uninsured people who have been unemployed or in a policy programme for at least 18 months. Unemployed parents of minor children should be able to choose between participating in the guarantee programme or receiving unemployment benefits from the 301st through the 450th benefit day. Participation in the guarantee programme will not qualify individuals for a new period of unemployment benefits.

 

The government is also proposing a job guarantee for youth that would take effect 1 December 2007. It should be possible to provide places to youth under age 25 who have been registered as jobseekers with the Employment Office for 100 days.

 

The two guarantees contain measures that must be individually adapted and aimed primarily at encouraging unemployed people to look for work more actively and efficiently, which will help augment the effective labour supply. In the second step, unemployed people will be referred to work experience placements, jobs with employment support and skills development initiatives aimed at increasing their likelihood of gaining employment. In the third step, everyone who has not found a job after 450 benefit days under the job and development guarantee will be referred to long-term public service employment.

 

The number of places in labour market policy programmes is estimated at 95,000 as an annual average in 2007, a substantial reduction compared to 2006. The bulk of the cutbacks were implemented in late 2006 and early 2007. A further modest decline in programme volumes is expected in 2008–2010. Although volumes will decline somewhat in the future, projected volumes are higher in this forecast, due to the new initiatives, than anticipated in the Budget Bill for 2007.

 

Table 4.3 Participants in labour market policy programmes

 

Thousands, annual average

 

 

 

2006

 

2007

 

2008

 

2009

 

2010

 

Employed

 

56

 

41

 

20

 

12

 

12

 

Special employment support(1)

 

9

 

7

 

8

 

8

 

8

 

Bonus jobs

 

11

 

19

 

8

 

0

 

0

 

Other employment support(2)

 

25

 

7

 

0

 

0

 

0

 

Sabbatical year

 

10

 

5

 

0

 

0

 

0

 

Other

 

6

 

4

 

4

 

4

 

4

 

In education and training

 

82

 

54

 

75

 

78

 

78

 

Job and development guarantee for long-term unemployed

 

0

 

14

 

41

 

46

 

44

 

Job guarantee for young

 

0

 

0

 

28

 

28

 

28

 

Other

 

82

 

40

 

6

 

5

 

6

 

Total

 

138

 

95

 

95

 

90

 

90

 

 


(1)                    Starting 1 July 2007, the special employment support will be included in the job and development guarantee for long-term unemployed workers.

(2)                    Academic internships are included in this item.

Sources: National Labour Market Board and Ministry of Finance.

 

…but other initiatives expanded

 

The new start jobs was introduced in January 2007. New start jobs are aimed at helping people with a weak foothold in the labour market gain regular employment. New start jobs reduce labour costs by means of employer tax credits. The scheme was designed for people who have received unemployment benefits, sickness allowance, sickness and activity compensation or social assistance benefits for more than a year. Recently arrived refugees and their families will also be eligible for new start jobs for three years after receiving a permanent residence permit. The tax credit will apply for a period equal to the time the individual has been out of work, up to five years.(19)

 


(19)              The tax credit period is doubled for people age 55 or older up to a maximum of ten years. Youth who have been unemployed for more than six months are covered by the tax credit for up to one year. New start jobs will be available only to private sector employers and public sector employers engaged in commercial activity.

 

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The number of new start jobs rose steadily during early 2007 and is expected to reach 20,000 by the end of the year, corresponding to an annualised average of 10,000. The number of new start jobs should continue to increase in 2008 up to an annualised average of 25,000 (see Table 4.4).

 

Table 4.4 New start jobs

 

Thosands, annual average

 

 

 

2006

 

2007

 

2008

 

2009

 

2010

 

New start jobs

 

0

 

10

 

25

 

30

 

25

 

 

Source: Ministry of Finance.

 

The employer is entitled to a tax credit for employees eligible for new start jobs. People in new start jobs will be defined as in regular employment, not as participants in labour market policy.

 

In this bill, the government is proposing a entry jobs scheme in a targeted initiative to benefit immigrants. Entry jobs will benefit asylum-seekers, quota refugees and their families.

 

In this bill, the government is also proposing expanded initiatives for people with disabilities.

 

Favourable indicators

 

The conditions for continued strong growth in the labour market are good. GDP growth is high and indicators point to strong employment growth in the next six months.

 

According to the National Labour Market Board, newly reported vacancies are very high and had increased by 40 per cent in February compared to a year before.(20) From an historical perspective, there has been a relatively strong correlation whereby growth in newly reported vacancies is followed two quarters later by growth in employment (see Figure 4.4). Newly reported vacancies has increased across most sectors and geographical regions. Increases have been recorded for both skilled and non-skilled and temporary and permanent jobs.

 


(20)               Note that National Labour Market Board statistics probably indicate an inordinately rosy picture of developments because the Board’s market share has increased, meaning that a larger percentage of vacancies is now being registered with the Employment Office. Statistics Sweden’s firm-based statistics also provide an optimistic view of the trend, despite lower growth figures. Reports from Statistics Sweden show that vacancies in the private sector increased by 25 per cent in the fourth quarter of 2006 compared to one year before.

 

The NIER Business Tendency Survey reveals optimistic hiring plans among firms in most sectors.

 

Figure 4.4 Newly reported vacancies and employment

 

Annual percentage change

 

 

Note: Three months moving average.

Sources: National Labour Market Board and Statistics Sweden (LFS).

 

The same survey shows increasing labour shortages in most sectors since early 2005. A co-weighted average for the business sector shows that about one fourth of firms are experiencing labour shortages. Shortages are most severe in construction and business services. There are no general indications that the time required to fill vacancies is increasing.

 

Employment growth will continue

 

Healthy demand is expected to generate favourable employment growth during the forecast period, despite cutbacks in 2007 and 2008 in labour market policy programmes whose participants are defined as employed. In the current economy, policy programmes are expected to a significant substitution of regular employment.(21) The net effect of programme cutbacks on employment will be smaller than it would have been in a poorer economy, but programme orientation varies widely, as does the impact on employment.

 


(21)              Substitution of regular employment refers to situations where either (i) a person who is employed under a recruitment incentive or other scheme would have been employed even if the subsidy did not exist, or (ii) another person, not eligible for the scheme, would have been employed if the subsidy did not exist. If substitution of regular employment is high (low), the net effect on employment will be insignificant (significant).

 

49



 

The income tax reductions and unemployment insurance reforms effective 1 January 2007 are expected to bolster employment growth in the future. The tax allowance for household services that will take effect in July 2007 should also promote employment growth in the private service sector.

 

Employment is estimated to rise by 2.3 per cent in 2007 and 0.9 per cent in 2008, equivalent to an increase of approximately 140,000 people in work. The increase in regular employment is estimated at about 175,000 people, taking into account a reduction during the same period of 35,000 participants in labour market policy programmes defined as employed (see Figure 4.5). Employment is projected to reach an unsustainably high level in 2008. A weaker employment trend is assumed in 2009 and 2010 as the economy adjusts towards normal resource utilisation.

 

Figure 4.5 Employment and people in the labour force

 

Thousands of persons

 

 

Sources: Statistics Sweden (LFS), National Labour Market Board and Ministry of Finance.

 

Employment growth will be strongest in the business sector

 

Around 80 per cent of employment growth in 2007–2008 is expected to be in the business sector. The service and construction sectors are expected to bolster increased employment, while industrial employment should continue falling slightly.

 

The hiring plans of firms in the private service sector are still positive in most segments. The service sector should account for the majority of total employment growth in 2007–2008.

 

Construction activity is still strengthening. Firms remain optimistic about the future, anticipating growth in construction activity as well as employment, but the shortage of construction workers since 2005 is still worsening. The problem is most severe for firms specialising in residential construction. In light of severe labour shortages in construction, employment has progressed surprisingly well in the last year. While this may indicate that shortages are restricted to certain occupational categories so far, the time required to fill vacancies has increased in the last six months, indicating that labour shortages may hold back future employment growth in the construction sector.

 

Industrial employment has trended downward for several decades, rising only in years when industrial activity has been unusually strong. Output growth is projected to be high in 2007 and 2008, but not sufficient to result in employment growth.

 

Strong local government finances are forecast to contribute to employment growth in the sector by 22,000 people between 2006 and 2008. Bonus jobs will increase employment in the local government sector in 2007,(22) while elimination of the sabbatical year and training replacement will restrain employment growth during the year. Employment in the local government sector is expected to continue rising in 2008 despite the phase-out of bonus jobs. In the central government sector, employment is expected to increase by around 2,000 people between 2006 and 2008. Elimination of the bonus jobs, sabbatical year and trainee replacement schemes will also restrain future employment growth in the central government sector.

 


(22)               As no further bonus jobs will be granted in 2007, the scheme will not increase employment during this year, but will increase average employment compared to last year because the average number of people in bonus jobs is higher in 2007 than in 2006.

 

Average hours worked will rise slightly

 

Average hours worked per person employed is determined the percentage of people absent from work for various reasons and the average hours worked by all people in work. Changes in average hours worked have been marginal for the last three years. In the past, there has been a strong correlation between sickness absence and the employment rate, but sickness absence has steadily declined in the face of continuous

 

 

 

50



 

employment growth for 18 months (see Figure 4.6). More stringent procedures applied by the Social Insurance Agency are believed to have deterred sickness absence, but there was a slight rise in the fourth quarter of 2006, which may indicate that the decline is levelling off. Sickness absence accounted for around 20 per cent of absence in 2006. Absence for reasons other than sickness has risen since early 2005. Holiday leave makes up around half of all absence and temporary parental benefit leave accounts for approximately 15 per cent.

 

Figure 4.6 Absence and employment

 

 

Note: Absence refers to those who have been absent the whole reference week.

Source: Statistics Sweden (LFS).

 

Total absence is expected to increase in 2007–2008 with adverse impact on average hours worked. The strong overall labour market is a key driver of rising absenteeism. Absence for reasons other than sickness is expected to rise during the forecast period. The trend is mainly dependent on economic conditions, but also on an upward trend in temporary parental benefit leave due to factors including larger families. Sickness absence(23) is expected to remain essentially stable. The expansionary economy is pushing sickness absence up while the government’s policy of lowering the ceiling for sickness insurance benefits and the Social Insurance Agency’s more restrictive procedures have an opposite effect.

 


(23)               In the Labour Force Survey (LFS), sickness absence is reported as either “sickness absence the whole reference week” or “sickness absence part of the reference week”. LFS statistics are not directly comparable with Social Insurance Agency (SIA) statistics on the number of people on sick leave. SIA statistics include only people who have been on sick leave for more than 14 days, while unemployed persons and students on sick leave are included in SIA statistics but not in LFS statistics.

 

Demographic trends are also expected to adversely impact average hours worked in future years. Population growth is strong in age groups with low average hours worked and vice versa. For cyclical reasons, the employment rate for age groups with low average hours worked is expected to rise more than for the average, exacerbating the effect.

 

Opportunities for underemployed individuals often become available in an expansionary economy, with positive impact on average hours worked.

 

It is hard to assess the impact on average hours worked of the new earned income tax credit. The credit will promote higher average hours worked, given that it will be more profitable for people, particularly low-income earners, to increase their working hours. But there is risk that high-income earners will cut back their working hours and some people who gain employment as a result of the proposal will work part-time.

 

Beyond the earned income tax credit, other components of the government’s policy are aimed at ameliorating labour market exclusion. It is reasonable to presume that some of the people entering the labour market will work fewer hours than the average, which would lessen average hours worked. On the other hand, the unemployment insurance reform is encouraging more people to work full time.

 

Phasing out the sabbatical year scheme will bolster average hours worked in 2007 because people on sabbatical leave are defined as employed, even though their working hours are zero.

 

Adjusted for the variation in the number of working days from year to year, a marginal increase in average hours worked is expected in future years. A relatively strong decline in average hours worked is expected for 2007, on an annualised basis, due to developments in previous years.

 

Productivity growth will taper off

 

Productivity growth moderated in 2005, due to a temporary slowdown in industrial activity and

 

 

 

51



 

the reduced contribution from merchanting.(24) As economic growth gathered momentum in early 2006, productivity growth was very high among private market producers of goods and services. Productivity growth remained high in the second half of 2006, stimulated in part by a strong contribution from merchanting.


(24)               Merchanting is the trade margin that arises when Swedish parent companies manage billing for sales to third countries by foreign subsidiaries. The trade margin is accounted for as output in the Swedish National Accounts, but this output does not correspond to any hours worked at the relevant point in time.

 

Productivity growth is forecast to fall in the future, as economic growth moderates and the economy moves towards higher resource utilisation. Initially assessed as positive, the productivity gap will consequently close.

 

Labour supply will continue to grow

 

The total economy strongly influences labour supply trends. Higher demand for labour stimulates more people to enter the labour market. The impact of the economy on the labour supply varies according to worker age group. The labour participation rate varies more over an economic cycle among young workers due to their strong tendency to participate in the labour force only after they get a job.(25) Labour force participation among older workers is often affected more than the average by economic conditions, as they tend to stay in work longer when the labour market is flourishing. When the labour market is shaky, older workers are inclined to retire earlier than they would have otherwise.


(25)               For instance, young people have greater opportunities to get summer and temporary jobs in an expansionary economy. Rising employment among youth does not necessarily mean they are abandoning their studies. If a person works one or more hours during the reference week, he or she is regarded as employed in the LFS (whether or not the individual is a full-time student).

 

The labour supply is also affected by demographic trends. A larger population obviously means that there are more people available to work, but the structure of population growth is also significant (see Figure 4.7). From a labour force perspective, demographic trends in the coming years will be relatively unfavourable. Age groups with low labour force participation will grow strongly. This applies particularly to the 16–19 and 60–64 age groups, but also to the 20–24 age group. The 45–54 and 55–59 age groups, which have a high labour force participation rate, will decline or remain largely unchanged.

 

Labour force participation among workers age 60–64 has trended strongly upward for several years. This trend is mainly driven by the increasing numbers of older workers who are choosing to remain in work longer than earlier generations. The oldest groups in the labour market are mainly people born in the 1940s. They are healthier on average than their predecessors and have a strong foothold in the labour market. They were not hit as hard by the economic crisis of the 1990s as the people who were at that time the older groups in the labour market. Reform of the pension system may also have affected labour participation among older workers. Indications are that the rising labour participation trend among older workers will continue in coming years.

 

Figure 4.7 Labour participation by age group

 

Percentage of the population

 

 

Note: Due to the harmonisation of statistics in 2005 the numbers are not totally comparable.

Source: Statistics Sweden.

 

Income tax and unemployment insurance reforms previously proposed by the government combined with reduction of employer’s social contributions for certain categories are expected to have favourable long and short-term impact on labour supply. Employer’s contributions have been waived for workers over 64 to make them more attractive in the labour market and improve their opportunities to remain in work longer. A weaker labour supply trend is expected due to the proposed job and development guarantee for long-term unemployed workers and job guarantee for youth, as participants in the programmes will be statistically defined as outside the labour force. But the effective labour supply will be augmented when unemployed workers participate in programmes

 

 

 

52



 

that enhance their employability and encourage active job search.

 

The labour supply is anticipated to increase by 1.5 per cent in 2007. Growth in 2008 is expected to level off at 0.3 per cent, partly due to the expanded scope of policy programmes whose participants are statistically categorised as outside the labour force. Higher growth in labour force participation and employment is forecast for the oldest and youngest workers than for other groups. The growth rate is expected to slacken further in 2009, followed by a slight decline in the labour supply in 2010.

 

Unemployment will drop

 

There was a relatively swift decline in open and total unemployment(26) in autumn 2006 and winter 2007. The decline in open unemployment trend was surprisingly strong considering the recent sharp cutbacks in labour market policy programmes. There was little improvement in youth unemployment, despite very strong employment growth for the group, probably because more people register as jobseekers when the labour market improves.


(26)               Open unemployment and participants in labour market policy programmes that are dependent on economic activity, as a percentage of the labour force.

 

The decline in open unemployment is expected to continue during the forecast period (see Figure 4.8). Robust employment growth is the main driver, but the job and development guarantee for long-term unemployed workers and the job guarantee for youth are also expected to have an impact. Open unemployment is projected at 4.7 per cent in 2007 and 4.1 per cent in 2008.

 

Total unemployment is also expected to fall during the forecast period, more so than open unemployment between 2006 and 2007 due to the sharp cutbacks in policy programme volumes. Forecast total unemployment will be 6.7 per cent in 2007 and 6.2 per cent in 2008.

 

Open unemployment should rise marginally in 2009–2010 due to the assumed adjustment of the economy towards normal resource utilisation. Total unemployment is forecast at 6.2 per cent in 2010.

 

Figure 4.8 Open and total unemployment

 

Percentage of labour force

 

 

Sources: Statistics Sweden, National Labour Market Board and Ministry of Finance.

 

 

 

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Labour supply and employment

 

Achieving and maintaining high employment is critically important to people on a human level and to ensuring a flourishing Swedish economy. Individuals who are now jobless are at greater risk of permanent exclusion or earning persistently lower wages if they do manage to find work. Joblessness also takes a toll on people’s health and well-being. As labour income is the most important tax base, high employment also brings high tax receipts, making it possible to finance good public service while maintaining a surplus in public finances. Given that demographic pressure on public finances is going to increase in the future, achieving high employment will reduce public debt and the need for future tax increases, which are harmful to employment.(27)


(27)               Demographic pressure on public finances can be illustrated with the demographic dependency ratio, which shows the number of people younger than 20 and older than 64 in relation to the number of people age 20–64.

 

Demographic dependency ratio

 

Per cent

 

 

Note: The dependency ratio shows the number of people younger than 20 or older than 64 in relation to the number of people age 20–64.

Source: Statistics Sweden.

 

Employment at any given time can theoretically be divided into two components: a structural component usually called potential employment and a cyclical component that describes cyclical variations around the potential level. As described in the explanatory box, “Potential GDP and the output gap”, potential employment is the level of employment consistent with an economically sustainable wage growth and inflation consistent with the Riksbank’s target. The cyclical variation is temporary and arises when supply and demand in the total economy shift in relation to each other. A flexible and adaptable economy combined with a stabilising monetary policy speeds up the readjustment to a level of employment consistent with stable wages and prices.

 

Labour supply critical to high employment

 

Potential employment is determined by two factors: how many workers are willing and able to participate (potential labour supply) and the percentage of those who are unemployed (equilibrium unemployment). Accordingly, higher employment over the long term can be achieved by increasing the labour supply and/or reducing equilibrium unemployment.

 

Labour supply will have to increase substantially to make a substantial and lasting increase in employment in Sweden possible. As shown in the following figure, variations in unemployment rate are relatively minor among OECD countries. Estimated equilibrium unemployment in Sweden is currently between 4 and 5 per cent. It is unlikely that it can be lowered by more than 2 percentage points, considering that no OECD countries have unemployment below 2 per cent.

 

Contributions to employment rate variations among selected OECD countries compared to Sweden, 2005

 

Percentage points

 

 

Note: Number of employed in relation to population in the age group 15–64.

Source: OECD.

 

Variations in unemployment are relatively minor among OECD countries, but differences in the labour participation rate are much greater. A high labour supply is the key factor for achieving a high employment rate, while the unemployment rate is less significant. If Sweden is to achieve an employment rate on par with Switzerland and Iceland, for example, the labour

 

 

 

 

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supply must rise to the levels comparable to those countries.

 

The role of economic policy

 

The structure of the labour market is complex and its functions are shaped by the behaviour of various actors: the political system, firms, workers and other regions. Accordingly, it is impossible to provide an exhaustive and yet concise description of all factors that affect labour supply and employment. In addition, analysts accord varying importance to a range of explanatory factors. Nevertheless, there is significant consensus as to how economic policy can influence labour supply and equilibrium unemployment, and thus employment.

 

The design of economic policy sets the frameworks for economic development. Long-term, credible and predictable systems promote fundamental stability. Such systems include the fiscal policy framework, the independence of the Riksbank and the stability of the pension system.

 

The direction of economic policy may also more directly contribute to higher employment. Three aspects are particularly important here: the incentive to work, the level of employer’s contributions and matching in the labour market.

 

Stronger incentives increase the labour supply

 

The combination of high taxes and relatively high social insurance benefits provide little incentive to look for work. Stronger incentives to participate in the labour force can contribute to increasing the effective labour supply and thus employment. The earned income tax credit that took effect in January 2007 is a good example of how incentive can be heightened.(28) The earned income tax credit will narrow tax wedges and make it relatively more profitable for people to be employed.(29) Likewise, lower benefits make working more profitable.


(28)              See the explanatory box “Long-term impact the government’s economic policies” for an analysis of the government’s supply reforms.

(29)               The tax wedge measures the difference between what the employer pays in total labour costs per hour worked in relation to the employee’s net pay.

 

Targeted reductions of social contributions increase demand for labour

 

One problem in the labour market is that the productivity of some individuals is not sufficiently high in relation to labour costs – or such is perceived to be the case. Generally high tax pressure contributes to these costs. Due to the compressed wage structure, there is also little demand in Sweden for workers with relatively low productivity. But general reductions in taxes and employer’s social contributions mainly affect labour demand in the short run. One reason factors like general reductions of employer’s social contributions are not thought to have significant long-term impact on labour demand is that such reductions tend to be passed on to employees as correspondingly higher wages. Lower contributions entail higher profits for firms, leading to greater demand for labour and thus higher wages. In the long run therefore, workers gain the primary benefit from reductions in employer’s social contributions through higher wages. Higher wages will however also make it more profitable to work. General reductions in employer’s social contributions and income taxes may thus promote higher labour supply and to some extent higher employment, but cause a relatively substantial reduction in tax receipts, in relation to the employment effects.

 

Targeted reductions of employer’s social contributions are less likely to be passed on to workers as higher wages. As a result, demand stimuli that target specific sectors or worker categories may lead to greater long-term employment effects. Examples of targeted stimuli implemented by the government include a tax reduction for household services, the new start jobs scheme and targeted reductions of employer’s social contributions for specific groups.

 

Effective vocational training may also contribute to improving people’s productivity and opportunities in the labour market.

 

 

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Policy can also influence wage formation and thereby labour market efficiency. The self-financed component of unemployment benefit funds was increased partly to encourage the worker collective to take greater responsibility for wage formation by bearing a larger share of the costs for wage growth that leads to higher unemployment.

 

Better matching in the labour market will cut unemployment

 

Measures to facilitate and improve matching (the process by which jobseekers and potential employers are brought together) may contribute to lower unemployment and higher employment. Bolstering incentives to look for and find work, such as through tax reductions and lower unemployment benefits, is one aspect. Labour market policy may also encourage better matching. An efficient Employment Office that provides employer contacts and gives jobseekers active support (‘job coaching’) improves their opportunities to find jobs. Likewise, vocational training adapted to the needs of the labour market can help ensure that jobseekers’ skills better meet the needs of prospective employers.

 

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4.2      Wages

 

Subdued wage growth in 2006

 

Wage growth has been modest for the last four years. According to preliminary statistics, nominal wage growth in the business sector was 3.2 per cent in 2006. Wages increased at essentially the same rate in the industrial, construction and service sectors. This may seem somewhat surprising in light of strong output and employment growth in construction. Possible explanations for subdued wage growth in the construction sector may be that labour immigration held back wage formation and that labour shortages have been restricted so far to isolated occupational categories, whose wage growth does not have significant impact on average wage growth for the industry.

 

Wages rose in the local government sector by 2.7 per cent in 2006. The low growth rate is partially explained by the lower-than-average wages of people in bonus jobs employed during the year. Note that the statistics will likely be revised upward due to ‘retroactive wage distributions’. Wages in the central government sector rose by 3.3 per cent.

 

Improved labour market will accelerate wage growth

 

Low labour resource utilisation is the primary explanation behind the low wage growth of recent years. Since 2005, however, strong trends in the number of hours worked and the number of people employed has increased resource utilisation. Strong labour market trends are expected to have greater impact on wage growth during the forecast period in parallel with further increases in resource utilisation (see Figure 4.9).

 

Workers will be in a stronger position for the 2007 wage round compared to the last major wage round in 2004. Agreements are likely to result in higher wage levels this time. (See explanatory box “2007 wage round”.)

 

Wage growth is expected to accelerate in all sectors, but faster in the business sector than in the general government sector. Wages are expected to rise fastest in construction, given that labour shortages are more severe in that sector than in others.

 

Figure 4.9 Employment gap and wage growth

 

 

Sources: Statistics Sweden and Ministry of Finance.

 

The changes to unemployment benefits rules that took effect on 1 January 2007 are likely to restrain wage growth to a certain extent.

 

Nominal wages in the total economy are expected to increase by 4.0 per cent in 2007 and 4.3 per cent in 2008, with a further increase in wage growth during 2009–2010. Taken as a whole, real wages are forecast to rise by around 2 per cent a year for the next four years (see Figure 4.10).

 

Figure 4.10 Nominal and real wage growth

 

Annual percentage change

 

 

Sources: Statistics Sweden and Ministry of Finance.

 

Wages are set to rise in the next four years at a rate somewhat faster than considered consistent with long-term productivity and inflation trends. It should, however, be noted that wage growth has been below that level for the past four years.

 

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2007 wage round

 

Some 80 per cent of all workers will be covered by the 2007 wage round. This year’s wage round is comparable in magnitude to the 2001 and 2004 wage rounds. All sectors other than transport and banking will renegotiate agreements in 2007.(30)  The majority of agreements in the business sector expired on 31 March. The agreements expire in June in the local government sector and September in the central government sector.


(30)               The two sectors not included in this wage round will be renegotiating their agreements in 2008.

 

‘Industry Agreement’ sets standard

 

Following several decades of less than ideal wage formation, conditions changed in the 1990s with the advent of the Riksbank’s inflation target and the 1997 Industry Agreement. Negotiations within the framework of the Industry Agreement assume that the scope for wage increases should be based on the economic outlook presented by the Economic Council for Industry. As well, the highly competitive export industry should function as a benchmark for other industries and sectors. During the latest wage rounds, there has been broad consensus that the agreements in industry should set the standard for subsequent agreements.

 

Wage formation increasingly decentralised

 

Wage formation has become increasingly decentralised since the late 1990s. Many agreements provide an opportunity for local parties to agree on the total scope for wage increases as well as pay allocation at an individual level. However, the rules are often linked to fall-back agreements that come into effect if the parties fail to agree at the local level. All workers in the central government sector are covered by agreements based on some form of local wage formation. The proportion is 30 per cent in the business sector and 5 per cent in the local government sector.

 

Outcomes of previous wage rounds

 

In the latest major wage round in 2004, which covered the entire central government sector and nearly the entire business sector, almost all agreements were equivalent to the 7.3 per cent rise in pay over three years set in industrial negotiations.(31) Most of the agreements in the business sector and all in the central government sector were for three years.


(31)               The agreement level refers to agreements including the value of reduced working hours.

 

Business sector agreements were 0.5 percentage points lower per year than for the previous agreement term of 2001–2003, mainly due to the lower negotiated reduction in working hours. Agreements in the central government sector were 0.3 percentage points lower per year compared to 2001–2003.

 

The 2005 wage round was not as comprehensive as 2004 and mainly covered the local government sector. Central agreements in the sector are largely similar, providing in most cases 2 per cent a year. The negotiated pay rise for the Swedish Municipal Workers’ Union, by far the largest trade union, was higher than for the others at an estimated 2.9 per cent a year. Overall, the average negotiated pay rise in the local government sector was 2.4 per cent.(32)  The Swedish Municipal Workers’ Union agreement was 0.8 percentage points lower than the agreement signed in 2001 and 0.3 percentage points lower than the one-year agreement of 2003.


(32)               This agreement level is not directly comparable to the agreement levels referred to in the section above and the table on the following page, because these figures include agreements that do not specify figures.

 

Agreement levels in relation to actual wage growth

 

The average agreement level for the total economy in 2004–2006 was 2.0 per cent. During the same period, actual wage growth was 3.2 per cent (see table on the next page). The agreements were 0.4 percentage points lower than the previous period, while actual wage growth was 0.8 percentage points lower. Weak labour resource utilisation that slowed wage drift is the likely reason actual wage growth in 2004–2006 shifted downward more than the agreement

 

 

 

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level. It should, however, be emphasised that the transition to more decentralised wage formation has made it increasingly difficult to accurately allocate wage growth between negotiated increases and wage drift.(33)


(33)               This is because local agreements are not publicised and reports from the National Mediation Office on negotiated wage increases cover only the central agreements. The difference between actual pay increases and negotiated pay increases, which could previously be defined as wage drift, now includes both wage drift and wage increases according to local agreements.

 

Central agreements and wage outcomes 2001–2006

 

Percentage change per year

 

 

 

Agreements

 

Outcomes

 

 

 

2001-03

 

2004-06

 

2001-03

 

2004-06

 

Business sector

 

2.6

 

2.1

 

3.8

 

3.1

 

Industry

 

2.3

 

2.0

 

3.7

 

3.1

 

Construction

 

2.6

 

2.3

 

4.1

 

3.0

 

Private services

 

2.7

 

2.1

 

3.8

 

3.2

 

Local government

 

2.3

 

1.9

 

4.4

 

3.4

 

Central government

 

1.8

 

1.6

 

4.2

 

3.1

 

Total

 

2.5

 

2.0

 

4.0

 

3.2

 

 

Note: Average over three calendar years. The figures include agreements that do not specify figures.

Sources: National Institute of Economic Research and National Mediation Office.

 

Wage demands compared to previous wage round

 

Initial wage demands by trade unions were generally higher than in the preceding wage round. Certain public statements and opening counter-offers from the management side also point to a higher level this time. If the cost of the ‘gender equality pay pool’ is factored in, the Swedish Trade Union Confederation’s joint agreement demands equal an estimated 4.45 per cent a year, slightly more than 1 percentage point higher than in the 2004 wage round.

 

But the relevance of initial demands to the final agreement level is highly uncertain. The difference between initial demands and final agreements tends to be large, while calculating the costs associated with the various demands entails certain difficulties.(34)


(34)               The last two negotiations for the Swedish Municipal Workers’ Union (SMWU) are an example of how difficult it is to make predictions based on union demands. When SMWU negotiated in 2003, the final agreement level was 2.3 percentage points lower than their demand. In contrast, the agreement level in 2005 was around 1 percentage point lower than demanded. It is noteworthy that the final agreement levels were relatively similar after both negotiation rounds.

 

Higher agreement levels expected

 

A comparison of the level of resource utilisation when the preceding wage rounds took place indicates that the agreement level in the 2007 wage round will be higher than in 2004 but lower than in 2001.(35) But it is likely that other factors will also affect the outcome of negotiations. How union members and representatives perceive the latitude allowed by economic conditions is probably significant, for instance. On the one hand, people are more optimistic about the economy in future years than they were in 2001, but the favourable trend in the labour market prior to the 2007 wage round has not endured as long.


(35)              At present, the assessed employment gap is slightly negative. In contrast, the assessed employment gap was sharply negative when the 2004 wage round took place and sharply positive in 2001.

 

The first industrial agreements were reached in mid March 2007. The total cost framework for the agreements totals 10.2 per cent over three years or 3.4 per cent a year on average. Wages will increase by 3.2 per cent a year on average including pay reviews. Other changes include improved occupational pensions and curtailed working hours corresponding to 0.2 per cent a year. However, the substance of the agreements varies from one to the next and between occupational categories (‘white-collar’ and ‘blue-collar’ workers).

 

A number of adjustments must be made to compare the new industrial agreements with those of 2004. Occupational pensions are not included in short-term wage statistics, for instance. The greater component of guaranteed wage drift expressed as a guaranteed level of pay review makes historical comparison of agreement levels difficult. The guaranteed wage drift is made up mainly of the wage drift that would probably have come about even without an agreement. Comparing the agreements including the guaranteed level of pay review thus provides an overstated view of the upward adjustment of the agreements. The overall assessment is that agreements are around 0.8 percentage points higher in terms of short-term wages than the corresponding agreements in the preceding wage round.

 

High corporate earnings and more favourable industrial activity than in either 2001 or 2004 are

 

 

 

 

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possible reasons the industrial agreements were adjusted upward more than a comparison of resource utilisation in the various years would indicate.

 

Given the normative role of industry in Swedish wage rounds, the industrial agreements finalised thus far indicate that agreements for other sectors will also be higher than in the two preceding wage rounds. The extent to which a higher central agreement level will affect final wage outcomes is however uncertain.

 

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4.3                  Inflation

 

Inflation still subdued, but rising

 

Inflation began a slow rise in 2005 (see Figure 4.11) that continued in 2006. Inflation measured as the percentage change in the consumer price index (CPI) over a 12-month period averaged 1.4 per cent in 2006. Underlying inflation measured according to the Riksbank’s UND1X was slightly lower at 1.2 per cent. Unlike the CPI, the UND1X was not affected by the rise in mortgage rates in the second half of 2006.(36) Inflation has continued to rise in early 2007. In January and February, average CPI inflation was 2.0 per cent and UND1X inflation was 1.3 per cent.


(36)               UND1X excludes interests costs for owner-occupied dwellings and the direct effects on consumer prices caused by changes to indirect taxes and subsidies.

 

Figure 4.11 Consumer prices

 

Annual percentage change

 

 

Sources: Statistics Sweden and Ministry of Finance.

 

Housing costs and domestic goods prices main drivers of CPI inflation

 

Domestic and international factors both enter into the inflation trend of the last year. Figure 4.12 illustrates the positive or negative impact of price trends for various groups of goods and services on total CPI inflation, expressed in percentage points. As shown, energy prices were a strong contributor to inflation in the first half of 2006 but somewhat less so in the second half. Lower prices for imported goods other than oil and petrol in early 2006 compared to one year before restrained inflation in the first quarter of 2006. These import goods have since had a neutral or mildly inflationary effect.

 

Figure 4.12 Effects on CPI inflation of prices for various goods and services

 

Percentage points

 

 

Sources: Statistics Sweden and Ministry of Finance.

 

Domestic goods prices increasingly contributed to rising inflation in 2006 and early 2007. The contribution from domestic services (excluding housing) continued slipping in 2006 but rebounded slightly in January and February 2007. In those two months, prices increased for categories such as vehicle repair and maintenance, telecommunications services and equipment as well as recreational and cultural services. Prices for telecommunications services and equipment have otherwise been declining (except in isolated months) for several years, due to stiffer competition in the telecommunications market and falling producer prices.

 

Housing costs are currently the main driver of inflation. After having kept inflation in check since March 2003, rising mortgage rates began contributing to inflation in July 2006.

 

The rise in inflation over the past year stemmed mainly from higher energy prices, domestic goods prices and housing costs. But for the first time since spring 2003, all goods and service groups reported in Figure 4.12 have been contributing to inflation since April 2006.

 

Domestic inflationary pressure will rise in 2008

 

Low labour resource utilisation is the main factor behind the low domestic inflationary pressure of recent years. Employment declined in 2003 and 2004 before climbing again in 2005. There were abundant available resources in the

 

 

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labour market during those years; wage growth was moderate and productivity growth high. Favourable employment growth continued in 2006 in tandem with controlled wage growth and strong productivity growth. Employment is forecast to continue rising rapidly in 2007 and 2008 as available labour market resources progressively shrink. The employment gap (the difference between actual and potential employment, see introduction to Section 4) is set to cross over from the negative position of the last several years to a positive gap in 2007, rising further in 2008. Due to rising labour resource utilisation, estimated wage growth in 2007–2008 will be considerably higher than during the immediately preceding years (see Figure 4.13). Productivity growth is forecast to be somewhat lower than the average in recent years.

 

Rising domestic cost pressure is expected with higher consumer prices lagging after. Several measures in the Budget Bill for 2007 and in this bill are expected to stimulate labour supply growth and favourably influence wage formation, restraining wage growth and the rise in inflationary pressure in 2008 and afterwards.

 

Strong demand trends in the total economy are also making it somewhat easier for firms to improve margins.

 

Figure 4.13 Hourly wage and inflation

 

Per cent, annual average

 

 

Sources: Statistics Sweden and Ministry of Finance.

 

Stronger krona leading to declining prices for imports

 

The consumer price trend for imported goods depends on trends in producer prices for the goods, exchange rate movements and retail margins.

 

Due mainly to the depreciation of the krona in 2005, import prices (excluding oil) began contributing to inflation in 2006. Exchange rates normally affect consumer prices for imports after a slight lag (see Figure 4.14). The krona rebounded in 2006 only to fall again after the end of the year. The slump is expected to be temporary and a strong krona is forecast (see also Section 2.2), which is expected to result in falling import prices.

 

Figure 4.14 Exchange rate and imported inflation

 

 

Sources: National Institute of Economic Research, Riksbank and Ministry of Finance.

 

Producer prices for finished goods have been depressed for some years by increased international trade and stiffer competition in the world market, which are aspects of globalisation. The phenomenon has also restrained inflation in Sweden. Long-term, the trend should affect only consumer prices and not the inflation rate, but adjustment to the new level will likely be a protracted process lasting several years.

 

Both exchange rate movements and trends in producer prices for imported finished goods are expected to further reduce prices for imported consumer goods, holding down inflation during the forecast period.

 

Oil prices will check inflation

 

Oil prices reached very high levels intermittently in 2006 but declined towards the end of the year. Previously inflationary, prices for heating oil and petrol are now having a deflationary impact. Oil prices started 2007 by rising once again, but are still lower now than during most of 2006.

 

Measured in dollars, oil prices are expected to remain stable in 2007 and 2008 and decline in the two following years (see Section 1.4 and Figure 4.15). The direct impact of oil price trends in

 

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dollars on Swedish consumer prices is neither immediate nor complete; as for other imported goods, the impact also depends on the exchange rate and trade margins, in this case for oil companies. Due to the forecast appreciation of the krona, oil prices measured in Swedish kronor will decline during the forecast period despite remaining stable near current levels in 2007 and 2008. The deflationary impact of consumer prices for petrol and heating oil is expected to continue.

 

The indirect effects of high oil prices are difficult to quantify, as they involve factors such as how firms pass on increased costs (such as for transport) to consumers. The current assessment is that indirect effects of high oil prices in recent years may continue contributing to somewhat higher inflation in 2007 and 2008.

 

Figure 4.15 Oil price in USD and SEK and petrol in the CPI

 

 

Sources: Statistics Sweden, Reuters and Ministry of Finance.

 

Low rent increases this year

 

Residential rents are one of the main CPI items contributing to the low inflation of 2006. Centrally negotiated rent agreements so far indicate rent increases will be higher than in 2006, but still relatively low in 2007. Rents are expected to rise by 1.7 per cent during 2007. Due to higher interest rates, energy costs and maintenance costs, rents are expected to increase by about 2.9 per cent in 2008, consistent with the trend since 2000.

 

Falling electricity prices in 2007

 

Consumer prices for electricity were high in 2006, pulling up inflation. The spot price (for immediate delivery) on the Nordpool Nordic power exchange remained high for most of 2006 but fell sharply in autumn and continued dropping through the early months of 2007. The price of electricity for delivery at a later date also fell, but not as dramatically as the spot price. The average price of electricity to consumers has so far not declined in parity with the drop in the spot price on the power exchange.

 

Consumer prices for electricity are expected to decline further in spring 2007 before beginning a slow upturn. The price of electricity is expected to reduce CPI inflation by 0.4 percentage points in late 2007 and increase it by 0.2 percentage points in late 2008.

 

Rising mortgage rates will increase the CPI

 

Based on the interest forecast provided in Section 2.2, mortgage interest costs for owner-occupied dwellings is expected to swell CPI inflation throughout the forecast period. CPI inflation will thus be higher than underlying inflation measured with UND1X. Mortgage rates are expected to increase CPI inflation in late 2007 by 0.9 percentage points. The impact will be less in following years, but mortgage rates are still expected to contribute 0.2 percentage points to CPI inflation in late 2010.

 

Tax and subsidy changes inflationary in 2007 and deflationary in 2008

 

A number of tax reforms, including increases in taxes on tobacco and energy, were implemented in January 2007 that contributed overall to pushing up CPI inflation. The government has announced a number of other changes to taxes and subsidies in 2007 including a new tax on car insurance premiums, permanent implementation of congestion charges in Stockholm and tax reductions for household services. For 2008, the government has announced reduced social contributions for certain segments of the service sector and a new central government subsidy for dental care. Overall, the net effect of tax and subsidy reforms is expected to increase CPI inflation by around 0.4 percentage points in December 2007 and reduce it by around 0.2 percentage points in December 2008.

 

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Inflation will rise above Riksbank target in 2009–2010

 

The overall assessment is that underlying inflation will remain low in 2007, in part due to a stronger krona, low electricity prices and low rent increases. Rising labour resource utilisation is expected to bring higher wage growth than in recent years along with slackening productivity growth. The impact of these factors on inflation will manifest after a time lag. The low wage growth and high productivity growth of recent years will check inflation this year to a certain extent, but underlying inflationary pressure is set for a relatively rapid rise in 2008. The upturn in inflation in 2008 will be constrained somewhat by the tax and subsidy reforms discussed above.

 

The interest forecast in Section 2.2 assumes successive increases in the repo rat