New "Dutch disease" has lessons for housing markets elsewhere

Downside to spending equity

AMSTERDAM - Policy makers concerned about falling real estate prices need only to look at the Netherlands to see how even a soft landing can dampen growth. With the Dutch economy in the fifth year of a slowdown, persistently low consumer spending has led commentators to diagnose a "new Dutch disease," and an economy "hostage to the housing market." Uncertainty about the government’s social policies has eroded consumer confidence.

For the second time in two years, the economy is on the brink of recession, with gross domestic product shrinking 0.8 percent in the first quarter compared to the final quarter of 2004, when growth was flat, and the outlook gloomy.

The term "Dutch disease" refers to the 1960s, when the discovery of natural gas in the Netherlands led to a sharp rise in exports, driving up the currency and hurting export-oriented manufacturers. But Europe's sixth-largest economy recovered to be the envy of its neighbours with low unemployment and growth rates of 2.9 to 4.3 percent from 1994 until 2000, helped by wage restraint and booming exports.

Rising asset prices allowed Dutch pension funds to keep premiums low, and house prices, which rose by 50 percent from 1997 until 2000, stimulated consumption further as owners borrowed and spent against the higher value of their homes.

Spending equity

The Dutch Central Bank (DNB) estimated two years ago, that spending on consumer goods, electronics and even holidays financed by cheap mortgages boosted gross domestic product by as much as 1 percentage point in 1999 and 2000. This spending is greatly encouraged by the mortgage costs deductibility on one’s income tax form.

Real estate prices, supported by lower interest rates, did not crash when the economy slowed in 2001, but price increases were markedly lower than during the boom years. The ratio of savings and pension contributions to disposable income, which had fallen to 7 percent in 2000 from more than 17 percent in 1992, jumped in 2001 as consumers sought to rebuild wealth and pension funds hiked premiums to compensate for equity losses.

Since then, consumption growth slowed and eventually turned negative, when in 2003 the economy dipped into recession. The Netherlands remains one of the weakest in the euro zone. DNB President Wellink however believes that the Dutch economy fares better than some analysts recently have reported. These remarks themselves have led to a ‘doom scenario,’ which Wellink calls ‘exagerated.’ He expects an economic recovery in the second half of 2005, although he cautions that ‘certain factors’ such as the high price of oil will continue to have an impact. Wellink sees more positive indicators, such as the drop in the number of bankruptcies, and the sharp increase in the number of job vacancies.

Government attempts to rein in the swelling budget deficit to comply with euro zone fiscal rules made matters worse, the Dutch parliament's economic advisers said in May.