Economy

By Frank Øland Hansen, Senior Economist, Danske Bank

TAX-CUTS ON THE WAY

ECONOMY: The outcome of the election on November 13, means that the economic policy of recent years will continue, the freeze on tax hikes will be maintained and the tax cuts planned for 2008 and 2009 will go ahead.

Both before, during and after the election the government and most of the opposition parties were largely in agreement on the course for economic policy in Denmark. This is why there was not much concern ahead of the election about whether the sound macroeconomic policy that has helped Denmark to healthy growth, low unemployment and surpluses on both the budget and the current account could be in jeopardy after the election. That said, there was a clear tendency for the parties to try and outbid each other in the course of the campaign. This, together with hefty wage demands in the public sector, could result in an excessively expansive fiscal policy in the coming years.

Labour force boost

The new policy statement presented one week after the election contained a number of interesting elements that could help strengthen Denmark’s competitiveness. Perhaps most interesting was the government’s proposal to reform the tax system. The aim is a marked reduction of taxes on wage income, including the tax rate on the last krone earned. In a situation with labour shortages, in which there is a need to motivate people to make an extra effort, to attract highly qualified foreign labour and to retain skilled Danes, a more concerted effort to cut marginal taxes is an appropriate strategy. With just 86,000 people (or 3.1% of the labour force) out of work, the shortage of labour is one of the most acute problems on the agenda. To begin with, however, the government will simply set up a tax commission that will deliver its recommendations in early 2009, meaning the government has given itself some breathing space. The policy statement also contained a number of other measures that could help boost the labour force. For example, it should be easier for foreigners to come and work in Denmark, and the “Green Card” and “Job card” schemes are to be expanded.

Referendum on EU opt-outs

The government’s policy statement also paves the way for a referendum on Denmark’s four EU opt-outs. This could open the door to Denmark abolishing the krone and joining the euro zone within a few years. However, it remains unclear whether the vote will come soon, or whether rescinding the four opt-outs should simply be viewed as a declaration of intent for now. No matter what happens, one should probably be prepared for a close race between the ’Yes’ and ’No’ voters. Danske Bank regularly surveys Danish support for participation in the EMU. The latest results show a handsome margin in favour of exchanging the krone for the euro. However, the current ’Yes’ lead does not necessarily translate into a certain ’Yes’ at a future referendum. Previous EU referendums have seen comfortable ’Yes’ leads crumble in the course of the campaign. Denmark is already conducting a very credible fixed exchange rate policy with a narrow fluctuation band against the euro. This means the economic advantages of introducing the euro would probably be relatively limited. The other three Danish opt-outs concern union citizenship, defence and cooperation on justice and domestic affairs.

Danish economy shifting down a gear

Irrespective of the economic policy pursued, economic growth in Denmark is shifting down a gear. Following growth of 3.5% in 2006, growth will probably be just below 2% this year and is unlikely to be higher in the coming years. This is mainly due to the shortage of labour, which is severely limiting the chance to increase production. In fact, labour shortages have already hit export growth this year. The lack of capacity is being exacerbated by demographic developments moving in the direction of a smaller labour force. The baby-boom generation is now beginning to retire and the number of young people entering the labour market is relatively low. Therefore, even a focused labour market policy will probably be incapable of increasing the labour force much in the next few years. That said, there may be a little room for exports to grow, as the consumption spree is being replaced by a more moderate growth in consumer spending. This is very much due to the slowdown in the housing market that has followed in the wake of the interest rate increases of recent years.  

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