Denmark -- 2004 Article IV Consultation, Concluding Statement of the IMF Mission
IMF News, March 30, 2004
Source details
- Canonical URL
- Denmark -- 2004 Article IV Consultation, Concluding Statement of the IMF Mission
Other formats
Bibliographic details
- Published: March 30, 2004
Overview and recent performance
- Denmark experienced a slowdown in economic activity beginning in 2001; the economy contracted over the second and third quarters of 2003.
- Growth over the past three years has been below potential.
- The size of the slowdown, both in terms of activity and unemployment, was contained by the low-interest rate environment and the automatic fiscal stabilizers that helped to support household income and demand.
- Denmark continues to enjoy high labor force participation rates and low unemployment.
- Inflation is well under control, and the external current account remains in surplus.
Growth outlook and risks
- The mission expects that growth will pick up in 2004 to a rate of just under 2 percent (taking account of the recent fiscal measures), but there are downside risks.
- Private consumption spending should lead the recovery as tax cuts increase disposable income; positive wealth effects are expected from improving equity markets and still-strong housing prices.
- The rebound in consumption in the fourth quarter of last year was a positive sign.
- Downside risks noted:
- A delay in the turnaround of unemployment could dampen consumer confidence.
- Near-term prospects for growth in Europe may worsen, especially if the euro appreciates further, which could affect external demand for Danish exports and consumer and business confidence.
Fiscal policy, recent measures, and medium-term framework
- The Government package of measures introduced on March 16:
- Brings forward reductions in personal income taxes planned for 2005-07, increasing households' disposable income and improving incentives to work.
- Suspends special pension contributions in 2004 and 2005, temporarily augmenting disposable income and increasing the tax base.
- The package should have only a limited impact on fiscal balances this year — with the surplus expected to stay unchanged from last year at around 1¼ percent of GDP — and is consistent with medium-term fiscal objectives.
- The mission considers the package is likely to provide an impetus to growth of perhaps 0.2 percent of GDP, depending on how much of the disposable income consumers decide to spend.
- Policy guidance:
- Denmark has been well-served by focusing on medium-term fiscal targets and relying on large automatic stabilizers to support demand during downturns.
- Discretionary counter-cyclical policy should be kept as an exceptional response to avoid creating an expectation of fine tuning and short-term fixes that could weaken the medium-term fiscal framework.
- Preparations for aging:
- Denmark has already made considerable progress in preparing for the fiscal pressures from aging; the medium-term fiscal framework provides an important anchor for policy.
- Targets are set to maintain the Danish welfare system as the population ages while finding space to reduce the overall tax burden.
- Medium-term plans appropriately concentrate on containing growth in public consumption expenditure and increasing employment.
Public spending discipline and tax policy recommendations
- Targets for growth in government consumption should help contain the relative size of government, freeing resources for private sector use.
- Preliminary results from 2003 suggest that the tax freeze and spending targets are having a disciplining effect.
- If slippages occur, authorities may consider:
- Further enhancements to mechanisms for local government spending discipline, including extending the legally binding rule for tax-freeze compliance to the municipal level.
- Basing medium-term spending policy on explicit nominal expenditure targets as an alternative to targets defined in real terms, to instill more discipline and be more transparent and monitorable.
- Introducing user fees to better align demand for scarce public resources with need; revenues from user fees could also provide additional room for cuts in distortionary taxes.
Labor market, participation, and employment policy
- With a labor force participation rate already high by international standards, achieving the targeted increase in Denmark's employment will require strong efforts.
- Recent initiatives are steps in the right direction; additional measures will be needed.
- Policy recommendations to increase employment:
- Measures that directly affect incentives to work will have the greatest impact; additional reductions in labor income taxation are desirable.
- Un-freezing the ceiling on property valuation for tax purposes would provide space for such reductions.
- Increase employment among specific groups with lower employment rates:
- Address the substantial reduction in labor force participation among those 60 and over caused by early retirement schemes; creative solutions to improve incentives to continue to work are needed.
- Speed students' progress through the education system.
- Make education and activation programs more responsive to labor market needs.
- Continue efforts to better integrate immigrants into the active labor force.
Institutions, commissions, and structural change
- The mission welcomes the establishment of the Welfare Commission to analyze and stimulate public debate on maintaining protections of the welfare system while ensuring fiscal sustainability and intergenerational equity.
- Regarding the Structural Commission, the mission agrees that increasing the size of local governments and redistributing responsibilities has potential for more effective provisioning of public services and economies of scale; careful planning and a phased transition will help limit adjustment costs.
Competitiveness and product-market reform
- Medium-term growth depends on increasing labor supply and continued improvements in competitiveness of product markets.
- Recent progress has been made in strengthening competition laws and liberalizing markets, including in the energy sector.
- Further enhancements in competition are needed, particularly as product and labor market reform momentum picks up in neighboring countries.
- Potential gains from reform exist in construction, transportation, retail and wholesale sectors.
- External competitiveness:
- Denmark's external competitiveness has been adequate to generate a continuing current account surplus.
- Wages in Denmark have risen more rapidly than in partner countries over the last several years, and the euro has appreciated.
- Recent decline in Denmark's export trade share during the latter half of 2003 bears watching.
- Labor cost pressures, if unchecked, could slow the recovery in employment and put a brake on medium-term growth.
- Importance of appropriate moderation in upcoming local wage negotiations; the central framework agreement for annual growth in labor costs of 3-3½ percent over the next three years is a positive development.
Exchange rate, financial system, and housing
- Exchange rate system:
- The krone is kept stable against the euro, providing a valuable anchor for expectations and discipline on economic policies.
- Variation around the central parity has been minimal, and interest rates follow those in the euro area with only a small, stable spread.
- Financial system:
- The financial system has weathered the slowdown well and is in good position to support an upturn in activity.
- Housing prices continue on an upward trend, but the increase has been less than in some other countries and prices do not seem out of line with fundamentals.
- The increasing use of adjustable rate and deferred amortization mortgages seems to have contributed a small amount to the increase in prices and is expected to add to the sensitivity of the economy to changes in short term interest rates.
Development assistance
- The mission takes note of Denmark's leadership in development assistance and encourages the continuation of this policy.
- Although aid as a share of gross national income has fallen slightly in recent years, the mission welcomes the policy of maintaining development assistance at a level representing at least 0.7 percent of gross national income—still among the highest of any country.
Concluding Statement of the IMF Mission, March 30, 2004.