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General summary.

1.1 Introduction

The economic recession in Sweden will be deeper and more protracted than we envisaged earlier. The international prospects are bleaker now than six months ago, though exports are still turning upwards this year. The outlook for domestic demand is appreciably weaker, with steeply failing investment and a marked drop in private consumption. The contraction of production is partly counteracted, however, by a retardation of stock reductions.

Early in the summer there were some signs that industrial activity might soon turn upwards. In the Business Tendency Survey, in June, firms reported that production had risen in the second quarter and their third-quarter expectations were also clearly optimistic. The September survey suggests, however, that production has been checked and expectations are again more subdued. There will probably be a further delay before industrial output picks up, a clear increase is unlikely before next autumn. Construction activity is still weakening and the outlook for this sector in the September survey is very bleak.

The situation in the labour market has deteriorated rapidly and unemployment reached 5.8 per cent in August. The rising proportion of long-term unemployed is disturbing and unemployment among youth is also very high. The surveys of industry, construction and services all point to a continued drop in employment, though the impact of this on the unemployment rate is counteracted by extensive efforts of labour market policy, with additional measures this autumn. '

The recession has resulted in a clear retardation of price and wage increases and the rates are now very low even internationally. Export prices are falling and producer prices for the domestic market are also very subdued.

Our forecasts for the next two years are summarized in sections 1.3 to 1.5 and some key data are presented in Table 1.1.
Table 1.1 Selected statistics
Percentage change unless stated otherwise
 1991 1992 1993 1994
GDP -1.4 -0.7 -1.8 0.9
Industrial production (NA) -5.3 -2.6 -0.5 3.5
Employment in hours -2.3 -3.0 -2.7 -0.7
Unemployment (per cent) 2.7 5.0 6.5 7.0
Hourly wage 5.6 3.5 3.0 4.0
CPI (year-on-year) 9.4 2.1 3.7 2.7
Trade balance (SEK bn) 30.6 40.8 51.2 63.3
Current-account balance (SEK bn) -20.3 -18.4 -10.2 3.9
Sources: Statistics Sweden, Central Bank and the Institute.

1.2 Conditions for the forecasts

Most of the work on this report was undertaken in September and accordingly coincided with dramatic events in the European money and exchange markets as well as in the Swedish money market. The market unrest also necessitated the two "crises" agreements between the Government and the Social Democrat opposition at the end of September. The restrictive measures and the efforts of labour market policy in those agreements clearly have important consequences for our forecasts for 1993 and 1994.

On October 2, the cut-off date for the forecast, the situation in financial markets in Sweden as well as in the EC countries is still uncertain in essential respects. The British and Italian currencies have left the ERM but the relationships between the remaining major currencies appear to have stabilized. In Sweden the Central Bank's marginal overnight rate stands at 24 per cent and market rates are still very high, but have fallen sharply in the last few days.

A crucial assumption for our forecasts is that the situation in financial markets stabilizes in the coming weeks. This implies, for instance, that the interest level in Sweden can soon return to "normal", though in real terms the level will remain high throughout the forecast period. In our scenario, the interest differential with ecu rates will be just below 3 percentage points in December and then narrow by degrees to 2 points next autumn. This presupposes that a reduction of interest rates can begin in Germany and accordingly spread through Europe during 1993.

Our assessments also assume that the exchange rates on 21 September (when it was clear that the French referendum narrowly supported the Maastricht Treaty) apply throughout the forecast period. It should be noted that the estimates for the Swedish economy, for instance as regards market growth and relative prices, are not particularly sensitive to shifts in exchange rates as long as these largely cancel out when weighted for trade. We also count on an increase in the barrel price of crude oil (Brent) from $19.5 in 1992 to $20 in 1993 and $22 in 1994.

1.3 The international background

International economic activity is recovering so slowly that even 1992 must count as a week year. Growth is strengthening from 1991 only in North America, to around 1 3/4 per cent. The rate in Japan is slackening markedly and growth in Western Europe is continuing at the same low rate as last year, approximately 1 per cent. Aggregate GDP growth in the OECD area is improving from only 3/4 per cent in 1991 to 1 1/2 per cent in 1992. Unemployment continues to move up and the rise of consumer prices is still slackening.

A variety of factors have been curbing growth. Important causes in many countries, including the United States, Japan, the United Kingdom and the Scandinavian countries, have been crises in banking and real estate as well as high levels of personal debt. The household saving ratio has risen in many countries and private consumption has been very weak. An additional factor in Japan has been the collapse of share prices.

In Western Europe the principal constraint has come from the high level of German interest rates, a reflection in turn of the determination of the Bundesbank to prevent the cost of reunion from generating increased inflation. As a consequence of the ERM, the other participant countries, as well as those whose currencies are pegged to the ecu, have been obliged to keep interest rates up.

During the summer a number of currencies came under heavy pressure. Early in September the Finnish exchange rate with the ecu could no longer be maintained and the mark was allowed to float. The situation in the ERM subsequently became untenable and the Italian lira was written down 7 1/2 per cent, while the Bundesbank lowered the discount rate by 1/2 a percentage point. These measures proved insufficient and it was not long before the Spanish peseta was also devalued and the United Kingdom and Italy left the ERM.

A crucial assumption for our forecast, as mentioned earlier, is that interest rates in Western Europe go on falling in the years ahead. If this does not happen, the envisaged acceleration of growth in Western Europe to around 2 per cent in 1993 and 3 per cent in 1994 may well be delayed and/or be appreciably weaker.

For Japan we calculate that, with the stimulatory package presented recently, the growth of total production will pick up next year to around 3 1/2 per cent. Much the same growth rate is also estimated for the United States and Canada in 1993. Private consumption in the United States is calculated to rise considerably faster next year, assuming that the saving ratio ceases to move up. With comparatively low interest rates and an appreciable improvement in business profits, there are also good conditions for stronger investment. In 1994 GDP growth in Japan and in North America is expected to be somewhat higher than next year.

Aggregate GDP growth in the OECD area is estimated to reach 2 3/4 per cent in 1993 and 3 1/2 per cent in 1994. Consumer prices ate expected to rise 3 1/2 per cent next year and 4 per cent in 1994. The assesment of international economic activity in 1994 are of a general nature and are therefore not included in the presentation in Chapter 2.

1.4 The Swedish economy in 1992 and 1993

Domestic demand

Having picked up in the second half of 1991, private consumption fell steeply in the first half of this year, when the level was more than one per cent down on the first half of 1991. Household purchases of cars and other durables decreased markedly, accompanied by an increase for everyday goods, for which VAT had been lowered at the beginning of the year. Real disposable income also decreased in the first half of this year but household saving still tended to rise.

After rising very strongly for three years, household income is more subdued this year, when the real level of disposable income is estimated to go up less than 2 per cent. The recession is causing wage and other earned income to fall in real terms but public transfers, not least those connected with the labour market situation, are rising and are entirely responsible for the real increase. The annual forecast for private consumption is strongly conditioned by the weak outcome for the first six months. Neither is there yet any indication of a swing in consumption this autumn. Households, moreover, are still adapting to the 1990-91 tax reform. Saving has been rising sharply for three years and it is to be expected that liabilities will continue to be reduced relative to disposable income. Several factors suggest that this process may be accelerating this year. The financial market unrest in the autumn, with exceptionally high interests rates, is no doubt making households more prone to adjust their liabilities without delay even if the situation soon normalizes. The very high real rates of interest may be felt in particular by households with a high consumption propensity, for instance young families who recently acquired a home of their own. It was not until late in 1991 that house prices began to fall in earnest. Depreciating assets in the form of real estate and shares accentuate the need to adjust liabilities.

The rapid weakening of the labour market, which now involves virtually all sectors, adds to future uncertainty about household income. Unemployment is particularly high among youth, one of the strongest groups of spenders in the boom. We therefore count on a further seasonally-adjusted fall in private consumption in the second half of this year, implying that the annual level drops more than 2 per cent and the saving ratio rises markedly.

In 1993 household income will be appreciably weaker, with a sharp drop for wage and other earned income. The measures in the two recent crisis packages are estimated to reduce real disposable income by 3 1/2 per cent. We envisage that next year, private consumption falls 2 1/2 per cent, which implies a slightly lower saving ratio.

Public consumption has been rising annually in recent years by 1 to 2 per cent but this year the level is calculated to be the same as in 1991. A very large share of local government consumption expenditure consists of wage costs. Local government employment fell in the first half of this year despite the expansion of relief work and induction places for youth. We count on a slight fall in local government consumption this year, offset by an increase for the central government. Next year central government consumption is also calculated to fall and total public consumption may then be down on this year by more than half of one per cent.

Gross fixed investment is falling for the third consecutive year and the estimated drop of almost 7 per cent this year is almost as much as in 1991. Investment is still declining steeply in virtually every part of the private business sector but above all in construction, financial and real-estate management and transport, while the fall in manufacturing is slowing down.

It is still primarily machinery investment that is falling, while the decline of construction investment is less marked despite the acute problems in the real-estate market. This is partly because construction investment by central government authorities and public enterprises is rising strongly as a result of efforts for infrastructure. A more important explanation, however, is that residential investment is being sustained this year by very extensive reconstruction in blocks of flats. Reconstruction investment rose more than 40 per cent in the first half of this year; conditions for reconstruction loans were tightened from the beginning of the year, leading in December 1991 to a large number of applications and approvals under the earlier regulations. Surveys by the National Housing Board also indicate that a very large proportion of the approved projects are being carried out.

In 1993 the problems in real-estate markets will have a growing impact on investment activity. Residential investment is expected to collapse for new housing as well as for reconstruction. Even if the interest rate differential with the rest of the world at the time of writing returns to a more normal level, the real rates will continue to be very high. The new system for housing finance as of 1993 involves decreased housing subsidies. The number of vacant dwellings has risen sharply. The exceptionally weak labour market is contributing to a further fall in housing demand. It appears realistic to expect that new housing starts will fall in 1993 by more than one-third to 27,000 units. Residential investment contributes more than 8 percentage points to the overall decline of fixed investment. The construction of commercial premises will also continue to fall.

Industrial production is expected to turn upwards in the course of 1993 and lower payroll charges will tend to improve profits. But with high real rates of interest and persistently weak domestic demand, we foresee only a modest expansion of total industrial investment. The level next year will still be almost 25 per cent below the peak in 1989. Although total business investment is expected to stop falling and the public efforts for infrastructure will continue, the overall level of gross fixed investment will drop more rapidly than this year.

Stock levels in the economy have been undergoing a continuous reduction since the early 1980s. The contraction last year was exceptionally large in industry as well as in trade and the acceleration tended to lower domestic demand by the equivalent of more than two percent of GDP. In the first half of this year industrial stocks went on falling, whereas they rose in trade, which agrees with the unexpectedly weak consumer demand at that time. Starting from the stock assesments of firms in the Business Tendency Survey, we count on continued destocking in industry as well as in trade, in the rest of the year. The annual change in stockbuilding should represent a positive contribution of 0.7 per cent to domestic demand.

The depressed profitability in connection with the recession and the very high real rates of interest make it reasonable to count to slacken, however, implying a further small positive contribution to domestic demand.

Wages and prices

A favorable aspect of the economic situation is the clear retardation of wage and price increases. For most negotiating groups, last year's two-year agreements were in line with the proposals from the Rehnberg Commission. Including the carry-over from agreements in earlier years, the negotiated wage increases average 2.8 percent last year and 2.7 per cent this year, which is appreciably lower than previously. Wage drift is also considerably more subdued; last year it roughly matched the negotiated component and this year it has been limited still further and is likely to stop short of one per cent, The hourly wage rise this year would then amount to only 3 1/2 per cent, by far the lowest annual figure in recent decades. In 1993 the labour market will continue to weaken, making a renewed acceleration of wage increases unlikely. We count on an hourly wage rise of 3 per cent for 1993. The wage equations that are used for the forecasts suggest that even this may be on high side.

The expected wage rise in the Swedish economy is low compared with other OECD countries. The development of industrial productivity is also internationally favourable. To this is now added the effect of lower payroll charges (equivalent to 3 percent of wage costs in the business sector). As illustrated in Diagram 1.1, the relative level of unit labour costs in Swedish manufacturing is expected to fall this year and next by a total of 8 per cent. Converted into a common currency, the improvement in competitiveness is somewhat smaller, not quite 7 per cent, because the value of the krona rises relative to the other currencies when the shifts in exchange rates are weighted for competition.

The rate of both producer and consumer price increases has slackened appreciably. The level of producer prices in manufacturing for the domestic market has been unchanged since the beginning of 1991 and export prices have fallen.

The rise of consumer prices has also been markedly subdued. The underlying rate of inflation began to fall back last year but as the tax reform was still contributing to price increases, in the course of 1991 the consumer price index rose 8 per cent. In the first eight months of this year, however, prices have risen only 0.4 per cent and we count on the increase in the full course of the year stopping at 1.3 per cent. This assessment is strongly contingent, however, on the level of market rates of interest in the rest of the year. The forecast assumes that variable mortgage rates fall to 15 per cent in December. The reduction of VAT in January affects the consumer price index this year but even the underlying rate of inflation (the change in the price level excluding indirect taxes and subsidies) has fallen; we count on a rate of 2.7 per cent this year compared with 5.1 per cent in 1991.

The rate of price increases in very unlikely to accelerate again in the forecast period. Wage increases are subdued, domestic demand is very weak and import prices are calculated to fall this year. External inflationary impulses should also be slight next year even if import prices do tend to rise. Due to the changes in indirect taxation, however, the rise of consumer prices in the course of next year will substantially exceed this year's rate. At the same time, with the lowering of payroll charges, the underlying rate of inflation as measured by the net price index is estimated to be considerably lower.

Foreign trade

Foreign trade remained slack in the first half of this year and the volume of imports continued to be appreciably weaker than exports, the latter rising half of one per cent and the former falling one per cent.

The growth of markets for Swedish manufactured exports is expected to pick up this year from the very poor outcome in 1991. Preliminary figures show a first-half increase in 14 OECD countries of 3 per cent and we count on much the same rate for 1992 as a whole. Markets in other groups of countries may well grow somewhat more strongly. Next year we count on a further improvement of 5 1/2 per cent in the 14 OECD countries and to almost 6 per cent at total level.

Since 1990 the average price of Swedish manufactured exports has roughly matched the rate in competitor countries and it is probably lagged effects of earlier increases in the relative price that are mainly responsible for the extensive loss of market share. The half-year figures suggest, however, that the loss of share is now diminishing. We count on roughly unchanged prices this year and the possibility of reduced relative prices in 1993. In the forecast period the annual loss of market share for Sweddish exports could then stop at about 1 1/2 per cent. Manufactured exports are expected to rise 2.1 per cent this year, which in general terms implies that the seasonably-adjusted level in the remainder of the year continues at the average for the summer months. The outlook for 1993 appears somewhat more favourable, with an overall increase of 5 per cent and somewhat less in the OECD area.

International activity has not yet generated an upswing for exports of raw materials. In the forecast period the volume of exports is likely to be consistently weaker for raw materials than for manufactured products. The international recovery is expected to be so gradual that the international surplus capacity that now exists, for instance in forest industries, will not be utilized in full. This means that, contrary to the usual pattern in an upswing, demand will probably not be sharply reinforced by speculation in future price increases.

Manufactured imports went on falling in the first half of this year. The domestic demand components that are relatively important for imports still slack. We envisage that the annual level of manufactured imports will fall somewhat less than import-weighted demand, that is by 1 1/2 per cent (for further details see Section 3.2) In 1993 the weakening of demand will come substantially from residential construction, accompanied by increased demand for machinery investment and manufactured exports, which usually have high import shares. Despite the expected fall in total demand, we therefore count on a one percent increase in the volume of manufactured imports.

Production and employment

GDP is falling this year by just over half of one percent and production in the business sector is declining at much the same rate. Business sector employment is being cut very sharply, implying an unusually marked improvement in productivity in the present phase of activity. It is mainlyy in industry and construction that productivity is rising. Labour supply is falling, too, but not sufficiently to avoid an increase in registered unemployment. The annual level of unemployment in 1992 is estimated to reach 5 per cent of the labour force.

Activity will continue to weaken next year, when GDP is estimated to drop almost 2 per cent. Business sector production is calculated to fall somewhat more than this and productivity will go on rising, though not as markedly as this year, which means that employment will decline less steeply. A marked drop is calculated for labour supply, mainly as a consequence of the measures of labour market policy (participants in labour market training and the new schemes for youth training and temporary development are not classified as belonging to the labour force.) As the fall in labour supply is exceeded by that in employment, registered unemployment is calculated to rise to 6 1/2 per cent of the labour force.

1.5 The Swedish economy in 1994

Our assessment of the outlook for 1994 clearly has to be based on less comprehensive and more uncertain material than the assessments for this year and next. There are no survey data about expectations or plans for production and investment in various sectors, neither is there a foundation for forecasting the picture in individual countries. Our picture of the international background is therefore confined to a very general assessment of total production and imports in the OECD area plus a rough estimate of market growth in other groups of countries.

At the same time, the present forecast for the Swedish economy in 1994 is more thorough and detailed than the equivalent forecasts in the two preceding autumn reports. Whereas the latter constituted model estimates, the third year has now been integrated in the regular forecasting process for all components of supply and demand.

Our assessments suggest that the initial position for the economy in 1994 will contain two contrasting tendencies: a marked recovery of international activity and increasingly strong market growth for Swedish exports, and persistently weak domestic demand, particularly for residential construction and local government consumption.

The rate of inflation in Sweden will probably remain very low. Our forecast implies increases of 4 per cent for wages and just over 2 1/2 per cent for consumer prices from 1993 to 1994.

Compared with the previous sharp upswing in 1988-89, Swedish export firms should be in a better position to step up sales in response to market growth. Their capacity utilization is low initially and the "puff" from domestic purchasers will certainly be very weak. The relative level of Swedish wage costs is expected to fall sharply in the period 1992-94 and Swedish exporters have been exercising price restraint since 1990.

Even with these improvements, Swedish exporters may continue to lose some market share in 1994 but only on a small scale compared with the early 1990s. We count on a volume increase in manufactured exports of 7 per cent. Export growth for raw materials will be appreciably lower. For total exports of goods and services our forecast points to a 6 per cent increase in volume, the highest figure for a decade.

Final domestic demand, on the other hand, is expected to go on falling, albeit modestly compared with the slump in the two preceding years. With a positive contribution from stockbuilding (a smaller reduction than in 1993), total domestic demand in 1994 is expected to be much the same as in 1993.

Private consumption is the only component of final domestic demand that is expected to rise in 1994; including restrictive effects from the crisis agreements, the increase in household purchasing power is estimated to stop at about one per cent. We count on an unchanged saving ratio and consumption would then also rise one per cent from 1993. Public consumption, on the other hand, is likely to fall about one per cent as a result of cuts in both the central and the local government sector.

Gross fixed investment is expected to fall about 3 1/2 per cent in 1994, with large variations between sectors as well as between machinery and construction. The volume of non-residential business investment is forecast to rise approximately 4 per cent, while residential construction drops 30 per cent. After two years of massive efforts, for instance for road construction, some fall is foreseen for public investment.

The composition of total demand will shift towards a larger share for components with relatively high import contents, with increases for machinery investment and manufactured exports and a further fall for construction and public consumption. A fairly marked upswing for imports is therefore to be expected in 1994. For total imports of goods and services we count on growth between 4 and 4 1/2 per cent.

These forecasts imply a GDP growth rate of less than one per cent from 1993 to 1994. This is clearly below the growth of capacity and means that 1994 will be another distinctly weak year for the Swedish economy. The growth of demand and production is far too weak to improve the situation in the labour market. Unemployment is estimated to rise instead by more than another 20,000 persons from 1993 to 1994 or from 6 1/2 to 7 per cent of the labour force.

1.6 Balance of payments and financial saving

The balance on current account improves in the course of the forecast period, representing a reinforcement of domestic saving. Our estimates point to an elimination of the current-account deficit in 1994.

The consolidation of the current account comes from a growing trade surplus plus the fact that the combined deficit for services, investment income and transfers stops rising. The improvement in foreign trade mainly reflects a favourable development in volume terms, with exports rising more rapidly than imports. This has to do with the weak activity in the Swedish economy, where domestic demand is slacker than elsewhere throughout the forecast period.

Domestic financial saving continues to improve in the forecast period, when a marked increase in the public sector deficit is offset by a reinforcement of financial saving by households and firms.

The deterioration of public saving comes mainly from the central government. Saving in the social security sector also tends to fall and local government saving turns into a deficit at the end of the period. Our estimates indicate that the central government deficit is rising this year to almost SEK 140bn, followed by a roughly unchanged level in 1993 and some reduction in 1994.

The central government financial deficit is rising sharply this year because revenue is actually falling while expenditure rises at an undiminished rate. This is very much a consequence of the recession; low wage increases and falling employment are accompanied by decreased revenue from indirect taxes in conjunction with weak domestic demand and markedly curbed price increases. Central government revenue from direct taxes is also held back this year by the disbursement of local tax funds, which is still subject to a two-year lag and therefore rises sharply. This system is being changed as of 1993 so that local tax funds are disbursed in the year in which they are collected. The relatively rapid increase in expenditure comes in large measure from transfers to households in conjunction with the weak situation in the labour market. The high real rate of interest is also generating a rapid increase in interest expenditure. Still it is clear that the imbalance in the central government budget is also structural. The "crisis package" in September aimed to rectify the major part of the structural component. In the short run (the two years covered by the forecast period) the positive effects of those measures are counteracted by the further deterioration in the labour market, leading to a continued increase in transfers to households. When economic activity does turn upwards, public saving can improve all the more rapidly.

Household saving is rising strongly this year. As this is accompanied by a fall in real investment by households (in private housing), the improvement in financial saving is unusually marked. Financial saving in the business sector is also rising; a weak development of profits is offset by decreased fixed investment and large stock reductions.
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Publication:The Swedish Economy
Date:Sep 22, 1992
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