17 September 2002 • Cyclical Upturn, with Structural Problems Persisting. Medium-term Projections for the Austrian Economy until 2006 • Josef Baumgartner, Serguei Kaniovski, Markus Marterbauer

The Austrian economy is about to enter a phase of cyclical upturn that should last until 2004, when growth may rise above 3 percent. For 2005 and 2006, a marked slowdown should be expected. The business cycle is determined primarily by international developments exerting a direct impact on exports and investment in machinery and equipment. The further course of the world economy also holds the major risks to the projections. Domestic demand, while initially lagging behind the growth of output, will lend increasing support to overall activity towards the end of the forecast horizon. Employment will post sizeable gains as the recovery proceeds, although a fall in unemployment may be held back by the ample supply of foreign labour. Financial scope in government households will remain tight, as policy is facing major challenges in shaping budgetary structures and in the areas of education and innovation.

The present medium-term projection 2001-2006 is based upon the short-term outlook 2002-03 presented by WIFO in June. There, WIFO has worked on the assumption of a smooth recovery of activity world-wide, while at the same time pointing to the risk for such a recovery being delayed. In Austria, the cyclical upturn may peak in 2004, at an annual growth in real GDP of 31/4 percent. Exports and investment in machinery and equipment are expected to be the main drivers of the rebound from the 2001 recession.

The Austrian economy may benefit particularly from a pick-up in demand from its major trading partners, as price competitiveness of domestic exporters has been boosted by a favourable trend in unit labour costs. The expected strong expansion of goods exports will give major incentives for investment in machinery, vehicles and immaterial goods. During the upswing, domestic demand will rather have a dampening impact on the pace of activity. Gains in private consumption may be held back somewhat by a rise in the household saving ratio towards its medium-term average. Growth in the construction sector will be subdued, as demand for new homes is set to remain sluggish.

The cyclical pattern underlying the projections points to a marked slowdown in 2005 and 2006. Once again, the driving forces will come from the most volatile components of demand, i.e., exports and equipment investment, which by then should both post only modest further gains. Domestic demand, for its part, should help sustain overall activity towards the end of the forecast period. Private consumption will keep rising by over 2 percent p.a., and construction activity should finally overcome its protracted recession, once investment in transport and communication facilities will receive incentives from EU enlargement and housing demand starts heading up.

Over the period 2001-2006, real GDP in Austria is expected to grow by 21/4 percent p.a., slightly below the EU average (2.4 percent) and keeping broadly the same pace as from 1996 to 2001. Nevertheless, a number of structural problems are becoming apparent: while the foreign contribution to growth is rising significantly, this is to be attributed, apart from favourable external cyclical conditions, to a moderate trend in wages rather than to strong productivity gains driven by a successful innovation strategy.

The business cycle upturn will give rise to stronger employment growth. The number of active workers and employees is set to increase by 19,000 or 0.6 percent per year. This will not, however, reduce unemployment to the same extent. Although the population of working age, unlike in previous periods, will hardly rise, labour supply will be boosted substantially by the inflow of foreign workers, either on a seasonal basis or as a consequence of eastern enlargement of the EU as from 2004. The overall jobless figure is expected to just edge down to 205,000 by 2006, corresponding to a rate of 5.9 percent of the dependent labour force or 3.3 percent of the workforce according to Eurostat.

Assuming a restrictive stance for public spending, and abstracting from any cuts in taxes and non-wage labour costs as well as from the envisaged increase in defence spending, the model projections yield a balanced general government budget for 2003 and a small surplus for the following years (2005 +1/2 percent of GDP).

The forecast gives no indication for significant inflation risks. The average inflation rate over the period 2001-2006 is expected at 1.7 percent. Real wages per capita will rise by 1 percent per year, distinctly lagging behind labour productivity.

The risks to the present medium-term projections are primarily located at the international level. In the USA, growth may turn out lower in the case of the macro-economic imbalances (low household saving ratio, high current account deficit, over-valuation of stocks and real estate assets) being corrected. In Europe, the different actions of the monetary, fiscal and wage-setting authorities may not in all instances yield the appropriate policy mix. Eastern enlargement of the EU has been assumed to take place in 2004. The successful integration of the candidate countries may have lasting positive effects on growth not only for the new members, but also for western Europe. Potential risks remain nevertheless significant, such as in the event of a premature accession to monetary union.