Executive summary
Denmark used its large fiscal space when COVID-19 hit. Rapid action to support firms and households in spring 2020 and again in the winter contained the economic contraction to one of the mildest in Europe. Fast vaccine rollout enabled the removal of shutdown restrictions and an early reopening, though restrictions on the unvaccinated were reintroduced in late 2021 as Delta variant cases rose rapidly. Low interest rates and credit guarantees have also facilitated the recovery.
Employment support has mitigated job losses. Unemployment increased by around 1 percentage point, less than in most EU countries. A temporary job retention scheme reduced the number of job losses while allowing people to quickly return to work once the economy improved.
Growth is projected ease to 2.4% in 2022 and 1.7% in 2023 (Table 1). Activity has rebounded fast, with GDP exceeding its pre-pandemic level by mid-2021 (Figure 1). Nevertheless, downside risks remain, notably further outbreaks domestically and abroad threatening domestic and external demand. On the upside, labour shortages have become widespread and household spending of excess saving during the crisis could see higher growth.
Policy support should continue to be withdrawn where economic activity has recovered. The uncertain worldwide health and economic situation warrants ongoing flexibility in policy action. While employment has rebounded, structural measures should now be targeted at the youth, migrant workers, and low-educated.
Fiscal space remains available to deploy public investment during the post-pandemic recovery. Denmark has ambitious plans to build back better once the outbreak is under control. Low-carbon public investments are key aspects of the recovery strategy, together with transfers to households to protect inclusiveness. This will be enabled by available fiscal space if plans to prepare for an ageing society via strong indexation of retirement ages to life expectancy are fully implemented. Relaxation of the 0.5% structural deficit limit would provide space to address longer-term challenges, without threatening fiscal sustainability.
Source: OECD, Economic Outlook 110 database.
Denmark’s tax system is overall well-designed, but the shift from income to less distortionary forms of taxation should continue. High top marginal tax rates on wage and capital income dull incentives for entrepreneurship, investment and increasing employment. Simultaneously increasing taxes on housing, with costs falling predominantly on high-income groups, would reduce negative distributional consequences.
Monetary policy is strongly expansionary. Inflation has picked up due to energy price growth, while wage pressures remain contained despite labour shortages. The currency peg to the Euro has served Denmark well, but implies negative interest rates that could generate macroeconomic imbalances as the recovery proceeds. In particular, rapid house price growth and high household gross debt (Figure 2) exacerbate financial risks. Some features of the mortgage loan market are worrisome: high share of loans with variable interest rates or no repayments; comparatively low down payment requirements; and no absolute debt-to-income limit. Macro-prudential tightening would impact households without sufficient income to service their debt, increasing the importance of access to affordable social rental housing. Danish saving is already high, however, and reducing access to mortgages could increase the already large current account surplus.
Source: OECD, Economic Outlook and National Accounts databases.
Physical and transition risks associated with climate change could affect financial stability. The central bank has started to assess the exposure of banks to climate change. Though systemic risks in case of gradual increases in stringency of environmental policy are contained, other financial vulnerabilities are likely elsewhere in the financial system. More information and monitoring is necessary to assess these risks.
Denmark is well prepared to benefit from the digital transformation. Danish firms are leaders in adoption of digital tools, assisted by good broadband coverage, digital government services and digital skills. The benefits of new technologies could be spread more widely by supporting the growth of new firms through access to finance and reducing barriers to digital trade.
Danish women suffer from a significant drop in earnings after motherhood and are under-represented among managers. Increasing the share of parental leave reserved for the second parent, as planned, while increasing gender balance in leadership positions and offering greater flexibility in childcare services has the potential to improve equality and boost aggregate output.
Benefits from immigration are held back by large gaps in employment and educational outcomes. Insufficient language skills remain a key barrier facing immigrants.
Denmark cut its greenhouse gas emissions by 36% between 1990 and 2019, largely thanks to renewable energy (including biomass), which now accounts for over 80% of electricity generation. It is now one of the least carbon-intensive countries.
Emissions have been cut without overall employment losses. Workers displaced by stringent environmental policies have been helped by Denmark’s reskilling programmes, which demonstrated their capacity to cushion much larger displacements in manufacturing during the 2008 financial crisis. Thanks to this, Denmark has preserved full employment, with 75% of the working-age population having a job, one of the highest employment rates in the OECD.
Denmark plans to halve its emissions over the next decade. The Climate Act sets the legally-binding objective of reducing emissions by 70% by 2030 from 1990. The target is one of the most ambitious among OECD countries and would put the country on track for carbon emissions neutrality by 2050 (Figure 3). However, this will require radical technological changes and vast resource reallocation. Greater certainty on how targets will be met is important to send strong signals to investors. Investment needs in the order of 1% to 2% of GDP will need to be funded, though could also carry long-term benefits if there is good project selection and incentives for private involvement.
Denmark’s well-functioning “flexicurity” facilitates reemployment of workers displaced by the energy transition. Jobs have already declined in fossil fuel generation, but new jobs were created in renewables. Projections of further abatement suggest that job losses in agriculture would be roughly matched by job creation elsewhere.
Uniform carbon pricing would effectively mitigate emissions but needs to be complemented by flanking measures that provide a clear and predictable regulatory environment and support green infrastructure and innovation. Pricing all greenhouse gas emissions at a uniform minimum rate reflecting the evolution of prices in the EU Emissions Trading System would contribute to cost-effective abatement, though on its own would be insufficient to meet targets. Public acceptability for increased pricing is crucial and can be enhanced by transparent use of government revenue to support to the green transition, reskilling of workers and offsetting distributional effects. If high carbon prices cannot be sustained, the government will need other incentives to attract private investment and innovation in clean energy, as well as public investment in green infrastructure.
Source: UNFCCC GHG Data Interface; Danish Climate Law.
Denmark has made huge progress towards renewable energy (Figure 4). Through learning by doing, the cost of renewable energy has fallen considerably. Large investments are being made to progress further with low-carbon energy, supporting new technologies such as clean hydrogen and carbon storage. Emissions have been cut in district heating by switching from coal to biomass and the next step is to switch to other renewables and free up scarce supplies of sustainable biomass for other uses. Attracting private investment and enhancing competition would ensure that new technologies are commercially viable and affordable.
Cutting transport emissions should continue to avoid leaving behind vulnerable groups. CO2 emissions from transport have not substantially declined so far (Figure 5). Denmark is encouraging take-up of vehicles using electricity, hydrogen and biogas, requiring large investments in charging and refuelling stations, including in remote areas. The overall taxation of vehicles should still reflect their external costs, including congestion, noise, road damage and local air pollution. Policies are needed to support those most adversely affected and offer alternatives to private car use including public transport, shared mobility, cycling and walking.
Source: IEA, World Energy Balances and Statistics databases.
Source: OECD estimation based on EEA; Statistics Denmark; ITF.
Agriculture is a major and growing source of greenhouse gases, mainly from livestock. The sector has made little progress in cutting emissions so far. A recent agreement will enable emission cuts from low-hanging fruit such as rewetting of peatlands, with limited impact on activity while also reducing other environmental damages. Domestic regulation should focus on emission-intensive activities such as livestock and grain and detailed monitoring of farms’ emissions. This would make a substantial contribution to the 2030 target, reducing the burden on other sectors. Further investment for research and development could substantially enhance the contribution of agriculture to a net-zero target. However, agriculture is highly exposed to international trade and carbon leakage. Hence, Denmark should work with other EU member states towards greening the Common Agricultural Policy.