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Strong recovery: Netherlands used “textbook policies,” broad public support to sustain growth, create jobs

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 2000
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What were the key elements in the transformation of the Dutch economy?

Watson: For the most part, the Netherlands adopted textbook policies. Over the past fifteen or more years, the authorities reduced their fiscal deficit sharply; contained inflation through the use of a clear and transparent anchor for monetary policy—an exchange rate pegged to the deutsche mark; reduced the burden of taxes and social security contributions on labor; and lowered the real level of some social benefits, the minimum wage, and, especially, the youth minimum wage. The authorities had very clear-cut macro-economic policies and pursued a number of key structural reforms. Also, they maintained a very effective dialogue with the social partners. Labor unions had already come to view high real wages as part of the problem of structural unemployment. The gains they saw from the government’s broad strategy—namely, in employment and in lower taxes on their members—convinced them to buy into a policy of wage moderation. Taken together, all these elements created an environment in which businesses felt comfortable investing in the future.

Both the Occasional Paper and the recent IMF Executive Board discussion cite the Netherlands’ success in creating a “virtuous circle.” How did this come about?

Watson: In general terms, synergy is created when strong macroeconomic policies are properly underpinned with good structural reforms and when broad public support enables these reforms to be sustained. This type of complementarity is at the forefront of our policy concerns at the IMF.

But the Netherlands achieved a virtuous circle in more specific ways also. Its reforms were carefully crafted and mutually reinforcing. Progress with social benefits reforms helped restrain public spending, and thus reduce the budget deficit, and also allowed some reduction in the tax burden. In addition, cutting taxes and reforming benefits served to foster and sustain a policy of wage moderation. And wage moderation and a real reduction in minimum wages, especially for youths, over time helped strengthen the demand for labor and bolster the exchange rate and the entire anti-inflation strategy. Finally, as employment started to grow, the tax base increased and tax rates could be lowered. Back in the early 1980s, the Dutch were already thinking in terms of policy complementarities, and their strategy worked well. That is the essence of how they got growth and job creation going.

In what ways did the Dutch experience differ from, say, that of the United States or the United Kingdom, which also recorded strong growth?

Ford: The United States did not experience a crisis of the magnitude of the Netherlands, nor did it have to embark on the type of labor market reforms that the Dutch did. But both countries were successful in creating jobs—something that I attribute primarily to their willingness to allow greater labor flexibility. The Netherlands permitted a large expansion in part-time employment, which is severely regulated in many continental European countries. These regulations are meant to preserve good jobs, but the effect has been to create no jobs at all.

Watson: The difference between income levels is also much narrower in the Netherlands than it would be in the “Anglo-Saxon” model. It is often asked whether rapid employment growth can be achieved without wide wage dispersion. In practice, the Netherlands has been fortunate that the influx to its labor force has included a lot of skilled spouses who were employable at close to average wages. They also had an influx of trained young people. Modest wage differentiation did not pose an obstacle to bringing these people into the employment pool. A question still outstanding, however, is whether the labor costs of the low-skilled need to be reduced further to help redress the problem of hard-core unemployment.

Ford: The Dutch government recently introduced a U.S.-style earned income tax credit to provide more incentive for the long-term unemployed to return to the workforce. But other things will likely also be needed, including job training and a more proactive approach to administering benefits.

Is the impact of the Netherlands’ job creation efforts diminished, as some critics would argue, because so many of these new jobs are part-time jobs?

Ford: Surveys suggest that many people prefer part-time jobs, and most part-time jobs are held by women who often do not want to work full time. In any case, it’s not clear that full-time jobs are an option. The only option might be no jobs, and clearly part-time jobs are better than no jobs.

Watson: If you measure the jobs per hour rather than per head, you still have a striking rise in employment. Even calculated on a full-time basis, the number of persons added to the job market is dramatic; the Dutch have clearly added to potential output through these part-time jobs.

What lessons does the Netherlands’ successful defense of its exchange rate peg to the deutsche mark hold for other countries, particularly those seeking admission to the European Union?

Watson: The Netherlands’ extremely credible exchange rate peg allowed it to make a very smooth entry into the European Economic and Monetary Union (EMU). A key lesson is that the Netherlands, in adopting an exchange rate peg, supported that peg with essential fiscal and structural reforms. Had the Netherlands not brought its budget under control or failed to reduce its unemployment, the peg would not have been as credible. The Netherlands also subordinated monetary policy entirely to the needs of the peg. There was never any question that interest rates would be raised, if needed, to defend the peg. When there were stresses in the European exchange rate mechanism, the Netherlands was a beneficiary, not a target, of the volatility.

The difficult debate now is the extent to which exchange rate pegs can be used by emerging market countries. Conventional wisdom dictates very strong preconditions for an exchange rate peg. A country must already have in place good fiscal and structural policies and, particularly, a sound financial sector.

Ford: Belgium is another example of a country that had a successful peg to the deutsche mark. It has been highly integrated with the German and Dutch economies—a degree of integration that is not characteristic of all the transition economies. All three countries have roughly the same degree of industrialization and share very strong trade links, all of which help. As Max stressed, countries must do things to support a peg, and they must be seen to be doing these things. In neither the Netherlands nor Belgium in recent years was there ever any suggestion that monetary policy would be used for anything but holding the currency to the peg. That is important, because without political consensus in support of the peg, there will always be suspicion that a country might try to cheat a bit. That suspicion can undermine the credibility of the whole operation—sometimes fatally. Ultimately, running a successful peg is as much a political operation as an economic one.

Is the Netherlands well positioned to meet the challenges and take advantage of the opportunities afforded by the EMU?

Ford: A country like the Netherlands may face two potential challenges from participation in a single market, but it is well positioned to address both of them. One challenge derives from the relative strength of its economy, which is probably most evident in the real estate boom. The Netherlands could probably use a bit tighter monetary conditions than most of Europe. Portugal and Ireland also find themselves in this position. One possible answer is to use fiscal policy instead of monetary policy. If you have excess demand, you could use fiscal contraction to take it out. But in any case the Netherlands has a long, successful record in a de facto monetary union. We expect the Netherlands to continue to manage very well.

The other potential challenge arises from participation in a single financial market. Since there will no longer be any currency risk or exchange cost, a Dutch firm can now borrow as readily from a German bank as from a Dutch bank. But the Dutch financial system seems to be in good shape to cope with competition. It has already undergone the consolidations that are only just beginning in France and Germany. The Dutch and Belgians have also set up cross-border links and already have very large bank-insurance-securities groups. These financial sector restructurings across borders and across traditional areas of specialization do, of course, raise issues of regulatory supervision. The Dutch have created a Council of Financial Supervisors to make sure that nothing falls through the cracks. And there has also been talk of the European Central Bank taking on a supervisory role. Regulatory supervision in the aftermath of consolidation is something the authorities of the EU will have to keep an eye on.

What key reforms remain for the Netherlands?

Ford: Essentially more of the same, only deeper. The Dutch authorities have instituted an expenditure control system, with expenditure targets laid out four years in advance, and this should help contain expenditures and, therefore, taxes. But expenditure concerns will be compounded by the pension needs of an aging population. Within 15 years, there will be substantial pressure on expenditures from the government health care and pension systems—this despite the fact the Dutch are almost unique among continental Europeans in having a substantial private sector pension system.

More structural reforms will be needed. Workers aged 60 to 65 continue to be offered early retirement benefits, disability benefits, or indefinite unemployment benefits until they retire. Sooner or later, the current older nonworker problem will be transformed into a pension problem. But it is important to keep the next cohort of workers in the labor force. The Netherlands also has a very large disability program that it has not been able to reduce and that is, in fact, beginning to expand again. The country is experimenting with a unified system of delivering social security benefits. Disability and unemployment are now provided from the same office that offers training and job search services. The privatization of employment services is proving controversial, however.

Watson: A good many countries are experimenting right now with ways to train unemployed people and help them find jobs. Countries are curious to see what works, and they are learning from one another. This will be one of the intellectual growth industries of the next decade.

Ford: The Dutch are also experimenting with public sector jobs as a means of bringing the long-term unemployed back into the workforce. The effectiveness of these programs is being assessed right now. I suspect these programs will not be very successful in isolation. They may need to be integrated with job training and job placement services.

What lessons does the Netherlands’ experience hold for other countries?

Watson: Three elements of the “Dutch miracle” hold great value as lessons for almost any economy. First, these were fundamentally orthodox reforms, and they worked. The Dutch did not reinvent the wheel. Second, their reforms were highly complementary, and they succeeded in creating a virtuous circle. Was it a miracle? We would argue it was chemistry, not alchemy. The reforms were very carefully designed, but there was little magic in them, except the magic of broad support. Third, by achieving this wide ownership, the Netherlands was able to sustain these reforms for more than a decade and a half.

But there were also three unusual starting conditions in the Netherlands’ case. One was a deep crisis that helped trigger a consensus for reform and established a low bar against which to measure success. Unemployment had risen so high that the door was open for a major reversal. Another was that wages in an absolute sense were very high. Profits after interest and taxes were negligible. By reducing labor costs over time, you could stimulate the growth in employment. That’s certainly not the case in all economies, but wage moderation could play a major role in this instance. And, finally, a young and growing population and an initially very low level of female participation provided a reservoir of skilled labor, including flexible part-time work, in a setting of not very dispersed wages.

We believe the crucial difference is on the labor market side. The wage moderation that characterized the Netherlands may not be needed where high unemployment is due wholly to structural factors, but you do need to stimulate the return of the labor force. Benefit and training reforms, and the high labor costs of the low skilled, take on even greater importance where there is no natural inflow to the labor market. These special factors in the Netherlands have largely run their course. Now the Netherlands has core issues that have much in common with countries elsewhere in Europe. But here, too, the country is trying imaginative solutions, and we look to them for lessons in the future also.

Copies of IMF Occasional Paper No. 181, The Netherlands: Transforming a Market Economy, by C. Maxwell Watson, Bas B.Bakker, Jan Kees Martijin, and Ioannis Halikias are available for $18.00 ($15.00 academic rate). Copies of IMF Staff Country Report No. 99/126, Kingdom of the Netherlands: Staff Report for the 1999 Article IV Consultation, are available for $15.00. Both publications can be ordered from IMF Publication Services. See page 11 for ordering details. The full text of the Netherlands and other staff country reports is also available on the IMF’s website (www.imf.org ).

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