Kingdom of the Netherlands -- The Netherlands 2000 Article IV Consultation -- Preliminary concluding statement

March 20, 2000

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Kingdom of the Netherlands—The Netherlands 2000 Article IV Consultation
Preliminary concluding statement

The Hague
March 20, 2000

1.  For several years the Dutch economy has been characterized by remarkably high growth of GDP and employment, and steeply declining unemployment rates. This past year was no exception, as growth is estimated to have been well above trend and the unemployment rate has fallen to historically very low levels. This strong performance is in good part due to sustained fiscal consolidation based on a medium-term fiscal framework, and to structural labor and product market reform. As a result, public finances are now in surplus, for the first time in decades. Together with wage moderation, these policies have been the key to high employment creation and increased dynamism of the private sector. In this environment of rising incomes and wealth, it is not surprising that private consumption has been the main engine of growth, especially in recent years.

2.  With strong growth likely to continue, prudent policies will be essential to meet the short-term challenge posed by emerging demand pressures. Broadly speaking, policy plans are supportive of favorable economic prospects and an orderly unwinding of cyclical tensions. Both in the short and medium term, expenditure restraint and adherence to a rules-based fiscal framework will be critical. The current economic climate is also auspicious for making progress in tackling difficult problems in labor markets and in social security reform. Product market reform needs to be reinvigorated, to ensure further gains in productivity and dynamism.

Current economic situation, outlook, and short-term policy requirements

3.  On balance, economic activity is now probably above sustainable levels, though indicators are still somewhat mixed and such assessments are subject to considerable uncertainty. Growth in house prices, which has proved to be a sign of aggregate demand pressures in some other countries, has been very high. Labor markets are extremely tight, with near record vacancy rates and evidence of widening labor shortages. There are also some tentative indications that wage growth may be beginning to accelerate. Goods price inflation, however, has remained modest.

4.  In the near term, output growth is likely to stay above trend, further intensifying demand pressures. Exports will be fuelled by the pickup in the large European economies. Given the relatively advanced position of the Dutch economy, monetary conditions are anticipated to remain supportive despite the recent rate increases by the European Central Bank. Household consumption, the key component of domestic demand, is subject to conflicting forces. Higher interest rates should dampen house price increases and thereby moderate the strong wealth effects that have driven consumption in recent years. On the other hand, the cuts in income taxes and social security contributions scheduled for 2001 as part of the tax reform will significantly boost household disposable income.

5.  In the context of this outlook, several adjustment mechanisms will help to bring about a "soft landing." In the short run, productive capacity can be increased somewhat through greater labor force participation, further reduction in unemployment, and higher labor productivity. As capacity constraints bite, there will also be greater reliance on imports to satisfy domestic demand, as well as increasing pressure on labor costs and, as a result, a gradual deterioration in external competitiveness and an eventual slowdown in growth. The strong competitiveness and current account position of the Dutch economy provide room for such adjustment. The process is likely to be accompanied by an increase in underlying inflation, which is expected to rise above the euro-area average. Headline inflation will be additionally boosted by the planned indirect tax increase at the beginning of 2001. Since its exceptional nature is widely understood, there should be little risk that it will lead to increasing wage demands.

6.  However, with cyclical pressures likely to persist for some time and given the risk that aggregate demand might prove stronger than projected, careful policy management takes on heightened importance. In the current circumstances, any further upside demand pressures—for example stemming from stronger than expected house price increases or a breakdown of wage moderation—could lead to a much steeper rise in costs and non-traded goods prices. In this case, there would likely be a disruptive deterioration in competitiveness and the current account which, unlike in the soft landing scenario, would ultimately threaten growth prospects.

7.  Against this macroeconomic backdrop, any fiscal impulse would exacerbate cyclical tensions. Admittedly, the fiscal balance is now turning out much stronger than expected, but the present surplus is largely transient in nature, reflecting the buoyant state of the economy. Calls to use the surplus for tax cuts or more spending are thus misguided. The current situation also raises the question of how best to deal with the fiscal impulse associated with the 2001 tax reform. Clearly, since such important structural reforms involve significant costs in preparation and implementation, postponing or materially changing the package at this stage would be unduly disruptive. Nonetheless, it will be important to minimize the fiscal thrust of the package in the near term, including by avoiding additional tax cuts, and the cautious approach considered by the government is therefore welcome.

8.  The actual and currently anticipated cyclical pressures should be manageable within the fiscal framework, which should not be abandoned given its proven advantages. In this context, prudence would require devoting all accumulated and prospective revenue and expenditure windfalls to the balance. Using room under the expenditure ceiling to introduce new spending programs or to advance already planned initiatives would only add to the risks posed by cyclical tensions. Given the asymmetric nature of these risks, fiscal policy requirements will nonetheless have to be reassessed on a regular basis.

Medium-term policy

9.  Beyond the current government period, fiscal policy should continue to be conducted within a medium-term framework. Expenditure restraint again ought to be at the core, since it is a prerequisite for combining sustained reductions in the tax burden with improvement in the fiscal balance. Selective changes relative to the current framework would allow other considerations to be addressed. For example, both transparency and longer-term provision for population aging would be enhanced by incorporating an explicit view on the desired long-term path of public debt, and therefore the deficit—issues that are implicit in the current framework. It would also be useful to allow more complete automatic stabilization, in place of the current formula for dealing with revenue fluctuations.

10.  Commendable progress has been made in resolving weaknesses in labor and product markets. Extending structural reforms will be key to further increasing employment and productivity, which will be instrumental in accommodating the effects of population aging. It is now a promising time to introduce additional measures. Buoyant economic conditions will help to facilitate structural adjustment and, conversely, the reforms would increase the economy's capacity to adapt to cyclical tensions. Paradoxically, in certain areas past successes and the strong economy appear to have reduced the perceived need for further action.

11.  In broad terms, the challenge in the labor market is to raise labor supply by sharpening the incentives to work. Several measures that have been implemented are welcome, as are others that are planned or have been proposed. As part of the 2001 tax reform, the general reduction in income taxes and social security contributions, and especially the introduction of the workers' tax credit, should promote employment. The progressive shift toward actuarially fair early retirement provisions, and the proposal to phase in a job-search requirement for older people on unemployment schemes should raise labor market participation. In particular, both will help to ensure that the next cohort will not face undue incentives to leave the labor force prematurely. Sickness and disability programs remain an especially difficult area to tackle, though the system of experience rating now applied to firms is a step in the right direction.

12.  At the same time, further efforts are needed. Reducing the poverty trap remains a priority. Enlarging the workers' tax credit would help, although phasing it out in order to contain fiscal costs would have the disadvantage of increased marginal tax rates at higher income levels. Scaling back income-related benefit programs, such as rent subsidies, would also be effective. More vigorous enforcement of the obligations of benefit recipients would be desirable. Regarding sickness and disability programs, the incentives facing workers could be sharpened significantly by lowering replacement rates, which in many cases are close to 100 percent. Finally, the use of subsidized job programs should be de-emphasized, especially in a climate of increasingly tight labor markets.

13.  The reorganization of the administration of the social security system also has the potential to strengthen incentives for reintegration. The establishment of the Centers for Work and Income should help to foster a more comprehensive view of moving benefit claimants to employment. The privatization of the reintegration services promises to generate efficiencies through competition, although the overall effectiveness of the system will depend crucially on the structure of the financial incentives facing these services, as well as the ability of the proposed public social insurance agency to manage the reintegration process. The planned increase in incentives for municipalities, which are responsible for welfare benefits, is welcome.

14.  It is also vital to push ahead with measures to improve product market performance, an area that seems particularly vulnerable to reform fatigue. It is commendable that in some sectors, notably electricity and telecommunications, EU requirements have been exceeded. The important MDW program should move forward: initiatives to analyze the costs and benefits of specific reforms and to increase the involvement of stakeholders are promising. Finally, although the policy to reduce the administrative burden has had mixed success, the ongoing efforts are welcome, particularly the establishment of an independent advisory body to assess the effects of legislation on the burden.

15.  The sound financial system has been underpinning economic prosperity. In response to the emergence of financial conglomerates and to promote a level playing field, the Council of Financial Supervisors was established last year. The Council has made headway in fulfilling its mandates, particularly in terms of ensuring adequate supervision of conglomerates, and in the area of consumer information and protection. In light of macroeconomic tensions and risks related to the housing market, vigilance will be required to safeguard the health of the financial system. In addition, the rapidly evolving structure of financial markets, both in the Netherlands and worldwide, will pose continuing supervisory challenges.

16.  We commend the high level of development assistance, which exceeds the United Nations target of 0.7 percent of GDP.


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