Mission Concluding Statement 

Kingdom of the Netherlands--The Netherlands 2002 Article IV Consultation-- Preliminary Concluding Statement

March 25, 2002

INTERNATIONAL MONETARY FUND

Kingdom of the Netherlands—The Netherlands

2002 Article IV Consultation

Preliminary concluding statement

The Hague, March 25, 2002

The Dutch economy has performed extremely well for many years, reflecting fundamental structural reforms, sustained wage moderation, and substantial fiscal adjustment. In recent years, however, growth exceeded potential and the unemployment rate fell to very low levels, resulting in inflationary pressures and a gradual but cumulatively significant erosion of international competitiveness. Inflation peaked last year at 5 percent, the highest rate in the euro area, as indirect taxes and fuel and food prices rose, and wages accelerated. Activity slowed sharply in 2001, due principally to a weak world economy, declining rates of asset price growth (notably house prices), and lower profits, especially in tradable-goods sectors. We expect growth to pick up in the second half of this year, as the recovery of the U.S. economy now apparently underway extends to the euro area and the Netherlands.

The economic slowdown has begun to ease labor-market tensions, opening the way to lower wage and price increases this year and next. Vacancies have been falling and the unemployment rate, which remains low because of labor hoarding, is expected to rise in the course of the year. As a result, the wage-bargaining atmosphere appears to be evolving toward greater moderation. Ensuring a sustained return to inflation rates in line with the rest of the euro area will nevertheless require the social partners to take full account of softer labor markets in upcoming negotiations. There may be relatively high wage increases in sectors still suffering acute labor shortages, and allowing greater wage differentiation will therefore be necessary to limit spillover to other sectors.

The government also has a critical role to play by ensuring that fiscal policy does not add to inflationary pressures. In 2001 and 2002, unfavorable macroeconomic developments resulted in a cyclical deterioration of the fiscal position (beyond the effects of the tax reform). However, 2003 is expected to be a year of economic expansion, and it would therefore be preferable to avoid a further worsening, as is currently projected by the CPB. In any case, an improvement in the structural balance would be desirable to move toward the medium-term objective of a structural surplus of 1¼ to 1¾ percent of GDP.

To achieve this objective, renewing the strong fiscal framework centered on multiyear spending ceilings and the strict separation of revenues and expenditures will be critical. Indeed, room for maneuver is likely to be significantly less in the next government period than in the past four years, due to a less favorable evolution of output growth, unemployment, and interest expenditures, as well as the likelihood that more resources will be devoted to health care, education, and infrastructure. The study group on the budget margin has recommended that the automatic stabilizers should be allowed full play on the revenue side, so long as the budget is between a surplus of 3 percent and balance. We support the use of the stabilizers, and the closely related proposal to substantially narrow the safety margin on assumed growth. However, the limits on the stabilizers could lead to pro-cyclical fiscal policy, especially in the next couple of years when the balance will still be some way from the medium-term surplus target. (Of course, the stabilizers should be offset if the deficit threatened to exceed the Maastricht ceiling.)

A reinvigorated program of structural reform will be the key to improving medium-term growth, durably raising employment, and ensuring a strong fiscal position, especially in view of population aging. Priorities include the disability program, poverty traps at low earnings levels, active labor-market policies, and product-market reform. Commendably, proposals for consideration by the next government have recently been put forward to address many of these issues.

There is widespread agreement on the need to reduce the disability program. Although of diminishing importance relative to the economy, the scheme, with its nearly one million beneficiaries or about 13 percent of total employment, still deprives the economy of a significant fraction of its potential labor supply. A detailed blueprint for reform has been prepared, which envisages a sharp reduction of the inflow into disability. Some aspects of this proposal are long overdue, notably tighter medical criteria (which might prove successful if sustained longer than the initiative in this area in the 1990s) and enhanced incentives for the partially disabled to seek work. On the other hand, increasing the replacement rate and eliminating firms' experience rating (the PEMBA) would only intensify incentives to have workers declared fully and permanently disabled. In view of the need to scale back the program, it would be prudent to implement the former set of measures first, and to consider reducing, rather than increasing, the replacement rate.

Another structural factor discouraging employment and activity is the poverty trap. Effective tax rates at low earnings levels can be as high as 130 percent, taking benefit withdrawal into account, leaving little or no incentive to move from benefits to work, or to work more. Making inroads into this problem is a major challenge. As a preliminary step, transferring municipal incomes policies to the central government and integrating some benefits into the tax system would increase transparency and thus highlight the need for reform. More substantively, job-search requirements for benefit recipients should be extended in some cases (for example, to those over 57½ receiving unemployment insurance benefits) and be strictly enforced in all cases. Some municipalities have already made welcome progress in strengthening enforcement, and the extension of block grants in the financing of welfare would further sharpen their incentives in this regard. Consideration should also be given to indexing benefits to prices rather than wages, thereby gradually reducing the poverty trap while maintaining the real incomes of beneficiaries.

Years of high employment growth and dwindling unemployment have rendered policies to raise labor demand largely obsolete. Thus, it is time to rethink and scale back subsidized employment and public-sector job programs. More and more, such policies are depriving the private sector of labor, or subsidizing activities which crowd out others. In the current and prospective economic environment, budgetary resources would be better redeployed to enhancing labor supply, for example by reducing the poverty trap.

Productivity improvements are the key to sustained economic growth in the years ahead, especially as available labor supply will increasingly be constrained by population aging. Continuing the reform of product markets will thus remain prominent on the policy agenda. The authorities' leadership in the liberalization of gas and electricity markets is commendable, and we urge them to complete the process as quickly as possible. Reducing the administrative burden on firms is another area where progress has been made; notably the formal examination of proposed legislation for its impact on the burden has become a more central part of the policy process. Nevertheless, actual improvements to date have fallen short of expectations and more needs to be done. For instance, the administrative costs for setting up a company in the Netherlands compare favorably with those in Germany and France but are still much higher than in Denmark, the United Kingdom, and the United States, a source of concern since start-ups are thought to add to dynamism and innovative potential.

Although the Dutch health-care system scores well in international comparisons, service levels are perceived as inadequate and waiting times too long. The proposal to make the system more responsive to demand by gradually replacing supply-side controls with enhanced competition among health-care funds should improve efficiency. Likewise, combining the various current health-care insurance programs in the so-called second compartment would usefully simplify and rationalize the financing system. There is a risk, however, that the relaxation of supply-side controls will lead to a rapid rise in overall costs, which would have adverse fiscal implications and might ultimately threaten health-care coverage. In view of the uncertainties involved, the step-by-step approach now contemplated prudently allows for mid-course adjustments as experience dictates.

Financial supervision, which is already of high quality, should be further strengthened by the recent change from a system based on line-of-business to one based on prudential versus conduct-of-business supervision. Three conditions would seem to be important to reap the full benefits of this reform. First, regarding the supervision of large conglomerates, close cooperation between the two prudential supervisors (the central bank and the insurance supervisor) needs to be assured, and the new practice of cross appointments of senior officials is therefore welcome. Second, the distinction between prudential and conduct-of-business supervision (the latter carried out by the new Authority for Financial Markets) should be clarified as much as possible, to avoid overlaps and ensure consumer interests are fully protected. And third, over time the underlying regulations governing various financial institutions should be harmonized to level the playing field and reduce the scope for regulatory arbitrage.

We commend the authorities' support for multilateral trade liberalization and their efforts to improve the capacity of developing countries to participate in this process. We also commend the high level of development assistance provided by the Netherlands, which remains above the UN target of 0.7 percent of GNP.