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Statement by Age Bakker, Executive Director for Kingdom of the Netherlands—Netherlands June 13, 2007

Author(s):
International Monetary Fund
Published Date:
June 2007
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I thank staff for their to-the-point assessment and I would like to convey the appreciation of the authorities for the open and in-depth discussions during the mission.

After several years of headwind, the Dutch economy has been advancing above potential growth since last year. Although major structural reforms have been carried out in the past years, challenges remain. The new coalition government, which took office in February, is well aware of these challenges. It has put forward several additional measures, focused on increasing labor participation and improving the long-term sustainability of public finances.

Economic outlook

Following a kick-start driven by exports in the first part of the cycle, economic growth is now broad based, with domestic demand fuelled by increasing consumer and producer confidence. Although it has not yet reached the levels that were registered at the turn of the century, consumer confidence has steadily increased since 2003. Household consumption is forecasted to grow rapidly this year, but is still only marginally above its long-term average. Investment grew rapidly in 2006, bolstered by a steady positive trend in producer confidence, increasing profits, and accelerating production. This year, investment growth is expected to decelerate somewhat, before picking up again to high levels. In general, the short term outlook for the Dutch economy is positive: economic growth is forecasted to remain well above potential and the output gap is expected to turn positive in 2008.

Fiscal policy

The Netherlands has a well-developed pension system, including a significant (funded) second pillar, and is, as rightly noted by staff, relatively well-placed to cope with the budgetary cost of ageing. Nevertheless, the government is committed to further improve the long-term sustainability of public finances. Budgetary consolidation, in combination with structural reforms, is planned to deliver such an improvement and to reduce the so-called sustainability gap.

Previous governments have achieved a reduction of the debt ratio from close to 80 percent in the mid-nineties to well below 50 percent nowadays. The new government is committed to build on this achievement and has defined its budgetary policy agenda in light of an ageing population. The authorities have decided to set a target of a structural surplus of 1 percent of GDP in 2011, as previously recommended by staff. In conjunction with the measures aimed at higher labor participation, this is expected to lead to a decrease in the sustainability gap by approximately one third.

The Coalition Agreement of the new government provides for concrete measures to improve the fiscal position. On the revenue side, environmental taxes will be increased and the tax system will be revised with a view to enhance labor participation. On the expenditure side, gains are to be realized mainly through efficiency-enhancing measures. The most eye catching example is the significant reduction in the number of civil servants by approximately 13,000, to be achieved before 2011. This figure amounts to 7 percent of the work force of the government, resulting in an expenditure reduction of € 630 million.

Since the completion of the Article IV mission, short-term setbacks in the fiscal position have appeared, resulting in a reversal from a budgeted surplus to an expected deficit of 0.7 percent GDP in 2007. Compared to the budget in September, this means a worsening of the balance by 0.9 percent of GDP. This can mainly be explained by lower gas revenues (0.5 percent of GDP) and expenditure overruns in the health care sector (0.2 percent of GDP). These setbacks in the fiscal position do, however, not alter the medium-term outlook. The government’s aim is to once again register a budgetary surplus in 2008. To this end, the upcoming budget will include, among other things, measures to contain health care expenditures. Moreover, the authorities have reiterated their commitment to a structural surplus of 1 percent of GDP in 2011.

In the 2006 fiscal ROSC, the budgetary framework of the Netherlands was found to meet or exceed the principles of the fiscal transparency code. To achieve further improvement, the authorities have recently implemented some of the recommendations of the 2006 article IV consultation and the fiscal ROSC. These measures include a larger safety margin to avoid a breach of the EMU budgetary rules by lowering the signal value for the deficit from 2.5 percent of GDP to 2 percent of GDP. Moreover, interest payments have been brought outside the expenditure ceilings, the tradition of cautious growth assumptions has been replaced by using best (realistic) forecasts, and measures have been taken to improve the management of the resources in the government’s savings fund for infrastructural outlays.

Financial sector

The report gives an accurate overview of the current state of the financial sector and financial stability in the Netherlands. I am pleased with staff’s finding that the Dutch supervisory framework and implementation represents best international practice. Staff rightly expresses words of caution on the expansion of responsibilities of the Netherlands Authority for the Financial Markets (AFM) as a consequence of new domestic and EU legislation. The AFM is currently fully capable of executing its tasks, but the authorities agree that adding new large tasks could negatively impact the execution of its core responsibilities and note there is no intention to broaden the mandate of AFM.

Staff rightly notes that cross-border banks require intensified coordination with supervisors in other countries. Because of the strong internationalization of the Dutch financial sector, the authorities gained a lot of experience in this respect, both within and outside of the European Union. It is expected and needed that coordination and cooperation among supervisors and other authorities will be strengthened in the future. Staff also signals a possible increase in competition in the pension sector from foreign-based providers and the need for measures to increase transparency of pension supervision in the EU. I agree that transparency is a key issue in this matter. It is crucial that all parties involved have a complete and thorough view of the consequences of differences in supervisory regimes in EU Member States.

Structural reforms

The structural reforms of the past years, like the overhaul of the disability scheme, continue to pay off. Labor participation increased by one percentage point in 2006 compared to 2005 and is expected to increase further one percentage point in 2007. Although the effect is waning in 2007 and 2008, the additional labor supply stemming from policy measures is still estimated at 50,000 persons. Last year, the Dutch competitive position increased for the first time since 2000. The structural reforms and the improvement of the competitive position have helped Dutch companies to take full advantage of the favorable development of the world economy. The return-on-equity has steadily improved over the past few years and is currently at the highest level since the mid-eighties.

Notwithstanding the increase in labor supply, labor market tensions are reappearing in some segments. Labor market shortages which would lead to substantial wage increases would prevent a significant improvement in the Dutch competitive position and limit the extent to which the economy can grow in the current economic upswing. Further increasing labor supply by fostering labor participation is therefore of utmost importance. A key goal of the government is to increase participation in society in general and in labor markets more specifically. In the past three years labor market dynamics have already gone in the right direction. New and filled vacancies have been increasing since the second quarter of 2003.

The government plans various measures which should help to further enhance labor participation. Measures will be specifically targeted at groups currently underrepresented in the workforce, notably older workers, women, and foreign-born workers. The measures foreseen include a reduction of the possibility to transfer the general tax credit from the nonworking to the working partner and the introduction of an earned income tax credit to make low-paid work more attractive. Moreover, the tax credit for the working elderly will be increased and stronger incentives in the state pension will be introduced. These measures aim to increase the attractiveness of continued employment at an older age. At the same time, the government intends to improve labor-market participation of young people in co-operation with the private sector.

Conclusion

The structural reforms implemented over the past few years continue to pay off. The flexibility and competitiveness of the economy have improved, the structural budgetary position has significantly improved, and with domestic demand picking up, economic growth is now broad based. Although the expected deterioration in the fiscal position in 2007 is disappointing, it does not change the medium-term and long-term fiscal outlook. The authorities are committed to put forward measures in the 2008 budget to again achieve a budgetary surplus. Moreover, the target of a structural surplus of 1 percent of GDP in 2011, combined with the planned structural reforms, is expected to address one third of the sustainability gap. The reforms in the labor market will also help to alleviate upward pressure on wages. All in all, this makes the Netherlands relatively well-placed to reap the benefits of the current benign international economic environment and to cope with the budgetary cost of ageing.

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