Abstract

The economic turnaround described in the previous section was associated with a major shift in policies in 1982. In that year, a new government took office, with the objective of pursuing fiscal consolidation and, in a number of respects, reducing the intervention of the state in the economy. In addition, agreement was reached between the labor unions and employers on the need for wage moderation, which has since prevailed. From then on, policies were based on fiscal consolidation, a tight and credible link of the guilder to the deutsche mark, and wide-ranging structural reforms—particularly in the related areas of social security and the labor market.

The economic turnaround described in the previous section was associated with a major shift in policies in 1982. In that year, a new government took office, with the objective of pursuing fiscal consolidation and, in a number of respects, reducing the intervention of the state in the economy. In addition, agreement was reached between the labor unions and employers on the need for wage moderation, which has since prevailed. From then on, policies were based on fiscal consolidation, a tight and credible link of the guilder to the deutsche mark, and wide-ranging structural reforms—particularly in the related areas of social security and the labor market.

Monetary Policy

Monetary policy, from 1983, played a crucial role in stabilizing expectations and underpinning a return of confidence among economic agents.

Monetary policy was geared essentially to maintaining a fixed link with the deutsche mark. Following a final devaluation in 1983, the guilder–deutsche mark parity remained unchanged until January 1, 1999, when both currencies were replaced by the euro (Figure 3.1). The credibility of the link was clearly demonstrated in the exchange rate market turmoils of 1992 and 1993, when the guilder–deutsche mark parity did not come under attack. Moreover, while the exchange rate bands of almost all EMS currencies were widened, the guilder-deutsche mark exchange rate was left unchanged. This contrasts with the de facto devaluations against the deutsche mark of the 1970s.

Figure 3.1.
Figure 3.1.

Exchange and Interest Rate Developments

Source: IMF, International Financial Statistics.

Monetary policy was important in bolstering the confidence of the private sector. By focusing on maintaining a fixed link with the deutsche mark, inflation was reduced to very low levels (at least until the strong cyclical pickup during the mid- and late 1990s), while the credibility of the link led to the lowest long-term interest rates within the EMS.

Since the early 1980s, the rate of inflation in the Netherlands has been among the lowest in the world, and in many years even below that in Germany. At the time, such low inflation was a novelty, as in the 1960s and 1970s, it had been well above that in Germany—although still not high by European standards.

Behind the low inflation was a very modest increase in unit labor costs. From 1983 until 1990, unit labor cost increases never contributed more than 0.4 percentage points to inflation, as measured by the price index of consumer goods. Inflation during this period was mainly the result of increases in import prices, administered prices, and a widening of profit margins of firms.

The excellent price performance led to the disappearance of the inflation differential with Germany. As no exchange rate devaluations took place after 1983, the risk premium on Dutch interest rates, vis-à-vis German rates, gradually disappeared. Moreover, the gradual improvement in economic performance, the low inflation rate, and the various reforms that were introduced were likely responsible for improving investors’ confidence in the economy, thereby increasing the attractiveness of Dutch bonds.

The combination of a nominal exchange rate link with better wage-cost and inflation performance than Germany led to a substantial real exchange rate depreciation vis-à-vis Germany (Figure 3.2). The real exchange rate vis-à-vis other countries did not change greatly, as the better inflation and wage-cost performance was offset by an appreciation of the nominal exchange rate. Thus, after a substantial decline of the real effective exchange rate in the early 1980s, the effective exchange rate changed relatively little.

Figure 3.2.
Figure 3.2.

External Indicators

(1980 = 100)

Source: IMF, International Financial Statistics.

A full discussion of the experience with the deutsche mark peg, and the way in which the economy adjusted, relative to developments in Germany, is given in Section V.

Fiscal Policy

From 1983 onward, fiscal policy aimed at restraining the growth of public expenditure, thereby creating room for both deficit reduction and a cut in the collective burden of taxes and social security contributions.

Public expenditure was reduced from 66 percent of GDP in 1982 to 50¼ percent in 1998, revenue from 56½ percent of GDP to 50½ percent, while the broadly measured deficit declined from 9½ percent to a surplus of ¼ of 1 percent of GDP (Table 3.1 and Figure 3.3).1

Table 3.1.

Public Finances

(In percent of GDP; on a cash basis)

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Source: Data provided by the Dutch authorities.
Figure 3.3.
Figure 3.3.

Fiscal Policy

(General government, in percent of GDP)

Sources: Netherlands Ministry of Finance, Miljoenennota, 1997; Central Planning Bureau, Macroeconomic Outlook, 1999.

The expenditure reduction was in large part the result of three policy approaches:

  • The share of social transfers in GDP was cut by holding down the value of benefits. Due to the nominal freeze of the minimum wage and minimum benefit, the delinkage of benefit growth from average wage growth, and the reduction of unemployment and disability benefit replacement rates from 80 percent to 70 percent of wages, social transfers were reduced as a percentage of GDP. The volume component contributed much less to expenditure reduction, as through most of the period the number of social security benefit recipients continued to rise. However, owing to the favorable employment development, the ratio between the total numbers of inactive and employed persons (the so-called I/A ratio) decreased from 83½ percent in 1984 to just under 75 percent in 1998. The I/A ratio in the Netherlands is now lower than in its neighboring countries—which all saw an increase in this ratio since the mid-1980s (Table 3.2).

  • The civil service salary bill, as a percentage of GDP, was cut by containing the level of salaries and the numbers employed. The value component was held down by a nominal salary cut of 3 percent in 1983, and, subsequently, by very limited nominal increases; the volume component was contained by a slight reduction in the number of civil servants.

  • On-lending by the state was cut substantially, and capital transfers to firms were in large part replaced by an accelerated depreciation system.

Table 3.2.

Ratio of Benefit Recipients to Employment

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Source: Ministry of Social Affairs, Sociale Nota (1999).

Expenditure reduction was aided by a substantial improvement in expenditure control and tightening of budget procedures of the central government. Between 1985 and 1991, several improvements took place: the cash and liability administration of the departments were integrated; the auditor’s control was intensified and the administrative organization of departments was strengthened; and the backlog in finalizing the annual accounts of departments was cleared. As a result, budget overruns, which occurred frequently in the 1980s, declined substantially thereafter.

The share of taxes and social security contributions in GDP was reduced from 47½ percent of GDP in 1983 to 43½ percent in 1998.2 The share of income taxes and social security contributions in GDP declined more, by 5½ percentage points, but this was partly offset by an increase in indirect taxes (almost one percentage point) and an increase in corporate tax revenues resulting from the recovery of profitability. The tax wedge at all income levels declined substantially between 1983 and 1998: at the average wage level from 48 percent to 41 percent, at twice the average wage level from 58 percent to 53 percent, and at the minimum wage level from 34 percent to 16 percent. By 1996, the average wedge on labor income in the Netherlands was well below that in Belgium, Germany, Italy, and France, although still higher than in the United States and the United Kingdom (Table 3.3).

Table 3.3.

Average Wedge on Labor Income, 19961

(In percent of total labor costs)

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Sources: OECD, Tax Database; and The Tax/Benefit Position of Employees.

For single employee with average wage in enterprises.

In dollars of equal purchasing power.

While the average tax burden declined substantially, the decline in marginal tax rates was much less marked, and marginal tax rates are still high in comparison with those of other countries (Table 3.4). The most significant reduction of marginal tax rates took place in 1990, when the highest tax rate was reduced from 72 percent to 60 percent, and the number of tax brackets was reduced from 11 to 3. Marginal tax rates suffered from an erosion of the tax base, particularly so in the 1990s, when for a variety of policy reasons the tax base lost some 50 billion guilders, leading to estimated tax losses of 25–30 billion guilders (3½ percent of GDP), which could also have been used to reduce all marginal tax rates by 7–9 percentage points (De Kam, 1998).3

Table 3.4.

Highest Tax Rates, 1998

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Sources: OECD, Tax Database; and The Tax/Benefit Position of Employees.

Income tax and social security contributions.

Includes temporary increases, local income tax, and cumulation of social security contributions and income tax.

Ratio of starting level highest tax rate and average wage enterprises.

For 1997; for Germany April 1998.

Profits tax for paid-out profits, including “Gewerbesteuer.”

Fiscal consolidation was interrupted by the collapse of oil prices in 1986. With gas prices linked to oil prices, natural gas revenues of the central government dropped sharply, from 4¾ percent of GDP in 1986, to2½ percent in 1987, and 1½ percent in 1988. Other nontax revenues also have declined since 1982: as the government cut back on its on-lending, the repayment of loans (and hence nontax receipts) decreased correspondingly.

As regards the choice of the fiscal target, from 1983 until 1993 the operational target was the cash deficit of the central government. Administrations set a time path for the reduction of deficit financing as a percentage of GDP. Moreover, limits were set on the “collective burden” of taxes and social security contributions, thereby forcing deficit reduction to be achieved through expenditure reduction.

The use of an actual deficit target at times led to strongly procyclical fiscal policy. During the economic boom of the late 1980s, expenditure slippages were compensated by cyclical tax revenue gains, and the structural deficit increased. In the economic downturn in the early 1990s, cyclical revenue losses were compensated by additional expenditure cuts, and the structural deficit declined.

In 1994, a switch was made from a deficit target to an expenditure target, with a view to achieving a less procyclical fiscal policy and a more strategic approach to expenditure management (the deficit target had necessitated frequent and arduous cabinet meetings to decide spending reductions). Expenditures were set in a medium-term framework, with ceilings on spending for the central government, social security, and health care. The time path for expenditure was based on conservative assumptions with regard to economic growth. Ceilings were set on the central government deficit as well, although the use of conservative assumptions on economic growth minimized the risk that additional measures would be needed, once annual budgets had been passed. If growth was higher than expected at the time the expenditure framework was set, the additional revenues would be used for both tax and deficit reduction; the expenditure ceilings would not be changed. Overall, spending in 1994–97 was held below ceiling levels.

The Netherlands met the criteria of the Stability and Growth pact for the first time in 1996—one year before most other participants in the European Economic and Monetary Union (EMU). In 1996, the general government deficit on the Maastricht basis declined from 4.0 percent to 2.3 percent, well below the limit of 3 percent. The government debt ratio did not meet the target (at 77 percent of GDP it was well above the reference value of 60 percent) but declined rapidly enough.4

Overall, the government saving balance, which deteriorated sharply during the 1973–82 period, has improved by about 4 percentage points since 1982.5 Thus, fiscal policy since 1982 achieved, strikingly, the twin objectives of strengthening public saving and cutting back on the level of taxation, especially on labor income.

The government that took office in August 1998 is to continue using an expenditure ceiling. During the 1998–02 period, expenditure is set to grow by 1½ percent a year in real terms. As a result, if GDP growth during that period amounts to 2¼ percent on average, the general government deficit will be reduced from an at that time estimated 1.4 percent of GDP in 1998 to 1.0 percent in 2002. Should growth turn out to be higher, three-fourth of additional revenues will be used for deficit reduction and one-fourth for tax cuts (if the deficit is lower than ¾ of 1 percent, one-half will go to tax cuts and one-half to deficit reduction).6 Thus, if growth were to average 2¾ percent, the 2002 deficit would amount to ¼ of 1 percent of GDP; and if growth were 3¼ percent, there would be a surplus of ¼ of 1 percent.

From a longer-term perspective, it is important to reach a balanced budget early in the next decade. Not only would this leave room for automatic stabilizers to operate, thus avoiding having to increase taxes during a recession, but the resulting decline in interest payments could be an important offset to expenditure pressures arising from the graying of the population (Box 3.1).

Demographic Shift and Public Finances

In the next four decades, the Dutch population will age dramatically. The ratio of people aged 65 and above to those between 20 and 65 will increase from 21 percent in 1996 to 46 percent in 2040 (see table). The demographic transition in the Netherlands starts later and is more severe than in many other European countries, as the postwar baby boom in the Netherlands lasted longer and the decline in the birth rate was sharper than elsewhere.

The graying of the population will significantly increase public expenditure on pensions and health care. By 2040, according to Dutch projections, expenditure on both items will have increased by 4½–7 percentage points of GDP:1

  • Expenditure on public pensions will increase by 2½ percentage points. Pensions in the Netherlands consist of three elements: a public, universal pension; supplementary branchwide private pensions; and individual private pensions. The public pension for a single person is equal to 70 percent of the legal minimum wage (for each person of a married or unmarried couple, 50 percent) and is universal in that any resident, whether in the labor force or not, is eligible. Public pensions are financed through a payroll tax on persons below 65, and, increasingly, through the budget. Supplementary pension funds provide benefits under defined benefit plans, with the promised total pension (i.e., including the public pension) at age 65 generally equal to 70 percent of pay in the last year or several years for an employee with a complete work history (at least 40 years). Supplementary pensions are financed through premiums of employers and employees to fully funded private pension funds.

  • Health-care expenditure will increase by 2–4½ percentage points. If health-care consumption per person would not change, demographics would raise expenditure by 2 percentage points; if consumption per person would continue to rise in line with real GDP, the increase would be 4½ percentage points.

The impact of demographics on public finances could be offset in three ways:

  • By structural policies in health care that would ensure efficient use of health care and thereby avoid excessive increases in costs.

  • By a reduction in interest payments that would result from a decisive cut in the debt ratio. To ensure such a cut, it would be essential to quickly bring the public finances to balance.

  • By an increase in the participation ratio that would result from further labor and product market reforms. In this respect, it is pivotal that the participation of the age group between 55 and 64 is increased. Currently only one out of four persons in this age bracket has a job; and the first result of the demographic transition will be a sharp increase of the share of the working age population in this age bracket.

Population Projections, 1996–2050

(In millions)

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Source: Data provided by the Dutch authorities.
1 Studiegroep Begrotingsruimte, Tiende rapportStudiegroep Begrotingsruimte (1997).

A reform of the tax system is planned for 2001. The two highest tax rates of 50 percent and 60 percent will be lowered to 42 percent and 52 percent, while the lowest tax bracket with a rate of 36 percent will be split into two brackets with rates of 36 percent and 32 percent. The lowering of the tax rate will be partly financed by a series of measures designed to broaden the tax base, including the restriction of deductions and the conversion of the (transferable) tax-free amount into an individual tax credit, but this will not fully offset revenue losses, which are estimated at about ½ of 1 percent of GDP

Changes in the Labor Market and Reforms of the Social Security System

Various labor market measures and reforms of the social security system were implemented. They boosted labor demand, improved supply-side incentives, and reduced government expenditure, thereby creating room for tax cuts.

Labor Market Measures

Labor market policy reforms focused on reducing wage costs and improving supply-side incentives, especially for young people.

First, the legal minimum wage was reduced significantly in real terms. The nominal minimum wage for adults was frozen during most of the 1980s and 1990s. In 1984, the minimum wage was reduced by 3 percent; subsequently it was frozen until 1990, and then again from 1993 until 1996. As a result, the gross real minimum wage declined substantially, and by 1997 was 22 percent lower than in 1979 (Figure 3.4, top panel). The youth minimum wage was twice cut substantially (at the beginning of 1981 and mid-1983, Table 3.6); at other times, it followed the nominal freeze of the minimum wage for adults. For ages 15 to 19, the youth minimum wage was lowered by a cumulative 25 percent to 30 percent, and by somewhat less for ages 20 to 22. Thus, real youth minimum wages declined substantially; the real minimum wage for an 18-year-old, for instance, declined by 43 percent over the 1979–97 period. Actual minimum wages declined by less than the legal minimum wage. Often, the lowest scales increased in line with average wages. As a result, in 1990, in 90 percent of all collective labor agreements, the lowest wage scales were above the legal minimum wage, compared with 60 percent in 1983.7

Figure 3.4.
Figure 3.4.

Gross Wages

(1979 = 100)

Sources: OECD, Economic Outlook; Dutch authorities; and IMF staff calculations.
Table 3.5.

Youth Minimum Wages

(In percent of adult minimum wage)

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Source: Data provided by the Dutch authorities.
Table 3.6.

Employment by Education Category

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Source: Ministry of Social Affairs, Sodale Nota (1999).

Primary, lower secondary (“MAVO”), and lower vocational (“LBO”).

Higher secondary (“HAVO”/“VWO”), and intermediate vocational (“MBO”).

Higher vocational (“HBO”) and university.

Second, because of its link to the minimum wage, the gross minimum social benefit declined in real terms by more than 20 percent (and the net minimum benefit by some 12 percent), thus strengthening incentives in the labor market (Figure 3.5).

Figure 3.5.
Figure 3.5.

Replacement Rates

(In percent)

Source: Data provided by the Dutch authorities.

Third, partly with a view to encouraging wage moderation, taxes and social security contributions paid by employees were cut substantially. The reduction of taxes and social security contributions allowed for an increase in disposable income even in the absence of real gross wage increases, thereby reducing wage demands. The impact of cuts in taxes and social security contributions was quite substantial; whereas the real gross wage of the average production worker increased by only 0.9 percent over the 1983–98 period, the corresponding real net wage went up by 14.8 percent (Figure 3.6).

Figure 3.6.
Figure 3.6.

Gross and Net Wages

Sources: OECD, Economic Outlook; Dutch authorities; and IMF staff calculations.

From the early 1990s onward, various measures were taken to cut nonwage labor costs, especially at the lower end of the wage spectrum. As a result, the tax wedge for low-paid workers declined substantially (Figure 3.7). Two broad schemes are now in effect to cut nonwage labor costs for the low-paid and the long-term unemployed. For workers hired at close to the minimum wage, social security contributions were reduced 58 percent, which cut employment costs by 10½ percent.8 The scheme operates together with similar, larger cuts for long-term unemployed (those out of work for more than a year); for workers meeting both criteria, no contributions are payable, reducing labor costs by 23¼ percent for those workers during the first four years of their employment.

Figure 3.7.
Figure 3.7.

Average Wedge Private Sector Workers

(In percent)

Source: Data provided by the Dutch authorities.

Finally, tightening eligibility and shortening the duration of unemployment and disability benefits—described in detail below—also strengthened supply-side incentives, especially for younger workers. The crucial elements appear to have been a cut in the duration of unemployment benefits from 2½ years to 6 month for workers less than 23 years of age, with smaller but still substantial cuts for older workers, and the reduction in benefits from 80 percent to 70 percent of the last earned wage. By contrast, the similar measures taken for disability benefits were likely far less effective, as in many cases additional insurance was provided by firms.

No measures were taken to stimulate part-time work; indeed it was at times made somewhat less attractive for employers to hire part-time workers. For instance, in 1992, the minimum wage, which so far had applied only to workers employed at least one-third of full-time, was extended to all workers.9

One negative influence on the supply side of the labor market was that participation of the elderly was reduced by government policy. From 1984 on-ward, the unemployed aged 57½ and older were no longer required to look for a job, thus opening a substantial gap between registered unemployment and unemployment benefit recipients.

Social Security Reforms

The social security system has been reformed comprehensively since the early 1980s. During the 1980s and early 1990s, reforms mainly focused on reducing benefits, shortening duration, and tightening eligibility, while since the mid-1990s they have focused on progressively privatizing social security and introducing and enhancing competition among social security benefits providers.

Entitlement Reductions

From 1986 onward, unemployment benefits were reduced, duration was shortened, and eligibility was tightened. Disability benefits were curtailed and eligibility tightened. Sick leave benefits were also cut back.

As regards unemployment benefits, before 1986, an unemployed worker who had worked for at least 130 days in the year preceding unemployment would receive for six months a contribution-financed unemployment benefit (WW) of 80 percent of the last earned wage, followed by two years of a budget-financed unemployment benefit (WWV) of 75 percent of the last-earned wage.10 After two and a half years of unemployment, the unemployed worker would be eligible for welfare. Unemployed workers who were at least 58 years old at the time they received WWV-benefits would retain them until age 65. Key reforms took place in 1986, 1987, and 1995:

  • In 1986, WW unemployment benefits were reduced to 70 percent of the last-earned wage.11

  • In 1987, both forms of unemployment insurance were merged into a new, premium-financed, unemployment insurance. While benefits remained at 70 percent of the last-earned wage, the duration for younger workers was shortened, and eligibility was tightened.12

  • In 1995, eligibility was tightened further,13 moreover, the unemployed now had to accept a wider range of jobs and be prepared to participate in training.

As regards disability benefits, before January 1985, benefits for persons who were more than 80 percent incapacitated were set at 80 percent of the last-earned wage (up to a maximum), while persons with lesser degrees of disability were paid partial benefits. Benefits lasted until age 65. The degree of disability was determined by calculating the ratio of the salary a disabled person would be able to earn after and before the disability. However, if a person was partially disabled but was unable to find a job, it was assumed that unemployment was because of the disability, and therefore would receive full benefits. Key reforms took place in 1985 and 1993:

  • In 1985, two changes took place. First, benefits were reduced from 80 percent to 70 percent. Second, if a partially disabled person could not find a job, that person would no longer receive full disability benefits; instead, partial disability benefits were supplemented by unemployment benefits—which tapered off after a few years.

  • In August 1993, benefits were reduced further. Benefits for new disability claimants were reduced sharply (the existing disabled were grandfathered).14 The reduction involved limiting the duration of full benefits—70 percent of the last-earned gross wage—to not more than six years (six months for disabled above age 32, six years for those above 58, with increasing duration in between), while a lower entitlement was paid subsequently, depending on the age at which the scheme was entered and the salary previously earned.15

  • In addition to the reduced benefits, eligibility was tightened. In calculating disability, the reference point became the ability to perform any paid job, regardless of previous training or work experience. As the range of alternative employment considered was widened, claimants could now be found to have a lower degree of disability. Moreover, existing beneficiaries under the age of 50 were reexamined.

As regards sick leave, in the early 1980s, state-financed benefits were 80 percent of net wages. In various steps, benefits were reduced to 70 percent of wages, although in many cases, in spite of the reductions, a supplement was paid by employers to top up sick leave to 100 percent.

Privatization and Decentralization of Social Security

In the 1990s, a series of complex structural reforms were launched with the common aim of introducing a greater role for market forces in social security. It is helpful to consider these under two main leads: shifting financial risks to firms and then reforming the method remaining central institutions use to carry out their task.

Since 1994, the sick leave and disability schemes have progressively been “privatized,” by shifting financial risks and responsibility to firms and private insurance schemes. Sick leave benefits have been fully privatized, disability insurance partially.

  • Sick Leave. From the beginning of 1994, sick leave benefits were only paid out by a collective insurance after the first six weeks of sickness. Firms were made legally responsible for payment of salary equal to a least 70 percent of salary during the first six weeks of sickness.16 In 1996, the collective insurance was abolished, and firms were made legally responsible for sick leave payments during the first year of sickness (after the first year, disability benefits became applicable).

  • Disability Insurance. To reduce inflows into disability insurance, the disability insurance scheme was overhauled in early 1998. Premiums are now fully paid by employers (previously, employees contributed as well) and for the first five years of disability are differentiated by enterprise (depending on inflows into disability in the previous three years); the risk for the first five years may be insured with private companies or carried by enterprises themselves.17

  • Unemployment Insurance. To reduce inflows into unemployment, the government progressively decentralized unemployment insurance. The period in which benefits are financed at the sector, rather than national, level was extended in two steps from 8 to 26 weeks; this aimed to strengthen incentives for sectors to reduce unemployment.

The steps that have been taken to reform the central institutions flowed from a parliamentary inquiry in 1993, which indicated that employees had far too easy access to disability benefit, while few efforts had been made to reintegrate disability benefit recipients. The leitmotiv of these reforms has been to shift away from a system managed by the social partners to one managed by the government, and then to decentralize the new system and introduce market forces.

The Social Security Council, which supervised the social security system and set the contribution rates, was replaced by two new organizations:

  • The Social Security Supervision Commission (College van Toezicht Sociale Verzekeringen) became responsible for the execution of social insurances and supervision, with its board comprising three government appointed members, who have no links with either unions or employers’ organizations. This ended the involvement in supervision of unions and employers’ organizations, who each had had a third of the seats in the Social Security Council.

  • The Temporary Institute for Coordination (Tijdelijk Instituut voor Coordinatie en Afstemming) and its successor the National Institute for Social Insurances (Landelijk Instituut Sociale Verzekeringen) became responsible for setting contribution rates. The board of the institute comprises representatives of government, unions, and employers’ organizations; the government appoints the chairman.

In 1997, day-to-day management of social security insurance was contracted out to social security agencies, who were to be centrally concerned with reintegrating the unemployed into the work force and who could be privately owned. Specifically:

  • Prior to 1997, collection of social contributions, payment of benefits, prevention and control of sick leave, and medical reintegration of disability benefit recipients were all implemented by the same organizations—branch-associations (bedrijfsverenigingen), which were run by employers’ organizations and unions.18 These branch-associations could not compete with each other, and membership was compulsory.

  • In 1997, the functions were split. The branch associations were reorganized and henceforth called social security agencies (uitvoeringsin stelling (uvi). Under the responsibility of the National Institute for Social Insurances, the social security agencies took care of the collection of contributions and the payment of benefits.

  • The social security agencies were allowed to compete with each other, and with private companies. By introducing competition, the government hoped to improve effectiveness and create incentives for providers to find benefit recipients a new job—thus stimulating reintegration of benefit recipients. In the event, private insurance companies established alliances with the existing institutions, leading to five big conglomerates.

The reform of the social security system is not yet complete. According to plans that aim to further enhance competition, new, government controlled, organizations will determine whether a person is eligible for disability or unemployment benefits. Social security agencies will be responsible for calculating benefits (based on government rules), and for getting benefit recipients into a new job as soon as possible. How the agencies do this will be their own responsibility; they may use the assistance of insurance companies, temporary work agencies, labor exchanges, labor services, or other institutions. Successful social security agencies will be able to charge lower execution costs to employers; they may also be rewarded by a government subsidy for every benefit recipient for whom they find a new job.

Wage Moderation

Real wage costs increased only slowly during the 1980s and 1990s, rising ½ of 1 percent annually between 1983 and 1998, compared with 4½ percent annually in the 1970–78 period. (Figure 3.8). The labor-income share declined from 95 percent in 1981 to 81½ percent by 1989. From the late 1980s on-ward, however, the main effect of wage costs moderation was in a more labor-intensive growth pattern. The labor-income share did not decline further in the 1990s, although wage growth continued to be moderate.

Figure 3.8.
Figure 3.8.

Real Wage Costs

(1982 = 100)

Source: OECD, Economic Outlook Database.

The initial consensus on the necessity of wage moderation appears to have resulted from experiences in the 1970s. The combination, in the early 1970s, of substantial GDP growth and stagnating employment had cast doubt on the view that unemployment was a Keynesian problem, and stimulated the idea that persistent unemployment was caused not by insufficient effective demand but by a lack of profitable opportunities to produce. This idea was underscored by the introduction at the Central Planning Bureau (CPB) of a new generation of models, which contained supply-side, as well as demand-side elements (den Hartog and Tjan, 1974). According to these models, the excess growth of real wage costs over the rate of technical progress affected employment in two ways: it led to accelerated scrapping of old labor-intensive vintages of capital, and it implied lower profitability, which resulted in lower investment, slower growth of the capital stock, and fewer new jobs.

The gradually emerging consensus on the necessity of a different strategy on wages was formalized in November 1982, when labor unions and employers reached the “Wassenaar agreement”—an understanding to pursue moderate wage growth to stimulate employment creation. While wage growth had slowed in the 1970s, the slowdown had been insufficient to prevent a sharp increase in the labor-income share, which reached the unsustainable level of 95 percent in 1981. Wage moderation went into effect from 1983 and continued after the economy began to recover from recession; the beneficial impact on employment creation was widely felt and recogniz ed. by the late 1980s, wage moderation had become a virtually unchallenged policy recipe among labor unions, employers, and political parties in the Netherlands.

The Wassenaar agreement abolished automatic price indexation. As in many sectors collective labor agreements for 1983 had already been concluded, a special law was passed in December 1982 that suspended automatic price indexation and declared all concluded labor agreements void. By 1985, automatic price indexation had virtually disappeared; only 10 percent of all collective labor agreements still included it.19

Another element of the 1982 agreement was the decentralization of wage bargaining. Before 1982, unions and employers’ organizations sought agreement at the national level, thereafter negotiations only took place at the sectoral level. The degree of change in the process of decentralization is debatable however. Although agreement was always sought at the national level before 1982, negotiations were often unsuccessful and ended up at the sectoral level anyway. Moreover, after 1982, there was a high degree of coordination within labor unions and employers’ organizations at the national level.

The government encouraged wage moderation in several ways. Important was a reduction in taxes and social security contributions, which allowed real net incomes to rise, even in the absence of real gross wage increases. Apart from that, the government threatened on some occasions (such as in 1993) to intervene if it considered that negotiated wage increases were too high. Finally, the substantial cuts in the real minimum wage and in social benefits, and the decline in real government wages, are likely to have underpinned continuing wage restraint in the private sector.

Other factors that favored wage moderation included a rapid rise in the participation of women, and a strong increase in the working age population: with a sizable increase in labor supply, wage pressures were less likely to emerge. Indeed, without the reforms on the demand side of the labor market, unemployment would clearly have risen steeply. There may also have been an indirect influence in the other direction: wage moderation, through its positive impact on employment creation, is likely to have induced participation and thus a higher effective labor supply.

To what extent did the Wassenaar agreement result in greater wage moderation than could be expected on the basis of high unemployment and tax cuts? Research by the Dutch Ministry of Economic Affairs suggests that underlying fundamentals and policy changes go a long way in explaining wage moderation. In other words, union behavior was not exogenous, but rather adapted to a change in economic circumstances and in the policy framework. In this research, Oudshoorn (1993a, 1993b) focuses on why wages grew less than labor productivity in the 1984–89 period, thereby leading to a substantial decline in the labor income share. Making use of the wage equation in the CPB’s FKSEC model,20 Oudshoorn concludes that the decline in the labor income share between 1984 and 1989 can be adequately explained by underlying fundamentals and policy changes. In particular, 35 percent of this decline can be accounted for by a Phillips curve effect (captured by the level of the unemployment rate and its change), 30 percent by the decrease in taxes and social security contributions, and 11 percent by a decline in the replacement ratio, with the remainder accounted for by the change in the terms of trade. Subsequent research by the Ministry of Economic Affairs reportedly failed to identify a structural break in the relationship between the labor income share and these underlying variables: this suggests that an exogenous shift in labor union attitudes in the early 1980s probably played a minor role in explaining wage moderation since that time. Essentially, wage behavior was in line with changes in economic and policy fundamentals.

Analysis of the determinants of Dutch labor costs by the IMF tends to confirm that the moderation of wage growth relative to productivity growth in the 1980s was triggered by underlying fundamentals, while its continuation was aided by government policy. Dutch labor costs are in large part determined by three factors: productivity growth, the change in taxes and social security contributions, and the change in unemployment (Appendix I). A change in taxes and social security contributions has a pronounced impact, with an increase in taxes and contributions of 1 guilder leading to an increase of labor costs of 0.7 guilders. The impact of unemployment is also significant, with each percentage point rise in the unemployment ratio leading to a reduction in real wage growth of 0.6 percentage points.21 The rapid increase in unemployment in the early 1980s reduced real wage growth; subsequent cuts in taxes and social security contributions helped keep wage growth moderate.

The Wassenaar agreement, however, probably played a crucial role, which went beyond a simple internalization of economic developments, because it amounted to a very broadly based social compact that changed employers’ expectations of future wage growth. Since the late 1980s, the Dutch labor market seems to have settled into a new kind of equilibrium: wages grew roughly in line with labor productivity growth, but both rose very slowly. Thus, the Netherlands seems to have switched to a more “U.S. style,” that is, a more labor-intensive growth pattern, resulting in low productivity but high employment growth. The economy shifted from an equilibrium involving rapid wage growth, associated with rapid productivity increases and poor employment performance, to one based on slower wage growth, associated with better employment performance, but lower productivity increases. The switch to a more labor-intensive growth pattern is likely to have resulted from a shift in employers’ expectations of future wage growth. Becoming convinced that future wage increases would be moderate, employers felt much less incentive to substitute capital for labor or to continue shedding labor.

Seen in this way, the change in union behavior may have played a role in creating a more labor-intensive growth pattern, by changing employers’ expectations on future wage growth. Such a shift would be hard to detect in an empirical wage-costs equation, since it is reflected in a simultaneous reduction in productivity and wage growth. In this view, while it is likely that the change in employers’ expectations was not triggered by a single event, such as the Wassenaar agreement, the continuous support of labor unions for wage moderation is likely to have been important.

Why Did Employment Grow So Fast?

The successful employment creation in the Netherlands since the early 1980s has attracted considerable interest among policymakers and researchers alike. This section explores the role policies played in fostering employment growth, which has been so much out of line with experience in most economies of the European Union (EU).

Contribution of Wage Costs

One of the first detailed studies of the determinants of employment growth in the Netherlands was undertaken by the Central Planning Bureau in 1991.22 By that time, it had become clear that employment’s strong recovery from its depressed levels of the early 1980s was primarily structural rather than cyclical. The recovery in employment growth was indeed striking: whereas employment in the market sector decreased by 250,000 persons during 1975–82 (4½ percent of total 1975 employment), it increased by 500,000 persons between 1983 and 1990 (9 percent of total 1983 employment). In other words, employment creation in the market sector during 1983–90 was 750,000 persons higher than in 1975–82.

The study concluded that the difference of 750,000 jobs was mainly the result of a more favorable development in wage costs. If the labor income share had remained at its 1979 level, real wage costs would have been 22 percent higher, and employment in persons 380,000 lower. The increase in part-time work also played a role; without it, employment in persons would have been 150,000 less. Other factors were not very important. International developments hardly played a role; relevant world trade growth was only 1¼ percent higher during 1983–90 than during 1975–82, creating 135,000 jobs, and two-thirds of its positive impact was offset by an increase in real interest rates. The impact of the relative decline of the minimum wage was rather modest (35,000 persons), as in many cases the lowest wage scales rose in line with average contract wages, rather than in line with the minimum wage. The impact of the reduction in the working week was also not very important (35,000 jobs).

The CPB attributed the more favorable development in wage costs to high unemployment, which moderated wage demands, and also to a reduction in social security contributions and taxes. The reduction in social security contributions and taxes was in large part the result of the delinkage of public sector wages and social security benefits from contract wages, which reduced government expenditure.

According to the CPB, the impact of lower wage costs on employment was not through its impact on production, but mainly through its impact on labor intensity. If the labor-income share had not declined, the impact on production in the market sector would have been modest (a decline of 2 percent, with lower exports and investment compensated by higher consumption), but enterprises would have reacted to higher wage costs by shedding more labor, and employment would have declined commensurately.

Estimates over a somewhat longer period (1970–97) tend to confirm the importance of real wage costs for employment developments (Appendix II). While such estimates should be interpreted with care, they seem to suggest that the long-run impact of higher wages on employment was quite important, with a 1 percent higher real wage associated with a little less than ½ of 1 percent lower employment.

Role of Average Wage Cost

An important question is whether wage moderation mainly stimulated employment growth because it contained average wage growth or because it slowed, as a byproduct, the growth of the minimum wage. A priori, there are arguments for both:

  • With labor income having a high share in total income in the early 1980s, it is likely that the average wage was not in equilibrium. The subsequent moderation of average wage growth helped restore profitability of firms and investment and reduce the excessive substitution of capital for labor, thereby stimulating employment growth.

  • In an environment where greater wage differentiation was not viewed as feasible for political and cultural reasons, the slowdown in overall wage growth may have been the only feasible way to reduce wage growth at the lower end of the wage spectrum. To the extent that wage costs were a more serious constraint for low-skilled workers, the main impact of wage moderation would have been on jobs for the lower skilled, with much less effect on jobs for the higher skilled.

Data on employment creation by skill level of employees show that in the 1980s and early 1990s the employment situation changed for both high- and low-skilled workers (Figure 3.9). The contrast between the 1970s and the late 1980s is particularly marked. Between 1972 and 1977, employment in full-time equivalents decreased on average by 1.1 percent a year, as a large decline in low-skilled employment (contributing −2.0 percentage points) was only partially compensated by an increase in high-skilled employment (contributing 0.9 percentage points). Between 1986 and 1991, employment increased by 2.3 percent, as the contribution of high-skilled employment creation became much stronger (2.6 percentage points) and the decline in low-skilled employment became much less pronounced (−0.3 percentage points). Interestingly, these data show that the changes in employment in skilled and unskilled employment were of similar magnitude. Intuitively, this shows that the impact of wage moderation did not arise from its impact on low-skilled wages but was an across-the-board effect.

Figure 3.9.
Figure 3.9.

Employment: High Skilled and Low Skilled

(In millions of full-time equivalents)

Source: Data provided by the Dutch authorities.

Employment of low-skilled workers continued to decline in the 1980s, albeit less strong than before. Research by the Central Planning Bureau into the causes of the relative decline in low-skilled employment points to two contributing factors:23 wage differentials declined, which encouraged substitution of high-skilled for low-skilled workers, and labor-saving technological progress was much stronger for low-skilled than for high-skilled workers, which, even with unchanged wage differentials would have resulted in strong reduction of low-skilled labor.

The decrease in employment of low skilled workers continued throughout the 1990s. A breakdown of employment into three skill categories shows a striking difference between employment creation for the highest skilled and the lowest skilled: while employment of the highest skilled increased by 4½ percent a year, employment of the lowest skilled declined by 1½ percent (Table 3.7).

Table 3.7.

Balance of Payments

(In percent of GDP)

article image
Source: IMF, Balance of Payments Statistics.

While employment of the low skilled declined, low-paid employment did not. In fact, employment growth in lower-paid jobs was much faster than overall employment growth.24 Between 1985 and 1989, low-paid employment (in persons) grew by almost 4 percent annually, compared with almost 2 percent for overall employment; between 1989 and 1994, the corresponding figures were 3 percent and 1 percent. Many new jobs were low-paid, part-time jobs, which were occupied by high-skilled women or students. Also, many of the new higher-skilled workers were young and therefore had a relatively low wage.

Overall, the impact of the reduction in the minimum wage is hard to disentangle from the reduction in the average wage. On the one hand, low-paid employment grew faster than overall employment, suggesting that the reduction in the minimum wage was more important. On the other hand, low-skilled employment continued to decline, wage differentials narrowed further, and employment creation mainly benefited new entrants in the labor force, for whom likely no jobs would have been created if average wage costs had not been moderated. To gain a deeper understanding of the contrasting employment and wage developments for high-skilled and low-skilled workers, two issues are addressed in some detail. First, the analysis of employment creation is completed by taking a closer look at the causes and composition of the increase in labor supply. The subsequent subsection returns to the difficult labor market position of the unskilled, as wage differentials have decreased.

Sources of Rise in Participation

The substantial growth in employment since the mid-1980s would not have been possible without a marked rise in labor force participation. Following a decline in the 1970s (from 63 percent in 1970 to 61 percent in 1982), the participation rate rose strongly in the 1980s and 1990s, to 66 percent in 1997. With unemployment and low labor force participation concentrated among the unskilled, the expansion of employment that took place in skilled jobs was only made possible by younger, relatively skilled, workers entering the labor force.

The increase in the participation rate was entirely due to higher participation by women: female participation increased from 39 percent in 1982 to 53 percent in 1998, while male participation declined slightly (from 83 percent in 1982 to 79 percent in 1998).

Determining the role that government policies have played in increasing female participation is difficult. While a positive impact of government policies is plausible, it should be noted that the increased participation of women in the labor force was not notably different from that observed during the 1970s; the participation rate of women aged between 20 and 64 increased from 31 percent in 1970 to 39 percent in 1982, and from 39 to 48 percent between 1982 and 1994. The observed increase is likely to have been largely the result of shifts in cultural patterns that have been observed in other countries also; the sharp increase in the female participation rate observed in the Netherlands was basically a catch-up to the European average.

Government policies are likely to have played a role in ending the decline in the male participation rate. The drop (from 95 percent in 1970 to 80 percent in 1985), in large part associated with an increase in early retirement and disability benefits, and an increase in educational participation, ended in the mid-1980s; ever since the rate has been virtually stable.25

Government policies helped participation in several ways:

  • Social security benefits were lowered and eligibility was tightened, which made leaving the labor force for social security benefits less attractive. The percentage of the working age population receiving disability slowed from the mid-1980s onward, and from 1993 onward, declined.

  • The difference between minimum benefits and the effective minimum wage was progressively widened. While both the official minimum wage and minimum benefits were delinked from contract wages, the lowest wage scales moved until recently in line with contract wages, resulting in a widening gap between wages and benefits.26

Participation may also have been stimulated by strong employment growth. Many women who previously were not in the labor force may have been encouraged to find a job, and the use of early retirement and other exits of the labor force as an alternative to unemployment is likely to have been reduced under the influence of a strong labor market.

Supply-side policies were only partially successful: although they managed to attract newcomers to the labor market, they did not succeed in reintegrating those who had dropped out of the labor market. Thus, the male participation rate did not recover to its earlier levels, and participation among the elderly remained minimal.

Overall, the main cause of the participation increase seems to have been cultural factors that led to increased participation by women; but government policy may also have played a role, especially in bringing to a halt the decline in participation by men.

Viewed in this way, the initial conditions in the early 1980s of low female participation were ideal for an expansion of employment. If in the early 1980s, female participation had already been at elevated levels, the observed strong increase in employment would probably not have continued as long. Moreover, if the increase in female participation were to taper off in the future, labor supply growth would decline, and employment could only continue to grow at the same rate if workers in categories or age cohorts that typically dropped out of the labor force in the past could be reactivated.

Wage Differentiation and Plight of the Unskilled

According to OECD data, wage dispersion among income groups in the Netherlands has increased only slightly since the mid-1980s.27 From 1985 to 1995, the ratio of earnings in the ninth decile to earnings in the first decile increased only from 2.51 to 2.59, whereas the ratio of earnings in the ninth decile to earnings in the fifth decile increased from 1.62 to 1.66. Countries such as the United States and the United Kingdom have experienced far larger increases in wage dispersion. By international standards, wage dispersion in the Netherlands remains low: it is not only lower than in the United States and the United Kingdom, but also, for instance, than in France and Italy. It may appear surprising that a substantial reduction of the ratio of the minimum wage to the average wage was not associated with a greater increase in wage dispersion among income groups. One explanation may lie in the fact that the lowest scales in collective labor agreements (at least until 1994) generally rose in line with average wages, thus opening up a gap between the legal minimum wage and the actual minimum wage.

Wage dispersion between high-skilled and lowskilled labor has also decreased since the early 1980s.28 The ratio of wages of low-skilled workers relative to those of high-skilled workers increased in both the sheltered and exposed sector; in the sheltered sector from 0.71 in 1982 to 0.82 in 1993, and in the exposed sector from 0.73 to 0.92. Thus, while real wages of high-skilled workers remained stable, those of low-skilled workers continued to increase (Figure 3.10).

Figure 3.10.
Figure 3.10.

Real Wages: High-Skilled and Low-Skilled Workers

(1982 = 100)

Source: Data provided by the Dutch authorities.

The decline in wage differentials between high-skilled and low-skilled workers has also been documented by other authors. Salverda (1998) found that the wage premium of university-educated workers over those with only primary education decreased from 73 percent in 1979 to 50 percent in 1989.29 Salverda also found that wage differentials among age categories increased, as did differentials among sectors.

From a demand-side perspective, the decline in wage differentials is somewhat surprising, as technological progress has increasingly reduced demand for low-skilled workers. This shift in demand from low-skilled to high-skilled labor has also been observed in other OECD countries, and a common view is that it has led to rising wage inequality in the United States and to rising unemployment among the low-skilled in Europe (Freeman, 1995). The Netherlands would seem to fit in well with the rest of Europe in that wage differentials have not increased, resulting in high inactivity among the low skilled.30

The narrowing of wage differentials in the Netherlands becomes more understandable if supply is also taken into account. The supply of skilled workers increased strongly, caused by a sharp increase in the participation rate of young, skilled women (see above) and by an increase in education among young people in general. Wages of high-skilled workers adjusted to the large inflow of skilled workers, and the strong increase in relative supply of high-skilled workers reduced wage differentials.31 At the lower end, wages did not decline despite a reduced minimum wage and high unemployment, with replacement rates at low wage levels often close to 100 percent, the incentive to search for a job may not have been very strong, and employers found it very difficult to attract workers at wage levels close to the minimum wage.

Although measured wage dispersion among income groups increased little, the reduction in the real minimum wage may still have had beneficial supply side effects. Because minimum benefits are linked to the legal minimum wage, a widening of the gap between the actual minimum wage and the legal minimum wage increases the difference between wages and benefits, thus improving incentives to find a job.

The declining wage differentials among skill categories were probably detrimental to employment for low-skilled workers. According to the CPB, low-skilled and high-skilled labor are good substitutes: if wage costs for low-skilled labor are decreased by 10 percent, employment of low-skilled workers increases by 15.4 percent, and employment of high-skilled labor decreases by 8.1 percent (Draper and Manders, 1997).

A breakdown of employment growth by skill puts the performance of the Dutch labor market in perspective. While it performed well in absorbing high-skilled newcomers to the labor market, including in jobs at the lower end of the wage spectrum, it performed poorly in reabsorbing the low-skilled unemployed.

Changing Enterprise Behavior and the External Current Account

Since the early 1980s, the current account of the balance of payments of the Netherlands has increased substantially, shifting from a deficit of ½ of 1 percent of GDP in 1980 to a surplus of about 6 percent in 1997 (Table 3.4 and Figure 3.11). This section explores the causes of the increase, from both a balance of payments and a saving-investment perspective, and shows that it is linked to the decline in the labor-income share.

Figure 3.11.
Figure 3.11.

Current Account and Its Components

(In percent of GDP)

Source: IMF, Balance of Payments Statistics.

From a balance of payments perspective, the increase in the current account seems to be associated with the real effective exchange rate depreciation. The improvement in competitiveness was not only used to gain market share, but also to restore profit margins. Thus, it was associated with a substantial improvement in profitability of enterprises: the share of labor income in value added declined dramatically (Figure 3.12). Developments in domestic demand have had a pronounced cyclical impact on the trade balance only. The sharp increase in the Dutch trade balance in the 1980–82 period was associated with a decline in imports, rather than a surge in exports, and this decline in imports was associated with very weak domestic demand (Figure 3.13). The increase in the trade balance in 1993 also was associated with very weak domestic demand. In both periods, business investment, which has a high import component, declined strongly. As the Netherlands exports relatively few investment goods and instead specializes in products such as food and food products, exports generally decline less than imports during European-wide recessions, resulting, ceteris paribus, in an improvement in the trade balance in such periods.

Figure 3.12.
Figure 3.12.

Real Effective Exchange Rate and Labor Income Share

Source: IMF, World Economic Outlook.
Figure 3.13.
Figure 3.13.

Domestic Demand and Its Components

(1980 = 100)

Source: OECD, Economic Outlook Database.

From a saving-investment perspective, the increase in the current account since the early 1980s mainly reflects an increase in the saving surplus of enterprises (Figures 3.14 and 3.15). The saving surplus (i.e., saving minus investment) of households has not shown a clear trend while the saving surplus of government only showed a significant improvement from the mid-1990s onward.

Figure 3.14.
Figure 3.14.

National Saving Surplus and Its Components

(In percent of GDP)

Source: IMF, World Economic Outlook.
Figure 3.15.
Figure 3.15.

Saving Surpluses of the Various Sectors

(In percent of GDP)

Source: IMF, World Economic Outlook.

The increase in the saving surplus of enterprises in the early 1980s was substantial. Between 1980 and 1984, the saving surplus rose from a deficit of 1¼ percent of GDP to a surplus close to 5 percent. Between 1980 and 1982, the increase was mainly associated with a decline in investment; but in the following two years, it reflected a strong recovery in saving, which outpaced the increase in investment. Since the early 1980s, the saving surplus of enterprises has displayed a cyclical pattern, but it has been at a structurally higher level than in the 1970s. Several exogenous factors could be behind this shift:

  • Real long-term interest rates rose sharply in the late 1970s. Following their fluctuation around zero percent in the 1960s and early 1970s, they increased to over 6 percent in the early 1980s and did not fall below 5 percent until 1996.

  • Demand growth was slower during the first part of the 1980s, which reduced the need for capacity-expanding investment. Wage growth was also much less rapid, which slowed down the substitution of capital for labor by capital-deepening investment.

  • There was a large decline in the labor-income share, which boosted corporate profits and hence savings.

The shift may also have reflected a change in the risk preference of enterprises. The large bank borrowings of the 1970s made firms vulnerable in the recession of the early 1980s, when demand declined sharply and interest rates rose for a protracted period. This experience may have increased firms’ risk perception of bank loans and reduced their willingness to finance investment through loans—a pattern observed in Belgium also. Thus, firms now finance their investments almost entirely out of retained earnings. Empirical analysis by the IMF, however, did not detect a clear change in enterprise behavior: in the 1980s and 1990s, corporate investment and corporate saving appear to have behaved in broadly the same way as in the 1970s (see Appendix III):

  • The ratio of corporate investment to GDP tracks real GDP growth, with rapid GDP growth associated with a high investment ratio (Figure 3.16). Thus, the slowdown of investment during the 1970s, and its collapse during the early 1980s, mirrored developments in GDP growth, which in turn reflected developments in world trade growth (Figure 3.17), as did the recovery of investment in the second half of the 1980s.

  • The ratio of corporate saving to GDP closely follows the capital-income share (Figure 3.18).32 Thus, the boost in corporate saving in the first half of the 1980s was associated with a strong increase in the capital income share.

Figure 3.16.
Figure 3.16.

Corporate Investment and Real GDP Growth

Sources: IMF, World Economic Outlook; and OECD, Economic Outlook Database.
Figure 3.17.
Figure 3.17.

Export Market Growth and GDP Growth

Source: OECD, Analytical Database.
Figure 3.18.
Figure 3.18.

Capital Income Share and Corporate Saving

Source: IMF, World Economic Outlook.

Thus, the most important factor behind the shift in the saving surplus would seem to be the decline in the labor-income share. Other factors, such as the increase in real interest rates, and a more cautious behavior of enterprises, may also have played a role, but their role is difficult to demonstrate empirically.

An important reason for the high level of the enterprise-saving surplus may be the dominating position in the Dutch economy of multinational firms. Albeit it a small country, the Netherlands harbors quite a few large multinational firms (Royal Dutch Shell, Unilever, Philips, and Elsevier Reed). As these firms expand worldwide, rather than in the domestic market only, they invest a large part of their profits abroad, resulting in a combination of a large corporate saving surplus and substantial foreign direct investment outflows. Thus, in 1996, for instance, a corporate saving surplus of 4.4 percent of GDP was combined with a net foreign direct investment outflow of 3.9 percent of GDP.

The analyses are, of course, complementary. From a balance of payments perspective, the main factor behind the increase in the current account emerges as the exchange rate depreciation. From a saving-investment perspective, on the other hand, the dominant factor behind the increase appears to have been the sharp increase in the corporate saving surplus. A key element underlying the increase in both the saving-investment balance and the export-import balance was the decline in the labor-income share. By shifting income to a sector with a high marginal saving rate, the decline in the labor-income share strengthened the saving-investment balance; and by reducing domestic demand and hence imports, it improved the export-import balance.

The strong improvement in the current account in the early 1980s was to a large extent a reversal of developments in the 1960s and 1970s, when competitiveness had deteriorated strongly. As noted earlier, while a real exchange depreciation of 25 percent between 1977 and 1984 is huge when seen in isolation, it essentially brought competitiveness back to the level of the mid-1960s (Figure 3.19).

Figure 3.19.
Figure 3.19.

Exchange Rate Indicators

(1977 = 100)

Sources: IMF, International Financial Statistics; and OECD, Analytical Database.

Seen in this much longer time horizon, the high level of the current account seems to reflect several underlying factors: a relatively young population in the face of a demographic transition that will be more severe than in many other countries; a pension system that is funded rather than financed on a pay-as-you-go basis; a relatively high per capita income; and the presence of a number of very large multinationals that invest a substantial part of their earnings abroad.

Interlinkage of Structural Reforms and Policy Lessons

The turnaround in economic performance has been hailed by some as “the Dutch miracle,” and as an example for other economies. But are all of these “lessons” necessarily replicable? How far did the success depend on specificities of the economic, political, and cultural setting of the early 1980s? Can success be attributed to a single policy, or rather to the combined impact of an entire policy package?

It can certainly be argued that the Netherlands, as a very open economy, faced with a crisis, had little choice. It needed to opt for flexibility, to remain competitive in a climate of increasing globalization: there was a sense of urgency that may not be present to the same degree in other countries.

The approach to reform was gradual, and implementation broadly consultative—but this can be overstated. While there was a consensus from the beginning on wage moderation, other reforms were initially resisted: acceptance developed only over time. Moreover, the change in the wage-bargaining approach by the labor unions was to a high degree an endogenous response to the government’s “changing the rules of the game”—cutting benefits and minimum wages, and offering income gains through tax cuts under a new fiscal strategy. The style was sui generis, the content orthodox.

The reforms were to a large extent interlinked and mutually reinforcing. Thus, there was not a single policy element to which success can be attributed, but together their impact was powerful; many policy reforms would have been more difficult to implement in isolation and also would have been less effective. Wage-cost moderation, benefit reform, and fiscal consolidation were in particular linked:

  • Benefit reform played an important role in slowing the growth of public expenditure, while also changing incentives on the supply side of the labor market.

  • Wage-cost moderation was helped by fiscal consolidation, which created room for cutting taxes and social security contributions. Cuts in taxes and social security contributions paid by employees allowed disposable incomes to rise even in the absence of significant wage increases. In the 1970s, sharp increases in taxes and social security contributions had been shifted to wages: it was expected that by lowering taxes and contributions, wage demands would be mitigated. Cuts in social security contributions paid by employers reduced wage costs directly. Cuts in social security contributions were especially targeted toward low-paid workers and the long-term unemployed; by 1999, these fiscal measures reduced wage costs at the minimum wage level by maximum 10½ percent (for long-term unemployed maximum 23¼ percent).

  • Fiscal consolidation was helped by wage-cost moderation, which, together with the cuts in the real minimum wage, strengthened the economy and shifted it toward a more labor-intensive growth pattern. With strong growth in employment, the percentage of the working age population that was employed rose markedly—with important effects on the public finances.

Unique initial conditions on the supply side of the labor market clearly amplified the impact of reforms, although they could have exacerbated unemployment in the absence of strong job creation. These conditions included a low labor force participation rate, with relatively few women in the work force; rapid demographic growth, which underpinned wage moderation; and the existence of a large wage gap, reduction of which triggered rapid employment growth. This was a propitious setting for measures on the labor demand side to be effective; in more typical circumstances, even stronger labor supply-side measures would have been needed to foster such strong employment growth. This is, indeed, the key caveat for other countries that might seek to emulate the Dutch experience.

The improvement in overall performance was accompanied by a slowdown in productivity growth, which may appear a negative aspect of the experience. This slowdown, however, reflects—at least in part—the impact of a reversion toward equilibrium relative levels in the factors of production.

Recent performance is in part a correction or catch-up with neighboring countries, from an alarming starting position. Indeed, the tax rates and debt ratio are still high and labor force participation—adjusted for demographics and in full-time equivalents—while rising, is low; 16 percent of the working age population receives disability or unemployment benefits. In this connection, observers focusing on a single summary statistic—published unemployment, as low, or hidden unemployment, as high—may be missing the essence of the lessons from the Dutch experience. The interest of the reforms lies rather in the remarkable employment creation and turnaround in participation achieved since the early 1980s. The “stock” or “level” problems that remain serve mainly to emphasize that reform is still far from complete.

In sum, various “special” features clearly enhanced the impact of reforms, but they do not detract from general policy lessons. In essence, the Dutch miracle is neither a miracle nor uniquely Dutch, but rather illustrates the mutually reinforcing impact of relatively orthodox reforms, both macroeconomic and structural, which benefited from broad “ownership,” and were pursued consistently over a long period.

1

Net of on-lending, the deficit on the Maastricht basis fell from 6½ percent of GDP in 1982 to 0.7 percent in 1998.

2

The Netherlands is, together with Sweden and Denmark, one of the few countries that taxes social security benefits and hence pays out gross benefits. Other countries pay out net benefits. Since taxes and contributions paid by benefits recipients amount to about 5 percent of GDP taxes paid by employees and enterprises—the relevant yardstick for comparison with other countries—therefore only amount to 39 percent of GDP.

3

The basic income tax exemption was increased substantially for incomes policy reasons, eroding the tax base by 35 billion guilders; the standard labor cost deduction was reduced to increase the difference in net income between workers and benefits recipients (tax base erosion: 7 billion guilders); a special tax deduction for people over 65 was introduced (erosion: 5 billion guilders), and a new tax-free savings instrument for employees (spaarloon) was introduced (erosion: 4 billion guilders). The tax base also suffered from the increased popularity of tax deductible annuities and life insurances, and from the increase in mortgage interest payments.

4

The government debt, expressed as a percentage of GDP, declined from 1995 onward. In the early 1980s, the debt increased rapidly, from 47 percent in 1980 to 71 percent in 1985 and 79 percent in 1988. In 1995 the debt ratio was still unchanged from its 1988 level, but thereafter it declined rapidly, to around 67 percent in 1998.

5

The saving balance is defined as saving minus investment. The increase in the saving balance was less than the reduction in the deficit, as a substantial part of the expenditure reduction reflected a cut in on-lending and capital transfers—which do not affect the saving surplus.

6

In a symmetrical way, three-fourth of revenue shortfalls resulting from lower economic growth will be reflected in a higher deficit, while one-fourth will be clawed back by reducing tax cuts. If the deficit were to exceed 1¾ percent, the distribution would be changed to 50/50. If the deficit were to rise to 3 percent, additional measures would be needed, but this is only projected to happen if economic growth were to fall to ¾ of 1 percent on average.

7

In recent years, the government has put pressure on employers’ organizations and unions to introduce new wage scales at levels closer to the minimum wage. As a result, the average wage in the lowest wage scales has declined from 111.8 percent of the minimum wage in 1994 to 106.7 percent in 1997. Approximately 8 percent of all employees is in these scales (Visser and Hemerijck, 1998).

8

For persons under 23 years or working part-time, lower reductions apply.

9

A recent example of a law that may have not helped to stimulate part-time employment is the Flexibility and Security Act, which came into force in early 1999. This law, which was aimed at protecting part-time and contract workers, was being reviewed only weeks after it came into force, because employers had been terminating temporary posts to avoid the extra burdens imposed by the legislation. Among its provisions were that, after someone serves three temporary contracts and is offered further work within three months by the same employer, he or she is entitled to join the staff. Those employed only on call, but brought in for at least 20 hours a month for three months in a row, gained in most cases the right to a fixed contract.

10

For married men, the benefits would, however, be at least equal to the minimum wage. Married women were not eligible for the budget-financed unemployment benefits. When women became eligible as well, in 1985, benefits were reduced from 75 percent to 70 percent.

11

WWV benefits had already been reduced to 70 percent in 1985.

12

A person who had worked at least 26 weeks during the year preceding unemployment would be eligible for half a year of unemployment benefits. To receive benefits during a longer period, that person now also needed to have worked for at least three out of the last five years. A worker who had worked at least four out of five years would, if he or she was below age 23, receive six months of unemployment benefits; and from age 23 to age 28, nine months of benefits; if above age 58, six years of benefits; and between ages 28 and 58, an increasing duration of benefits applied.

13

A person now needed to have worked at least 26 weeks in the 39 (rather than 52) weeks before dismissal, and to have worked at least four of the last five years (instead of three).

14

Many firms took up additional insurance to compensate for the reduction in benefits under the official disability scheme. Thus, for most workers, the reduction in insured benefits was less than suggested by the reforms.

15

Reduced benefits rise with the age (A) at which the scheme is entered. The benefit is equal to the minimum social benefit, or 70 percent of the minimum gross wage (M), and a supplement that depends on A and the last-earned gross wage (W). Specifically, the benefit is determined as 0.7 M + 0.14(A–15)(WM). Thus, a worker of 40, with a wage equal to 130 percent of the minimum wage would receive a benefit equal to 61.9 percent of the last-earned wage.

16

For the unemployed, as well for pregnant women, the collective insurance continues to exist.

17

The previous scheme, a population-wide program at the minimum wage level, topped up with a wage-related disability scheme for employees, has been replaced by three schemes—for employees, the self-employed, and those disabled before working age. Under the current reforms, the impact on labor costs has been offset by other tax and social security contribution changes; premiums in existing cases and for those disabled more than five years are not differentiated; and employers can only carry the risk with a bank or insurance company guarantee.

18

Prior to 1995, sick leave prevention and control, and reintegration of disability benefit recipients were the responsibility of the Common Medical Service (Gemeenschappelijke Medische Dienst), while collection of contributions and payments of benefits was done by branch-oriented associations. In 1995, the Common Medical Service was abolished, and its functions transferred to the branch-oriented associations.

20

For a critical appraisal of this approach, see Moons and Cornielje (1993) of the Dutch Ministry of Social Affairs. For a description of the model, see Central Planning Bureau (1992).

21

The level of unemployment emerges as insignificant.

25

While the increase in educational participation continued after 1985, its effect on the participation rate was offset by a sharp decline in the share of youngsters in the working age population, which decreased from 25.4 percent in 1985 to 18.7 percent in 1996.

26

Until 1994, the lowest wage scales closely tracked overall wage scales. From 1994 onward, the lowest wage scales were lowered, under government pressure, relative to overall wages. Altogether, between 1983 and 1996, the average nominal increase of the lowest wage scale was 16.9 percent, right in between the increase of the minimum wage (7.1 percent) and the increase of all wage scales (27.8 percent). However, not all enterprises actually use the new low wage scales; in 1996, only 4 percent of all employees were in those new wage scales (Salverda, 1998).

27

OECD, Employment Outlook (1996).

28

Low-skilled labor is here defined as labor with primary and extended primary education. High-skilled labor involves labor with secondary, higher vocational, and university education.

29

During the same time period, in the United States the premium increased from 92 percent to 123 percent.

30

In 1997, when the overall (registered) unemployment rate was 5.5 percent, unemployment among workers with a university education was 4 percent, compared with 16 percent among those with only primary education. Even more telling were the differences in employment rates: of the working age population with a university education, 86 percent had a job, compared with 33 percent of those with only primary education.

31

Another reason for the compression of wage differentials has been the relative decline of the salaries of civil servants, who are on average more highly skilled than the population at large.

32

The capital-income share is the complement of the labor-income share.

Transforming a Market Economy