Kingdom of the Netherlands—Netherlands: Staff Report for the 2003 Article IV Consultation

Following several years of expansion, the Dutch economy is in its third year of weak growth. Executive Directors commended the authorities on prudent economic policy, and advised for fiscal consolidation in view of population aging. They welcomed the multiyear fiscal framework, and underscored the need to press forward with labor and product market reforms. They appreciated the sound fiscal and structural policies. They agreed that the Dutch financial sector remained sound and well supervised, and commended authorities for taking measures to strengthen the public finances.

Abstract

Following several years of expansion, the Dutch economy is in its third year of weak growth. Executive Directors commended the authorities on prudent economic policy, and advised for fiscal consolidation in view of population aging. They welcomed the multiyear fiscal framework, and underscored the need to press forward with labor and product market reforms. They appreciated the sound fiscal and structural policies. They agreed that the Dutch financial sector remained sound and well supervised, and commended authorities for taking measures to strengthen the public finances.

I. Introduction

1. A staff team comprising Mr. Ford (head), Ms. Detragiache and Zhou, and Mr. Hofman (all EU1) visited Amsterdam and the Hague during May 9–19, 2003. The mission met with the finance minister, the governor of the central bank (DNB), the head of the pension supervisor (PVK), the head of the Social and Economic Council (SER), the staffs of several ministries and government agencies, employer and labor representatives, banking economists, and academics.

2. Following elections in May 2002, the government collapsed and new elections were held in January 2003, and a center-right coalition (Christian Democrats, Liberals, and D66) was sworn in on May 27. The coalition agreement, which outlines the government’s economic policies for its four-year term (to 2007) was published on May 16.

3. At the conclusion of last year’s consultation (Public Information Notice: http://www.imf.org/external/np/sec/pn/2002/pn0263.htm), Directors commended the authorities on prudent economic policy, and argued for further fiscal consolidation in view of population aging. They also agreed that a renewed commitment by the new government to a multi-year fiscal framework would be essential in this regard. Directors underscored the need to press forward with labor and product market reforms.

4. The policies of the Dutch authorities have long been broadly consistent with Fund advice. Considerable fiscal consolidation took place in the 1980s and 1990s, reducing expenditures and taxes as a fraction of GDP, and eliminating the deficit in 1999. As discussed below, however, a substantial deficit opened up again in 2002. Structural reform and wage moderation delivered one of the best labor market outcomes among advanced economies, with rising participation and employment rates, and very low unemployment rates. In the past year, the absence of a stable government resulted in a pause in the implementation of a series of needed reforms to rein in the disability scheme, reduce poverty traps, and further liberalize product markets.

5. Data provision is timely and adequate for surveillance purposes (Appendix I). The Netherlands has accepted the obligations of Article VIII (Appendix II). An FSAP is scheduled for completion in the first half of 2004. The authorities intend to publish this staff report.

II. Background

6. The strong economic expansion of 1996–2000 has given way to a period of very little growth (Table 1, Table 2, and Figure 1). This slowdown reflects in part an unwinding of imbalances that had built up during the boom. Wage and price inflation rose, threatening profits and international competitiveness (Figure 2); rapid asset-price rises, which had boosted domestic demand by an estimated ½ percent a year, ended as the stock market collapsed and house prices flattened out (Figure 3); saving rates rebounded after falling earlier as asset price increases bolstered household balance sheets (Figure 4); and investment rates fell from very high levels. As a result, business investment has been falling since 2001, and household consumption was nearly flat in 2002. Exports have also been very weak, owing mainly to the worldwide economic slowdown (Figure 5). International competitiveness has eroded gradually, but the trade balance, export market shares (until end-2000, after which there are indications of erosion), and inward direct investment (a proxy for the attractiveness of locating in the Netherlands) have proved robust. This somewhat surprising development may reflect the still strong competitive position that had been established in the 1980s and early 1990s and possibly also a lag due to pricing-to-market by Dutch exporters.

Table 1.

Netherlands: Basic Data

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Sources: Dutch official publications; International Monetary Fund, International Financial Statistics; and Fund staff estimates.

Contribution to GDP growth.

In percent of disposable income.

For 2002, the purchase of gas rights from DSM (0.3 percent of GDP) is excluded.

Table 2.

The Netherlands: Quarterly Real GDP Growth

(Changes from previous quarter; seasonally adjusted)

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Sources: Statline online database; and IMF staff estimations.

Contribution to GDP growth.

Year-on-year percentage change.

Figure 1.
Figure 1.

Netherlands: Growth Performance Comparison

Citation: IMF Staff Country Reports 2003, 239; 10.5089/9781451829372.002.A001

Source: WEO.
Figure 2.
Figure 2.

Netherlands: Prices and Wages

Citation: IMF Staff Country Reports 2003, 239; 10.5089/9781451829372.002.A001

Sources: Eurostat; CPB; and IMF, IFS and staff estimates.
Figure 3.
Figure 3.

Netherlands: Development of Asset Prices

Citation: IMF Staff Country Reports 2003, 239; 10.5089/9781451829372.002.A001

Source: BIS, WEFA, and IMF staff estimates.
Figure 4.
Figure 4.

Netherlands: Saving and Investment Adjustment Over Asset Price Cycle

Citation: IMF Staff Country Reports 2003, 239; 10.5089/9781451829372.002.A001

Source: OECD and IMF Staff estimates.
Figure 5.
Figure 5.

The Netherlands: External Performance

Citation: IMF Staff Country Reports 2003, 239; 10.5089/9781451829372.002.A001

Source: WEO, IFS, and DOT.

7. The slowdown has eased inflationary pressures. In 2001, employment growth began to fall, and the unemployment rate to rise, although firms, with the memories of labor shortages during the boom period still fresh, appear to have been reluctant to shed workers (Figure 6). In the first months of 2003, however, the unemployment rate rose sharply, to 5.3 percent in March. With labor-market pressures easing, the social partners agreed to wage increases of no more than 2.5 percent in 2003, an agreement that is, by all accounts, being respected. Inflation is also falling, and converging to the (lower) euro-area average.1

Figure 6.
Figure 6.

Netherlands: Output Gap and the Labor Market

Citation: IMF Staff Country Reports 2003, 239; 10.5089/9781451829372.002.A001

Source: IMF, WEO.

8. The fiscal position has deteriorated sharply, from a surplus of 2.2 percent of GDP in 2000 (1.5 percent excluding UMTS proceeds) to a deficit of 1.2 percent of GDP in 2002 (Table 3). This reflected both the automatic stabilizers and a weaker structural balance, and helped to cushion demand. The extent of the deterioration in 2002 was unexpected. As late as December the authorities were predicting a deficit of only 0.7 percent of GDP. Relative to the 2002 budget, tax inflows proved much lower than anticipated, with most of the shortfall in direct taxes stemming from the corporate profits tax (see Table). The shortfall was due to weak profits and to provisions allowing firms to carry back losses. In any event, the revenue buoyancy associated with the boom of the late 1990s was, in retrospect, unsustainable and not likely to re-occur. In addition, spending was about 1 percent of GDP higher than budgeted, reflecting in part health-care spending, which rose nearly 9 percent in volume terms. The expenditure ceiling was nevertheless respected owing to higher non-tax revenue (which, under the rules, offsets spending) and profits from the central bank.

Table 3.

Recent Developments in the General Government Accounts

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Source: National accounts, Ministry of Finance, CPB, and Fund staff calculations.

Estimates.

Projections.

For 2000 includes UMTS receipts (0.7 percent of GDP) and for 2001 includes purchase of gas right from DSM (0.3 percent of GDP).

For 2000 excludes UMTS receipts (0.7 percent of GDP) and for 2001 excludes the purchase of gas rights from DSM (0.3 percent of GDP).

Deterioration in the Fiscal Position

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Source: Ministry of Finance, CPB, and Fund staff calculations.

Figures exclude UMTS revenues in 2000 and the purchase of gas rights from DSM in 2001.

2002 Budget

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Source: Ministry of Finance and staff calculations.

Net of other revenues.

9. The authorities took strong measures to contain the deficit in 2003. The 2003 budget and a spring budget bill included spending restrictions and revenue increases amounting to some 1¼ percent of GDP, in part to offset rising health-care expenditure growth. The required measures are being implemented, and the staff expects a deficit of 2¼ percent of GDP and a modest improvement in the structural balance. Despite the best efforts of the authorities, it is possible that significantly weaker growth than now expected, a further collapse in corporate tax revenues, or substantially higher health-care spending could yield a worse outcome.

III. Policy Discussions

10. Against this backdrop, the fiscal situation dominated the discussions. The key fiscal challenges are to reverse the deterioration of the public finances and, to prepare for population aging, move toward a structural surplus by 2007. Discussions also covered second-pillar (occupational) pensions, the evolution of labor relations, labor and product market reforms (also partly motivated by population aging), financial sector supervision, trade policy, and overseas development assistance.

A. The Short-Term Outlook

11. Activity is projected to rise somewhat in the second half of 2003, and strengthen further in 2004 (Table 2). In view of the two quarters of decline at the turn of the year, this pattern translates into a year-on-year fall in real GDP of 0.2 percent in 2003, and a rise of 1.4 percent in 2004.2 A recovery in the United States and Europe would boost Dutch exports. Monetary conditions have eased substantially in the euro area, despite the adverse effects of the recent appreciation of the euro (Figure 7). While the authorities did not comment directly on the appropriateness of the ECB’s policy stance, they agreed with the mission that there was scope for further easing from the point of view of the Dutch economy. The ECB cut its intervention rate a further 50 basis points on June 5. Domestically, the correction of asset price, labor market, and inflationary imbalances, as well as the end of a substantial drawdown in inventories, should set the stage for recovery.

Figure 7.
Figure 7.

Netherlands: Monetary Conditions

Citation: IMF Staff Country Reports 2003, 239; 10.5089/9781451829372.002.A001

Source: IMF, IFS.1/ An increase implies less accomodative conditions.

12. The authorities and the staff agreed that the outlook was fraught with uncertainty and risks. Most risks are common to Europe as a whole, where the projected recovery is far from certain. There are no concrete signs of stronger growth, and consumer and business sentiment remain weak in most countries, including in the Netherlands (Figure 8). A protracted adjustment of corporate balance sheets,3 needed fiscal retrenchment, and, for the euro area, the currency appreciation are all important downside risks. The key domestic risk is a possible sharp fall in house prices, which rose rapidly to historically high levels during the boom period. The authorities argued this was unlikely because housing is thought to still be in short supply. If it occurred, however, the effect could be substantial. The CPB has estimated that a 13 percent fall in house prices in 2003–04 would cut aggregate demand by 0.6 percent.

Figure 8.
Figure 8.

Netherlands: Cyclical Indicators

Citation: IMF Staff Country Reports 2003, 239; 10.5089/9781451829372.002.A001

Source: WEFA, Intline Database; and IMF, IFS.

B. Fiscal Policy

13. The widening deficit raised concerns about the underlying fiscal situation. In the absence of corrective measures, the deficit had been projected to reach 2.3 percent of GDP in 2004 (assuming real GDP growth of ¾ percent in 2003 and 1¾ percent in 2004), uncomfortably close to the Maastricht ceiling. Moreover, analysis by the Bureau for Economic Policy Research (CPB) pointed to an erosion of the tax base in the coming years, due to proposed tax cuts, more deduction of mortgage interest, and higher second-pillar pension contributions, which are tax deductible. The mission, while noting that, on the staff’s standard assumptions, fiscal sustainability was not in jeopardy,4 argued for measures to restrain spending and protect the tax base in order to restore a sound fiscal position over time. This would imply a steady improvement in the underlying fiscal position, and allow the automatic stabilizers to play.

14. The coalition agreement contained a host of measures to reverse the deterioration, a package that was supported by the mission. These have been incorporated in the recent Stability Program, and will be fleshed out in the 2004 budget.5 They comprise mainly spending cuts and some tax increases, amounting 2½ percent of GDP over the government period. Important measures include holding public-sector wage growth 1 percent below the standard linkage with private-sector wages and limiting wage drift; indexing social security benefits to public rather than an average of public and private-sector wages, cutting back unemployment benefits, housing subsidies, and certain labor-market programs; and imposing spending cuts on some ministries and public agencies. For 2004, the proposed tightening of ¾ percent of GDP would, taking account of downward revisions to projections, still result in a deficit to 2.4 percent of GDP, but in a small reduction of the structural deficit (Table 4).

Table 4.

Netherlands: Medium-Term Macroeconomic Forecast

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Sources: Dutch official publications; International Monetary Fund, International Financial Statistics; and Fund staff estimates and Fund staff estimates.

For 2001, the purchase of gas rights from DSM (0.3 percent of GDP) is excluded.

15. During the four years ending in 2007, the authorities and staff project the fiscal position to improve significantly. The authorities assumed the fiscal package would have adverse demand effects, yielding growth of 2 percent a year, which is below potential. On this basis, the CPB projected a deficit of ½ percent of GDP in 2007, and a structural surplus of ½ percent of GDP (using the CPB method). The CPB noted that this structural surplus would fulfill the long-term objective of a surplus of 1 percent, because it includes the effects of a temporary increase in tax-deductible second-pillar pension contributions (expected to be reversed in 2011; see below), which will reduce revenues by 14 percent of GDP. The staff argued that the fiscal outcome might prove better than officially projected. In particular, whereas the authorities’ assumptions imply a substantial output gap, the staff medium-term scenario assumes real GDP returns to potential by 2008, resulting in real GDP growth of 2.6 percent in 2004–07 and a surplus of ¼ percent of GDP in 2007 (Table 4).

16. The authorities and the mission agreed on the importance of renewing the multi-year fiscal framework, and of devoting budgetary windfalls to deficit reduction. The mission viewed this as particularly important given the possibility that the medium-term fiscal outturn might prove better than officially projected. The key features of past successful frameworks—real expenditure ceilings and the separation of expenditures and revenues—are to be put in place. The mission argued that devoting windfalls on both the revenue and expenditure sides to deficit reduction would help solidify the medium-term fiscal position. The coalition agreement was silent on expenditure windfalls, but the authorities agreed that room under previous spending ceilings should not be used to raise structural spending. In addition, the mission again proposed aligning the spending ceiling with national accounts concepts to improve transparency. The authorities agreed, but noted that the ceilings were tied to budgetary concepts, which differed in some respects from those in the national accounts.

17. The coalition agreement also proposes measures to protect the tax base, some of which should improve supply-side incentives. Tax deductibility of mortgage interest is to be further restricted by excluding capital gains on a previously owned house, a planned elimination of a property tax is to be scaled back, and contributions to second-pillar early-retirement programs (prepensions) will no longer be deductible. The mission welcomed these initiatives, agreeing in particular that the first measure reduces a distortion in capital taxation, and the last would reduce the attractiveness of early retirement schemes and could thus boost labor-force participation of older people. The mission argued that further reduction of mortgage interest deductibility is warranted. One step would be to eliminate the tax advantage of spaarhypotheken, as a step toward ultimately abolishing the deduction.6 While agreeing in principle, the authorities noted that this is a politically difficult issue, as more than half of households own houses.

18. Accelerating health-care costs pose a challenge for expenditure control. Following court decisions that guaranteed access to a range of services in the “care” sector (long-term care, home care, and so forth), top-down budgetary controls were relaxed and health-care spending—which had previously been well contained—rose sharply. The authorities noted that controls on prices remained, and argued that increased copayments (which are low in the Netherlands) and deductibles would blunt demand pressures. Nevertheless, the coalition agreement reserved the possibility of reimposing budget controls. Later in the coalition period, a comprehensive reform will, among other things, replace centralized controls by competitive, regulated insurance providers who, it is hoped, will also hold down costs. The mission expressed strong concern that such measures might not be sufficient, noting strong cost pressures in virtually all countries, particularly in the United States, which has copayments, deductibles, and competitive insurers (Figure 9).

Figure 9.
Figure 9.

Netherlands: Health Care Spending and GDP (2001, PPP-Based)

Citation: IMF Staff Country Reports 2003, 239; 10.5089/9781451829372.002.A001

Source: OECD, Health Data 2002 4th ed.

19. Population aging looms over the long-term fiscal outlook, and action on a number of fronts becomes increasingly urgent with each passing year. Two key fiscal responses are to contain, through program reform, the budgetary costs of aging and to finance additional costs while stabilizing tax rates by running a sustained budget surplus of some 1 percent of GDP (see the Selected Issues from the 2002 Article IV staff report: http://www.imf.org/external/pubs/cat/longres.cfm?sk=15903.0). The authorities continued to support the goal of long-term budget surpluses, despite the recent setbacks, a position supported by the mission. They also noted that while first-pillar pensions were not especially generous, together with the second pillar the maximum replacement rate was 70 percent of final earnings.7 The mission suggested reducing this rate and, in light of longer life spans, raising the retirement age, perhaps from 65 to 67. The authorities considered the current focus to be on reforming second-pillar plans.

Performance of Dutch Pension Funds

(In percent)

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Source: CPB.

20. The authorities emphasized that second-pillar plans, which have recently faced difficulties, remained a strength of the Dutch system. The recent stock market collapse revealed a long-term underfunding situation of these defined-benefit plans, and caused a sharp decline in coverage ratios (assets divided by the present value of liabilities; see Table). The pension supervisor (PVK) moved to correct this situation in September 2002 by requiring each fund to attain a coverage ratio of 105 percent by end-2003. In addition, depending on the riskiness of each fund’s portfolio, the PVK has required that substantial buffers be built up by 2011 which according to CPB estimates will result in average coverage ratios of 130 percent. Consequently, absent reform, contribution rates are expected to rise by some 4 percentage points, to about 15 percent of the wage bill, about half of which is needed only temporarily until buffers are restored.

21. The authorities have been concerned that higher contribution rates needed to assure long-term financing and build up buffers would raise labor costs and depress employment. The CPB estimated that raising contribution rates from 11.1 percent to 15.4 percent would cut market-sector employment by 0.8 percent. The mission argued that treating contribution rates as a labor-cost wedge overstates employment effects. To a large extent, higher contributions are needed to fulfill past obligations, which firms cannot now avoid by reducing employment—that is, they are not a marginal cost of labor.8 In addition, the alternative to higher contributions is not business as usual, but rather a steady decline in assets relative to pension liabilities, which would in itself surely eventually have adverse macroeconomic consequences.

22. Second-pillar funds are undergoing gradual reform, with a view to reducing long-term liabilities. Consideration is being given to reducing pension generosity by reducing the degree of indexation of benefits, and switching the base for benefits from end-of-career to career-average earnings is already underway. The mission raised the issue of a possible rise in defined-contribution plans, as has occurred in other countries. The authorities expected some movement in this direction, but felt that the tradition of solidarity would preserve defined-benefit plans as the norm. Finally, the government, in close cooperation with the PVK, is seeking legislation to codify and modernize the rules regarding the prudential supervision of pension funds. Regarding early retirement plans, a more actuarially fair system is being phased in, though the process will not be complete until 2022. The mission suggested that further gains along these lines could be made by integrating all second-pillar systems, to reward working up to 65 years of age and beyond. In addition, as mentioned, the tax deductibility of contributions to early retirement plans is to be abolished.

C. Financial Markets

23. The financial sector has suffered from the economic downturn. As already noted, the collapse in stock markets sharply reduced the assets and coverage ratios of second-pillar pension funds, although their liquidity position remained strong. Banking income and profits also fell in 2001 and 2002, reflecting poor commission income and higher provisioning (see Table). Nonetheless, capital-asset ratios remain strong and banks are moving to reduce costs by shedding labor. Regarding mortgage exposure, the authorities have been keeping close watch on the situation, as in recent years banks have tended to relax lending criteria and have developed exotic and tax-efficient products (spaarhypotheken and beleggingshypotheken).9 The authorities argued that the sector was not at risk, because a sharp fall in house prices was unlikely, mortgage defaults have been historically quite low, and banks are well provisioned. The FSAP scheduled for 2004 should shed further light on potential vulnerabilities in the sector.

Bank Performance

(Percent changes over previous year)

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Source: Dutch central bank.

24. Reform of financial supervision is continuing. Last year, prudential supervision was vested in the central bank (for banks) and the PVK (for insurance and pensions), and the AFM was charged with conduct-of-business supervision (consumer protection, for example) and supervision of stock markets. A key feature of the new structure was a closer relationship between the central bank and the PVK, embodied by the cross-appointment of senior officials. The staff has long supported such closer links, because they would improve oversight of the large conglomerates which dominate banking and insurance. The reform has been taken a step further, with the full merger of the central bank and the PVK to be completed by January 2004. The implementation appears to be smooth, although concerns linger in the private sector of too much overlap, or too little coordination, among supervisors.

D. Labor Markets

25. It was agreed that long-term increases in employment rates would be an important part of the response to population aging. Although the Netherlands scores relatively well in terms of overall employment rates (Figure 10), the authorities noted that disincentives had curtailed labor supply, thus aggravating shortages during the boom period. Particular efforts are underway to increase the participation of those over 55 years old, a relative weak point and one of increasing concern as this group is expected to expand rapidly in the next few years. Perhaps most important will be the changes to early retirement plans described above, which will tend to reduce the attractiveness of early retirement. In addition, those over 57½ years old will now be required to search for work to qualify for unemployment benefits. A new labor-tax credit has been introduced for workers over 57. Finally firms are to be penalized for firing older workers, although as the mission pointed out this measure might also discourage firms from hiring them.

Figure 10.
Figure 10.

Netherlands: Labor Market Indicators (2001)

Citation: IMF Staff Country Reports 2003, 239; 10.5089/9781451829372.002.A001

Source: OECD, Employment Outlook, July 2002.1/ Refers to persons aged 16 to 64. (ESP, GBR, NOR, SWE, USA)2/ Refers to persons aged 16 to 24. (ESP, GBR, NOR, SWE, USA) Countries are: AUS=Australia, BEL=Belgium, CAN=Canada, FRA=France, DEU=Germany, ITA-Italy, JPN=Japan, NLD=Netherlands, NZL=New Zealand, NOR=Norway, PRT=Portugal, ESP=Spain, SWE=Sweden, GBR=United Kingdom, USA=United States.

26. The authorities intend to reform the disability program, which has beneficiaries equivalent to about 13 percent of employment. The previous government had decided to implement some parts of the reform package proposed last year by the SER: restricting eligibility to those deemed fully disabled, strengthening medical examinations, and eliminating top-up agreements between social partners (which often raised replacement rates to 100 percent for the first year or two of benefits). Other parts of the package, notably raising the replacement rate and eliminating firms’ experience-rated premiums (PEMBA), are to be implemented only if inflows fall satisfactorily. The mission supported this approach. It argued further that PEMBA should be retained and, if necessary, replacement rates should be cut, not raised. Inflows into the program already dropped substantially in early 2003, although the cause is not yet known. The authorities tentatively attributed this development to a new “gatekeeper” system designed to move people back to employment, or to experience-rated premiums, both of which came into full effect at the turn of the year. The authorities and the mission concurred that this development did not vitiate the need to press ahead with reform.

27. A number of other measures to sharpen work incentives has been proposed. The coalition agreement calls for abolishing short-term unemployment benefits (for those not eligible for regular benefits) and follow-up benefits (for those who have exhausted regular benefits). And a longer employment period will be required to qualify for regular unemployment benefits. In addition, indexation of the minimum wage and social security benefits will be reduced by restrictions on civil-service wage rises. Noting the very high prevalence of part-time work, the mission raised the possibility of increasing work hours of this group. It agreed with the authorities, however, that part-time work should not be discouraged because it is an important factor in the overall good labor-market performance in the Netherlands.

28. Reducing the significant disincentives to work at the low wages (poverty and unemployment traps) remains a difficult policy challenge.10 Rent subsidies, which are an important component of the problem, are to be reduced. However, the authorities argued that reducing poverty and unemployment traps would be difficult without increasing poverty (if benefits were cut excessively) or raising taxation elsewhere, with damaging incentive effects. While agreeing that the best approach would be to reduce the overall tax burden, the mission noted that marginal effective tax rates are extremely high at the low end, and that reducing them here, even at the expense of some increase at higher incomes, might well have net positive benefits.

29. The so-called “polder model” has come under strain in recent years. This model emphasizes cooperation and consensus among the social partners and the government, and embraces both labor relations and broader social policy issues (reform of the disability scheme, for instance).11 Wage moderation, a key benefit of the model, was undermined during the boom of the 1990s, when labor shortages resulted in increasingly high settlements. And the labor representatives expressed concern that the reform agenda of the new government might signal a period of reduced cooperation and increased labor strife.

30. However, the model still enjoys wide support. It was revived by the 2003 wage agreement, although the innovation of setting a national wage-growth ceiling is not likely to be repeated. The authorities and social partners pointed to the advantage of a very low incidence of labor disputes. The mission suggested that the centralizing aspects of labor relations in the Netherlands—embodied in institutions, national level negotiations between employers and trade unions, and automatic extension of contracts12—may have limited wage differentiation, resulting in efficiency losses. The authorities argued that cultural factors were largely responsible for the narrow wage dispersion and noted that, in any case, economic outcomes had been quite good.

E. Product Markets

31. The authorities considered further product market reform vital to raise productivity. Liberalization of the energy sector (gas and electricity) is proceeding rapidly, with medium and large businesses able to choose suppliers since January 2002. The aim is to liberalize entirely by July 2004, although concerns have arisen about the uneven playing field in the EU due to differing paces of reform. More broadly, the MDW program, an umbrella for a wide range of product-market reform projects, has been succeeded by new programs involving several ministries, which are to focus on reducing government administrative burden and red tape, improving the delivery of public services, and increasing choice.

32. However, for various reasons enthusiasm for reform has waned. A few liberalizations in other countries had turned out badly, increasing political skepticism. In the Netherlands, falling standards of service led the government to put considerable pressure on the independent management board (ownership had never been relinquished). And various difficulties encountered by electricity suppliers cast doubts over liberalization in this sector. The authorities themselves were reconsidering the approach to reform, with a view to shifting the emphasis from producer to consumer benefits. The mission supported such an initiative, and noted that political support might be further increased by ensuring that regulation, while promoting the gains from reform, protected consumer interests.

33. Initiatives to strengthen corporate governance are also being put in place. The authorities argued that, overall, corporate governance was sound and not in need of radical overhaul. Nevertheless, in the wake of prominent scandals, including at the Dutch company A hold, the authorities are increasing public oversight of accounting standards and auditing by increasing the role of the Authority for Financial Markets (which is responsible for conduct-of-business supervision) in this area. The code of corporate governance will also be strengthened, although compliance will remain voluntary. Shareholders are to be given more rights, including approval of options and shares schemes for executive directors and the ability to appoint and dismiss members of the supervisory boards of large companies. The mission argued that shareholder rights could prove important in the Netherlands, given the presence of large institutional pension-fund investors. The authorities noted that pension funds had become somewhat more active in this respect, although not to the degree seen in the United States.

F. International Trade and Development Assistance

34. The authorities expressed strong support for multilateral tariff reduction, and argued for strengthening aspects of the current system. They fully approved of the goals of the Doha round, which should benefit the Dutch economy.13 But they were concerned that the window for successful negotiation was closing, identifying agricultural trade liberalization as the key roadblock. The authorities strongly supported agricultural liberalization and CAP reform. They felt the effects on the Netherlands would be limited, because Dutch agriculture was not specialized in those products now subject to the greatest protection. While strongly in favor of the rules-based international trade system, because it protected the weakest countries in particular, the authorities argued for some reform. They felt the system of “special and differential treatment” should be restricted to truly poor countries, and not based on various national preferences. They also felt the WTO dispute mechanism was too slow, and found it anomalous that the remedy for illegal trade restrictions was retaliatory trade restrictions (while admitting that alternatives were difficult to find).

35. Regarding development assistance, the government continues to review its effectiveness and coherence. Dutch assistance is generous by international standards at 0.8 percent of GNP. It is also in the process of being reformed to focus on a few countries, adopt a sectoral (rather than a project) approach, and ensure as much as possible coherence between trade, development, agricultural, and investment policies.

IV. Staff Appraisal

36. Following the boom in the late 1990s, the economy is in its third year of weak performance. This protracted weakness can be traced to both domestic and external factors, and reflects to some extent the unwinding of imbalances that had built up in the boom period of the latter half of the 1990s. Business investment declined, as high wage increases threatened profits and external competitiveness. Household consumption growth fell sharply as the large house and equity price increases, which had been boosting wealth, came to an end. And exports fell, mainly due to a slump in the Netherlands’ trading partners, but competitiveness was also eroded. While the labor market initially reacted slowly to these developments, unemployment began to rise sharply in the first half of this year. On the other hand, wage and price inflation has fallen, and is converging on euro-area levels, reflecting both softer market conditions and the cooperative attitude of the social partners.

37. The outlook, which is subject to a number of risks, is for a very gradual increase in growth in the second half of this year, and a stronger pickup in 2004. Recovery will depend critically on a broader firming of economic conditions in the rest of the world, especially the euro area. This outcome is far from assured, however, as business and household confidence are low, corporate balance sheets remain weak, and, for the euro area, the currency appreciation poses a downside risk. In this regard, the recent cut in interest rates by the ECB is welcome from the viewpoint of Dutch economic prospects. Also, the social partners need to continue to act responsibly to contain costs, and household consumption would suffer if a correction in housing prices materialized.

38. The key immediate policy need, which the new government is addressing, is to restore the health of the public finances. The fiscal position has deteriorated sharply and, in part, unexpectedly in the past two years. This reflects in part the operation of the automatic stabilizers, and to that extent has been an appropriate response to the economic slump. But there has also been a significant structural deterioration which, if not corrected, would jeopardize longer-term prospects. In particular, it would throw in doubt the policy to maintain a budget surplus, of about 1 percent of GDP, to reduce the debt and free budgetary resources to deal with population aging.

39. The measures taken in the 2003 budget and proposed in the new government’s coalition agreement are therefore welcome. In 2003, the widening of the deficit is expected to reflect only the automatic stabilizers. For 2004–07, the strong measures in the coalition agreement should reverse the deterioration and, by the end of the coalition period, generate a structural surplus. At the same time, they allow substantial play to the automatic stabilizers in the short run, which is appropriate given the still uncertain pace of recovery. The commitment to devote revenue windfalls to deficit reduction is commendable. Expenditure windfalls (spending below expectations) should also be used to cut the deficit, in part to avoid the prospect that cyclical gains are used to fund structural programs. More broadly, the multi-year framework with spending ceilings and separation of expenditures and revenues will, as in the past, help to ensure fiscal discipline.

40. Expenditure control will be a difficult challenge, especially given the prospects of continuing large increases in health-care spending. Long-term reductions in the tax burden, which are needed to sharpen work incentives, will require expenditure growth well below output growth. The emphasis in the coalition agreement on spending cuts, rather than tax increases, is therefore wise, and the focus on durable measures explicitly designed to strengthen public finances through 2007 and beyond is welcome. However, policy changes in the wake of court decisions have had the effect of allowing very high increases in health care spending. Raising co-payments and deductibles, and reducing the scope of coverage, will help to contain pressures, but even so medical services must be offered at far below their true marginal cost. The statement in the coalition agreement that budgetary controls may be re-imposed if necessary is therefore welcome. The more sweeping reforms scheduled for later in the government period should improve the efficiency and responsiveness of the medical care system. However, close attention will have to be paid to their cost implications if the health sector is not to crowd out other public expenditures.

41. There is room to broaden the tax base in ways that could improve allocative efficiency. The planned elimination of the tax deductibility of contributions to early retirement schemes should both raise revenue and, by ending the subsidy to such schemes, promote the continued employment of older workers. The authorities intend to further limit mortgage interest deductibility, but additional steps are warranted. Removing the tax advantages of the spaarhypotheken and eventually eliminating the deduction altogether would result in more uniform treatment of different forms of saving. Such fundamental reforms would also tend to depress the level of house prices, and such initiatives should therefore be introduced in a predictable manner to avoid a disorderly market response.

42. The key medium-term structural challenge is to further increase labor-force participation and employment rates, in part to mitigate the effects of population aging. Recent and proposed measures to increase the labor-force participation of those over 55-years old are welcome, especially as that age group is about to grow substantially as the population ages. Requiring job search for unemployment benefits and reforms to early retirement schemes should improve incentives. The proposal to penalize firms who fire older workers may, however, cut both ways, as firms may be less willing to hire such workers. The proposed scaling back of unemployment insurance benefits should also stimulate employment. More needs to be done to reduce very high marginal effective tax rates (including the loss of benefits) at the low end of the earnings scale. Reducing rent subsidies would be a useful step, but, in the final analysis, the problem would be best attacked by reducing the overall tax burden, which will in turn require medium-term spending restraint.

43. The determination to reform the large disability program is commendable. The authorities’ approach of introducing first those measures designed to curtail inflows is prudent. Even after these measures are in place, however, the program will remain quite generous relative to other income support schemes. A key to containing it is rigorous medical screening of applicants, a task that should be made easier by restricting eligibility to the fully disabled. Nevertheless, in the past this screening has not been fully effective, pointing to the need to adjust economic incentives as well. In this regard, retaining experience-rated premiums and possibly reducing the replacement rate may prove necessary in the longer run.

44. Further product-market reform will be critical to enhancing productivity. The Netherlands enjoys high productivity per hour, on a par with the United States, and has been a leader in the liberalization of telecommunications, electricity, and gas. Nevertheless, the new government should work to build momentum to continue progress on liberalization and privatization, reduce the administrative burden faced by firms, and strengthen corporate governance. Building public support will be critical, and care must therefore be taken to ensure that benefits to consumers and households are clear, and are clearly understood.

45. Though the financial sector appears strong, continuing reforms to supervision are welcome. Financial-sector performance has been somewhat weakened by the cycle, but institutions have responded with cost-cutting measures and, in the pension sector, higher contributions. In this regard, prompt action by the pension supervisor was appropriate. A sharp fall in house prices would add further stress, but the large institutions which dominate the sector are well positioned to weather such an event. The merger of the banking and insurance-pension supervisors should further strengthen oversight of the conglomerates. The key challenges for the immediate future are to ensure smooth integration at management and working levels, and to minimize possible overlap and duplication in supervision. Proposals to clarify pension regulation and the responsibilities of the supervisor also merit support, particularly in view of the significant role of second-pillar funds in financial and labor markets.

46. The authorities’ support for multilateral trade liberalization is commendable. They are encouraged to continue their efforts to strengthen support for the Doha round, to enhance the role of developing countries in multilateral negotiations, and to improve the system of trade disputes. Their substantial effort in terms of overseas development assistance, which exceeds the United Nations target of 0.7 percent of GNP, is also noteworthy.

47. It is proposed that the next consultation be held on the normal 12-month cycle.

Table 5.

Netherlands: Indicators of External and Financial Vulnerability1

(In percent of GDP, unless otherwise indicated)

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Sources: Data provided by the authorities, and IMF, International Financial Statistics.

The interpretation of some indicators is affected by the launch of monetary union in 1999.

Reserves and foreign liabilities refer to the Dutch central bank, both before and after EMU. End-of-period.

From 1999 onward claims on/liabilities to non Euro Area countries only.

Average of the three largest banks.

Emerging markets: Africa, Latin America, Middle East (excluding Israel), and Asia (excluding South Korea, Taiwan, Province of China, Hong Kong S.A.R., and Singapore).

APPENDIX I Netherlands: Fund Relations

As of April 30, 2003

I. Membership Status: Joined December 27, 1945; Article VIII.

II. General Resources Account:

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III. SDR Department

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IV. Outstanding Purchases and Loans: None

V. Financial Arrangements: None

VI. Projected Obligations to Fund: None

VII. Exchange Rate Arrangements:

The Netherlands entered the final stage of European Economic and Monetary Union on January 1, 1999, at a rate of 2.20371 guilder per euro.

VIII. Article IV Consultation:

Discussions for the 2002 Article IV consultation were held in Amsterdam and the Hague in March 15–25, 2002. The staff report for the 2002 Article IV consultation (SM/02/151, 5/17/02) was considered by the Executive Board on June 10, 2002 (EBM/02/58). The Article IV discussions with the Netherlands are on the standard 12-month consultation cycle.

IX. Exchange Restrictions:

The Netherlands maintains exchange restrictions vis-à-vis Iraq (notified to the Fund under Decision 144-(52/51) in EBD/90/267 (8/27/90) and EBD/94/83 (5/13/94)); and the Socialist People’s Libyan Arab Jamahiriya (see EBD/94/83).

APPENDIX II Netherlands: Statistical Data Issues

The Netherlands publishes a wide range of economic and financial statistics. Specifically, annual and quarterly national account data are provided by the Central Bureau of Statistics; financial and balance of payments data are provided by De Nederlandsche Bank; and fiscal data are provided by the Ministry of Finance. These data are increasingly available in electronic form. Macroeconomic data are generally of high quality.

The frequency and timeliness of the availability of the core statistical indicators for Fund surveillance purposes are summarized in the attached table. The authorities subscribe to the Special Data Dissemination Standard, providing information about their data and data dissemination practices on the IMF Dissemination Standards Bulletin Board.

Netherlands: Core Statistical Indicators

As of June 6, 2003

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De Nederlandsche Bank = central bank.

Central Bureau of Statistics.

APPENDIX III

Netherlands: Public Sector Debt Sustainability Framework, 1992–2007 (In percent of GDP, unless otherwise indicated)

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Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or grass debt is used.

Derived as [(r − π(l+g) − g + αε(l+r)]/(l+g+π+gπ)) times previous period debt ratio, with r = interest rate; n = growth rate of GDP deflator; g = real GDP growth rate; of share of foreign-currency denominated debt; and ε=nominal exchange rate depreciation (measured by increase in Local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r−π(l+g)and the real growth contribution as-g

The exchange rate contribution is derived from the denominator in footnote 2/ as αε(l+r).

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

Derived as nominal interest expenditure divided by previous period debt stock.

Real depreciation is defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator).