Authorities’ views

19. The authorities emphasized that further extending broad pandemic support programs beyond the third quarter of 2021 could create unintended consequences and delay the normalization of the economy. However, measures remain in place to support sectors still facing restrictions. In addition, the experience with these pandemic support programs will be helpful to facilitate their reintroduction, if needed. Nevertheless, a program relaunch would most likely be more restricted and targeted than before, thereby also implying a time-lag. The authorities further noted that a new wave of infections would likely have comparatively limited impact on the economy, thanks to the strong adaptation of businesses, but also because containment measures would mostly likely be localized. They pointed to global supply bottlenecks as another important source of near-term risks for the Netherlands, given the open nature of its economy. They stressed also that although it is too early for an in-depth assessment, programs in place to facilitate reallocation of labor seem to be working. They indicated their readiness to tighten macroprudential policies if credit developments call for it in the foreseeable future. They showed an openness to work with private creditors towards ensuring the debt sustainability of viable but temporarily challenged borrowers, though concrete modalities of engagement are still being explored.

Fiscal Policy

20. Despite the large fiscal package deployed to combat the pandemic, fiscal space remains substantial, providing room to support growth-enhancing reforms. Undercurrent policies, staff projects the fiscal balance to return to a small surplus in the medium term, as the economy recovers, automatic stabilizers shrink, and pandemic-related emergency support measures are phased out. Public debt is projected to start declining after 2022, returning to about 50 percent of GDP by 2026.⁷ Even if a deficit above current projections were maintained in the medium term, policy space would be more than adequate to deal with unanticipated shocks (See DSA and Carton and Fouejieu, 2020). The extraordinarily low Dutch government bond yields provide further room for maneuver when setting medium-term fiscal objectives. Without prejudging future discussions on European fiscal rules after 2022, the structural fiscal balance would return above the pre-pandemic MTO in the medium term. Thus, policy space is available to foster a stronger and greener recovery, while contributing to address external imbalances, even as fiscal buffers are gradually replenished.

21. Raising public investment in education can help address skill mismatches and shortages accentuated by the pandemic. Already before the pandemic a significant proportion of Dutch firms found it difficult to fill ICT vacancies, and the changes in the structure of production post-pandemic may exacerbate skill shortages. Although total public spending on education is in line with the euro area average, spending in primary education has declined in recent years, while pre-primary education spending is well below the EU average. Student-to-teacher ratios in pre-primary, primary and secondary education are also significantly higher than the EU average. These factors could explain the deterioration of the Netherlands’ PISA reading score in the last several years, which now falls slightly belowthe OECD average. Also, persistent educational achievement gaps exist among children from different socioeconomic backgrounds. The authorities’ recent announcement of new spending worth 8.5 billion euros over two years (about 1 percent of 2021 GDP) to support a National Education Plan is welcome. Additional structural investment in education, while addressing potential efficiency problems, would help address these challenges and maintain the Netherlands among frontier countries in terms of educational outcomes (see Selected Issues Paper).

22. Increasing direct public support to R&D will generate positive spillovers and boost productivity growth. Total spending on R&D in the Netherlands is in line with the EU average, but it remains below that in frontier countries. In fact, government support for R&D in the Netherlands has declined in the past decade, while increasing in frontier countries. Increasing public spending on basic research would not only help maintain the Netherlands’ position as an innovation leader, but would also generate positive spillovers, expanding the productivity frontier. The launch of the National Growth Fund, with R&D one of the main targeted areas of investment, is a welcome development. Post Covid-19, the authorities should also support further development of digitalization, which proved its worth during the pandemic. Next Generation EU funds earmarked for the Netherlands, while relatively modest, can nonetheless be useful in this area.

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Government Spending and Support for R&D

Citation: IMF Staff Country Reports 2021, 243; 10.5089/9781589068735.002.A001

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23. The Netherlands has an ambitious climate change mitigation commitment and policy framework, but more needs to be done to reach its emissions reduction goals. The Netherlands is committed to reducing greenhouse gas emissions by 49 and 95 percent, by 2030 and 2050, respectively, relative to 1990 levels. These commitments are likely to be revised upward in the context of the new EU Green Deal, which envisions a 55 percent emissions reduction by 2030 relative to the 1990 level and net zero by 2050. The Dutch Climate Agreement adopted in 2019, moreover, defines targets across five sectors, with the largest emission reductions envisaged in the power sector (over 50 percent by 2030) based on a strong increase in renewable energy and the phaseout of coal generation. However, under policies adopted as of 2020, GHG emissions are projected to fall by only 34 percent by 2030.⁸ Newly approved measures in 2021, including a back loaded carbon levy on industry, could reduce emissions by another 9 percentage points— leaving a 6 percentage-point gap relative to the national target. The Independent Study Group on “Implementing the Green Deal” has estimated that public spending on green investment may need to increase by between ½ and ¾ percent of GDP a year in the next decade to ensure the Netherlands meets its goals. The inclusion of additional resources for green spending in the 2022 budget is a positive step.

Greenhouse Gas Emissions Per Sector

(Mt CO_₂ Equivalents)

Source: Netherlands Climate and Energy Outlook 2020 (KEV)

Greenhouse Gas Emissions Per Sector

(Mt CO_₂ Equivalents)

	1990	2019	2030 proj (KEV)
Power	39.6	42.3	18.8
Industry	87	56.7	53.1
Built environment	29.9	23.3	18.6
Mobility	32.2	35.2	31.6
Agriculture	32.9	26.4	24.5
Land use	6.5	4.8	3.6
Total	228.1	188.7	150.2
Percent reduction relative to 1990 levels			34.2

Source: Netherlands Climate and Energy Outlook 2020 (KEV)

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Greenhouse Gas Emissions Per Sector

(Mt CO_₂ Equivalents)

	1990	2019	2030 proj (KEV)
Power	39.6	42.3	18.8
Industry	87	56.7	53.1
Built environment	29.9	23.3	18.6
Mobility	32.2	35.2	31.6
Agriculture	32.9	26.4	24.5
Land use	6.5	4.8	3.6
Total	228.1	188.7	150.2
Percent reduction relative to 1990 levels			34.2

Source: Netherlands Climate and Energy Outlook 2020 (KEV)

24. Climate change mitigation policies should be further strengthened, which would open new growth opportunities. Carbon pricing can be reinforced with feebates (revenue-neutral tax-subsidy schemes) to reduce emissions per unit of production or activity in the five sectors covered by the Climate Agreement, without a large increase in energy prices for the public at large. Carbon prices could also be better aligned across sectors to avoid distortions. The newly introduced industry carbon levy could be made more cost-effective through a revenue-neutral feebate design, which naturally embeds incentives for all firms to cut emissions and better addresses competitiveness and leakage concerns. To attain reduction targets in power generation, taxes on residential and industrial electricity could be gradually removed and replaced with additional surcharges on C02 emissions from power generation/district heating and coal generation (Batini at all, 2021⁹). The recovery post-pandemic also provides an opportunity to foster a greener and more sustainable economy. Public support to innovation and adoption of greener technology among Dutch firms would create new growth opportunities. The National Growth Fund could be used to promote such investments.

25. The Netherlands has continued reforming its international taxation framework to reduce the scope for aggressive tax planning. The Dutch tax system has played a key role in attracting foreign direct investment (FDI) from multinational corporations (MNCs) through special financial institutions (SFIs). SFIs transact mainly with non-residents and typically have little (or no) physical production or employment in the Netherlands, thus contributing relatively modestly to the Dutch economy. Their wide use for tax planning has come under scrutiny and prompted reform initiatives by the government aimed at tightening the rules. These include the introduction of a cross-border conditional withholding tax (WHT), revisions to the Advance Pricing Agreements (APA) and Advance Tax Rulings (ATR) practice to strengthen qualifying substance requirements and presence tests, modifications to the innovation box regime, and revisions to the tax treaty policy. These efforts are welcome and should continue. While it is early to quantify the effect of the tax reforms on the activities of MNCs, there are indications of a slight decline in the number of SFIs and of reduced benefits from using the Netherlands as a conduit since the introduction of the new conditional WHT.¹⁰

Authorities’ Views

26. The authorities broadly agreed with staff assessment of medium-term fiscal policy recommendations. They noted that medium-term debt sustainability is not a concern at the moment. The 2022 Budget Memorandum also forecast debt-to-GDP ratio to be several percentage points below the 60 percent SGP limit in the medium term. They also see the need for additional investment in education, including to catch-up with learning losses incurred during the pandemic, due to school closure, but also to address pressing needs in the most disadvantaged schools. They noted that efforts are being made at regional levels to address skill shortages, with cooperation between regional authorities and employers in different sectors. They emphasized that National Growth Fund is aimed at supporting R&D and boost productivity.

27. The authorities agree with staff that additional measures are needed to meet the national climate targets for 2030. They believe that carbon pricing remains the most effective instrument to bring about change but might need to be complemented by expenditure measures, such as subsidies and a ramp-up in green investment, including carbon capture and hydrogen infrastructure. They also believe that there are tradeoffs between addressing the supply side of housing and preservation of biodiversity as construction is a source of nitrogen emissions. Given the disproportionate contribution to total emissions relative to GDP, it will also be inevitable to reduce farm agriculture, in particular livestock.

28. Furthermore, the authorities deem important to continue the current reforms to international taxation. They reiterated their commitment to an internationally agreed minimum income tax to help fight tax avoidance globally.

Maintaining financial stability

29. Real estate markets call for heightened vigilance and the pursuit of policies to address near-term risks and long-term challenges confronting residential and commercial properties.¹¹ Prices – and valuations – for housing have continued to soar during the pandemic (see chart), reflecting longstanding supply bottlenecks, low interest rates, and the favorable tax treatment of owner-occupied housing. Existing vulnerabilities have been exacerbated by a further rise in already elevated levels of mortgage debt, with some households exceedingly stretching their debt servicing capacity. Consequently, the activation of floors for risk weights applied to mortgage lending from 2022 is welcome and may be complemented by measures such as an additional reduction in eligible loan-to-value ratios, and reviewing the taxation of owner-occupied housing.¹² In addition, efforts to improve the elasticity of the housing supply appear warranted, as structural rigidities, such as distorted planning incentives and restrictive building or zoning laws, maintain imbalances. Such policies will also support macroeconomic stability by lessening households’ exposure to house-price fluctuations, which can significantly affect consumer spending.

30. Vacancy rates for commercial properties have increased due to the recession yet with little effect on prices as investment yields have stayed attractive in relation to other assets. With banks maintaining comparatively large exposures, valuation has become a concern, especially since long-term structural change may prevent the full recovery of some property segments. The authorities should contemplate options to better steer the investment cycle of commercial real estate to avoid a build-up of financial stability risks, potentially modelled on policies in place for owner-occupied dwellings. Furthermore, incentivizing climate-friendly modernization or the rededication of obsolete structures should help preserve the value of existing buildings.

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Real Estate Pricing and Valuation

Citation: IMF Staff Country Reports 2021, 243; 10.5089/9781589068735.002.A001

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31. The crisis has exposed and compounded financial sector challenges, also by suppressing interest rates even further. Since end-2019, net interest margins of banks have declined, lowering the share of operating income originating from traditional intermediation activities. Portfolios of pension funds and insurers have shown some shift towards riskier assets by lengthening durations and reducing holdings of safer assets. Some asset management companies experienced liquidity pressures during the financial market turbulences in early 2020 while lending by other non-bank financial institutions, such as factoring companies, appears to remain brisk, also facilitated by the difficulties of some SMEs to access bank financing. Hence, the crisis has put existing financial sector challenges into sharper relief, warranting supervisory vigilance about, possibly undue, risk-taking behavior. In this context, efforts to improve the transparency of exposures, e.g., with the help of a credit registry, and the development of macro- or micro-prudential tools to address risks outside the banking sector, e.g., by creating supervisory leeway to limit investment fund redemptions at times of stress, would constitute useful complements.

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Bank Net Interest Margin and Income

(Percent; basis points)

Citation: IMF Staff Country Reports 2021, 243; 10.5089/9781589068735.002.A001

Source: EBA.

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32. Anti-Money Laundering /Countering the Financing of Terrorism is a key financial stability and integrity issue in the Netherlands.¹³ Given the open nature of its economy, the Netherlands should continuously monitor international financial flows and carry out analysis to remain agile in its risk-based supervisory activities. A central register for beneficial owners of legal persons went live in September 2020. The authorities should continue refining the accuracy of the beneficial ownership information and promptly establish the planned beneficial ownership register for legal arrangements (e.g., trusts). The Netherlands should continue to prioritize close inter-agency and international cooperation among AML and tax authorities.

Authorities’ Views

33. The authorities broadly shared staff’s assessment of financial sector challenges and policy priorities. They acknowledged imbalances in real estate markets as a key area of concern, requiring a combination of policies to address demand and supplyside pressures while containing associated financial stability risks. Authorities highlighted the potential benefits of the introduction of a credit bureau to support SME financing. They perceived risks in the non-bank financial sector as no immediate cause for alarm but acknowledged the need to monitor developments and stressed efforts to improve transparency and to consider instruments to contain potential vulnerabilities, such as borrower-based measures that would also put limits on the lending activities of non-bank financial institutions or restricting investment fund redemptions at times of stress to preserve liquidity and avoid fire sales of assets. They share the view that effectively addressing AML/CFT challenges requires international co-operation and welcome measures suggested by the EUAML Action Plan in this regard.

Addressing specific vulnerabilities in the Dutch economy

34. While the labor market proved generally resilient during the crisis, the self-employed and workers with flexible contracts were shown to be vulnerable. These groups of workers are more likely to lose their jobs and incomes, and they enjoy lower safety-net coverage in downturns, putting them at higher risk. While having one of the strictest protections for regular contracts among OECD countries, the Netherlands has a comparatively liberal framework for employment under flexible contract arrangements, leaving them vulnerable during the pandemic. In addition, sectors of activity with a high share of flexible work arrangements tend to exhibit relatively lower labor productivity levels and growth, likely reflecting lower incentives for employers to invest in the skills of workers.¹⁴

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Employment Protection – Regular vs Temporary contracts

Citation: IMF Staff Country Reports 2021, 243; 10.5089/9781589068735.002.A001

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35. Policies to reduce labor market duality can contribute to increase resilience to future shocks and support productivity growth. Ensuring appropriate social protection, including a mandatory disability insurance and some basic pension insurance for the self-employed, as currently planned, are steps in the right direction. Continuing realigning tax and other incentives across different types of employment, by, e.g., gradually reducing the tax credit for self-employed once the pandemic has been left behind, would contribute to reducing labor market duality. Improving employment protection for workers inflexible contract arrangements could enhance the resilience of the labor market to adverse shocks, and support wage growth. Given the high prevalence of part-time employment among women, improving availability and affordability of childcare (currently, its cost exceeds EU and OECD averages) would better enable women to work full-time. Ongoing reforms of parental leave, including the expansion of paternity leave, would also facilitate full-time female labor participation. Employing a larger share of the workforce on a more permanent basis would also incentivize employers and employees to invest in training, supporting higher productivity.

36. The second pillar occupational pension system has been under stress for several years. The system is considered one of the most solid in the world, as it incorporates correction mechanisms to ensure that it can stand behind the benefits it offers. However, low interest rates have boosted liability valuations putting pressure on funding ratios.¹⁵ As a result, painful corrections have been made, including repeated hikes to contribution rates and suspension of cost-of-living adjustments. Thus trust in the existing system has waned, resulting in a decline in active pension contributors over the past decade, especially among younger cohorts.

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Policy Funding Ratios of Dutch Pension Funds

(Percent)

Citation: IMF Staff Country Reports 2021, 243; 10.5089/9781589068735.002.A001

Source: DNB.

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37. The agreement on pension reform is welcome and delays on its implementation should be kept to a minimum. In June 2019, the government and social partners signed a pension agreement, envisaging a shift of occupational pensions from a defined-benefit to a defined-contribution type model while also incorporating elements of risk sharing among members and insurance against longevity risk.¹⁶ In May 2021, the authorities decided to postpone the date on which the reform will become effective from January 1, 2022 to January 1, 2023, mainly to allow sufficient time to address a host of technical adjustments. Consequently, present pension arrangements are now required to transition to the new system by January 1, 2027 only. The modifications to pension modalities foreseen by the legislation are anticipated to stabilize contribution rates, encourage early enrollment by acknowledging the time value of money, and may dampen some of the effects of low interest rates on consumption under the current framework. ¹⁷ They also upgrade the pension framework to deal with an evolving labor market, characterized by higher mobility and changing patterns of work. Transitional and operational aspects of the reform need to be managed in a careful and timely manner to ensure its success. Moreover, offering additional flexibility, e.g., in contribution levels, may further strengthen incentives for participation and improve economic stability.

Authorities’ Views

38. The authorities agreed that the pandemic further stressed long-standing vulnerabilities across job contracts in the Dutch labor market. They indicated that policy already initiated to reduce labor market duality (including gradually reducing tax incentives or the self-employed) will continue, as noted in the 2022 budget memorandum. In addition to the recently adopted reform of partner leave and a parental leave reform that is now being finalized in Parliament, the government is supporting municipalities through increased financing to improve childcare services. This will contribute to a more equal division of work and child care responsibilities between partners. They however stressed that more structural policies are needed to address these challenges, and the upcoming government will need to take additional steps to increase labor participation rates, and reduce the gap between flexible and permanent labor.