Public Information Notice No. 02/63

Public Information Notice: IMF Concludes 2002 Article IV Consultation with the Kingdom of the Netherlands-Netherlands

June 19, 2002

On June 10, 2002, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Kingdom of the Netherlands—Netherlands.¹

Background

Real GDP is projected to rise by 1 percent in 2002, implying a return of growth to about 3 percent at an annual rate in the second half, and to rise by 3 percent in 2003. The pickup reflects an improvement in the worldwide economic climate, as well as last year's easing of monetary conditions in the euro area. The slowdown in 2001 and the first half of 2002 significantly reduced the demand pressures that had built up in the Dutch economy over the past several years, as evidenced by rising vacancy rates and an increase in the unemployment rate (though from very low levels). Inflation is accordingly expected to slow gradually from some 5 percent in 2001, to 3.8 percent this year and 2.4 percent next year.

The fiscal position deteriorated last year, reflecting both the long-planned tax reform (which reduced the surplus by an estimated 0.7 percent of GDP) and the cyclical slowdown. A deficit of 0.3 percent of GDP is projected this year, and 0.6 percent of GDP next year (which does not necessarily represent policy, since there is no 2003 budget or a fiscal framework). A government study has recommended that the fiscal framework be renewed in the coming government period, largely along the lines of the existing framework. The study has recommended a medium-term structural surplus of between 1.3 and 1.8 percent of GDP in anticipation of the fiscal costs of population aging.

The labor market has improved greatly over the years, and the Netherlands has among the lowest unemployment rates in the industrialized world. Still, employment and participation rates are broadly similar to the EU average, suggesting that more needs to be done. A number of studies have been prepared on structural issues for consideration by the next government. A proposal for reform of the large disability program, agreed by the social partners, would restrict benefits to the fully and permanently disabled, tighten medical criteria, raise the benefit replacement rate, and eliminate experience rating for firms. Another study argues that subsidized jobs and government employment be de-emphasized, in view of tight labor-market conditions. A study examining the health-care sector envisages greater play of market mechanisms in order to increase efficiency, while still guaranteeing full insurance coverage.

Executive Board Assessment

Executive Directors commended the authorities on their record of sound macroeconomic policies, including sustained fiscal consolidation, and important structural reforms. Along with wage moderation, these policies have underpinned strong economic growth, rising employment, and a very low unemployment rate. The past year had witnessed a slowdown, but this was not unwelcome given the build-up in inflationary pressures. Directors expected economic growth to begin to recover in the second half of this year, since worldwide activity is recovering, monetary conditions are supportive, and the adverse effects of special factors, notably higher oil prices and livestock diseases, should dissipate.

Directors observed that the long cyclical expansion, and wage increases unmatched by productivity gains, had raised Dutch inflation above that in the euro area and reduced the economy's international competitiveness. While the economic slowdown has helped to reduce demand pressures, setting the stage for a gradual decline in inflation, continued erosion of competitiveness seems likely as Dutch inflation will possibly remain higher than in the euro area for some time, and negotiated wage agreements continue to be in excess of that in neighboring countries. To contain this erosion, Directors stressed the need for prudent fiscal policies, and for structural reforms in the labor and product markets to ensure sustained increases in productivity.

Directors saw a need for fiscal policy to remain prudent, not only to guard against a re-emergence of inflation, but to deal with long-term population aging. In the short term, fiscal policy should avoid stoking demand pressures. In particular, the deficit should not be allowed to deteriorate in 2003, a year of economic expansion. Directors agreed that, over the medium term, achieving a sustainable fiscal surplus of about 1½ percent of GDP will be an appropriate way to deal with the anticipated fiscal costs of population aging, although some observed that this would be difficult to achieve. They stressed the need for early action so as to permit dealing with these costs relatively smoothly. While noting the strong reputation of Dutch pension and health-care systems, some Directors urged that consideration also be given to further reform in these two areas to contain future costs.

Directors agreed that a renewed commitment by the new government to the existing fiscal rules will be essential. Pointing to the successful experience of the past, they emphasized the advantages of a transparent, multi-year budgeting framework and of strict spending ceilings that are independent of revenue developments. Directors supported the full use of the automatic stabilizers on the revenue side, although some agreed that some cyclically sensitive items should be excluded from the expenditure rule.

While commending past progress on labor-market reforms, Directors underscored the need to press forward with these reforms, and focused on three key areas. They were encouraged by the widespread agreement in the Netherlands on the need to reform the large and growing disability program. They noted that the proposal agreed by the social partners had a number of strengths, but that the issue of incentives to curb entry into the program remains to be addressed. Directors also pointed to high inactivity and poverty traps as impediments to further improving labor market performance. They recommended that the host of redistributive programs should be rationalized to make them more transparent and better targeted, and to continue the process of increasing the incentives to work. Finally, Directors agreed that public employment programs have largely outlived their usefulness and ought to be scaled back.

Regarding product markets, Directors welcomed the liberalization of the energy sector, and encouraged the authorities to renew the momentum for reform, to help ensure sustained increases in productivity. The government can contribute to the required increased flexibility and innovation by lowering barriers to entry, including by further reducing the administrative costs facing firms.

Directors noted that Dutch financial markets appear to be robust, despite a cyclical downturn in banking profits, and well supervised. While acknowledging that banks' high exposure to mortgages merit special attention, as a slowing economy could lead to a rise in mortgage defaults, Directors believed there was little chance of this occurring at the present time. They considered that financial supervision will be strengthened by the closer links recently established between banking and insurance supervisors. This should improve the supervision of the large conglomerates that dominate the Dutch financial system. Directors looked forward to the results of the Financial Sector Assessment Program scheduled for 2003. They commended the authorities for the decisive steps taken against money laundering and the financing of terrorism.

Directors commended the authorities for their support for the reduction of barriers to the exports of developing countries, and for their generous development assistance which, at 0.8 percent of GNP, is one of the highest among advanced economies.