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The following OECD assessment and recommendations summarise Chapter 1 of the Economic Survey of the Netherlands 2005 published on 15 December 2005.
What are the economic challenges faced by The Netherlands?
After having stagnated during the past five years, the Dutch economy finally appears to have begun to recover. Substantial progress has been made towards correcting the financial imbalances that contributed to the downturn. Furthermore, major labour market, social benefit and health care reforms are underway to enhance labour utilisation and labour productivity. At the same time, cost competitiveness is being gradually restored. Barring further international energy price spikes, the Dutch economy should grow above trend in 2006, turning the page on one of the worst periods of stagnation since the 1930s. Even so, the economy remains vulnerable in the face of adverse shocks.
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The prolonged downturn has taken its toll on public finances, necessitating substantial consolidation measures since 2003 to respect the Stability and Growth Pact, but more needs to be done to achieve a sustainable path.
Is a recovery unfolding?
Dutch economic growth has been weak since the start of the decade. A temporary rebound in economic activity unfolded in 2004, but was stalled by weak domestic and external demand, not least due to rising oil prices. After five years of below trend growth, the output gap has fallen from a peak of + 4% in 2000 (compared with + 2% for the euro area) to 3% in 2005 (-2% for the euro area), making this a very ample cycle by both historical and international comparison. The magnitude of the downturn is partly explained by the fact that a number of factors that boosted growth in the late 1990s – notably developments in housing and stock markets and in the euro-dollar exchange rate – have since contributed less (housing) or even dragged the economy down. In addition, the decline in capital market returns adversely affected pension funds, necessitating large increases in pension contribution rates to restore solvency. These increases are estimated to have reduced GDP by 2 percentage points. The impact of these factors was aggravated by a large loss of international cost competitiveness, even against other euro area countries.
After five years of sluggishness, an economic recovery appears in the offing (1)
1. National accounts are based on official chain-linked data. This introduces a discrepancy in the identity between real demand components and GDP. For further details see OECD Economic Outlook Sources and Methods,
(http://www.oecd.org/eco/sources-and-methods).
2. Numbers in brackets are adjusted for the new compulsory health care system to be implemented in 2006 which will replace the partly private system; private health care expenditure will become public expenditure.
3. Contributions to changes in real GDP (percentage of real GDP in previous year).
4. As a percentage of GDP.
5. As a percentage of disposable income, including savings in life insurance and pension schemes.
Source: OECD Economic Outlook 78 database.
Competitiveness is now improving and exports are once again stimulating the economy. The fiscal and pension fund financial imbalances have been largely corrected. Corporate earnings are growing fast, helping build up business capital formation. Real GDP accelerated sharply in the second quarter and unemployment declined slightly during the summer, after having stabilised during the first half of the year. Assuming that oil prices stabilise and that there is a pick up in other European economies, strengthening exports and domestic demand could well propel annual economic growth to above 2% in 2006.
How could increased labour-market flexibility foster macroeconomic resilience?
While special factors have undoubtedly exacerbated the recent downswing, the slow speed at which the economy is returning to trend suggests that re-equilibrating forces are weak. Empirical evidence presented in this Survey shows that inflation is slow to respond to cyclical conditions, especially in comparison with non EU countries. This appears to be so because adjustment channels have operated weakly, notably the response of labour costs to cyclical downturns. As firms have difficulty adjusting their levels of employment owing to employment protection legislation (EPL) for regular contracts, which is strict by international comparison, labour productivity growth falls sharply during the initial stages of an economic downturn, holding up unit labour costs, and therefore eroding international competitiveness and limiting the extent to which inflation falls. Even though there is a reasonable degree of wage moderation when there is labour market slack, this occurs only after a significant lag.
Inflation, core inflation and output gap developments
Year-on-year percentage change
1. Unit labour costs in the manufacturing sector relative to those of competitors, all expressed in dollars. Weights for competitors’ costs take into account the structure of competition in both export and import markets of the manufacturing sector for 42 countries. An increase in the index indicates a real effective appreciation and a corresponding deterioration of the competitiveness position. For details on the method of calculation, see Durand, Madaschi and Terribile (1998).
Source: OECD Outlook No. 78 Database.
In the latest cycle, labour hoarding was unusually large because many employees recruited during the economic boom of the late 1990s had permanent contracts, employers had faced high hiring costs and they had initially anticipated a quick recovery. Also, labour costs were inflated by large increases in pension premiums. All of this suggests that the adjustment of unit labour costs has occurred only slowly in the face of economic slack, thus lengthening the period of stagnation required for market forces to operate. On the whole, the slowness of adjustment appears to result, for the most part, from the strictness of EPL on regular contracts, which increases employment adjustment costs.
The government has announced measures to ease EPL, which come into effect in October 2006, and the Social and Economic Council will advise on further reforms. The announced measures, lower the administrative costs of dismissals and increase flexibility for employers. Even so, EPL will remain strict by international comparison. In this context:
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Return to the Economic Survey of the Netherlands 2005
A printer-friendly Policy Brief (pdf format) can also be downloaded. It contains the OECD assessment and recommendations, but not all of the charts included on the above pages.
To access the full version of the OECD Economic Survey of the Netherlands:
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Non-subscribers can purchase the PDF e-book and/or printed book at our Online Bookshop.
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Government officials can go to OLISnet's Publication Locator.
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For further information please contact the Netherlands Desk at the OECD Economics Department at webmaster@oecd.org. The OECD Secretariat's report was prepared by David Carey, Ekkehard Ernst, Jelte Theisens and Rebecca Oyomopito under the supervision of Patrick Lenain.
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