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UNCLAS SECTION 01 OF 04 THE HAGUE 000449 
 
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SIPDIS 
 
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TREASURY FOR IMI/OASIA/VIMAL ATUKARALA 
PARIS ALSO FOR OECD 
STATE PLEASE PASS FEDERAL RESERVE 
 
E.O. 12356: N/A 
TAGS: ECON EFIN EINV ELAB NL
SUBJECT: Can the Netherlands Overcome Dutch Disease? 
 
Ref: A) 05 Paris 7641 
 
     B) 05 The Hague 2595 
     C) 05 The Hague 3194 
     D) 05 The Hague 2993 
     E) The Hague 140 
 
THE HAGUE 00000449  001.2 OF 004 
 
 
¶1. (U) SUMMARY: The recent OECD study 'Going for Growth' 
emphasized the growing gap in national income between the 
U.S. and the countries of Europe.  The study argues that 
European countries have done too little to boost 
productivity or strengthen work incentives, thus maintaining 
high implicit taxes on labor.  In the Netherlands, which 
suffers from many of the rigidities noted by the OECD, the 
government has worked hard to implement a broad range of 
structural reforms over the last two years.  But independent 
experts of the Dutch economy question whether these reforms 
have been effective and sufficient in dealing with the 
country's larger challenges.  Specifically, they contend, 
the Netherlands needs stronger competition among Dutch 
companies as well as among Dutch workers, requiring 
structural reforms of product markets as well as of the 
labor market.  It also needs to drive the workforce into 
knowledge intensive services and invest more in their 
skills.  These challenges will need to be addressed at the 
political as well as at the individual level.  Politicians 
will need to get outsiders back into the game, while the 
workforce will need to play harder.  The Dutch have always 
been competitive abroad, but will now have to start 
competing at home, both with themselves and with newcomers. 
END SUMMARY 
 
Going for Growth 
---------------- 
 
¶2.  (U)  The welfare states of Europe are bracing themselves 
for the impact of globalization and population aging.  The 
challenge is clear, but structural reforms are only slowly 
being implemented.  In early 2005, the OECD published 'Going 
for Growth,' the first edition of what was intended as an 
annual survey and scorecard of member states' structural 
inhibitions and policy reforms.  That study, the second 
edition of which was released on February 7, noted the 
growing per capita income gap between the U.S. and the 
OECD's other members and prescribed specific structural 
reforms to boost each member state's labor input and labor 
productivity.  In the Dutch case, the OECD recommended 
changes in residential zoning laws to improve labor mobility 
and reform of the Netherlands' disability and general 
welfare systems to improve work incentives.  To boost 
productivity, the OECD economists suggested changes in land- 
use laws and reduced barriers to foreign ownership, both of 
which were intended to facilitate the entry of new firms and 
thus encourage competition, particularly in utilities and 
retail distribution.  (See 
www.oecd.org/growth/GoingForGrowth2006 for the updated 
assessment of individual OECD members' structural reforms; 
ref A summarizes the latest OECD review of the Dutch 
economy.) 
 
¶3.  (U) The Dutch government, in the third year of its four- 
year (2003-2007) parliamentary term, is hoping to reap the 
benefits of structural reforms implemented over the past two 
years (see ref B).  After performing exceptionally well in 
the 1990s, the Dutch economy has struggled since 2001, with 
growth averaging less than one percent per year.  After five 
slow years, growth in 2006 is expected to accelerate (ref 
C), with forecasts ranging between 2 and 2.75 percent.  But 
while growth is expected to pick up in the Netherlands this 
year, several structural problems remain.  To assess the 
prospects for structural reform and to judge whether this 
year's pickup in growth is sustainable, Econoffs recently 
met separately with four leading university professors: 
Jules Theeuwes, Joop Hartog, Bas Jacobs, and Ruud de Mooij 
(affiliations noted in paragraph 12 below).  All agreed that 
recent reforms have been necessary, but also that further 
changes are called for to transform the Netherlands into a 
knowledge-based economy ready to meet the challenges of 
globalization and aging. 
 
Background: From star to laggard 
-------------------------------- 
 
¶4.  (U)  The period of high growth in the Netherlands in the 
 
THE HAGUE 00000449  002.2 OF 004 
 
 
1990s is often referred to as the Dutch miracle.  This 
'miracle' was the result of increased flexibility in labor 
contracts and of an increasing number of women entering the 
labor market.  Following this period of high growth, the 
Dutch economy ground to a halt in the early 2000s.  This 
slowdown started when house prices stopped rising and share 
prices fell.  As in the U.S. more recently, rising house 
prices were a source of additional purchasing power in the 
1990s.  This stimulus to demand dried up after 2000, 
however, when prices plateaued.  Falling share prices caused 
increases in pension premiums to compensate for the worsened 
financial position of the Dutch pension funds.  The required 
premium hikes increased labor costs for employers while at 
the same time decreasing disposable income for workers. 
 
¶5.  (U)  Rather than increase government spending to boost 
the economy, the GONL responded with spending cuts intended 
to bring the fiscal deficit back within the three percent of 
GDP Maastricht ceiling.  (In fact, the thanks to spending 
restraint and the extra revenue from higher natural gas 
prices, the deficit fell from 3.2 percent in 2003 to 0.5 
percent last year.)  In addition, the government decided on 
a package of structural reforms aimed at increasing labor 
market participation and improving the economy's overall 
performance.  Over the past two years, the government has 
reformed unemployment insurance, disability insurance, 
health insurance, and has ended early retirement schemes. 
The government sees the next two years as the time when it 
will reap the economic benefits of these structural reforms, 
hoping that people will vote with their wallets in this 
year's municipal elections and next year's national 
elections.  After slow growth in the past two years, the 
economy is expected to be back on track in 2006 (ref C). 
Official estimates for 2006 have growth somewhere between 2 
and 2.75 percent. (The IMF estimates it at 2.0 percent, the 
OECD at 2.2 percent, while more recent local estimates by 
the Central Bank (DNB) and the Dutch Bureau for Economic 
Policy Analysis (CPB) place it at 2.5 and 2.75 percent 
respectively, slightly higher than the euro zone average.) 
 
Academics question reforms' effectiveness 
----------------------------------------- 
 
¶6.  (U)  Academic experts interviewed by Econoffs question 
whether this improvement can be attributed to government 
reforms.  They point to the fact that these reforms are to a 
large extent being undermined by recent collective wage 
agreements.  (Although no longer required by law, employers 
and employees agree on contractual terms equally favorable 
as before the reforms.)  This does not only undermine the 
effectiveness of government policy, it also creates a 
further break between those in the labor market and those 
outside trying to get in.  The increased flexibility that 
allowed the economy to grow in the nineties was the result 
of employing additional workers through flexible, temporary 
contracts.  As Bas Jacobs points out, permanent jobs 
continued to be protected.  The flexible workers that fueled 
the growth of the nineties were also the ones who lost their 
jobs at the downturn.  (Note:  Among the workers hardest hit 
by this downturn in the labor market were members of ethnic 
minorities, whose unemployment rate has more than doubled 
since 2001.  See refs D and E.)  Employers and employees 
with long-term contracts are now undoing government efforts 
to further increase labor market flexibility at the 
negotiating table, thereby reducing the possibilities for 
newcomers to compete for jobs. 
 
¶7.  (U)  The labor market is not the only market that could 
do with more competition.  Competition policy in the 
Netherlands is still at an early stage.  Bas Jacobs stressed 
that many product markets and, more importantly, services 
remain uncontested.   Interestingly, although overall Dutch 
productivity, measured on a per hour basis, is comparable to 
that in the U.S., productivity levels are especially low in 
the sectors where the Netherlands' large multinational 
companies are most active: banking (ABN AMRO), insurance 
(Aegon), retail (Albert Heijn), wholesale (Unilever).  At 
the national level, these companies do not have enough 
competition.  In addition, the manufacturing sector is still 
the main exporter and the services sector is only slowly 
taking over this role, noted Jules Theeuwes. 
 
The 'Polder Model' - Help or Hindrance? 
 
THE HAGUE 00000449  003.2 OF 004 
 
 
--------------------------------------- 
 
¶8.  (U)  The experts disagreed sharply among themselves as 
to whether the Netherlands' famed 'polder model' of 
intensive consultation and negotiation among stakeholders 
was a help or a hindrance towards fostering a more dynamic 
and flexible economic system.  Those who believed that the 
Dutch economy does in fact respond well to market pressures 
saw such consensus-building among 'social partners' as an 
effective method of lubricating the adjustment process and, 
minimizing the strikes and other conflicts that have stalled 
reform elsewhere.  Those who instead emphasized the Dutch 
economy's rigidities thought that such negotiations would 
inevitably protect the interests of established insiders -- 
i.e., those at the table -- while shortchanging the needs of 
the unrepresented, such as new immigrants or potentially 
disruptive entrepreneurs.  They saw the Prime Minister's 
'Innovation Platform' -- a committee consisting of the 
Netherlands' business and academic elite -- as doomed to 
failure, since the leaders of such established organizations 
would never favor policies that would facilitate the 
emergence of a Google or a Ryanair. 
 
Dutch labor market - how flexible? 
---------------------------------- 
 
¶9.  (U)  Low productivity levels are a problem for a country 
that needs to shift towards exporting knowledge intensive 
services.  A rigid labor market is another.  Joop Hartog 
claimed that the economy may be rigid in terms of hiring and 
firing, but not in a structural sense.  A shortage of labor 
in one sector can simply be overcome by making jobs more 
attractive.  The Dutch economy has demonstrated this type of 
flexibility before when a great many teachers were required 
to educate the large baby boom generation.  A larger 
problem, however, is the demographic situation.  There are 
not many workers coming just out of school, so it will be 
those in the labor market that will have to change and learn 
new skills.  This is a problem that will grow as the 
population gets older.  Ruud de Mooij emphasized the 
importance of this problem by noting that the labor market 
for older workers is the most rigid.  Collective wage 
agreements define minimal salaries that go up with age. 
While productivity tends to go down with age, salaries go 
up.  The result is that older workers have little wage 
flexibility and are overpaid given their productivity.  And, 
after a certain age, it becomes impossible for workers to re- 
enter the job market after losing a job.  This is another 
example of insiders protecting their vested interests 
against outsiders trying to get (back) in. 
 
¶10.  (U)  The shift towards a knowledge intensive economy 
also requires high investment in education.  Ruud de Mooij 
raised this as an immediate problem.  With one of the 
highest employment ratios in the OECD already, the economy 
needs innovation to grow.  But how should the traditionally 
egalitarian Netherlands optimize its investment in human 
capital and knowledge creation?  Should this money be 
invested in high-level education, or in bringing up the 
mean?  The experts remain divided.  Bas Jacobs said that the 
GONL should foster academic excellence and allow private 
investment in education.  Joop Hartog, on the other hand, 
favored a broader approach, reasoning that a knowledge 
economy needs people to implement innovations and a well- 
organized labor force at all levels.  The consensus is that, 
in the words of Jules Theeuwes, people should learn to 
invest in themselves rather than expect to be taken care of. 
 
Housing as a labor market barrier 
--------------------------------- 
 
¶11.  (U)  In the medium term, the next big challenge will be 
the housing market.  As noted earlier, house prices soared 
in the 1990s but have risen only modestly since.  But the 
high cost of housing creates a barrier to relocating, which 
adds to inflexibility in the labor market, as noted by the 
OECD.  Strict land use controls have limited new 
construction, thus helping to keep housing prices high.  The 
high level of government sponsored mortgage loans not only 
raises house prices further, but also makes the Netherlands 
sensitive to shocks in financial markets.  In addition, the 
deductibility of mortgage interest raises budget and equity 
concerns; it amounts to 10 percent of taxes, with expenses 
 
THE HAGUE 00000449  004.2 OF 004 
 
 
primarily going to the rich. 
 
¶12.  BIO NOTE:  Joop Hartog is a professor of economics and 
program director of human capital at the University of 
Amsterdam.  Bas Jacobs is an assistant professor at the 
University of Amsterdam and at the University of Tilburg, 
and is also a researcher at the Netspar Institute for 
Savings, Pensions and Retirement.  Ruud de Mooij is a 
professor of fiscal economics at the Erasmus University 
Rotterdam and is the program director for welfare state 
research at the Netherlands Bureau for Economic Policy 
Analysis.  Jules Theeuwes is a professor of economics at the 
University of Amsterdam, managing director of the Economics 
Network for Competition and Regulation (Encore), and member 
of the Scientific Council for Government policy (WRR).  END 
NOTE 
 
Comment: Promoting competition at home to meet competition 
from abroad 
--------------------------------------------- --------------- 
--- 
 
¶13.  (U)  The Netherlands became a textbook example for 
development economics when it experienced the original case 
of 'Dutch disease.'  Large-scale exports of natural gas 
caused a rising real exchange rate, leading to a loss of 
international competitiveness and providing the resources to 
fund an increasingly bloated welfare state.  The Dutch 
'miracle' of the 1990s led to a eurozone-era variant of the 
malady by the end of that decade, this time by pushing up 
real wages instead of the nominal exchange rate.  Wage 
moderation in recent years has helped the Dutch economy to 
regain at least some of its competitive position.  But in 
the globalized 'flat' world of the 21st century, 
competitiveness is far more a function of innovation and 
dynamic flexibility than of wage or price levels, especially 
for an advanced, post-industrial, service-dominated economy 
such as that of the Netherlands. 
 
¶14.  (U)  Dutch political and economic leaders have put 
innovation at the top of their reform agenda, an agenda that 
may have gone as far as is politically feasible.  But the 
Netherlands' disappointing productivity performance -- only 
0.7 percent average annual growth since 1995, the second- 
lowest rate in the OECD (after Italy) -- suggests perhaps 
that its top-down, supply-driven approach to revitalizing 
its economy can only go so far.  The Dutch have succeeded in 
expanding the knowledge base for innovation by subsidizing 
and promoting science, R and D, and education, but they have 
not sufficiently dismantled the industrial concentration and 
other protective traditions of the Netherlands' internal 
market.  These traditions have softened the pressures on 
companies to innovate.  Increasing competition at home -- 
and thus the demand for innovation -- may be the best way 
for the traditionally internationalist Dutch to meet the 
increased competitive challenge they face from abroad. 
 
ARNALL