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Perceived constraints for Dutch unemployment policy Keuzenkamp, H.A.; van der Ploeg, F.

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8823 for 1992 ~mic Research llllllf'mllnlf~lnlllll 74 I''Illlllllllllllllllllll

Perceived Constraints for Dutch Unemployment Policy

by H.A. Keuzenkamp and F. van der Ploeg

Reprinted from C. de Neubourg (ed.), The Art of Fuli Employment - Unemployment Policy in Open Economies, Amsterdam: Elsevier Science Publishers (North-Holland), 1991

~`~Q' ~ Reprint Series , J~ -,~~, ,

~~~eJQ~ , : ~; no. 74 CF.N'1'FA FOR ECONOMIC RESEARCH

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Eduard Bomhoff Erasmus University Rotterdem Willem Buiter Yale University Jacques Dréze Université Catholique de Louvain Theo van de Klundert Tilburg University Simon Kuipers Groningen University Jean-Jacques Laffont Université des Sciences Sociales de Toulouse Merton Miller University of Chicago Stephen Nickell University of Oxford Pieter Ruys Tilburg University Jacques Sijben Tilburg University

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ISSN o924-7874

1991 Q~~-1Z ~ for Economic Research

Perceived Constraints for Dutch Unemployment Policy

by H.A. Keuzenkamp and F. van der Ploeg

Reprinted from C. de Neubourg (ed.), The Art of Full Employment - Unemployment Policy in Open Economies, Amsterdam: Elsevier Science Publishers (North-Holland), 1991

Reprint Series no. 74 Thc Art o! Full Employment C. dc Ncubourg (Editor) ~ Elsevier Science Publishers B.V. (North-Holland), 1991 7

PERCEIVED CONSTRAINTS FOR DUTCH UNEMPLOYAIENT POLiC~'

H.A. Keuzenkamp and F. van der Plceg'

1 Introduction

Apart from a very short interval in 1982 the Netherlands have been governed by a central-right coalition from 1978 to 1989. During the first four years Mr. van Agt was prime minister. This coalition was secured with 76 of the 150 seats in parliament. This period was marked by a sharp increase in unemployment and quickly deteriorating govemment finances. Halfway during its term, the Minister of Finance, , quit after a quarrel in which he insisted on further restrictions on government spendin~ whereas his colleagues did not give him sufficient support. In 1982 a central-left government took over, but was unable to agree on its policies. Govetnment finance deteriorated further and so did unemployment. New elections in 1982 brought a gain of ten seats for the conservative-liberal party, VVD, and a small loss for the centrist Christian Democrats (CDA). They formed a new coalítion under Mr. as prime minister and former banker Dr. Onno Ruding as Minister of Finance. The program of this govetnment strongly emphasised the need for sound government finances, and a recovery of the market sector to beat the unemployment problem. First priority became to beat the budget deficit, whatever the means. The Lubbers government was more convinced and convincing on its goals than its two predecessors. Hence, Mr. Lubbers secured a second term of office after the election on 21 May, 1986 and was able to continue to focus on his policy of sound bovernment finance. However, some fatigue with this policy started to occur as budget discipline deteriorated during the course of the second government of Lubbers and Ruding. On the nibht of 2 May, 1989 the VVD forced a break in the coalition over the finance of the National Environment Plan. The election results of 6 September 1989 resulted in a change of coalition leading to a centrist-left wing coalition with a rather pragmatic program. Sound government finance is still very much emphasised, but the days of benign neglect of the unemployment problem seem to be past. The new coalition still has to face a number of unpleasant constraints to device a new unemployment policy. They are discussed in this paper. There are many constraints for Dutch unemployment policy, but the main ones are financial ones and the associated lack of government investment. However, the 8 H.A. KeuZeriknmp arut F. van der Ploeg

true constraints differ from the perceived coostraints. Hence, we strongly believe that there are possibilities for an effective reduction of unemployment despite these perceived financial and other constraints. This issue has occupied the minds of politicians, journalists and in the Netherlands during the last decade. Our purpose is to review the debate, pin-point the areas of concern for the future development of the Dutch economy, pay attentioa to the composition of the pool of unemployed, which is the main problem facing the Dutch economy, and provide some macroeconomic analysis. Section 2 discusses the unemployment problem. Section 3 describes the attempts that have been made by the governments under Mr. Lubbers to make finances of the public sector more hexlthy. Section 4 discusses the policy of De Nederlandsche and the strong external constraints it is faced with. Section 5 discusses savings, the current account and credit constraints. Section 6 goes on to investment and constraints on productive capacíty, human capital and the environment. Section 7 concludes the paper.

2 The economic problem: alienation of the long-term ununployed

The Netherlands has a very high rate of unemployment compared with other OECD countries. After the second oil crisis in 1979, unemployment figures doubled. A peak occurred in 1983 at 1246 (adjusted by the OECD secretariat. The unadjusted peak is 15.446 in 1984. This adjustment is made to facilitate international comparisons. It amounts to deleting employed persons registered as unemployed, and adding unemployed persons not registered at the unemployment office). Table 2.1 presents some unemployment figures for 1977 (the fall of the centre-socialist government), 1982 (the starting year for the present prime minister, Mr. Lubbers) and the years after, up to 1987 (the most recent figures available from the OECD). The standardised unemployment rates for 1987 were 9.6 46 for the Netherlands, 6 96 for the US and and only 2 4b for Sweden, so the Netherlands clearly scores relatively very badly on the target for unemployment. The rise in unemployment can partly be ascribed to a fairly strong increase in the Dutch labour force, particularly because of an increase in the participation rate of women. In 1975, this participation rate was embarrassing low at 31.09b, the lowest in the OECD (the OECD average was 49.596). In ten years time, female participation rose by ten percentage points, as Table 2.2 shows. This growth in labour supply was accompanied by a decline in private-sector employment. This decline started in 1972 and lasted till about 1984. Since then, a rather strong recovery in employment occurred (see Table 2.3). In 1985, 25.3 96 of the total labour force worked part time (less than 35 hours s week), and 55.246 of females work part time. Both figures are the highest within the OECD (see OECD, Economrc Outlook, December 1988, Table 1.4). It is obvious that jobs taken up by females are, in a sense, inferior jobs. It is no surprise that there are strong Perceived Constraints for Dutch Unemployment Poticy 9

political pressures in the Netherlands for more public and private provisions for child care and day-centres.

Table 2.1 Unemployment rates

1977 1982 1983 1984 1985 1986 1987 19 8 8

Netherlands 5.3 11.4 12.0 11.8 10.6 9.9 9.6 9.3 (unadjusted) 5.5 12.4 15.0 15.4 14.2 13.2 12.6 - Sweden 1.8 3.2 3.5 3.1 2.8 2.7 1.9 - US 6.9 9.5 9.5 7.4 7.1 6.9 6.1 5.4 Germany 3.6 6.1 8.0 7.1 7.2 6.4 6.2 6.2 UK 6.0 11.3 12.4 11.7 11.2 11.2 10.3 8.3 7.4 12.6 12.1 12.1 11.3 11.2 11.1 10.1 7.0 8.4 9.3 9.9 10.1 10.9 11.8 - lreland (unadjusted) 8.8 11.4 14.0 I5.5 17.4 17.4 17.7 -

Source: OECD, Economic Outlook, December 1988 (Table R.17, unadjusted figures: Table R.18); Centraal Economisch Plan, 1989.

Table 2.2 Participation rates

1975 1985

Total: Netherlands 57.3 59.9 OECD 68.3 69.4

Male: Netherlands g3,2 7g.2 OECD 87.3 83.5

Female: Netherlands 31.0 41.2 OECD 49.5 56.1

Source: OECD, Employment Outlook, Table I and J 10 H.A. KeuZenknmp and F. van der Ploeg

Table 2.3 Empioyment

1981 1982 1983 1984 1985 1986 1987 1988

Wage-earners 3389 3274 3192 3192 3246 3324 3383 3401 (1000 workyears)

Self-employed 619 611 606 606 607 609 610 610 (1000 workyears)

Private employment -2.1 -3.1 -2.2 0 1.7 2.1 1.4 1.2 ( 3'o change)

Private and public employment ( 9b change) -2.1 0.5 -1.4 -0.6 0.7 2.1 2.3 1.7

Source: CPB, Centraal Economrsch Plan 1988

The efforls of the government to reduce unemployment have been rather low. The philosophy has been to emphasize the "own responsibility of the labour market participants", which is best translated as a"benign neglect" of the unemployment problem. The government tríed to propagate wage moderation. Indeed trade unions have been moderate in their wage demands, partwise forced by the high unemployment rate. It is therefore hard to argue that this moderation really results from government policy, furthermore it will be a mistake to think that this moderation will continue until unemployment is back to normal. The growing number of long-term unemployed disrupt the standard Phillips-curve effect. Driehuis (1986) presents a decomposition table for the determinants of the rise in unemployment for a number of periods. For 1980 to 1983, his results are that labour supply rose on average by 68,000 per year, employment in the market sector declined by 69,000, whereas in the public sector employment increased with 7,000 a year. Thus, unemployment rose by 130,000 a year. Labour market imperfections accounted for 9,000 of these unemployed per year, job shortage accounted for 57,000, and cyclical movements for 64,000. "Mismatch" seems hardly to be a problem of the Dutch labour market. The Lubbers-administration consistently emphasised a lack of labour-market flezibility and job-matching problems as sources for unemployment. Labour-market flexibility is low in the Netherlands, but this is much more a problem for "insiders" than for "outsiders". There is a strong disincentive to change jobs, because of what is called "pension- Perceived Constraints jor Dutch Unemployment Policy 1 1 break". Pension claims depend on the number of years worked at a particular company, and the highest earned wage before leaving or retiring. If wages during the beginning of the career are relatively low, they still count for the full end-of-career wage used to calculate pensions, ezcept if the employee changes jobs. In that case, the pension build up shows a break: pension claims are split up into two parts. The first part is low because at the end of that job, the wage was still relatively low (beginning of career), whilst the second part is low because the period worked in the high-career job is shoR. Besides the remarkable high rate of unemployment, the rate of long term unemployment is even more shocking. Figure 2.1 and Table 2.4 show that long- term unemployed are strongly over-represented among Dutch unemployect. The proportion of those who have been unemployed for more than a year to the total of unemployecl, has risen from 0.32 in 1982 to 0.56 in 1986. Only Belgium and Spain have higher proportions of long-term unemployed. According to the OECD study, long-term unemployed in the Netherlands are disproportionally found in the group of prime-age adult males and especially older male workers (OECD Unemployment Outlook 1987, Table 7.2). Unemployment in the Netherlands also falls mostly on the low-skilled.

Table 2.4 Proportion of Long-Term Unemployed in Some OECD Countries

1980 1981 1982 1983 1984 1985 1986

Ncthcrlands 25.9 22.0 31.6 43.7 54.5 55.3 56.3 Sweden 5.5 6.0 8.4 10.3 12.4 11.4 8.0 US 4.3 6.7 7.7 13.3 12.3 9.5 8.7 Gcrmany 17.0 16.2 21.2 28.5 32.7 31.0 32.0 UK 19.2 22.0 33.6 36.5 39.8 41.0 41.1 Bclbium 57.9 52.4 59.5 62.8 68.0 68.3 68.9 Italy 37.1 37.8 41.9 50.0 56.4 Ircland 34.8 30.5 31.8 31.0 39.1 41.2 44.3

Source: OECD, Economic Outlook, September 1987 (Table 7.1, exeept Italy: Table Q).

There are different explanations for the increase in long-term unemployment. One is the hysteresis effect, also called state dependence or the "duration effect". Long-term unemployed have a higher probability of staying unemployed, because they loose human capital, motivation, etc. Another explanation is the "heteroge- neity effect", which implies that the most employable find jobs fairly quickly whereas the less productive ones remain unemployed, given minimum wages or 12 H.A. Keuzenkamp and F. van der Ploeg transfers. Belderbos and Teulings (1988, Table 3.tí) show that search duration increases with age, decreases with schooling, and is much lower for native workers than for immigrant workers. They also find a strong crowding-out effect in the sense that employers become more selective as unemployment increases. They do not test for hysteresis effects, however. In the UK there is strong empirical evidence for hysteresis, whilst the 'heterogeneity effect' seems much less important (Budd, Levine and Smith, 1988).

Figure 2.1

0.6 , 86 85 1987 84 ám m ~ 0.5 ~ á o á 83 ~ ~ 0.4 á ~ ~ 0.3 82

0.2

0 0.02 0.04 0.06 0.08 0.1 0.12 0.14 0.16 0.18 Unemployment as a percentage of the labour force

A simple Phillips-curve is unable to explain wage changes during the eighties in the Netherlands. The impact of long-term and short-term unemployed on wage inflation seems to be rather different. Recent studies argue that long-term unemployed drop out from the labour market and therefore do not have a downward effect on wage formation. The OECD (1987) estimated a wage equation for a number of countries, among which the Netherlands, using semi-annual data (1973 to 1985) in which no significant ccefficient for short- and long-term unemployment was found. This equation attributes most changes in wage rates to wage indexation (one per cent inflation results in two percent wage Perceived Constrai~rt.rjor Dutch Unemployment Policy 13 increases, a violation of homogeneity) and a dummy. This cannot be a good explanation for wage formation in the Netherlands. A more sophisticated approach is presented by Graafland and Huizinga (1988), who use a cointegration framework. Their long-term wage equation, using annual data from 1963 to 1986, shows a strong impact of unemployment and productivity on wage changes. The effect of long-term unemployment is found to be less important than the effect of short-term unemployment. In another paper we present similar results (see Keuzenkamp and van der Plceg, 1990a). Thus it may be concluded that unemploy- ment in the Netherlands shows strong persistence, despite a more recent decline in short term unemployment. Long-term unemployment will remain hígh: it does not give much downward wage pressure, and the general recovery of the economy can continue without having to hire long-term unemployed because of the strong growth of Dutch labour supply. Therefore, special measures to decrease long-term unemployment are necessary and are a major task for a next government. This is reflected in the results of recent orientation discussions with the long-term unemployed: 20~ cannot be helped; 2096 can easily be found a job; and 60`~o can through schooling and assistance improve their chances of finding a job. Figure 2.2 illustrates the unpleasant side-effects of hysteresis within the context of a simple analytical model, when there is a negative shock to the demand for labour (e.g, arising from a fall in world trade or government expenditure, or a rise in interest rates or taxes) and an increase in the supply of labour, n. Such a shock occurred in the Netherlands during the early eighties. The demand for labour, 1, is a decreasing function of the real consumers' wage, w, and shifts out when the aggregate demand for goods increases, whilst wages are an increasing function of bargaining strength (proxied by employment among other things). In the short run the equilibrium shifts from E to E', so that real income falls and unemployment rises. After some time the long-term unemployed drop out of the labour market and the wage-bargaining curve shifts up, so that the equilibrium shifts over time from E' to E". 71tis leads to more persístent unemployment. Since hysteresis is to a large extent an irreversible process, unemployment stays at a persistently high level when the shock is reversed, i.e., when labour demand recovers and labour supply falls back again. In other words, the equilibrium goes from E" to E"' instead of to the original equilibrium, E, and therefore temporary negative shocks have permanent effects on unemployment (also see Campbell and Mankiw, 1987). It foilows that the best policy to get rid of long-term unemployment is to offer these people scholing and job experience. It is sad that the Dutch govemment spends relatively very few funds on such programmes. Only recently, and this is more a result of pressure from the opposition party than from own government initiatives, special attention has been paid to long-term unemployed (via the so called "Vermeend-Moor" law). In 1987, 0.39 of GDP was spent on labour-market training programs, special youth measures and direct wabe subsidies for job creation. 1n the UK this was 0.69~, in Ireland 1.289o and in Swuien (with a much lower unemployment rate) 0.9`~, hence the Netherlands shows a relatively low effort in this area. 14 H.A. KeuZenkamp and F. van der Ploeg

Figure 2.2

eupP1Y aupply'

demand

wage

1' ' 1' 1~ n' ~uLus ~. ~~ u-u 1 ~

Another unemployment policy that is discussed a lot in the Netherlands is to cut the minimum wage. If heterogeneity is important rather than hysteresis and duration, this policy may have some effect (van Soest and Kapteyn, 1988). The way this policy is to be implemented is to leave the minimum wage itself unaffected, but to cut employers' taxes and contributions on the minimum wage. The problem with this approach is that marginal wedges of more than 1004ó are introduced, which can be highly distortionary. The demand for labour is a negative function of the real production wage. It follows that equilibrium employment decreases with the tax wedge. This has been very high in the Netherlands (see Section 3), hence a lot of effort has been directed towards reducing this wedge.

3 The government budget constraint, taxalion and financial constraints

During the last twelve years the public sector deficits have led to a steady rise in government debt and in debt service, as Figure 3.1 shows. After the fall of the Christian-Democrat Labour coalition in 1977 government finance started to dzter- Perceived Coiutrnintsfor Dutch Unemployment Policy 15

Figure 3.1

1987

0.45 0.5 0.55 0.6 0.65 0.7 0.75 0.8 Government debt (oió NNP)

Source: Financial deficit: Centraal Planbureau, CEP 1989; Government debt: De Neclerlandsche Bank, various annual reports.

iorate. The second oil crisis did not help to improve government finance. Basical- ly, increasing gas profits did not outweigh the decline in tax revenues and the rise in unemployment benefits. Also remarkable is that the first Lubbers government apparently was more successful in turning the tide than the second one; from 1983 to 1986 the deficit decreases but afterwards the govemment seems to loose grip on its expenditures. Tables 3.1 and 3.3 give some further details on government finance. We can summarise them as follows: - the public sector financial deficit fluctuated around 3`Yo of NNI until 1978, from this year onward the deficit rose steadily to 9.4`~ in 1983. In 1988 the deficit still is twice as much as the average for the early seventies. The public sector borrowing requirement includes repayment of debt and has increased even more dramatically: from 1.63'o in 1970 to 11.19b in 1987 and 10.59b in 1988. - As a result, government debt increased from a steady 40 Y during 1973-1977, to nearly 803'0 of NNI in 1987 (the most recent available figure). - Interest payments on government debt therefore rose from roughly 2 ~o to about 16 H.A. Keuzenkamp and F. van der Ploe~

7~ of NNI. For comparison, this equals 609b of the government wage bill, and this poses a serious threat to crowd out other expenditures as a result of debt servicing.

Table 3.1

1970 1975 1980 1985 1987 1988~`

Financial deficit 1.1 3.4 5.0 6.7 7.4 6.0 Debt repayments 0.5 0.5 1.1 2.3 3.7 4.5

PSBR 1.6 3.9 6.1 9.0 11.1 10.5

Govemment debt 30 23 33 59 65 69 Average maturity 12.2 10.7 9.3~`~ 9.3 8.5 8.4 Interest rate 8.0 8.8 11.9~~ 7.6 6.5 6.3 Interest payments 1.5 1.4 2.3 5.2 5.5 5.5

Source: Ministry of Finance (1989). ~ Provisional figures. ~`~ These figures are for 1981.

Table 3.2

Financial deficit a f n- 4.54b

1988 1990 1991 1992 1993 1994 1995 2005

(i) 5 9b from 1990 69.1 73.7 75.4 77.0 78.5 80.0 81.4 92.5 (ii) 39b from 1994 69.1 73.7 74.9 75.5 75.6 75.2 74.8 71.8 (iii) 246 from 1994 69.1 73.7 74.6 74.8 74.2 72.8 71.5 61.4

Financial deficit x~- n- 2.5 46

(i) 5 96 from 1990 69.1 75.1 78.1 81.0 83.9 86.7 89.4 113.4 (ii) 39b from 1994 69.1 75.1 77.6 79.5 81.0 81.8 82.7 90.2 (iii) 24b from 1994 69.1 75.1 77.3 78.8 79.5 79.4 79.3 78.5

Source: Studiegrcep Begrotingsruimte (1989). Perceii.ed Constraints for Dutch Unemployment Policy 17

It is therefore no surprise that a consensus has emerged in the Netherlands to stabilise the government debt as a percentage of national income, so that the fall in debt service allows more room for productive government expenditures. But the way in which this has been implemented has, in our view, not been thought through very well. First we will take a look at the proposals made by the Studie- grcep Begrotingsruimte. According to the 1986 Government Agreement the finan- cial deficit should drop to 5',d 96 by 1990. Afterwards, three assumptions can be made: (i) no further reduction in the fmancial deficits; (ii) further gradual cuts towards 3',4 96 by 1994; (iii) further gradual cuts towards 2'k 4b by 1994. Roughly speaking, these three alternatives correspond to a PvdA, CDA and VVD view, respectively. A real growth rate (n) of 2.546 and an inflation rate (A) of 2~ are assumed. Table 3.2 then shows that a reduction in the financial deficit of 0.5 ~o - 0.75 9b points per year is a necessary requirement for the ratio of government debt to national income to start falling during the period 1990-94. However, if there is no inflation and nominal interest rates remain the same, the rise in the government debt ratio will not be reversed unless the financial deficit is eventually cut to 2',4 9. The Studiegrcep Begrotingruimte ( 1989) therefore makes a strong plea for the financial deficit to drop to 2-3 9b of the national income. It also argues to force these cuts in financial deficits through something similar to the Gramm-Rud- man-Hollings law for the US.

Table 3.3

Gross debt (4b of GDP) Net debt (96 of GDP)

1980 1986 1990 1980 1986 1990

Belgium 77 122 127 69 114 119 Italy 59 88 100 54 86 98 Netherlands 46 74 90 25 48 64 Canada 45 67 71 12 34 38 Japan 52 69 65 17 27 23 US 38 51 50 20 30 29 Sweden 45 68 50 -14 16 -2 Spain I9 48 49 8 30 31 Denmark 34 59 49 7 28 17 37 46 48 14 25 28 Germany 33 42 45 14 22 25 UK 55 53 39 48 46 32 Norway 56 38 34 7 -16 -20

Total 42 56 55 22 33 33

Source: OECD, Economic Outlook, December 1988. 18 H.A. Keuzenkamp and F. van der Ploeg

One can make a number of crítical remarks about these proposals. To put them in perspective, consider a simple version of the government budget constraint (more properly: the budget identity, since as Buiter (1985) remarks, the constraint relates to solvency):

á~ f-(Afn)d, f~ g- r f id - z, (3.1) where d and f denote government debt and the financial deficit, g and r, are government expenditures (ezcluding debt service) and taxation, i denotes the nominal interest rate on government debt, z, denotes the return on government investment, ~r denotes inflation and n denotes the real growth rate. The first criticism on the proposals to reduce f is very basic: there is no theoretical consensus on how important deficits really are. Romer (1988) investigates the costs of excessive deficits for the USA, and lists some views on the possible effects of government deficits. On the one extreme is the supply-side and Reaganomics view, according to which deficits resulting from reclucing marginal tax rates are highly desirable as they reduce distortions and will probably pay themselves back in the long run thanks to higher incentives for economic growth. Then there is the Ricardian view, according to which deficits are rather unimportant. Rational agents anticipate higher future taxation resulting from an increase in current deficits and there will therefore be no net effect on total spending, because the decline in human wealth exactly off-sets the increase in non-human wealth. The reason is that the present value of future taxes is exactly equal to the rise in current taxes that would have been necessary if the govemment would not let its deficit rise today, so that the siae of the deficit does not distort the behaviour of private sector agents. Alternatively, agents save more in order to meet future taz claims. Incidentally, the Ricardian view dces not tell us anything about the size of the government sector, only about the indifference between taz and debt finance. Finally, there is the view that excessive deficits are distortionary, as a current deficit places a burden of taxation on future generations which seerns "immeral". This argument (among others defended by Buchanan) is rather hard to understand, except if the deficits are primarily used for current consumption and thus crowd out investment in human or physical capital. What seems to be most important is the effect of government spending on economic growth, an issue that remains somewhat neglected in the discussion about optimal govemment deficits. Study of this issue can also appraise the possibly beneficial effects of running counter-cyclical deficits on long-term economic prospects and growth. These points lead to the second problem of the proposal of the Studiegrcep Begrotingsruimte. That is, the analysis fails to take account of the intertemporal aspects of the government budget constraint (e.g., Buiter, 1985). The returns on assets have to be taken care of. Solvency of the government finances and (3.1) yields the present-value budget constraint: Perceived Constrnints jor Duteh Unemployment Policy 19

d(t) f f;(g~(s) f g,(s)] exp[ f; - r(s')ds']ds -

k(t) t f~(r{s) f z,(s)] exP( f; -r(s')ds']ds (3.2) where r g i- a- n denotes the growth-corrected real interest rate, ~ denotes government consumption, g, denotes govemment investment, z, denotes the return on government investment, and k denotes the public stock of capital. The point is that, as far as government investment has the same return as the market rate of interest, it can be netted out of the intertemporal govemment budget constraint (3.2). The recommended reduction of the financial deficit to 2'á 9b (Studiegrcep Begrotingsruimte, 1989) dces not take full account of this point; it makes a lot of difference whether the cut in the deficit is achieved through cuts in government consumption, through cuts in govemment investment or through tax increases. In practice, the cut in the Dutch financial deficit has been accompanied by cuts in govemment investment which seems a rather short-sighted policy. 1t is a pity that since 1977 Dutch govemment accounting does not make a clear distinetion between government consumption and government investment anymore. The political reasons are that ministers will try to claim that all their expenditures are investments, so that budgetary control may become more difficult. However, in practice government investment has fallen dramatically since 1977 (see Section 6). Many economists in the Netherlands now advocate the "golden rule of government finance", which says that firstly the govennment is allowed to borrow for investment purposes only to the extent that they bear the market rate of return and secondly that the amount of tazed levied should be high enough to finance government consumption and the interest payments on the initial government debt (~(s) t i(s)d(s) - r(s), s z r). The desired or sustainable financial deficit is thus id f g, - z, . Table 3.4 provides some information on government interest payments capital income and govemment investment. Since an important part of the proposecl new government expenditures in the Netherlands are investment, witness the National Environment Plan (see Section 7), it is of the utmost importance that investigations into the intertemporal features of the government bud~et constraint are initiated. Ideally, one would like to calculate an estimate of the permanent deficit for the Netherlands (Buiter, 1985, Keuzekamp and Van der Plceg, 1990b). This is the real perpetuity equivalent of the discrepancy in the government's ex-ante comprehensive balance sheet, i.e., the annuïty value of the present value of spending plans minus the net worth of the public sector, where net worth equals public sector assets nunus public sector debt plus the present values of taxes and seigniorage and public sector capital formation. Privatisation of public assets, such as the Dutch State Mines, or privatisation of student loans do not affect net worth if the revenues from the sale (-~k(t)) exactly match the discounted value of the future incomes associated with these assets ( f; Az,(s) exp( f; r(s')ds']ds). The Ministry of Education provides a very sad example of how to reduce the financial deficit in the wrong way. Education has been successful, since more people have participated in education in the last years. The 20 H.A. Keuzenkamp and F. van der Ploeg

Table 3.4

Government Government interest capital Government NNP payments income investment

1977 251,180 8,390 10,870 9,280 1978 269,660 9,310 10,900 9,640 1979 285,940 10,300 12,800 9,800 1980 303,630 12,540 15,900 10,970 1981 316,270 15,710 21,120 11,100 1982 330,620 19,010 21,970 10,620 1983 342,390 21,710 23,550 10,190 1984 358,560 23,870 25,830 11,190 1985 375,990 26,140 29,010 10,940 1986 385,440 26,580 22,720 10,180 1987 386,470 26,420 15,680 9,960

Source: Columns 3 and 4: CBS, National Accounts 1983, Table 12, 1987, Table R.S. Column 5: CBP, CEP 1989, B.1. All in millions of guilders.

total budget has been the same, so the sum available per student has gone down. This seems short-sighted, because education can be seen as an investment in human capital which to a large extent earns itself back. Even more serious has been the 409b discounts given when student loans from the past are immediately repayecl. The idea is to help cut the financial deficit, but it completely ignores that a future Minister of Education no longer receives repayments. Such short-sighted measures fail to distinguish between cash-flow and assets and illustrate the lack of financíal discipline that began to prevail under the second Lubbers administration. Thirdly, it seems odd that the desired financial deficit is independent of the achieved inflation rate. Given that the De Nederlandsche Bank maintains a fizecl parity of the guilder versus the Deutschemark, an increase in inflation in Germany will eventually lead to higher inflation in the Netherlands. For example, if intlation rises to 4.596, then equation (3.1) shows that a financial deficit of 5.6~ is warranted when one wants to stabilise the ratio of government debt to national income at, say, 0.8. Hence, it seems more sensible to advocate guidelines for the inflation- corrected financial deficit, f~ f-~rd, of, say, f- nd - 296. If one substitutes f in (3.1), one obtains

d-(i-A-n)d f 8~ f S~ - r-~. (3.3) Perceived Constraintsfor Dutch Unemployment Policy 21

From this it is clear that the impact of inflation on the debt ratio is zero as long as the real interest rate, i-a, and the ratios of govemment spending and taxes do not change with inflation. However, there is a negative correlation between the real interest rate and inflation, particularly on a world scale (the Mundell effect) and thus higher inflation may, for a given debt-GDP ratio, sustain a higher ratio of the primary deficit to national income, g~ f g,. In addition, highet inflation may make it easier to cut the ratio of government spending to national income. Government debt is not indexed in the Netherlands. An unexpectedly low inflation therefore leads to excessive gains for capital owners. The curcent low rate of inflation leads to redistribution from tax payers to owners of government debt. These owners coincide partly with the common taxpayer (pension funds own large sums of government debt), but the extra gain for wealthy persons may be substantial. Finally, it is true that the Netherlands have experienced a larger explosion in government debt than most other OECD countries (see Table 3.3). Only Belgium, Italy and Ireland now have a higher debt-GDP ratio than the Netherlands. However, the debt-GDP ratio in most other countries is under-estimated because no provision is made for future pensions to be paid by the government. For the Netherlands the ~overnment pension fund; ABP, has assets of 145 billion guilders (and a future actuarial liability of the same amount), which would reduce the debt-GDP ratio by almost 4046 points. When one takes account of this difference, the debt-GDP ratio for the Netherlands does not seem so high compared with the other OECD countries. Apart from the question what the optimal size of govemment debt would be, there remains the question what caused the recent increase in government debts. In an intemational comparison, Roubini and Sachs (1989) analyse this question. One of their conclusions is that difficulties of political management in coalition governments account for some of the growth of government debt ratios. Lack of consensus on economic policy may have accounted for the increase in the debt ratio in the late seventies and early eighties. Indeed, the first Van Agt-coalition (VVD and CDA) and the short-lived second one (CDA and PvdA) lacked consensus on financial policies. These governments also experienced the highest increase in govemment debt. Only the first Lubbers administration was strongly directed to reducing the deficit. The second Lubbers coalition suffered due to the loss of the VVD at the elections, perhaps this loss of popularity induced VVD-ministers to support some popuiar expenditures thus leaving the task of improving government finance to the CDA Minister of Finance, Mr. Ruding. Despite popular belief he lost grip on govemment finance. The last years of the CDA-VVD coalition witnessed a remarkable lack of financial discipline; which can also be seen from the fact that government spending in 1989 was 9 billion guilders (2~Y of NNI!) higher than planned in the Budget of September 1988 (Sterks, de Haan and de Kam, 1989, see also the resulting discussion between them and Ruding in Economische Statistische Berichten). We conclude that cuts in the financial deficit are desirable, but that in practice the cutbacks have worsened the mix of govemment spending at the expense of 22 H.A. Keuzenkamp and F. van der Ploeg public investment in infrastrvcture, the environment and education. The worsening of the mix already occurred before 1977, when the revenues from Dutch gas explorations were mainly used for consumption purposes. The "government budget constraint" has never been a real constraint in the sense of being binding. Solvency is not the problem of the Dutch government, crowding out (of produc- tive and other useful expenditure by interest payments) is. Sound government finance is a necessary condition for being able to implement environmental policies, labour market programs for reducing (long-term) unemployment, and so on. The second link between govemment finance and the labour market goes via taxation. Since 1 January 1990 a change of the Dutch tax system ("Plan Oort") is in force. The main ideas are to reduce the bureaucracy of filling in tax forms, to reduce the number of tax brackets from 9 to 3, to combine the national insurance contributions rate with the first tax bracket at a rate of 35`Yo, and to abolish or diminish a number of tax-deductable expenses. In addition, taxes are cut by 4.1 billion guilders or almost 109b of the total tax bill.

Table 3.5

Taxes and social Average Total Top income tax premiums tax rate marginal rate ( ~o of GDP) tax wedge~`

1965 1983 1983 1983 Actual Proposed

Sweden 36 50 61.7 73 75 60 Netherlands 34 47 37.5 73.5 72 60 Norway 33 47 50.4 63 56 Belgium 31 45 48.1 61.7 72 55 France 35 45 47.6 59.7 56.8 UK 31 38 39 54.5 40 Germany 32 37 36.6 57 56 53 US 26 30 28.2 42.6 28 Japan 18 28 19.1 39.9 88 66

TotaIOECD 27 37 39 55.8

Source: OECD Economic Studies, No. 7 and 8. t Mamed worker with two children, incl. indirect taxes and employers' contributions. Perceived Constrnints for Dutch Unemployment Policy 23

Figure 3.2

MARGIfVAL TAX RATE

Employces premium ------Employees tax load 80 , -- --- Employers premium

40

20

0 1-r-.--. 1966 197Ye~1976 1980 1986

nvERAGE TAx ttATE

- Employees prcmium ----- Employees tax load - -- - Employers premium

1965 197Ye~ 975 1980 19fl5

Table 3.5 shows that the wedge between producers' and consumers' wages is the highest in the OECD and this ezplains why Dutch governments have been very keen to reduce this. Due to the enormous scope for taz-deductable ezpenses, the average taz rate in the Netherlands is low compared with the rest of Europe (but hibher than for the US and Japan). Marginal tax rates are, however, very high in the Netherlands and the proposed reform of the system will remove a large 24 H.A. Keuzenknmp and F. van der Ploeg number of tax distortions. The problem is that due to the very generous pension system the premiums are extremely high compared with abroad, but then these lead to tangible benefits for those who pay for it. Figure 3.2 and Table 3.5 show that both the marginal and the average wedge have risen steadily since the sixties. The marginal wedge for a mamed employee with two children is about 73 ~ whereas in Germany and the OECD it is only about 569b. However, the average tax wedge (excl. social premium) is only 37.5 96 in the Netherlands, compared with 39 96 for the OECD.

4 Monetary policy and the external constraint

The latest annual report of De Nederlandsche Bank expresses satisfaction that the Delors Comnuttee argues for a European System of Central and eventually economic and monetary union that differs very little from the institutional structure of the Dutch central bank. On the whole all the main Dutch political parties are strongly in favour of increasing the process towards monetary unification in Europe and of establishing a European Central Bank that is independent of the fiscal authorities. De Nederlandsche Bank and the Bundesbank enjoy, in contrast to the Bank of England and the Banca d'Italia, autonomy in the sense that they conduct a policy quite independent of the fiscal suthorities. In other words, De Nederlandsche Bank will never allow finance of the public sector deficit by printing money and, indeed, seigniorage revenues in the Netherlands have been either negligible or non-existent. This is in sharp contrast to the countries of southern Europe. For example, central bank loans to the Treasury as a percentage of total debt are in 1987 14.6 9b, 7.2, 96 , 7.2 96 and 32.8 9b for Greece, Spain, Italy and Portugal, respectively, and non-existent for the Nether- lands and Germany (Giavazzi and Pagano, 1989). This is reflected in the fact that the main goal of De Nederlandsche Bank is laid down by constitutional Iaw to be a stable price level and thus zero inflation. Figure 4.1 and Table 4.1 show that from this narrow perspective De Nederland- sche Bank has scored extremely well. Inflation has been less than one per cent and even lower than in Germany. Together with Japan, the Netherlands has the lowest inflation rate in the OECD. De Nederlandsche Bank is very much concer- ned about higher inflation because prices of non-energy raw materials rose by more than 20`ii;, strikes and other labour disputes are on the increase, capacity limits are being reached, and productivity growth is levelling out. However, one can seriously ask whether a policy of near-zero inflation is not a mixed blessing. It may be that some íntlation, as long as it does not get out of hand, may be desirable as this may lead to less unemployment (as an incomes policy may be easier to conduct) and as the stabilisation of the debt-GDP ratio may be easier due to erosion of the real value of nominal government debt, bracket creep in a progressive tax system and incomplete indexation of benefits and salaries of civil servants (also see Section 3). Dornbusch (1989) discusses the unpleasant side Perceii~ed Constrnints for Dutch Unemployment Policy 25 effects of the cut in inflation achieved in Ireland and some of these may also be relevant for the Netherlands. It is clear that to a certain extent the optimal rate of inflation is a political choice and may be different from zero. In any case, due to the emerging dangers of inflation (witness the rise of bank credit by 149b in 1988 and the rise of M2 in 1988, see Table 4.2), De Nederlandsche Bank has raised interest rates and has even imposed a new (more subtle) version of the old instrument of quantitative limits on bank lending. This may be a bit over-cautious, because Dutch consumers have on average a personal debt for consumption purpOSes of 1700 guilders whilst German and US consumers have a personal debt of 4000 and 6000 guilders, respectively. Lack of credit availability for consump- tion and investment purposes may slow down the expected increase in economic growth. Given the fact that capacity in the Netherlands is lower than needed for full employment, it is rather odd that investment should be slowed down in this way. Credit constraints are unwarranted. A somewhat higher rate of inFlation is the least important economic problem that the Netherlands currently has to fear, and anyway the higher German inflation will gradually be followed by higher Dutch inflation except if De Nederlandsche Bank is willing to appreciate the guilder vis-à-vis the Deutschemark.

Table 4.1 International comparison of inflation rates

1983 1984 1985 1986 1987 1988

Belgium 7.7 6.3 4.9 1.3 1.6 1.9 Denmark 6.9 6.3 4.7 3.6 4.0 4.5 Germany 3.3 2.4 2.2 -0.2 0.2 1.6 Greece 20.2 18.4 19.3 23.0 16.4 14.0 Spain 12.2 11.2 7.8 8.8 5.3 5.9 France 9.6 7.3 5.9 2.7 3.1 (3.1) Ireland 10.4 8.6 5.4 3.8 (3.1) 2.7 Italy 14.7 10.8 9.2 5.8 4.8 (5.4) 8.7 6.5 4.1 0.3 -0.1 1.9 Netherlands 2.7 3.2 2.3 0.3 (-0.2) 1.0 Portugal 25.1 28.9 19.6 11.8 9.3 (11.7) United Kingdom 4.6 5.0 6.1 3.4 4.1 6.8

Europe ( 12) 8.6 7.4 6.1 3.6 2.9 (4.4) US 3.2 4.3 3.6 1.9 3.7 4.4 Japan 1.8 2.4 2.0 0.7 (0.0) (0.9)

Source: Europenn Economy, January and February 1989 26 H.A. Keuzenkamp a~ui F. van der Ploeg

Figure 4.1

0.10 ,

0.08 ~

ó 0.06 ~m

~ 0.04

0.02

0.00

-0.02 ~-T-i-r---~ 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988

Source: Centraal Planbureau, CEP 1989

This, however, conflicts with the secondary goal of De Nederlandsche Bank, which is to maintain a stable exchange rate between the guilder and the Deutschemark. This is why in practice, the monetary policy of De Nederlandsche Bank has followed very much the policy of the Bundesbank and can therefore not be conducted in an independent fashion. The main reason is that the Dutch economy has liberalisation of capital markets, so that interest-rate differentials in favour of Germany would lead to a flight of capital out of the Nztherlands and this would lead to downward pressure on the guilder and thus eventually violate the exchange-rate target. Italy and France have had capital controls and have been able to pursue a somewhat independent monetary policy, but this will no longer be the case on 1 July 1990 when their capital markets should be liberalised as well. Obviously, this asymmetry or Germw hegemony in the EMS means that Dutch monetary policy and, eventually, inflation are determinecl by the Bundesbank. The imbalances in balances of payments in Europe (deficits in Italy, Spain and now France, and surpluses in the Netherlands and Germany) cause tensions in EMS- Perceived Con.rtraints jor DutcR Unemployment Policy 27

Table 4.2 International comparison of monetary growth rates

1983 1984 1985 1986 1987 1988

Belgium ( M2) 8.7 5.9 7.6 11.5 10.5 8.1 Denmark ( M2) 25.5 17.8 15.8 8.4 4.4 1.9 Germany ( M3) 5.3 4.7 5.1 6.8 6.0 6.8 G reece ( M 3) 20. 3 29. 4 26. 8 19. 0 24. 8 24. 6 Spain (ALP) 15.9 13.2 12.8 11.4 14.0 10.9 France ( M2) 13.7 9.8 6.0 4.1 4.3 4.2 ireland ( M3) 5.6 10.1 5.3 -1.0 10.9 4.6 Italy (M2) 13.3 12.1 10.8 9.4 8.3 8.4) Netherlands ( M2) (10.7) ( 6.8) (10.5) 4.5 3.9 10.7 Portugal ( L) 16.8 24.6 28.9 25.9 16.8 15.0 United KinB- dom(LM 3) 11.1 10.1 13.4 19.1 22.9 20.3

Europe (12) (m) (11.4) (9.8) (9.6) 9.7 (10.1) (9.8) US (M2) 11.7 8.2 8.1 9.1 3.4 5.6 Japan (M2) 7.3 7.8 8.7 9.2 10.8 (10.4)

Source: European Economy, January and February 1989

parities, hence some argue that a convergence of budgetary policies is necessary for stahle intra-European er.change rates. If headway is made on the proposals for economic and monetary union made by the Delors Committee, then exchange rates will be fixed and binding restrictions on national budget deficits will hold. Hence, regional imbalances in Europe will persist for longer as neither the exchange rate nor the budget deficit can be used for stabilisation purposes. It follows that Brussels will have a greater role to play in alleviating regional imbalances, so that one of the prices one pays for monetary unification is greater intervention on an EEC level. Given these interactions between monetary and fiscal policies for Europe in the future, many Dutch politicians are concemed about delegating responsibilities about these matters to a European System of Central Banks when the European Parliament and thus democracy still has relatively little to say in these matters. 28 H.A. Keuzenkamp and F. van der Ploeg

5 Savirtgs, the current account and credit constraints

In the previous section we already mentioned in short the policy of De Nederlandsché Bank to stabilise credit. In our views such a policy is out of place in the current situation. Stiglitz and Weiss ( 1988) study the importance of credit. Even with an accomodating credit policy of the Dutch Central Bank there remain special problems in the Dutch economy that may make creciit constraints binding in significant parts of the economy. Table 5.1 shows the development of consumptive credit since 1980. In real terms, in 1988 credit was still IOgó lower than eight years before.

Table 5.1 Consumptive credit

1979 1980 1981 1982 1983 1984 1985 1986 1987 1988

Providcd by banks 4,338 4,445 4,397 4,378 4,493 4,396 4,677 5,238 5,678 5,869 Othcr 7,590 8,093 7,921 7,442 7,005 6,640 6,486 6,836 7,376 7,726

Total 11,928 12,538 12,318 11,820 11,498 11,036 11,163 12,074 13,054 13,595 ln n;al tcrms 101 100 93 84 80 75 74 80 87 90 (1980 - 100)

Source: De Neclerlandsche Bank, Annua! repon 1988, Table 2.3 (millions of guilders); Price index: CPB, CEP 1989, C.1.

A major feature of Dutch saving- and investment behaviour is the strong degree of risk aversion due to forced savings in pensions. Pension funds tend to prefer investment in bonds, especially government bonds. Table 5.2 provides some figures for the investment behaviour of pension funds. The civil servants pension fund, ABP, invested approximately two third of its capital in government loans. The private funds invested nearly 4096 of their funds in the government. In contrast to this, the ABP invested only 246 in equities, the private pension funJs reach nearly 846. The high savinbs rate of the Netherlands consists mainly of forced savings. Giving the investment behaviour of these big pension funds it is hard to issue risk-bearing capital. Table 5.3 shows the relative performance of the Dutch economy as far as real growth is concerned. Average growth during the period 1982-88 was 1.7 ~O (excl. energy revenues about 0.2 ~O higher), but throughout the OECD it was 3 9o and throughout the European countries of the OECD growth it was 2.39. It is thus Perceived Constraintsjor Dutch Unemployment Policy 29

considerahly worse than the average performance for Europe and for the OECD and comparable with the modest performance of Germany. More recently, Dutch growth has been picking up. Tables 5.4 and 5.5 show that this has been associated with relatively large current-account surpluses for the Netherlands. The main reason is that savings of the private sector have risen from about 109b in 1980 to 169b in 1988 and this ha.t more than off-set the borrowing of the public sector. Viewed in this light, the public-sector deficits do not look too bad. A consequence of this has been very low growth in real private consumption; less than 146 per annum during the period 1980- 88. The growth in real income during this period of 1.3 ~ per year has been mainly achieved through a growth in real exports of 3.5~, but despite a decline in govemment investment of 3.546 per year during this period. This has been due to the disproportionate burden of government cuts on investment and due to a substantial improvement in the competitive position of the Dutch economy.

Table 5.2 lnvestment behaviour of pension funds

Private Sector Private Building Loans and Sector, and Foreign Govern- Bonds Equity Mortgage Assets ment Total

Insurance Companies 27.4 10.2 42.1 9.3 37.5 126.5

Private Pension Funds 42.6 I5.5 31.2 31.3 74.5 195.1

Civil Servants Pension Fund 30.0 3.1 15.7 4.3 92.9 146.0

Total 100.0 28.8 89.0 44.9 204.9 467.6

P.M. NNP 1988 401.2

Source: De Nederlandsche Bank, Annual report 1988, Table 2.2 (bns of guilders).

The contrast between the Dutch and the Britisch economies in recent years is striking (see van der Plceg, 1989). The UK has experienced a consumption-led boom leading to more than 496 growth recently, whereas the Netherlands has had very modest growth originating almost entirely from the substantial increase in exports arising from the recent recovery in world trade (see Table 5.6). Inflation 30 H.A. Keuzenkamp and F. van der Ploeg in the Netherlands is very low, whereas ín the UK inflation is now surging to above 896. Private savin8s (incl. pension funds) in the UK are much lower than in the Netherlands, whereas the UK is now paying off government debt and the Netherlands still has substantial public sector deficits. Hence, the UK has substan- tial current-account deficits and the Netherlands has substantial current-account surpluses. It follows that there is considerable room for demand expansion in the Netherlands, whereas the UK is a prime example of over-heating. The mirror image of the above picture is that the Netherlands invests a lot abroad, but this does not generate jobs at home.

Table 5.3 Real growth

1981 1982 1983 1984 1985 1986 1987

US 1.9 -2.5 3.6 6.8 3.4 2.8 3.4 Japan 3.7 3.1 3.2 5.1 4.9 2.4 4.3 Germany 0.0 -1.0 1.9 3.3 1.9 2.3 1.8 France 1.2 2.5 0.7 1.3 1.7 2.1 2.3 UK -1.2 1.8 3.7 2.2 3.5 3.2 4.3 Italy 1.1 0.2 1.1 3.2 2.9 2.9 3.1 Canada 3.7 -3.2 3.2 6.3 4.6 3.2 4.0 Belgium -1.4 1.5 0.2 2.2 0.9 2.0 2.1 Denmark -0.9 3.0 2.5 4.4 4.2 3.3 -1.0 Ireland 2.6 -0.7 -1.6 2.0 -0.1 -1.3 4.8 Luxembourg -0.2 1.5 3.0 6.5 3.8 2.9 2.0 Netherlands -0.7 -1.4 1.4 3.2 2.4 2.1 1.3

TotaIOECD 1.6 -0.4 2.7 4.9 3.4 2.7 3.3

OECD Europe 0.2 0.8 1.8 2.6 2.6 2.6 2.8

Source: OECD, Economic Outlook, Decembzr 1988

Table 5.4 Savins

1979 1980 1981 1982 1983 1984 1985 1986 1987 1988

Private sector 11.6 10.6 12.0 14.7 14.6 15.7 14.9 16.0 15.6 15.6 Public sectort 0.6 1.0 -0.4 -2.7 -2.2 -1.2 0.1 -1.3 -2.2 -2.7 Current account -1.4 -1.6 2.5 3.5 3.5 4.6 4.8 3.2 2.0 2.0 Capital account}}0.1 0.3 -1.3 -2.2 -2.4 -2.4 -3.2 -5.5 -1.5 -2.0

Source: CEP, 1988; ' Including social insurance institutions; }~ Private and public sector Percei~~ed Constraintsjor Dutcit Unemployment Poficy 3l

Table 5.5 Current accounts

1985 1986 1987 1988 1989

Unitcd Statcs}' -2.9 -3.3 -3.6 -3.1 ~.6 Japan~~ 3.7 4.4 3.6 2.9 2.6 Germany " 2.6 4.2 3.9 3.8 3.3 Francc -0.1 0.4 -0.5 -0.5 -0.6 Unitcd Kingdom 0.9 0.0 -0.4 -1.3 -1.6 Italy -0.9 0.5 -0.1 -0.1 -0.1 Canada -0.2 -1.8 -1.7 -1.9 -2.2

Total o( thc abovc countrics -0.7 -0.2 -0.4 -0.4 -0.3

Austria -0.2 0.2 -0.1 -0.2 -0.4 Belgium-Luxcmbourg 0.8 2.6 1.8 1.4 1.2 Dcnm ark -4.6 -5.2 -2.9 -2.4 -2.2 Finland -1.3 -1.3 -2.5 -2.5 -2.9 Greccc -9.8 -4.2 -2.7 -3.5 -4.1 Iccland -4.2 0.4 -2.6 -3.9 .. Ircland " -4.3 -3.1 1.7 2.0 1.2 Nctherlands 4.3 2.6 1.5 1.7 1.9 Norway 5.3 -6.4 -5.0 -6.1 -5.8 Portugal 1.9 3.9 I.8 -0.2 -2.2 Spain 1.7 1.8 0.1 -0.7 -1.4 Swcdcn -1.2 0.7 -0.6 -1.1 -1.4 Switzerland 5.6 5.0 4.1 3.4 3.1 Turkey~; -1.9 -2.6 -I.5 -1.4 -1.3

Total of smaller European countries 0.8 0.6 0.1 -0.3 -0.6

Australia -5.5 -5.9 -4.5 -3.4 -3.1 Ncw Zealand -6.3 -5.5 -3.9 -2.6 -2.6

Total of smaller countrics -0.2 -0.3 -0.S -0.7 -1.0

TotaIOECD -0.6 -0.2 -0.4 -0.4 -0.4

Four major Europcan countries 0.8 1.6 1.1 0.8 0.5 OECD Europe 0.8 1.3 0.8 0.4 0.2 EEC 0.8 1.4 0.9 0.6 0.3 Total OECD less thc US 1.3 1.8 1.3 1.0 0.7

Source: OECD, Economic Outlook, Junc 1988. ' Figures for 1988 and 1989 arc projections; '~ Pcrccntage of GNP 32 H.A. Keuzenkamp and F. van der Ploeg

Table 5.6 Growth in world trade

1977-79 1980 1981 1982 1983 1984 1985 1986 1987 1988

5~ 2.0 0.3 -2.3 1.8 8.3 3.1 4.1 6.2 9.0

Source: Central Planning Bureau, CEP 1989.

6 Investing in the future

There are no statistics for productive capital in the Netherlands. However, investment data are readily available and summarised in Table 6.1. This table shows a strong de~line in both private and public investment, that started in the early seventies. Two major showdowns occurred just after the two oil crises. Private investment as percentage of GNP was at an absolute minimum of 15 Yb in 1982, after which a slow recovery started. Government investment has halved and remained in decline, even with a few grand projects (building new dikes) going on. The decrease in investment, in addition to an increase in labour supply, must have led to a decrease in the relative level of full capacity. If anything, government investment policy only made things worse. As mentioned in Section 3 the govemment budget constraint does not discriminate between consumptive and productive government expenditures. In times of budget cuts, it is easier to stop making new investments than to reduce government consumption (as sacking or cutting salaries for public servants invariably leads to strikes and political embarrassment). Figures 6.1 and 6.2 portray the development of the share of profits and the share of investment in the national income. It is obvious that the last seven years of wage moderation by the trade unions have resulted in a dramatic fall of the share of labour from over 90 96 in 1982 to about 77 96 seven years later. The resulting increase in profits combined with the recent recovery in world trade and demand, has led to a recovery of investment during the last few years. This is consistent with a Kaleckian and Keynesian explanation of private invzstment behaviour. However, it is interesting to note that the recovery of profitability has not led to a full recovery of investment (see Figure 6.1). This corresponds to a kind of hysteresis in investment. Environmental issues have become increasingly important in the economic debate. Some argue that more economic growtó conflicts with preserving the environment. Zero, or even negative growth is proposed, the lower employment should be divided equally over the labour force. Jan Pen satirically describes this as the world of small farmers and fishermw, happily reading Tolstoi after lunch, Perceived Constrnintsjor Dutch Unernployment Policy 33

dancing, and playing flute in the evening. In our view, growth and improving the environment need each other. The environmental constraint constrains the direction of growth, not its possibility. in other words, a solution to the environment problem may imply a huge shift in the sectoral composition of the Dutch economy (e.g., away from agriculture to services). The huge subsidies given by the EEC to, for ezample, agriculture can be used to make such a shift less painful.

Table 6.1

1970 1975 1980 1985 1988

Private investment 23.1 16.7 18.3 17.1 18.7

Government investment 4.7 3.9 3.3 2.tí 2.3

Source: Central Planning Bureau, CEP 1989 (Table B.1). Ezpressed as a percentage of GNP.

Figure 6.1

0.26 0.25 ~ 0.24 ,~, 0.23 aai 74 ~ 0.22 m ~ 0.21 ~ 0.2 a ~ 0.19

0.18

0.17 81 82 0 16 - ~ 0.07 0.Ó9 0.11 0.13 O.lb 0.17 0.19 0.21 Pro6ts ~ IvNP 34 H.A. Keuzenkamp and F. van der Ploeg

Figure 6.2

Source: CPB

We saw earlier that most of the perceived constraints for unemployment policy are not truly binding. Reducing unemployment is not easy but should remain a prime long-term goal. Accordingly, active unemployment policy is an investment in the future. Schooling unemployed, investing in their human capital, has long term pay-offs that are beneficial for botó long-term government finance and for reducing unemployment. Investing in the environment today is cheaper than restoring the damage tomorrow, which again benefits long term government finance. Furthermore, it can be used to create employment. Private investment already booms and the balance of payments is very favourable. The private sector is effectively beating a good deal of the unemployment problem, but long term unemployment still needs special measures to be reduced.

7 Summary

In the preceeding sections we described the unemployment problem and listul a number of constraints for policy. These issues may be summarised in 10 stylised conclusions. They are: Perceived Constrnints for Dutch Unemployment Policy 35

1. The level and duration of unemployment in the Netherlands is higher than in most other industrialised countries. 2. High-skilled employed crowd out lower skilled employees. As a result, most of the unemployed are to be found among low skilled persons and immigrants. 3. There has been significant wage moderation during the last decade, stimulated by government but mainly due to weakening of bargaining position of labour (Phillips-curve effect). 4. 'I'he simple Phillips~urve does not seem able to ezplain wage changes, but if the distinction between long- and short-term unemployed is made, then a good explanation can be given. It appears that long-term unemployed become alienated and "drop out" of the labour market. 5. From a budgetary point of view, unemployment policy concentrated on paying benefits. Special labour market training programs were largely absent in the Netherlands. 6. Unemployment benefits have been high since the sixties; they were cut in the early eighties but are still high compared with other countries. 7. The taz wedge in the Netherlands is very high, which introduces considerable supply-side distortions. A move to lower margina) tax rates, even if average tax rates remain the same, is essential. 8. Monetary policy can be used less and less as an instrument for unemployment policy, because increasing monetary integration prevents the use of the exchange rate as an independent policy instrument. Instead, some of the unemployment policy must shift to EC level. 9. Investment collapsed in the early eighties, due to decreased profitability and slowdown of world trade. These factors recovered, but investment did not recover as strongly as might have been expected or needed. Public investment has fallen dramatically; more investment in schooling, training, infrastructure and the environment is badly needed and need not detoriate the long-term financial position of the Rovernment. 10. The Netherlands cannot expand demand on its own; instead it must persuade the rest of Europe (in particular West Germany) to engage in a supply-friendly demand expansion.

The major constraint for effective employment policy is misunderstanding of long-term effects of unemployment on the one hand (hysteresis) and of sound government finance on the other hand. 36 H.A. Keuzenkamp and F. van der Ploeg

Notes

1. CentER for Economic Research, Tilburg University, P.O. Box 90153, 5000 LE Tilburg, The Netherlands. This paper is an abridged version of tóe one presented at the conference on "The Art of Full Employment: Unemployment Policy ia Open Economies", The University of Limburg, Maastricht, 28-30 September, 1989.

References

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