Elga Bartsch | London The Dutch economy is the first country in the euro area that has successfully completed a full roundtrip in terms of relative growth performance. This is not only very good news for the Netherlands, which at 2.4% on our forecasts is set to grow above its own trend rate and above the European average next year. Thus, after several years of relatively meagre growth performance, the Netherlands is now firmly back in the European growth league. But the comeback of the Dutch economy is also very good news for the euro area, where the continued growth discrepancies have prompted discussion on whether there is a properly functioning adjustment mechanism that can correct these intra-EMU growth and inflation differentials (see EU Commission: Adjustment Dynamics in the Euro Area – Experiences and Challenges, November 22, 2006). Some observers have voiced worries that the adjustment process that would cause overheating countries to cool and underperforming ones to recover might not be powerful enough to correct these growth divergences. As the ECB’s monetary policy by definition has to be “one-size fits-all,” such deepening divides in terms of growth and inflation could potentially undermine the proper functioning of the currency union.
But the relative performance of the Dutch economy over the past ten years shows how such an adjustment mechanism can work successfully. However, to date the Netherlands is the only country that completed the full cycle. Germany could potentially be another such case, but we first have to see whether the current recovery proves to be a lasting one and whether it manages to withstand the cyclical headwinds it will face in 2007 (see German Economics: Putting the Recovery to the Test, December 15, 2006). Being small and very open, the Dutch economy very much feels the heartbeat of global trade cycle due to its role as a logistics hub. But it also feels the heartbeat of the intra-EMU tensions and the adjustment processes these can trigger. This is the reason why in my view the Dutch government was so quick to react to a marked decline in the deterioration of cost competitiveness vis-à-vis the rest of the euro area, and after consulting with trade unions and employers, the government essentially imposed a two-year wage freeze in 2003. The turnaround in the cost-competitiveness is one of the reasons for the smart rebound in Dutch growth, in my mind.
In the late 1990s, the Dutch economy was one of the star performers in Europe, and investors were referring to its stellar growth performance as the “Dutch miracle”. Policymakers from other parts of Europe considered copying the Polder model to revive growth dynamics while maintaining social cohesion. In 2001, however, the Dutch economy hit rock-bottom due to a combination of shocks; including the global equity market crash, a subsequent cooling of the Dutch housing market and a sharp rise in labour costs. During this period Dutch GDP growth fell short of the euro area average by a considerable margin, and sentiment indicators registered record lows that were even more depressed than the levels observed in neighbouring Germany.
Today, Dutch GDP growth is broad-based: consumption is picking up as a result of an increase in purchasing power and employment growth; export demand and investment spending are rising considerably. As a result, unemployment which at 3.9% of the labour force is already way below the Euroland average of 7.7% is decreasing rather rapidly. Increasing labour supply is a key issue for the long-term growth prospects of the Dutch economy. But as in the UK, there is substantial hidden unemployment amongst people on disability and early retirement schemes. A key aspect in boosting labour supply in the Netherlands will be to encourage people to work longer hours, thereby reversing a trend towards part-time work, which has reduced the average work-week in the Netherlands to around 30 hours. Nevertheless, inflation and wage developments are expected to remain moderate in 2007 and stay well below the euro-area average; thus further improving the competitive position of the Netherlands. For the first time since the boom year 2000, the general government budget will be in the black again. In addition to a reduction in corporate tax from 29.1% to 25.5%, various relief measures (including an income tax cut for low income earners) will provide overall tax relief of EUR 1 billion (equivalent 0.25 % of GDP).
Looking at the election results. Notwithstanding the turnaround in the economy and an impressive track record on reforms, the centre-right government led by Jan-Peter Balkenende suffered a major defeat at the general election held on November 22. The surprising winners of the general elections were the populist left-wing Socialist Party as well as a number of smaller parties at the fringes of the political spectrum. Contrary to Germany, the two main parties in the Netherlands don’t even have enough seats to form a “purple” coalition, the Dutch equivalent of Chanceller Merkel’s “grand” coalition bringing together the country’s two largest political parties. This increasing fragmentation of the political spectrum, where extremist parties both on the left and on right gain at the expense of the political centre, likely reflects the bifurcating forces of globalisation. In the Netherlands, alas, it might take several months before a new government is being formed.