Saturday, September 20, 2014
23

A Dutch Cure for the Dutch Disease

STANFORD – Far too few governments rein in their countries’ bloated welfare states before disaster strikes. As a result, some citizens eventually suffer the economic equivalent of a heart attack: wrenching declines in living standards as they are victimized by unsustainable programs’ endgame. Greece and the city of Detroit are only the most recent grim examples.

Many more suffer from the meager growth and barely rising incomes that result from the toxic combination of government overspending, burdensome regulations, and corrosive taxation. Much of Europe fits this category of economic stagnation.

Occasionally, however, governments stage successful retreats from welfare-state dysfunction. Canada reduced spending by over 8% of GDP in the 1990’s, and the United States reduced non-military spending by 5% of GDP beginning in the mid-1980’s – a trend sustained by center-right and center-left governments alike.

So, when a European country reverses course to reduce welfare dependency and restore work incentives, it is worth noting – especially when that country is the Netherlands, which built one of the world’s most expansive welfare states in the 1960’s and 1970’s.

Recently, the Netherlands’ King Willem-Alexander, delivering his first annual address to Parliament, said, “Our labor market and system of public services no longer fully meet the demands of the twenty-first century….The classical welfare state is slowly but surely evolving into a participation society.”

That represents a genuinely remarkable shift. From the 1960’s and 1970’s on, those writing about the Netherlands often lamented the “Dutch disease.” There were so many generous subsidies, grants, and transfer payments – aimed at everyone from the truly needy to artists unable to sell their work – that after-tax wages were often barely higher than benefits. So people rarely returned to work after they lost or left a job, or did so in the underground economy, with its unreported cash payments.

Whether one considered the Dutch welfare state humane and generous, or bloated and foolhardy, its largesse took a heavy toll on the economy. But unlike, say, the French, the Dutch have responded to their past excesses with a series of policies designed to promote a return to work in the formal labor market. Indeed, they deserve an orange-hued salute for innovative reforms that governments worldwide might usefully emulate in the interest of maintaining a targeted, effective, and affordable safety net.

For example, disability insurance has become a huge, rapidly growing problem in many countries, despite the dramatic decline in the share of workers in physically demanding and dangerous jobs like construction and manufacturing. To stem the dramatic rise in disability payments, the Dutch now require firms with high claim rates to pay more for disability insurance, thereby creating a strong incentive to ensure greater workplace safety.

But reducing disability claims (and thus payments) is only half of the equation. The other half is returning those who can do so to gainful employment. (In America, fewer than 1% of the disabled return to work.) Early intervention and informational campaigns about return-to-work options are promising possibilities. Much economic research shows that job skills deteriorate the longer one is away from work; so retraining, information, and re-entry programs are very important.

Similarly, the Dutch have embraced welfare reform, much as the United States did in 1996, when a Democratic president, Bill Clinton, and a Republican Congress agreed on time limits, as well as work and training requirements. As a result, the Dutch welfare system now requires beneficiaries to show proof of an active job search prior to eligibility; to perform work or volunteer community service while receiving benefits; and to take a job even if it requires a long commute.

America’s 1996 welfare reform grew out of initiatives in the US state of Wisconsin. And, just as Wisconsin’s reform proved to be a model that was successfully adopted nationally, so reforms in one European Union country could spur policy innovations elsewhere in the EU and around the world. And contagious successful policy reforms are precisely what Europe and most of the world need.

To see why, consider the tax rate necessary to pay for social benefits, which equals the replacement rate (the average level of benefits relative to taxpayer incomes) multiplied by the dependency ratio (the share of the population receiving the benefits). The higher the replacement rate and/or dependency ratio, the higher the tax rate needed to pay for the benefits.

What is absolutely certain is that the dependency ratio will rise virtually everywhere, owing to inexorable demographic trends. The combination of rising life expectancy, lower fertility rates, and, in some countries (including the US), the retirement of the post-World War II baby-boom generation, implies a rapid increase in the old-age dependency ratio.

The US, for example, will go from one retiree for every three workers today to a 1:2 ratio in the next three decades. Italy and Germany will have a 1:1 ratio. And the share of China’s population that will be over 65 a generation from now will be larger than in the US.

Common-sense policy reforms that ought to be adopted for their own sake, like the Dutch disability and welfare reforms, will provide a second dividend by lowering the dependency ratio. That will not be enough to maintain sound public finances indefinitely. But, by demonstrating cures to the “Dutch disease,” the Netherlands is giving all of us an invaluable lesson.

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  1. CommentedRobert Snashall

    Another inane article by Boskin. Can't be bothered to wade through the neoliberal idiocy so I'll just cut to one key point.
    Why is the idea of raising taxes to pay for welfare such a disgusting idea? And don't you think that the destruction of industry and falling wages for lower and middle class workers are hugely more powerful causes.

      CommentedJose araujo

      When government is involved, this guys become irrational.

      They rather pay to private companies then pay a tax, even if you end up paying much more.

  2. CommentedChee-Heong Quah

    Just abolish all welfare benefits. Yes, completely. Let people plan for themselves. Let the private insurance and pension funds work freely and the market will solve things by itself. As for newborns, parents should already have insurance coverage for them. Otherwise, these parents should be held liable. Since newborns have not consented to be born, the law has to take up the role. If someone is born with disability, parents should be responsible, not the rest of the society or the child himself.

      CommentedJose araujo

      Private insurance are much less efficient then Governments, and in this type of goods, markets are not efficient.

  3. CommentedJason Krishnan

    The Netherlands taxes all income over 56 thousand euros at 52%, and has a flat tax of 1.2% on the total value of any savings an investment (regardless of gains or losses). Presumably he's advocating comparable tax rates, as the United States seeks to address the long term solvency of Social Security and Medicare.

  4. CommentedThomas Wensing

    What I find puzzling is that there is very little evidence put forward to support the notion that 'bloated welfare states' are the cause of the current economic crises. The USA has rolled back social programs since Nixon, and adopted a model of debt-fueled economic growth since Reagan. All it did was nourishing political extremes, polarizing the country and to increase income inequality to catastrophic levels. The USA is now propped up by China, but these policies have not replaced a single manufacturing job outsourced to low-wage countries.
    It is baffling, furthermore, that one of the real causes of the cycle of economic crises we are experiencing is not mentioned: the increased financialization and interconnectedness of global financial markets. The last time I checked the credit crunch was caused by a lack of oversight and regulation, not by the already low corporate taxes and the cost of a 'bloated welfare states'.

    What is oft forgotten is that welfare states are essential in maintaining a healthy economy and in striking a balance between social and economic interests. All sorts of social indicators (child poverty in the U.S. is largest of any developed country) point towards the success of welfare states in Europe when it comes to achieving this balance between social and economic interests. The cost of child poverty and poor education will translate into a work force which is not fit to work in the high end specialized jobs which the U.S. economy requires. The right in the U.S. is now seriously proposing to cut foodstamps while statistics show that the majority of families in these programs are the working poor. (the so-called precariat). This is an example of the way in which the cost of business has been externalized, or socialized, and the profits have been privatized. I do not see why the taxpayers have to subsidize corporations with low corporate taxes, when they increasingly rely on social programs to be able to pay sub-standard wages. I have not even begun to discuss the fact that an economy of low-wage workers will not have the same buying power as a healthy middle-class and will not be able to make an economy grow.
    The fact that the Dutch are praised in this way by a neo-liberal economists is the real food for thought.

  5. CommentedMark Daniël Huisjes

    Although there are a couple of noteworthy passages in this text I would like to reply to the following two:

    ''Many more suffer from the meager growth and barely rising incomes that result from the toxic combination of government overspending, burdensome regulations, and corrosive taxation. Much of Europe fits this category of economic stagnation''

    Just because most of Europe does not have economic growth right now does not mean our economic system is wrong. Consider that wages in the US were cut severely compared to Europe. If labour costs are lower naturally growth will pick up faster.

    Also the passage about disabled people:
    ''In America, fewer than 1% of the disabled return to work.''

    This is an odd thing to say if you believe that this group is composed of people who are unable to go to work. Therefore I infer that the author thinks that these people are largely unwilling to go to work. I hope that the reader will consider that the US of A does not have a working healthcare system to fix the fixable disabilities (however this may be amended slightly by ObamaCare).

  6. Portrait of Michael Heller

    CommentedMichael Heller

    I notice commenters are wasting their time instructing this eminent professor on the meaning of a thing so elementary as 'Dutch Disease' (if you know what it means you can be sure he does). I think Michael has been clever. It's all about the natural resource curse right? Think of it this way -- If the Dutch come to rely heavily on extremely scarce state welfare resources they will inevitably destroy their famed human resourcefulness and talent for trade and industry. Adam Smith said it long ago.

      CommentedMatthijs de Zwaan

      So, if I understand Michael Heller's argument below, whenever I see a mistake, I should first check if the author is 'eminent', and if so, I should assume it is in fact not a mistake but try to think of an argument that will make the eminent author right? Excellent idea, that would solve a lot of difficult debates. Some practical advice on when someone should be considered 'eminent' would be helpful.

  7. CommentedJose araujo

    On the future trends, it’s my firm believe that reality is going to be very different from what Boskin proposes. There are two very powerful determinants that shape my beliefs.

    First there is strong empirical evidence that social goods demand grows with wealth, the evidence is both for individuals, wealthy individuals spend more on education, health, security, etc and countries.

    Second extremely powerful fact is that Governments are much more efficient producing social goods then private initiative (not only there is strong empirical evidence of the fact but there are very strong economic reasons why that occurs)

    Joining both facts, you come to the conclusion that welfare and social states are actually going to grow, and that our future society is going to be much more public then private.

  8. CommentedHans Paardekooper

    Dear mr. Boskin, 'Dutch disease' isn't about welfare but, as Prof E. Engelen already wrote, about the resource curse of the Dutch natural gas fields in the North sea. The resource curse means that the abundant availability of natural resources drive prices and wages up, making it harder for exportcompanies to be competitive. So, the accords of Wassenaar solved this particular problem by making agreements on the height of the wages and prices, making exportcompanies more competitive. As Prof E. Engelen already wrote, it had nothing to do with the welfare state.

    Kind regards

  9. CommentedEwald Engelen

    This is utterly ridiculous. It got the disease wrong (Dutch disease refers to resource curse) and it got the history upside down. It was the 1990s when Dutch welfare entitlements were cut - from a public sector of 44.8 % of GDP in 1986 to 37.4 % in 2003. Those were the years of the Dutch miracle, remember? The shock of the Great Financial Crisis, on the other hand, has been completely mismanaged. Austerity (tax hikes) have resulted in a steep rise of the collective sector to 40.6 % of GDP in 2014. The 'participation society' is mere rhetoric, covering up incompetence and deadlock. No Dutch acquaintances?

  10. Portrait of Michael Heller

    CommentedMichael Heller

    This is an informative insightful article from the always reliably right-thinking Michael J. Boskin. May I retrieve one of my own from Project Syndicate's archive as potentially complementary - https://www.project-syndicate.org/blog/the-end-of-the-welfare-state-by-michael-heller

  11. CommentedMatt Steinglass

    This is utterly hilarious. "Dutch Disease" describes what happens when a country experiences a windfall natural-resources export boom, driving up its exchange rate and rendering its manufacturing industries uncompetitive. This is what happened in the Netherlands in the 1960s after the natural-gas finds in Groningen and the North Sea. The term is now used as a general description for other countries that experience the same problem. It has nothing to do with welfare or social benefits. What an embarrassment.

      CommentedTimon Pieter

      The very generous welfare system was the policy to allocate part of the windfall profit. It turned out that the profit was unsustainable because of the price plummeted.
      The policymakers realized that economically and politically government was unable to undone that largesse.

  12. CommentedPeter Thal Larsen

    Dear Mr Boskin; I have three questions: 1) What evidence do you have that the Dutch have "embraced welfare reform"? Or do you view the current popularity of right- and left-wing opposition parties as an endorsement of the coalition government's policies? 2) You seem to be using a different definition of "Dutch disease" from the economics textbooks. Can you explain why? 3) Did anyone edit this piece before it was published?

  13. CommentedJoshua Ioji Konov

    Even I would like to agree with you that the lowering taxes, social expenses, and regulations will raise productivity and overall improve the economy: the facts are that these only could not steer a long term growth for which the European Union's policies toward the less developed South gave very good example; However, the very high prices of goods and services in Denmark, which are result of a long term governmental policies are a move into a wrong direction, too. But, the policies should not go strait to neo liberalization: simply a more open market competition by allowing more market participants supported by more open employment and small business market would deleverage the redundancies. The deep cut to the already social expenditures will have a negative effect on a well developed market balance and bring deflation.

  14. Commentedsanjeev verma

    Good food for thought;the author is presaging the collapse of bloated spendings, and to rationalize,reform the State endowments ;it will help to ensure the sustainability of such welfare programmes.
    However,innovation is also important to ensure that welfare shall ever remain at the vanguard ,not be sacrificed at the altar of fiscal prudence.The think -tanks shall have the onus to prescribe innovative solutions ,in this regard.

  15. CommentedJason Gower

    Jose (below), is your point that a larger welfare state leads to higher development? Correlation does not imply causation and in this case I believe that the causation may be the reverse of what you have suggested.

    There are countries that have combined very large social spending with a dynamic and growing economy. These are primarily the Skandinavian states and they each have a unique model that by all means should be analyzed and copied where possible.

    On the other hand, when one looks at the demographic trends, the share of state spending on social programs and the level of innovation in most parts of central and western Europe, the author is absolutely correct to question the sustainability of this model going forward, and the drag that it will increasingly cause on growth and ultimately the standard of living. That doesn't mean scrap the model completely, as Europe, in aggregate, has indeed since the war managed to create a society that combine robust growth and a high standard of living that the world absolutely should be jealous of. However, and as the author points out in his first paragraph, it is better to reform the broken/unsustainable parts of the system in a controlled and pragmatic fashion than to wait until the obvious plays out and forces a painful, sudden transition period that could take decades to recover from.

      CommentedJose araujo

      @Jason
      Any predictive model has to have the capacity to explain reality, so if you hint a relation saying the problem of a country it’s the size of welfare, you better explain why the most developed countries have bigger social functions, and the most poor countries welfare in minimal.
      You say is merely a correlation, but I can think of models where there is actually causation, and empirical evidence confirms it. Take the US for example, the periods of higher growth are associated with periods where welfare was expanded and syndicalization higher, this because there is a clear link between demand and growth.
      On the future trends, it’s my firm believe that reality is going to be very different from what Boskin proposes. There are two very powerful determinants that shape my beliefs.
      First there is strong empirical evidence that social goods demand grows with wealth, the evidence is both for individuals, wealthy individuals spend more on education, health, security, etc and countries.
      Second extremely powerful fact is that Governments are much more efficient producing social goods then private initiative (not only there is strong empirical evidence of the fact but there are very strong economic reasons why that occurs)
      Joining both facts, you come to the conclusion that welfare and social states are actually going to grow, and that our future society is going to be much more public then private. What is broken is the American system that never worked because it’s fundamentally private and very inefficient.
      Regarding the drag of the demographics on social security, most of the arguments presents da simply falsities easily demonstrated.

  16. CommentedMatthijs de Zwaan

    The "Dutch disease" was about the curse of natural resources, and had (has) little to do with the welfare state. See here: https://en.wikipedia.org/wiki/Dutch_disease

  17. CommentedWalter Gingery

    In evaluating this post, you should know that Boskin is professor at Stanford Univ., a conservative-leaning institution; a member of the Hoover Institution, a knee-jerk right-wing think tank; and he heads his own firm and has served as a director on the boards of numerous corporations. His yearly income is estimated at over $336,000 by Bloomberg News.

  18. CommentedJose araujo

    There is a clear correlation between the size of welfare and the development level of a countrie, but I'm afraid the correlations doens't goe the way Boskin likes... Yes the higher the level of welfare, the higher the development of a country.

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