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.