The Future of the Social Market Economy

I should like to share with you some thoughts on the potential to improve the performance of the European economy, which is - as you know - high on the European agenda. At the meeting of the European Council in Lisbon in March of this year, the Union has formulated new strategic goals for the next decade. According to these goals the EU must, within ten years, become the most competitive and dynamic knowledge-based economy in the world, capable of sustainable economic growth, with more and better jobs and greater social cohesion. It is assumed that it is possible to reach an average annual economic growth of around 3%. Moreover, the labour participation rate should rise from the current 61% to 70% in 2010. These goals are very ambitious - very ambitious indeed - and their achievement will require a tremendous effort! It will require that we take a hard look at reality and discard ideological blinkers.

Which policy reforms are needed to attain these objectives? In various papers the EU has offered a wide array of policy measures which are conducive to that end. But I would venture the thought that the list is not exhaustive and that more is needed to turn our aspirations into reality. In this context the question arises whether the rich variety of economic policies which are being pursued in various member countries of the European Union, may offer some additional orientations and guidelines. I believe that this is indeed the case. And I would venture the thought that the Dutch so-called Polder Model - with which I am most familiar - offers some clues - positive and negative ones - which may contribute to a better understanding of what to do and what not.

Some years ago President Bill Clinton lauded the Dutch Model of economic policy as a "success story"?? It deserved imitation, he said. Economic editors of most international newspapers also praised the economic performance in the polder behind the dykes.

Such favourable comments refer to the above-average economic growth (compared with other member states of the European Union), the rapid increase in employment, the low rate of inflation and the reduction of the tax level and budget deficits. According to those foreign commentators, this economic performance stems from a number of characteristics typical of the Dutch economic order. But opinions differ on the exact meaning of that order.

Against this background I shall attempt to explain its ambiguity and explore its consequences. In doing so, I should also like to try to dispel some myths about the Polder Model, because there is a great deal of confusion and misunderstanding about its real nature.

The Dutch Polder Model is often perceived as one of the variants of the so-called Rhineland Model, a notion which has been coined by the French author and former director of the French Planning Agency, Michel Albert. In a famous book, Capitalisme contre capitalisme, he compares the performance of the Rhineland Model with what he calls the Anglo-Saxon Model, which prevails in the US and - to some extent - also in the UK.

The Rhineland Model may be seen as a regulated market economy with a comprehensive system of social security. Government, employers' organisations and labour unions consult each other on economic goals and on the policy instruments to be used. In the Rhineland, therefore, the welfare state is combined with a so-called "consultation economy".

Rhineland participants in the economic process (widely known as stakeholders) try to achieve a harmony of interests. In such a stakeholder economy the primary goal, it is said, is not the maximisation of short-term profits for the benefit of the shareholders. The main concern is a sustainable, stable and continuous economic growth and a high level of employment.

In contrast to the stakeholder economy there is the American or Anglo-Saxon shareholder economy. Under the American form of capitalism, private enterprise is about maximising short-term profits for those who invest. It is less regulated than the Rhineland. Its focus is said to be not on any harmony of interests, but on competition and if necessary confrontation. In going for profits, Americans are more willing to take risks. Where Europeans may be risk-avoiders, Americans are risk-lovers. Under the Anglo-Saxon type of capitalism individual responsibility plays a more important role than in the Rhineland, with its organised care and solidarity.

How does the Dutch Polder Model fit into this scheme? The Polder Model fits certainly in the Rhineland mould, but it also has some distinctive features, which imply a certain convergence towards the Anglo-Saxon Model. Many in The Netherlands and abroad attribute its success to harmonious relations between social partners. They appear to think that this is what the Polder Model boils down to, both in the past and in its recently modified form (of which more later). The Dutch previous minister of social affairs - a social democrat - said: Ich bin ein Rheinländer. Certainly such good relations play a role. But it is other factors, which have caused the Polder Model's recent success.

In this context it is crucial to make a clear distinction between the institutional aspects of the Polder Model and its substantive aspects. As far as the first category is concerned - the institutional dimension - in The Netherlands, the Social and Economic Council (an advisory semi-corporatist council for social and economic affairs) and the Labour Foundation (a council for employers organisations and unions) play important roles. It is here that consultation between social partners takes place. When people think of the Polder Model, they tend to focus exclusively on this institutional dimension. But it is often overlooked that, over time, the nature of this consultation has fundamentally changed.

It is often believed that there is a consensus about economic policy in those institutions. This may have been partly true in a distant past. However, at a certain point in time the Dutch came to the conclusion that their initially strongly centralised model resulted in slow adaptation and low flexibility. That was the time of the notorious Dutch disease. Therefore, over the past twenty years, the Model was adjusted: there is currently less emphasis on consensus building and much more on the achievement of concrete policy goals.

The famous Wassenaar agreement of 1982 between employers' federations and trade unions - Wassenaar is a suburb of The Hague - which included wage restraint, a reduction of working hours and greater labour flexibility, is often seen as the turning point and proof of the effectiveness of the social dialogue and the consensus model. But this agreement in fact led to erosion of the consultation economy.

Moreover, some of the most important policy reforms in The Netherlands have been pushed through without a consensus, in fact against strong opposition. The reduction of the tax burden owing to the slimming of public finance; the policy to stop matching any increase in wages with an equal increase in minimum social benefits; the decentralisation of collective bargaining agreements; the reduction of benefits for the disabled; and the privatisation of health insurance: all these went against the grain of consensual politics. They triggered one of the largest demonstrations in Dutch history. Clearly, the Dutch Model has not always been consensual.

This brings me to the substantive aspects of the Polder Model, which to my mind are far more important than its institutional aspects. The success of the Polder Model may first and foremost be attributed to a comprehensive and coherent mix of policies which included: budgetary restraint, wage moderation, tax reduction, an absence of policy measures to influence actively the business cycle, privatisation, promotion of flexibility, and, more generally, the improvement of the functioning of markets.

The factor that is perhaps mostly seen as having driven the recovery of the Dutch economy from the Dutch disease is wage moderation, which was favoured by a tax reduction, since such a tax reduction encouraged lower wage demands. Wage moderation in The Netherlands resulted in a drop in the share of labour in national income. That movement was mirrored by a rise in the share of profits, which in turn caused a strong recovery of the investment ratio, particularly since the middle of the 1980s.

Wage moderation is also regarded as the most important factor in the remarkable growth in jobs. Annual increases in Dutch jobs have averaged 1.6% over the past 15 years. That is four times the European average and equal to the American employment machine. The conclusion is that wage moderation and cutting taxes, not raising them, is the way to create jobs.

But how much success has the Dutch economy actually had? Job opportunities for low-skilled people remain scarce. Moreover, if statistics were to take into account all those who are able to work but receive social benefits instead,

unemployment figures would rise to over 20% of the labour force.

Viewed in this light, the recent success of the Dutch economy is merely relative to a worse past. Of course, improvements have been made. For instance, the share of public expenditure in national income was 66% in 1985. Now it is 50%. And the government has made social security less collective by allowing privatisation and introducing market elements.

In 1997, consultants at McKinsey published a report on the Dutch economy. Four important barriers were seen to play a key role in holding The Netherlands back. First, a lack of competition. Dutch legislation on competition has in the past been relatively lax. Some time ago the Dutch government passed a new law on competition which sets stricter rules. To boost growth The Netherlands will have to enforce those rules vigorously.

The second barrier is formed by labour-market rules, including those on working hours and on hiring and firing, and by stringent collective bargaining agreements.

The third barrier has to do with the unattractive climate for setting up new companies in what are or should be fast-growing sectors. Strict regulation drives up labour costs. This is particularly true for small businesses.

The fourth barrier consists in the lack of incentives for the low skilled to find jobs. Social security benefits in the Netherlands are still among the most generous in the world. Many of the unemployed are therefore stuck in a poverty trap. Wider margins between benefits and wages should lead to jobs becoming available for those who can work but now depend on social security.

These recommendations imply that The Netherlands should keep moving in the same direction as in the past few years. Through deregulation the functioning of markets should be further improved and social security trimmed. In particular, the government must get a grip on the mounting number of registered disabled, of which there are many more in The Netherlands than in Germany or Belgium. Officially, 13% of the working population is now disabled. If a genuine figure, that would make The Netherlands the unhealthiest place in northwestern Europe, although having the highest life expectancy.

In short, the Dutch economic order will have to move further towards the Anglo-Saxon model of capitalism. Policies which point in that direction have begun to bear fruit. And such policies should not be construed, as many have chosen to, as a reinforcement of the Rhineland model. Quite the contrary.

If The Netherlands still have a long way to go, that goes even more for those European countries which are still firmly stuck in the Rhineland rut. European unemployment is a man-made disaster. Policy harmonisation may cause this blight to spread. According to conventional wisdom the co-ordination of economic policies is considered the key to creating employment. This belief is often professed by governments which espouse unsuccessful policies. They say they fear that tax rates will suffer a race to the bottom. Harmonisation, though, is more likely to result in a race to the top. High tax rates will undermine economic incentives and thus be inimical to investments, growth and employment. Altogether, harmonisation would lessen the pressure to carry out necessary but unpopular structural adjustments to the welfare state.

Should The Netherlands go all the way? Should it change to the type of market economy that exists in the United States? My answer to these questions is: no. The Anglo-Saxon model has its own problems. Europeans do not like its excessive income inequality. Moreover, maximising utility in the short term leads to too few savings and insufficient investment. Americans have not invested enough in public provisions like infrastructure and education. In the Rhineland, savings are considerable and investments are on an altogether higher level. But that does not mean that there are no improvements possible. I believe, for instance, that social security will have to be reformed in order to boost incentives to increase economic performance and so create more jobs. But I also believe that the essentials of the system should be retained, provided public expenditure is kept durably under control.

A synthesis of the Anglo-Saxon and Rhineland models ought to be possible. A Mid-Atlantic?model would unite the positive elements of both. But that model has not yet been reached in The Netherlands. More liberalisation is required if the Dutch economy is to achieve its full potential, to raise living standards for all and to fight social exclusion - and the same applies to the rest of the European Union.

As far as Europe is concerned the question arises which measures should be taken in addition to those which have already been identified. In the light of what I have said, one might think of:

• Wage moderation and differentiation;
• Liberalisation of legislation on job security;
• Less generous and more strictly administered unemployment and other welfare-state benefits;
• A policy that would reduce the market power of established parties.
  

I am aware that these recommendations may sound tough. But I sincerely believe that progress on these fronts will be highly rewarding in terms of more prosperity and more employment. Experience with the overextended welfare state over de last few decades has taught us that rigidities at micro level will result in bad economic performance and instability at macro level, whereas flexibility and propensity to change at micro level will increase performance and stability at macro level.

Europe should therefore focus on micro-economic fundamentals and supply-side reform. I am glad that the European Council at the Lisbon Summit in March of this year outlined as its main objective "to create the most competitive and dynamic knowledge-based economy in ten years time." The realisation of this objective is the best guarantee of sustainable economic growth with high levels of employment and a strong sense of social cohesion.

The Lisbon Agenda marks an important change in the way Europe approaches these issues. It leaves behind the era of macro-economic policies, which generated high levels of state expenditure. Instead it puts the economy on the track of fundamental micro-economic reform. The Summit called for an accelerated liberalisation of key economic sectors such as transport, gas, electricity and postal services. The Commission has put forward proposals in all these fields and looks for majorities in both the European Parliament and the Council.

We must stick closely to the timetable produced in Lisbon if we want to achieve the goals set out in this ambitious agenda. I want to stress in particular that we have to remain firm in its implementation in order to prevent complacency which would undermine our endeavours. It would be devastating for the legitimacy of European co-operation and the strength of our common currency if the European Union were to be strong on declarations of ambitious goals but weak on achieving them. As the American saying goes: if you talk the talk, you must walk the walk. Failure to do so would create the impression that Europe is not capable of concerted reform.

I am pleased that the Commission raised the issue of micro-economic reform at the Lisbon summit. In fact, today's agenda for such reform is to a considerable extent the result of the Commission's contribution to the political debate in Lisbon. And I am grateful that the President of the Commission, Romano Prodi, stressed the importance of an ambitious agenda of supply side micro-economic reforms in his contacts with the heads of government.

The process of European integration has always been driven by a set of clear economic objectives and a determination to reach those goals. Competitiveness and growth must be at the heart of our strategy for the next decade if we want to meet the challenges of enlargement, the threat to the sustainability of our social model in an ageing population and the pressures of immigration. Strong policies will also help to create a strong currency. Indecisiveness and fear of change will undermine it.

• We must therefore transform the culture of Europe from complacency into a vibrant entrepreneurial society.
• We must support and welcome business initiative not punish it.
• We must encourage risk-taking and creativity; not scorn those who dare and create.
• We must change from cultural pessimism and shortsightedness to optimism and a clear vision of the future.

The main lesson of Lisbon is that we need sound micro-economic fundamentals, competitiveness and growth to create the sort of society we want and give people the opportunities to realise their aims and ambitions.

In conclusion, I believe that in order to achieve Europe's ambitious goals, we need to include some tougher policy options than the ones which have been identified so far. It will require a lot of persuasion to reach a political consensus. But at the same time experience in some EU member countries has proved that it can be done and that the overall effects are highly remunerative.

There is no doubt in my mind that Europe has the potential substantially to improve its economic performance - far beyond the level that has been reached so far. It is all within our reach. And there is nobody else to blame if we fail to realise our declared aspirations.