The Dutch Door To Prosperity.

The Netherlands has struck a balance between the welfare state and flexible labor markets.

Netherlands is a nation of just 16.5 people. But the Dutch influence on world affairs is out of all proportion to their numbers. In economic policy, for example, Holland's unemployment rate is less than 3 percent, while unemployment hovers between 9 and 10 percent in other euro-zone countries. Over the past fifteen years, job creation in the Netherlands has been four times the European average. How do the Dutch keep unemployment so low and job creation so high? And can their formula for success be duplicated in other European countries?

Many ascribe Dutch economic success to the so-called "Polder Model" of social cooperation between big business, big labor, and big government. Nothing could be further from the troth. Social cooperation has been a hallmark of Dutch economic policy since the end of World War II. Yet, it did not save Holland from the severe economic difficulties of the 1960's and 1970's. Why should it be credited for the economic recovery of the 1980's and 1990's?

What really happened? Because of the hard times in Holland, the Dutch political consensus changed in the early 1980's away from bloated welfare state-spending fueled by North Sea gas and oil, away from strict adherence to welfare state rules, particularly in labor markets and, yes, away from corporatism and the "consultation economy" to decentralization and greater reliance on market forces.

If there is a "Dutch model" for other European nations to emulate, it is to mimic the new Dutch consensus for decentralization, a smaller welfare state, and flexibility in applying welfare state rules to labor markets.

Old-fashioned social democrats miss the point when they link superior Dutch labor market performance to moderate trade union wage demands. First, as the ex-leader of the Dutch Liberal Party, Frits Bolkestein, points out in The Economist, "tax cuts played an important part in wage moderation. They increased people's purchasing power and, thus, made it possible to limit increases in wages." But even more important, wage moderation never could have sparked the dramatic unemployment gains witnessed in Holland over the past decade and a half without the structural reforms that took place in the Dutch labor market. Primary among the reforms was the widespread use of part-time employees and temporary labor contracts.

The move to part-time employment in the Netherlands was intended to increase the labor-force participation rate of women. But men also benefited, and both did from the move to temporary contracts. Regular, full-time employees are almost impossible to sack under Dutch law. But employers can fire part-time workers and not renew temporary contracts when these run out.

There is an "iron law" of employment: If employers can't fire workers, they won't want to hire them. Ironically, employment boomed in the Netherlands precisely because the proportion of the work force that could be fired increased. U.S. Federal Reserve Chairman Alan Greenspan has made this exact point. "Because [U.S.] costs of dismissing workers are lower [than in Europe], "Greenspan said last July before a conference of U.S. state governors, "the potential costs of hiring and the risks associated with expanding employment are less. The result of this significantly higher capacity for job dismissal has been, counter-intuitively, a dramatic decline in the U.S. unemployment rate in recent years."

Among the Euro-11 countries, the Netherlands was the first both to get this point and act upon it. The Dutch, to be sure, have not yet gone all the way. Regular, full-time employees are still almost impossible to sack under Dutch law. This explains the extraordinarily high proportion of the current Dutch labor force--12 percent--that is officially classified as "sick" or "invalid." Practically the only way Dutch employers can get rid of unwanted full-time employees is to put them on disability. This is costly to business, government, and the employees themselves. It also makes a mockery of the law.

Thus, while still extremely low for continental Europe, the official Dutch unemployment rate understates the tree level of joblessness in the Dutch economy because it excludes the disguised unemployment of the "sick" and "disabled." Politically, the Dutch model is the best Europe can do. But it still is second best from an economic efficiency point of view.

The ability to fire workers not only keeps unemployment low, but it increases the overall flexibility of the labor force. The movement of workers from low to higher productivity uses--whether from firm-to-firm, sector-to-sector, or region-to-region--is thwarted if employers do not have the power to sack.

This is not a class struggle issue but an economic growth one. As Greenspan asked, "why do U.S. businesses and workers appear to have benefited more from the recent advances in information technology than their counterparts in Europe and Japan?" His answer: "The relatively inflexible and, hence, more costly labor markets of these economies appear to be a significant part of the explanation ... Europe has participated in the wave of invention and innovation, but appears to have been slower to exploit it."

What Greenspan suggests is that the labor market flexibility gap between the United States and Europe may be more important in explaining relative economic performance than the alleged technology gap.

It also helps explain the disappointing performance of the new European currency--the euro--on foreign exchange markets. The euro dropped from a high of $1.18 to a point where joint intervention by the Group of Seven nations was deemed necessary to limit its decline. Many link the euro's fall to the assumption that Europe is technologically behind the United States. An alternative and more convincing explanation is that the United States has far greater labor market flexibility--and thus, greater ability to exploit the new technologies--than does Europe. This view implies continued downward pressure on the euro until Europe can reform its labor markets.

CAN THE DUTCH MODEL BE EXPORTED?

Politically, no European country can, or really wants to, adopt the U.S. model. Economic efficiency is not the only value in life and the Europeans have their own attractive lifestyles. At the same time, there is growing political demand in Europe for better economic performance. European unemployment rates are unacceptably high, and U.S. economic growth has put pressure on European politicians to do better.

The Dutch have the solution that best fits Europe's present political realities: Keep the welfare rules in place, but give people the chance to get around them. The Dutch retain the job-killing laws that make it impossible to sack regular, full-time employees. But they nonetheless allow employers to sack part-time workers and temporary employees when contracts expire.

Other European countries are following the Dutch lead in this regard. For example, according to the latest German statistics, almost 10 percent of the German labor force today is made up of part-time workers. This is good news for German labor market flexibility. In addition, when the French recently changed their labor law to mandate the thirty-five-hour work week, the substantial restrictions that previously existed on the use of part-time and temporary employees by French employers were removed. This explains the recent upsurge in French job creation. Superficially, it looks like France has become more of a welfare state. But the reality is that French labor market flexibility has been increased.

Flexibility in applying welfare state roles is only one dimension of the new Dutch consensus. The Dutch also have shown Europe that consensual politics can move the economy away from corporatism to more market-oriented solutions. Referring to the so-called Wassenaar Agreement of 1982, Bolkestein writes: "At Wassenaar, a suburb of The Hague, employers' organizations and unions reached an agreement on wage moderation and the creation of jobs. But the agreement in fact led to an erosion of Dutch corporatism. It brought centralized wage bargaining to an end and led to a release of market forces. Decentralization was a move away from the consultation economy and towards the market."

It remains to be seen whether the pressure to do better economically will lead to a similar retreat from corporatism in other European countries, such as Germany or France. One thing is clear: If the "New Europe"--and the euro--are to succeed, the continent's economic contours will have to very much resemble those of the new Dutch consensus. In this extremely important sense, the Dutch are the tree leaders of Europe and their model the relevant one for the Twenty-first Century.

Melvyn Krauss is a Senior Fellow at the Hoover Institution. Lee R. Thomas is the Senior International Portfolio Manager at PIMCO.