The development of income distribution in the Netherlands for different political regimes:

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1 The development of income distribution in the Netherlands for different political regimes: Name: Teun van der Velden Student Number: /2008 Date: August 24 th 2008 Bachelor thesis Supervisor: Pontus Rendahl Study: Economics Track: International Economics and Finance Department of Economics University of Amsterdam

2 2 Table of Contents 1 Introduction 3 2 A brief summary of post-war economic history of the Netherlands 3 3 A description of the existing literature 5 4 Data and methodology 6 5 An explanation of the different regime qualifications 8 6 Data analysis Christian Democrats and Social Democrats Left-wing governments and Right-wing governments 13 7 Concluding remarks 16 8 Literature 17 Appendix 18

3 3 1 Introduction National politics in the Netherlands are a heavily debated topic within the country. At election time, different parties compete to win seats in the Tweede Kamer, the parliament of the Netherlands. During this battle for power, the issue of income distribution plays an important role in the debate surrounding economic issues. There is a general belief amongst Dutch citizens that left-wing political parties act more in the interest of the lower income groups and that right-wing parties act more in the interest of the higher income groups. This paper will analyze the influence of different political regimes on income distribution in the period of It will analyse this issue from the perspective of ten different income groups and, in doing so, will clarify the role of different administrations on income distribution in the Netherlands. The Netherlands is marked by a political system in which several political parties coexist. There has never been one single party that obtained a majority of the votes. A multi-party coalition government has always been formed after intensive negotiations between various parties. Due to the structure of this multi-party system, it is not possible to clearly identify two or three individual political regimes as it is in the American system, for example. This paper will address this issue by providing two different qualifications for political regimes which form the basis of the comparison made in this paper. The second section of this paper will provide a short summary of the economic history of the Netherlands after The Second World War. The third section will discuss existing literature on income distribution. In the fourth section, data and methodology will be presented. In the fifth section, the two political regime qualifications will be discussed. This is followed by data analysis of the two political regime qualifications and, finally, a summary of significant conclusions derived from this study. 2 A brief summary of Dutch post-war economic history The economic wonder that The Netherlands experienced between 1951 and 1973 was marked by high economic growth (Van Zanden and Griffiths, 1989, p.210). Due to this high growth, the several governing parties in office were able to substantially increase

4 4 government expenditures. The laissez-faire approach to economics was abandoned and instead, the government claimed a bigger role in the economy as a result of increased possibilities for expenditure. In addition to the increased resources available to the government, government expenditures as a percentage of GDP also increased during the 20 th century. In the period before 1960, the Netherlands had a relatively small government compared to the rest of Western Europe. In the two decennia that followed, the public sector in the Netherlands grew substantially. Greater emphasis was placed upon social security, and, as a result, the so-called welfare state was created (Van Zanden and Griffiths, 1989, p.66). In the period after 1973, the Netherlands was deeply affected by an economic crisis that promptly put a halt to the strong economic growth. This crisis was countered by the government in office with further expansion of government expenditure. The discovery of natural gas in the Netherlands and the resulting extra income made the increase in government expenditure possible. This increase in expenditure was used to create an even larger public sector in the Netherlands, specifically in the realm of social security. From the 1980s onward, due to the large deficits that resulted from previous high expenditures, the government reduced its spending. In cutting back social security, the government adopted an approach opposite to the expansive approach of the 1960s and 1970s (Van Zanden and Griffiths, 1989, p.258). The economic policy of the last period of interest for this paper, the 1990s, was marked by the so-called Zalm-standard. The Zalm-standard focused on, among other economic issues, lowering the Dutch national debt. This meant that any positive income developments were to be used for lowering the budget deficit. Significant for this paper is the fact that this initiative also focused on the reduction of misuse of the social security system. Whether or not this initiative had been successful was a topic of debate at the end of the term.

5 5 3 A description of the existing literature with respect to income distribution There has been much scientific literature produced that addresses the issue of income distribution. This section summarizes literature of importance to this paper. It focuses on income distribution in the Netherlands. This paper was inspired by the article Partisan Politics and the U.S. Income Distribution written by Bartels (2004). In this paper, Bartels analyzes the differences in income distribution policy between Republicans in office and Democrats in office. He concludes that Democrats perform better for the lower income groups and Republicans perform better for the higher income groups (Bartels, 2004, p.6). Furthermore, he concludes that Democrats perform better than Republicans for each income group. (Bartels, 2004, p.6). The Sociaal Cultureel Planbureau or SCP (1999. p16) describes the sentiments which are present amongst Dutch citizens with respect to the income distribution. It states that the more the political party finds itself on the left-wing of the political spectrum, the more its voters find that social security expenditures should increase. On the other hand, the more a political party finds itself on the right-wing of the political spectrum, the more its voters find that social security expenditures are at an acceptable level (Sociaal Cultureel Planbureau, 1999, p.16). Furthermore, the overall distribution of income is a more political issue than is the level of social security. As can be expected, left-wing voters are strong proponents of further income leveling and rightwing voters oppose this policy (Sociaal Cultureel Planbureau, 1999, p.17). With respect to the presence of income inequality in the Netherlands, Afman (2005) concludes that inequality actually decreased until 1975, and has continued to decrease ever since (Afman, 2005, p.50). This is in opposition to a study conducted by the SCP in which it is stated that 1977, 1985 and 1990 can be identified as breaking points in the growth of income inequality (Sociaal Cultureel Planbureau, 2003, p.245). This study concludes that stabilization only took place between 1977 and 1985 and after 1990 (Sociaal Planbureau, 2003, p.245).

6 6 4 Data and Methodology The following section will present the method that is used with respect to the data which form the basis of this paper. Several assumptions explained and a few simple calculations with respect to the growth shares are given. The first dataset that forms the basis of this paper is constructed by Afman (2005). He constructed a new dataset out of different datasets which forms decile income shares in total income between 1959 and 2000 (Afman, 2005, p.15) (Appendix, figure 1). As can be seen from the dataset, not all years in this period are provided with an income distribution. This complication requires further calculations and assumptions which will be presented throughout this section. Let us take S = percentage of total disposable income of a particular income group, and Y = Real GDP per Capita or Income per Capita (we use per capita data to correct for population growth). Then S*Y is equal to the disposable income share per capita. To find out the percentage change in S*Y we must calculate ((S t+1*y t+1)-(s t *Y t))/(s t *Y t). This equation is approximately equal to LN (St+1*Yt+1)-LN (St*Yt) 1 = LN (St+1) - LN (St) + LN (Yt+1) - LN (Yt). This means that the percentage change in total disposable income share is equal to the percentage change in relative income share plus the percentage change in Real GDP per Capita. When calculating the percentage change in S=LN (St+1) - LN (St), without all data being available some assumptions have to be made. Let us take the example of the period 1959 until The yearly percentage change in relative income shares cannot 1 This equation assumes the continually compounding of GDP data. (S t+1*y t+1 - S t*yt)/(s t *Y t)= growth rate, r = (S t+1*y t+1)/(s t *Y t)-1. (S t+1*y t+1)/(s t *Y t)=1+r Assuming continual compounding, (1+r/n)^n, (with n ). This limits to ^r (1+r). =>, LN (1+r) r LN((S t+1*y t+1)/(s t *Y t))= LN (St+1*Yt+1)-LN (St*Yt)

7 7 be calculated from these data (Appendix, figure 2). If you consider the percentage change from 1959 until 1962 you get the average relative percentage change in income share over these three years. This paper assumes that the individual change in each year does not alter significantly from this average which means that the percentage change is the same for the years 1960, 1961 and 1962 (e.g. 5.2%). The method is used throughout the whole dataset which solves the problem of missing data. The second dataset is taken from the Penn World Tables and gives the yearly Real GDP per capita numbers. When constructing the material needed for the final comparison, first the percentage growths of these numbers must be calculated. Remember that (LN (St+1) - LN (St)) + (LN (Yt+1) - LN (Yt)) is needed, so for each income group the percentage change of the matching year should be added to create the desired percentage change in income share. Finally, the numbers for each income group are divided in political regime years. After dividing the several political regimes in to years, the average of these years is taken for each income group. This creates the average growth for the different political regimes for each income group 2. These political regimes are described in the following paragraph. 2 In this paper, there is assumed to be a time lag of one year in which the policy of a government becomes effective.

8 8 5 An explanation of the different political regime qualifications. Due to the absence of a clearly partisan system as used in the study of Bartels (2004), an alternative way to compare influences on income distribution is necessary. This section offers an explanation of the two different political regime qualifications that are used in the analysis on income distribution in the Netherlands. For both political regime qualifications, the data constructed in the previous paragraph are divided over the years and form the basis of the data analysis in the sixth paragraph. Figure 3. Governments in the Netherlands; The first regime qualification is determined by identifying the party that obtained the largest share of votes and thus delivered the Prime Minister (PM) for the government in office. Figure 3 shows the governments that have been formed during the time period of interest for this paper. The color green represents a Christian Democratic (until 1977; KVP/CHU/ARP, as from 1977; CDA) party which obtained the largest share of votes and automatically delivered the PM. On the other hand, the color red represents the Social Democratic party (PvdA) that delivered the PM. Figure 3 reveals that during a majority of years (30 out of 41) which are of interest for this paper, a Christian Democrat government was in office. However, a number of difficulties arise choosing such a political system. This problem has already been discussed in the introduction of this paper. The Netherlands is marked by a political system where several parties form a government together and different weights can be attributed to each party. These weights are determined by the number of seats they obtain in the parliament. Therefore, in a government in which

9 9 Christian Democrats and Social Democrats formed a government together, and the Christian Democrats delivered the PM, the Social Democrats may still have had a significant influence on policy and vice versa. In looking more closely at the different administrations, there has indeed been a large number of governments in which Christian Democrats and Social Democrats formed a government together. This problem makes it naïve to analyze the data for only this regime qualification. The significant influence of the party that did not deliver the PM would disrupt the results derived from the first regime qualification. Therefore, a second political regime qualification will be constructed. The second political regime qualification determines which are the so-called right and left-wing administrations. By analyzing different characteristics of Social Democrats and Christian Democrats, we see that Social Democrats fit the description of being left-wing. However, the characteristics of Christian Democrats could be described as both left and right-wing in nature. From this point of view, there is of course no difficulty in a government where Social Democrats obtained the largest share of seats and the Christian Democrats the second largest share. This type of government is labeled left-wing because of the leftwing character of the party. However, the difficulty lies with the qualification of an administration where the Christian Democrats are the biggest party in terms of seats, and deliver the PM. Because they could be described as being both left and right-wing, the label this particular administration would receive depends on the parties with which they formed the government. Christian Democrats formed governments with Social Democrats as well as the Liberals (the VVD). The Liberals could be described as being right-wing. This leads to the following qualification: A government in which Christian Democrats are the biggest party and deliver the PM and the Liberals have the second largest share of seats in the government, it is labeled right-wing. On the other hand, if the Social Democrats had this second largest share of seats in the government, it is labeled left-wing. Again, if the Social Democrats obtained the largest share of seats and delivered the PM it is labeled left-wing due to the left-wing character of this party. This qualification results in the following distribution of governments; ; Right-wing ; Right-wing ; Left-wing

10 ; Right-wing ; Right-wing ; Left-wing ; Right-wing 1982; Left-wing ; Right-wing ; Right-wing ; Left-wing ; Left-wing The result of this qualification is that in the period of 1959 until 2000, there were 18 years in which a left-wing government held office, and 23 years in which a right-wing government held office. The two regime qualifications described in this section form the basis for this paper. In the following section there will be an analysis of both regimes and a conclusion will be presented in the last section. 3 This government was the so-called purple government. It consisted of PvdA, VVD and D66. It is labeled left-wing because D66 is considered to be a more leftwing liberal party. Christian Democrats were not involved in the government for the first time in 80 years.

11 11 6 The data analysis The fourth section described the data used for this paper. The analysis of this data will now be presented for both regimes as they were described in the fifth section. The section is divided into two subsections which analyze the first and second political regime qualification, respectively. This analysis is performed with and without interpolation of the missing data. 6.1 Christian Democrats and Social Democrats Christian Democrats Social Democrats Income growth Income group Figure 4. Income Distribution by income group for Social Democrat and Christian Democrat administrations, Figure 4 shows the analysis for the first political regime qualification with interpolation of the missing data. This qualification divided the governments into Christian Democrats and Social Democrats, depending on what party received the largest share of votes and thus delivered the Prime Minister. As can be seen from the figure, no clear pattern can be derived from this analysis. There is a great outlier in the outcomes for the first income group, where Social Democrats perform significantly worse for lower

12 12 income groups than the Christian Democrats. Furthermore, Social Democrats seem to perform better for almost all other income groups except for the third highest group and the second lowest group. Except for the outlier of the Social Democrats for the first income group, the lower income groups seem to perform better overall. This development decreases income inequality. The overall decrease of income inequality is in line with the studies of Afman (2005) and the SCP (2003), which also observed this downward trend Christian Democrats Social Democrats Income growth Income Group Figure 5. Income Distribution by income group for Social Democrat and Christian Democrat administrations, (no interpolation) Figure 5 shows the analysis for the first regime qualification without interpolation of the missing data. What can be seen from the graph is that Christian Democrats perform better for every income group. This means that for each income group, Christian Democrats generated higher economic growth. With respect to the income distribution, it can be stated that the Christian Democrats nor the Social Democrats performed significantly better for a certain income group. These results do not seem to hold much conclusive power. It is assumed in this paper that this poor result is due to the regime qualification. The only way to get more trustworthy results is to analyze the data for a second, more sensible qualification. This

13 13 qualification as described in the fifth section of this paper is analyzed in the following subsection. 6.2 Left-wing governments and Right-wing governments The expectations for the leftwing governments and the rightwing governments are clear. As paragraph two already discussed, the SCP (1999) concludes that leftwing voters are more concerned for more income leveling and higher social security. This could mean that leftwing governments, as discussed in the introduction, would act more in the interest of the lower income groups and the rightwing governments would act more in the interest higher income groups Right wing Left wing Income Growth Income Group Figure 6. Income growth by Income group in Left Wing and Right Wing administrations for the Netherlands, However, figure 6 shows remarkably different patterns. Three of these different patterns are worth discussing in this paper. First, rightwing governments seem to perform better for all income groups. This means that in all the years a rightwing government was in office, there has been an average higher growth for all income

14 14 groups. This is the same result as the result we got for the Christian- and Social Democrats (without interpolation of the missing data), where Christian Democrats outperformed Social Democrats. The second pattern which can be seen from the figure is that both governments performed better for the lower income groups then they did for the higher income groups. So, at first sight there is not a party that exclusively performed better for a certain income group. The lines seem to walk together from high performance for lower income groups to lower performance for high income groups. This opposes the general belief among Dutch citizens that rightwing governments would act more in the interest of high income groups only. If this expectation would be true, it would create an upward sloping line for the rightwing governments. However, the third pattern does show that the difference in performance for high and low income groups is bigger for the leftwing governments than for the rightwing governments. This indicates that the rightwing governments not only perform better for all income groups then leftwing governments, the superiority in performance is greater for the higher incomes then for the lower incomes. So in this respect, one could say that rightwing governments act more in the interest of the nation as a whole and leftwing governments only act in the interest of lower income groups. Only for the highest income group the difference in performance is fairly small again. The downward trend of both lines indicates an overall decrease in income inequality. Again, this in line with the studies of Afman (2005) and the SCP (2003). It can be concluded from the third pattern as discussed above, that the left-wing governments contributed more to this decrease then the right-wing governments. Their difference in performance for the higher and lower income groups is larger then that of the rightwing governments.

15 Right wing Left wing Income growth Income Group Figure 7. Income growth by Income group in Left Wing and Right Wing administrations for the Netherlands, (no interpolation). Figure 7 shows the analysis for the second regime qualification without interpolating the missing data. Once again, this graph shows that the right-wing parties perform better for every of the ten income groups than the left-wing parties. Now the superiority in performance of the right-wing governments is even greater. From these results it seems that there is sufficient evidence to state that right-wing governments have generated higher economic growth. The statement is robust because with or without interpolating, this conclusion can be drawn. Of course, it is possible that voters vote for right wing-parties when the economy is booming. This would create high GDP and would influence the results given above. The extent of this paper does not cover this problem.

16 16 7 Concluding remarks This paper analyzes different governments in the Netherlands in terms of their influence on income distribution in the country. When dividing governments into Social Democrat governments and Christian Democrat governments, no clear cut results arise. As discussed in the fourth section, this qualification is not strong enough to produce trustworthy results. Because of this weak definition, conclusions can and will only be drawn from the alternative labeling described in section 6.2. Performing the analysis for the alternative political regime qualification namely, label governments as left and right-wing, the results are clear. Right-wing governments generate higher economic growth than left-wing government. For every income group, the growth in income share is higher compared to that of the left-wing governments. With or without interpolating the missing data, this is true and therefore this result is robust. This difference in performance is larger for higher income groups then for lower income groups which implies that left-wing governments contributed more to the decreasing income inequality than right-wing governments. That finding is in line with expectations as right-wing parties such as the VVD openly oppose the concept of extra income redistribution, whereas left-wing parties such as the PvdA are in favor of income leveling. However, this result is only to be found when the missing data are interpolated and therefore, this result is not robust. In terms of possibilities for further research, this paper provides a foundation for the creation of a complete dataset. Interpolation of the missing data would become unnecessary and this would create. Furthermore, it would be interesting to investigate the results which show that right-wing parties create higher economic growth. Is this actually due to sound economic policy? Or, perhaps, does the voter follow a cyclical pattern where it votes for right-wing parties when times are good and for left-wing parties when times are bad?

17 17 Literature: Afman, E. (2005). Income Distribution in the Netherlands in the 20 th century; long run developments and cyclical properties. Working Paper 05/38. Amsterdam: University of Amsterdam Bartels, L. (2004). Partisan Politics and the U.S. Income Distribution. Department of Politics and Woodrow Wilson School of Public and International Affairs: Princeton University Sociaal Cultureel Planbureau (1999). Sociale en Culturele Verkeningen Rijswijk: Sociaal Cultureel Planbureau. Sociaal Cultureel Planbureau (2003). Inkomen Verdeeld. Trends in ongelijkheid, herverdeling en Dynamiek. Rijswijk: Sociaal Cultureel Planbureau. De Vries, J. (2002). Paars en de managementstaat: het eerste kabinet Kok ( ). Apeldoorn: Garant. Van Zanden, J.L. and Griffiths, R.T. (1989). Economische geschiedenis van Nederland in de twintigste eeuw. Utrecht: Het Spectrum

18 18 Appendix Figure 1. Dataset decile disposable income shares (Afman, 2005)

19 19 Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Netherlands Figure 2. Real GDP per Capita (Penn World Tables)

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