Thursday, 7 October 2004

Third Way? No Way!

Some time ago I wrote an article for TCS on the Dutch Polder Model (“A Hole in the Dike“). Only a couple of years ago the Dutch Polder Model was still considered to be a “Dutch miracle”. Today, however, it seems pretty deadlocked. The Netherlands economy is one of the worst performers in Europe.


In my article I tried to explain to an American readership what the Polder Model is all about. That is not easy. From conversations with non-Dutch I learned that it is even almost impossible, because the model includes a couple of features which are rather alien and thus incomprehensible to them. Therefore, I concluded my article with a quote by Alan Greenspan: “If I seem unduly clear to you, you must have misunderstood what I said.”


One of my American readers, Katy Delay, wrote me that I failed to be “unduly clear” to her. Posing herself as an “neophyte”, she asked me a lot of pertinent questions about the functioning of the Dutch Polder Model. I answered her to the best of my ability. Subsequently she sent me a new wave of questions, even more inquisitive than the previous ones. These were definitively not the sort of questions which a “neophyte” could make up. It made me curious of the identity of the real Katy Delay. Fortunately she revealed her true colors in the course of our further exchange of views. She wrote me that she was the daughter of a distinguished American economist, Edward C. Harwood, who in the 1930s had some pretty tough discussions with John Maynard Keynes on his “Treatise on Money” and who was fiercely opposed to the “policy of inflation” which Keynes was advocating. Harwood was a believer in the dynamism principles expressed by Virginia Postrel. Katy also wrote me that, as a teenager, while accompanying her father, she had dinner with Friedrich von Hayek. So, neophyte? With such nature and nurture it is perhaps hard to remain a novice, even without formal schooling in economics.


I really value the views of outsiders, even non-experts. They may offer a mirror in which one is able to get a clearer picture of oneself. That was at least my feeling after the exchange of views with Katy Delay. I believe that a somewhat re-edited summary of this exchange may also be useful to fill the possible gaps in understanding among a wider readership. More importantly, however, they expose the fatal flaws in the Dutch Polder Model in a way (sometimes quite humorously) which I cannot remember having encountered in scholarly journals. Since the Polder Model shows similarity with the so-called “Third Way“, Katy Delay’s criticism mutatis mutandis applies to economic models prevailing elsewhere in the world, not only in Europe, but also in Asia.


The Third Way, middle way, or social market economy is a kind of half-way house between the purely free enterprise economy and the command economy. It is claimed to be a mixture of the best elements of capitalism and socialism. British Prime Minister Tony Blair described the Third Way as “combining a dynamic market economy with a strong sense of social provision and national unity and purpose.” He also calls it “social democracy renewed”. The Polder Model could perhaps be qualified as The Third Way “avant la letter”, though with a couple of distinctive features, because it preceded the ideas of New Labour in the UK.



Katy: I read your article on the Polder Model with much interest. I believe that it is important to lift the wool off the public’s eyes with regard to certain ideas about the free market on the one hand and centralized economies on the other; also about how certain politicians try to increase the public’s wealth to get their vote, and how others wish to maintain the public’s poverty and dependence for the same reason.


And then I read another of the articles you wrote for TCS, “The New Road to Serfdom” and I’m confused. Not so much about the Polder Model (which, I admit, sounds to me at first blush to be something like the proverbial camel, i.e. a horse that was designed by a committee), but rather more about what seems to be a contradiction of principle. Now, because I’m sure it’s just a question of my lack of understanding and sophistication, perhaps you could clarify a question for me?


From my reading of your first article about “The New Road to Serfdom”, I thought you were expressing dismay at the world’s return, in spite of the fall of the communistic model, to conditions strikingly similar to those which brought about fascism in the 30s. I also thought that you perceived those conditions to be the socialization, the re-centralization of political power, e.g. socialized medicine, etc. Then in this article, “A Hole in the Dike”, you used phrases such as “the wage freeze was long overdue.” Now I can understand that perhaps one must fight fire with fire, that the government of Holland might need to intervene with measures that will counteract measures already in place (such as government-dictated or committee-dictated wage increases) quickly and perhaps with a strong, centralized arm of strength (e.g. a wage freeze.) But how can a government-imposed wage freeze be compatible with free market? Or does the Polder Model eventually find a way to get government out of wages and prices, indeed out of all markets, by some mysterious slight of hand? A kind of now-you-see-it, now-you-don’t, “intervention” (which really isn’t one)?


And lastly, isn’t the Polder Model just a disguised, “committee” version of centralized government systems, where a dictating Minister of Industry has simply been replaced by a “cooperative council”, but the edicts are just as controlling of, and detrimental to, the free market in the end?


Hans: Indeed, free-market proponents are right to criticise the inconsistency be
tween the relevant passages in the two articles which I have written. So I owe them some explanation. My basic view is that Europe finds itself on a slippery slope towards socialization of its economy and faces today the same risks as those which Ludwig von Mises and Friedrich von Hayek have so brilliantly analysed in many publications in the first half of the previous century. Nevertheless I expressed support for a wage freeze in The Netherlands. But, as you rightly pointed out, in my view this was a necessary correction of the wage level which have been agreed earlier, which were too high in the light of the prevailing market conditions. So qualifying them as “fighting fire with fire” hits the nail on the head.


As far as the functioning of the Dutch Polder Model is concerned I can understand that (classical) liberals wonder how it can be squared with a fully free market economy. It seems to be ridden with contradictions.


The Polder Model or consensus economy aims at harmonious relations between the government, employers federations and trade unions. In a semi-permanent tripartite dialogue they analyse the development on the Netherlands economy and try to clarify the limits within which various interests and claims can be accommodated, without harming the economy at large. The achievement of some degree of wage solidarity by agreement on quasi-uniform across-the-board wage rises, constitutes an important element of the Model. The experience of the last few years teaches us, however, that this process has produced deficient outcomes.


For a long time the Polder Model seemed to work in practice. But – as French intellectuals use to say – one was not sure whether it could also work in theory. Now practice has converged with theory. It has become clear that theory was right after all. Today the Polder Model shows a very poor performance. Maybe it is even on the verge of collapse.


Of course it is impossible to deviate too much and too long from the market-determined outcome. But it is very difficult to negotiate a package which is identical with the outcome of the market. Though the centrally agreed wage rises (or freezes) are “orientations”; they may be somewhat adjusted, both upward and downward by individual sectors and/or companies, depending upon their level of profitability. This introduces a certain degree of flexibility into the system, in conformity with the market.


Katy: Are you saying, then, that your committee do not actually dictate, for example, a minimum wage, or a wage schedule, but rather just suggest such a wage? That employers in actuality are free to pay their employees wages and benefits as they wish? That the committee in reality have no authoritative jurisdiction at all?


Hans: No, no, it is a sort of half-way house with a lot of smoke in mirrors. The minimum wage is set by the government. Central wage orientations agreed upon in the Social Economic Council provide guidelines for decentralised sector-wise or company-wise wage bargaining which results in collective labour agreements.


Katy: How is it that the private sector “obeys” the committee’s suggestions, in view of the fact that to do so ultimately distorts the free market? Sounds like the blind leading the blind. Or perhaps the private sector has its hands in the committee members’ pockets?


Hans: It is a tripartite exercise. That implies that the discussions take place between representatives of government, employers and trade unions. They try to reach consensus. No corruption and no bribes.


Katy: Forgive me, but if I have understood the process correctly, the corruption comes about at the very beginning, when the committee persuades the public that they have ideas that are actually useful, when in fact all they are doing is mucking up the system. Once the system is mucked up, of course the committee appears like the White Knight managing to save the day, when in fact they are just creating mirages to seize power, which is the beginning of corruption. Do I have some misunderstanding here? Please elucidate my errors.


Hans: It is all about some measure of wage solidarity and equality in society at large. The intentions are very noble. But as the saying goes: the way to hell is paved with good intentions.


Katy: I am still confused. Why must one “negotiate” anything, when the market does it automatically and so beautifully? Why is it necessary to deviate one iota from the market-determined outcome?


Hans: Because the market does not produce equality of outcomes, which so many people want it to do.


Katy: The only reason I can find is to create the appearance of appeasing the impatience of labour, and thus get re-elected (i.e. please the voters now, let them pay for it later). In other words, as I see it, the committee is simply trying to justify its own existence, first by lying to labour by saying that “Yes, just watch us, we see the problem of the limitations of the market and will fix it,” and then lying again, “Oh, look, now we have to intervene again.” (But you and I know it is to correct the corrections.) And then once again, “You see, Stupid Labour,” (with a wink to the Greedy, Power-Hungry Labour Leaders, with whom the Committee intends to share the spoils), “the market cannot do this by its own, we, the Almighty Learned Committee, must intervene to help it along.” (Lies, lies, lies – but votes, votes, votes.)


Hans: I believe that the market process can be manipulated up to a point. It is justified by solidarity considerations and the desire to preserve peaceful and “constructive” labour relations. This is political logic. Unfortunately there is a clash between political logic and economic logic. There is a price to be paid for the political “benefits” in terms of losses of efficiency, prosperity and employment. But we are always facing choices, contradictions and dilemmas in our personal and social lives. Most of the time we can, or have to cope with it. However, at a certain point in time the contradictions may exceed a critical threshold which will trigger a crisis, which has to be remedied by counteracting and/or reversing the earlier measures which were not or not sufficiently in conformity with the market. Then we have to reconsider our priorities. As far as the Polder Model is concerned, we should have done this already many years ago. The same applies to the Third Way.


Katy: Most of the time the factor labour wants to receive more than the market will bear. So why must government listen to them? Why can’t they (or shouldn’t they) simply be led to understand why and how the market cannot bear more? I do not believe they are really stupid. They are impatient, but not stupid. And it takes a little leadership, that’s all.


Hans: In Europe today this “little leadership” boils down to political suicide. It requires a sort of Thatcherite revival, which is nowhere in sight. Chancellor Schröder’s timid proposals for reform – which go in the right direction, but are nevertheless too little and too late – have raised hell in his own party. They will surely be diluted, thus postponing the day of reckoning. Anyhow, history will almost certainly qualify Schröder’s incumbency as a lost chancellorship.


Katy: Now if I understand correctly, you admit that the Polder committee has simply mucked around with the system. I don’t get the justification.


Hans: You may have missed the justification, but I believe that you have very well understood the mechanics.


Katy: In the US, we have found another solution. Government only symbolically appears to adjudicate the minimum wage. And although Organized Labour has been quite strong here, and they have managed to increase labour’s wages in certain industries to an unbelievable level. Fortunately for some reason the pendulum swings back and forth about the unions, and things tend to want to work themselves out. Here, however, we have the problem that people would not stand for a “deflation” of wages (which would ordinarily be just a correction, re-establishing their purchasing power to where it was), so we inflate the dollar every year, a 2 percent here, or a 3 percent there (perhaps more, but it is very difficult to measure, and it is all Milton Friedman’s fault), and the effect is the same as your Polder “suggestions/corrections” system. That way labour has the impression that their wages are constantly rising, even though their purchasing power is actually shrinking over the years. The net result is that the little guy gets stuck with the bag once again, but he doesn’t realize it. I suspect that as usual a correction is in the works, and the general trend will right itself. Unless our present American liberalization (in the European sense) is curtailed by November’s elections, and by our public’s distaste for war and Mr. Bush’s handling of it, in which case we will cut off our nose to spite our face (do you understand that expression?) and make an about-face towards socialism again. Only time will tell.


By the way, as regards the participation of the trade unions, does it mean that the whole of the Dutch labour force is unionized?


Hans: No, but the unions are also being recognised as the representatives for the non-unionised labour force.


Katy: That must be the ultimate death to the concept of a free market.


Hans: It depends upon the degree of deviation from the outcome of pure market forces which they agree/decide.


Katy: This kind of committee system will surely detract from the reactive liquidity of the labour market and will add enormous weight in the form of wages for the bureaucrats, which must be paid out of the tax trough, and also in the form of non-productive time away from the capitalistic ventures of employers and labour, which perforce also translates into a kind of ‘tax’ upon employers in the end, isn’t it?


Hans: In principle yes, but I do not believe that these administrative costs are very high. The costs of the ensuing market distortion are of course considerably higher.


Katy: Isn’t Holland a highly socialized country? I really am quite ignorant of this, but I assumed that it was, for some reason. Perhaps because of my knowledge of the Scandinavian system, which I may have transferred in my mind to Holland as well. What is the system in Holland? Isn’t it socialized?


Hans: Not socialized in the sense of state-owned companies.


Katy: For example, is there a high unemployment rate with wonderful unemployment benefits?


Hans: Yes, high and fast rising unemployment with wonderful unemployment benefits compared with the US. Those who have to live on it, have of course a different opinion.


Katy: Is the medical system orchestrated through a central government entity?


Hans: No, there are many public and private actors in this field.


Katy: Are there goodies like maternity leave, disability?


Hans: Yes.


Katy: What are taxes like?


Hans: Pretty high, compared with the US. In the Netherlands the personal marginal tax rate is 52% for the highest income bracket.


Katy: Is it like the French system or is Holland a much more liberal country? (Liberal in the European sense, of course.)


Hans: It is quite similar. Nevertheless in a number of ways the Netherlands is a more liberal country. See the economic freedom index ( The Netherlands ranks number 10, behind the US and the UK (3 and 4 respectively), but before Germany (20) and France (44)


Katy: Well, this is most interesting. I appreciate so much that you have taken the time to respond to me. I do hope you are not bored with this discussion, but in any event, please know that I am very grateful.


Hans: Maybe I failed to clearly explain to you how our system is functioning. But I flatter myself with the hope that I have been able to raise your confusion to a somewhat higher level of sophistication. In the mean time I want to thank you to help me for lifting the fog in which many of the phenomena tend to be shrouded by political rhetoric and providing me with inspiration for subsequent articles.


So, what is the upshot of all this? Third Way? No Way! According to Katy (this time without any) Delay.


By Hans Labohm

This article first appeared on