The Dutch Government's Collapse and the European Implications

Dutch Prime Minister Mark Rutte announced that his Cabinet would resign April 23. The announcement came after the government failed to agree on budget cuts with its key partner the Party for Freedom, whose support had boosted the minority coalition to a parliamentary majority.

The collapse of the Dutch government comes as no surprise; tensions among the political parties have been simmering for weeks. This does mark the first collapse of a core eurozone government since the European debt crisis erupted in 2010. The upcoming elections and the intervening domestic political paralysis will have wider European implications.

Analysis

Rutte's liberal People's Party for Freedom and Democracy (VVD) formed a government with the Christian Democratic Appeal (CDA) after the elections in 2010. A special agreement with the right-wing and eurosceptic Party for Freedom (PVV), ensured the government had enough votes to secure a narrow parliamentary majority.

The three parties spent March and April attempting to negotiate budget cuts that the Netherlands needs if it is to reduce its budget deficit and comply with the three percent deficit target set by the European Union. The Netherlands has violated the deficit rules set out by the Maastricht criteria since 2009. The government is expected to present its budget plans to the European Commission on April 30 to be reviewed under the excessive deficit procedure, which requires countries to reduce their deficits under the commission's supervision.

PVV leader Geert Wilders stopped negotiations with the coalition the weekend of April 22 and said that the austerity measures under discussion would hurt the Dutch population. He likely withdrew his support hoping that his party (which is having internal struggles after a PVV lawmaker left out of protest against Wilders' leadership) would not be affiliated with the implementation of future austerity measures.

A Wealthy but Troubled Economy

The Netherlands is one of the richest countries on the Continent in per capita terms and is one of four remaining triple-A rated countries in the eurozone (the others are Germany, Finland and Luxembourg). Along with other northern European countries, particularly France and Germany, The Hague has pressured peripheral countries to implement drastic austerity measures since the beginning of the European debt crisis.

Although the Netherlands has one of the lowest unemployment rates in the European Union, the country is currently in recession and is experiencing a real estate crisis that has increased household debt levels and reduced an already low domestic consumption. Because of the ongoing recession, the Netherlands is expected to carry a budget deficit of 4.6 percent gross domestic product in 2013 if no additional budget cuts are implemented. The Dutch government was negotiating cuts of around 14 billion euros ($18.4 billion). The government reportedly planned to increase certain student and medical fees, raise the retirement age to 66 in 2015 instead of 2020, freeze salaries in the public sector and increase the value-added tax.

The Netherlands, a core eurozone country, is now less able to comply with the EU deficit rules that it supported in the past. Rutte is expected to lead a caretaker government and to iron out an agreement with opposition parties that will allow him to present a half-finalized budget plan to the European Commission on April 30.

From Eurozone Anchor to Source of Uncertainty

The European Commission will likely not take concrete measures to enforce Dutch compliance, showing that the institution, especially as regards core EU countries, is not fully capable of enforcing its own rules. At a time when countries such as Spain and Italy have already softened their deficit goals, peripheral European countries will use the Dutch to justify their own resistance against austerity and their failure to achieve deficit targets. This will make it more difficult for Germany to ensure fiscal compliance with the fiscal rules.

The Netherlands has a low threshold for entry into parliament, which makes it harder for a single party to win an outright majority. Because of the high number of parties in parliament, forming a government coalition takes a relatively long time. Elections in the Netherlands would take place no earlier than June. Due to electoral laws, however, they will likely take place in September. Current polls show that Rutte's VVD would remain the strongest party in the country but would still be required to form a coalition. Until then, the Netherlands will remain an uncertain force at the core of Europe, which so far has supported the German and French attempt to stabilize the eurozone in order to ensure containment of German power and the push for austerity measure implementation in the periphery.

Apart from leading to higher borrowing costs, the coming months of political paralysis in the Netherlands will weaken current and forthcoming eurozone rescue measures.

Ratings agencies have indicated that the country's political uncertainty could lead to a downgrade. A loss of the Dutch triple-A rating could have wider European implications because the country's rating affects the rating of the European Financial Stability Facility (EFSF), the only European bailout fund currently in place.

Furthermore, the Dutch Parliament has not yet ratified the second and permanent European bailout fund, the European Stability Mechanism (ESM), which is supposed to replace the EFSF in July. The Dutch Parliament in its current situation is not certain to ratify the ESM, which could mean that the ESM will not be operational by July. This would create new market tensions and a reluctance by the International Monetary Fund to help Europe.

The Netherlands has not yet ratified the fiscal compact. Several parties oppose the pact, which they see as a dictate from Brussels that imposes budget rules that are too strict. While Dutch participation is not required to make the fiscal compact functional, it would be a big defeat for Germany if its immediate neighbor does not sign up.

A Key Moment for Austerity and Euroscepticism

These three points are likely to lead to further market pressure. To some degree they will force the Dutch parties to collaborate and form a government as soon as possible. Once again the European Central Bank will have to step in as the only institution able to delay a further severe expansion of the eurozone crisis.

So far the Netherlands has remained stable throughout the crisis. The government's April 23 fall means the country is apt to become a source of uncertainty and trouble. The upcoming Dutch elections will show how strongly voters in a core eurozone country stand behind austerity as a solution to the crisis and how strongly voters support eurosceptic parties.