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San Marino 1998 Article IV Consultation
November 23, 1998
2. Despite these advantages, several characteristics of the Sammarinese economy nevertheless render it vulnerable to adverse shocks. First, the scope for active policy responses is limited by the use of the Italian lira (and, in the immediate future, the euro). Second, the economy’s openness and small size relative to potential external shocks preclude a role for counter cyclical fiscal policy. Third, economic activity has grown in part by exploiting favorable tax advantages, which may come under pressure in the future. The challenge for policymakers is to reduce this vulnerability by maintaining strong public finances, and by further enhancing the flexibility of labor, product and financial markets.
The Public Finances
3. San Marino’s tradition of prudent fiscal policy has enabled the government to impose generally low rates of taxation, while accumulating banking deposits that are sizable relative to its overall expenditures and maintaining only a limited level of debt. However, public finances have come under pressure in recent years. This reflects continued increases in the wage bill, in health care expenditures, a temporary increase in capital expenditures, and an increased fiscal burden from targeted subsidies and tax exemptions. Moreover, in the absence of reforms, prospective demographic developments will place further burdens on the public finances. We welcome the authorities’ commitment to reverse the recent deterioration in the budget, and urge that central administration deposits be stabilized over the medium term as a share of GDP or of total expenditures at levels roughly comparable to those held today, in order to provide an adequate cushion in light of the economy’s above-mentioned vulnerability.
4. Among the new government’s goals are to re-examine the scope and scale of the public sector. They intend to more closely align public and private sector compensation (and thereby reduce labor market segmentation through "wait" unemployment, and the resulting reliance on cross-border workers), to instill a renewed sense of responsibility among public sector employees, and to increase public sector transparency and accountability. This should, inter alia, release resources for necessary infrastructure investment. To this end, we welcome the adoption of the Budget Accounting Law, and the creation of the Public Finances Control Commission. The new information system envisaged under the accounting law should enable a more economically useful preparation of accounts for the enlarged public sector, which will facilitate not only expenditure monitoring and control, but program analysis and efficiency studies as well. The recently imposed hiring freeze should also help to halt growth in public sector employment, but should be viewed as a temporary tool of control, to be replaced by a more reasoned reduction in and redeployment of staff, in the context of general public sector reorganization. We also agree that it will be necessary to limit future public sector wage increases (including nonpecuniary benefits), and that a shift to performance-based pay should further improve the quality of public services. Given the demonstration effect from public sector wage developments, these reforms should also provide a salutary benefit for private sector competitiveness.
5. Since the beginning of the decade the government has increasingly relied on targeted tax and social security exemptions and subsidies in order to ease restructuring, induce economic activity in specific sectors, or subsidize particular goods and services, including first-time house purchases. We welcome the fiscal transparency displayed regarding these costs in the budget documentation, and recognize the social dimensions of the policies. Nevertheless, we feel that such intervention is an inefficient way of achieving the desired ends, since it distorts activity in a way inconsistent with the economy’s underlying comparative advantage. It also places a sizable burden on the budget, and stands in contrast to a general pattern among other economies, including in Europe, of reduced direct intervention. It would be preferable for the government to focus on providing needed infrastructure investment that would support higher value-added activity more broadly, or to lower tax rates more generally, rather than to target specific sectors. We are therefore encouraged by the indications that the government may soon review some of these deductions, and urge it to reexamine the logic behind these subsidies. We also welcome the government’s intention to adjust public sector tariffs to bring them in line with, and to index them to, their costs of production.
6. While the rate of growth of health care expenditures has been reined in in recent years, the per capita level of these expenditures remain significantly above those in Italy in general and even in surrounding regions, and is unlikely to be fully explained by a higher quality of services in San Marino. We agree that the recent imposition of fees for services provided to nonresident citizens should help to defray costs at the margin, and that an agreement allowing Italian citizens use of prespecified facilities without prior approval, to be financed by local Italian health units, would further improve the rate of utilization of domestic facilities. However, in a world of rising health costs, and in light of prospective demographic developments, continued free and universal health care may require sizable increases in health care contribution rates. Public/private partnerships in the provision of services may be possible in some particular instances to limit costs, but it should be noted that the experience of a number of other countries suggests that private sector health care provision is not necessarily less expensive. Thus, in order to rationalize usage, we would suggest the consideration of fees and co-payments.
7. Following the election-related lull, we welcome the renewed preparation for reforms in the pension system. We understand that the discussions are at a preliminary stage, with a wide variety of proposals under consideration, including possibly a shift toward some form of a fully funded, defined-contribution component. In light of San Marino’s enviable position regarding its overall public deposits, such a shift would appear to be feasible with relatively limited distortions. Moreover, this would improve incentives to contribute to the system and could also improve intergenerational equity.
8. Were such a reform to be adopted, however, a number of other considerations should also be borne in mind. First, the government would still have to provide a minimum level of income as a social safety net for the poorest segment of society. Second, the transition period would be lengthy, and existing and future pension rights of current contributors would have to be financed through a combination of their remaining contributions, a decumulation of existing social security assets, and possibly through general revenues. For this reason, we agree that it would be desirable to change the basic parameters of the existing system, so as to place it on a sound financial footing. In particular, retirement ages, contribution rates, accrual rates and base periods for pension calculations should be reviewed. Third, the defined contributions accumulated by participants in the new system should be managed, whether publicly or privately, with the sole goal of maximizing returns for an appropriate level of risk, and should not be used to subsidize or promote nascent financial institutions or sectors.
Labor and Product Markets
9. The government has taken a number of positive steps to liberalize and improve the flexibility of the labor market, including the full elimination of backward-looking inflation compensation in the public and private sectors, and improved labor market retraining capabilities. In addition, reforms currently contemplated in the public administration should reduce labor market segmentation through "wait" unemployment, thereby increasing domestic private sector labor supply and reducing reliance on cross-border workers. We understand that consideration is also being given to expanding the scope for temporary employment and to further liberalizing the rules governing hiring from the employment list. This would result in improved job matching, and is welcome. We would also suggest considering the possibility of alternative, including private sector, job placement services, in order to further facilitate the matching of both short- and longer-term supply and demand for labor market services.
10. We welcome the government’s intention to review the "business licensing system" (sistema concessorio). We support the aim of reducing the role of "political discretion in awarding such licenses" (la discrezionalitá politica dell’ atto concessorio). Indeed, this represents an important step towards product market liberalization, which would increase productivity in the Sammarinese economy. It would also enhance the economy’s dynamism in light of evolving technology and consumer preferences, and would in turn facilitate labor mobility.
11. The Sammarinese financial sector has made important contributions to economic development in recent years. Banks are well-capitalized, profitable and have shown remarkable resilience to changes in sudden shifts in financial flows and in investor preferences. The period ahead will offer opportunities to further broaden the scope of services offered by the domestic financial system, but also bring increased competition from foreign institutions and an increased demand for effective supervision.
12. We understand that the Financial and Exchange Agreement with Italy should be fully implemented in the coming weeks. The soon-to-be-adopted bill on money laundering is welcomed in its own right and has helped to facilitate this agreement. The Agreement, by allowing Sammarinese banks to undertake financial transactions directly with non-Italian counterparts, should promote the provision of a greater diversity of services at home, and reduced costs for local businesses regarding their transactions abroad.
13. The anticipated adoption of the euro should also further economic prospects by lowering exchange rate-related costs and risks, and by promoting a higher degree of economic specialization and integration throughout the euro area. We are sympathetic to the authorities’ desire for a formal clarification on the part of EU institutions of San Marino’s monetary status, and would welcome a statement to this effect in order to facilitate a smooth transition to the euro.
14. These new developments, while offering increased economic opportunities, are not without their costs. Unlike other financial systems in the euro area, it is not anticipated that Sammarinese banks will lose substantial revenues from the reduced scale of foreign exchange transactions. But the introduction of a common currency should reduce costs and increase efficiency in the banking sector, both in the euro area in general and in Italy in particular, thereby increasing competition with Sammarinese banks. Moreover, nominal convergence in the euro area has led to lower inflation and interest rates, resulting in a switch in investor preferences from comparatively simple repurchase transactions to increasingly sophisticated financial products and services, requiring more highly trained banking personnel and increased expenses relative to banks abroad that had already provided these services. In addition, the increased variety and sophistication of the domestic financial service sector (which may soon include an insurance industry), will place increased demands on the supervisory system. It will become increasingly important, as the Sammarinese financial community further integrates its activities with other European institutions, that the supervisory authorities are in a position to monitor the financial system using standard benchmarks that are internationally comparable. In this regard, we encourage the authorities to adopt as soon as feasible the Basle Core Principles for Effective Banking Supervision.
15. The authorities have made great strides in improving their statistical system in recent years. Monetary statistics are largely compiled on an internationally comparable basis, and it is anticipated that current difficulties in distinguishing customers on the basis of residence will soon diminish. The accounting system included in the newly adopted Budget Accounting Law should facilitate the provision on a timely basis economically useful consolidated data on the central administration and enlarged public sector. National accounts estimates are also now available using the latest European Statistical Agency methodology, which is notable given that very few EU members have yet to adopt this system of accounts.
16. Despite these improvements, it is important that further efforts be made to effect improvements required to bring the statistical system up to the level necessary for informed economic policymaking. Moreover, expectations by the international community relating to the provision of comprehensive and timely statistical data have recently increased, although due regard must be paid to limitations imposed by San Marino’s small size. In this context, it would be useful if monetary statistics were made available monthly, and fiscal data under the new system initially on a quarterly basis at the least. It is imperative that additional trained personnel be devoted to compiling the national accounts, including conducting underlying economic surveys necessary for their estimation. Balance of payments data are less informative and important, given the absence of border controls and San Marino’s use of a common currency with the surrounding region. However, data on private sector industrial production, wages and unit labor costs would be useful in monitoring external competitiveness and San Marino’s evolving comparative advantage. As resources permit, improvements in consumer price data would also be welcome.
17. The Sammarinese authorities are faced with a number of new challenges and sizable new opportunities. The economy is well-placed to address these given its diversity and history of prudent fiscal policies. We encourage the authorities to implement those reforms necessary in order to make best use of the opportunities ahead.