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INTERNATIONAL MONETARY FUND
Norway—2000 Article IV Consultation
Concluding Statement of the Mission
October 24, 2000
1. The Norwegian economy is experiencing another year of solid economic growth, stretching further the current exceptional upswing. As the world's second largest oil exporter, Norway has also become the beneficiary of sizeable windfall gains conferred by the sharp rise in its terms of trade, and these gains have in turn contributed to boosting confidence and demand. The generally sound macroeconomic management of recent years, premised on financial stability and a prudent husbanding of the oil wealth, underlies the present strong economic fundamentals. However, with oil production nearing its peak and the visible build-up in the State Petroleum Fund setting off a clamor for spending more of the oil wealth now, this is also an opportune time for a calm and sober reflection on the long-run policy options facing Norwegian society. The choices made today will determine in large measure the long-run durability of the current prosperity and the scope for enhancing the welfare of both the present and future generations of Norwegians. Myopia as well as misdiagnosis would entail high costs.
2. A sustainable long-run economic strategy should be grounded in the admirable Norwegian emphasis on sharing the benefits of the resource wealth across generations. Here, one needs to begin by acknowledging that over the past quarter century, a sizeable portion of the oil wealth has already been spent through deficit financing which has permitted a large increase in public sector employment. Moreover, looking ahead from the present vantage point of a high oil price, a strong U.S. dollar, and a peak in oil output, any projections of wealth are subject to a high degree of uncertainty—after all, the price of oil was a third of its current level less than two years ago and the secular trend is, if anything, for a decline in the real prices of all commodities. In the face of such uncertainty, experience suggests that wisdom lies in caution. Furthermore, the impending demographic shift implies not only a large and growing burden of the cost of pensions as well as health and care services, but perhaps more importantly, a likely sharp decline in the growth of effective labor supply and future potential output, undermining the economy's ability to provide an aging population with the needed services. Indeed, a rush to raise spending in the expectation of a permanent rise in oil wealth is dangerous not only because it would raise public spending even higher than it is today and would be very difficult to cut back if oil prices were to reverse course later. An expansion of public spending would also risk increasing the layers of bureaucracy, diluting the focus on urgently needed reforms in the pricing, management and incentive structures in the public services and enlarging a constituency against reforms in this sector. Effective reforms may well show that the resource shortages in public services are largely artificial. More broadly, a preoccupation with spending the oil wealth risks diverting the public debate away from the imperatives of other structural reforms—particularly in the product and labor markets—which remain central to raising the potential growth of the mainland economy and easing its transition to the post-oil era.
3. In the short term, the economy, rebounding smartly from the brief pause in the first half of 1999, has gathered momentum over the course of this year and is set to resume another year of solid growth, underpinned by the continued buoyancy of private consumption supported by large wage gains, and a steady rise in public consumption. Indeed, with the level of mainland output expected to remain above potential, resource constraints have become increasingly binding. They are evident in a rate of unemployment that remains below estimates of the natural rate, a historically low vacancy rate, and widening shortages of skilled labor reported across a range of sectors—from construction and information technology to health and care services. Increasingly, cost and price indicators have begun to mirror these overheating pressures. Wage costs, boosted by two additional vacation days, are projected to rise by 5 percent this year, well outpacing the projected increases in the main trading partner countries. Consumer price inflation has picked up to 3 ½ percent and underlying inflation has also accelerated to about 3 percent, well above the rate in the euro area. House and equity prices have increased rapidly as well.
4. The outlook for 2001 is clouded to some extent by the uncertainty about the price of oil and the impact that a sustained high price would have on the prospects for growth in the world economy. Nevertheless, on an assumption of an average price of around $25 per barrel and solid growth in the main trading partners, the central forecast is for some moderation in the pace of expansion of the mainland economy but with a continuing low rate of unemployment and only a gradual decline in the rate of inflation. The continuing tight labor markets suggest that wage drift may be sizeable and, adding in the recently announced supplementary payroll tax, would point to a rise in labor costs of about 6 percent, well above that in the main trading partners. The risks to the projections for mainland growth and inflation from domestic sources are mainly on the upside.
5. Against this backdrop, the logic of the Solidarity Alternative would clearly suggest a restrictive fiscal stance at the general government level to contain demand and minimize pressures on the exposed sector. While in the current climate of opinion the authorities have arguably done their best in sticking to a broadly neutral stance in the proposed state budget, there is a real risk that concessions in the forthcoming parliamentary negotiations and overruns in spending at the central, and especially at the local level, would lead to an expansionary fiscal outcome. Such an outcome would make the task of bringing inflation down to the level in the euro area more painful and could impose excessive strains on the policy framework of the Solidarity Alternative.
6. Over the past year, Norges Bank has enhanced its reputation by judiciously exercising the greater scope for discretion flowing from the consensus that exchange rate stability is to be viewed as a medium-term goal rather than as an operational target, and by effectively communicating its forecasts and policy decisions. However, with Norway's actual and projected inflation remaining well above that of the euro area, and with the support of the social partners and the political community for the increased emphasis on the inflation objective yet to be truly tested, there remains some uncertainty about the future course of monetary policy. In particular, if the actual fiscal stance for 2001 becomes weaker than proposed, this might lead to expectations of a real appreciation of the krone, and in turn, if monetary policy is credible, a nominal appreciation. In such an event, markets are likely to wonder about the point at which Norges Bank would consider it appropriate to request a change in the government budget or a revision of the guidelines for monetary policy. We would reiterate our view that an explicit recognition of the objective of low and stable inflation in a revised mandate to Norges Bank would help enhance the transparency and credibility of the policy regime. The political authorities, as elsewhere, would decide on the choice of the objective for inflation and the time horizon under which it is to be attained, taking into account factors such as the desired level of competitiveness, but giving Norges Bank full operational independence to implement policy. Such a framework would ensure that monetary policy credibility is underpinned by clear institutional arrangements and that there are no incentives for inflation surprises.
7. The extension of the value added tax to cover more services and the closing of the loopholes in the dual income tax regime proposed in the 2001 budget are welcome measures that widen the tax base. The attempt to offset the proposed sizeable boost to spending by other tax increases, however, entails undesirable side-effects. For instance, the increase in the payroll tax would have an immediate impact on costs and the price level. More importantly, acquiescing to new taxes risks making them permanent and providing a rationale for a permanently higher level of public spending. Moreover, ad hoc increases in taxation to meet the exigencies of the annual budget risk undermining the solid achievements of the tax reform put in place in the early 1990s by introducing distortions into what is generally a clear and rational tax system. For instance, the new tax on dividends tilts the level playing field in the taxation of investment income and could, on the margin, hamper investment in Norway, including in the emerging "new economy". More generally, future consideration of changes in tax policy should be consistent with the principle of neutrality underlying the earlier tax reform and, in particular, with keeping Norway attractive for investment in a world of rapidly integrating financial markets.
8. The long-run sustainability of public finances is intrinsically linked to the authorities' ability to rein in public spending. The lack of a medium-term fiscal anchor that includes a medium-term expenditure plan has probably contributed to a ratcheting up of public spending, especially since the fiscal discipline imposed by public debt in many other countries is lacking. With growth of underlying annual spending exceeding the budgeted amount by ¾ percentage points on average in recent years, there has been significant "base-drift" in the level of public spending. A medium-term fiscal framework would help ensure that spending restraint is achieved on a strategic basis. It may also help bring to the fore the tensions between the popular desire for a large public sector and the adverse incentive effects of the high tax burden needed to support it. Such tensions are likely to rise in an era of increasing competition to attract global resources.
9. A key long-term challenge remains that of stemming the relentless increase in the cost of social insurance benefits. Recent adverse trends in early retirement, sickness absences and disability are of concern and need to be reversed by appropriate changes in incentives. Such changes should encompass a tightening of eligibility rules for disability, restructuring of early retirement and pension benefit schemes to encourage remaining in work longer, and implementing a reform of sickness benefits, taking into account the recent recommendations of the Sandman Commission. Even then, ensuring the long-run viability of the pension regime may require further changes such as a reduction in the value of pension benefits and a move toward a system of a publicly financed basic pension, supplemented by defined- contribution plans.
10. The renewed strains experienced by the centralized system of wage bargaining in the 2000 wage round highlight the fragility of the framework and call into question its ability to deliver wage moderation in the upward phase of the economic cycle. Moreover, any gains in wage moderation are offset by a gradual build-up of distortions at the micro-economic level. One indicator of these is the relatively high compression in the wage structure which acts as a disincentive to the supply of certain types of skilled labor and lowers the returns to education. The ongoing shift toward services, the shortages of skills in the public sector, and rapid international integration pose a growing challenge to the wage determination framework that would need to be addressed in the coming years.
11. The present prosperous times would seem well-suited for an acceleration of structural reforms in labor and product markets. Indeed, with its educated labor force, high penetration of information technology and location in a region which is at the forefront of the development and use of the new technologies, Norway should be well positioned to exploit the sizeable productivity gains that the "new economy" seems to offer. However, to capitalize on these strengths, appropriate incentives in the wage structure and tax policy would need to be in place, and the pace of deregulation and privatization in the product markets speeded up. Measures to improve flexibility in the labor market would help reduce bottlenecks and promote work and education incentives. The recent decisions to sell the second largest public sector bank and to move fast to privatize telecommunications are welcome, but it would be desirable to address the complex issues in reducing the public stake in the petroleum sector as well. Finally, the reform agenda would have to give priority to overhauling the extensive and costly regime of protection to agriculture. Trade liberalization in this sector would tend to benefit exports of developing countries and would aptly complement Norway's exemplary record of official development assistance.