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Assessment and recommendations.

The Norwegian economy is emerging early from a mild recession

The global financial crisis hit Norway less severely than many other OECD countries. The recession was shallower than elsewhere and consumer demand picked up relatively early. This relatively early and strong recovery can be ascribed to a number of factors. The dynamism of household demand and the direct effect of public expenditure growth were major factors in sustaining demand, while the bounce back in oil prices also supported investment in the petroleum sector. By Norwegian standards, there has been a significant rise in the unemployment rate, though it is not expected to exceed 4% and it will fall back as the recovery gathers strength. Good growth is expected for the mainland economy this year, strengthening somewhat in 2011. Amid global uncertainty, some downside risks remain, however, both for the world economy and within Norway.

Policy measures to deal with the crisis were substantial

The economy's resilience can be partly ascribed to the strong policy response. Norway went into the global financial crisis with an expansionary fiscal stance. Augmented by exceptional measures taken early in the year, 2009 saw a massive fiscal stimulus, followed by another expansionary budget for 2010. In addition, the central bank reduced interest rates by 450 basis points between October 2008 and June 2009 and it increased the supply of liquidity. The authorities' response also included a number of unconventional measures: a scheme was set up by which banks could temporarily swap covered bonds against treasury bills, which improved the banks' access to longer term funding. Furthermore, the government established a Finance Fund to supply core capital to banks to strengthen their lending capacity, and a Government Bond Fund to boost the supply of credit in the bond market.

Interbank market liquidity seems to have recovered

The interbank market in Norway seized up as in other countries when the financial markets storm hit. Norwegian banks are heavily reliant on foreign funding and even interbank borrowing is largely dependent on foreign interbank markets, completed by swaps between US dollars or Euros and Norwegian krone (NOK), making the NOK-denominated interbank market very small. In addition to the measures taken in Norway itself, the supply of dollar liquidity from foreign central banks thus directly helped to restore the functioning of the Norwegian interbank market, and it has subsequently benefited from the better situation of global financial markets.

Extraordinary liquidity measures are being wound down and policy interest rates have begun to rise

As the financial market situation improved, the central bank began to phase out many of the exceptional liquidity measures in summer 2009. Credit conditions have eased, first for households, then for the corporate sector, with less uncertainty in the markets and perceptions of an improved economic outlook. The rebound in the housing market since the drastic cuts in interest rates in late 2008 has been remarkable. High incomes and employment explain some of the strength of house prices, but some indicators such as price-to-rent ratios suggest that prices are above long-term average values. It is thus unclear if a bubble is developing. Even if it were possible to identify such an asset price bubble, there is much uncertainty and discussion internationally about the appropriate response and it is not clear in any case whether monetary policy alone could easily head it off. While the target for monetary policy should remain price stability, it is advisable to ensure that asset prices--notably house prices and the exchange rate--are sufficiently taken into account in the monetary policy reaction function, in the light of their implications for the real economy and thus for inflation. In fact, partly in response to rising house prices, the central bank was one of the first among OECD countries to begin reversing monetary easing, increasing the policy rate by 25 basis points in October 2009, a further 25 basis points in December, and pointing to a rise of another 100 basis points over the next year. This appropriate tightening will, if the recovery proceeds as currently foreseen, need to continue firmly, but progressively so as to reduce the risk of excessively sharp exchange-rate appreciation.

A timely exit strategy calls for prompt fiscal tightening

With a recovery apparently underway, the large fiscal stimulus needs to be withdrawn to avoid overheating in 2011-12. Such fiscal consolidation would reduce the need for a tighter monetary stance, which would push up the exchange rate and might induce destabilising capital inflows. A better policy mix would be to begin to reduce fiscal deficits, allowing a more gradual withdrawal of monetary stimulus. In this light, the further expansion embodied in the 2010 budget of about 0.6% of GDP, while useful as insurance at the time the budget was formulated, now appears excessive in retrospect. If the recovery evolves as expected, deficit reductions need to start in earnest soon, aiming at a return to the 4% path--that is, the structural non-oil central government deficit should be 4% of the Government Pension Fund Global (GPFG)--by 2013, or even earlier. A fiscal consolidation package should include a reversal of the remaining anti-crisis measures; many have been terminated already but some have been converted into new spending. In addition, generous transfer schemes such as sick leave and disability should be reformed and spending cuts may be envisaged in those areas of public spending where there is evidence that resources are used inefficiently, as discussed below.

Pro-cyclical deviations from the 4% path should be avoided and its implementation integrated with multiannual budgeting

The purpose of the GPFG is to support long-term management of petroleum revenues. Proceeds from the fund are used to finance the non-oil budget deficit. Since 2001 this framework has been supplemented by the fiscal guideline stating that only the expected long run real returns can be channelled into the budget; the long run real rate of return is estimated to be 4%, and over time the non-oil structural deficit should correspond to this. Taken together, the GPFG and the 4% guideline have had a major, highly favourable impact on both the economy and public finances. It is important to maintain this framework.

In practice, the structural non-oil central government deficit has averaged only slightly more than 4% of the GPFG since its inception in 2001. However, in 2009 it overshot by a very wide margin in response to the recession. Returning quickly to the 4% path, as suggested above, will be key to maintaining its credibility as a guide to fiscal policy. Moreover, it will help to preserve the GPFG for future generations, as intended, helping to finance the expected substantial increase in ageing costs. Indeed, the authorities should seize the opportunity of periods of above-trend growth after 2013 to undershoot the 4% path. This would reinforce the credibility of the framework by confirming that it is operated symmetrically. Credibility of the 4% guideline would also be strengthened by developing a multi-year approach to budgetary planning, which would specify the fiscal measures envisaged by the government in the coming years; this would prove especially useful in the context of the need for a period of fiscal consolidation. Norway could also follow the example of some OECD countries and create a fiscal council, which would periodically evaluate budgetary developments, including the implementation of the fiscal guidelines, thus providing further transparency and enhanced credibility.

Current fiscal policy must also be seen in the context of longer-term objectives, as overspending today widens the long-term fiscal gap. Filling this gap, estimated by the Finance Ministry at an excess of spending over revenue of 6% of GDP in 2060 (the pre-crisis estimate was 3.5%), despite expected revenue from the GPFG, will require the completion of the pension reform, both to reduce expenditure and to encourage higher labour participation. The latter is one of the most effective ways to reduce the long-run gap. In this regard, a key piece of the reform will be to harmonise the actuarial adjustment in disability benefits with those already implemented in old-age pensions.

Fiscal consolidation should include measures to reduce sick leave and disability spending and also focus on low-efficiency spending

Reforming sick leave and disability benefits would be doubly beneficial for public finances, by on the one hand allowing sizeable expenditure savings and, on the other, increasing participation and hours worked, thereby boosting tax revenue. As recommended by the previous Survey and by the 2006 OECD Sickness, Disability and Work Review, it is necessary to tighten the access to sickness and disability benefits. In addition, employers should co-finance sickness and disability benefits and a reduction in the rate of long-term sickness benefit should be considered.

The share of public spending in mainland GDP is one of the highest in the OECD and there is evidence of spending inefficiencies, for example in education, which was the subject of a special chapter in the 2008 Economic Survey, and health care, which was reviewed in the 2005 Economic Survey. Comparisons of outcomes (such as pupil performance for education, or life expectancy for health) and expenditure across countries, controlling for factors such as socioeconomic conditions and income levels, show that Norway is not getting as much as it could from its public expenditure.

In education, closing cost-ineffective schools should lead to resource savings and the government could consider funding incentives to encourage municipalities to pursue this faster. In higher education too, there are too many institutions for economies of scale to be pursued effectively and some of these could be closed. Significant savings could be made from reducing the subsidy to students in higher education, some of which could be diverted to early childhood education where the impact on improving equity would be greater. Other reforms, such as giving teachers outcome-based targets, and merit-based salary policies, could improve results and, later, make room for improved utilisation of resources.

In the health care sector, there were reforms some time ago designed to improve efficiency, notably the centralization of hospital responsibility and the organization of hospitals as enterprises, and moves towards fee-for-service financing. Though some measures of efficiency have improved over the last decade or so, overall spending climbed rapidly partly because of the fee structures themselves, partly because of the lack of hard budget constraints imposed on hospitals; the number of doctors and nurses relative to the size of population is at present significantly above OECD average, for example. Restructuring and merging of cost-ineffective healthcare institutions must be pursued, including through more effective cost control. Co-payments should be introduced or increased where there is evidence of excessive consumption, compared with assessed care needs, and demand is price-sensitive; this may be the case in physiotherapy and care for the elderly, for example. Co-ordination between municipalities and hospitals also needs to be improved.

Spending efficiency should be improved further, including at the local government level

This and previous Surveys highlight the need to increase the efficiency of public spending. The growth of public employment, especially at local level, must be better controlled. Existing tools, such as regulatory impact analysis and cost-benefit analysis, should be used systematically and given more weight in policymaking. Wide dissemination of information on performance of schools, hospitals and other public services can also be useful in securing support for expenditure rationalisation.

Efficiency and neutrality of the tax system can be improved

The already high level of taxation should not be increased. Tax expenditures in Norway are not especially high but are growing fast, especially in housing. Generous tax treatment of housing, for which there is no obvious economic justification, is likely to distort investment decisions and may have contributed to the house price boom. Reform of housing taxation should include measures to phase out the asymmetries resulting from the deductibility of interest payments on owner-occupied dwellings without taxing imputed rent, and from the remaining substantial discount applied to housing for the wealth tax. Marginal tax rates at high income levels could be reduced, partly to reduce the incentive to misreport labour income as more favourably treated capital income. Reducing progressivity could also increase returns to education, and thus provide stronger incentives to undertake higher education studies. Revenues losses from such measures could be fully compensated by the increases in housing taxation.

Banks, and the supervisory system, performed well in the crisis

In the last two years, banks' losses have increased, though less than in other OECD countries. The strong earnings that Norwegian banks had accumulated over the previous upturn had given them some buffer to face the crisis. Relatively risk-averse behaviour in the financial sector was partly due to sound financial regulation for all types of financial institutions, including uniform capital requirements, with conservative treatment of subsidiaries, off balance sheet assets and securitisation. The existing deposit guarantee scheme helped to avoid runs on banks, and it was not necessary to increase the coverage level or provide a government guarantee for banks. Eksportfinans, the public export credit agency, made substantial losses on the securities market and was supported by the government; one other Norwegian-based institution, a subsidiary of an Icelandic bank, also got into trouble. The macro-prudential framework appears to have performed well, with the three responsible institutions--the Ministry of Finance, Norges Bank and the Financial Supervisory Authority (FSA)--maintaining close contact and co-operation. It will be critical to maintain such relationships in the future, and for all three institutions to maintain heightened awareness of systemic risks posed by excessive credit growth, asset price increases or indebtedness. In the aftermath of the crisis it would be useful to strengthen further the macro-prudential framework in line with the decisions adopted at the European and worldwide levels. Norway's participation in the new EU supervisory framework seems assured. It should in addition examine areas where it would be feasible to adopt its own reforms, if doing so would address possible areas of weakness. For example, risks linked to high household indebtedness could be reduced by introducing a limit on loan-to-value ratios, which would also give mortgage borrowers additional protection against overly-aggressive lending practices. The supervisors should continue to encourage banks to build additional capital cushions against future risks, such as potentially bad loans for commercial property and shipping, and in the Baltic States. For DnB NOR, the dominant institution in the market of banking insurance and fund management, raising private equity could give the opportunity to significantly reduce government ownership, helping to reduce perceptions of an uneven playing field. However, the authorities are concerned that this would risk DnB NOR being no longer subject to Norwegian prudential regulation and supervision if it were acquired by a foreign bank and operated as a branch. Also, to reduce the incentives to risk-taking, fees paid to the Bank Guarantee Fund could vary more as a function of the risk characteristics of banks' portfolios than they do now. The ceiling on the size of the Fund should also be removed, and fees could vary inversely with the cycle.

The sustainable development strategy establishes useful principles for promoting green growth ...

Norway has long been a key promoter of environmental and social sustainability as well as sustainable economic growth as essential objectives of economic policy. The incorporation of the current strategy for sustainable development into the 2008 budget documentation was partly intended as a sign that it should be central to all policy making. The strategy sets out a number of indicators for judging progress as well as some key principles that are to be applied in policy making. In addition, the strategy makes clear that policy options should also be subject to a test of cost-effectiveness, once these principles have been applied. This test could usefully be incorporated into the principles themselves, to foster maximum progress for given use of resources.

... though the objectives and potential trade-oils could be clearer

These indicators should not be treated as objectives. As objectives the indicators may suffer from two important defects: a narrow focus on certain problems to the exclusion of others; and the inclusion of indicators which represent policy inputs rather than policy outcomes; for example, the level of official development aid. The list of indicators should be kept focused, but would benefit from a clearer and explicit separation of input from out-put indicators. As an approach to policy in all sectors, rather than specific sectors, sustainable development may not need the same level of attention in every budget. However, if the government wishes to maintain sustainable development as a central policy objective, the budgetary and policymaking process should periodically start with an assessment of progress and needs from the sustainable development perspective, in line with the four-yearly revision of the Sustainable Development Strategy.

Climate change is a key priority: Norway's ambitions can be a valuable example to other countries

Blessed with enormous hydroelectric and petroleum energy resources for its small population, Norway is also cursed with responsibility for significant and growing emissions of greenhouse gases from the petroleum industry itself. Moreover, the substantial use of hydro power means that, for domestic purposes, Norway already has a very high share of renewable energy and that further cuts in greenhouse gas emissions will come at a relatively high cost. In any case, Norway plans ambitious emissions cuts, in part to encourage other countries to follow its lead. It has announced a target for 2008-12, 10% below its commitment under the Kyoto Protocol and a 30% cut compared with 1990 by 2020. Norway has declared its ambition to become carbon neutral (taking into account Norway's contribution to emissions reductions abroad) by 2050 at the latest and, as part of a global agreement in which sufficient other countries also take on major obligations, it would bring this target forward to 2030. However, despite reductions in some industries, domestic emissions have risen and, as planned, Norway will use offset schemes such as emission trading and the clean development mechanism (CDM) to meet its short and medium-term commitments. To keep down the cost of meeting its future objectives, and to better demonstrate to other countries how to effectively cut emissions, Norway should rationalise its domestic policies.

Norway could get more out of the C[O.sub.2] tax and the emission trading system, and could address leakage at lower cost

More than 70% of GHG emissions are covered by emissions trading or the variable rate C[O.sub.2] tax. The remaining sectors should be brought into the post-2012 trading system; emission allowances should be auctioned or sold, not issued for free. The C[O.sub.2] tax could logically be abolished for sectors covered by the trading system if Norway were content with the emission targets implicitly reflected in the price in the EU trading system. Stronger action could be achieved with a supplementary domestic trading system or a fiat-rate C[O.sub.2] tax applying to all emissions. While there is concern about potential leakage from certain industries, research shows that the likelihood of significant leakage is rather small. In Norway, the real concern is often regional, as some vulnerable plants are located in remote areas. Allowing such concerns to distort climate change policy does not set a good example. Norway will almost certainly be a big user of the clean development mechanism, and thus has a strong interest in verification and enforcement. In part to demonstrate its commitment in this area and to promote improvements, Norway should consider making extra efforts to improve and develop UN procedures to validate and monitor the effects of CDM projects.

Other policies to reduce emissions, ranging from waste management, urban and transport planning to building standards and educational programmes, also have important roles. The KlimaKur programme should be used not to specify sectoral targets but to provide information on cost-effectiveness to guide priorities in these areas. In parallel, cost-benefit analyses of public investment, and of other programmes designed to reduce emissions, should all use the same, explicit assumption on the cost of emissions (i.e. the price of emission allowances plus any general tax) over their lifetime. For example, given the increasing urgency of action on climate change, consideration could be given to a comprehensive assessment of constraints on cost-effective increases in the supply of hydropower and other renewable energy, which could for example supply European electricity markets, thereby reducing the cost of emission reduction there and earning significant economic returns for Norway.

Sustainability is an essential part of fisheries policy and depends on international co-operation

Following periods of stock collapses and very poor stock levels in a number of important fisheries, sustainability has become a key preoccupation of fisheries policy. The treatment in this Survey is insufficient to draw comprehensive conclusions on what policies make for successful stock management, but it is clear that, in addition to setting maximum limits on the fish catch, some regulation of the fishing technology used, such as net design, remains indispensable. Also indispensable is effective co-operation between the different countries fishing the same stocks; such co-operation needs to cover both agreeing the policy setting, such as maximum catches, and effective enforcement.

Co-operation seems to be easier when few countries are involved than when there are many: the two key stocks that are shared largely between Norway and Russia, with other countries relatively insignificant, have recovered quite strongly over the last decade; but those in the North Sea, shared more equally with a number of countries (the European Union has a common fisheries policy but implementation is delegated to individual countries), are generally still struggling. But Norway too sometimes subordinates the interests of longer-term sustainability to the interests of coastal communities, such as in the case of the coastal cod fishery. Extending and widening the use of a discard ban by the European Union, as experimented with in the North Sea, could be a fruitful area for discussion between Norway and its European partners.

The fishing industry has been weaned off most subsidies but is largely self-regulated and exempted from parts of competition law

In the past, the fishing industry was quite heavily subsidised. As some fisheries have recovered and prices have generally remained high, average profitability is now quite high and the remaining subsidies, though substantial, are through exemptions on fuel and pollution taxes and income taxes for fishermen. In line with the recommendations above, fuel tax exemption should be phased out, if possible in co-operation with neighbouring countries, all of which have similar tax breaks. One reason for improved profitability is that the system of vessel-specific quotas, self regulation and exemption from competition law allow the supply side of the industry to collect a combination of monopoly and resource rents and protect them from new entrants. Such an organisation of the fishing industry may be helpful for resource management purposes, but should not go unchallenged. Without prejudice to the current exemptions, the competition authority should be asked to investigate the operation of the quota system and the governance structure to verify that constraints on competition are no more than is necessary to manage the stocks effectively. Untying quotas from specific vessels and removing restrictions on quota trading would allow competition to improve the economic efficiency of the industry.
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Publication:OECD Economic Surveys - Norway
Date:Mar 1, 2010
Words:3835
Previous Article:Executive summary.
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