What are the main challenges for the Swiss economy?
Although trend growth of GDP has been meagre for two decades (1¼ per cent against 2¾ per cent for the OECD average), per capita income in Switzerland remains among the highest in the OECD. In recent years, output growth was less resilient than in most other OECD countries, with the economy being in recession during the first semester of 2003. This is partly due to the global slump in the financial and capital goods sectors which are very important for the Swiss economy, but the unsatisfactory growth performance is largely attributable to the timid pace of structural reforms over many years. Against this background, there are three major challenges for economic policy:
· In the short term, the most urgent task is to support the projected upturn and to minimise deflation risks, inflation being currently very low. The recovery should not be constrained by a fiscal tightening, while the National Bank should maintain easy monetary conditions, even though it has no margin left for lowering interest rates.
· In the medium term, the main challenge is to increase the economy’s speed limits, mainly by raising productivity growth. Substantial efforts are needed to deal with the serious shortcomings in the functioning of the product markets, which are reflected, inter alia, in the very high level of prices compared with other countries. Moreover, the strict implementation of the new legal framework for competition will be vital.
· In the longer term, the challenge is to keep the public finances healthy. Underpinning this objective is the new fiscal rule that requires that the Confederation’s accounts remain balanced in structural terms. If trend growth does not pick up, a difficult trade-off presents itself between curtailing spending, especially social spending, or raising tax pressure, which could well impair growth potential further. In this light, a further reform of the pension system to ensure its financial viability beyond 2015 appears essential.
Indicators of income and production per capita
At constant 1995 prices and PPPs
1. Excluding Czech Republic, Hungary, Poland and Slovak Republic.
2. The “command GDP” curves are in dark bold, with command GDP defined as:
Command GDP = GDP + (Terms of Trade – 1) * Exports.
How was recent macroeconomic performance?
The downturn in activity has been severe, with almost no growth in 2002 and probably a small decline in 2003. Apart from the slump in the financial and capital goods sectors, exports were hit by the sluggishness of German demand and the franc’s appreciation until spring 2003. In addition, final domestic demand has been depressed by the fall in investment since early 2001, following an investment boom in the late 1990s. Private consumption has also lost steam with the saving ratio drifting up because of mounting uncertainty. The unemployment rate has risen, reaching 3.8 per cent in autumn 2003, the highest in five years, but it is still low in international comparison. Because of weakness in the labour market and the negative output gap, inflation, which was already very low at the start of the recession, fell to ½ per cent (year‑on‑year) in November 2003.
How can monetary policy strengthen the recovery?
Responding to sagging activity, policy has been eased. Monetary policy started to be relaxed at the beginning of 2001 and the 3-months LIBOR rate was cut successively by 3¼ percentage points to 0.25 per cent. As measured by a monetary conditions index, the easing more than offset the real effective appreciation of the Swiss franc, which took place till the spring of 2003, partly in response to international uncertainties. While monetary conditions have become even easier more recently as the franc has weakened, the economic prospects for the rest of the year remain bleak. Activity, which has started picking up in the third quarter of 2003, pulled by exports, will however firm with the international recovery, and growth could reach 1¼ per cent next year, close to potential output growth. Reflecting a large negative output gap, inflation could fall further and even be negative for a few months in the near future. Deflation risks should not be exaggerated but need close surveillance. They could intensify if the negative risks surrounding the outlook materialise, in particular if the exchange rate were to strengthen substantially. In that event, and given that there is no room for further rate cuts, the Swiss National Bank (SNB) should stand ready to use unorthodox instruments to avoid deflation from becoming entrenched in expectations. In this respect, interventions in foreign exchange markets would be most effective. In any case, even in the absence of deflation, the monetary stance should remain easy until the recovery is firmly established. Overall, the monetary policy framework adopted since 2000, with its focus on inflation prospects over the next three years, has allowed the National Bank to respond flexibly and effectively to economic developments.
Three-month LIBOR and the CHF/EUR exchange rate
1. The shaded area corresponds to the National Bank’s intervention corridor.
Source: SNB, Bulletin mensuel de statistiques économiques, October 2003 and OECD.
How urgent is the need to put federal finances back on track?
Following the consolidation of the 1990s, public finances have deteriorated uninterruptedly in the past few years, even though the deficit remains below the euro area average and that of the United States. The budget balance moved from a surplus of 2½ per cent of GDP in 2000 to a deficit of almost 2 per cent of GDP in 2003. While partly explained by sluggish activity, more than half of this swing is the result of a substantial decline in the cyclically‑adjusted balance as conventionally measured. While discretionary measures only played a limited role, it is mostly due to the marked downturn in financial asset-related federal revenues, which have distorted the trend in and calculation of the structural balance. A structural deficit of ½ to 1 per cent of GDP is likely to be recorded in 2003 for government as a whole and the Confederation, instead of the previously projected balanced budget. Fiscal policy in 2004, which is based on a growth assumption of 1 per cent, is in principle bound by the debt containment rule. Its strict application would require the elimination of the federal structural deficit. As this could further weaken an already depressed economic situation, and in view of the uncertain outlook, the government has proposed to relax this constraint to avoid an immediate fiscal tightening, with the structural deficit then being gradually eliminated between 2005 and 2007. Under this scenario, the fiscal stance as a whole would remain slightly expansionary next year, largely because of the planned cut in unemployment insurance contributions. All told, the general government deficit could increase to 2½ per cent of GDP in 2004. The federal authorities’ strategy of taking any restrictive steps only when the recovery is underway seems appropriate, as does the reduction in social insurance contributions as this does not jeopardize the long‑term financial viability of the unemployment insurance system. On the other hand, a further structural deterioration in the public accounts would be neither desirable nor a particularly effective way of stimulating activity in a small and outward‑oriented economy.
Fiscal balances of general government
As a percentage of GDP
1. “Statistique financière révisée” basis. The Swiss structural balance excludes exceptional factors such as the sale of shares in Swisscom in 2002.
Source: Administration fédérale des finances and OECD.
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