The following OECD assessment and recommendations summarise Chapter 3 of the Economic survey of Norway published on 30 January 2007.
Should fiscal policy undershoot the rule?
Conversely, fiscal policy has been running a larger deficit than targeted in each of the first five years of the fiscal rule’s existence. This overshooting was initially justified by weak economic conditions and asset prices, thereby helping to stabilise the economy. Once the recovery started in 2004, however, there was no need for fiscal policy to continue providing stimulus, especially with the output gap turning positive in 2006. The spending of oil income in excess of the 4% expected real return on the Fund has gradually been reduced every year since 2003. The 2007 Budget reinstates a strict adherence to the fiscal rule. The structural non oil deficit is estimated by the authorities at 4.6% of mainland trend GDP, which is 0.3 percentage points higher than in 2006, suggesting a modest stimulus. Government expenditure is projected to grow by 3 per cent in real terms, with large increases going to primary education, foreign aid and infrastructure projects. In view of the strong economic momentum, a slightly more ambitious budgetary stance would have been desirable. Therefore, any windfalls in 2007 should be used to strengthen the budget. Over the medium term, it will be important to undershoot the rule sufficiently to compensate for the cumulative overshooting to date, consistent with the symmetry enshrined in the fiscal rule. The economic justification is threefold: first, a sharply expanding baseline for the rule, owing to high oil prices, could over stimulate the already well heated economy if strictly adhered to; second, there is a large fiscal gap after 2020 arising notably from steeply increasing ageing related expenditure; and third, boosting spending now, i.e. on more generous welfare programmes, risks adding to the long term challenges of fiscal policy. In view of these fiscal challenges, the authorities might consider introducing an expenditure rule.
Spending under the fiscal rules
As a percentage of mainland trend-GDP
Source: Ministry of Finance.
In order to respect Norway’s obligations vis-à-vis all generations, fiscal policy needs to be forward looking in not only a quantitative sense, i.e., by following the fiscal rule, but also qualitatively. This means, above all, using the oil money in ways that do not distort the work leisure choice. Norway has so far been remarkable in providing incentives for older workers to remain in the labour market and in setting the retirement age at 67. Nonetheless, there are signs that the tradition of relatively late retirement is being increasingly undermined by policy settings. If exits through disability pensions for persons older than 50 years and AFP early retirement pensions are included, the expected retirement age is now down to 63½, i.e., 3½ years less than the formal age of retirement. This is a sign that welfare policies have a large impact on the participation of older workers. Thus, any reform of the pension system should restore later retirement incentives and close early exit routes.
How can the pension system be made more sustainable?
Norway should be no different from other OECD countries that have all instituted pension reforms. It is true that in Norway old age pensions are partly pre funded by the oil cushion. Nonetheless, even if the expected income from the oil fund were to be exclusively used to pay for future pensions, this would cover only about 40% of the pension funding gap. The pension system is still immature and the high female participation rate is recent, which obscures the underlying deficit. The combined effects of the retirement of baby boomers, longer life expectancy, maturation of the system and declining labour utilisation imply that the pension system is not on a sustainable footing.
A comprehensive pension reform proposal was formulated in 2004, and in May 2005 Parliament reached broad agreement on key elements of the reform, that are now being put into place. In January 2006, a new mandatory occupational pension scheme was introduced, with a minimum contribution rate, and employers have started to make contributions. The Petroleum Fund was also transformed into a “Global Pension Fund” and merged with the existing NIS fund; although largely symbolic, this step should help convince the public that oil revenues should be saved for future use. The pension agreement in Parliament also included the introduction of a life expectancy factor, benefits based on lifelong earnings and pension benefits indexed on an average of prices and wages after retirement.
A new White Paper on pension reform was presented to Parliament in October 2006. The new White Paper retained the proposal concerning the introduction of a flexible retirement age in the Social security system from 62 years based on actuarial principles. At the same time the government proposed somewhat higher pension credits to people with low to medium earnings than in the former White Paper, while preserving the long run fiscal saving envisaged earlier (3% of GDP). The government also stated its intention to negotiate changes in the present AFP early retirement system with the social partners, in order to transform it to a supplementary benefit to the Social security old age pension based on actuarial principles. In order to make this possible, the Government signalled its intention to increase its contribution to AFP in line with demographics. Continuation of the state subsidies should be conditioned to the social partners reaching agreement on reforms coherent with the objective of securing actuarial neutrality in the overall pension system.
In non pension welfare areas, reforms are also essential. Health care and long term care spending is a particular source of concern because its projected increase, most of which is due to ageing, nearly doubles the projected fiscal funding gap. Wide ranging reforms were launched in the health sector to make greater use of quasi market mechanisms, eliminate shortages, raise efficiency and improve citizen satisfaction. However, with the introduction of activity based financing and other related measures, spending accelerated after the reform and, if current trends were to continue, they will substantially add to the required effort associated with ageing.
The Policy Brief (pdf format) can be downloaded. It contains the OECD assessment and recommendations but not all of the charts included on the above pages.
The complete edition of the Economic survey of Norway 2007 is available from:
For further information please contact the Norway Desk at the OECD Economics Department at email@example.com. The OECD Secretariat's report was prepared by Alexandra Bibbee and Benoît Bellone under the supervision of Patrick Lenain.