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Country focus: Switzerland: Economic reform in a direct democracy

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
July 2005
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Switzerland’s unique system of direct democracy is sometimes blamed for the country’s slow growth. Voters can decide on many aspects of policy, including structural reforms and fiscal management. But reforms are rarely popular, which leads to the argument that direct democracy bolsters the status quo, which over time could cause Switzerland to fall behind its peers. But is this really the case? A recent IMF Selected Issues paper looks at whether popular participation impedes fiscal adjustment or reform, and examines the circumstances under which voters do accept change.

No other country gives voters as much say on economic policies as Switzerland. Referendums can be called on all laws and international treaties, provided more than 50,000 voters sign a petition. The Swiss currently vote in about 15 national referendums per year, and the number doubles if one includes cantonal and local referendums. Since consensus is important for political success, legislation is slow and involves extensive consultations. For the same reason, the federal government includes the four largest political parties, ranging from conservative to leftist.

political trends

The average political position of Swiss voters has been fairly stable over time. An analysis of federal and cantonal elections shows no trend toward either left or right in the period 1970–2004. The distribution of political power in parliament, however, shows increased polarization between the left, the right, and the center. Among the three political positions, the two dominant parties—the populist conservative SVP and the leftist SP, which have fairly contrasting programs—enjoy the strongest voter support, while support for the center parties has been weaker.

Spending impact

Increased polarization has driven fiscal expenditure higher.

Data: IMF staff calculations.

A strengthening of the extremes at the expense of the center poses a threat to Switzerland’s consensus-based political system. It makes compromise more difficult and encourages disruptive referendums. It has also increased tensions within the federal government, which has a broad political composition. Government parties take contradictory positions in referendums, undermining their ability to persuade voters. Increased polarization may be the result of several factors: Swiss society is becoming less homogeneous; the Swiss are having fewer children; and traditional values are becoming less important compared with individualism, globalization, and affluence.

Apart from these long-term developments, political polarization in the short term seems to follow the economic cycle. Polarization increases during economic upturns, while moderation and unity strengthen during recessions. Clearly, voters are less inclined to experiment politically in difficult times.

Change under pressure

Reflecting political pressures, Swiss fiscal policy has been pro-cyclical. Fiscal adjustment has generally taken place during recessions, when voters have been more unified, while slippages have occurred during upturns, when they have been more polarized. Indeed, the structural balance tended to deteriorate during upturns, mainly through a loss of expenditure control (see chart, left). Recessions restored moderation and fiscal discipline. Switzerland’s inclusive political system is not adverse to fiscal adjustment, but it needs a downturn to trigger action.

The many checks and balances of the Swiss political system encourage a status quo bias during normal times. An indicator based on the results of 162 referendums and 17 unchallenged laws on structural reform for the years 1970-2004 shows that severe economic pressure during the mid-1990s led to a wave of reforms (see chart, page 191). A prolonged recession, large fiscal deficits and a sharp increase in unemployment created the necessary pressure to persuade the Swiss of the need for change. Within a short period of time, the electorate agreed to cuts in pension and unemployment benefits, reforms of competition and antitrust laws, the privatization of telecoms and airports, bilateral treaties with the European Union, and the introduction and increase of a value-added tax (VAT).

The introduction of the VAT is a particularly instructive case study. For decades, economists and the government extolled the virtues of a VAT as welfare-enhancing in contrast to the distortive sales tax. Nevertheless, attempts to introduce a VAT failed in 1977 and 1979, when economic growth was strong and unemployment low. The electorate felt no urgency for structural change and feared hidden tax increases. A third attempt finally succeeded in 1993, when Switzerland faced a recession, high unemployment, and a soaring fiscal deficit. In this situation, voters even accepted a rate increase. Another proposed VAT rate increase failed in 2004, when the economy was in recovery.

Room to evolve

In the Swiss political system of direct democracy, reforms are more likely to be adopted under economic pressure, when the political climate favors compromise. Under these conditions, reforms can be significant and quick, and once in place, they cannot be reversed easily in the consensus-based system. However, the present combination of economic expansion, political polarization, and internal stress in federal and cantonal governments makes fiscal adjustment and economic reform difficult.

Reform urgency

The recession in the 1990s prompted Swiss voters to approve a wave of fiscal and structural reforms.

(indicator of structural reforms)1

Citation: 34, 12; 10.5089/9781451938685.023.A008

1Reforms are classified according to significance. Positive values indicate faster and deeper reforms.

Data: IMF staff calculations.

Nevertheless, the system is able to evolve, as proven by the addition of the “debt brake” to the constitution in 2001. The debt brake is an explicit attempt to break the pattern of procyclical fiscal policy, by stressing structural, not actual, balances. In its first three years of operation, the debt brake has indeed bolstered fiscal discipline despite political polarization. For the first time, fiscal adjustment is actually taking place during an upturn.

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