This Background Paper examines the medium-term economic outlook (1997–99) for Norway. The central feature of Norges Bank’s reference case projection for the medium term is that the expansion of mainland output will slow from 3.3 percent in 1995 and 2.8 percent in 1996 to an annual average of 2 percent in 1997–99. Overall GDP growth will also slow from about 4 percent in each of 1995 and 1996 to 2 percent in 1997–99. Inflation is forecast to remain low, at 2 percent in 1996 and on average 2.3 percent per year in 1997–99.

Abstract

This Background Paper examines the medium-term economic outlook (1997–99) for Norway. The central feature of Norges Bank’s reference case projection for the medium term is that the expansion of mainland output will slow from 3.3 percent in 1995 and 2.8 percent in 1996 to an annual average of 2 percent in 1997–99. Overall GDP growth will also slow from about 4 percent in each of 1995 and 1996 to 2 percent in 1997–99. Inflation is forecast to remain low, at 2 percent in 1996 and on average 2.3 percent per year in 1997–99.

I. Medium-Term Economic Outlook1/

1. Introduction

In recent years, Norway has experienced a strong recovery in mainland economic activity and a marked improvement in public finances; employment has also expanded and inflation has remained low. At the same time, oil and gas output and exports have continued to rise rapidly and the current account has moved into a healthy surplus. In the short term, mainland output is expected to continue to grow, albeit at a somewhat slower pace than over the last two to three years, and there are few signs that inflation is picking up.

This chapter reviews the medium-term (1997-99) outlook for the Norwegian economy. Three official bodies, the Ministry of Finance, Norges Bank and Statistics Norway, have recently issued medium-term projections with those by Norges Bank being the most complete. 2/ The projections are, nevertheless, quite consistent and rest on similar assumptions (Table 1.1). With this in mind, the discussion below focuses on Norges Bank’s medium-term projections but also draws on the projections of the Ministry and Statistics Norway.

Table 1.1.

Norway: Medium-Term Projections

(Percentage change in real terms from previous year) 2/

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Ministry of Finance, Salderingsproposisjonen 1996, December 1995.

Figures for 1997-99 are annual averages unless otherwise noted.

Norges Bank, Penger og Kreditt 95/4, December 1995.

Ministry of Finance, Nationalbudsjettet 1996, October 1995.

Statistics Norway, Okonomiske analyser 9/95, December 1995.

A positive change indicates a deterioration in competitiveness. The figure in the 1997-99 column refers to the cumulative change over the period.

In percent of the labor force. The figure in the 1997-99 column refers to the end of the period.

In percent of GDP. The figure in the 1997-99 column refers to the end of the period.

2. Norgeg fiance projections

The central feature of Norges Bank’s reference case 3/ projection for the medium term is that the expansion of mainland output will slow from 3.3 percent in 1995 and 2.8 percent in 1996 to an annual average of 2 percent in 1997-99. 4/ Overall GDP growth will also slow from around 4 percent in each of 1995 and 1996 to 2 percent in 1997-99. Inflation is forecast to remain low, at 2 percent in 1996 and on average 2.3 percent per year in 1997-99.

The reference case is premised on a number of important assumptions. GDP growth among trading partners is assumed to be somewhat slower than earlier, or 2.5 percent per year on average through the projection period.

Fiscal policy is assumed to develop in line with the Ministry of Finance’s medium-term projections in the National Budget for 1996. Essentially this entails no real expenditure growth in 1996 but 1 percent real growth annually in 1997-99, while tax rates will be kept unchanged; on this assumption the non-oil budget deficit is expected to remain largely unchanged through the projection period whereas the overall budget will record rising surpluses as the net cash flow from the petroleum sector rises. 1/

In line with past experience at this stage in the cycle, wage growth is expected to pick up somewhat, from 3.3 percent in 1995 and 3.8 percent in 1996 to an average of 4.5 percent per year during 1997-99. However, this path of wage increases is lower than wage equations estimated on past data would give, as it is assumed that some of the wage moderation that has developed over recent years will be preserved even as the labor market gradually tightens. 2/

With the rate of productivity growth expected to be lower than among trading partners, this wage path implies a gradual deterioration in competitiveness, measured in terms of relative unit labor costs (RULCs); cumulatively RULCs could be about 6 percent higher in 1999 than in 1994.

Rising real wages and increasing employment are projected to raise real disposable income by 2.8 percent in 1996 and 2.5 percent per year on average during 1997-99. Private consumption growth is, on the other hand, assumed to ease to 2 percent per year in 1997-99, down from 3.3 percent in 1995. This entails a gradual rise in the household saving rate from 5.8 percent of disposable income to 7 percent in 1999. This assumption is predicated on the observation that much of the increase in consumption in recent years, that has resulted in a decline in the saving rate, has been related to the purchase of durable goods--cars, furniture, white goods—reflecting the need for replacements after a prolonged period of weak purchases. Counting durable purchases as investment rather than as consumption, indicates a more stable underlying saving behavior among households.

On the basis of stated Government intentions, public consumption is projected to rise by 1.5 percent annually through the projection period.

On the investment side, housing investment, which has risen sharply in response to the fall in interest rates in 1993 and 1994, is expected to expand by a further 8 percent in 1996, whereafter the expansion is assumed to ease to around 2 percent per year.

Mainland business investment, not least in manufacturing, has also shot up over the last two years, and been a major contributor to the broadening of economic growth. Mainland business investment is projected to expand by another 10 percent in 1996, whereafter it is expected to stabilize.

Investment in the petroleum sector is generally on a declining trend, following an intensive investment program in the early 1990s. However, petroleum sector investment is projected to rise moderately in 1997 and 1998 related to enhanced recovery from existing fields in the North-Sea.

A number of factors are expected to contribute to a moderation of the growth of exports. of which there are already signs. Traditional Norwegian exports have a high component of raw materials and typically respond quickly to the beginnings of an international recovery. However, as the recovery matures and growth moderates demand for traditional Norwegian exports tends to ease. The potential deterioration in competitiveness (referred to above) could also hamper Norwegian exports (as well as import-competing firms) although it is difficult to quantify the possible effect. On this basis, it is assumed that the growth of traditional exports will slow to 4.3 percent already in 1996 (from 13.3 percent and 4.8 percent in 1994 and 1995, respectively) and remain at that level through the projection period. It is also foreseeable that the growth in oil and gas exports will soon slow from the double digit rates of recent years; oil and gas exports are projected to increase by a hefty 14.4 percent in 1996, but only by 2.8 percent per year thereafter.

Over the past few years, imports have been boosted by the heavy consumer demand for durables and the sharp rise in investment in business investment; on the other hand, the growth of imports has been tempered by the slowdown in investment in the petroleum sector. With durables demand approaching saturation and mainland business investment stabilizing, overall import growth is expected to slow from 4.5 percent in 1995 to 4 percent in 1996 and to 3 percent per year from 1997-99; the slowdown in the growth of traditional goods, imports is projected to be even more marked, from 9.8 percent in 1995 to 4.8 percent in 1996 and 3.3 percent per year from 1997-99.

While the projections for exports and imports imply that the traditional merchandise trade balance will deteriorate by around 1.5 percent of GDP between 1995 and 1999, increased oil and gas exports, as well as lower factor payments and transfers abroad, 1/ are expected to lead to almost a doubling of the current account surplus between 1995 and 1999, from around 3.5 percent of GDP to 6 percent. 2/

Employment is up sharply over the last two years (a total of 3.5 percent over 1994-95) but the unemployment rate has come down only modestly (1 percentage point) because of a sharp rise in the participation rate. As the rate of expansion of the mainland economy slows, employment growth is expected to slow as well, to 1 1/2 percent in 1996 and 0.8 percent per year during 1997-99. The unemployment rate is projected to continue on its gentle downward trend and reach 3.8 percent in 1999, down from 5 percent in 1995 (and a historical peak of 6 percent in 1993).

3. Ministry of Finance and Statistics Norway projections

The projections of the Ministry of Finance and Statistics Norway do not differ greatly from those contained in Norges Bank’s reference case (see Table 1.1).

The Ministry of Finance projected in October an annual medium-term growth rate of the mainland economy of 2.3 percent, compared with Norges Bank’s 2 percent; mirroring this the Ministry saw employment rising by 1 percent per year from 1997-99, compared with the Bank’s 0.8 percent. The difference is largely one of timing, the Bank having prepared its projections in December, two months later than the Ministry, when the slowdown in the international expansion had become more pronounced. However, the Bank projects a less favorable development in competitiveness than the Ministry. These two factors are reflected in that the Bank projects exports rising by 3.5 percent per year from 1997-99, whereas the Ministry projected a 4 percent annual rise; this accounts for most of the difference in the two growth projections. The difference between the two projections regarding the development of the current account surplus results, on the one hand, from the Bank’s lower export projections, and, on the other, from the Bank’s assumption of somewhat lower oil prices in the medium term.

The projections of Statistics Norway further confirm the conclusions of the projections by Norges Bank and the Ministry of Finance, although they indicate a slightly weaker output performance, largely on the basis of slower private consumption growth.

4. Uncertainties

There are a number of significant uncertainties associated with Norges Bank’s reference scenario (as with the projections of the Ministry of Finance and Statistics Norway), both up and down.

The path of wage increases assumed, although to some extent patterned on past wage behavior, is lower than would be projected on the basis of past statistical relationships; in essence, it has been assumed that a structural change has taken place in labor market relations in favor of wage moderation. This view is supported by the fact that real disposable incomes have in fact risen faster during the recent years of wage moderation than they had during the previous period (1970s and 1980s) of high nominal wage increases, as well as by the rather low demands for nominal wage increases the Confederation of Labor Unions (LO) has brought to the negotiating table in the ongoing wage round. However, because of hysteresis effects, the labor market could be considerably tighter than indicated by the still (in a Norwegian context) relatively high unemployment rate. Furthermore, the rather benign behavior of private consumption projected rests on the assumption that consumer and banks learnt a lesson from the credit driven overheating of the 1980s; however, household balance sheets have strengthened notably in recent years as has the financial position of the banking system.

On the other hand, there is the possibility of a more pronounced slowdown in industrial country economic activity; as a result, the growth of export markets for traditional Norwegian exports could be slower than assumed. Also, while real oil prices are currently far below their highs of the early 1980s, and the likelihood of a collapse in prices as occurred in 1986 seems low, the Norwegian economy remains vulnerable to a shock to oil prices. 1/

1/

Prepared by Birgir Arnason.

2/

Ministry of Finance, Nationalbudsjettet 1996, October 1995; Norges Bank, Penger og Kreditt 1995/4, December 1995; Statistics Norway, Okonomiske analyser 9/95. December 1995.

3/

Norges Bank also looked at cases in which fiscal policy was somewhat tighter and wages rose more moderately. The differences between the respective cases were not large.

4/

According to Norges Bank, the mainland economy is already at, or very close to potential. With the mainland economy expanding by 2.8 percent in 1996, mainland output could well rise above potential. The growth of potential output has been estimated at 2-2.3 percent.

1/

According to the Government’s Long-Term Program for 1994-97 fiscal policy in the medium term is premised on keeping expenditure growth below that of mainland output while preserving the basic elements of the tax system introduced in the early 1990s.

2/

Purely for technical reasons, the exchange rate against the ECU was assumed to remain stable over the projection period at its average level over the three-month period September-November, 1995, and current interest differentials were assumed to be consistent with that stable exchange rate.

1/

Regarding the factor payments abroad, it is worth noting that Norway became a net creditor to the rest of the world in the course of 1995 but that significant dividend payments abroad on the heavy foreign investment in the petroleum sector will continue.

2/

These projections assume oil prices of around US$17 per barrel (1996 prices) through the projection period.

1/

A measure of the vulnerability of the Norwegian economy to an oil price shock is that a 10 percent reduction in the price would reduce exports by around 3 percent and reduce the net cash flow from the petroleum sector to the budget by around 0.8 percent of GDP.