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.

V. Norway and the European Union 1/

1. Introduction

In a referendum on November 28, 1994, the Norwegian people narrowly rejected membership in the European Union (EU) for the second time in the last quarter century. 2/ Norway thus broke ranks with the other European Free Trade Association (EFTA) countries seeking EU membership (Austria, Finland and Sweden), which all elected to accede to the EU in national referenda at about the same time. It is very unlikely that the question of Norway’s membership in the EU will again be raised until well after the EU’s upcoming intergovernmental conference at the earliest. 3/

Norway weathered a period of uncertainty--characterized by a softening of the currency and a rise in interest rates 4/--in the run up to the November referendum, partly as a result of the Government’s prompt decision in the aftermath of the no-vote to strengthen the fiscal stance for 1995 in order to boost confidence. 5/ The favorable conjunctural position and the fundamental strengths of the Norwegian economy--discussed in the Staff Report--also contributed to calming financial markets following the referendum. 6/ At this time, it is impossible to discern that Norway has suffered significant adverse macroeconomic effects in the short run from the rejection of EU membership. However, concerns remain about what effects staying out of the EU will have on the Norwegian economy in the longer run, particularly regarding business investment.

This chapter first reviews the economic case that was made for EU membership in advance of the referendum as it sheds some light on these long run concerns. It then turns to Norway’s relationship with the EU and the European economy more generally in light of the no-vote.

2. The economic case for EU membership 1/

It is important to note at the outset that, for two main reasons, the Government made the case for Norway’s membership in the EU to a large extent on non-economic grounds.

First, with the completion of the EU’s single market project and the Maastricht treaty, the development of the political and security dimensions of the EU was expected to gain ever greater importance. It was felt that, as Europe shouldered a greater share of its security burden, Norway, definitely a European country and a founding member of Nato, needed to be a full participant in the deliberations, not least because of its position on the European continent’s northern flank and its common border with Russia. It was also argued that many of the problems Norway faced--for example, in the environmental area--crossed national borders, and that Norway needed to have a seat at the table where common policy responses were formulated; the EU was expected to become the preeminent forum for such policy discussions in the hemisphere in the future. 2/ In essence, the Government’s argument was that the formal surrender of national sovereignty in limited areas entailed by EU membership was more than outweighed by the influence gained over decision that could fundamentally affect Norway.

Second, Norway had largely secured its economic interests in relation to the EU through the European Economic Area (EEA) agreement, which was concluded between the EU and the EFTA countries in 1992 and entered into force at the beginning of 1994. 3/ The EEA agreement incorporated most of the EU’s single market for industrial goods and services, as well as the free movement of capital and people across national borders. The agreement afforded Norwegian firms access to the EU’s internal market on terms very similar to those of EU country firms. Better market access was thus not a major reason for seeking EU membership.

While non-economic arguments figured prominently in the case for EU membership, the Government also advanced an economic case based on some aspects of the EEA agreement which, from Norway’s perspective, could prove costly in the long run. Although the agreement incorporated most of the EU’s single market legislation, it allowed for only a limited role for Norway and the other EFTA countries in the formulation of additional single market legislation, legislation that these countries would be forced to accept in order to preserve the integrity of EEA agreement. The influence of the EFTA countries on the EU’s legislative process was expected to decline even further with the accession to the EU of one or more of the other EFTA countries seeking membership. The EEA agreement also kept Norway out of the EU’s customs union and common agricultural and fisheries policies, implying the maintenance of rules of origin with respect to goods from third countries, as well as of border controls between Norway and EU countries. Finally, the EEA agreement contained no references to economic and monetary union and only very limited provisions concerning economic and monetary policy cooperation.

In light of these inadequacies of the EEA agreement, the Government argued that among the direct, additional long-term economic benefits of EU membership would be:

  • - A stronger competitive position for Norwegian firms as a result of lower input prices and lower transaction costs related to shipments across borders and currency transactions.

  • - More secure access to EU markets through participation in the customs union which would abolish rules of origin, as well as a stronger trade negotiation position against third countries through the pooling of resources with other EU countries.

  • - A lower level of interest rates as a result of a lower risk premium on investment in Norwegian financial assets.

  • - A lower price level and increased household purchasing power related, inter alia, to the abolition of the differential between Norwegian and EU producer prices for agricultural goods. Because of the very high level of agricultural protection that has prevailed in Norway, EU membership was estimated to lower Norwegian food prices by 10-20 percent from the date of accession. 1/

In addition, the Government argued that EU membership could have favorable indirect effects on the business environment in the long run:

  • - Membership could over time strengthen the ability of Norwegian firms to adjust and restructure, both as a result of intensified competition, which in turn would lead to increased productivity, and a more stable and predictable economic environment, relating inter alia to exchange rate developments and access to the European market.

  • - A more stable and predictable economic environment was also likely to cause a greater number of firms in exposed sectors, whether Norwegian or foreign, to choose to locate their activities in Norway, with important consequences for the level of business investment. A permanently lower level of interest rates would pull in the same direction.

These potential benefits to Norway of EU membership needed to be weighed against the costs associated with membership, which the Government equated to the net financial contribution it would make to the EU, i.e. the direct contribution to the EU budget minus the transfers Norway was expected to receive from the EU through the common agricultural policy and from the structural funds. Because Norway’s per capita income exceeded the EU average by a substantial margin it was always clear that Norway’s net contribution would be positive. The Government estimated that, after a five-year transition period, the net contribution would reach 3/4 percent of GDP; 1/ in other words, the cost of EU membership was estimated to reduce Norway’s disposable income directly by 3/4 percent of GDP.

Although the Government did not provide quantitative estimates of the potential benefits accruing from EU membership, it maintained that the spur to economic growth--resulting, inter alia, from a more competitive business sector and a higher level of investment--would over a ten-year period more than cover the costs to Norway associated with membership. More specifically, the Government maintained that the additional growth stemming from membership would over a ten year period exceed the 0.15 percentage points per year needed to compensate the state budget for the net contribution to the EU, given Norway’s tax rate of around 50 percent.

Membership of the EU was thus expected to provide net economic benefits to Norway over the long run, but the desire to seek membership was motivated at least as much by political as by economic considerations.

3. Norway and the European economy 2/

The enlarged EU of 15 countries is by far Norway’s most important trading partner; close to 80 percent of Norway’s goods exports are shipped to the EU and around 70 percent of goods imports originate there. The rejection of membership does not alter this fundamental fact, and the Norwegian authorities are faced with the challenge of developing the relationship with the EU, and the broader European economy, under conditions very different from those provided by membership. The EU is also evolving, with economic and monetary union and enlargement to the east high on the agenda. The authorities recognize that, although outside the EU, Norway will be profoundly affected by its evolution and will need to adjust its policies accordingly. In a sense, being outside the EU may force Norway to be even “more European” than if it were in the EU.

For the foreseeable future, Norway’s relationship with the EU will be premised on the EEA agreement, which, for the time being at least, provides most Norwegian firms access to the EU’s single market on terms similar to those of member country firms. It is, however, clear that the development of this relationship on the basis of the EEA agreement will have to be piecemeal and ad hoc.

In 1995, the Government sought to minimize the disruptive effects of the rejection of membership and the accession of Austria, Finland and Sweden on Norway. For a time, it looked as if the no-vote threatened the long standing passport union among the Nordic countries. The Government sought to avert this threat by requesting associate member status in the Schengen agreement concerning passport free travel within the EU. Whereas the EFTA countries had enjoyed free trade in fisheries products, the accession of Sweden and Finland to the EU raised some trade barriers against Norwegian fish exports to these countries. The Government sought to ameliorate the disruptive effects of these new export barriers on the rather small, but politically important, fisheries sector through negotiations with the EU. The Government has also sought to continue Norway’s participation in the EU’s Trans-European Networks (TEN) project in the fields of transport, telecommunication and energy on a bilateral basis. It seems likely that the authorities will need to react to emerging problems in their relations with the EU on a similarly ad hoc basis more or less continuously. An important issue that the Norwegian authorities have singled out are the strict rules of origin that apply to goods from third countries.

The short run effects of the rejection of EU membership on the Norwegian economy appear to have been quite limited, and even to some extent opposite to what was expected in advance of the referendum. 1/ As noted above, the current upswing and sound stance of policies could be masking the underlying deterioration in Norway’s position, but it also seems clear that the presence of the EEA agreement has also played a role. However, looking to the future, the EEA agreement may gradually cease to be what it was when it was put in place--the extension of EU’s single market to include the EFTA countries--as the single market continues to develop. The accession of Austria, Finland and Sweden to the EU has left the EFTA pillar of the EEA consisting only of Iceland, Liechtenstein and Norway. As a result, the economic significance of the EEA to the EU has dropped dramatically. With the EU’s overloaded agenda, it may prove difficult in the future for Norway to find an audience within the EU for EEA related grievances. A single market less to Norway’s liking could easily make firms wary of locating their investment projects there with deleterious effects on economic growth.

The move to economic and monetary union, and a single currency, within the EU is of paramount significance to Norway because of the close integration of the Norwegian financial markets to those of the EU. Norway has in the past sought to maintain a stable exchange rate of the krone against European currencies, first, through a unilateral peg to the ECU from 1990-92 and, subsequently, through a monetary policy framework with a similar, though less strict, orientation. 1/ Monetary union is likely to affect Norway’s exchange arrangements but, unlike those EU countries that do not participate in EMU, Norway will not be participating in the EU’s institutional structure. At this time, it is unclear what form such arrangements could take for monetary union outsiders within the EU. As the episode with pegging to the ECU during 1990-92 suggests, a unilateral exchange rate arrangement with an EU monetary union could leave the krone vulnerable to market turmoil and speculation. A lack of a stable relationship between the krone and a single European currency could lead permanently positive interest differentials with respect to Europe.

4. Conclusion

Norway’s rejection of EU membership in late 1994 has had limited--if any--immediate effects on the country’s economic performance, and, for the time being, the EEA agreement appears to provide adequate institutional arrangements with the EU. However, it is less clear that this will continue to be the case over the long run, and the Norwegian authorities face important challenges in adjusting to the continuing evolution of the EU.

1/

Prepared by Birgir Arnason.

2/

Norwegians had previously rejected membership in the EU’s predecessor--the European Economic Communities (EEC)--in the early 1970s, when Denmark, Ireland and the United Kingdom became members.

3/

On the first anniversary of the no-vote, Ms. Brundtland, the Prime Minister, said she did not see the EU question arising again during this century.

4/

See Chapter 2 for a discussion of exchange rate and interest rate developments in the period surrounding the referendum date.

5/

The Government had announced in advance of the referendum that, all other things equal, a rejection of EU membership would require a stricter fiscal policy to assure markets that Norway remained committed to sound financial policies. The actual fiscal tightening amounted to about 1/2 percent of GDP.

6/

Norway, for example, comfortably meets all the Maastricht criteria.

1/

This section draws on the National Budget for 1995 presented by the Government in October 1994.

2/

Prime Minister Brundtland summarized the political case for EU membership in a speech she gave to the European Institute in Washington, D.C., on May 18, 1994.

3/

The EEA agreement was eventually ratified by all the EFTA countries with the exception of Switzerland.

1/

Norway’s membership agreement stipulated that Norwegian agricultural prices would be brought down to EU levels immediately upon accession. The agreement also allowed for transitional support for Norwegian agriculture beyond that stipulated under the EU’s common agricultural policy to soften the blow to farmers and food processors. EU membership was at most expected to hasten developments in Norwegian agriculture that would have been inevitable under, for example, the GATT agreement.

1/

The net contribution in 1995--the first year of membership--was put at 1/3 percent of GDP.

2/

This section draws on the National Budget for 1996 presented by the Government in October 1995.

1/

It is, for example, notable that mainland business investment rose markedly in 1995 (21.4 percent) and is expected to do so again in 1996 (7.3 percent).

1/

The current monetary policy framework aims to maintain exchange rate stability against European currencies--in practice the ECU--but without commitment to defend any particular parities. In the case of significant deviation from desired parities--3-5 percent below the ECU peg of 1990-92--Norges Bank will orient its policies to bring the exchange rate, over time, back to the desired parities.