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.

VIII. Norway’s Long-Term Fiscal Challenge 1/

1. Introduction

In the medium-term, Norway’s fiscal position appears quite healthy. The state holds significant financial assets in net terms and fiscal surpluses are projected for the remainder of the decade. However, looking into the early decades of the next century, the authorities are faced with the twofold challenge of coping with a projected decline in revenue from the petroleum sector and increased pension expenditure related to the aging of the large population cohorts born in the post-Second World War period.

This chapter reviews two recent studies of the potential size of this challenge, one prepared by government ministries and the other by Norges Bank. The two studies reach similar conclusions regarding the potential gap between net petroleum revenue and pension expenditure that could emerge after 2010 and complement each other to a significant extent.

2. Government’s view of the long-term fiscal challenge 2/

A collaborative effort among a number of government ministries in 1995 produced an analysis of the long-term fiscal challenge Norway faces.

a. Future petroleum production and revenue

Norway’s output of oil and gas has grown rapidly over the last decade or so (Chart 8.1), propelling Norway into second place among oil exporting countries, with net exports reaching an average of 2.8 million barrels per day (BPD) in 1994. Total petroleum output in 1995 is estimated at close to 170 million tons of oil equivalent (TOE), up from around 60 million TOE in 1980. In 1995, the split between oil and gas in total petroleum output was about 85/15 (140 million TOE oil, 30 million TOE gas).

CHART 8.1
CHART 8.1

NORWAY: OIL AND GAS PRODUCTION

(Million tonnes oil equivalent)

Citation: IMF Staff Country Reports 1996, 015; 10.5089/9781451829624.002.A008

Source: Ministry of Industry and Energy.

The petroleum sector has also come to make an important contribution to government finances (Table 8.1).

Table 8.1.

Central Government Petroleum Revenue 1992-95

(In percent of total revenue)

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Source: Ministry of Finance

In recent years, the petroleum sector has accounted for around 13 percent of total central government revenue; with state investment in the petroleum sector netted out, the sector’s contribution has varied between 8 and 10 percent. In relation to GDP, net central government revenue from the petroleum sector (the “net cash flow”; Box 1) has hovered around 4 percent during the early 1990s.

State Involvement in the Petroleum Sector

The Norwegian state is heavily involved in the petroleum sector. First, by Norwegian law, the state holds title to all petroleum deposits on the Norwegian continental shelf and issues licenses to firms interested in exploring for or producing oil and/or gas on the continental shelf. Second, the state is directly engaged in petroleum exploration and production through the wholly state-owned oil company, Statoil. Formed in 1972, Statoil originally accounted for all the state’s involvement in oil and gas production, as well as in the transportation, refining and marketing of petroleum and derived products. In 1984, Statoil’s participation in most production licenses was divided between Statoil proper and the state itself. Since then, Statoil’s petroleum production activities have been divided into two parts: production for its own account, on the one hand, and the management of the state’s direct financial interest (SDFI) in the petroleum sector, on the other. As a result, a part of Statoil’s gross revenue from petroleum production is transferred directly to the state and a corresponding part of its expenditure (operating costs, investment, etc.) is paid by the state. The split between the state’s direct financial interest, on the one hand, and Statoil, on the other, is determined separately for each production license, but is typically of the order of 50/50. The state also takes a direct financial interest in production activities of oil companies other than Statoil, and currently has an interest in most offshore oil and gas fields.

An important objective of Norway’s petroleum policy is to secure for the state a high and stable net cash flow from petroleum activities. There are three principal sources of state petroleum activities. Of these, the dividend on die state’s equity in Statoil is least important. The other two are taxes and royalties paid by oil companies, including Statoil, on the one hand, and the profit from the SDFI in the petroleum sector, cm the other. The most significant elements in the petroleum tax system are the standard company tax of 28 percent and a special company tax of 50 percent. In addition, a royalty amounting to 8-16 percent of gross production value is levied on oil from fields approved for development before 1986. No royalty is levied on gas production.

Based on what is currently known about Norwegian oil and gas reserves and expected recovery rates, 1/ petroleum output is expected to continue to expand through the remainder of the century and gradually decline thereafter (see Chart 8.1). More specifically, total petroleum output is expected to peak at 220 million TOE in 2001, whereafter it is projected to decline to 170 million TOE in 2010, 130 million TOE in 2020 and below 100 million TOE in 2030. However, oil production is expected to peak already in 2000 at 160 million TOE and is projected to decline to below 100 million TOE in 2010 and below 30 million TOE in 2030. Gas production, on the other hand, is projected to increase for another decade or so until it reaches 70 million TOE, whereafter it stays at that level through the first half of the next century.

As Chart 8.1 clearly indicates, projections of future petroleum production have been subject to large revisions in the past. For the most recent exercise, the authorities put a considerable effort into preparing realistic projections; nevertheless, this projection profile must be regarded as highly uncertain, especially in the details. However, some certainty attaches to the general shape of the oil production profile, given that estimates of Norwegian oil reserves have remained stable while estimates of gas reserves have risen. In addition, there are considerable constraints on the expansion of gas output associated with the need for designated pipelines to the purchasing countries. The overall conclusion must be that Norway needs to brace itself for a gradual decline in petroleum output after the turn of the century.

On the basis of an oil price of Nkr 105 per barrel (PB) (US$17; 1996 prices) from 1996 to 1999, and Nkr 120 PB (US$20; 1996 prices) thereafter to 2030, 1/ and the petroleum production profile discussed above, the authorities have estimated the path of the state’s net cash flow through the first three decades of the next century. 1/ The net cash flow is projected to go from around 4 percent of GDP in 1995 to a peak of 8.6 percent of GDP in 2001; thereafter it is projected to fall to 4.6 percent of GDP in 2010, 3 percent of GDP in 2020 and 1.3 percent of GDP in 2030. While a number of provisos are in order, it is notable that these projections indicate a decline in the state’s net cash flow from the petroleum sector of 7 percent of GDP over the first three decades of the next century.

b. Demographic change and pension expenditure

Along with other European countries, Norway is faced with a significant aging of the population in the next century, especially after 2010, and a concomitant increase in the burden of pensions on the state budget; the impact on the budget will be compounded by the simultaneous maturing of the pension system introduced in 1967.

Although small differences in underlying assumptions can make a large difference over a long projection period, all projections of demographic developments in Norway over the coming decades indicate a significant rise in the proportion of older people in the population (Table 8.2).

Table 8.2.

Aging of the Population

(In percent of total population)

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Source: Ministry of Health and Social Affairs

The population growth scenarios are premised on different assumptions regarding fertility, life expectancy and net immigration. Fertility ranges from 1.7 children per woman born in 1980 and thereafter to 2.1; life expectancy for men rises from 74.2 years in 1992 to 76-82 years in 2050 and for women from 80.3 years in 1992 to 81.5-87.5 years; immigration varies between 4-12 thousand persons per year.

It is notable that in all the population growth scenarios in Table 8.2, the proportion of persons above the retirement age of 67 actually declines between now and 2010 but rises steeply thereafter; in the medium growth scenario the proportion of the population aged 67 and above goes from 14.4 percent of the population in 1992 to 13.3 percent in 2010, but the rises to 17 percent in 2030. The rise in the proportion of the population above 80 is also notable. 2/

The aging of the population after 2010, along with the maturing of the pension system, will bring a sharp rise in the number of pension recipients and the ratio of the number of pensioners to the labor force (the “dependency ratio”) (Table 8.3).

Table 8.3.

Number of Pensioners 1/

(In thousands of persons)

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Source: Ministry of Health and Social Affairs

Based on the medium population growth scenario. The growth in the number of disabled persons is expected to slow after 2010 as measures aimed at reducing the incidence of disability begin to show success.

The dependency ratio is projected to remain largely stable at just above 40 percent until 2010 but thereafter to rise and reach 57 percent in 2030.

On the assumption that the pension entitlements of the National Insurance Scheme (NIS) 1/ would be kept intact, under the medium population growth scenario above the authorities estimated that state pension expenditure would begin to gradually rise from the current level of around 7.5 percent of GDP after the turn of the century to reach 9 percent of GDP in 2010, 11.3 percent of GDP in 2020 and 14.4 percent in 2030.

c. Long-term fiscal challenge

Pulling together the authorities’ central projections for net petroleum revenue and pension expenditure over the long run, indicates a growing gap between the two after the turn of the century, which can be interpreted as a measure of the long-term fiscal challenge Norway faces (Chart 8.2). It is, of course, an incomplete measure as it does not take into account the increased health care needs of the aging population nor does it reflect the possibility of reduced expenditure on education for the young. Over the next few years, net cash flow from the petroleum sector will rise steeply while pension outlays will remain fairly stable and at the turn of the century, net petroleum revenue is projected to exceed pension expenditure by 1 percent of GDP. By 2010, however, pension expenditure is projected to exceed net petroleum revenue by more than 4 percent of GDP, by more than 8 percent of GDP in 2020 and by 13 percent of GDP in 2030; the projected cumulative divergence between petroleum revenue and pension expenditure between 2001 and 2030 is of the order of 14 percent of GDP.

CHART 8.2
CHART 8.2

NORWAY: OLD-AGE AND DISABILITY PENSIONS AND PETROLEUM REVENUES

(In percent of GDP)

Citation: IMF Staff Country Reports 1996, 015; 10.5089/9781451829624.002.A008

Source: Ministry of Finance.

The authorities performed some sensitivity analysis which suggest elements of a response to this long-term challenge; thus, an increase in the effective retirement age from 61 to 64, through, for example deferred old-retirement and a reduced incidence of disability, was estimated to lower pension expenditure by almost 3 percent of GDP in 2030. On the other hand, the authorities did not present quantitative estimates of the impact of indexing pension benefits to the price level rather than the general income level, nor of taxing pensions like earned income, possible alternatives for lowering the future pension burden. The authorities have placed great emphasis on the need for fiscal surpluses in the period ahead, as well as the accumulation of resources in the State Petroleum Fund (SPF), 1/ in order to meet the twofold fiscal challenge looming on the horizon.

3. Norges Bank’s analysis of the long-term fiscal challenge 2/

Norges Bank also projects a growing gap between annual petroleum revenue and net expenditures on old-age and disability pensions based on an analysis similar to that of the government ministries. The gap is projected to reach 9-11 percent of GDP over the next 40 years and widen further thereafter. This is a somewhat smaller gap than projected by the government ministries. One reason is that Norges Bank projects that petroleum revenue will decline to 3 percent of GDP in 2030 whereas the ministries project a decline to 1.3 percent of GDP. Also, Norges Bank projects a rise in pension expenditure of 12-14 percent of GDP, compared with the ministries’ 14.4 percent.

Norges Bank has estimated that closing the gap created by the decline in oil revenue and increase in net pension expenditure would require the accumulation of financial assets in the SPF through two expedients--the “Oslo criteria”: (i) saving all increases in petroleum revenue from current levels; and (ii) fiscal tightening of 3-4 percent of GDP. The assets accumulated in the SPF are assumed to generate an (ambitious) average annual return of 4 percent (Table 8.4).

Table 8.4.

Oslo Criteria

(In percent of GDP)

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Source: Norges Bank.

The first of the Oslo criteria assumes an unchanged fiscal position to permit the accumulation of all of the incremental income from the final surge in petroleum revenue, equivalent to 3-5 percent of GDP annually over the next 10 years. However, the combined effects of falling oil revenue and the growing burden of an aging population would erode the assets so accumulated well before the peak in pension expenditure. Merely saving the expected incremental oil revenue is inadequate under all scenarios considered by Norges Bank. Hence the need for the second of the Oslo criteria--fiscal tightening equivalent to 3-8 percent of GDP, depending on its phasing. 1/ Taken together, these measures and the return generated by the investment of SPF assets are estimated by Norges Bank to be sufficient to establish a self-sustaining fund equivalent to about 170 percent of GDP capable of maintaining its assets at a constant level of GDP while contributing to long-term fiscal sustainability. 2/

These estimates are sensitive to the assumed return on SPF assets. The degree of fiscal tightening required over 10 years ranges from 2.1 percent of GDP under a real return assumption of 5 percent to 4.6 percent of GDP for real returns of 3 percent. As discussed in chapter 7, historical financial market performance suggests that the SPF portfolio would have to be oriented more toward equities than cash or bonds to achieve the target annual real return of 4 percent.

4. Conclusion

While the two analyses the of long-term trends in petroleum revenue and pension expenditure--that of the government ministries, on the one hand, and Norges Bank on the other--differ somewhat in their details, they both point to the same conclusion: Norway faces a formidable long-term fiscal challenge. They both underscore the need to set aside resources in the medium-term (in the SPF) to meet future obligations and the need to examine existing entitlements.

STATISTICAL APPENDIX

Table A1.

Norway: Demand and Supply

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Source: Okonomiske analyser, various issues.

Changes in percent of previous year’s GDP.

Excludes items related to petroleum exploitation and ocean shipping.

Table A2.

Norway: Private Consumption

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Source: Okonomiske analyser, various issues.
Table A3.

Norway: Household Income and Saving

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Source: Okonomiske analyser, various issues.

Saving is negative in some years and the changes are therefore not shown.

Table A4.

Norway: Gross Fixed Investment

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Source: Okonomiske analyser, various issues.

Excludes items related to petroleum exploitation and ocean shipping.

Table A5.

Norway: Real GDP by Sector

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Source: Okonomiske analyser, various issues.

Excludes items related to petroleum exploitation and ocean shipping.

Table A6.

Norway: Indicators of Petroleum Activities

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Source: Okonomiske Analyser; Olje- og gassvirksomhet; and Nasjonalbudsjettet
Table A7.

Norway: Indicators of International Competitiveness and Trade Performance

(Annual percentage change)

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Source: Central Bureau of Statistics, National Accounts Statistics; and IMF Research Department.
Table A8.

Norway: Exports of Goods and Services

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Source: Central Bureau of Statistics, National Accounts Statistics.
Table A9.

Norway: Imports of Goods and Services

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Source: Central Bureau of Statistics, National Accounts Statistics.
Table A10.

Norway: Currant Account Balance

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Source: Okonomiske analyser, various issues.
Table A11.

Norway: Net External Debt

(In billions of NKr)

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Sources: NasjonalBudsjettet, various issues; and Norges Bank, Economic Bulletin.
Table A12.

Norway: Labor Market Indicators

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Source: Monthly Bulletin of Statistics.
Table A13.

Norway: Wages and Prices

(Annual percentage changes)

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Source: Okonomiske analyser, various issues.
Table A14.

Norway: Central Government Finances 1/

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Source: Nasjonabudjettet 1996.

On a cash basis, including social security and non-budgetary funds.

Net saving less net real investment.

Table A15.

Norway: Local Government Finances 1/

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Source: Nasjonalbudjettet 1996.

On a cash basis.

Table A16.

Norway: General Government Finances 1/

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Source: Nasjonabudjettet 1996.

On a national accounts basis.

Net saving less net real investment.

Table A17.

Norway: Interest Rates

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Source: IMF, International Financial Statistics.

End of period.

Period averages.