This Selected Issues paper attempts to quantify the impact of the demographic shift on growth and public finances in Switzerland. It examines the intertemporal consistency between current policy plans and unfunded liabilities, focusing primarily on social security, and explores policy options. It finds that so far, the impact of aging on the economy has been moderate. The number of pensioners has risen in recent years, but this is mainly owing to early retirees taking advantage of the generous disability and pension systems. The paper also examines the need for health care reforms in Switzerland.

Abstract

This Selected Issues paper attempts to quantify the impact of the demographic shift on growth and public finances in Switzerland. It examines the intertemporal consistency between current policy plans and unfunded liabilities, focusing primarily on social security, and explores policy options. It finds that so far, the impact of aging on the economy has been moderate. The number of pensioners has risen in recent years, but this is mainly owing to early retirees taking advantage of the generous disability and pension systems. The paper also examines the need for health care reforms in Switzerland.

III. The Political Economy of Adjustment and Reform in Switzerland27

82. Switzerland’s unique system of direct democracy is sometimes mentioned as contributing to the country’s slow growth. Voters can decide on many aspects of policy, including structural reforms and fiscal management. Since reforms are rarely popular, it is argued that frequent referenda introduce a status-quo bias, and could over time cause growth to fall behind that of peers. This paper tries to shed empirical light on this hypothesis. The issue is important, given that Switzerland will need deep reforms to control the cost of pensions and health care. While other countries confront these challenges as well, none gives so much power to the voters than Switzerland. Three questions appear of particular interest:

  • Does popular participation impede fiscal adjustment or reform?

  • Under what circumstances do voters accept change?

  • Are there well-defined windows of opportunity?

After a brief review of political institutions, the paper will try to answer these questions.

A. Political Institutions28

83. Switzerland is a decentralized state with strong elements of direct democracy. Since consensus is important to help guide legislation through referenda, the federal government has included the four largest parties since 1959: the populist right-wing Swiss People’s Party (SVP), the center-right Radical Democratic Party (FDP), the centrist Christian Democratic Party (CVP) and the left-wing Social-democratic Party (SP).

84. The government has been very stable. The Federal Council is the highest executive body. Its seven members are elected individually by parliament, and each heads a ministry. One federal councilor is elected president for one year. The presidency rotates among federal councilors and has only representative purposes. Between 1959 and 2003 a so-called magic formula fixed the representation of the four main parties. It gave the SP, the FDP and the CVP two seats and the SVP one. However, after becoming the strongest party in the elections of 2003, the SVP gained a second seat and the CVP lost one.

85. The legislative power of referenda supersedes that of parliament. Parliament has two chambers, the National Council (lower house) and the Council of States (upper house), which are elected every four years. The 200 members of the National Council are elected by proportional representation. The Council of States comprises two representatives from each of the 23 cantons. All legislative proposals have to pass both chambers of parliament.

Referenda are held at the federal, cantonal and local level. Two main instruments exist at the federal level.

  • A people’s initiative can be called to change the federal constitution, provided it gathers more than 100,000 signatures.

  • A referendum can be called on laws and many international treaties passed by parliament, provided more than 50,000 voters sign a petition.

86. The number of referenda has increased rapidly over time, from 10 or 20 per decade in the early 20th century to currently around 140 per decade (see chart). This number easily doubles if one includes cantonal and local referenda as well. Voter turnout is usually less than 50 percent, but has remained stable since the 1960s despite the sharp increase in the frequency of referenda. This suggest that voters in Switzerland are dedicated and well-informed.

87. Lower levels of government enjoy a great deal of autonomy. Because of historical tensions between different languages and religious groups, Switzerland’s constitution gave strong autonomy to the cantons. Although the tensions have long subsided, cantonal autonomy remains very important. The federal government is therefore comparatively weak, and it accounts for less than a third of public spending. It is responsible for foreign policy, defense, pensions, post, telecommunications, railways, and the currency. All other responsibilities are handled by cantons, including economic regulation, education, health care, and most judiciary functions. Within cantons, communes in turn enjoy a high degree of independence, in particular in fiscal policy.

88. This political system makes for slow legislation. Bills go to parliament only after an extensive consultation process with all interest groups involved. The subsequent parliamentary debate can be lengthy, as members of parliament do not obey strict party discipline. After that, the bill may be rejected in a referendum despite the efforts to ensure consensus. Once approved, however, implementation is quite rapid and efficient.

Figure III-1.
Figure III-1.

The number of referenda has mushroomed.

Citation: IMF Staff Country Reports 2005, 188; 10.5089/9781451807271.002.A003

B. Political Variables

89. The government’s parliamentary majority is usually ample. In most countries, the extent of a government’s majority in parliament defines the coherence of its economic policies. In Switzerland, this majority is rarely challenged, as the four largest parties rule in coalition. Figure III-2 shows a measure of the political majority of the combined federal and cantonal governments. It reflects the share of seats of the four large parties in the federal lower house and the parliaments of the five largest cantons, weighted by population. The majority usually fluctuates around 85 percent of the seats, only declining to 76 percent during the severe economic downturn of the mid-1990s.

Figure III-2.
Figure III-2.

The government’s large majority dipped in the 1990s.

Citation: IMF Staff Country Reports 2005, 188; 10.5089/9781451807271.002.A003

90. The government spans a wide ideological spectrum. One can arrange the political parties of Switzerland along an political left-right axis: Figure III-3 follows the relative ranking of the Federal Statistical Office (2004) and assigns numerical values to ideological positions (as shown below). Values increase from left to right persuasion and range from 1 to 7. These values are then weighted by seats in parliament, both at federal and cantonal elections, to form an index of the weighted average political position of the voters. The lower house represents the federal level, while the five largest cantons (ZH, BE, VD, AG, SG) represent the cantonal level. These cantons together account for over half of the Swiss voters.

Figure III-3.
Figure III-3.

Classification of Political Parties

Citation: IMF Staff Country Reports 2005, 188; 10.5089/9781451807271.002.A003

91. The average political position of voters has been fairly stable over time. The index for the period 1970–2004 is given in Figure III-4. It shows no trend to either left or right, but some cyclical fluctuations. The electorate tended more to the right in the early-1970s, the early-1980s and toward 2000, and more to the left in the late 1970s, late 1980s and in recent years. Statistical tests failed to correlate this left-right pendulum, which swings about every seven years, to economic patterns.

Figure III-4.
Figure III-4.

The average political position has been stable.

Citation: IMF Staff Country Reports 2005, 188; 10.5089/9781451807271.002.A003

92. However, the political distribution has several peaks. Positions of Swiss voters and parties are multi-modal, and the system of proportional representation has impeded a gravitation towards the center. The number of Swiss parties remains high, and the largest two (SVP and SP) have fairly contrasting programs. Figure III-5 shows the political distribution in parliament, using data from Jeitziner and Hohl (2004). The authors rate parliamentarians according to their voting record, revealing three distinct frequencies, with the center being the weakest today.

Figure III-5.
Figure III-5.

The political distribution is multimodal.

Citation: IMF Staff Country Reports 2005, 188; 10.5089/9781451807271.002.A003

93. Within the political spectrum, there has been increasing polarization. While the average of the left-right index remained fairly stable, its variance has widened. Figure III-6 shows the standard deviation of ideology for the period 1970–2004. The dispersion of voters around the mean has increased in a stepwise fashion. This poses a threat to the consensus-based political system of Switzerland as extreme positions make compromise more difficult, and encourage disruptive referenda.

Figure III-6.
Figure III-6.

Political polarization has increased.

Citation: IMF Staff Country Reports 2005, 188; 10.5089/9781451807271.002.A003

94. Even within the federal government, tensions have increased. The Statistical Office publishes voting recommendations of the four government parties. These recommendations have increasingly diverged. The period 1970–2004 saw 325 referenda in Switzerland. Each of the four government parties issued voting recommendations, which are given numerical values (“no” = 0, “yes” = 1, and “without recommendation” = 0.5). The standard deviation of this measure is an indicator of tensions in the government. Figure III-7 shows that tensions have again built up after a lull in the mid-1990s. Contradictory positions can undermine the government’s overall strength in persuading voters.

Figure III-7.
Figure III-7.

More tensions in the government in recent years.

Citation: IMF Staff Country Reports 2005, 188; 10.5089/9781451807271.002.A003

95. Political polarization partly follows the economic cycle (i.e., is procyclical). The secular trend towards increasing polarization may be due to Swiss society becoming less homogeneous. Families are getting smaller, while individualism, globalization, and affluence gradually loosen traditional values. Around this long-run trend, a cyclical pattern emerges that can be linked to the economy. Figure III-8 compares the (detrended) polarization index with staff estimates of the output gap, lagged by two periods. Economic upturns were associated with increased polarization, while recessions favor moderation and unity. Voters thus seem less inclined to political experimentation in difficult times. In fact, a statistical test indicates that the output gap Granger causes a change in polarization (Table III-1).

Figure III-8.
Figure III-8.

Upswings tend to favor political polarization.

Citation: IMF Staff Country Reports 2005, 188; 10.5089/9781451807271.002.A003

Table III-1.

Granger Causality between Output Gap and Polarization

article image

C. Fiscal Adjustment

96. Reflecting political pressures, Swiss fiscal policy has been procyclical. Fiscal adjustment mostly occurred during recessions, when the public was more unified. Figure III-9 plots the fiscal impulse together with the output gap. The two series are highly correlated. Slippages occurred during economic upturns, when the electorate was more polarized.

Figure III-9.
Figure III-9.

Swiss fiscal policy has been highly procyclical.

Citation: IMF Staff Country Reports 2005, 188; 10.5089/9781451807271.002.A003

97. Indeed, the structural balance deteriorates mainly through a loss of expenditure control, as show Figure III-10 shows. Recessions restore moderation and fiscal discipline. The inclusive political system of Switzerland is not hostile to fiscal adjustment, but needs a downturn to become active. This makes fiscal policy procyclical.

Figure III-10.
Figure III-10.

Polarization drives expenditure higher.

Citation: IMF Staff Country Reports 2005, 188; 10.5089/9781451807271.002.A003

98. Table III-2 presents formal econometric evidence on the link between fiscal policy, politics, and the cycle. Five-year centered moving averages are used to eliminate short-term noise. The fiscal impulse is the dependent variable, while the output gap and (lagged) unemployment represent cyclical conditions. The procyclicality of fiscal policy is statistically significant. Ideology, government majority and polarization are political variables. A shift in the political climate to the right seems to favor fiscal adjustment, consistent with the preference of conservative parties for smaller government. In contrast, the size of the government’s majority is insignificant, possibly because of offsetting ideological positions. Finally, increasing polarization has the expected negative effect on fiscal adjustment, as it makes expenditure control more difficult.

Table III-2.

Political Economy of Fiscal Adjustment

article image

D. Structural Reforms

99. The many checks and balances of the political system make experiments difficult and encourage a status-quo bias. Nevertheless, the system is able to reform under pressure. We constructed an indicator of structural reform for the years 1970–2004 (see detailed Appendix table). The indicator is based on the results of 162 referenda and 17 unchallenged laws on structural reform. Changes that reduced economic distortions or government regulations have a positive sign. Reforms were classified according to significance, from 1 (least significant) to 3 (most significant). To account for referenda bunching and random lags in the consultative process, the raw numbers were averaged over a rolling five-year period. Figure III-11 plots the resulting time series of structural change. Positive values indicate faster and deeper reform.

Figure III-11.
Figure III-11.

A long recession in the mid-1990s facilitated reforms.

Citation: IMF Staff Country Reports 2005, 188; 10.5089/9781451807271.002.A003

100. During the mid-1990s, severe economic pressure led to a wave of reforms. An inherently conservative electorate slowed the expansion of the welfare state in Switzerland in the 1960s and 1970s, but also resisted structural reforms later on. Only a prolonged recession in the 1990s and a sharp increase in unemployment created the necessary pressure to persuade the Swiss of the need for changes. The mid-1990s saw important reforms of pension and unemployment benefits, competition law and antitrust, the privatization of telecoms and airports, bilateral treaties with the EU, and the introduction of a VAT. The subsequent economic upturn again reduced the reform drive.

101. The introduction of the VAT is an instructive case study. The reform was widely regarded as welfare-enhancing, and the precursor sales tax as highly distortive. Nevertheless, two attempts to introduce a VAT failed in 1977 and 1979. In both years, economic growth was around 2 ½ percent, unemployment was low, and the electorate felt no urgency for structural change. The third attempt finally succeeded in 1993, when Switzerland faced a recession, high unemployment and a soaring fiscal deficit. In this situation, voters even approved a rate increase. The pressure was off again in 2004, when another rate increase to finance pensions fell victim to economic recovery.

102. Table III-3 shows a regression of the indicator of reform on the same explanatory variables as above. While the output gap turns out to be insignificant, unemployment increases the pressure for structural reform. Ideology is not significant, as the broad range of structural reforms ran across party lines. However, both a large government majority and political polarization detract from reforms. The government majority in parliament reached a low point during the mid-1990s in part because of dissatisfaction with the status quo. Opposition parties gained support, and put pressure on the main parties to act. Subsequently, however, much of the protest vote was absorbed by SVP and SP. This reduced the need for the government to make difficult reforms, and also increased internal tensions.

Table III-3.

Political Economy of Structural Reform

article image

E. Conclusion

103. The Swiss political system of direct democracy can adopt reform under economic pressure when the political climate favors compromise. Under these conditions, reforms can be significant and quick, as in the mid-1990s. Once in place, the consensus-based system ensures that reforms are not easily reversed. The present combination of economic expansion, political polarization, and internal stress in federal and cantonal governments, make fiscal adjustment and economic reform difficult.

104. That the system is able to make progress is shown by the recently introduced constitutional “debt brake.” The debt brake is an explicit attempt to break the pattern of procyclical fiscal policy, by stressing structural, not actual balances. In its three years of operation, the debt brake has upheld fiscal discipline in a difficult political-economic environment. For the first time, fiscal adjustment is taking place during an upturn.

APPENDIX Switzerland: Referenda with Economic Content 1970-2004

article image
article image
article image
article image
Type:Direction:O = compulsory referendum (obligatorisches Referendum)F = non-compulsory referendum (fakultatives Referendum)I = people’s initiative (Volksinitiative)G = government counter-proposal (Gegenentwurf)L = unchallenged law1 = decrease in taxations, regulation, distortion-1 = increase in taxation, regulation, distortion

References

  • Federal Statistical Office (2004): Statistical Yearbook, p.754.

  • Jeitziner, B., Hohl, T. (1997): Measuring Political Preferences: Ratings for Members of the Swiss National Council. Schweizerische Zeitschrift fur politische Wissenschaft, 3 (4), 127. Figure III-5 is based on the most recent data for 2004, available under www.parlarating.ch.

    • Search Google Scholar
    • Export Citation
27

Prepared by Benedikt Braumann.

28

See also the Economist Intelligence Unit country report on Switzerland, December 2004.

Switzerland: Selected Issues
Author: International Monetary Fund