Selected Issues

Abstract

Selected Issues

Wages and Competitiveness in Norway1

Wage growth was high during the 15 years before the 2014–16 oil downturn, substantially outpacing productivity growth and wages in trade partners. But Norway was able to avoid a large deterioration in aggregate competitiveness, thanks to sizable terms of trade gains—not only in oil2 and oil-related industries, but also metals and fisheries. Still, other tradable sectors have experienced declining exports—and these sectors will be important in the future to absorb labor as oil production eventually declines. This paper presents evidence that despite Norway’s stellar institutions to manage oil revenues parts of its non-oil economy nevertheless suffered due to the oil boom. To address competitiveness challenges in these sectors, and to prepare the transition out of oil, it would be helpful to: (i) continue the wage moderation started during the oil downturn, and (ii) use the current economic upturn to start gradually tightening fiscal policy.

A. Background: One Country, Two (Interlinked) Economies

1. Oil production is projected to decline starting in the mid-2020s. After discoveries in the late 1960s, production started in the mid-1970s. It reached a first peak by the mid-2000s, which it is expected to reach once more as a large field comes onstream by the early 2020s. While the difficulties in forecasting oil production ought to be acknowledged, forecast errors in the past have not been enough to throw into doubt the view that oil is close to its peak.

uA01fig01

Petroleum Production

(Million of Sm³ oil equivalent)

Citation: IMF Staff Country Reports 2018, 280; 10.5089/9781484377109.002.A001

Sources: Norwegian Petroleum; and IMF staff estimates.

2. The oil sector has strong spillovers on Norway’s mainland economy, chiefly through large oil-related industries. Norway’s petroleum production represented ⅛ of output and ¼ of exports in 2017. Direct employment in the oil sector is 2 percent of total employment. But the oil sector also has important spillovers on the mainland economy: a further 8 percent of employment is estimated to indirectly depend on it.3 In particular, Norway features sizable oil-related industries. It is commonly referred to as the oil services industry, although this is somewhat of a misnomer as the industry provides both specialized manufactures and vessels as well as engineering and other services to oil companies. It is also a strong export sector: it accounts for 1/3 of mainland, i.e. non-oil, exports.

3. Oil and oil-related industries lifted Norway’s GDP above regional peers, but also contributed to developing a two-speed economy. The oil and the oil services industries have grown rapidly and the 2004–13 oil boom led to a further expansion of the sector. Oil services firms extracted terms of trade gains during this period as—being quite specialized—they could use pricing power to their advantage during this time of high global oil investment. Despite the rapid growth of the oil services industry,4 which forms part of the mainland economy, mainland real GDP only increased in line with peers. As resources were in fact reallocated toward these oil-related industries, this implies that the non-oil economy actually grew less than peers.

uA01fig02

Estimated Demand for Oil and Gas Services

(Percent of mainland GDP)

Citation: IMF Staff Country Reports 2018, 280; 10.5089/9781484377109.002.A001

Sources: OECD; and Norwegian Ministry of Finance.
uA01fig03

Composition of Mainland Norway’s Exports, 2017

Citation: IMF Staff Country Reports 2018, 280; 10.5089/9781484377109.002.A001

Source: Statistics Norway.
uA01fig04

Real Gross Value Added per Capita

(1975=100)

Citation: IMF Staff Country Reports 2018, 280; 10.5089/9781484377109.002.A001

Sources: Eurostat; Statistics Norway; and IMF staff estimates.
uA01fig05

Industry Contributions

(Percent of GDP)

Citation: IMF Staff Country Reports 2018, 280; 10.5089/9781484377109.002.A001

Sources: Statistics Norway; and IMF staff estimates.

4. This paper evaluates the channels through which competitiveness of certain non-oil tradables may have declined during the past 15 years. This is important because non-oil tradables will need to become a larger contributor to growth if Norway is to sustain its strong performance as oil production declines over the long term. The paper departs from the literature studying the incidence of Dutch Disease in Norway. This literature concludes that Norway in many ways has managed to contain Dutch Disease symptoms well, but that it was not able to shelter the economy completely (Section B). This literature, however, focusses relatively little on wage developments since the 2000, which we complement in Section C. This section notes that Norway’s collective bargaining system, on the one hand, enabled a broad sharing of these terms of trade gains through relatively homogenous wage increases across sectors. On the other hand, this has strained sectors not benefitting as much from terms of trade gains, whose competitiveness decreased by more than that of the economy on aggregate. Section D shows that the expansion of non-oil fiscal deficits during the last decade may have indirectly exacerbated competitiveness pressures; therefore, a tightening of fiscal policy would now be appropriate, given the current economic up-cycle.

B. The Literature on Dutch Disease in Norway

5. Dutch Disease is a phenomenon by which a boom in the natural resource sector can result in a real appreciation of the exchange rate through two channels (Corden and Neary, 1982):

  • A spending effect: The boom in the resource sector generates additional income. If it is spent, demand for tradables and non-tradables expands. While prices of tradable goods have to remain aligned with international prices, prices of nontradable goods climb. As a consequence of higher wages and higher prices of nontradable goods, the tradable sector’s costs increase and therefore its competitiveness declines.

  • A resource allocation effect: During the resource boom, labor (and capital) is reallocated towards the resource sector. Higher remuneration in the resource sector and related activities will attract labor. This increases the cost of labor for the whole economy. In the non-tradable sector, prices will rise as the sector needs to pay higher wages to attract labor.

uA01fig06

The Transmission of Oil Shocks

Citation: IMF Staff Country Reports 2018, 280; 10.5089/9781484377109.002.A001

6. Norway in many ways has done an excellent job in limiting Dutch Disease and safeguarding competitiveness. Some econometric studies find limited evidence of Dutch Disease (Hutchison, 1994, Bjørnland 1998, and Bjørnland and Thorsrud, 2016). The literature in particular highlights the role of strong institutions and policies, development of other (related) industries, and migration.

  • Strong institutions and policies.5 The fiscal framework (see Staff Report, Annex III) ensures that oil revenues are saved abroad in a sovereign wealth fund. Only the expected real returns of those savings, revised down in 2017 from 4 percent to 3 percent, are gradually injected into the Norwegian economy. This delinks spending from contemporaneous oil revenues and contains the spending channel of Dutch Disease (Davis et al, 2003; Medina and Soto, 2016). Norway’s institutions also prevented rent-seeking behaviors and sound fiscal policy contained government spending.

  • Development of other (related) industries. Bjørnland and coauthors6 argue that complementarity between oil and the rest of the economy play a critical role inhibiting a real GDP growth deterioration. Development of the oil services sector alongside the development of oil production itself created a new export sector—and although it is related to oil and subject to much of the same fluctuations, it offsets in the aggregate the lower growth of other tradables. Anecdotal evidence furthermore suggests that there are favorable knowledge spillovers from oil-related engineering, which have fostered innovation in other areas.

  • Migration. Inward migration in boom phases helps buffer the resource reallocation effect, thereby softening wage pressures from Dutch Disease (Cappelen and Eika, 2017). Traditionally, Norway’s labor market has been well integrated with the other Nordic countries, facilitating migration. In addition, Norway has received significant immigration from various EU countries, which contained wage pressures during the oil boom.

7. But Norway may not have been able to counteract the resource allocation channel as much. Several studies observe a resource movement effect in Norway, as epitomized by the stagnation of non-oil exports and manufacturing growth. Gylfason (2001) also emphasizes the lack of a high-tech manufacturing sector, in contrast to Sweden and Finland. Larsen (2006) identifies weaker growth than Denmark and Sweden in the second half of the 1990s and a contraction of manufacturing as concerns. Holmøy and Massey (2005) conclude that Norway’s competitiveness was indeed affected by its high wage growth and real exchange appreciation since the mid-1990s.

8. Loose fiscal policy can exacerbate the spending channel. Holmøy and Massey (2005) also emphasize that a favorable financial situation for the government and the economy can confuse the public with respect to long run consumption possibilities. Similarly, Gylfson (2001) warns that the assets in the sovereign wealth fund can generate a false sense of security; difficult decisions could thereby be delayed, jeopardizing long term growth. Since these authors studied the issue, the sovereign wealth fund has grown much larger, and now stands above 300 percent of mainland GDP. The Norwegian authorities have recognized this and tightened their fiscal rule in 2017. But even adhering to the tightened fiscal rule’s long-run benchmark of spending 3 percent of the sovereign wealth fund is still expected to mean non-oil deficits of some 8 percent of mainland GDP.

C. Wage and Competitiveness Developments of the Last Twenty Years

9. The Dutch Disease literature on Norway has paid relatively little attention to wage developments during the last decade. This is because many studies were published before the mid-2000s and more recent studies do not explicitly focus on wages.

10. This matters, because over the last two decades, wage growth in Norway has notably outpaced that in trade partners. Since 1995, nominal manufacturing wages in Norway have risen by 160 percent, compared to less than 100 percent in other Nordics and less than 80 percent in Germany. Similar trends are observable for services, though the magnitudes of differences are slightly less stark.

uA01fig07

Manufacturing: Labor Compensation and Productivity

Citation: IMF Staff Country Reports 2018, 280; 10.5089/9781484377109.002.A001

Sources: OECD; and IMF Staff estimates.

11. At the same time, productivity growth has been slower than in trading partners. Since 1995, productivity in manufacturing has only grown by 50 percent, while that of other Nordic peers more than doubled. In contrast, productivity in services increased somewhat more than in trading partners, but not enough to offset the higher wage increases in the sector compared to peers.

uA01fig08

Services1: Labor Compensation and Productivity

Citation: IMF Staff Country Reports 2018, 280; 10.5089/9781484377109.002.A001

1/ Excluding real estate activities.Sources: OECD; and IMF Staff estimates.

12. In Norway’s collective bargaining model, the manufacturing sector, a considerable part of which supplies oil firms, leads wage negotiations. Norway’s sector-level bargaining negotiations follow the so-called “pattern bargaining” process: the manufacturing sector, which is deemed the most exposed to international competition, agrees on a wage target. This target is then applicable to the other sectors as well. The blue-collar workers in the manufacturing sector traditionally (i.e. up to 2014) negotiated their wages first, setting a starting point for the wage agreement for all workers in the sector. The wage norm agreed in manufacturing, in turn, served as a target for the average wage rises in the rest of the economy, including the public sector. Within manufacturing, oil-related manufacturing played an important role and could afford high wage increases as the rising price of oil in much of the last 15 years increased demand for the sector’s products.

13. High wage increases were then passed onto sectors that had not experienced terms of trade gains. While there are no laws preventing different sectors from deviating from the norm established by the manufacturing sector, social partners have historically complied with the central agreements. Given this close adherence of follower sectors, the manufacturing sector’s high wage increases—of above 4 percent during 2001–13—permeated throughout the economy. Arguably, social partners’ traditional objective to contain wage dispersion in the economy also played a role.

uA01fig09

Nominal Wage Growth by Sector, 2001–2013

(Yoy, in percent)

Citation: IMF Staff Country Reports 2018, 280; 10.5089/9781484377109.002.A001

Sources: Eurostat, IMF Staff Calculations

14. Wage increases in excess of productivity growth increased aggregate unit labor costs (ULC). Non-agricultural ULC have increased by more than 120 percent since 1995, compared to less than 40 percent in Nordic peers. In manufacturing, ULCs increased by 70 percent, running far ahead of peers. In services, Norway’s ULC also outpaced peers but to a lesser extent. Deteriorations in unit labor costs were particularly pronounced during 2005–13, when global commodity prices spiked.

uA01fig10

Unit Labor Costs, All Sectors

(Index; 1995 = 100)

Citation: IMF Staff Country Reports 2018, 280; 10.5089/9781484377109.002.A001

Sources: OECD, and IMF staff estimates.
uA01fig11

Unit Labor Costs, Manufacturing

(Index; 1995=100)

Citation: IMF Staff Country Reports 2018, 280; 10.5089/9781484377109.002.A001

Sources: OECD, and IMF staff estimates.
uA01fig12

Unit Labor Costs, Services

(Index; 1995=100)

Citation: IMF Staff Country Reports 2018, 280; 10.5089/9781484377109.002.A001

Sources: OECD, and IMF staff estimates.

15. Not surprisingly, the ULC-based REER has appreciated significantly. The deviation of the ULC-based REER from the CPI-based REER has been startling in Norway, especially over the last decade. The latter has hardly moved and now stands slightly below its 1995 level. In contrast, the ULC-based REER in 2013 was some 70 percent more appreciated than in 1995, with rising labor costs being virtually the sole driver as the nominal effective exchange rate was quite stable. Only half of this trend appreciation has been reversed during the recent oil downturn, as a result of krone depreciation.

uA01fig13

Annual Growth REER – Unit Labor Cost Base

(Percent)

Citation: IMF Staff Country Reports 2018, 280; 10.5089/9781484377109.002.A001

Sources: IMF staff estimates.
uA01fig14

Real Exchange Rate

(Jan-1995=100)

Citation: IMF Staff Country Reports 2018, 280; 10.5089/9781484377109.002.A001

Source: IMF staff estimates.

16. Despite these negative developments, large terms of trade gains cushioned the decline in aggregate competitiveness. Large improvements in key prices of export products such as oil, metals, and food products mitigated the competitiveness deterioration for the overall economy. One way to see that wage gains may not have been unsustainable in the aggregate is to note that wages have not increased as a share of GDP. At a time when several other advanced countries experienced falling labor shares, Norway’s remained constant. It likely played a role that maintaining a stable share of labor compensation in domestic income is an important objective of collective wage bargaining in Norway.

uA01fig15

Price of Key Norwegian Exports

(Index 2000=100)

Citation: IMF Staff Country Reports 2018, 280; 10.5089/9781484377109.002.A001

Source: IMF, WEO.
uA01fig16

Labor Compensation Share

(Percent of gross value added)

Citation: IMF Staff Country Reports 2018, 280; 10.5089/9781484377109.002.A001

Sources: Eurotat; country authorities; and IMF staff estimates.

17. Nevertheless, competitiveness is now a challenge in non-oil manufacturing sectors (Figure 1). Non-oil manufacturing’s value added has approximately halved in terms of mainland GDP since the late 1990s. True, this trend can be interpreted benignly, as an optimal reallocation of resources to the sectors benefiting from terms of trade gains. However, this reallocation will likely make diversification away from oil, which is ultimately needed over the longer term, more difficult. Also, their response to the 20 percent real exchange rate depreciation of the recent oil downturn has been muted so far. In contrast, oil-related manufacturing showed a robust performance. It was able to retain its share of value added in the economy through 2014. After that they were impacted by declines in global oil investment, but the latter is already recovering.

Figure 1.
Figure 1.

Non-oil Competitiveness

Citation: IMF Staff Country Reports 2018, 280; 10.5089/9781484377109.002.A001

18. Moreover, in some non-tradable sectors a segmented labor market is arising as a result of high wage costs. Traditionally the non-tradable sectors—such as retail trade, restaurants, and construction—do not directly face international competition. However, as wage growth could not be completely neutralized by productivity gains in these sectors, they have been experiencing considerable inward labor migration. Migrants often accept lower wages and tend not to be covered by collective agreements, unlike most native workers. Therefore, union coverage in certain sectors has been decreasing quite rapidly. The consequences of the rise of non-unionized employment on Norway’s tight social compact remain to be seen.

uA01fig17

Employment Growth between 2008–2014

(Percent of total employment in 2008)

Citation: IMF Staff Country Reports 2018, 280; 10.5089/9781484377109.002.A001

1/ Proxied with local workers.2/ Proxied with immigrant workers.Sources: The Norwegian Confederation of Trade Unions; and IMF staff estimates.

19. Wage growth has moderated substantially in the last few years. Social partners have been able to deliver wage moderation since the onset of the oil downturn. Wage growth in the manufacturing sector was less than 2 percent on average during 2014–17, with other sectors reducing their average wage growth from above 4 to 2.3 percent during the same period. This helped prevent further deterioration of cost competitiveness, although losses from the past decade have not been reversed. Reforms to the collective bargaining system, effective 2014, likely also had a positive impact on the outcomes (Box 1).

The 2013 Amendments to the Wage Setting Agreement

In 2013, Norway appointed a commission to examine wage formation experiences since the introduction of the fiscal rule and the monetary policy inflation target. The committee recommendations highlighted that wage moderation would be needed in the long run. Key changes implemented starting in 2014 included:

  • 1) Setting a wage increase for all workers. Before 2014 the agreement only set blue-collar workers’ wages. This resulted in white-collar workers’ wages growing above blue-collar workers’.

  • 2) Giving the NHO (main employers’ confederation) and LO (confederation of Trade Unions) the task to set a benchmark for wage growth. This reduced uncertainty and disputes at firm and sector level. Before 2014, the wage leading agreement was set by the Federation of Norwegian industries (Norsk Industri) and the metal workers. As many blue-collar workers received additional wage increases at the firm level, the scheme was fostering higher wage increases.

  • 3) More focus on benchmarking competitiveness and wage growth against trading partners.

uA01fig18

Norway: Average Real Wage

(Year-on-year percent change)

Citation: IMF Staff Country Reports 2018, 280; 10.5089/9781484377109.002.A001

Sources: Statistics Norway; and IMF staff estimates.

The timing of the recommendations and their implementation was optimal, as in 2014 the sharp decline in oil prices provided an opportunity to test the framework. The framework has delivered wage moderation during the last few years.

Sources: Norwegian Government (2013).

D. Fiscal Policy and Competitiveness

20. Norway’s fiscal institutions have contained the spending of oil revenues to a greater extent than in other resource-rich countries. The fiscal rule (see Staff Report, Annex III) has significantly contained the procyclicality of fiscal policy and helped contain government spending during the oil boom particularly in relation to other oil-rich countries. Nevertheless, the sovereign wealth fund has now expanded to some 300 percent of GDP, and the non-oil deficit allowed by the fiscal rule has increased commensurately. Specifically, the non-oil deficit has gone from 1–2 percent of mainland GDP in the early 2000s to some 8 percent now. The authorities have commendably tightened the fiscal rule in 2017 (by assuming a lower real return of the sovereign wealth fund) but even under the tighter parameters non-oil deficits could remain at 7- 8 percent of mainland GDP in the foreseeable future.

21. The continuous fiscal expansion is likely to have worsened cost competitiveness. Government consumption has increased significantly in Norway, bucking a trend seen in other Nordic countries. Such a rise is likely to have appreciated the real exchange rate above and beyond what could be expected from terms of trade gains. Another way to see this is that the loose budget constraint allowed the public sector to fully accommodate and reinforce large wage increases led by oil sectors, instead of providing an anchor.7

uA01fig19

Norway: Government Footprint1 on the Economy

(Percent of mainland GDP)

Citation: IMF Staff Country Reports 2018, 280; 10.5089/9781484377109.002.A001

1/ Gov. Footprint includes government consumption + public investment.Sources: Statistics Norway; and IMF staff estimates.
uA01fig20

Norway: Average Wages

(NOK per month)

Citation: IMF Staff Country Reports 2018, 280; 10.5089/9781484377109.002.A001

Sources: Statistics Norway; and IMF staff estimates.

E. Conclusions and the Challenges Ahead

22. Going forward, Norway may have to downwardly revise its expectations for wage growth if it is to avoid a significant loss of competitiveness and manage the transition to a less oil-dependent economy. Norway was able to afford very high wage growth in the past (notwithstanding the noted challenges in several sectors) thanks to good fortune in its terms of trade. Going forward, it would be prudent not to count on being fortunate twice: wage moderation would help build resilience in case of less favorable trends in international prices. It would also help facilitate the needed transition out of oil by supporting sectors that did not benefit from past terms of trade gains. Communication from the government can continue to help in managing public expectations.

23. There are reasons to be optimistic for the future. Norway was exposed to sizable terms of trade declines during 2014–16. Its effects were cushioned by krone depreciation and, importantly, by social partners’ ability to deliver wage moderation.

24. Fiscal policy plays a key role in promoting competitiveness and containing the spending effect of Dutch Disease. After a prolonged expansion of fiscal policy—partly enabled by large valuation gains of the sovereign wealth fund—it is now appropriate to gradually start tightening fiscal policy. The ongoing up-cycle provides an ideal setting to get started on structural consolidation, which will ultimately be needed to face to address aging pressures. Relatively timely adjustments to negative shocks and a conservative approach to internalizing positive shocks into fiscal policy would help competitiveness. This is particularly important for Norway, because its public sector net worth is subject to higher fluctuations as a result of asset and petroleum prices than that of other countries (Cabezon and Henn, 2018). Finally, further reorienting spending to make it more productivity-enhancing would also help support competitiveness.

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1

Prepared by Ezequiel Cabezon and Christian Henn.

2

In this SIP, the term “oil” is used to define both oil and gas.

4

Note that the oil services industry is hard to statistically pin down and separate from the remaining mainland economy. However, it is illustrative of its rapid growth that went from being nonexistent in the 1960s to constituting 1/3 of exports in 2017.

7

Public wages in Norway follow the guidelines set by the social partners’ economy-wide benchmark agreement and thereby the government has only a limited role in wage negotiations.

Norway: Selected Issues
Author: International Monetary Fund. European Dept.