Switzerland is still a prosperous country, but it is stuck in a low-growth trap and faces growing fiscal policy problems. While economic activity is affected to some extent by unfavourable conditions in Europe, low trend growth has structural roots. Indeed, growth of production and per capita income has been among the lowest in the OECD for many years, largely reflecting weak productivity gains.

Switzerland suffers from low growth in production and per capita income and has to confront medium- to long-term fiscal management issues. This situation is only partly related to poor cyclical developments in Europe as trend growth has also been slowing. Moreover, in the absence of a significant pick-up in efficiency, trend output growth will diminish further due to population ageing, inducing growing fiscal pressures. In this context, the authorities face two key policy challenges: i) Raising growth performance.

Since the early 1990s, Switzerland has been confronted with a growing fiscal management problem which stems only in part from sluggish growth: it is primarily rooted in insufficient control over public expenditure which has triggered a sharp rise in taxation, as well as a rise in deficits and debt. The causes for the expansion of the public sector, which has been very pronounced, are many. They include the high income elasticity of demand for numerous public programmes, such as health care or education (“Wagner’s law”), whereas there are scant productivity gains in the production of those services (“Baumol’s law”).

The adoption of a better fiscal policy framework should be complemented by reforms to moderate the strong growth of public expenditure. While the increase in spending by all government levels has outpaced GDP growth, the sharpest rises occurred in the social and medical domain. Deep structural reforms to the disability, health and pension insurance schemes are needed, as recognised by the authorities. However, the difficulties in implementing these reforms raise fears that the scope of changes currently proposed is insufficient.

The inadequate functioning of some product markets and lack of competition has undermined the dynamism of the economy, in particular productivity growth. International comparisons confirm that Switzerland suffers from stringent product market regulation, particularly in the sheltered sectors of the economy; this pushes up prices, which are, on average, among the highest in the world. The authorities are fully aware of the situation and competition policy has moved up the policy agenda.

Given high labour costs, Switzerland needs to maintain a top position in innovation to preserve its competitiveness and a high living standard. Despite some weakening in the 1990s, partly due to sluggish trend growth, the Swiss innovation performance has been very strong. There are, however, areas in which reforms could strengthen innovation. Slow labour productivity growth and mixed results in entrepreneurship surveys suggest that the innovativeness of some parts of the economy could be improved, especially regarding small enterprises in sheltered services sectors.

This chapter examines how labour supply can be raised in order to sustain higher potential growth. Structural problems in the labour market remain limited. The agreement on the free movement of persons with the European Union, that was recently extended to the new EU member countries, has had little impact on the labour market so far.