Strong growth through the five years to 1998 necessitated fiscal and monetary policy tightening which, together with a drop in oil investment, damped activity since then. However, the labour market has remained tight with tensions persisting in many sectors, even though the unemployment rate has risen slightly to 3.7 per cent in early 2002. Rapid wage gains have caused a sharp deterioration in competitiveness since the mid-1990s. On the other hand, inflation has remained under control, reflecting a squeeze in profit margins, cuts in indirect taxes and more recently the appreciation of the krone. As Norway is the world’s third largest oil exporter behind Saudi Arabia and Russia, high oil prices since 2000 have led to an extremely large current account surplus which reached 15 per cent of GDP in 2001.

Strong growth through the five years to 1998 was induced by a strong expansion in the private sector due to the improvement in competitiveness in the early 1990s, a significant fall in interest rates in 1993 and higher oil investments. It necessitated a fiscal and monetary policy tightening, which, together with a drop in oil investment, has damped activity since then. Despite moderate output growth in recent years, the labour market has remained tight (Figure 1), causing a sharp deterioration in competitiveness. Furthermore, as Norway is the world’s third largest oil exporter behind Saudi Arabia and Russia, the high oil price since 2000 has led to very large current account and government surpluses.

At more than 50 per cent of mainland GDP, Norway’s public spending is very high by international comparison. This partly reflects two important choices of Norwegian society, namely ensuring an extensive and universal welfare system and maintaining a decentralised settlement pattern in the country: local governments provide a wide range of public services, even in the most remote jurisdictions so as to retain people, and often at a high cost. Within this context however, the distribution of spending responsibilities across government levels also raises efficiency issues while the funding system of local governments does not provide strong incentives to contain local spending. Several additional factors contribute to high spending: the incentive structure for public bodies and their employees does not promote efficiency gains; competitive pressures on public service suppliers are largely lacking; and the use of price signals to contain demand for public services is limited. Abundant petroleum revenues have so far mitigated strains on public finances and the current double-digit budget surplus makes it politically difficult to implement public sector reforms. This economic context has also been reflected in the new fiscal framework, which is expansionary over the medium and long term. But tensions will arise with the projected decline in oil revenues beginning later in this decade. In particular, strong projected public employment growth seems unsustainable, as it crowds out private sector labour demand, creates wage pressures in the public sector and results in higher government outlays. Better control of public spending is necessary in order to cope with the fiscal consequences of ageing and of the depletion of oil reserves. It could also allow a reduction in the high tax burden, which would boost potential output growth.

While there are features of the Norwegian economy that favour strong growth in its already high standard of living, there are also some key weaknesses that significantly hamper progress. National income per capita will continue to be boosted by additional revenues due to the natural resource wealth. Furthermore, the institutional framework of the Petroleum Fund reflects a commitment to prevent a surge in spending from being costly through a rapid structural shift from the exposed to the sheltered sectors. Other aspects of the Norwegian economy also favour high living standards. In particular, Norway’s tradition of work-oriented social inclusion encourages high labour force participation, and ensures that only a small minority of households plays no active role in the economy, thus reducing the risk that growth is associated with a sharp widening of the income distribution. At the same time however, the oil-wealth has created supply bottlenecks, masked the need for reforms, especially in product markets, and has encouraged a large government sector that lacks strong incentives to make efficiency gains. This chapter begins with a broad overview of the main growth challenges facing Norway and then analyses key developments in labour, product and capital markets as well as taxation issues.