Identifier
Created
Classification
Origin
07OSLO302
2007-03-29 08:53:00
UNCLASSIFIED//FOR OFFICIAL USE ONLY
Embassy Oslo
Cable title:  

MONEY TALKS, BUT IS NORWAY LISTENING?

Tags:  ECON EPET ENRG EINV NO 
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VZCZCXYZ0000
PP RUEHWEB

DE RUEHNY #0302/01 0880853
ZNR UUUUU ZZH
P 290853Z MAR 07
FM AMEMBASSY OSLO
TO RUEHC/SECSTATE WASHDC PRIORITY 5415
INFO RUEHCP/AMEMBASSY COPENHAGEN PRIORITY 2262
RUEHHE/AMEMBASSY HELSINKI PRIORITY 7895
RUEHFR/AMEMBASSY PARIS PRIORITY 0957
RUEHRK/AMEMBASSY REYKJAVIK PRIORITY 0785
RUEHSM/AMEMBASSY STOCKHOLM PRIORITY 3064
RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY
RUEHBS/USEU BRUSSELS PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC PRIORITY
RHMFIUU/DEPT OF ENERGY WASHINGTON DC PRIORITY
UNCLAS OSLO 000302 

SIPDIS

SENSITIVE
SIPDIS

STATE FOR EUR/NB RDALLAND
USDOC FOR 4212 MAC/EUR/OEURA
PARIS FOR OECD

E.O. 12958: N/A
TAGS: ECON EPET ENRG EINV NO
SUBJECT: MONEY TALKS, BUT IS NORWAY LISTENING?


UNCLAS OSLO 000302

SIPDIS

SENSITIVE
SIPDIS

STATE FOR EUR/NB RDALLAND
USDOC FOR 4212 MAC/EUR/OEURA
PARIS FOR OECD

E.O. 12958: N/A
TAGS: ECON EPET ENRG EINV NO
SUBJECT: MONEY TALKS, BUT IS NORWAY LISTENING?



1. (U) Summary: On March 22 Norges Bank Governor General
Svein Gjedrem presented diplomatic corps members with a
vision of an incredibly vibrant, but oil-dependent, Norwegian
economy reaching new fiscal heights on the wings of
increasing energy demand and oil prices. Gjedrem's analysis
of the economy included some criticisms and concerns,
particularly regarding individual pension abuses. The speech
tracked many of the OECD's observations in its January 2007
Survey on Norway, although Gjedrem glossed over glaring
weaknesses in Norwegian innovation and entrepreneurship that
the OECD report highlights. End summary.

Giddy with Globalism: Terms of Trade Turn in Norway's Favor
-------------- --------------


2. (U) Governor Gjedrem stated that Norway's oil-rich
economy is experiencing strong growth, high-capacity
utilization and low inflation. Gjedrem attributes this rosy
picture to a series of favorable global developments and
"positive supply-side shocks." Norway's capacity utilization
is high in most industries, with rising unfilled vacancies
and labor shortages across several sectors. Purely physical
production constraints (such as shortages of rigs in the
petroleum industry and construction industry machinery)
appear the only factors constraining the utilization.


3. (U) Unemployment has declined, with the unemployment
rate hovering slightly over 2 percent. Temporary foreign
labor supplies increased markedly after the EU's enlargement
in 2004, with labor inflows amounting to more than 30 percent
of growth in Norway's labor force.


4. (U) Recent trends in the terms of trade have benefited
Norway tremendously. Global growth has spurred a vibrant
upswing in Norwegian export industries, most notably
Norwegian petroleum exports. Strong demand growth, coupled
with solid profitability, have also stimulated fixed
investment. The increased integration of China, India and
other emerging economies into global trade markets, in
conjunction with lower tariffs and reduced trade barriers,
has led to a significant decline in prices of imported
finished goods. In Norway, imports from low-cost countries

have significantly increased. Gjedrem noted sharp price
declines for Norwegian consumers in a wide-range of consumer
goods, from footwear to audiovisual equipment. The increase
in developing market acquisitions has led to a substantial
decrease in U.S., Japanese and EU (excluding "new" EU
members) consumer imports. The confluence of higher
Norwegian export prices and lower import prices for most
consumer goods created a remarkable favorable shift in
Norway's terms of trade, which improved by approximately 40
percent since 2002.


5. (U) Domestically-produced goods and services have
decreased in price, which Gjedrem attributes to increased
competition. In a recent Bank survey, 58 percent of the
responding companies noted intensification of competition in
the last 2-3 years, with only 15 percent finding a
competition decrease. In retail trade and services, 70
percent of sector respondents noted increased competition.


6. (U) In the Norwegian business sector, increasing
integration of information technology and productivity gains
in banks and financial service sectors also contributed to
the overall Norwegian economy's growth.

Monetary Policy: What Next?
--------------


7. (U) The Bank utilizes a flexible inflation targeting
regime as part of a monetary policy oriented towards low and
stable inflation (annual consumer price inflation stands at
about 2.5 percent). Consumer price inflation is expected to
increase, however, due in part to capacity constraints that
limit future growth, falling unemployment, gradual upticks in
wages, and marked price increases for inputs, services and
building materials. Acknowledging these concerns, the Bank
will continue to raise interest rates, while watching the
impact of higher interest rates on the Norwegian kroner
exchange rate when inflation is low. The Bank's Executive
Board decided on March 15 to pursue a course designed to
level the key policy rate at between 4-5 percent, rising to
approximately 5 per cent by the end of 2007, depending on
economic conditions.

A Person's Home Really Is A Castle
--------------


8. (U) Housing costs have trebled over the last 14 years as
more people migrate to densely populated areas. Consumer
demands for high standards, coupled with new building
regulations, push up housing construction costs and thus
housing prices. Declaring that the housing market is in a
state of "euphoria," Gjedrem noted that the historical
determinants of housing price inflation have been income,
unemployment, interest rates and residential construction.
These have recently coupled with migration to urban areas and
consumer expectations that housing prices will continue to
rise, inducing younger buyers to enter the housing market
earlier for investment purposes. Rising housing prices have
increased household debt, now twice the level of disposable
income, with debt to income ratios at the highest levels ever
seen in Norway.

The (Multi) Billion-Dollar Question: The Pension Fund's
Strategy
-------------- --------------


9. (U) Currently worth about $293 billion, the Norwegian
Pension Fund continues to increase on the strength of high
energy prices. Gjedrem emphasized that Norway does not view
petroleum revenues as income, but rather as a transfer of
capital from petroleum extraction to diversified foreign
securities. Gjedrem shrugged off critics who call for
spending Pension Fund revenues on social needs, noting that
the Fund's cash flow has swung widely in the past and
spending it would cause significant fluctuations in domestic
demand. Currently, the Fund is approaching the nominal value
of one year's GDP, and may reach two in the next decade. The
GON spends about 4 percent of the Fund's revenues annually to
cover budget shortfalls based on the theory that the Fund's
average real return is an equivalent percentage. Gjedrem
thought the percentage could rise as high as 15 percent of
government expenditures in 10 years.

Not All is Happy in Mudville
--------------


10. (U) Fielding questions from the diplomatic audience,
Gjedrem shared insights on the dilemmas facing emerging oil
economies, challenges to the Fund and societal issues that
could affect Norway's robust economy. Addressing the
Nigerian economic counselor, Gjedrem advised emerging oil
countries to balance increased oil production capacities with
infrastructure investments. Gradual improvements in
infrastructure would lead to increased production capacity.
With respect to investment strategies, he stressed that
emerging economies should follow the prudent strategy of
diversifying wealth in international markets.


11. (U) Gjedrem outlined challenges that could face the
Pension Fund -- an unexpected sharp decrease in oil prices or
an "overheated" Norwegian economy, harbingers of which could
include wage inflation and a housing market bubble. While
reiterating the Pension Fund's strategy to diversify between
equity investments and bonds, he stressed that Fund proceeds
should be spread out in several portfolios. Gjedrem strongly
supported the Norwegian Fund's policy to invest 100% of its
proceeds abroad. He emphasized that Norwegians simply do not
want to subsidize capital, since domestic Fund investments
(such as those in government projects) would eventually mean
lower returns. Questioned whether the GON's use of 4 percent
of Fund proceeds for government spending is adequate, the
Governor answered in the affirmative, noting that government
revenues were projected to increase by 15 billion NOK (about
USD 2.5 billion) in 2007. He added that for every one
billion NOK spent by the GON, the Bank would tighten its
monetary policy constraints.


12. (SBU) Gjedrem was blunt regarding early retirement and
disability drains on the Fund. He noted that although the
official retirement age in Norway is 67 years old, the
average real retirement age is 60. He revealed that the
government is considering increased benefit incentives to
keep workers in the labor force until age 70. He thought it
necessary to reduce incentives for early retirement and cited
as worrisome the growing number of disability claimants in
their thirties and forties (approximately 7 percent of the
workers available in that age bracket). Acknowledging his
thoughts controversial for a public official, he advocated
greater businesses contributions to pension financing and
decreased benefits to disability claimants.

OECD Survey: Some Warning Signs, and Government Response
-------------- --------------


13. (U) The Organization for Economic Cooperation and
Development (OECD)'s Survey mirrors several of Gjedrem's
themes. The Survey describes a booming economy, with low
unemployment and moderate underlying inflation. The
influence of globalization on the economy's continued
vibrancy (namely supplying high-priced exports like petroleum
while importing lower-cost consumer goods) was highlighted.
Inflationary controls and the Bank's decision to edge up
interest rates were also discussed. The Survey shared
Gjedrem's concerns that the effective retirement age is on a
downward trend, despite the high statutory age. The Survey
warns that the Pension Fund may not be sustainable if the
trend continues, particularly as social benefit "schemes"
(sickness and disability benefits and early retirement) tend
to undercut incentives to remain in the work force. The
Survey warns that "Norway must resist the temptation of
finding in higher-than-expected oil revenues an excuse for
delaying the adoption of necessary reforms."


14. (U) Innovation is also a real concern. The Survey
critiques Norwegian technology-driven innovation, stating it
is low by cross-country indicators. The OECD points to weak
research and development intensity, only moderate patenting
and a limited interest in innovation activity. Encouraging
product-market innovation was one OECD proposal. The OECD
credits the GON for its desire to promote innovation, but
questions whether government spending plans can accomplish
the objective. For example, while crediting as well-designed
Norway's plans to increase innovation through research grants
and tax credits, the Survey questions whether additional
fiscal support would be very effective given the private
sector's reluctance to spend much on innovation.


15. (U) To promote entrepreneurship, the Survey proposes
strengthening competition policy and relaxing product market
regulations, while reducing state ownership in the economy.
Additional public money will not, in itself, foster a greater
innovation culture. The OECD recommends private-public
research and facilitating commercialization of university
innovations. Finally, the OECD recommends allocating more
public funds to institutions that channel venture capital
funds to private start-ups.


16. (U) The Norwegian Ministry of Finance issued a
statement calling the Survey's analysis of the Norwegian
economy "comprehensive." Finance Minister Kristen Halvorsen
said the document should "stimulate the debate on important
economic policy issues," but brushed aside the OECD's call
for more innovation by declaring that Norwegian firms'
abilities are no worse than companies in other developed
countries.

The IMF: More Mounting Concerns
--------------


17. (U) On March 26, the International Monetary Fund (IMF)
issued a report warning that the Norwegian economy is
confronting growing inflationary pressures, citing continuing
credit growth and housing price increases. The report
suggested that the GON confront rising inflation by raising
interest rates. In addition, the IMF report recommends that
the GON refrain from spending the entire 4 percent of the
Fund's revenues annually, given that petroleum prices are
much higher today that when the guidelines suggesting this
dedicated percentage were instituted.

Comment: Lots of Money, Lots of Oil: What, Me Worry?
-------------- --------------


18. (SBU) An economy largely dependent on vast petroleum
riches, coupled with a strong social welfare system, would in
most countries be a recipe for disaster when the oil pumps
run dry. Norges Bank believes that a policy of fiscal
austerity, with a commitment to diversifying Pension Fund
riches, could generate sufficient income to put the day of
reckoning off indefinitely. Governor Gjedrem voiced the word
"diversification" over a dozen times in his speech. In
recent months, the Bank has recommended spreading some of its
moneys (USD 75 billion for starters) into international
commercial real estate and private equity/venture capital
markets. If approved by the Norwegian parliament,
investments of that volume could begin to play a significant
role in U.S real estate and venture capital markets.


19. (SBU) But will buying more foreign assets keep Norway
afloat in the long run? We concur with the OECD's assessment
that innovation and entrepreneurship are areas of deep
concern. Norway's over-reliance on petroleum revenues and
Pension Fund money contribute to a cultural atmosphere of
dependence reflected in a declining national work ethic. In
European consumer preference surveys, for example, Norwegians
rank taking a good annual vacation at the top of the list,
well above finding interesting work or building a productive
career. These and other cultural roadblocks, like the
Scandinavian penchant for social leveling, discourage
entrepreneurship. The dependency on oil largesse is
contributing to lower productivity -- not in the statistical
sense, in which Norway outranks many other developed
countries, including the United States -- but in the sense
that many basic skills and standards of service seem to be
eroding. Norwegians are turning to a growing foreign
workforce to do much of the heavy lifting. Even in the lead
petroleum sector, most of the infrastructure construction
work in major investment projects is now performed by
imported foreign workers. Norway seems to have bought into
its own press -- seeing itself as a highly productive,
innovative society -- but the very fact that the Norwegian
government is compelled to invest significant public funds on
innovation programs speaks volumes. The government, with its
dominant role in the economy and as guarantor of the
cradle-to-grave social welfare system, has so undercut
individual initiative that the GON must institute a
government program to re-stimulate it.
WHITNEY