Subhash Thakur

Valerie Cerra

English

Research Papers in Economics

N
orway’s population is expected to age steadily over the
coming century. The proportion of the population over
the age of 80 will likely double by 2050. Birth rates
have been falling and the average lifespan getting longer,
leading to fewer young workers available to replace and
support those retiring. This trend is broadly similar in scope to
that faced by many other advanced countries and will present
difficult challenges to policymakers trying to ensure adequate
supply of labour and manage the strains on public finances.
Petroleum resources
Norway’s substantial petroleum resources place it in a
favorable position relative to other countries in adjusting to
the fiscal shock of the demographic transition. The production
and exports of oil and gas have increased significantly over the
past three decades, and petroleum exports now contribute
significantly to economic activity. The government’s net
income from the petroleum sector has also been substantial.
The state receives ongoing revenue from oil enterprises
through taxes, fees and income from state oil interests. Oil
revenues are currently at high levels due to peak years of
extraction and high oil prices. However, this boom in oil
revenue is not expected to last, as the extraction of oil falls
dramatically over the coming decades.
The Norwegian authorities took a commendable decision to
establish the Government Petroleum Fund (GPF) in 1990, with
the goal of gradually transforming the nation’s oil wealth into
foreign financial assets. The GPF is also aimed at avoiding
excessive spending of petroleum revenues and accumulating
public savings to help cover the expected increase in pension
and health care costs related to the looming demographic
shock, coming at a time when oil revenues are expected to
taper off. Contrary to some popular perceptions, however, the
GPF assets are not sufficient, to cover the expected rise in
pension costs, let alone the total costs associated with an
ageing population.
Intergenerational equity
Norway, like the other Nordic countries, has a strong and
widely admired concern for equity and social protection. The
public sector provides most of the education and healthcare
services and manages a variety of transfer programmes. Most
transfers and welfare benefits, including the public pension
system, are financed on a pay-as-you-go basis. 
The Norwegian ideal of equity extends to generations not yet
born. Successive governments have declared that the nation’s
oil wealth must be used in a manner consistent with equity
across generations. The current generations have already
consumed a significant amount of oil income over the past
three decades to fund non-oil public budget deficits.
Therefore, achieving intergenerational equity will require
saving a large part of the oil wealth beyond the next several
decades. This would mean choosing between competing uses
of the oil wealth: satisfying current demands for spending,
financing the demographic bulge in pension and healthcare
costs – a choice that would also favour current generations
and save the wealth for future generations.
The current pension system
All persons residing or working in Norway are insured
compulsorily under a pay-as-you-go National Insurance
Scheme (NIS). The NIS is financed by contributions from
employers, employees and general tax revenues and is
integrated into the government budget rather than as a
separate account with contribution rates tied to outlays, as in
many other advanced industrialised countries. In the past ten
years, pension benefits have been growing at rates at least as
fast as wages.
The principal NIS benefits are old-age and disability pensions.
Old-age pensions consist of a basic pension and a
supplementary pension that depends on the number of
pension earning years and income as measured by ‘pension
points’. The distribution of old-age pension benefits is relatively
flat, effectively entailing a transfer of wealth from high income
earners to low income earners. Disability pensions are available
to working-age people whose capacities are permanently
impaired due to illness, injury or defect. The level of benefits
and eligibility requirements are both relatively liberal. The state
also finances a contractual early retirement scheme, with
benefits comparable to disability benefits. Central government
workers and teachers are covered by a pay-as-you-go
government occupational pension, which guarantees a total
income replacement rate of 66%. 
IMF Economists, Subhash Thakur and Valerie Cerra, discuss the 
options for pension provision in Norway…
The need for 
pension reform
FINANCE
16 Meeting the needs of Nordic investors 
Contact: barry_maclennan@standardlife.com
Tel: +44 131 245 8268Why reform is needed
Costs of these social insurance programmes are expected to
rise rapidly in the coming decades. Most strikingly, spending
on national insurance pensions may increase by
approximately 10% of GDP by 2050, reflecting both the
demographic transition and the full phasing in of benefits.
This rise in costs is almost three times more than the average
rise for other OECD countries. In the 1990s, a number of these
have undertaken reform measures such as increasing the
pensionable age, promoting longer employment, increasing
the contribution rate or the required contribution period, or
reducing the benefit rate. In addition, a number of countries
have increased reliance on funded schemes, as well as
promoting privatised pension schemes. Norway, by contrast,
has yet to start a serious reform of its pension system. 
Unless the pension system is reformed, the goal of ensuring
intergenerational equity will be difficult to achieve. Current
fiscal projections suggest that government wealth, which
accrues largely from oil wealth, is expected to be consumed in
its entirety by the middle of the century, due to the rising costs
of pensions and other age-related expenditure. This implies
that the current generations will end up consuming more than
the permanent portion of the income from oil wealth. Indeed,
there may be no oil wealth remaining for future generations to
consume, beyond the first half of this century. 
Moreover, there is growing evidence that the generosity of
social insurance schemes may be contributing to a decline in
the labour supply, which is a key determinant of economic
growth and tax revenues. Sickness absences have been
growing rapidly, as have the number of disability pensioners
and early retirees. Indeed, at some income levels, the current
system encourages early retirement by penalising continued
employment. 
Pension reform options and issues
In March 2001, the government appointed a commission of
representatives of the political parties and independent
experts to present recommendations for pension reform by
October 2003. In its preliminary report, the commission has
suggested two main alternatives for pension reform. The first
option would be a system that links pension benefits to
lifetime wage income. The second option would be a flat
pension system. As the debate on pension reform continues,
several issues and options would need to be considered:
Financial sustainability. Additional annual financing of 3%
of GDP is needed to make the pension system viable, given
demographic changes. This entails a combination of higher
contributions to the system, containment of benefits, and
postponement of retirement. In a rapidly globalising world,
with greater opportunities to invest and find employment
abroad, the scope for tax increases is likely to decline. A
reduction in pension benefits, such as by indexing benefits to
prices rather than wages, or an increase in the retirement age
by several years will be required to ensure financial
sustainability of the system. 
Labour supply incentives. Flexibility in choosing the
retirement age is desirable, but reform should ensure that those
retiring later are financially rewarded. Schemes which link
contributions to benefits may help stimulate labour supply by
increasing the future benefits that accrue from work. Using the
entire lifetime of earnings to determine the level of pension
benefit – rather than just the 20 highest years of income, as in
the current system – will also improve work incentives. For
those opting for early retirement, the benefit level can be
reduced for both the lower number of years of accrual and the
additional length of drawing the pension benefit. The age at
which workers become eligible for early retirement benefits can
be indexed to economic and demographic conditions and tax
measures designed to discourage early retirement. 
Distributional concerns. Pension reform options will have
different effects on the income distribution. The income-
related option could imply a redistribution of benefits from
middle wage earners to those with high lifetime incomes,
relative to the current system, while increasing work
incentives. An alternative is to scale down the system, which
17 Going public with private equity – see our profile on pages 20 and 21
Contact: barry_maclennan@standardlife.com
Tel: +44 131 245 8268currently implies large transfers to the middle class, part-time
workers and those working fewer years. The benefits to these
groups might also be reduced by the flat pension alternative.
While public attention has so far focused on the effects on the
income distribution within pension cohorts, intergenerational
equity is tied to ensuring a viable system that does not shift
the burden to future generations.
Funding. An explicit earmarked fund for future pension
benefits could draw attention to the need for actuarially
sound pension finances and therefore could increase support
for greater public saving. Linking costs to benefits could 
help ensure intergenerational equity. It would probably be
necessary to provide initial funding from the GPF, so as to
avoid current generations having to pay both for the current
generation of seniors under the unfunded schemes, as well as
funding their own future pensions. New private supplemental
schemes or publicly-provided notional accounts, such as in
Sweden, could be introduced. Funded schemes that provide
investment choice may be invested more efficiently as private
sector funds compete for business. This can also contribute to
the development of financial markets in Norway. On the other
hand, individuals would bear increased risk from investment
returns and schemes allowing individual choice could be more
costly to administer. A large, abrupt increase in domestic
investment may also be difficult to absorb.
Use of the GPF. There are many options for using the GPF to
fund pensions. Accumulated assets of the GPF could be used
to partially finance existing accrued obligations, with a shift
to defined contribution plans going forward. Alternatively,
new oil revenue could be set aside in a pension fund linked to
new pension rights and the current GPF could be used to
meet other priorities. This option would still require reform to
ensure the sustainability of the system, such as a reduction in
benefits. GPF assets could provide initial funding for a system
designed, as in Sweden, with contributions and benefits linked
to smooth contribution rates and adjusted for demographic
and other factors that affect the system’s viability. 
Other issues. Reform of the NIS would need to be co-
ordinated with the public service pension system, including
ensuring transferability between the public and private
sectors. The reform would need to consider transitional
arrangements to safeguard the accrued pension rights of
current pensioners and individuals close to retirement. The
disability retirement scheme also needs reform. Liberal access
to it contributes to disincentives to work for those at peak
earnings. Reform could also aim at reducing poverty among
people born with disabilities and preventing abuse of the
scheme through experience rating or requiring severance pay
even if an employee were to become disabled.
Concluding remarks 
Norway faces challenges of a major demographic change in 
the coming decades. Given its generous social security regime,
the transition towards an older and smaller working-age
population is likely to have far-reaching effects on economic
growth and public finances. In order to ensure a smooth
transition and preserve Norway’s high living standards, a reform
of social security arrangements needs to encompass, first and
foremost, a comprehensive pension reform. While oil wealth
provides a welcome cushion, it should not be a cause for
complacency. It is to be hoped that the Pension Commission
will provide the impetus and a roadmap for reform.
References:
Cerra, Valerie, and Elie Canetti,’“Long-Term Fiscal and External Issues’, Norway: Selected
Issues, IMF Country Report No. 01/34.
Ministry of Finance, Preliminary Report of the Pensions Commission, 4thSeptember 2002.
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Subhash Thakur
Advisor
Valerie Cerra
Senior Economist
STHAKUR@imf.org
www.imf.org
18 Meeting the needs of Nordic investors 
Contact: barry_maclennan@standardlife.com
Tel: +44 131 245 8268

Finance, Preliminary Report of the Pensions Commission,

The Need for Pension Reform

http://128.118.178.162/eps/pe/papers/0509/0509001.pdf

The Need for Pension Reform

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