PDF to HTML - Convert PDF files to HTML files

Færøudvalget 2014-15 (1. samling)
FÆU Alm.del Bilag 4
Offentligt

BÚSKAPARRÁÐIÐ

Á vári

2015

Búskaparfrágreiðing

II.

Konjunkturmeting

Fíggjarliga haldførið hjá almenna geiranum

Mars 2015

Economic report from the

Economic Council of the Faroe Islands,

Spring 2015, with Executive Summary in

English: (I) Economic outlook, and (II) a long-term projection with focus on the the sustainability of the

Faroese public sector finances.

Redegørelse fra det

Økonomiske Råd på Færøerne,

forår 2015: (I) Udsigterne for konjunkturudviklingen,

og (II) beregninger angående den langsigtede holdbarhed af den offentlige sektors finanser.

PDF to HTML - Convert PDF files to HTML files

English Summary

–

Short Term Economic Outlook

Statistics Faroe Islands and The Economic Council have jointly evaluated

economic growth

in 2014 and

2015 and 2016. To facilitate the evaluations, an economic model developed by the former Faroese

Landsbankin and Statistics Faroe Islands was used. Statistics Faroe Islands has determined that

nominal economic growth for 2013 was 7.5%, which is somewhat higher than estimated (5.1%).

For 2014, nominal economic growth was projected to be 4.1% in current prices, and for 2015 the

estimate is 2.5%, and for 2016, growth is projected to be 2.2%. Wage payments according to the

national accounts are expected to grow by 3.7% in 2014, 2.5% in 2015 and 2.3% in 2016.

Aside from 2010, the trend since the financial crisis through and including 2012 showed little economic

growth, while at the same time the public sector accounts showed a large deficit, which in the main

derived from a deficit in the National Treasury (landskassin).

A shift was observed in the trend in the last half of 2013, when most key economic indicators revealed

a hint of growing economic activity and economic growth in current prices. Nevertheless, this did not

prove sufficient to turn the result in the National Treasury (landskassin) from a deficit to a surplus, but

there is a suggestion, however, of a declining deficit in the National Treasury.

What has sustained economic growth over the last few years especially is the price trend for exported

farmed salmon, the trend in exports in general, the trend in investment activity and the trend in private

consumption. It is believed that the growth in private consumption over a somewhat longer period of

time will be limited by low pension savings by the Faroese and the obligatory pension system, and that

this can contribute to limited economic growth. Given the current level of technology, there is also a

limit to how much the aquaculture industry can grow, and, with the current pelagic fisheries quota, the

catch is limited. A increasing part of the economic growth observed in the last few years stems from an

increase in capital earnings rather than in wages.

The growth in export prices reflects the export of farmed salmon over the last several years. Around

half of the growth in GDP in 2013 in current prices stems from the upward growth of the price of

farmed salmon. The price for farmed salmon grew as well in 2014, but perhaps not as much as in 2013.

The amount of farmed salmon was estimated to be exceptionally large in 2014, while it is believed that

there will be a small decline in 2015.

Growth in the export value of the pelagic fisheries, especially of mackerel, stems from increasing

catches because, among other things, the mackerel stocks have increased, and the Faroe Islands has

unilaterally set its own quota. In 2014, a new agreement was entered into among some of the coastal

states regarding mackerel. For the Faroe Islands, the agreement meant higher prices, but not a higher

quota compared to the years without an agreement. For the other pelagic fisheries, namely herring

and blue whiting, no agreement has been reached for 2015. It is anticipated that the quota for herring

will remain constant, while the quota for blue whiting could rise. In the end, it is expected that the

export value for 2015 will remain consistent with 2014.

Private consumption is a significant part of the economy; the level of private consumption in the Faroe

Islands is greater than the export of goods and services. The trend of private consumption, therefore,

has a major impact on economic growth. Private consumption is calculated at the same time as the

national accounts, but the latest updated figures on consumption are from 2013. For the period of time

after 2013, we have some indicators, including import figures, wage payments, VAT data and the data

from the Economic Confidence Survey conducted by the Ministry of Finance.

Changes for all imports in 2014, compared to 2013, reveal a decline of some 6.6%. Excluding ships and

airplanes, imports rose by 3.4%. For 2014, the import figures for immediate consumption show a

growth of 5.4%, which gives some indication of a growth in private consumption. The latest data on

wage payments shows an annual growth of 6%. The greatest growth is seen in the goods production

PDF to HTML - Convert PDF files to HTML files

industry, which also includes the construction industry and shipyards, while there was lower growth in

public sector wage payments. Data on VAT payments to the National Treasury also points to an

increase in private consumption. The Consumer Confidence Survey of the Ministry of Finance for private

households indicates greater confidence than has been seen since the financial crisis. The data from the

confidence survey, together with import, wage and VAT figures, give an indication that there is growth

in consumption. The growth in private consumption in 2014 is estimated to be 7.6% and for 2015 it is

estimated to be 4%.

There has been little growth in

public sector consumption

since the financial crisis. The growth is

estimated to be 2.3% in 2014 and 1.9% in 2015. Data from 1999 indicate that changes in public sector

consumption is pro-cyclical – when there is much in the treasury, much is spent and vice-versa – and

this has exacerbated rather than mitigated the fluctuations in the economy. It is advisable that the

government not repeat the excessive spending policies adopted at the beginning of the 21

century and

in 2007 and 2008, if economic activity otherwise increases in the years ahead.

We see a significant growth in total

public sector investment

in 2014, compared to 2013. We anticipate

that the investment in 2015 and 2016 will lie at the same level as in 2014. The growth in public sector

investment from 2013 to 2014 especially stems from investment by the national government and not

from investment by the municipalities. The investment activities of the national government are

considerably impacted by the construction occurring at Marknagilsdepl [the new secondary education

building]. Municipal investment has remained steady since 2008, but had been growing exponentially

up to that time. Investment in the main stemmed from loans in the 1990s. Improvements in the fiscal

status of the municipalities also impacts investment interest.

Just as with public sector consumption, public sector investments are deemed to be pro-cyclical, both

for the national government and the municipalities. It is therefore advisable for the public sector here

again not to repeat the actions taken during 2007 and 2008, if economic activity otherwise grows in the

coming years. The debt ceiling of the municipalities – meaning that debt shall not exceed the yearly

taxes assessed – does not necessarily encourage systematic planning of fiscal policy that encompasses

all public investment.

The deficits in all the

public sector accounts

have been large over the last several years and in the main

stems only from a deficit in the National Treasury. It is estimated that the net operational deficit of the

National Treasury for 2014 will be around DKK 230 million. Net assets of the public sector accounts

were around DKK 2.5 billion in 2007, but will be close to zero in 2014.

English Summary

–

Fiscal Sustainability

For the first time ever, The Economic Council undertook a fiscal sustainability analysis of the Faroese

economy. For this purpose, the Council created an economic model to calculate the fiscal consequences

of demographic changes and economic policy changes. This model enables a projection of public sector

expenses and revenue as well as GDP. The calculations are based on a projection of population size and

composition. Further, a financial formula is used to calculate present value as well as the fiscal

sustainability indicator, which indicates, in a single number, the fiscal sustainability of the public sector

economy.

The basis year for the calculations is 2012. This means that the projections of public sector revenue and

expenses is based on the public sector expenses and revenue in 2012, as compiled in the statistical

accounting data maintained by Statistics Faroe Islands of the public sector accounts. Projections were

made through 2051.

Positive fiscal sustainability means that the anticipated future public sector revenue at the very least

should cover future public sector expenses. If not, the level of fiscal sustainability is insufficient and

such situations customarily require intervention through politically-driven economic policy initiatives.

PDF to HTML - Convert PDF files to HTML files

Most all countries in Western Europe and the Western World conduct regular calculations of their

respective annual fiscal sustainability as a required element of forging public economic policy. It is

anticipated that in the future this will be done in the Faroe Islands as well. The main reason for this

interest is the demographic changes that lie ahead, and also the financial crisis.

Of course, there is always a certain amount of uncertainty associated with such calculations. In

essence, the goal of the calculations is simply an attempt to ascertain and pull together all the relevant

trends. For the Faroe Islands, some conditions are more explicit than others, e.g., the age distribution

of the elderly part of the population, and that GDP and public sector revenue and expenses are

conditioned on age distribution.

There is a presumption that the demographic situation in the Faroe Islands is more distorted relative to

age distribution than found in those countries with which we normally compare ourselves. The Table

below shows the historical trend and projections from 2013 for the older age groups in the Faroe

Islands.

Population of older age groups 1990 - 2050

Year

1990

1995

2000

2010

Over 70

3728

4159

4397

4864

Over 80

1074

1267

1510

1939

Source: Statistics Faroe Islands

2013

5475

2091

2020

6669

2267

2025

7488

2778

2035

2045

2050

9257 10173 10158

3860

4819

5150

GDP projections were based on 2013 data (provisional figures from the last audited public sector

accounts). Projections to 2051 are based on an assumed average annual price index increase of

1.75%, and an average annual growth in productivity of 1.5%. Otherwise, the calculations (present

value calculations) are based on an assumed average nominal interest rate of 4.75% for the period.

The fiscal sustainability calculations are based upon, among other things, how much each person on

average in each annual age band costs in 2012 for certain public expenses (individual public

consumption and individual public financial transfers). For each year forward to 2051, projections are

made for these expense groupings [age bands], based on assumptions about the yearly average price

index increase, as well as real growth, which corresponds to assumed growth in productivity (grounded

in the bases referenced above). The projections are made by multiplying the projected number of

people in each age band every year forward by how much each person on average in each annual age

band costs, where the costs are adjusted for assumed price index increases and assumed real growth,

corresponding to growth in productivity.

For non-age-specific (collective) public services and public sector consumption, the projections are

made based on projected growth in the population; also in this regard here again the cost is adjusted

for price index increases and a real growth that corresponds to growth in productivity.

For investment, the projections are formulated as a percentage of projected GDP (historical average

figures for the year 1998 – 2012 are used).

For almost all of the public revenue, the projections are formulated as a percentage of projected GDP

(historical average figures from the years 1998 – 2012 are used). For the Block Grant and other Danish

revenue support to the Faroe Islands, the projections are based on available Danish P/W figures. (i.e.,

price and wage index used by the Danish government)

Special attention has been focused on the calculations of public revenue under the old pension scheme

(with deferred tax) and the new pension scheme (with advanced tax). Changing from a deferred tax

scheme to an advanced tax scheme does not in and of itself affect fiscal sustainability (i.e., the

calculated fiscal sustainability indicator), but the consequences of this change could, on the other hand,

PDF to HTML - Convert PDF files to HTML files

easily worsen liquidity, if there occurs an adverse impact on the result of the public sector accounts

over time.

By basing our projected expense calculations on the assumption that real grow is equal to growth in

productivity, we also submit to the assumption that productivity growth has a neutral impact on fiscal

sustainability. Growth in productivity results in growth in GDP and public revenue. However, public

expenses have historically been seen to grow concomitant with growth in public revenue. The real

growth in public sector wages and services has in the long-term corresponded to growth in productivity.

Thus, historical experience demonstrates that growth in productivity and the economy does not in and

of themselves shelter fiscal sustainability – weak fiscal sustainability reflects disturbances or disruptions

in the economic structure. On the other hand, growth in productivity does occasionally protect jobs by

strengthening commercial competitiveness, and thereby indirectly strengthening the fiscal sustainability

of the public sector. But this type of impact, however, cannot be inserted into the computer model

being used. As with productivity growth, price index increases are also assumed in the calculations to

have a neutral impact on fiscal sustainability.

The following assumptions regarding “quality aging” were used in the projections for the three expense

line items listed below under the Ministry of Health (HMR) and the Ministry of Social Services (AMR):

Consumption under “10.2 old age services”, which encompasses home help, nursing homes and

retirement homes (under AMR);

Consumption under “7 health services” (under HMR)

Financial transfers provided under “7 health services” (under HMR).

These assumptions are incorporated into the economic model in the following manner: Beginning with

the 35-year-old age group, the 2012 expenses for each person are moved one year forward for each 5-

year age band. This means, for example, that a 99-year-old in 2018 would cost the equivalent of what

was provided to a 98-year-old in 2012. The assumption regarding “quality aging” is based on

experience from our neighbouring countries. Impact consequence analyses have shown that this

assumption or element in economic calculations has a major impact on the calculated fiscal

sustainability.

The graph below shows the result of a consequence calculation using the fiscal sustainability model

wherein the assumptions used by the Council are considered realistic, and also are deemed to be

essentially consistent with the policies articulated by the broad political majority. The assumptions on

quality aging are incorporated. Also incorporated into the model’s calculations is the assumption that

the price index and/or real growth adjustments would not be integrated into the national pension

scheme in the future. The base pension rate has not been adjusted since 1999, although the

supplemental rate has been adjusted. For 2015, no adjustment was made to the early retirement

pension scheme, etc., but in our projections we have, however, indexed these for price increases and

real growth.

The result of this consequence calculation is a fiscal sustainability indicator of minus five. This means

that a long-term tightening of fiscal policy, which in DKK equates to -5% of GDP, is necessary in order

to ensure that the net debt/asset of the public sector accounts as a percentage of GDP will remain the

same at the end of the projection period as at the beginning, i.e., unchanged. In 2015, 5% of GDP

equals around DKK 750 million (5% of DKK 15 billion).

The graph below shows how this result is derived. As depicted, expenses grow from revenue. One trend

that is evident from the graph below is prevented in and of itself because of extreme growth in debt.

Apart from this, we believe that the trend identified is correct, i.e., if no other economic policy

measures are enacted, or if nothing totally unexpected occurs.

PDF to HTML - Convert PDF files to HTML files

Revenue and Expenses in percent of GDP 1998 - 2051

66%

64%

62%

Revenue

Expences

% of GDP

60%

58%

56%

54%

52%

50%

2002

2004

2006

2008

2010

2020

2022

2024

2026

2038

2040

2042

2044

1998

2000

2012

2014

2016

2018

2028

2030

2032

2034

2036

2046

2048

S o urc e :

Calculatio n o f sustainablity. Fo r 1

998 -201 , data are actual balances, while fo r 201

2-2051(pro jected) data are primary balances (less interest)

The result also shows a growing deficit as a percentage of GDP.

Results of annual accounts in percent of GDP 1998-2015

15%

10%

% of GDP

-5%

-10%

-15%

2010

2012

2014

2016

2018

2020

2022

2038

2040

2042

2044

2046

2050

2048

S o urc e :

Calculatio n o f sustainablity. Fo r 1

998 -201 , data are actual balances, while fo r 201

2-2051(pro jected) data are primary balances (less interest)

This graphic representation shows quite clearly that there is considerable pressure on expenses;

demographic changes push expenses upward as a percentage of GDP, and revenue as a percentage of

GDP cannot withstand this pressure.

It is possible that rationalization efforts within the public sector could lead to reduced expenses; in the

first instance, this will cost jobs. To “offload” expenses from the public sector was the principal goal of

the new pension scheme. Given the lack of data, The Economic Council cannot determine if and when

this might become an actuality. Otherwise, major and/or drastic reductions in expenses could easily

result in the level of public services, public financial transfers, and also the basis for investments falling

well under the level found in our neighbouring countries. Such radical cuts could also set into motion a

vicious cycle of a declining economy and growing emigration.

To increase tax revenue and other related fee/surcharge revenue through the pressure of tightening tax

measures can have the same impact on the economy as the cutting of expenses. It is possible,

however, to impact both the revenue side and the expense side of the public sector accounts by making

the pension age more upwardly flexible, consistent with the trend in “quality aging”. At the same time,

2050

1998

2000

2002

2004

2006

2008

2024

2026

2028

2030

2032

2034

2036

PDF to HTML - Convert PDF files to HTML files

the government could broaden its tax and revenue basis. In this regard, we refer the reader, for

example, to the analysis of resource rent in The Economic Council’s report from the autumn of 2014.

Given the desire to assure a level of welfare that does not decline much below that provided in our

neighbouring countries, the problems with fiscal sustainability referenced above can be explained by

the fact that we will in future have too few working-age employees and too few competitive jobs for

them – we will lack both people and jobs. Therefore, the revenue trend will be what it is shown to be.

In conclusion, The Economic Council believes, however, that it is possible to safeguard public sector

fiscal sustainability in the Faroe Islands. In large measure, the question is dependent on political will

and political choice.

100