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Switzerland Must Decide

Strength of the franc, immigration, energy strategy, corporate tax: Switzerland has important steps to take in the next few years. How can the Swiss model of success be safeguarded? A commentary.

If you believe that economic uncertainty in Switzerland is at an all-time high now, just wait a bit. Soon, the turmoil could become even greater. At stake here is nothing less than the Confederation's relationship with its most important trade partner, the European Union (EU). The deadline for implementing the initiative against mass immigration expires on February 9, 2017. By that time, immigration has to be managed with annual limits and quotas as stipulated by the Swiss Federal Constitution, at least that's what has been written.

The EU Has Other Problems

Agreeing on a system of quotas is only one of two herculean tasks. The consultation process on the Federal Council's draft has already been fraught with controversy. But now the intensity of the discussion is expected to increase, because ahead of the recent election for the Federal Assembly and the forthcoming election for the Council the parties have avoided and continue to avoid burning their fingers on this hot-button issue. And even if it is possible to find a quota system capable of winning a majority, it would address only the domestic side of the equation.

The other part of the equation, foreign policy, is even more difficult. According to the EU, quotas violate the applicable Agreement on the Free Movement of Persons, which, in turn, could jeopardize all of the bilateral agreements due to the "guillotine clause" and all it implies. The EU is unlikely to change its mind on this subject by 2017. The now 28 members have a variety of crises to manage, in addition to countering an internal bias towards isolation. In light of this, granting new exceptions for Switzerland is hardly a priority. And the likelihood that Switzerland will settle on a quota system compatible with the EU agreements is rather low. The only thing for certain is uncertainty.

Uncertainty is Unhealthy

Under the most probable scenario, Switzerland will introduce moderate immigration quotas in 2017, and thus violate the bilateral agreements. But neither Switzerland nor the EU will terminate these treaties. The EU could, however, selectively slap Switzerland with sanctions, based on its dissatisfaction at the violation of the agreements, such as by levying value added tax or requiring customs declaration. That's something quite different from stable cooperation.

Uncertainty is unhealthy for investments. Regression analysis demonstrates a significant correlation between political uncertainty and investment behavior. The significance of the bilateral agreements themselves cannot be easily expressed in terms of francs and centimes; the agreements and the economy are far too complex for that.

But surveys conducted at companies indicate that terminating the agreements or not having agreements in place would be extremely disadvantageous. Companies belonging to the Swiss Business Federation (economiesuisse), for example, consider the agreements to be highly important. The companies were surveyed about eight partial agreements. Over one-third of the companies rated seven of the eight partial agreements as positive or very positive, and around 90 percent of all survey participants rated at least one of the treaties as positive or very positive.

The value of strong relationships with Europe is evident from the significance of the EU for the Swiss export industry. From its perspective, the world consists mainly of the neighboring (EU) countries. Last year, goods worth around 110 billion Swiss francs were sold to the EU. This amounts to over half of all proceeds from Swiss exports. The German federal state of Baden-Württemberg alone imports more Swiss goods than China and Hong Kong combined. Together, Baden-Württemberg and Bavaria, the two federal states sharing a border with Switzerland, are almost as important as the US.

When investing and creating jobs here, foreign companies want security. According to an analysis of 245 bilateral investment flows between 19 OECD countries as well as China and Brazil between 1991 and 2012, economic stability in the host country along with market size are the decisive criteria when it comes to direct investment. Furthermore, the analysis shows that cultural proximity based on a common national language, for example, attracts direct investment.

The most important factor for direct investment, however, is taxes, particularly the difference in how companies are taxed in the home and host countries. Up until now, the tax system was Switzerland's trump card in the international competition for attracting companies. However, Corporate Tax Reform III and the new international standards arising from it have changed the situation. On one hand, fair tax rates should apply to the foreign profits of the so-called "Statusgesellschaften," companies with primarily international operations subject to a special tax status in Switzerland. On the other hand, under the OECD program BEPS (Base Erosion and Profit Shifting), competitor locations such as Ireland, the Netherlands and Singapore also have to do away with their tax models for these types of companies, thus strengthening Switzerland's competitive position.

However, key issues of Corporate Tax Reform III are controversial, and their impact varies by canton, hindering domestic consensus. The reform has yet to be adopted, and a referendum is likely. This is expected to take place in 2017 – yet another landmark political decision.

Baden-Württemberg imports more Swiss goods than China and Hong Kong.

Pension Obligations Are too High

Furthermore, 2017 is also the year when the scope of banking confidentiality will be reduced for many foreign clients. Under the agreement, the automatic exchange of information between Switzerland and all EU countries will take effect in 2017. This is likely to advance the reorganization of the financial system significantly. The Federal Finance Administration also has 2017 circled on their calendars. According to the current budget estimate report, the 2017–2019 legislature finance plan must include a program to cut costs by around one billion Swiss francs in order to fulfill the conditions of the "debt brake." Another important locational factor for Switzerland will be put to the test in 2017: sound government finances.

However, no significant developments are anticipated in 2017 for an additional important question for the future – the demographic trend and securing retirement provisions. Thanks to healthy economic and population growth, coupled with the robust performance of the financial markets, levels of distress were tolerable, and this is expected to remain so for a few more years. Therefore, the will to implement reforms is correspondingly weak. While locational trump cards such as economic openness (with the exception of the Mass Immigration Initiative, six of the seven bilateral solutions submitted in the last ten years were successful) or the liberal labor market (rejection of a national minimum wage, a sixth week of vacation, etc.) have mostly enjoyed considerable popular support, as do even fiscal reforms, pension reforms are routinely rejected. But the fact remains: Switzerland is (over-)aging and today's pension obligations are too high.

A Fiasco in the Making

Issues such as urban and regional planning and regulation are less urgent but just as crucial. These are extremely complex issues, and no progress is expected by 2017 in these areas either. The same holds true for the energy supply and the energy transition sought by the Federal Council. The Confederation's current strategy falls short of the mark in many respects. Market mechanisms and foreign trade ties are being ignored, as is the continuing rise in electricity consumption. This could result in a fiasco. Whether a reasonable management system will replace today's subsidy system remains to be seen. And certainly much later than 2017.

The strong Swiss franc is perhaps the latest challenge, but definitely not the only one, for Switzerland. Yet growing awareness of today's major issue could help us in thinking about other problems yet to come.

Thanks to clever decisions in the past, Switzerland is a model of success, and one that we need to safeguard for the future. Consequently, there are some hopes that the right decisions will be made in 2017.