MINISTER OF FINANCE
Mr. ÁRNI M. MATHIESEN
9 May 2006
Speech by Icelandic Finance Minister,
Mr. Árni M. Mathiesen,
at a meeting about the Icelandic Economy
on 10 May 2006 in Copenhagen
The Icelandic economy – on a sustainable path
Introductory remarks
It is a great pleasure to be with you here today to talk about the Icelandic
economy, which has experienced a robust economic growth rate in recent
years. From 1996 to 2005, economic growth averaged 4,5 per cent in
Iceland – considerably faster than the 3% average growth rate in the
OECD–area. Over the same period, the growth of per capita real
disposable income averaged 4,5 per cent – also significantly more than in
the OECD-area. The unemployment rate, which averaged less than 3 per
cent in the past decade, is currently below 2%, despite growing inflows of
foreign workers. Economic growth and incomes are expected to continue
increasing in coming years and unemployment to stay relatively low.
The level and growth of GDP
in constant prices 2000–2010
Economic growth (left-hand axis)
%
GDP at constant prices (right-hand axis)
2000=100
10
145
140
8
135
6
130
125
4
120
2
115
110
0
105
-2
100
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Sources: Statistics Iceland and own forecast.
Temporary imbalances are not a threat to sustainability
Of course, such fast growth has not come without challenges. A large
current account deficit has emerged in recent years. The reason is
twofold. First, there has been a sharp increase in foreign direct investment
associated with the construction of aluminium smelter plants and related
energy production capacity. Second, merchandise imports have risen
sharply as consumer demand reflected the growing incomes and
increasing household wealth. The latter was the indirect result of recent
innovations in the housing mortgage market, which led to a rise in
activity on the real estate market and surging house prices. Fortunately,
these imbalances appear to have peaked and are on their way to unwind.
The growth in merchandise imports is now projected to taper off this year
and next while sharply increasing aluminium exports bring the
merchandise trade close to balance.
Growth of GDP and national expenditure and
current account deficit as share of GDP 1995–2007
%
20
Current account balance
Economic growth
National expenditure
15
10
5
0
-5
-10
-15
-20
1995
1997
1999
2001
2003
Sources: Statistics Iceland and own forecast.
2
2005
2007
The economy has performed very well in the past decade
The more important question is what it is that explains economic
dynamism in Iceland, which is all the more intriguing in view of the fact
that the economy is relatively small in size and remotely located. While
Iceland´s abundant fishing resources and its natural renewable energy,
both waterfalls and steam in the ground, have been important for the
overall economic success, the reforms of economic and structural policies
over past decades have also played an important role in gradually
transforming the economy and unleashing the dynamism of economic
agents. This has become more evident in recent years with the surge of
activity in other sectors of the economy, including in banking, retail, high
tech manufacturing, aviation and tourism. High tech manufacturing,
which includes pharmaceuticals, now accounts for 4% of GDP. It was
almost non-existent 10 years ago. Over the same time, the numbers of
foreign tourists has grown from around 160.000 to around 360.000.
Banks in Iceland, which were privatized some years ago, have more than
quadrupled in size and their profits increased more than tenfold in recent
years. Many of the new companies have also made significant inroads on
the markets of neighbouring countries.
3
Structural reforms began early
Although structural and economic policy reforms have been pronounced
in the past fifteen years along with the further opening of the economy to
the global market place in 1994 when Iceland joined the agreement on the
European Economic Area, it can be said with some certainty that earlier
reforms were of profound importance. That said the cumulative impact of
all of these reforms has been manifest strongly in recent years as
evidenced by the vigour of economic activity since the mid 1990s and not
least the robust growth of productivity and per-capita income.
Labour productivity1
Annual average growth 1994-2004 (%)
5.5
Slovak Republic
5.0
Korea
4.5
Ireland
4.0
Czech Republic
3.5
Hungary
3.0
Greece
2.5
Iceland
Japan
2.0
Turkey
1.5
Australia Sweden
USA
Finland
UK
Germany
Denmark
Canada
Portugal
Austria
Switzerland
New
Zealand
1.0
Norway
France
Spain
Luxembourg
Belgium
Netherlands
Italy
0.5
Mexico
0.0
0
10
20
30
40
50
60
Level 1994
1. GDP per hour worked, PPP adjusted, US dollars.
Source: National Accounts of OECD countries, OECD 2005.
4
The Territorial Waters Act in 1948
The reforms began some time ago. First allow me to mention the year
1948, when the Territorial Waters Act became law. This act proved to be
a watershed event in Iceland’s struggle for economic independence. It
established the scope for scientific management of the fishing grounds
and conservation of the fish stocks on the coastal shelf. Over time it also
became the basis for the expansion of the fishing limits to four miles in
1952, 12 miles in 1958, 50 miles in 1972 and finally to 200 miles in
1975. The authorities showed much foresight at that time. There were
subsequent important reforms with regard to the efficient operation in the
fishing sector and I will turn to those later in my talk.
5
Abundant renewable energy sources are being harnessed
Efforts to harness the renewable energy sources have also paved the way
for the development of energy-intensive industry, contributing to the
strengthening of the economy. The first aluminium plant, now operated
by Alcan, began operation in 1970 after several years of construction
activity. It was the only aluminium plant in Iceland for a long time and
during that time its production capacity was expanded. Another plant,
now operated by Century Aluminium, was constructed in the mid 1990s.
It is currently being expanded and a third even larger plant is being
constructed by Alcoa on the east coast of the country. The energyintensive aluminium industry has thus gradually become one of the pillars
of the economy. More such projects are being discussed and could take
place in coming years, which would increase the capacity further.
Aluminium production 2005-2015
Potential production
Intended production
Tons
1 800
Current production
1 600
1 400
1 200
1 000
800
600
400
200
0
2005
2007
2009
2011
Source: Ministry of Finance.
6
2013
2015
The financial system has developed
The financial system, which promotes saving in the economy and
allocates them to worthy investment projects, was significantly boosted in
1969 when private pension funds were created. Contributions to the
pension funds were made mandatory in 1974 and over time the pension
funds became an important contributor of financial saving in the
economy. In 1979, measures to safeguard the financial assets of the
pension funds from erosion by high inflation were introduced with the
introduction of inflation indexed financial instruments. In 1980, selfemployed persons were allowed to join the system. The pension fund
system was further strengthened in 1997 when pension fund contributions
were calculated on the basis of total wages instead of only day-time work.
The Icelandic private pension system is now close to being fully funded
and the pension system for civil servants is also on the way to becoming
fully funded. These farsighted reforms of the pension system will also
make it easier to fund increased outlays associated with an aging of the
population in coming decades.
7
Successful reforms of the fishing management system
In response to chronic over-investment and sagging profitability of firms
in the fisheries sector, important changes were made to the operating
environment of firms in this sector in the early 1980s. A system of
transferable catch quotas was introduced and the exports of marine
products were liberalized. The catch quota system created an incentive
for managers to rationalize firm operation, optimize investments in the
fishing fleet and take advantage of technical innovations. At the same
time, an export system whereby two major associations of fish producers
had a licence to export was changed such that smaller producers were
also allowed to export. This invigorated the export sector and improved
the efficient allocation between fishing and fish processing activities,
yielding benefits for all concerned. Over time, these reforms produced
larger more profitable fishing firms that have been more capable of
withstanding temporary fluctuations in the fish catch, prices of marine
products and exchange rates. In turn, the need for government or regional
assistance to the fishing industry has all but been eliminated.
8
Rationalisation of firms important for financial system development
The rationalisation of the fishing industry also had a knock-on effect for
the development of the financial market. As fish producers merged into
larger and stronger units they become better candidates for finance. The
banking system, which at the same time was undergoing a major
transformation with increased competition, was able to grow stronger by
funding the ongoing expansion and consolidation of the firms in the
important fishing sector.
9
Creation of the stock market was a natural outgrowth
At this point in time, it may safely be asserted that the enterprise
environment in Iceland had become substantially liberalised. The basis
for establishing a proper stock market had also come into place. Earlier, a
number of financial enterprises had joined together to establish a bond
market that mostly traded domestic government and governmentguaranteed bonds. After four years of operation 32 firms had been listed
on the stock exchange with fisheries companies playing a leading role.
The existence of the stock market encouraged further infusion of share
capital for further expansion of the fisheries sector.
10
Stability accord of employers and labour unions
Amidst all these developments, the labour market was undergoing
profound changes. In the late 1980s considerable unrest had developed in
the labour market due to the high and variable inflation rate and
instability in the economy. This led to an initiative by the Confederation
of Employers to the Confederation of Labour to join them in developing
an approach to ensure rising purchasing power of wages and at the same
time strengthen the foundations of market operation and economic policy.
This approach became known as the national economic accord. While
this new approach was not successful on the first try, the labour market
parties soon realised the economy was deteriorating further and in 1990
decided to join in the agreement to arrest the wage-price spiral and lay the
foundation for a more stable economy. With a floating exchange rate the
inflation management is more challenging, but there are reasons to be
confident that rising import prices will not premanently alter inflation
expectations or result in excessive wage demands. The benefits of
stability have been proved in recent years. Hence, the recent drop in the
exchange rate is expected to increase inflation only temporarily.
Inflation and the exchange rate of the króna
January 2004 – April 2006
12-mo.
change
(%)
6
CPI (left-hand axis)
31/12 ‘91
CPI excluding housing (left-hand axis)
Exchange rate of króna, monthly averages (right-hand axis)=100
128
5
124
4
120
3
116
2
112
1
108
0
104
-1
2004
2005
2006
11
100
Human resources are an important ingredient in the success
In reviewing individual changes in the economy, the role of increased
know-how in the workforce should not be overlooked. Icelanders are now
at the top of societies using computers and the internet. Financial
payments and tax filings are now mostly electronic. According to a recent
international study Icelanders are the most internet-based society in the
world. A new generation of people have entered business and
government, many of which have been educated in universities and
business schools in Britain and the US, returning home with fresh ideas
that are being applied. The refocusing of firm’s activity to the Single
Market and beyond is clearly reflected in the stock exchange, where the
listed companies receive around two-thirds of their profits from foreign
ventures. This also means that the stock exchange is less vulnerable to
fluctuating business conditions at home as it is based on a larger
foundation. This development is also helping to develop the financial
market further.
12
Economy has been opened up
The growth of Icelandic firm activity abroad also rests on the decision of
the authorities to liberalise Iceland’s capital movements pursuant to the
entry into force of the EEA agreement. As a result, firms could invest
abroad as they wished and foreigners could invest in Iceland – albeit with
a few exceptions. As a result, the debts of households and firms have
increased considerably. However, with the pension fund assets and
housing stock wealth combined, the assets of households are currently
triple their debts. Moreover, the net debt of the economy excluding the
banking sector turned positive in the past year for the first time, due to
foreign debt repayment of firms and the drawdown of public debt by the
government. Even if the net debt position of the commercial banks in
Iceland is negative, it should be noted that about three quarters of their
lending is abroad against foreign income and assets. Hence, their
exchange rate exposure in Icelandic krónur is quite limited.
Household assets and debt 1997–2005
Household assets (housing and pension funds)
Household debt
B.kr.
Household net assets
3 500
3 000
2 500
2 000
1 500
1 000
500
0
1997
1998
1999
2000
2001
2002
Sources: Central Bank of Iceland and Land Registry of Iceland.
13
2003
2004
2005
Regulatory system and surveillance institutions are up to EU standards
As a member of the EEA agreement, and therefore the Single Market, the
authorities have implemented regulations concerning product, services,
capital and labour markets, while also developing efficient surveillance
entities to ensure stable operations. As a result, the Icelandic banks have
become quite well capitalised and their risk assessement is considered
excellent. As a result, they are rated highly by international rating
agencies.
14
Significant efforts at privatising state owned enterprises
After 1990, an increasingly determined effort was made to strengthen the
foundations of the economy, in part with plans to privatise governmentowned enterprises and to reduce taxes. The government owned a number
of enterprises that had been established decades earlier at a time when the
private sector was weak and under-capitalised. Similarly, banks and
investment funds were almost exclusively in the government domain. The
time had now come to move these enterprises over to the private sector
and end the often lacklustre government involvement in activity that
would better be served by private actors. The privatisation effort has been
ongoing since the early 1990s and culminated with the sale of Iceland
Telecom last year. Under new ownership, the privatised enterprises have
flourished beyond expectation and have been at the forefront of forging
new trade and investment links abroad which has become the object of
recent news coverage.
Net debt of the general government 1991–2006
Treasury net debt
Local government net debt
% of
GDP
Treasury pension fund commitments
42
39
36
33
30
27
24
21
18
15
12
9
6
3
0
1991
1993
1995
1997
1999
2001
Sources: Statistics Iceland and own forecast.
15
2003
2005
Public policy reforms
The Government has consistently directed its efforts towards creating a
positive and innovative environment for business activity. In addition to
the structural reforms, economic policy has been completely overhauled.
The Central Bank adopted an inflation target and floating exchange rate
in 2001 as the new monetary policy strategy. In fiscal policy, the
Treasury has produced annual budget surpluses for most of the past ten
years. The result has been that the government debt has fallen
significantly and at around 6% of GDP is now one of the lowest in the
OECD countries. Amazingly this has been achieved while both the
personal income tax and the corporate tax have been steadily reduced.
The changes have helped the private sector to grow vigorously, with more
activity driving the tax receipts in stead of high tax rates. Work is
currently under way to simplify the tax system further and base it on a
true flat-tax approach.
The corporate income tax 1997–2006
In % of GDP (left-hand axis)
% of GDP
2.4
Tax rate (right-hand axis)
%
36
2.0
30
1.6
24
1.2
18
0.8
12
0.4
6
0.0
0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Source: Ministry of Finance.
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Conclusion
To conclude, let me say that many right choices have been made in past
decades concerning the structure of the Icelandic economy, including
reforms of the markets for goods, services, labour and capital, the pension
system, the tax system and the design of economic policy. These reforms
have been predicated on the belief in the ability of individuals to achieve
their own ends and thereby advance the cause of increasing welfare. The
opening up of the economy through participation in the EEA agreement
has enabled the firms to participate on the Single Market and beyond.
Further efforts are needed, but as things stand, Iceland is currently in a
good place and the outlook is promising. The productive base of the
economy, including infrastructure, financial system and production
system, has vastly improved and productivity has grown faster in recent
years. In our view, the present challenges to economic policy are
temporary and the resilience of a market-based economy, including the
sound banking institutions, will help to ensure continued strong economic
development. The dynamism and successful expansion of Icelandic firms
abroad in recent years is perhaps the best indication that the reforms have
been well designed and farsighted.
Thank you.
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