Árni M. Mathiesen's remarks at a conference on the Icelandic economy
Remarks at a conference on the Icelandic economy sponsored by the Royal Bank of Scotland and the German-Icelandic Chamber of Commerce in Frankfurt am Main.
Liebe Gäste, Botschafter Ólafur Davidsson,
meine verehrten Damen und Herren,
Ich danke der AHK - Island für die Einladung zu diesem Wirtschaftstag und der Royal Bank of Scotland für ihre Gastfreundschaft. Es ist das erste mal, das ich als Finanzminister nach Deutschland komme und ich freue mich sehr, zu einem so zahlreichen und hochkarätigen Publikum zu sprechen. Das Thema ist mindestens so aktuell wie es viele Fischereithemen zuvor waren. Ich bin in der glücklichen Lage, Finanzminister in Island zu sein, einer kleinen, aber äusserst prosperierenden Nation, mit einem gut aufgestellten Finanzhaushalt und soliden jährlichen Wachstumsraten. Peer Steinbrück dürfte mich darum beneiden.
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.
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 into balance.
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 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. But this will be discussed in more detail by other participants here today. Many of the new companies – some of which are represented here today - have also made significant inroads on the markets of neighbouring countries. In relation to this I could mention that Europe's Entrepreneurs for Growth awarded Icelandic aviation firm, Avion, second place on their Europe 500 list of most progressive firms in 2005. The question naturally arises what explains this stellar performance.
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.
First allow me to mention the year 1948, when the Territorial Waters Act became law in April. 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.
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 energy-intensive aluminium industry has thus gradually become one of the pillars of the economy.
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 by inflation indexing the pension funds. In 1980, self-employed 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 public pension system 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.
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.
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.
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 government-guaranteed 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.
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.
After 1990, an increasingly determined effort was made to strengthen the foundations of the economy, in part with plans to privatise government-owned 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.
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.
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. 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.
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 as share of GDP has fallen significantly and 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 time for an overhaul is due as the present pay-as-you-go income tax system was introduced in 1988.
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 are rated highly by international rating agencies.
Recently there has been an interesting debate in the media over the functioning of the Single Market and the revival of economic protectionism. It makes me wonder weather the recent stir about Icelandic banks in the press of some neighbouring countries isn’t really a part of the same debate as that surrounding Enel, Suez and Gaz de France, Mittle Steel and for that matter Dubai Ports. The Press calls this Economic Nationalism. One would think that nationalism was a thing of the past, at least on the Single Market of Europe.
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.
Die Beziehungen zwischen Island und Deutschland haben eine lange Tradition und sind sehr eng und vertrauensvoll. Die Handelsbeziehungen, zwischen unseren Ländern haben ihren Ursprung im Fischhandel und entwickeln sich über den Tourismus und andere Bereiche ausserordentlich gut. Diese unsere Zusammenarbeit wurde um so erfolgreicher, je internationaler und breiter die Aktivitäten wurden. Ich bin zuversichtlich, dass sich diese guten Beziehungen zwischen unseren Ländern in Zukunft noch vertiefen werden und sich ganz neue Bereiche und Möglichkeiten für eine Zusammenarbeit eröffnen werden.