Iceland

   

Economic Policies

#19
Key Findings
With the aftereffects of economic crisis easing, Iceland falls into the upper-middle ranks (rank 19) with regard to economic policies. Its score on this measure represents a decline of 0.2 points relative to 2014.

Undercut by a slowdown in tourist arrivals, growth has declined, but remains positive. The government has run small surpluses in recent years, but the balance was expected to fall into deficit in 2019. The central bank lowered interest rates to counter the slowdown in economic activity.

The unemployment rate has remained quite low, at between 3% and 4%. Given the small size of the economy, the bankruptcy of WOW Air boosted the unemployment rate quite significantly. Tax revenues have been stable at 42% of GDP, and public debt levels have fallen to sustainable levels after ballooning during the banking crisis.

The government still owns two-thirds of the country’s banking assets, and has yet to propose a plan for restructuring the sector. Banking oversight has been folded back into the central bank, a model that produced weak supervision in the past. The irrevocability of the withdrawal of Iceland’s EU application remains in question. R&D spending is very strong.

Economy

#18

How successful has economic policy been in providing a reliable economic framework and in fostering international competitiveness?

10
 9

Economic policy fully succeeds in providing a coherent set-up of different institutional spheres and regimes, thus stabilizing the economic environment. It largely contributes to the objectives of fostering a country’s competitive capabilities and attractiveness as an economic location.
 8
 7
 6


Economic policy largely provides a reliable economic environment and supports the objectives of fostering a country’s competitive capabilities and attractiveness as an economic location.
 5
 4
 3


Economic policy somewhat contributes to providing a reliable economic environment and helps to a certain degree in fostering a country’s competitive capabilities and attractiveness as an economic location.
 2
 1

Economic policy mainly acts in discretionary ways essentially destabilizing the economic environment. There is little coordination in the set-up of economic policy institutions. Economic policy generally fails in fostering a country’s competitive capabilities and attractiveness as an economic location.
Economic Policy
7
The economy has still not recovered fully from the harsh fiscal adjustment to the 2008 financial crash, which imposed a retrenchment equivalent to about 10% of GDP between 2010 and 2017. Public services, especially healthcare and education, have suffered a serious shortage of funds. Having run a small fiscal surplus in recent years, the central government now forecasts a deficit in 2019 due to lower tax revenue. Meanwhile, the central bank has lowered interest rates to counter a slowdown in economic activity due, among other things, to fewer tourist arrivals.

At 3%, inflation exceeded the official target of 2.5% in 2019 and may rise further as labor unions, under new leadership, continue to demand wage increases against the background of large wage hikes granted earlier by the Wage Council to members of parliament, senior public officials (and the president of Iceland who donated the salary increase awarded to him to charity). The salaries of members of parliament increased by 111% between 2011 and 2018. The Wage Council has since been disbanded. The council did not keep minutes of its meetings. Under these circumstances, and in view of ever higher CEO compensation, concerns about distributive justice in the labor market loom large.

The future of the banking sector remains uncertain. The government, which still owns two-thirds of banking sector assets in Iceland, has not yet presented any concrete plans for restructuring the banks. Iceland is one of very few countries in the world without any foreign competition in its domestic banking sector.

Iceland applied for EU membership in 2009. The preceding government had signaled its intention to abide by EU standards and to strengthen Iceland’s institutional environment, including its regulatory policy. Due to disagreements between the government’s coalition partners at that time, the application process was put on hold in January 2013. In 2013, a new government expressed its intention to unilaterally retract Iceland’s membership application. A formal withdrawal was announced in the spring 2015. However, the European Union and the Icelandic government seem to disagree on whether this means that Iceland has fully withdrawn from the process. Specifically, the European Union has questioned the authority of Iceland’s foreign minister to unilaterally withdraw an application approved by parliament. This question is most likely going to remain unanswered for some time.

Citations:
Gylfason, Thorvaldur (2015), “Iceland: How Could This Happen?,” in Reform Capacity and Macroeconomic Performance in the Nordic Countries, eds. Torben M. Andersen, Michael Bergman, and Svend E. Hougaard Jensen, Oxford University Press.

Gylfason, Thorvaldur (2018), “Ten Years After: Iceland’s Unfinished Business,” forthcoming in Robert Z. Aliber and Gylfi Zoega (eds.), The 2008 Global Financial Crisis in Retrospect, Palgrave.

International Monetary Fund (2018), Iceland: Staff Concluding Statement of the 2018 Article IV Mission, September 25, 2018.

Labor Markets

#17

How effectively does labor market policy address unemployment?

10
 9

Successful strategies ensure unemployment is not a serious threat.
 8
 7
 6


Labor market policies have been more or less successful.
 5
 4
 3


Strategies against unemployment have shown little or no significant success.
 2
 1

Labor market policies have been unsuccessful and rather effected a rise in unemployment.
Labor Market Policy
6
For a long time, labor market policy and labor market mobility within Iceland kept unemployment low in general. Just before the collapse in 2008 the unemployment rate was below 1%, reflecting an overheated economy. However, this changed following the collapse, but less than might have been expected. In 2010, the unemployment rate peaked at just under 8%. Thereafter, joblessness gradually declined to below 3% in 2018 before rising to 4%, still a low rate compared with other European countries. However, the bankruptcy of WOW air, an Icelandic airline, in late March 2019 has changed things. The collapse of WOW air led to 1,500 people losing their jobs, with a large proportion of these people still unemployed at the time of writing. The unemployment rate rose from 3.2% in March 2019 to 3.7% in April 2019 due to the bankruptcy (Vinnumálastofnun, April 2019).

Iceland’s labor market legislation has essentially remained unchanged since 1938 with wage contracts negotiated by the leadership of labor unions and employers’ associations, granting both partners significant market power. Many wage contracts were renegotiated between 2018 and 2019. In April 2019, two of the largest trade unions – VR (the Store and Office Workers’ Union) and Efling (a union covering workers across all sectors except commerce and trade) – reached a moderate collective agreement with the Confederation of Icelandic Enterprise (SA). Though, at the time of writing, several wage negotiations have not reached agreement, including negotiations covering almost the entire public sector.

Several decisions by the Wage Council in 2017 – including granting double-digit, retroactive wage increases to members of parliament, senior public officials, and the president of Iceland – have caused resentment among ordinary wage earners, as have rising differentials between CEO compensation and average wages. For this reason, a cloud of uncertainty hangs over future wage developments.

Wage rivalry between labor unions remains a prominent feature of Iceland’s labor market, a phenomenon that helps to explain Iceland’s high inflation in the past and current fears that inflation may rebound despite favorable external conditions for price stability.

Citations:
https://vinnumalastofnun.is/media/2271/april-2019-skyrsla-lok.pdf (Icelandic Directorate of Labour).

Statistics Iceland, https://hagstofa.is/talnaefni/samfelag/vinnumarkadur/vinnumarkadsrannsokn/. Accessed 22 December 2018.

Gylfason, Thorvaldur, and Assar Lindbeck (1984), “Union rivalry and wages: An oligopolistic approach,” Economica, May.

Taxes

#21

How effective is a country’s tax policy in realizing goals of revenue generation, equity, growth promotion and ecological sustainability?

10
 9

Taxation policy fully achieves the objectives.
 8
 7
 6


Taxation policy largely achieves the objectives.
 5
 4
 3


Taxation policy partially achieves the objectives.
 2
 1

Taxation policy does not achieve the objectives at all.
Tax Policy
6
Current tax revenues are insufficient for the government to fulfill its goals of revenue generation, equity, growth promotion and ecological sustainability. Education, healthcare, welfare provisions and environmental protection all remain underfunded. The tax system should be more progressive and the tax authorities should do more to tax wealth hidden in foreign tax havens, especially given the information exposed in, for example, the Panama Papers. Fishing fees remain far below potential as only 10% of the common property resource rent from fisheries accrues to the taxpayer while 90% accrues to the owners of fishing vessels. In late 2018, parliament decided to significantly lower fishing fees, while disadvantaged social groups (e.g., disabled people and pensioners) complain bitterly about being left behind.

Frequent changes of government since 2013 have not had a significant affect on tax policy. Tax revenue was stable at 42% of GDP between 2017 and 2018, but is projected to fall below this level in 2019. New labor market agreements could change this if the government, as the single largest employer, uses tax policy as a bargaining chip or if large wage increases trigger a change in tax policy.

Citations:
International Monetary Fund, 2018 Article IV Consultation, IMF Country Report No. 18/318, November 2018, https://www.imf.org/en/Publications/CR/Issues/2018/11/14/Iceland-2018-Article-IV-Consultation-Press-Release-Staff-Report-Staff-Statement-and-46357. Accessed 18 December 2018.

Indriði H. Thorláksson, “Veiðigjöld 2015. Annar hluti” (Fishing Fees 2015. Part Two), http://herdubreid.is/veidigjold-2015-annar-hluti/. Accessed 18 December 2018.

Budgets

#14

To what extent does budgetary policy realize the goal of fiscal sustainability?

10
 9

Budgetary policy is fiscally sustainable.
 8
 7
 6


Budgetary policy achieves most standards of fiscal sustainability.
 5
 4
 3


Budgetary policy achieves some standards of fiscal sustainability.
 2
 1

Budgetary policy is fiscally unsustainable.
Budgetary Policy
7
The 2008 economic collapse dramatically increased the country’s foreign debt burden. General government gross debt rose from 29% of GDP at the end of 2006 to 95% in 2011. Thereafter, it gradually decreased to 34% of GDP at the end of 2019 and is projected to decline to 24% by 2023. Reflecting a reduction in the public debt-to-GDP ratio, which stems in part from a fairly rapid expansion in output since 2011, interest payments on the public debt have declined from 4.5% of GDP in recent years to 3% in 2019. According to the IMF, Iceland’s foreign debt burden should remain sustainable. Nonetheless, fiscal sustainability remains a serious concern for the government given the dire financial situation of several key public institutions, such as the State University Hospital.

Three comments are in order. First, Iceland’s public debt burden is understated in official statistics because unfunded public pension obligations are not included, which is rare in OECD country data. Second, while the left-wing 2009 – 2013 government increased fishing fees significantly and budgeted for further increases, the center-right 2013 – 2016 government reversed course and reduced fishing fees against IMF advice, a policy continued by the center-right 2016 – 2017 government and the left-right government formed in late 2017. This reversal reflects a change in public expenditure and tax policy from a progressive to a regressive stance. Third, many public institutions remain in a dire financial situation, including the State University Hospital, schools and universities, and the State Broadcasting Corporation (RÚV). Fiscal balance is not on a firm foundation when vital public institutions and infrastructure continue to suffer from long-standing financial neglect.

Citations:
International Monetary Fund, 2018 Article IV Consultation, IMF Country Report No. 18/318, November 2018, https://www.imf.org/en/Publications/CR/Issues/2018/11/14/Iceland-2018-Article-IV -Consultation-Press-Release-Staff-Report-Staff-Statement-and-46357. Accessed 18 December 2018.

Research, Innovation and Infrastructure

#16

To what extent does research and innovation policy support technological innovations that foster the creation and introduction of new products?

10
 9

Research and innovation policy effectively supports innovations that foster the creation of new products and enhance productivity.
 8
 7
 6


Research and innovation policy largely supports innovations that foster the creation of new products and enhance productivity.
 5
 4
 3


Research and innovation policy partly supports innovations that foster the creation of new products and enhance productivity.
 2
 1

Research and innovation policy has largely failed to support innovations that foster the creation of new products and enhance productivity.
R&I Policy
6
Combined public and private research and development (R&D) expenditure in Iceland totaled 3% of GDP in 2006, one of the highest levels among OECD members. About 40% of this expenditure was provided by the government. This high level of R&D investment reflects the ongoing transformation from an economic focus on agriculture and fisheries toward manufacturing and services. In particular, this has led to the creation of new private firms in the biotechnology, pharmaceutical, and high-tech manufacturing sectors. Such export-oriented firms were helped by the depreciation of the króna (which lost a third of its value in real terms following the 2008 crash), but were then hurt by the króna’s gradual recovery, before once again benefiting from the depreciation of the króna during 2018. The economic collapse in 2008 led to a cut in R&D expenditure to 1.8% of GDP in 2013. According to the most recent available data, R&D expenditure was 2.1% of GDP in 2017, still well below the 2006 level. This is evidence of the long-lasting damage caused by the 2008 collapse, which compelled public authorities to drastically cut public expenditure and then change the composition of public spending following the country’s recovery – changes that would have been difficult to implement during normal times.

Citations:
Statistics Iceland, https://hagstofa.is/talnaefni/atvinnuvegir/visindi-og-taekni/rannsoknir-og-throun/ Accessed 16 September 2019.

Rannis (The Icelandic Centre for Research), https://www.rannis.is/starfsemi/arsskyrslur/. Accessed 21 December 2018.

Global Financial System

#33

To what extent does the government actively contribute to the effective regulation and supervision of the international financial architecture?

10
 9

The government (pro-)actively promotes the regulation and supervision of financial markets. It demonstrates initiative and responsibility in such endeavors and often acts as an international agenda-setter.
 8
 7
 6


The government contributes to improving the regulation and supervision of financial markets. In some cases, it demonstrates initiative and responsibility in such endeavors.
 5
 4
 3


The government rarely contributes to improving the regulation and supervision of financial markets. It seldom demonstrates initiative or responsibility in such endeavors.
 2
 1

The government does not contribute to improving the regulation and supervision of financial markets.
Stabilizing Global Financial System
4
In part because of its small size, Iceland has never sought to make a substantial contribution to the improvement of the international financial architecture. However, the government has taken significant steps to address the extreme instability of the domestic financial system, including steps that have attracted international attention and have been held out as an example for other countries.

The post-crash 2009 – 2013 government significantly strengthened the Financial Supervisory Authority (FME) and established a Special Prosecutor’s Office charged with investigating legal violations related to the financial crash. By late 2018, the Supreme Court had sentenced 36 individuals (30 bankers, three executives, two auditors and a cabinet secretary in the finance ministry) to a total of 88 years in prison for crash-related offenses, with an average jail term of 2.5 years. The 88 years of total prison time have not been evenly divided among the banks, however: Kaupthing got 32 years, Glitnir got 19, Landsbanki got 11 years, Savings and Loans got 12 years, and others 14 years. The uneven distribution of sentences across the three main banks (even if they were very much alike) may create concerns about unequal justice. At the end of 2015, the Special Prosecutor’s Office was merged with the District Prosecutor’s Office under the directorship of the former Special Prosecutor.

Under new management following the crash, the FME sought to impose tougher standards. For example, prior to the crash, the owners of the banks were their largest borrowers. This is no longer the case. Further, banks commonly provided loans without collateral, but this practice has since been discontinued. Before, it was common practice to extend loans to well-connected customers to purchase equities, with the equities themselves as sole collateral. Presumably, this is no longer being done. However, other practices have not ceased. For example, banks continue to be accused of acting in a discriminatory and nontransparent manner with some privileged customers allowed to write off large debts, while others are not, without appropriate justification for discriminating among customers. A number of Iceland’s most prominent business figures avoided bankruptcy following the crash because banks annulled their losses. Due to bank secrecy, such debt write-offs are impossible to ascertain. Under new management, since the proactive director of the FME appointed in 2009 was replaced in 2012, the FME lacks strong and clear leadership. The FME has once again adopted a passive, non-intrusive strategic approach. According to a February 2019 Gallup poll, banks are among the least trusted institutions in Iceland. Only 20% of respondents expressed confidence in the banks, compared with 18% confidence in the parliament and 27% confidence in the FME. The government decided in late 2018 to incorporate the FME into the central bank, marking a return to the arrangement that produced weak bank supervision in the past. This decision has now been implemented. Tellingly, in October 2018, Iceland was added to the Financial Action Task Force’s grey list of countries – a list of countries that have not introduced sufficient measures to combat money laundering and the financing of terrorism.

The government has yet to propose a plan for the reorganization of the banking system. This means that the future ownership structure of the banks remains uncertain, particularly the division between private and public ownership as well as between foreign and domestic ownership. Foreign competition in the banking sector remains absent, offering huge monopoly rents to bank owners, a unique feature of Icelandic banking, which helps explain why bank ownership is so coveted among Iceland’s clan-based business elite.

Citations:
Jensdóttir, Jenný S. (2017), “Ákærur og dómar vegna hrunmála” (Indictments and Verdicts in Crash-related Cases), Gagnsæi (Transparency), Samtök gegn spillingu (Alliance against Corruption), http://www.gagnsaei.is/2017/12
/29/domar1/. Accessed 18 December 2018.

Gylfason, Thorvaldur (2018), “Ten Years After: Iceland’s Unfinished Business,” forthcoming in Robert Z. Aliber and Gylfi Zoega (eds.), The 2008 Global Financial Crisis in Retrospect, Palgrave.

https://www.gallup.is/nidurstodur/thjodarpuls/traust-til-stofnana/. Accessed 16 September 2019.

Iceland Review (2019), “Iceland Grey Listed for Inadequate Money Laundering Policies,” https://www.icelandreview.com/news/iceland-grey-listed-for-inadequate-money-laundering-policies/.
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