Iceland´s Economic Performance
Iceland´s Economic Performance
Address by Davíð Oddsson, Prime Minister of Iceland
The American Enterprise Institute, Washington DC, 14 June 2004
I would like to thank the American Enterprise Institute for this opportunity to address you here today. It is a particular pleasure for me to be able to discuss Icelandic economic issues and their development with you.
This year in Iceland we are celebrating the centenary of Home Rule. With Home Rule, political authority was returned to Iceland from Denmark, which had ruled the country for centuries. This landmark in our political history also marked a breakthrough for our economy. After being one of the poorest countries in Europe for centuries, Iceland managed to become fairly prosperous in an incredibly short time. For most of the last century, fisheries were the mainstay of the economy, but in later decades other sectors grew, such as aluminium production, biotechnology, tourism and banking. The point has now been reached where Iceland enjoys one of the highest general living standards in the world. But although this broad picture is impressive, Iceland’s economic history has often not been plain sailing. We have repeatedly suffered severe external setbacks, but more often than not we have been our own worst enemies on the economic front.
The Government of Iceland faced a wide range of tasks in the nineteen-nineties. Inflation had run riot for decades. Most of the time it ran in double digits and at its worst point the monthly figure was equivalent to more than 100% inflation a year. Runaway inflation ruined people’s awareness of prices, made business planning more or less meaningless, ate up savings and eroded purchasing power. It did not help that the Icelandic state was actively and extensively involved in business activities at that time. Nothing seemed beyond its scope. Running a travel agency, fish meal processing plants, a knitting workshop, a printing company and all manner of other enterprises was taken for granted. The crucial factor, however, was the iron grip that the Icelandic state had on all business activity through its ownership of the commercial banks. Political power infused the entire financial system, which could hardly be distinguished from the political system. Furthermore, the fiscal position at the start of the nineteen-nineties was far from acceptable. The persistent Treasury deficit and the mounting debt that accompanied it were, in my opinion, one of the greatest threats to the Icelandic economy in those years. A recession in the early nineteen-nineties, which was caused among other things when the all-important cod quota had to be cut back by as much as one half, compounded the existing problem.
It is obvious from this account that politicians in Iceland faced a sizeable challenge. Equally clearly, there was no way to back down from solving it. It would not have made the world headlines if an island nation in the far north had thrown away its economic independence.
In my view, two important factors were decisive for the successful restructuring of Iceland’s economy. First, there was the will of the people themselves to normalise their economy. The whole nation suffered because of economic instability, and the ordinary wage-earner was worst hit of all. Thus the public at large were prepared to bear temporary difficulties if stability could be established by doing so. Most people realised that wage increases far beyond what companies could afford would only lead to inflation. A second important factor was that the coalition government which was formed in 1991 was based on very clear policies. Having a clear ideology is the best way that a politician can equip himself when setting off on a long, hard journey. It is both a driving force and a compass to point the way. Politicians need to take a standpoint towards a great number of issues, large and small, almost every single day – and it is impossible for them to keep their bearings if their ideology is vague. There are many sides to every challenge and every decision has consequences that must be taken into account. Politicians who lack clear political vision tend to go astray when there are many complex questions to ponder.
When Milton Friedman visited Iceland in the nineteen-eighties he was asked what solution he had to Iceland’s economic problems. Friedman gave a simple answer: “The solution is freedom”. The freedom of the individual and the freedom of the nation are the foundation of all well-being –spiritual and material alike. The motive behind attacking the Treasury deficit was not only its bad economic consequences. An equally important consideration was that a persistent deficit is a sure-fire recipe for higher taxes in the future, and higher taxes erode the freedom of the individual. Necessary as taxes may be, we must not forget that by their very nature they restrict our freedom. In 1995, Treasury debt in Iceland was equivalent to more than 50% of GDP. Next year it is forecast to be down to 15% of GDP. The Icelandic Treasury is in a solid position and Iceland’s international credit rating has never been better This success has been achieved not in spite of extensive tax cuts but, to a great degree, because of them.. In the early nineteen-nineties, corporate income tax was 50%. The Government cut it first to 30% and later to 18%, and Treasury revenues and economic growth actually increased as a result. Personal income tax has already been lowered and during the current government’s term of office it will be reduced by a further four percentage points. An income tax surcharge on the highest incomes will also be removed, and inheritance tax has been reduced and harmonised at a level which will never exceed 5%. In addition, it is planned to reduce value-added tax on food, which will benefit the lowest income groups in particular. I am convinced that these tax cuts will greatly strengthen the Icelandic economy well into the future. And not just the economy. The whole of society flourishes and becomes more diverse when each and every one of us keeps more of what we earn and can dispose of it as we please.
The political dialogue in the last century revolved around the dispute between those who believe in control and those who believe in freedom. Between those who regard the state as the be-all and end-all of everything, and those who are convinced that freedom of word and deed is the foundation for progress and prosperity. The privatisation debate touches on the essence of this conflict. When the Government launched its privatisation programme it encountered heavy political opposition. Left-wingers found fault with everything, and every time some state enterprise was supposed to be sold off, in their view precisely that enterprise happened to be the cornerstone of society. It did not matter whether a wool factory, printing company or fish meal factory was being privatised – the counter-argument was always that market forces were now taking over an important public service. So it was necessary to proceed slowly. There is little point in hoisting all the sails only to run aground on the nearest rock. But gradually the public noticed that the doomsday prophecies did not come true – far from it, service improved and expanded after privatisation. And support has steadily been growing for the view that market forces need to have as much say as possible. That a special case must be argued every time that the state undertakes to provide a certain service, such as health care or education. This is the natural course of things in my opinion. The market is fundamentally about the wishes and needs of the public at large, and these are best fulfilled by allowing individuals and their businesses to compete with each other to provide the best service. This is the way to achieve the most progress.
There would have been little hope of success if we had not carefully considered the order in which we went about privatising state enterprises. I am convinced, for example, that it would not have been appropriate to sell off the state-owned commercial banks at an early stage. The nation needed to have reached a broad understanding that it was advisable for the state to release its grip on this important market. The point has now been reached where the state has withdrawn completely from operations of financial companies, apart from housing loans, and the Icelandic financial market is much stronger as a result. Banks are now more capable of backing Icelandic business and have been expanding overseas on a growing scale. This is a very positive development which shows beyond all doubt the enormous force unleashed when the state entrusts individuals with freedom of action. In the near future, Iceland Telecom will be privatised. This will be the single largest privatisation project so far. Parliament has already approved the sale and I am convinced that the public accepts its privatisation.
Ladies and Gentlemen:
Privatisation, strong fiscal management and responsible leadership on the part of labour unions and employers have played a major part in the successful restructuring of the Icelandic economy. But many other factors have been important as well. The Central Bank was granted full independence and the Icelandic currency was floated in the market. Such a framework makes the economy more disciplined and solid. Another important point is that Iceland has sharply stepped up its spending on education in recent years. A large number of new educational establishments have appeared, and it is particularly pleasing to note that many of them are privately run, especially at university level. Although the state-run University of Iceland is still the leader in its field, there has been a massive increase in the number of courses offered, and what is most important, more people now find suitable courses of study than when the state had sole control of what was taught. Iceland now ranks with the countries that allocate the highest share of their national income to education, which is a very positive development. Our economy is built upon renewable natural resources, and higher levels of education will enable us to utilise them in new and better ways.
Economists are now forecasting robust growth in Iceland as far ahead as the year 2010. Continuous output growth has taken place since 1995, and last year it amounted to 4%. The rate of growth will speed up considerably in the next few years, driven by large-scale investments in the energy sector and aluminium industry. Real wages have also grown continuously since 1995, by more than 30%, which is the longest unbroken period of real wage growth in Icelandic history. Booming real wages have played a part in winning over public support for the political parties that have fought for greater freedom. Interventionist politicians think that the state can and should solve everyone’s problems. Like everyone else they see the obvious challenges, and it is often easy for them to demand action by the state. Free-thinking politicians put their faith in the market and are less able to point out specific, limited solutions. No one can tell in advance what solution the market will find to the problem in hand. But it is certain that if the market is given the time and the freedom, the solution it provides will as a rule be better for the community than anything the bureaucracy might invent. All the public sector committees and commissions rolled into one can never compete with the market. For each single idea from the public sector, the market has many, and what is more, ideas challenge each other in the marketplace and the best and most useful ones emerge as the victors. This is the best guarantee for the well-being of the general public in the long term. The problem facing politicians who champion freedom is that they are not always granted time enough to allow the market to do its job. It has been my great fortune as a politician to have been given a mandate by the people of my country for long enough to see what fruits freedom can bring.
Over the coming years, Iceland’s economic growth will depend upon how well we take advantage of the possibilities that prosperity has opened up for us in recent years. Freedom is an opportunity, a magnificent opportunity, but is matched by the duty to take advantage of it, and take good advantage of it. I believe that freedom has vast potential in Iceland. International surveys show that we rank with the countries offering the most business freedom in the world, and is also one of the easiest places to set up a business. This is crucial. Low taxes, business freedom and innovation are a combination that I know will bring benefits to Iceland. Furthermore, our Treasury is in a firm position, our pension fund system is solid, some 70% of our energy consumption is from renewable sources, unemployment is low and the work ethic is strong. Of course Iceland is not the first country in the world to have no problems. Far from it. But we now have more opportunity than ever before to prove that my grandparents’ generation was right in its belief that Iceland, despite its small population, could be a free and sovereign nation.
For centuries, Iceland was a very isolated country. It was so isolated, in fact, that once when we were a Danish colony, many months passed after the death of the King of Denmark before the news reached Iceland. That, I suppose, is what you call being loyal beyond the grave. Now, of course, times are different. Transport to and from Iceland is excellent, and advances and innovations in IT and telecommunications have transformed Iceland’s scope for international trade overnight. Globalisation presents a great opportunity for us. Naturally it poses risks for a small nation, but in Iceland’s case the potential far outweighs the problems. Iceland is totally dependent on the freest possible international trade. Our history is the story of how a poor nation managed to harvest its natural resources and export the products from them. That is how we began to prosper. If, at the beginning of the last century, we had not had access to foreign markets for our fish, the economic well-being we enjoy today would probably still be only a remote dream.
Market access is still one of the most important planks of Iceland’s foreign policy. In 1994 we became members of the European Economic Area Agreement, which granted us access to the single market of the European Union, by far our largest trading partner. The EEA Agreement removed the need for Iceland to join the EU. Membership of the EU would carry too high a price tag. The biggest factor here is the EU’s common fisheries policy, which is completely unacceptable for Iceland. It is based on the principle that the fishing grounds of member countries are controlled from Brussels. Another point is that Iceland’s fisheries sector operates on the same principle as other business activity – it is run commercially, since we cannot afford to do it otherwise. The EU fisheries sector is generally in a bad state, and relies heavily on government aid and centralised control.
There is another and perhaps equally strong reason that Iceland does not want to join the EU. A strong trend towards centralisation and integration seems to prevail within the Union and it appears to be heading towards becoming some kind of federal state. In my opinion the introduction of the euro has been the strongest stimulus in that direction. The European Central Bank now formulates a common monetary policy for all the countries in the euro area. For us in Iceland, it would be very difficult to live with that. Iceland’s economic cycles are often far out of pace with those on the continent. Recent economic history leaves us in no doubt about that. Fish catches, major investment projects and price developments in foreign seafood markets – all these factors can transform the Icelandic economy radically but have little or no impact in the countries whose economies the European Central Bank must reflect with its monetary policy.
The euro also exerts pressure towards establishing a single fiscal policy. We all know the fiscal conditions that the euro countries need to fulfil in order to avoid being penalised by Brussels. Advocates of a single Community tax policy are now making their voices heard. Germany’s Chancellor Schröder recently stated that corporate income taxes should be harmonised within the EU. And that they should be brought towards Germany’s current corporate income tax rate of 43%. Iceland does not want to follow such a course. We know from experience that low taxes are a driving force behind the economy and that nothing dampens people’s energy as much as watching most of the money they earn being taken away by the state. I believe it is absolutely vital that nations should compete to offer the best environment for businesses to operate in. Exactly the same arguments apply there as to competition by businesses in the marketplace. Competition imposes discipline and inspires new ideas, which is particularly necessary in the case of the state and how it exercises its authority. The fact of the matter is also that there is little point in countries shutting themselves away in a customs union with high corporation taxes and then trying to compete in global markets. Business will simply relocate to another part of the world, thereby reducing the tax base available to the state. Everyone can see where such a development would lead.
Ladies and Gentlemen:
Although the theme of my address is Icelandic economic issues, I do not want to forgo the opportunity, at this critical time in international affairs and while I am here in the capital city of Iceland’s closest ally, to touch briefly upon international security questions from the Icelandic Government’s perspective.
Iceland became one of the founding members of NATO in 1949, with the aim of ensuring its security and freedom in an alliance with the Western democracies with whom we had shared interests and values and a common destiny. Participation in NATO and the Defence Agreement made with the United States in 1951 remain the cornerstones of Iceland’s security policy.
Iceland and the US base at Keflavík were of vital military significance during the Cold War. After it ended US forces in Iceland were quickly reduced to provide for minimum defenses. The United States is now in the process of reviewing its global military posture, including its forces in Iceland. Regrettably, ideas have been raised within the US system for discontinuing Iceland’s air defences by removing the few fighter aircraft that remain at the Keflavík base. This would render our bilateral defence agreement meaningless and put an end to more than sixty years of defence cooperation between Iceland and the United States. I have faith that this matter will be successfully resolved, in the good spirit that has prevailed between our two countries for such a long time.
After the Cold War, NATO continued to have a crucial role for stability in Europe. And after the attacks on the United States on September 11 2001, the Alliance responded to terrorism and the proliferation of weapons of mass destruction.
Notwithstanding these new challenges, the Alliance’s cause remains unchanged of course, namely to ensure freedom, peace and stability. No international organisation has the same potential as NATO in this respect. At the same time, everyone realises that the disputes before the invasion of Iraq weakened the Alliance. A NATO Summit will be held in Istanbul towards the end of this month. Hopefully the Summit will demonstrate that the Alliance is united on how to tackle the main threats and dangers in the world today.
Iceland aligned itself with the nations in the Coalition of the Willing under US leadership before the Iraq war. We are all aware of the problems and difficulties that have arisen after the invasion and which have led to even more claims than before that it was a mistake made on false assumptions.
But the invasion of Iraq was justified. The Iraqi regime was a threat to peace and stability. Under Saddam Hussein, Iraq had attacked its neighbours, and not only produced weapons of mass destruction, but used them as well. Should the risk have been taken that Iraq could possess weapons of mass destruction or begin to develop them again? Everything suggested that the regime could not be trusted, including the information and suspicions of UN weapons inspectors. For more than a decade, Saddam Hussein had flouted UN resolutions and demands for disarmament. This was impossible to accept any longer. The credibility of the international community and the UN Security Council was at stake.
Now, Iraq needs to be put back on its feet after many years of suffering under a criminal regime. Notwithstanding disputes over the legitimacy of the invasion, everyone will surely agree that it removed a threat to peace in the region and that the Iraqi people are better off now than they were under Saddam Hussein and his henchmen. And everyone who favours peace in the area must realise the importance of successfully establishing democracy and stability in Iraq. The alternative is that instability and chaos will gain the upper hand, with awful consequences for the Middle East and for the war on terrorism.
The NATO Summit in Istanbul at the end of this month is expected to discuss how the Alliance may contribute to furthering freedom and democracy in the Middle East. Disregard for democracy and human rights is a prominent factor behind the troubles in that region and behind the threat posed by terrorism and weapons of mass destruction. NATO certainly has a contribution to make in this respect, as shown by the Alliance’s recent experience of assisting Central and Eastern European countries in the Partnership for Peace.
The war on international terrorism is a complex and far-reaching task. There is a genuine risk that terrorists may acquire weapons of mass destruction. NATO, the great transatlantic alliance of democratic nations, must remain alert to the grave danger of a combination of extremism, dictatorship and weapons of mass destruction and find effective means to counter such a horrifying threat.
Iceland has deployed civilian experts of various kinds for peacekeeping and reconstruction work in Bosnia, Kosovo and Iraq. Recently we began to participate in the NATO peacekeeping mission in Afghanistan by providing personnel for administrative control of Kabul airport and other tasks there. Iceland has also leased cargo jets for the airlifting of aid and peacekeeping forces to Afghanistan.
Ladies and Gentlemen:
Once again I would like to thank the American Enterprise Institute for this opportunity to address you here today. Politics are founded on ideology, and this institute performs an important role, not only here in the United States but much farther afield, in nurturing and developing ideas that can be used in the battle of freedom against control. Above all, politicians stand for ideas and ideologies. Their work is compared with the ideas they have presented to their voters. Good politicians are those who succeed in winning support for their convictions, are consistent and manage to implement their ideals. Politicians who have fought for freedom can look back proudly, for everywhere there are clear examples of the supremacy of freedom over control. In this context I would like to conclude by remembering a politician who has benefited the cause of freedom more than most others. Ronald Reagan was a politician who, by virtue of the strength of his ideals and his integrity, defeated communism, one of the most horrific forces of destruction in the history of mankind. In Iceland we remember him especially in connection with the Summit with Mikail Gorbachev at Höfði House in Reykjavík in 1986. But history will remember him above all else as the man who supremely benefited the cause of freedom. For his work we are all grateful.