by Prime Minister Halldór Ásgrímsson
at the Annual Meeting of the
Confederation of Icelandic Employers,
April 25th 2006
The events of recent weeks and the disquiet in the Icelandic financial market shows us that it is a thing of the past that Iceland is an islolated island far north in the Atlantic with limited connections to the outside world. As things stand today, a disturbance in our foreign exchange market reverberates throughout the world in an instant. This shows how integrated with the world economy we have become. This has both its advantages and disadvatnages. Our task is to see to it that the disadvantages be kept to a minimum.
A profound knowledge of the economy is a necessity
In recent weeks, we have clearly seen how important it is that the financial market has accurate and good information at its disposal. We have also become unpleasantly aware of how little is known about our economy abroad and of the adverse consequences of such a lack of information.
Icelandic financial institutions must respond to these changed circumstances with greatly increased information. The same applies to other entities that are engaged in this market, such as the Central Bank and the Financial Supervisory Authority. I also think that the government must participate in this effort. I believe that we have a good case to present. The Icelandic economy is strong and can withstand external shocks. This is in no small measure due to the profound changes in our economic organisation in almost all areas in recent years. There is no need to go into detail. This story is known to all here.
We must improve our presentation of these facts abroad so as not to be exposed to the risk that poor and ill-founded reports by foreign analysts, who know little of the Icelandic economy, create unnecessary disturbance in view of the small size of our economy. We can never escape the fact that the Icelandic economy will always be a small pawn by international comparison and therefore exposed to foreign disturbances, no matter how poorly supported they are with facts.
The exchange rate is too low
It lies in the nature of financial markets to speculate and go for a quick profit. Such a market also has a certain herd mentality. As soon as there is some disturbance, there is a tendency for all the market participants to move. Such behaviour has a tendency to exaggerate all changes and overshoot, such as in the foreign exchange market. In my opinion, this is what is happening with the Icelandic króna these days. Most observers agree that the króna exchange rate is by now too low in light of economic fundamentals. This will end at some point and these adverse developments will be reversed. The sharp rise in the exchange rate these last few days is an indication that the tide in the foreign exchange market is turning, whether it is permanent or not.
It does not come as a surprise to anyone who knows the Icelandic economy that the króna exchange rate has declined. It has been apparent for a long time and been clear to everyone that the high exchange rate could not be sustainable in the long run. A lower exchange rate will contribute to a better balance in the economy by reducing demand pressures and lower the current account deficit. That is a step in the right direction.
The adverse side is that inflation will inevitably increase more than one would wish while this adjustment is taking place. I believe that such an inflation burst will be short-lived, and that next year we will see inflation figures in the vicinity of the inflation target of the Central Bank. Let me point out that in the new economic forecast of the Ministry of Finance, next year’s inflation is projected at 3.5 per cent on average, declining to about 2.5 per cent in the latter half of the year, the inflation target of the Central Bank. Recent forecasts by Glitnir and Landsbanki predict a similar result.
No depression ahead
There is no reason to believe that the Icelandic economy is heading for a recession or depression. Those who take such a view are not reaslistically assessing the real aggregates of the economy as they appear in the statistics. The Ministry of Finance forecasts a 2 per cent economic growth next year and a 2½ per cent growth rate for the years 2008-2010. Although this is a lower rate of growth than has prevailed in recent years, it is nevertheless higher than in most European countries.
It happens time and again that people underestimate the strength of our economy, particularly its flexibility and ability to meet external fluctuations and react to them quickly and successfully. This is perhaps understandable since such a flexibility is rarely found in our neighbouring countries. Foreign observers tend to conclude that the situation here is similar to the one in their own countries in this respect. In actual fact, Iceland is counted amongst those countries that are seen as the most competitive in the world.
I would like to mention just one example of our special position vis-à-vis most other countries that at the same time underlines the strength of our economy. In a recent article in the Economist, the participation of women in the labour market is discussed. Its importance for the economy and its growth is rightly pointed out. The author of the article concludes that this represents a hidden treasure for the nations of the world, since increased participation by women in the labour market can constitute a source of growth and increased welfare.
I quite agree with this conclusion and believe that the development of our economy certainly confirms this. We are in the fortunate situation that the participation of women in the labour market in this country is about the highest in the world. According to the latest statistics, the participation rate here is 79.4 per cent, placing Iceland at the top of the list of OECD countries, followed by Norway, Denmark and Sweden with an average of 72-72 per cent and an OECD-wide average of 56 per cent.
This fact has not been much discussed in this country. This is nevertheless beyond dispute and there is every reason to maintain that this is an important reason why economic growth has been this strong, considerably higher than in our principal neigbouring countries. This reflects the strong position of women in the labour market which is getting stronger still. Actually, the same applies to the participation of older persons in the labour market, which is far greater here than in other countries. It is therefore no wonder that these issues are highlighted in foreign discussion regarding ways to increase economic growth.
Policy stability instead of policy change
There are those who maintain that the country is due for a major change in economic policy. I don’t agree. Great progress is always accompanied with some disturbance. When that happens, one should not immediately call for a change in direction. We need policy stability, not policy change. But what are the changes that are being called for in this discussion?
First, the privatisation of state enterprises and the change in the organisation of public entities has been subject to criticism. I ask you: Was it a mistake to privatise companies in competing operations? No. On the contrary, many of these companies have become engines for economic progress.
Second, the cut in taxes on business and individuals has been criticised. There are those who wish to rescind the further cut in the personal income tax and that the further coordination of the taxation of individuals and businesses be halted. The cut in taxes has been one of the main sources of economic growth. They have greatly increased business activity and kept companies in the country. The cut in income taxes has increased labour force participation, and the tax rate is approaching the level that was initially set at the time when the pay-as-you-earn tax system was introduced, a matter for which there was general agreement at the time. Next year’s tax cuts will increase purchasing power and reduce the need for wage changes. It will create greater room for increasing the lowest wages, a matter which now is being reviewed to avoid a more widespread impact. It is therefore not advisable to abandon this course.
Third, the restraint in fiscal operations is considered insufficient and the Treasury’s expenditure excessive in the present circumstances. There is always a need for great restraint in the expenditure of the Treasury and local governments. One can never be too careful in this respect. Social changes call for increased room for maneuver, particularly in the areas of education, health and the creation of new enterprise opportunities. These have been priority issues. I do not think that we have proceeded too fast in this respect and there are still many needs to be met. At the same time as the Government is accused of a lack of expenditure restraint, there are daily demands for new expenditures. We have exercised restraint in public investment and often postponed important investment projects. This could easily be repeated in the near future, should economic circumstances call for it. The trend in fiscal finances so far this year indicates that the fiscal surplus will be higher than estimated in the budget and fiscal restraint has in fact been greater than previously thought.
Fourth, the large increase in housing loans has been criticised. In my opinion, the changes in the housing finance system brought about by the Government were timely and have been of benefit to households. The banks, in my opinion, were too aggressive in their lending which led to a high level of private consumption maintained by borrowing. It is the responsibility of individuals and financial institutions to show greater caution and good sense.
Fifth, the investment in energy production and energy-intensive industry has come under criticism. I believe that with these investments we have used our opportunities to increase economic growth and diversify the economy. Was this unwise? No, on the contrary. With these investments, we have been able to create a large number of diverse and well-paid jobs and improve the living standard of all, the people, businesses and the public sector. The use of renewable energy is becoming ever more important and it would be absurd not to use the opportunities offered in this area. The forecast for rather scant growth over the next several years is a sufficient indicator that this course is necessary to ensure an even and stable progress. Out population increases faster than in many other countries and we therefore need relatively more economic growth. If we do not continue to create wealth, we will be unable to solve the many social and economic problems facing us. Like other nations, we need foreign investment in this country.
Sixth, it is often criticised that Iceland is investing heavily abroad and taking too much risk. While it is true that all investment is subject to risk, no opportunities can be seized without risk. In spite of rapidly increasing Icelandic investment abroad in recent years, we are still far behind other nations. Last year, Iceland’s investment abroad amounted to about one-third of GDP, whereas Denmark’s investment abroad was equivalent to 50 per cent of GDP and that of Sweden to about 60 per cent. What our companies are doing is more of a sign of normal participation in international commerce rather than an indication of undue risk.
I think it is therefore important that we carry on as we intended and do not be waylaid by temporary adversity. The Government’s economic policy has yielded enormous benefits, such as 25,000 new jobs in this country since 1995. This result has been achieved through policy stability. With wishy-washiness and lack of patience it would have been easy to miss out on our opportunities.
A family-friendly society
The keynote headline of this meeting is Greater success – a formidable challenge. It is indisputable that we have achieved a great deal in the Icelandic economy in recent years. But for us it is more important to look towards the future and consider how we can continue on this path and improve on our successes still further.
I see it as a challenge for those of us who are in politics to seek all avenues in order to create an efficient environment for business to grow in. At the same time it is no less important to create a family-friendly society where people wish to live and where they feel at home. In my view, we are going through a slow and quiet revolution in our society that is not only creating a favourable operating environment for business but also, and no less important, we are meeting the needs of individuals, of employees and their families.
This is an important task and I believe we have made considerable progress in these areas. We must however recognise that such measures taken by the Government call for increased funding unless savings can be made in other areas.
Since 1998, Treasury expenditure has increased by 20 per cent in real terms. Where has this money gone? To education, health, social security and welfare. As an example, funds for social security and welfare have increased by 45 per cent in real terms, more than twice as much as the increase in total expenditure. Spending on health has increased more, by nearly 50 per cent in real terms, for education by close to 60 per cent, and funds for education at the university level increased by no less than 80 per cent in real terms. Yet, in spite of this large increase in expenditures, total government operations have declined in relation to GDP by 2.5 per cent.
This is an important achievement that creates a foundation for our society in a broad sense of the word. Still, we must always maintain our vigilance and look towards the continued progress of the economy. Although it is clear that the fisheries sector will continue as one of our most important industries, it is nevertheless evident that it can not sustain continued economic growth. We must therefore look in other directions, as I feel we have done so vigorously in recent years.
Emphasis on enterprise innovation
We have developed a vigorous financial system that has played a key role in the economic progress of recent years. Tourist services have also become an important industry, constantly creating increased value. There are also a number of high-tech firms in pharmaceuticals, biotechnology, computers, software, and so on. These firms create a more diversified foundation for our economy, making it stronger and more competitive and better suited to withstand temporary fluctuations and shocks without creating the crises so well known to us in years past.
In this respect, I wish to call attention to the important work done by the Science and Technology Policy Council. The Council consists of ministers, scientists and industry representatives, and its main goal is to strengthen Iceland’s position in an international competitive environment. This work has yielded a great deal of results. Since the Council was established in 2003, appropriations to public funds intended to encourage competition have more than doubled, and universities are now turning out more graduates than ever before who are prepared for jobs that demand scientific rigour, knowledge and ability.
I recently presented a bill to the Althingi proposing that the work of the Council be expanded in accordance with plans to merge three public agencies into one, the Icelandic New Enterprise Centre, along with amendments to the provisions relating to the New Business Venture Fund. The name of the Council will be changed to the Science and New Enterprise Council. Its role will be to deal with issues relating to business development, innovation and new enterprises, in addition to science and technology.
The number of representatives on the Council will be increased by two, both coming from the business community. It is my hope that the participation of business in science, research and the creation of new enterprises will increase through these changes, since it is necessary that business and industry cooperate with universities and research institutes in a joint effort of the public and private sectors to work together in this important and rapidly increasing areas of Icelandic enterprise.
But there are many other issues at hand that I consider important for our society, which I hope we can implement soon. This relates more to households than directly to industry, but all of these issues are inter-connected and form an integrated social structure at the end of the day.
Lower food prices
The price surveys of Statistics Iceland in conjunction with Eurostat and the OECD have shown that food prices in Iceland are the highest in Europe. This issue has been under much discussion in recent years, and a number of inquiries have been made to find the causes. I believe it is important to arrive at a conclusion in this matter. For this purpose, I appointed a committee last January, with representatives from government, labour and farmers to present proposals as to how we can move our food prices more closely to those prevailing in neighbouring countries.
The committee has deliberated on many aspects of this issue and consulted many institutions and parties that have an interest stake in their task. The taxation of food is quite complicated and not very transparent. It has spawned a complicated system of exemptions and special provisions which has led to considerable cost increases. The imposition of an excise tax seems unclear, and the interplay of excise taxes and import duties appears haphazard.
I think it is important to simplify food taxation, eliminate those taxes that have an undesireable cascade effect and abolish the present exemption system. The imposition of import duties on imported agricultural goods must also be reviewed, in part because of international agreements that soon may take effect. Lower food prices would constitute a major improvement in household living standards and it would greatly help tourism as well.
The care of the aged and disabled
Improving the living standards of older persons is another important issue. The Government has already implemented substantial improvements in this area and improved the living standards of our senior citizens. I think it is important to carry on with this task and do still more. The number of older persons increases rapidly and their need for services is constantly increasing.
To meet this need, and in consultation with associations of elderly persons, I appointed a committee earlier this year which will deal with improvements related to older persons. The committee shall on one hand consider housing and services for the elderly and on the other hand inquire into the the means test related to support payments, having regard to the income-equalising purpose of means-tested income support. I expect that the proposals of the committee will be ready this autumn and so they can be taken into account in the drafting of the 2007 fiscal budget.
The problems of the disabled are also under close review in a committee that I appointed earlier this year, consisting of representatives from government, labour, employers, pension funds and the Association of Disabled Persons. One of the most important tasks of the committee is to deal with work rehabilitation and ways for the disabled to find suitable work. It is time that we change the emphasis and look towards the ability of each person to work rather than to the medically assessed degree of disability. Such a change would also call for a review of the means test for disability support in order to increase labour participation.
The committee is also reviewing various issues that relate to disability, such as a coordination of disability standards in the social security system on one hand and in the pension fund system on the other. In additon, one can mention a number of changes that are aimed at the implementation of disability assessment, monitoring and other related issues. I sincerely hope that the work of the committee will produce results so that we can use its proposals when drafting the next fiscal budget.
A formidable challenge
I certainly consider the issues that I have briefly discussed to be a “formidable challenge” indeed. This challenge is fair and we must meet it, both government and business. I have always seen it as the task for us politicians to work towards a better society, to improve the living standards of the people, create a healthy and good operating environment for Icelandic enterprises, while at the same time providing for a strong healthcare, education and welfare system.
I think our results have been satisfactory, looking back at the past ten years or so. We can of course always do better, and we will hardly ever satisfy everyone. The main thing is to set clear goals and understand what are the prerequisites for achieving such goals.
And what are these prerequisites? The basic requirement for all economic and social progress is that we produce increased goods and services. Without that, there will be no way to increase living standards. It is that simple. We must first and foremost look for ways and means to use all the opportunities accorded to us to increase our output of goods and services.
I sincerely believe that we as a nation have all the means to do this. The great progress we have made in recent years shows that we have the will and the ability, both individuals and enterprises. It is up to the government to find the path that leads us to further progress.