At Year’s End
In a recent book by Árni Þórarinsson and Páll Kristinn Pálsson, The Passenger, the philosophy of sages in the world of politics and media is described as an effort “to look over one’s shoulder as well as ahead without wringing ones neck”. Wringing your neck is unhealthy, but it will do us all good to review our accomplishments and set goals for the new year. The Icelandic nation can be quite well satisfied with its accomplishments in 2006, and all indications point to another good year. The economy continues getting stronger, although all our economic problems have certainly not been solved. The new year awaits us with new tasks, both in our private lives as well as in our life as a nation. The election this coming May will have much to say about our future.
Early this summer, former Prime Minister Halldór Ásgrímsson decided to retire from politics. A new Government under my premiership was formed. Halldór devoted his life to politics for more than 30 years and played a substantial role in the changes that took place in Icelandic society over this period. At the beginning of the new year, he will assume the post of Secretary General of the Nordic Council of Ministers in Copenhagen. He is well qualified for this post, having the experience of many years of Nordic cooperation. We wish him and Sigurjóna, his wife, well in their new endeavour.
The municipal elections took place last May and yielded interesting results. The Independence Party regained its leadership in the Reykjavík City Council. The new mayor, Mr. Vilhjálmur Þ. Vilhjálmsson, has made a fine start in his new post. He is well experienced in city affairs and has years of experience in municipal issues. The Independence Party gained considerable votes in the country as a whole and won a clear majority in many places. A number of strong leaders have emerged at the municipal level, some of whom will no doubt later enter into national politics under the banner of the Independence Party. The primaries of the party this past autumn indicate that there will be a considerable renewal in the parliamentary membership of the Independence Party this spring, as eight to ten new members will join the party’s parliamentarians.
The construction of the Kárahnjúkar power project is moving towards completion, and this great power station is scheduled to begin producing power next spring when the aluminium smelter at Reydarfjordur will also be completed. The designers and constructors have completed a Herculean task and solved many problems in the construction of this complicated project. It is satisfying to see how Icelandic engineers, geologists, contractors and others possess the know-how for such a gigantic project. This project has delivered a tremendous injection into the economy of the eastern part of the country and enriched the lives of the local people for the indefinite future. The project also accelerated growth for the entire country and the adverse effect on the labour market turned out to be less than anticipated because of the number of temporary foreign construction workers that came to the country for this project. Future exports from the aluminium smelter will offset the adverse effect of the construction project on the balance of payments as a result of its imports of construction materials and equipment in recent years. Although the decision to build the smelter at Reydarfjordur and the power project at Kárahnjúkar was all in accordance with law, the entire project has been subject to much controversy. It is of no use to continue this controversy now, since the construction is almost complete, but it is important to draw a lesson from this project for the future. It is unlikely that a power project the size of Kárahnjúkar will be constructed in the near future, and perhaps never. On the other hand, it would be a mistake to abandon the policy of using the energy potential of the country to improve the living standard of its people. It is quite evident that it will make sense to harness the lower part of Thjórsá as well as the geothermal energy that can be found in many areas. The experiments with drilling deep wells present an exciting promise, although it will take years to develop such potential. We must find a compromise between harnessing the resources of the country for the benefit of all Icelanders while at the same time preserving the natural beauty of our land. This is of course possible if all are prepared to contribute towards such a compromise.
Last March, we received the news that the United States would close its base before the end of September but would still adhere to their defence commitments in accordance with the Defence Agreement of 1951 between Iceland and the United States. This agreement does not stipulate that a defence force or certain equipment should be located in the country. This was a disappointing but not altogether unexpected decision. Ever since the end of the Cold War after 1990, the United States have reduced their presence here and the country’s defence has been adjusted to rapidly changing geopolitical circumstances in our part of the world. This situation left us with two alternatives. One was to strengthen our cooperation with the United States under these new circumstances and build upon the existing Defence Agreement. The other was to abandon the Agreement and look for new alternatives in the defence of the country. In my view as Foreign Minister at the time, as well as the Government’s, there were no realistic alternatives to the choice of continuing our cooperation with the United States. In fact, the abandonment of the Agreement would have created considerable uncertainty for the nation’s security. It was the Government’s duty to ensure that this would not happen. The former alternative was therefore chosen. I believe that the new agreement between Iceland and the United States, signed in Washington in October, is satisfactory. The agreement reconfirms the responsibility of the United States to defend Iceland, although they will not maintain a permanent base here. This unequivocal commitment stands in addition to the safety net embodied in our NATO membership. There is not doubt that many of the NATO members would wish to be in our place and enjoy a defence agreement of this kind with the most powerful nation on earth. The Government has initiated discussions with our neighbouring countries in the North Atlantic regarding search and rescue missions as well as other matters of security and area surveillance in times of peace. Such discussions are under way with Norway and Denmark and under preparation with the United Kingdom and Canada. The Coast Guard is at the same time being substantially strengthened with more helicopters, a new coast guard vessel and a new aircraft. The departure of the Defence Force also has a substantial domestic impact. In the Government’s declaration of September 26th, a number of issues are addressed that are under consideration. The main change in this regard is perhaps that Icelanders must themselves become more actively involved in our security and devote more resources for this purpose. We can not expect taxpayers in other countries to assume all the cost of the country’s defence.
The Icelandic economy has done very well in recent years, thanks to the economic policy pursued since 1991. The core of this policy has been to increase the freedom of enterprise in our economy, thereby strengthening the foundations of the economy and the improvement in the standard of living. Part of this policy was to ensure Iceland’s entry into the European Economic Area, a subject of much political debate. Since then, fifteen years have passed, and the time has come for university researchers to review and research the political controversy surrounding this decision. One can expect that some of the pessimistic warnings voiced at that time will astonish people today, as well as the change in attitude of individuals as well as political parties since then. There are those who maintain that this policy has led to increasing inequality. It is certainly true that many businessmen have become very rich, especially from international business, without earning such profits at the expense of their compatriots. However, if we look at income from employment since 1993, it emerges that the distribution of income has changed little. This means that the increase in employment income has been distributed quite evenly for all income groups over this period. This is good to know, although we can not expect that such a distribution will hold over a longer period. The change in emphasis of economic policy has enabled us to use the opportunities presented by increased international trade, globalisation and, last but not least, the revolution in telecommunications and software. Iceland has become an active participant in the open international economy. Icelandic investors enter into ventures in other countries and foreigners do the same in our country. One of the natural consequences is that foreign investors, rating agencies and financial institutions are closely watching developments in this country. As a young economist in the 1980’s, I worked for the Central Bank raising foreign loans for the Treasury. Sadly enough, the proceeds of these loans were often used to finance the deficit of the Treasury. It was seen only as a remote possibility, that the large international rating agencies, Standard & Poor’s’ and Moody’s, would rate the credit of the Icelandic Treasury, let alone that such a rating would be somewhere near the rating accorded to larger and richer countries. Today, we think of it as a matter of course that these agencies and others rate Icelandic entities and we expect that the Icelandic Treasury will be rated in the top three grades of these agencies. Since 2002, the Treasury has received an AAA rating from Moody’s, whereas Standard & Poor’s has always awarded a lower rating. S&P raised its rating in 2005 from an A+ to AA- without stirring any particular attention in the media or in the markets. A few days ago, S&P lowered its rating back to A+ and expressed concern about economic prospects, especially because of the amendments to the fiscal budget by the Althingi in its deliberations before the budget was passed. Moody’s, which bases its assessment on the same data, and has a staff with longer experience in this country, has not changed its AAA rating, in part by observing that the financial state of the Treasury is very solid and Treasury debt is low. The rating agencies are independent and not under the influence of governments or companies. They therefore enjoy the confidence of the market, and their rating awards represent indicators that facilitate lending transactions throughout the world. It is of no use to dispute the ratings, although opinions may differ on the conclusions that the agencies draw from the information available.
One of the most important tasks of the Government is to ensure full employment and an improvement in the standard of living. It may safely be said that this has proven to be a success, since the purchasing power of households has increased by about 60 per cent in just over a decade and unemployment is barely measurable. The pursuit of economic policy is however not always an easy task, although much has been gained through structural improvements. Inflation has, for example, been somewhat in excess of the Central Bank’s inflation target in recent years. Due to the size of energy-intensive construction projects, it was to be expected that there would be a temporary pressure on prices and the current account of the balance of payments. This was responded to in advance by a sharp tightening of fiscal policy, in part by postponing government investments. An increase in the Central Bank’s policy rate was also foreseen. The reaction of the commercial banks to the changes in the arrangement of government housing credits in 2004 was unexpected. The banks not only took the initiative of offering mortgage housing credits at much lower rates but also general consumer credits. This was an upset for economic policy. The negative and sometimes irrational analyses of several foreign observers in the first half of this year created disquiet in the foreign exchange market that led to a decline in the exchange rate with concurrent consequences for prices. It appears that we have overcome these difficulties now. The Government resorted to measures to tighten economic policy earlier in the year, in part by postponing new government investment for a few months. Measures were also taken in cooperation with the collective bargaining partners to ensure stability in the labour market and an extension of wage agreements through 2007. Last December, the Althingi passed the necessary amendments to existing laws for this purpose. The standard income tax credit was increased and child benefits extended to the age of 18 years. These measures have yielded results, and domestic demand is gradually receding. The turnover in the real property market is slower and real property prices have stabilised. Household consumption has also declined, as may for instance be seen from shrinking auto imports. Price increases have been scant in the past three months, and the general consensus is that the Central Bank’s inflation target will be attained before the middle of 2007. The current account deficit will also decline considerably and economic growth will be relatively slow in 2007 but revive in 2008. The balance of the Treasury has turned from deficits into strong surpluses in the past decade. The Treasury yielded a hefty surplus in 2005, 54 billion krónur excluding the proceeds from the sale of Iceland Telecom. Estimates for 2006 indicate that the surplus will have amounted to several billions and the 2007 budget was passed with a 9 billion krónur surplus. These developments have enabled the Treasury to make a sizeable cut in its debt. The net debt of the Treasury amounted to more than a third of GDP in 1995, whereas by the end of 2006 it had nearly disappeared. Indications are that the Treasury will already be holding net financial assets in 2007. This is a welcome development that will save vast sums in interest payments, payments that can be put to better use by cutting taxes or increasing spending on pressing needs in education, communications or social affairs.
In light of this economic situation, it is quite appropriate that the Althingi recently passed the Government’s bill into law calling for a sharp reduction in the taxation of food. These measures will be implemented on March 1st. They consist of the cut in the value added tax on food by half, the elimination of excise taxes and a sharp reduction in import duties on foreign agricultural products. These measures will lead to a considerable reduction in food prices, both in stores and restaurants. The value added tax on books, newspapers and magazines, cd disks, home heating, hotel rates and other items will also be cut. This will lead to a considerable cut in the consumer price index and a still further increase in household purchasing power. The personal income tax is being cut by one percentage point at the beginning of this year, and the standard personal income tax credit will be sharply increased, from 79,000 to more than 90,000 krónur a month. Previously, it has been decided in consultation with the collective bargaining partners in the labour market to rescind the previously planned income tax cut of two percentage points and reduce it to one per cent, raising instead the personal income tax credit by more than previously planned. The further cut in the personal income tax rate by one percentage point will have to await the next term of office after the Althingi election, and hopefully there will be room for further tax cuts. These tax measures represent the final phase in the tax cuts that the Government promised in its Policy Statement in 2003 and the Independence Party promised before the election in that year. The personal income tax has thereby been cut by three percentage points since 2005, the income surtax (sometimes wrongly dubbed as the high-income tax) has been abolished, the value added tax on consumer necessities halved, the net wealth tax on individuals and companies abolished and the inheritance tax slashed. Seen as a whole, these are the largest tax cuts that have ever been implemented in this country. However, Treasury revenue will not necessarily decline commensurably. The revenue from the corporate income tax has, for example, vastly increased after the tax was cut from 30 per cent to 18 per cent in 2001. It is of interest to observe the reaction of the opposition that has lost all of its credibility. It has both asserted that the tax cuts were an economic folly because they would be demand-stimulating, and also that the tax burden has increased in spite of these cuts, which, if true, must have restrained demand. It is an old and shabby political trick to compare incomparable figures and throw dust into people’s eyes. The correct comparison regarding tax cuts is to calculate how much a taxpayer pays after the tax cut compared to the payments under an unchanged system. This would show how much one would pay before and after, both adjusted for the change in income. Such a comparison shows that the tax cuts of recent years have benefited the working people of this country as they were intended.
An important agreement was concluded with the Association of Elderly Citizens this summer on ways and means of improving their lot. This was reflected in the joint statement of the Association and the Government. The statement calls for a substantial increase in pensions for the elderly, a simplification of the benefit and pension system, the introduction of a tax-free income threshold for income from work by pensioners as well as a reduction in the curtailment of benefits because of other income of pensioners and their spouses. Appropriations for the construction of nursing homes will be increased as well as for assisted at-home living of elderly persons. Emphasis will be placed on the construction of apartments designed for assisted living and old-age security. The Althingi passed a resolution to this effect before Christmas, and a large part of these changes will begin to be implemented in the beginning of 2007. The benefits for a large number of persons will therefore be immediately felt. Benefits for disabled persons will increase in line with old-age pensions. Disability issues have also been under special consideration in order to find ways to improve the ability to work and rehabilitate so that disabled persons will be able to use their capacity to work as suitable. A part of this work is to review the present disability assessment in order to take account of the ability of each individual to work. The aim is also to simplify the disability benefit system and make it more efficient so as to ensure a better overview of the choices available in each instance. The measures that have been decided upon in this respect will cost the Treasury about 12 billion krónur a year.
The will to work hard and pursue new initiatives has long characterised the Icelandic nation. Young people have pursued university studies in neighbouring countries on both sides of the ocean, basic studies as well as research and advanced scientific studies. There is no doubt that this endeavour has been important for the development of Icelandic society in the past century. In a recent study by experts from the OECD of higher education in member countries, it is observed that Icelanders have been ahead of other nations in sending students for university studies abroad. Iceland’s integration into the global community comes therefore as no surprise. The authors of the report confirm that the policy set out by the 1997 University Act has been successful and led to a vigorous expansion of higher education. The Icelandic student loan system is praised and how it has contributed to equality in higher education. The Icelandic university system is seen as very flexible, and the emphasis of the authorities on competition between universities has put Iceland into fourth place amongst OECD-countries in respect of attraction to university studies. We Icelanders can be proud of such a verdict. The Independence Party has been a leader in education and scientific issues for the past sixteen years. The activity of universities and in research has progressed rapidly over this period, and expenditure on these categories has nearly doubled in real terms in the past ten years. International cooperation in research and development has increased rapidly, and Icelanders are now active participants in a global effort in these areas and have become fully qualified providers in many special branches of science and technology, whereas before we only accepted the benefits of developments from elsewhere.
Iceland is a country of opportunities in these areas as well as in many others. There are many opportunities that await scientists and entrepreneurs as well as others. I hope we will be fortunate enough to seize these opportunities for the benefit of the entire nation. In the election this spring, we will vote on the continuation of the Government. The Independence Party will offer its continued leadership and I am looking forward to a fair and honest campaign and am fully prepared to continue shouldering my responsibility. I convey my greetings to the readers of Morgunbladid as well as to all my countrymen with my wishes for a prosperous and happy new year.