The Current Performance of the Icelandic Economy
Address by H.E. Mr. Halldór Ásgrímsson, Minister for Foreign Affairs and External Trade of Iceland, at a Business Seminar and Introduction to Icelandic Products and Services
Bangkok, January 29, 1999
Ladies and gentlemen.
It is indeed a great pleasure to have this opportunity to address such a distinguished group of Thailand's business leaders present here today. I am convinced that there is a great potential for increased trade and co-operation to the mutual benefit of Iceland and Thailand. My mission to Thailand with a delegation of 20 representatives of leading enterprises in Iceland should bee seen as a concrete sign of our determination to seek out opportunities entailed in further collaboration between our two countries.
Although our countries may be far apart, distances are increasingly becoming irrelevant in the age of rapid communication and electronic commerce. Like our ancestor, Leif Eriksson, or Leif the Lucky, surfed the open seas 1000 years ago to discover America, Icelandic firms are taking full advantage of these new means of doing business to discover markets in far away places by surfing the world wide web. The business environment in Iceland has as, a matter of fact, changed dramatically in the last few years. It is more outward looking than ever. The dramatic changes new technologies are bringing to the world of trade are particularly relevant to Iceland, a country situated far away from international markets. I believe it is our obligation to use these new developments and bring our enterprises together to the benefit of people both in Thailand and in Iceland.
Before I give you an overview of Iceland's recent economic performance I would like to mention that Asia plays an important role in Iceland's economy. Asia accounts for 10-14 per cent of all merchandise exports as well as merchandise imports. This ratio has been increasing during the last twenty years and I suspect that it will continue to do so in the near future.
Let me now turn to locating Iceland for you in economic and social terms in the international economy.
Iceland's Economy in Today's World
Iceland today is a very small open economy with basically the same social and economic fabric as the most advanced OECD countries. The economy is relatively market-orientated with quite an extensive welfare system - but still not over-stretched. Public expenditure as a proportion of GDP is close to the average in the OECD countries. Both GDP and private consumption per capita are in the top range among the OECD countries. The level of education is high and Iceland's technical infrastructure is well advanced. Macroeconomic performance has been remarkable in recent years. Economic growth has been rapid, inflation has been kept in check and employment has been increasing. As a member country of the European Economic Area, Iceland has a similar legislative framework for businesses and industries to those prevailing in the EU. Iceland's GDP per capita, for example, ranks fifth among OECD countries.
According to a World Bank ranking of the richest countries in terms of their wealth per capita, instead of measuring their flow of income such as GDP per capita, Iceland is the seventh richest country in the world. Furthermore, a reasonable macroeconomic balance has been established, inflation has been brought under control and the economy has rapidly moved towards openness and liberalisation of markets. The economy's move towards macroeconomic balance is in a way confirmed by the fact that it meets all the Maastricht convergence criteria. Now, Iceland is not on the road to EMU, at least for the time being, so why compare it and EU countries in such terms? The reason is simply that the Maastricht criteria provide a quick economic health check - not an uncontroversial one, but certainly provide one means of assessing an economy's performance. In sum, Iceland is doing quite well on this core.
Behind these improvements in recent years lie extensive economic reforms. The most significant reforms relate to the strengthening of markets, opening up of the financial markets and more disciplined economic management. Distortions in the economic environment have been corrected by containing inflation and allowing interest rates and the real exchange rate to be determined by economic conditions. Furthermore, general attitudes towards the economy have changed. There has been growing appreciation of the need for stability and a consensus appears to have emerged that economic stability is the key to future prosperity. The phases of economic reforms during this decade can be characterised by five milestones.
· First, inflation was contained in the beginning of the decade. Tight economic policies and moderation in the labour market achieved this.
· Second, the real exchange rate and interest rates were allowed to be determined by market forces.
· Third, the European Economic Area was established, creating a similar legislative framework for businesses in Iceland to those in the EU.
· Fourth, capital flows have been liberalised in steps during the past few years and the final step was taken in the beginning of 1995 by liberalising short-term capital flows.
· Fifth, ongoing market reforms, incorporation and privatisation. The latest development in this area is a successful first phase of privatisation in the financial market.
These reforms have significantly changed the structure and characteristics of Iceland's economy by establishing reasonable macroeconomic balance and integrating the national economy with the global one. Good macroeconomic conditions are a prerequisite for a competitive business environment and integration with the global economy provides conditions, which are conducive for growth in the export sector. Hence, the economy has been streamlined and is now fitter than before to meet the challenges of the future. The performance of the Icelandic economy has improved overall and there has been progress in many individual sectors. For example, the so-called knowledge industries, in particular software and biotechnology, have expanded rapidly and large investments have been made in the power-intensive sector. In addition, manufacturing in general and tourism have flourished over the past few years. The fisheries have strengthened as well, due to an advanced resource management system in the sector. There are also clear signs of increased productivity and improved efficiency in most other sectors, which are undoubtedly the result of the changed economic environment.
I think it can be safely said that economic policy during recent years has certainly had its successes. But there is, of course, scope for further improvements. The most important tasks ahead can, in my view, be summarised in three main points. Firstly, and probably also most compelling, is the need to achieve better fiscal balance and limit the public sector borrowing requirement. This is essential to promote national saving which is relatively low in Iceland. A better public sector financial balance is the surest way to lower interest rates and to ensure price stability, which in turn are preconditions for enabling economic activity to expand. Secondly, further market reforms are called for in some sectors of the economy still dominated by state enterprises, i.e. the telecommunication sector, the energy sector and still to some extent the financial sector, although as I mentioned earlier the privatisation process has already been initiated. Thirdly, the question of Iceland's future exchange rate regime needs more attention in light of the introduction of the single European currency, the Euro. The primary objective of Icelandic monetary policy has been to maintain a stable currency. However, a fully independent currency in the future may be too costly in terms of interest rate differential vis-à-vis other countries. Therefore, there is a compelling need to investigate alternatives, such as some form of a linkage with the Euro.
Current economic situation and prospects
Now, let me turn to the current economic situation and prospects. The Icelandic economy has been in a strong upswing. Over the last two years, economic growth has averaged 5 per cent and the outlook is good with growth estimated at 3 per cent this year and the next. Along with rising levels of economic activity, the labour market situation has improved dramatically. In place of unemployment, which peaked at 5 per cent of the labour force in 1995, the outlook is for less than 3 per cent unemployment this year. Labour shortages are even beginning to be encountered. Despite substantial increases in wage costs and a rising level of employment over the last three years, inflation has not increased. Current conditions in the labour market give us full reason to be on our guard against the dangers of accelerating inflation. In light of these conditions, inflation is expected to inch upwards next year, giving a 2 per cent increase between the 1998 and 1999 averages.
The terms of trade have improved sharply this year. Higher marine product prices and lower oil prices more than offset lower aluminium prices, giving positive terms of trade effect equivalent to 2 per cent of GDP in 1998. The terms of trade are expected to remain broadly unchanged in 1999. This is, however, dependent on the economic crises in Asia, Russia and lately Brazil, not causing a further contraction in world economic activity. Such a development would undoubtedly be felt in demand for Icelandic goods and services. A current account deficit approaching 40 billion kronur in 1998 is a cause for concern. Rising domestic demand is the main reason for the deficit. However, it is partly the result of large imports of capital equipment for the power intensive industry and the electric power industry. The forecast indicates that the current account deficit will narrow next year to 4 per cent from 6.6 per cent of GDP this year.
In sum, the outlook for internal and external economic conditions remains favourable for the years ahead, despite some clouds on the horizon due to increasing turbulence and uncertainty in the world economy. Economic growth is expected to be brisk, inflation should remain in check and unemployment looks set to decline.
[Naturally, alternative scenarios are possible. As food for thought I want in particular to point out two other scenarios.
Firstly, the economic difficulties in Asia, Russia and lately in Brazil might have a more profound impact on the advanced economies than is now foreseen. This would naturally lead to less optimistic growth prospects in Iceland. Forecasting the timing and scale of such events is of course impossible. The impact would depend on how such a crisis would break out in other advanced economies.
Secondly, additional new investment in power-intensive industries seems to be likely. This would stimulate growth further than has been projected and lead to an even more rapid annual economic growth in Iceland than is now expected. These alternative scenarios are an attempt to map different roads for the years ahead. We cannot rule out the possibility that it will be bumpy road, but the odds are against this happening; most likely we will have a fairly comfortable ride if the world economy recovers soon from its current turmoil.]
To sum up, the prospects for the Icelandic economy are in general fairly encouraging. There are opportunities ahead and they are to be found in closer co-operation between enterprises from Thailand and Iceland offering great potential. I hope Thailand will be active in taking advantage of these opportunities and that the already existing links between our two countries will be reinforced still further here today. I would like to wish all the participants here today good success for the future.
The Current Performance of the Icelandic Economy