The Icelandic economy - Present situation and future prospects

Ladies and Gentlemen
It is a pleasure to have the opportunity in this distinguished audience to talk about the Icelandic economy today, both the present situation and the future prospects. First, let me mention some basic facts. Today, Iceland is one of the fastest growing economies in Europe. Unemployment is low, in fact we have to import labour from other countries in order to fulfil our demands. Iceland also enjoys one of the highest standards of living in the world. The fiscal situation is sound and the level of public debt is among the lowest in the world. Furthermore, Iceland tops the league of European nations when it comes to competitiveness.

This favourable description of the economic situation in Iceland is not only recognised by the Government and our supporters but also by international organisations such as the OECD and the IMF as well as the major rating companies, Moody’s, Standard and Poor’s and Fitch international. Furthermore, a recent survey of the well-known IMD Business School in Luzanne in Switzerland places Iceland in fifth place in the world in terms of competitiveness. By comparison, in 1995 we were in 25th place. And, as you will hear more of later this morning, things are not only going well inside Iceland. In fact, what has happened is that because the business climate has been so favourable which, in turn, has created such strong and profitable companies is that the Icelandic market has become too small. This is why Icelandic businessmen have started looking for investment opportunities abroad, in Denmark, the United Kingdom, Sweden, Finland, Norway and many other countries.

Perhaps, it is not surprising, in view of the fact that Icelanders only add up to about 300.000 people, that this may have raised a few eyebrows here and there. Two weeks ago I was in Denmark explaining among other things how this was possible. How Icelandic investors were able to be such dominant figures, not only in the fishing industry, but in other sectors such as banking, inside and outside Denmark, in the pharmaceutical sector and telecommunications where the activity has stretched to Eastern Europe, the Balkans and Asia; in aviation where Icelandair, the biggest airline company in Iceland, holds 10% of Britain’s low-cost Easy-jet and another Icelandic airline company, Air Atlanta, has been investing in various foreign companies. And just a few weeks ago, a group of Icelandic investors became the second largest owners of Finnair. Finally, let me mention the flourishing investment activity of Icelandic firms in the food market, especially in the UK but also in France and Denmark. The same applies to other markets such as real estate, clothing, toys and jewellery stores.

I find these questions highly appropriate and understandable. However, as is often the case, the explanation is not as complicated as you might think. The main explanations for this strong investment activity of Icelandic businessmen abroad are, on the one hand, the impact of wide-ranging structural measures that have been implemented in Iceland in the past decade or so, and, on the other hand, the highly positive effect of increased globalisation, liberalisation and economic integration on the business environment in Iceland.

These changes have had a catalytic effect on the business community and fostered an entrepreneurial spirit that explains these large and diverse investments. But there are other factors at work. These changes have contributed to a rapid rise of asset prices as witnessed by the fact that the Icelandic Stock Exchange index has more than doubled since mid-year 2003. Another factor is the strong financial position of the pension funds in Iceland but their total assets amounted to about close to 1.000 billion krónur at the end of 2004, or 10% more than Iceland’s national income. This means that there is a lot of capital available for investment purposes both domestically and abroad. All of these factors explain the strong investment activity of Icelanders abroad.

Ladies and gentlemen.
Some of you may remember yesterday’s Iceland. When we were a closed and an isolated economy, with a record high inflation, a comprehensive state ownership in most sectors of the economy, including all major financial institutions, and a highly unstable economic situation. This was not a situation which was likely to foster an entrepreneurial spirit and create a positive environment for the business community to flourish. Fortunately, more and more people realised that drastic changes were needed and so, as is very much the Icelandic way, we simply set out to make the changes. Some changes came gradually while others were quickly implemented. As a result, the Icelandic economy has been fundamentally transformed.

Let me first mention that the financial market was liberalised. This has contributed to a much stronger capital base than earlier which has had a catalytic impact on the business sector by opening up new channels of financing, both domestically and abroad. The privatisation of the banking sector, which was completed two years ago, has also made the business environment much stronger than before.

The same applies to the privatisation of other state-owned companies. At present, the only remaining large state-owned company is Iceland Telecom. The preparatory work for the privatisation of Iceland Telecom is well underway. Market conditions are favourable at present and interest amongst investors is considerable, since Iceland Telecom is a well-run company. The Privatisation Commission is working on this issue using the counselling of Morgan Stanley of London. The sale of Iceland Telecom is going to be the largest privatisation in Icelandic history. It is therefore very important that this will be a success. I believe that the privatisation process has proceeded smoothly and contributed to increased competition and efficiency in the economy, for the benefit of both consumers and the business sector.

The third reason for the favourable business climate in Iceland is the complete overhaul of the tax system in Iceland. Thus, tax rates have been cut by a large margin. The personal income tax has been lowered from 49% to 38% today and further cuts will be implemented in 2006 and 2007 bringing the tax rate below 35%. The corporate income tax has been cut even more or from 51% to 18%, which is one of the lowest tax rates in Europe. A third major tax reform is that all forms for capital income are now subject to the same tax rate of 10%. Also, net wealth taxes have now been completely abolished. I would like to stress the importance of these tax reforms for the Icelandic economy, not least the business sector. And I can add that this has not had a negative impact on the fiscal budget; quite the opposite since this has broadened the tax base and raised the tax revenue.

Finally, let me mention two things. First, that we introduced a quota system in the fishing industry which has helped us manage our very important fish resources in a sustainable way. We have also introduced various important structural reforms in the fishing sector that have contributed to a stronger and a more efficient industry. The second is that Iceland has been a member of the European Economic Area which has no doubt speeded up the globalisation process in Iceland and helped us reap the benefits of increased economic integration in Europe.

All these changes have played a major role in transforming the Iceland economy and contributed to create a sound and stable economic situation after decades of instability. Furthermore, and no less important, is the fact that we have had a stable political situation.

What does this mean in economic terms? Let me first look at the business sector. In a relatively short time span, the Icelandic economy has evolved from being a primary goods producer, where fish products constituted the bulk of our exports, to a diversified and high-technology production and services economy where new industries and services play an ever bigger role. I am not simply referring to large scale power-intensive industries utilising our valuable energy resources but also to numerous companies in other sectors such as software development, pharmaceutical production and distribution, medical equipment production, biotechnology research and development, expansion of the telecom industry and other high-tech industries. At the same time Icelandic firms have expanded into foreign markets which has furthermore strengthened the foundations of the economy.
Needless to say, this development has also contributed to a sound macroeconomic situation in Iceland. Economic growth has been strong and is at present more than 5%. Unemployment is less than 3% and falling. Household purchasing power has also increased sharply, up by 40% since 1995 and forecast to increase by another 10% to the end of 2007. The fiscal situation has also been strong which has resulted in a sharp decline in public debt. Inflation has also been moderate between 2-3% most of the period. The recent hike is mainly due to sharply rising housing prices and to some extent also higher oil prices.

Ladies and Gentlemen.
It is very important to understand that the changes that have taken place in Iceland during the last decade or so have not only led to fundamental changes in the Icelandic economy but also served to compensate for the small domestic market in Iceland. The liberalisation of the capital market and the impact of increased globalisation and economic integration has made it possible for Icelandic businessmen to reach out and invest abroad which was simply not possible before.

But I also think that the favourable business climate in Iceland offers some opportunities for foreign investors to enter the Icelandic market. Not only because of the Icelandic market itself but to establish a home base, if you like, for business activities that could be global. This could apply to financial operations, software development, pharmaceutical production and development, biotechnology research and development, telecommunications and many other areas.

You may ask: What do we have to offer? My answer is that apart from the favourable business climate, low taxes and other things, I think that we have shown that the small is not only beautiful but also very efficient. The red tape is much smaller in Iceland than in other countries. It is easy to start a business in Iceland. The labour market is also flexible, which facilitates both entry into and exit out of the labour market. This is a major factor explaining the low unemployment in Iceland. And I am sure that your ambassadors will tell you that decision-making in Iceland is fast.

So, ladies and gentlemen, to conclude, let me say that in the same manner as I permit myself to credit us politicians with some of the results achieved, particularly by creating favourable and encouraging conditions, it still is our role to shape the future that provides still further opportunities. The Icelandic experience proves that you don’t have to be big to succeed, as always you only have to do the right things.