Third Iceland Investment Colloquium
Prime Minister}s speech at a seminar organized by Landsbanki Íslands
"Third Iceland Investment Colloquium" - 24. september 2002
It is a genuine pleasure for me to have the opportunity to address this seminar organized by Landsbanki Íslands. Financial services of various kinds have been one of the main growth edges in the Icelandic economy in recent years and it is very appropriate for Landsbanki, one of Iceland's leading banks, to organize a seminar and discussion on the Icelandic economy, its potential and its future.
Iceland's economy is now at a crossroads. Behind us is one of the greatest growth periods in the nation's history. Since 1995 the economy has grown by close to thirty percent, and this increase in GNP has been accompanied by a corresponding growth in real wages. It was certainly gratifying to see how well the economic improvement was spread through the whole community. In Iceland we have experienced periods of major growth in the past. But our problem has always been that they have inevitably been followed by downswings, because the economy was incapable of handling such a level of growth and overheated, often with terrible consequences for businesses and individuals alike. Many people thought they had good reason to predict that this story would be repeated, because it was becoming widely felt that a good harvest in summer was a sure sign of a harsh winter to follow.
Now it has been shown that the Icelandic economy was capable of absorbing such growth, and the old vicious circle of overheating and contractions, which so often cost us dear, was broken at last. It is worth reflecting on what changes took place in the Icelandic economy over the past decade or so to make this development possible. I think that the focuses to be found there provide us with the most useful guides on our way forward to the future.
The chief characteristics of the reforms over the past decade were privatization, fiscal consolidation, liberalisation of business in areas such as financial markets, strengthening of the fishing quota system and clear rules on transparent, solid public administration. All these factors, separately and in combination, transformed the image and character of the Icelandic economy from an unpredictable system which was prone to sharp swings and in many ways was completely different from those of neighbouring countries. It has been replaced by an economy which is overwhelmingly driven by market forces, an economy which is at once dynamic and progressive and enables Iceland to provide its citizens with general living standards on a par with the best anywhere in the world. But the vital point is that the framework now in place in Iceland is likely to provide a good foundation for ongoing economic growth.
Ladies and Gentlemen:
I cannot go into much detail here about the issues I think will characterize the way that the Icelandic economy will evolve in the next few years. However, several main themes will colour the trend that may be expected and I would like to take this opportunity to discuss them briefly. The first point is that then privatization process undertaken by governments in recent years has yielded great results. It has scaled down public sector operations and strengthened the equity market, and enterprises that were once operated as state institutions have been transformed into dynamic businesses that provide secure employment and pay their owners dividends. At the moment the two state-owned banks, Landsbanki and Búnaðarbanki, are in the process of being privatised. When this is completed, the state will largely have withdrawn from the financial markets, which is certainly big news. Important tasks remain to be done in this field, however, headed by completing the privatization of Iceland Telecom. The initial effort that was made to sell the company did not produce the desired result for a number of reasons, not least global and external ones. But the point is that Iceland's parliament has authorized the sale of the company and this goal has been set. We can say that after the sale of the state-owned banks and Iceland Telecom, a milestone will have been reached in Iceland's privatisation process. But we must not stop there. Operations of various services that the state now provides, among other things in the form of grants and subsidies, could be better off in the hands of the private sector than the public sector. For example, we could ask whether the operation of certain funds, which are now managed by the state, could be transferred to the banking system. For example, why not assign the operation of these funds to the banking system while the state continues to apply subsidies or direct grants in order to achieve the social goals that these funds are supposed to fulfil? The state would thereby save on operating costs, the banks would strengthen their operating base and the public would enjoy enhanced service. To my mind there is no reason to assume that the state is the only agency capable of providing the social services that we all agree should be paid for by the treasury. So numerous opportunities are at hand for streamlining public sector operations even further, at the same time as boosting the quality of the services currently being offered. Privatisation and social welfare are not opposites; on the contrary, privatisation, if properly managed, can enhance and augment social welfare.
Dynamic financial markets are a precondition for the economy to be able to grow and flourish. Now that the end of state banking operations is in sight, further progress can be expected in these markets. Icelandic banking institutions have become increasingly dynamic and professional in recent years, and provide businesses and individuals with better services. Banks in Iceland are beginning to penetrate overseas markets and have established branches in many countries. This is a very positive trend. Not only does the small size of the Icelandic market make it important for banks to expand their market region; it is equally important that banking operations in other countries will deliver to Iceland the know-how and practices of the most skilled professionals in this field.
At the same time as Icelandic banks have been expanding abroad, Iceland is also becoming a more attractive country for foreign banks to operate in. Foreign financial companies already deploy limited aspects of their operations here. Iceland can offer international financial companies an operating environment which is favourable for them but secure and reliable at the same time. Corporate income tax is now 18%, having been cut from 50% in the space of a few years, and there is a large supply of well educated people with expert training in business and finance. But although Iceland wants to attract foreign financial activities, it will definitely not be competing with tax havens or with places that turn a blind eye to the origin of the capital flowing through their banking institutions. The rules need to be simple and clear with firm assurances that they will be complied with. Iceland's financial markets are young and still taking shape. We therefore have a good opportunity to create the most suitable framework for these markets to attract foreign financial institutions over the course of time.
Ladies and Gentlemen:
Here in Iceland we have reason to be optimistic. Economic forecasts suggest that a growth period lies ahead. A very extensive hydropower development projects will most likely be launched in connection with increased aluminium production here. These projects will boost economic growth substantially over the next years and next decade. Measurements indicate that the cod stock, one of the pillars of the Icelandic economy, is strengthening significantly, which points towards more growth and an improvement in the regional economies, and thereby a smoother and healthier pattern of regional development. Our pension fund system is very strong, pension funds have the resources to meet their commitments towards their members and the age distribution of the population is positive. Both external and internal conditions are favourable and it is up to us how well we succeed in taking advantage of the opportunities ahead of us. Globalisation of business gives Iceland the chance to increase its trade and cooperation with other countries in all fields. But in order to be able to take advantage of these opportunities, Iceland must ensure that it is competitive with the best performers. Our country is somewhat off the beaten track, so we need to make more effort than most to attract investors and ensure that companies currently active in Iceland will continue to operate here.
All this makes it necessary for us to maintain full jurisdiction over our economic affairs and resources at the same time as ensuring our access to foreign markets. Iceland became a member of the European Economic Area in 1994. That agreement secured access for Iceland to the European Union's single market without needing to join it. This is a crucial factor for us. Europe is our largest market region and our cultural and historical roots lie there too. Access to the single market was absolutely vital in order to ensure that Iceland's economy would continue to grow and flourish. At the same time, it is clearly incompatible with our national interests to join the European Union, for a number of reasons. To mention one, the Common Fisheries Policy is unacceptable to Iceland. The fundamental difference in our fisheries policies is that fisheries in Iceland operate on market principles, while in most parts of Europe they are regarded as a regional or social problem. But the most decisive factor for us in Iceland is that the provision about common fish stocks is completely unacceptable. By transferring jurisdiction over Icelandic fisheries to Brussels, we would be handing away our economic independence. There is no doubt that the Icelandic nation would never agree to relinquish control in such a way.
Of course I do not need to tell anyone here today that it entails certain problems to have an independent currency and small economy. Stability is a key word in all business operations and a stable currency is vital. An independent currency calls for the government to implement its economic policies in such a way that the buyers and sellers of the króna have faith and confidence in our economy. A balanced fiscal budget, strong Central Bank and freedom of trade – all these strengthen Iceland's currency and put it on a stable footing. The value of the króna reflects the Icelandic economy and the currency adjusts itself to Icelandic reality and conditions. This lends the economy an element of flexibility which is so important for us here. One consequence of EU membership would be to adopt the euro. Inevitably, the exchange rate of the euro and the interest rates set by the European Central Bank reflect economic conditions among the large European nations but would take little account of the state of play up here in Iceland. Iceland's economy is far from synchronized with the economies of the continental European nations, which would make it a very risky move on Iceland's part to adopt the single currency. In this context, the recent experience of Germany is interesting for us in Iceland. The German economy is without question much more like the those of other large European nations than Iceland's economy is. Nonetheless, the fact is that the European Central Bank's interest rates are higher now than the rates called for by German economic conditions. This causes great problems for Germany because the budget deficit there is as much as 3% of GDP at the same time, leaving virtually no scope for fiscal measures to rectify the problems resulting from a wrong policy interest rate. It is certain that the problems currently experienced in Germany would be much more exaggerated and persistent here in Iceland – interest rates would either be too high or too low, with a corresponding economic downswing or inflation.
A number of points beside those I have mentioned here mean that EU membership would not serve Iceland's best interests. But it should be borne in mind that Iceland's standpoint is not based on the notion that the European Union is inherently bad, far from it. Although it is easy to find fault with certain aspects of the EU's working methods and policies, the fact remains that the Union has achieved its grand
objective of contributing to peace and prosperity in Europe. For this reason, Iceland supports the expansion of the EU into Eastern Europe where it will strengthen the countries that were formerly under the yoke of communism. Iceland's standpoint is primarily shaped by our own special circumstances. The Icelanders are indisputably a European nation. But you can still be a decent European and a pro-European without needing to be a European Unionist. The European Economic Area Agreement is a good framework for our trade with the EU countries while allowing us to avoid a number of serious drawbacks that membership would entail.
Ladies and Gentlemen:
It is now just about a hundred years since Iceland was granted home rule and regained control of its own affairs. This marked the beginning of the greatest period of progress in the nation's history. We fought our way up from poverty to well-being and now have one of the highest living standards in the world. The problems we need to tackle now are much smaller than those that Iceland faced just a hundred years ago. But the opportunities and possibilities are much greater than then, too, which gives us reason to be optimistic and full of confidence as we look ahead.
I would like to repeat my thanks to Landsbanki for organizing this fine seminar. It is highly productive to bring together economic experts from Iceland and abroad in order to exchange views about where our economy is heading, and Landsbanki deserves our thanks for this excellent initiative.