Economic Policies
#22Key Findings
Shaken by the pandemic-induced collapse in tourism, Iceland falls into the middle ranks (rank 22) with regard to economic policies. Its score on this measure represents a decline of 0.6 points relative to 2014.
After years of brisk growth, GDP fell by 6% in 2020, largely due to a 60% collapse in tourism earnings. However, growth rates were expected to recover to robust levels. Pandemic-related spending soared, with a deficit of 9% of GDP in 2020. Debt rose from 60% of GDP in 2018 to 80% in 2020.
Unemployment rates doubled to about 6% in 2020 and 2021, again largely due to the decline in tourism. As this eases, rates are expected to return to around 4%. Real wages have risen by nearly 50% since 2010, but have been eroded by rising prices. The central bank, which lowered interest rates early in the pandemic, has now reversed course in an attempt to counter inflation.
Taxes have hovered between 42% and 45% of GDP, but have left areas including education, healthcare, welfare and environmental protection underfunded. R&D funding is robust, and the country has seen a rising number of small high-tech companies founded in recent years.
After years of brisk growth, GDP fell by 6% in 2020, largely due to a 60% collapse in tourism earnings. However, growth rates were expected to recover to robust levels. Pandemic-related spending soared, with a deficit of 9% of GDP in 2020. Debt rose from 60% of GDP in 2018 to 80% in 2020.
Unemployment rates doubled to about 6% in 2020 and 2021, again largely due to the decline in tourism. As this eases, rates are expected to return to around 4%. Real wages have risen by nearly 50% since 2010, but have been eroded by rising prices. The central bank, which lowered interest rates early in the pandemic, has now reversed course in an attempt to counter inflation.
Taxes have hovered between 42% and 45% of GDP, but have left areas including education, healthcare, welfare and environmental protection underfunded. R&D funding is robust, and the country has seen a rising number of small high-tech companies founded in recent years.
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How successful has economic policy been in providing a reliable economic framework and in fostering international competitiveness?
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9
9
Economic policy fully succeeds in providing a coherent set-up of different institutional spheres and regimes, thus stabilizing the economic environment. It largely contributes to the objectives of fostering a country’s competitive capabilities and attractiveness as an economic location.
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Economic policy largely provides a reliable economic environment and supports the objectives of fostering a country’s competitive capabilities and attractiveness as an economic location.
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3
4
3
Economic policy somewhat contributes to providing a reliable economic environment and helps to a certain degree in fostering a country’s competitive capabilities and attractiveness as an economic location.
2
1
1
Economic policy mainly acts in discretionary ways essentially destabilizing the economic environment. There is little coordination in the set-up of economic policy institutions. Economic policy generally fails in fostering a country’s competitive capabilities and attractiveness as an economic location.
It took the Icelandic economy eight to nine years to recover from the harsh IMF-engineered fiscal adjustment to the 2008 financial crash. Recent years saw brisk GDP growth, which abruptly turned negative due to the COVID-19 pandemic in 2020. Real GDP contracted by 6% in 2020 as earnings from tourism collapsed by 60%, but real GDP is expected to expand by 4% in 2021 and 5% in 2022. Unemployment doubled to 6% of the labor force in 2020 and 2021, and inflation rose to 4% in 2021 and 6% in early 2022. The króna depreciated by 15% vis-à-vis the euro in 2020. In real terms, the effective exchange rate depreciated by 16% from 2017 to 2020. The current account of the balance of payments remains roughly in equilibrium. While remaining roughly balanced between 2016 and 2019, the government budget turned sharply into a deficit equivalent to 9% of GDP in 2020, as public expenditure rose above 50% of GDP for the first time since 2008–2011. Gross public debt rose from 60% of GDP in 2018 to 80% of GDP in 2019 and 2020. Public services, especially healthcare and education, remain hampered by a significant shortage of funds. The central bank, which lowered interest rates at the beginning of the pandemic in 2020 to stimulate the economy, has reversed course and started to increased interest rates to counter inflation.
With inflation at its highest level in a decade and the risk of more to come, labor unions, under new leadership, continue to demand compensatory wage increases, egged on by the large wage hikes granted earlier to members of parliament and senior public officials. To wit, the salaries of members of parliament increased by 111% between 2011 and 2018. Under these circumstances, and in view of generous CEO compensation, concerns about distributive justice in the labor market continue to loom large.
The government has taken a first step toward reducing its stake in one of the three main banks, but in a way that recalls the botched privatization of the banks that led to their demise shortly afterward in 2008. The local banks face no foreign competition. No specific reforms have been implemented to provide a more reliable economic framework or promote international competitiveness.
Citations:
Gylfason, Thorvaldur (2019), “Ten Years After: Iceland’s Unfinished Business,” in Robert Z. Aliber and Gylfi Zoega (eds.), The 2008 Global Financial Crisis in Retrospect, Palgrave.
Iceland: 2021 Article IV Consultation-Press Release; Staff Report; Staff Statement; and Statement by the Executive Director for Iceland. https://www.imf.org/en/Publications/CR/Issues/2021/06/08/Iceland-2021-Article-IV-Consultation-Press-Release-Staff-Report-Staff-Statement-and-50201
World Bank (2022), Real effective exchange rate index, Iceland, https://data.worldbank.org/indicator/PX.REX.REER?locations=IS. Accessed 2 February 2022.
With inflation at its highest level in a decade and the risk of more to come, labor unions, under new leadership, continue to demand compensatory wage increases, egged on by the large wage hikes granted earlier to members of parliament and senior public officials. To wit, the salaries of members of parliament increased by 111% between 2011 and 2018. Under these circumstances, and in view of generous CEO compensation, concerns about distributive justice in the labor market continue to loom large.
The government has taken a first step toward reducing its stake in one of the three main banks, but in a way that recalls the botched privatization of the banks that led to their demise shortly afterward in 2008. The local banks face no foreign competition. No specific reforms have been implemented to provide a more reliable economic framework or promote international competitiveness.
Citations:
Gylfason, Thorvaldur (2019), “Ten Years After: Iceland’s Unfinished Business,” in Robert Z. Aliber and Gylfi Zoega (eds.), The 2008 Global Financial Crisis in Retrospect, Palgrave.
Iceland: 2021 Article IV Consultation-Press Release; Staff Report; Staff Statement; and Statement by the Executive Director for Iceland. https://www.imf.org/en/Publications/CR/Issues/2021/06/08/Iceland-2021-Article-IV-Consultation-Press-Release-Staff-Report-Staff-Statement-and-50201
World Bank (2022), Real effective exchange rate index, Iceland, https://data.worldbank.org/indicator/PX.REX.REER?locations=IS. Accessed 2 February 2022.
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How effectively does labor market policy address unemployment?
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Successful strategies ensure unemployment is not a serious threat.
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Labor market policies have been more or less successful.
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Strategies against unemployment have shown little or no significant success.
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1
Labor market policies have been unsuccessful and rather effected a rise in unemployment.
For a long time, labor market policy and labor mobility within Iceland kept unemployment low in general. Just before the collapse in 2008 the unemployment rate was below 1%, reflecting an overheated economy. However, this changed after the collapse, but less than might have been expected. In 2010, the unemployment rate peaked at just under 8% of the labor force. Thereafter, joblessness gradually declined to below 3% in 2018 before rising to 6% during 2020–2021, still a low rate compared with many European countries. Most of the increase in unemployment, about 90%, is attributed to the collapse of tourism due to the pandemic. As the pandemic subsides, unemployment is expected to revert to 4% or thereabouts, a point or so above Iceland’s natural rate of unemployment by common assumption. Whether this happens, or happens quickly, depends on whether tourism will return to its pre-pandemic scale and scope, an uncertain prospect in view of concerns about foreign travel and climate change.
Iceland’s labor market legislation has essentially remained unchanged since 1938 with wage contracts negotiated by the leadership of labor unions and employers’ associations, granting both partners significant market power. Recent wage contracts resulted in high nominal wages. Real wages have risen by nearly 50% since 2010, but they have recently been eroded by rising prices, triggering concerns about destabilizing wage negotiations in late 2022, including competing wage claims (leapfrogging).
Citations:
OECD (2018), “How does Iceland compare?” https://www.oecd.org/iceland/jobs-strategy-ICELAND-EN.pdf
Gylfason, Thorvaldur, and Assar Lindbeck (1984), “Union rivalry and wages: An oligopolistic approach,” Economica, May.
Iceland’s labor market legislation has essentially remained unchanged since 1938 with wage contracts negotiated by the leadership of labor unions and employers’ associations, granting both partners significant market power. Recent wage contracts resulted in high nominal wages. Real wages have risen by nearly 50% since 2010, but they have recently been eroded by rising prices, triggering concerns about destabilizing wage negotiations in late 2022, including competing wage claims (leapfrogging).
Citations:
OECD (2018), “How does Iceland compare?” https://www.oecd.org/iceland/jobs-strategy-ICELAND-EN.pdf
Gylfason, Thorvaldur, and Assar Lindbeck (1984), “Union rivalry and wages: An oligopolistic approach,” Economica, May.
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How effective is a country’s tax policy in realizing goals of revenue generation, equity, growth promotion and ecological sustainability?
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Taxation policy fully achieves the objectives.
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Taxation policy largely achieves the objectives.
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Taxation policy partially achieves the objectives.
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Taxation policy does not achieve the objectives at all.
Taxation, which has in recent years hovered between 42% and 45% of GDP, is unable to fulfill the goals of revenue generation, equity, growth promotion and ecological sustainability. Education (though less so than before), healthcare, welfare provisions and environmental protection all remain underfunded, a long-standing issue. The tax system could be more progressive. In view of the information that came to light in, for example, the Panama Papers, the tax authorities could do more to expose and tax wealth hidden in foreign tax havens. Fishing fees remain far below potential as only 10% of the common property resource rent from fisheries accrues to taxpayers, while 90% accrues to the owners of fishing vessels as documented by Thorláksson (2015), a former director of Internal Revenue. Disadvantaged social groups (e.g., disabled people and pensioners) complain bitterly about being left behind.
As an example of a missed opportunity for generating revenue, and promoting equity, growth and environmental sustainability, the authorities have allocated the right to exploit Icelandic waters close to shore for aquaculture to private, foreign concerns without charge. It appears that the authorities were afraid of charging foreigners for the right to exploit Iceland’s natural resources, because it could strengthen the case of those who demand that domestic vessel owners pay more for their rights to exploit Iceland’s common property resource.
Citations:
Iceland: 2021 Article IV Consultation-Press Release; Staff Report; Staff Statement; and Statement by the Executive Director for Iceland. https://www.imf.org/en/Publications/CR/Issues/2021/06/08/Iceland-2021-Article-IV -Consultation-Press-Release-Staff-Report-Staff-Statement-and-50201
Indriði H. Thorláksson, “Veiðigjöld 2015. Annar hluti” (Fishing Fees 2015. Part Two), http://herdubreid.is/veidigjold-2015-annar-hluti/. Accessed 31 January 2022.
As an example of a missed opportunity for generating revenue, and promoting equity, growth and environmental sustainability, the authorities have allocated the right to exploit Icelandic waters close to shore for aquaculture to private, foreign concerns without charge. It appears that the authorities were afraid of charging foreigners for the right to exploit Iceland’s natural resources, because it could strengthen the case of those who demand that domestic vessel owners pay more for their rights to exploit Iceland’s common property resource.
Citations:
Iceland: 2021 Article IV Consultation-Press Release; Staff Report; Staff Statement; and Statement by the Executive Director for Iceland. https://www.imf.org/en/Publications/CR/Issues/2021/06/08/Iceland-2021-Article-IV -Consultation-Press-Release-Staff-Report-Staff-Statement-and-50201
Indriði H. Thorláksson, “Veiðigjöld 2015. Annar hluti” (Fishing Fees 2015. Part Two), http://herdubreid.is/veidigjold-2015-annar-hluti/. Accessed 31 January 2022.
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To what extent does budgetary policy realize the goal of fiscal sustainability?
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Budgetary policy is fiscally sustainable.
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Budgetary policy achieves most standards of fiscal sustainability.
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Budgetary policy achieves some standards of fiscal sustainability.
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Budgetary policy is fiscally unsustainable.
Fiscal sustainability remains a serious concern in view of the dire financial situation of several key public undertakings and institutions, such as social security and the State University Hospital, which declared a state of emergency during the COVID-19 pandemic. Several other public institutions remain in financial difficulty, including the State Broadcasting Corporation (RÚV). The fiscal balance is not on a firm, sustainable foundation, and vital public institutions and infrastructure continue to suffer from long-standing financial neglect. The rapid expansion of public spending and debt, partly to finance COVID-related measures, has led to the re-emergence of inflation, which will exacerbate the fiscal policy situation as interest rates rise globally.
Citations:
Iceland: 2021 Article IV Consultation-Press Release; Staff Report; Staff Statement; and Statement by the Executive Director for Iceland. https://www.imf.org/en/Publications/CR/Issues/2021/06/08/Iceland-2021-Article-IV -Consultation-Press-Release-Staff-Report-Staff-Statement-and-50201. Accessed 31 January 2022.
Citations:
Iceland: 2021 Article IV Consultation-Press Release; Staff Report; Staff Statement; and Statement by the Executive Director for Iceland. https://www.imf.org/en/Publications/CR/Issues/2021/06/08/Iceland-2021-Article-IV -Consultation-Press-Release-Staff-Report-Staff-Statement-and-50201. Accessed 31 January 2022.
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To what extent does research and innovation policy support technological innovations that foster the creation and introduction of new products?
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Research and innovation policy effectively supports innovations that foster the creation of new products and enhance productivity.
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Research and innovation policy largely supports innovations that foster the creation of new products and enhance productivity.
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Research and innovation policy partly supports innovations that foster the creation of new products and enhance productivity.
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Research and innovation policy has largely failed to support innovations that foster the creation of new products and enhance productivity.
Public and private research and development (R&D) expenditure in Iceland totaled 3% of GDP in 2006, one of the highest levels among OECD members. About 40% of this expenditure was provided by the government. This high level of R&D investment reflects the ongoing transformation from an economic focus on agriculture and fisheries toward manufacturing and services. In particular, this has led to the creation of new private firms focused on biotechnology, pharmaceuticals and high-tech manufacturing. Such export-oriented firms were helped by the depreciation of the króna, which lost a third of its value in real terms following the 2008 crash, but they were then hurt by the króna’s gradual recovery. The economic collapse in 2008 led to a cut in R&D expenditure to 1.8% of GDP in 2013. Since then, R&D expenditure has recovered to 2.5% of GDP (Statistics Iceland). In 2017, Iceland had 6,100 researchers per million people in R&D compared with 4,100 for the OECD region as a whole and 4,000 for the European Union (World Bank). The number of small high-tech startup companies has risen in recent years, supported by vigorous research in life sciences and energy, as well as by favorable investment incentives.
Citations:
Statistics Iceland, https://px.hagstofa.is/pxis/pxweb/is/Atvinnuvegir/Atvinnuvegir__visinditaekni__rannsoknthroun/FYR05101.px/table/tableViewLayout1/?rxid=70f04369-335f-4fab-b1a4-5d7d4232d9fb. Accessed 1 February 2022.
Rannis (The Icelandic Centre for Research), Annual Report 2020, https://www.rannis.is/media/arsskyrslur/Arsskyrsla-Rannis-2020-web.pdf. Accessed 1 February 2022.
World Bank, World Development Indicators, 2022, https://data.worldbank.org/indicator/SP.POP.SCIE.RD.P6. Accessed 1 February 2022.
Citations:
Statistics Iceland, https://px.hagstofa.is/pxis/pxweb/is/Atvinnuvegir/Atvinnuvegir__visinditaekni__rannsoknthroun/FYR05101.px/table/tableViewLayout1/?rxid=70f04369-335f-4fab-b1a4-5d7d4232d9fb. Accessed 1 February 2022.
Rannis (The Icelandic Centre for Research), Annual Report 2020, https://www.rannis.is/media/arsskyrslur/Arsskyrsla-Rannis-2020-web.pdf. Accessed 1 February 2022.
World Bank, World Development Indicators, 2022, https://data.worldbank.org/indicator/SP.POP.SCIE.RD.P6. Accessed 1 February 2022.
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To what extent does the government actively contribute to the effective regulation and supervision of the international financial architecture?
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The government (pro-)actively promotes the regulation and supervision of financial markets. It demonstrates initiative and responsibility in such endeavors and often acts as an international agenda-setter.
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The government contributes to improving the regulation and supervision of financial markets. In some cases, it demonstrates initiative and responsibility in such endeavors.
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The government rarely contributes to improving the regulation and supervision of financial markets. It seldom demonstrates initiative or responsibility in such endeavors.
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The government does not contribute to improving the regulation and supervision of financial markets.
Iceland has never sought to make a substantial contribution to the improvement of the international financial architecture. Even so, the government took significant steps to address the extreme instability of the domestic financial system after 2008, including steps that have attracted international attention and have been held out as an example for other countries.
The post-crash 2009 – 2013 government significantly strengthened the Financial Supervisory Authority (FME) and established a Special Prosecutor’s Office charged with investigating legal violations related to the financial crash. By late 2018, the Supreme Court had sentenced 36 individuals (30 bankers, three executives, two auditors, and a cabinet secretary in the finance ministry) to a total of 88 years in prison for crash-related offenses, with an average jail term of 2.5 years per convict. The 88 years of total prison time have not been evenly divided among the banks, however: Kaupthing got 32 years, Glitnir got 19, Landsbanki got 11 years, Savings and Loans got 12 years, and others 14 years. The uneven distribution of sentences across the three main banks (even if they were very much alike) may create concerns about unequal justice. At the end of 2015, after having been substantially reduced in terms of staff and funding, the Special Prosecutor’s Office was merged with the District Prosecutor’s Office under the directorship of the former Special Prosecutor.
Under new management following the crash, the FME sought to impose tougher standards. For example, prior to the crash, the owners of the banks were their largest borrowers. This is no longer the case. Further, banks commonly provided loans without collateral, but this practice has since been discontinued. Before, it was common practice to extend loans to well-connected customers to purchase equities, with the equities themselves as sole collateral. Presumably, this is no longer being done. However, other practices have not ceased. For example, banks continue to be accused of acting in a discriminatory and nontransparent manner with some privileged customers allowed to write off large debts, while others are not, without appropriate justification for discriminating among customers. A number of Iceland’s most prominent business figures avoided bankruptcy following the crash because banks annulled their losses. Due to bank secrecy, such debt write-offs are impossible to ascertain. Under new management, after the proactive director of the FME appointed in 2009 was replaced in 2012, the FME lacked strong and clear leadership, and was incorporated into the central bank in 2020. This was a controversial move because of the ineffectiveness of central bank financial supervision before the FME was established as an independent entity in 1998.
According to a February 2021 Gallup poll, banks are among the least trusted institutions in Iceland. Only 26% of respondents expressed confidence in the banks, compared with 34% who expressed confidence in the parliament and 46% who expressed confidence in the judicial system.
In October 2018, Iceland was added to the Financial Action Task Force’s grey list of countries, a list of countries that have not introduced sufficient measures to combat money laundering and the financing of terrorism. However, Iceland was taken off the list two years later after satisfactorily completing measures against money laundering and terrorist financing.
Foreign competition in the banking sector remains absent, offering huge monopoly rents to bank owners, a unique feature of Icelandic banking, which helps to explain why bank ownership is so coveted among Iceland’s clan-based business elite.
Citations:
Jensdóttir, Jenný S. (2017), “Ákærur og dómar vegna hrunmála” (Indictments and Verdicts in Crash-related Cases), Gagnsæi (Transparency), Samtök gegn spillingu (Alliance against Corruption), http://www.gagnsaei.is/2017/12
/29/domar1/. Accessed 18 December 2018.
Gylfason, Thorvaldur (2019), “Ten Years After: Iceland’s Unfinished Business,” in Robert Z. Aliber and Gylfi Zoega (eds.), The 2008 Global Financial Crisis in Retrospect, Palgrave.
Bibler, Jared (2021), Iceland’s Secret: The Untold Story of the World’s Biggest Con, Harriman House, https://icelandssecret.com/. Accessed 1 February 2022.
Gallup (2022), Trust in institutions (Traust til stofnana), https://www.gallup.is/nidurstodur/thjodarpuls/traust-til-stofnana. Accessed 1 February 2022.
Iceland Review (2019), “Iceland Grey Listed for Inadequate Money Laundering Policies,” https://www.icelandreview.com/news/iceland-grey-listed-for-inadequate-money-laundering-policies/.
The post-crash 2009 – 2013 government significantly strengthened the Financial Supervisory Authority (FME) and established a Special Prosecutor’s Office charged with investigating legal violations related to the financial crash. By late 2018, the Supreme Court had sentenced 36 individuals (30 bankers, three executives, two auditors, and a cabinet secretary in the finance ministry) to a total of 88 years in prison for crash-related offenses, with an average jail term of 2.5 years per convict. The 88 years of total prison time have not been evenly divided among the banks, however: Kaupthing got 32 years, Glitnir got 19, Landsbanki got 11 years, Savings and Loans got 12 years, and others 14 years. The uneven distribution of sentences across the three main banks (even if they were very much alike) may create concerns about unequal justice. At the end of 2015, after having been substantially reduced in terms of staff and funding, the Special Prosecutor’s Office was merged with the District Prosecutor’s Office under the directorship of the former Special Prosecutor.
Under new management following the crash, the FME sought to impose tougher standards. For example, prior to the crash, the owners of the banks were their largest borrowers. This is no longer the case. Further, banks commonly provided loans without collateral, but this practice has since been discontinued. Before, it was common practice to extend loans to well-connected customers to purchase equities, with the equities themselves as sole collateral. Presumably, this is no longer being done. However, other practices have not ceased. For example, banks continue to be accused of acting in a discriminatory and nontransparent manner with some privileged customers allowed to write off large debts, while others are not, without appropriate justification for discriminating among customers. A number of Iceland’s most prominent business figures avoided bankruptcy following the crash because banks annulled their losses. Due to bank secrecy, such debt write-offs are impossible to ascertain. Under new management, after the proactive director of the FME appointed in 2009 was replaced in 2012, the FME lacked strong and clear leadership, and was incorporated into the central bank in 2020. This was a controversial move because of the ineffectiveness of central bank financial supervision before the FME was established as an independent entity in 1998.
According to a February 2021 Gallup poll, banks are among the least trusted institutions in Iceland. Only 26% of respondents expressed confidence in the banks, compared with 34% who expressed confidence in the parliament and 46% who expressed confidence in the judicial system.
In October 2018, Iceland was added to the Financial Action Task Force’s grey list of countries, a list of countries that have not introduced sufficient measures to combat money laundering and the financing of terrorism. However, Iceland was taken off the list two years later after satisfactorily completing measures against money laundering and terrorist financing.
Foreign competition in the banking sector remains absent, offering huge monopoly rents to bank owners, a unique feature of Icelandic banking, which helps to explain why bank ownership is so coveted among Iceland’s clan-based business elite.
Citations:
Jensdóttir, Jenný S. (2017), “Ákærur og dómar vegna hrunmála” (Indictments and Verdicts in Crash-related Cases), Gagnsæi (Transparency), Samtök gegn spillingu (Alliance against Corruption), http://www.gagnsaei.is/2017/12
/29/domar1/. Accessed 18 December 2018.
Gylfason, Thorvaldur (2019), “Ten Years After: Iceland’s Unfinished Business,” in Robert Z. Aliber and Gylfi Zoega (eds.), The 2008 Global Financial Crisis in Retrospect, Palgrave.
Bibler, Jared (2021), Iceland’s Secret: The Untold Story of the World’s Biggest Con, Harriman House, https://icelandssecret.com/. Accessed 1 February 2022.
Gallup (2022), Trust in institutions (Traust til stofnana), https://www.gallup.is/nidurstodur/thjodarpuls/traust-til-stofnana. Accessed 1 February 2022.
Iceland Review (2019), “Iceland Grey Listed for Inadequate Money Laundering Policies,” https://www.icelandreview.com/news/iceland-grey-listed-for-inadequate-money-laundering-policies/.