Remarks by Angel Gurría,
1 September 2015
(As prepared for delivery)
Good afternoon Minister, Ambassador, Ladies and Gentlemen,
It is a pleasure to return to Reykjavik to launch our latest Economic Survey of Iceland. I am delighted to be joined by Minister Benediktsson. Your presence reflects the strength of our partnership and the increasing relevance of the OECD’s advice to Iceland.
I am also pleased to open this launch with a broadly positive message. Since successfully completing its stabilisation programme in 2011, Iceland’s economic activity has recovered steadily, returning to its pre-crisis level earlier than crisis-hit euro area countries. Iceland has entered its 5th year of economic recovery and prospects are good.
The recovery has been supported by the substantial depreciation of the Krona, the boom in tourism, rising fish prices and a recent recovery in consumer spending. External imbalances have narrowed, public debt is declining, and unemployment has fallen below 5%, among the lowest levels in the OECD, and is projected to decrease below 4% in 2015. The composition of exports has also changed, with less reliance on the traditional exports of fish and aluminium and more on services, notably due to tourism.
The recovery on the labour market has helped households to pay down their debt and fewer families are facing financial distress. And compared with its OECD peers, wellbeing is high in Iceland and inequality is low. According to our most recent data, the top 10% in Iceland earn on average just over 5½ more than the bottom 10%, well below the OECD average of almost 10 times.
So all in all, lower energy prices, improved household balance sheets, higher business investment, less fiscal drag and healthier export markets are all projected to sustain real GDP growth of 4.3 % this year and 2.7 % next year, compared to an average of 2.1% and 2.6% respectively in the OECD.
While these are impressive achievements, they should be no cause for complacency. Iceland, like any country, still faces important challenges. The Survey underlines in particular the need to ensure macroeconomic stability in the future, lock in progress in fiscal policy and lift productivity growth.
Delivering macroeconomic stability is vital given Iceland’s recent history. Drawing on the difficult experiences of small countries, the Nobel laureate Joseph Stiglitz compared volatile capital flows to the tumultuous waves that upset the balance of delicate boats adrift at sea. These waves almost swamped Iceland in 2008 and led to the introduction of capital controls.
As the economy has gained strength and financial supervision has been toughened, the need for such controls has lessened. We therefore welcome the government’s recently announced plan to lift them, which is comprehensive and offers a feasible solution to the problem. That said, with this move in sight, Iceland will again have to cope with volatile flows.
A second challenge to macroeconomic stability emerged during the recent wage bargaining round. The large wage increases awarded were well in excess of productivity growth and will require monetary tightening if inflation is not to re-emerge as an important weakness in macroeconomic management.
Iceland’s impressive progress on fiscal policy will also need to be sustained. The budget deficit has fallen gradually from almost 13% of GDP in 2008 and was largely eliminated in 2014, with a small surplus projected for 2016. As a result, gross debt levels - which almost reached 100% of GDP in 2011 - have begun to fall. Long-term projections in the Economic Survey suggest that fiscal policy is on track to achieve debt sustainability.
But the simulations also show that it would not take much to derail fiscal policy. In addition, spending pressures, notably some pension entitlements, and contingent liabilities, such as the Housing Financing Fund guarantee, create fiscal risks.
Finally, despite the recovery, income per capita remains lower than in other Nordic countries and near the OECD average, reflecting relatively low labour productivity. The average annual increase in labour productivity for the total economy since 2008 has been only 0.2%, which is among the lowest for OECD countries.
There is potential to boost productivity by lowering barriers to entrepreneurship. In particular, there remain complex procedures in the licensing and permitting systems and a restrictive foreign investment regime.
Also, despite improvements in educational attainment, the results of Iceland in the OECD’s Programme for International Student Assessment are lower than the OECD average. High drop-out rates from school, rising unemployment amongst university graduates, and outmigration of high-skilled people suggest low skills or skills mismatches in some segments of the labour markets. The recent boom in the tourism sector, while welcome, skews demands towards low-skilled jobs with only limited opportunities for productivity growth.
The OECD is committed to helping Iceland to address these challenges. I’d like to take you through some of the main recommendations of the 2015 Economic Survey.
Lifting capital controls while preserving stability
Given the challenges to monetary policy in supporting macroeconomic stability, the Central Bank should remain independent from political interference. The monetary policy committee introduced in 2009 should be retained, focusing on low and stable inflation over the medium term.
To protect the economy from unavoidable future shocks and reinforce confidence, buffers should be built up including ample fiscal space, foreign exchange reserves and bank capital and liquidity. The macroprudential framework should be strengthened in line with current plans. Finally, reforms to ensure greater macroeconomic resilience should include a reconsideration of the wage bargaining process. This could include, but not limited to, giving the state mediator more resources and power to arbitrate in favour of realistic wage agreements.
Locking in fiscal progress
It will also be important to lock in fiscal sustainability. The introduction of the Organic Budget Law, which includes medium-term fiscal rules and creates an independent fiscal council, has been on the cards for some time. This was a recommendation we made two years ago and we continue to support action on this front.
The lifting of capital controls and sales of government-held shares in the banking sector could bring in significant revenues for the government which should be used to pay down debt. It is also important to avoid accumulating further contingent liabilities.
Setting the course for productivity growth
Finally, the Survey makes recommendations to help Iceland address productivity shortfalls. The Growth Forum in Iceland has made some progress in identifying means to boost productivity growth. To build on this, the Economic Survey advocates following up on the priorities identified, preferably with the support of an existing or new body dedicated to boosting productivity growth. The OECD stands ready to assist Iceland, including with our recently established Productivity Network.
Lowering barriers to entrepreneurship and working to allow competition to emerge fully would help improve the business environment and spur innovation. In particular, the Government could review the number of licenses and permits required to run a business and the legal barriers to entry in transportation and other sectors. It could also push to strengthen enterprise governance in sectors not exposed to strong competition. The Government is working on simplifying the legal framework for investment, which will surely also bring positive results.
Given the small size of the economy, there is also a case for supporting innovation with public investment funds to help finance firm expansion.
Finally, Iceland will also have to make further changes in education and training to improve timely high-school completion rates and provide better incentives for skills acquisition. In line with OECD recommendations in the 2013 Survey, the authorities have reduced the length of upper-secondary schooling, allowing students to graduate a year early. Schools offering credit-based programmes have already seen markedly more pupils graduating early. In addition, the current experiments regarding flexible transition from compulsory education to upper secondary schools could also have positive effects, and if the evaluations of the new system are favourable, it could be rolled out further. Vocational education and training should also be strengthened and better linked to employers. Finally, the quality of education could be improved by identifying problems in underperforming schools earlier and possibly extending the school year which is comparatively short.
Minister, Ladies and Gentlemen, in the great Icelandic Saga of Grettir the Strong, it is written that “one’s back is vulnerable, unless one has a brother”. The struggles of today’s Iceland may be very different from those of the 12th century warrior Grettir. But the OECD has your back. We are here to help. The recovery has been impressive, but important challenges lie ahead. We can work together to ensure Iceland weathers future storms, continues to deliver strong, inclusive and sustainable growth and continues to enjoy high levels of well-being.