Economic Performance Lessons from the past and a guide for the future Björn Rúnar Guðmundson, Director
Analysis of economic performance Capital and labour: The raw ingredients in economic development However, increased productivity and advances are the key factors behind economic growth Industrial policy objectives How has the development of investment and labor been in different sectors? How has productivity evolved? Has the macroeconomic environment offered increased productivity and growth? What are the next steps?
Industrial policy objectives 1990-2008 Industrial policy in the two decades prior to the banking crisis has been characterised by very clear objectives Strengthens the fisheries sector by a system of freely tradable fishing quotas Build up of a second pillar for export revenue by harnessing unused energy potential. This has led to major investment projects in aluminium and energy sectors Support for a rapid growth of financial services sector Strong support for the tourist sector This policy has been driven and supported by Global liberalisation trend with a strong political backup in Iceland A consensus among social partners
Economic performance 1990-2008 Measured by real GDP growth Iceland was doing exceptionally well 10% 8% 6% Real GDP growth 1991-2008 4% GDP per capita on a PPP adjusted basis in 2008 was on the top of the list 2% 0% -2% -4% The fiscal position was also exceptionally good with close to zero net public debt The unemployment rate was among the lowest in the world and labour participation rates were very high 1991 1992 Norway United States Netherlands Iceland Denmark Sweden Finland United Kingdom Germany Japan EU 15 France 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 GDP per Capital (USD PPP adjusted) 2008 2007 0 10,000 20,000 30,000 40,000 50,000 60,000
Investments 1990-2008 During the last two decades investment has boomed in certain sectors Manufacturing and energy Huge buildup of smelter capacity Nine times more aluminium export than in 1990 Large energy project Construction and real estate Easy credit in the real estate market Spillover effect from the energy sector Financial services and other services Tremendous growh in the banking sector Too big for the economy and usustainable in the long-term Other business and services Annual increase in investment divided by industry sectors 1990-2008 Manufacturing and Energy Other businesses and services Construction and Real Estate Financial services Public sector Commerce, Hotel and Catering Fishery and Agriculture Transport and Communications Source: Statistics Iceland -6% -4% -2% 0% 2% 4% 6% 8% 10% Other sectors have contracted: Fisheries and agriculture Transport and communications
Labour development 1990-2008 Jobs have mainly been created in the service-related (labour intensive) sectors: Financial services Other businesses and services Commerce, hotel and catering The manufacturing and energy sectors on the other hand are capital intensive with high technology content. Therefore job creation is moderate Manufacturing and Energy Other business and services Construction and Real Estate Annual increase in number of jobs divided by industry sectors 1990-2008 Financial services Public sector Commerce, Hotel and Catering Fishery and Agriculture Transport and Communications Fisheries and acriculture has been shrinking Source: Statistics Iceland -4% -3% -2% -1% 0% 1% 2% 3% 4%
Productivity 1990-2008 Having looked at capital and labour in different sectors, how has productivity in Iceland evolved? Iceland has not been among highproductivity countries in Europe Such as Norway, Luxembourg, Netherlands, Belgium, Denmark, Sweden, Finland Annual working hours per worker is also quite high Similar to Japan, Italy, Poland and Portugal To be able to increase production and reduce working hours at the same time, Iceland needs to increase productivity GDP per Hour worke ed (US$ EKS PPP) 75 65 55 45 35 25 15 5 Average productivity and working hours 1990-2008 Norway Netherlands Denmark Belgium Sweden Luxembourg Iceland Poland United States Italy Portugal Ireland Japan Malta 1.3 1.5 1.7 1.9 2.1 2.3 Source: The Conference Board Total Economy Database Finland Estonia Hungary Annual hours per worker (Thousands)
Productivity growth 1990-2008 Annual average growth of labour productivity during 1990 2008 is slightly below other Western- European countries Also the growth has been volatile in Iceland the last two decades, which is reflected in high standard deviation of productivity growth In general a catch-up effect seems to emerge where the fast-growing countries in Europe are those with low productivity: Poland, Estonia, Hungary Average annual grow wth in labor productivity 5% 4% 3% 2% 1% 0% Japan Spain Finland Average productivity growth and stability 1990-2006 Poland Ireland UnitedKingdom Hungary Sweden Norway Portugal Switzerland Iceland Estonia 0% 2% 4% 6% 8% Source: The Conference Board Total Economy Database Standard deviation
Macroeconomic environment: Inflation Price instability Persistent inflation The icelandic krona is highly volatile carry-trade currency with strong spill over effect to domestic prices Inflation-targeting as a monetary policy model has not been very successful deviation Standard 10.0 8.0 6.0 4.0 2.0 0.0 Sweden Japan Price instability 1992-2010 Germany Czech republic Iceland Poland Slovakia Hungary Mexico -2.0-2.0 0.0 2.0 4.0 6.0 8.0 10.0 12.0 Source: OECD Average annual inflation
Macroeconomic environment: Real exchange rate The real exchange rate has fluctuated Has indirect impact on domestic prices Increases uncertainty in the business environment 120 110 100 90 80 Real exchange rate 1997-2010 The current account deficit has been in correlation with the real exchange rate 70 60 1997 1999 2001 2003 2005 2007 2009 Source: Central Bank of Iceland Currently the low real exchange rate improves the competitiveness of the export sector After a decade of strong real exchange rate 10% 5% Balance on goods vs. real exchange rate Quarterly data 1997-2010 2009-2010 0% -5% -10% -15% 60 70 80 90 100 110 120 Source: Central Bank of Iceland
Macroeconomic environment: Current account deficit Continuous current account deficit in 1997-2001 and 2003 2009 The current account deficit can be explained by: Strong real exchange rate -10% increased purchasing power leading to -15% higher volume of imported goods and -20% higher consumption -25% created difficult conditions for the export sectors High investment in energy and construction sectors Low savings rate 15% 10% 5% 0% -5% Current account decomposition 1997-2010 -30% 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: Central Bank of Iceland Balance on income Balance on goods Balance on services Current account (without DMBs undergoing winding-up proceedings) Current account
Lessons for the future It is not sufficient to have aboundant sources of growth. Sustainability of high living standards is just as important Stable macroeconomic environment is a pre-condition for sustaining success Policies should also focus on supportive infrastructure in order to enhance productivity Macro, micro and social policies need to work hand in hand Sector specific policies are less important