RETURN TO 1 RESTRICTFD I REPORTS DES116, p Report No. EA-159a WITHIN W *ONE_ WEEKJ This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION THE ECONOMY OF ICELAND May 12, 1966 Europe and Middle East Department Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized
Transcript
RETURN TO 1 RESTRICTFD
I REPORTS DES116, p Report No. EA-159a
WITHIN W*ONE_ WEEKJ
This report was prepared for use within the Bank and its affiliated organizations.They do not accept responsibility for its accuracy or completeness. The report maynot be published nor may it be quoted as representing their views.
INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT
INTERNATIONAL DEVELOPMENT ASSOCIATION
THE ECONOMY
OF
ICELAND
May 12, 1966
Europe and Middle East Department
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CURRENCY EQUIVALENTS
$1. 00 = 43. IKr1 Icelandic krona = 2. 3 U. S. cents = 1. 9 U. K.
1 billion Icelandic kronur = $23 million
Table of Contents
Page
BASIC DATA ......................................... i & ii
SUMMARY AND CONCLUSIONS ............................ 1 & 2
19. IAT.ANCfE OF PAYMENTS -------- pr1~IYP~P~~.Twl:Tfl~---------------- --- ------ --
1-4 RYTVERMAT. TVnRRTp.nm-.R q ----- p(
1. 11-TrTT~Tl~ ---- PA PT.............................. ..
I i 'TtUP DlTMVV'T T DDn T'QrP )
ANNEX I
STATISTICAL APPENDIX ............................. Tables 1 to 27, inc.
This report was written by miss Rena Zafiriou who visitedIceland in March, 1966.
BASIC DATA
Area: 40,000 square miles.
Population December 1964: 190,200Rate of growth (1960-1964): 1.8Population density (per square mile): 5
Gross National Product 1964at current market prices: $330 million (as estimated by Bank mission
Rate of growth (in real terms):1950-1956 4.51957-1960 4.01961-1965 5.5
1965 5.5
GNP per capita 1964 $1,700
Gross Investment as percent of GDP at 1960 prices
1961-1962 23.81063495 30A
Estimated Resources Gap (n,curent bln ofrd pamet deficit)+'
as a I of investment: 1964.
Tax Revenue as per cent of GDP 1964 32%
End November 1965 1962-1965
Total Money Supply 3,005 20Time and Saving Deposits 5,721 20Credit to private sector 8,88 1:>
Prices 1960-196
Cost of living probably about 6 a year
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Central Government Operations (million kronur)
1963 1964 1965
Current Revenue 2,518 2,946 3,693Current and capital expenditures 2,253 3,031 3,511
Surplus or deficit 265 - 85 182
External Public Debtrepayable in foreign currencies
Total debt june 30, 1965 $h0.6 millionTotal debt service, 1965 5.3Debt service ratio 1965 3.2
Balance of payments (US $ million)
1964 1960-1964increase
(I per year)Ernorts (f.o.b. 111.2 16Imports (f.o.b.) 120.6 lbAh-t -invi.qiblP.q 1-q 10Current account balance -7.9
Current account balance 1960-1964 -2.5
Commodity concentration of exports
1965 1962-1965
TIC ( m pors-
Months' Imports4
Summary and Conclusions
In 1960, after many years of unsound financial policies, arti-ficial exchange rates and a distorted price structure, Iceland adopteda stabilization program, with the support of IMF and OEEC, which has beenclosely adhered to during the past five years and has succeeded in re-storing external equilibrium and eliminating the worst distortions in theinternal economy. Foreign exchange reserves, which were negative at thebeginning of the program, have now reached a level corresponding to fourmonths' imports. The external public debt, which had more than doubledduring the previous decade. was actually reduced during 1960-1965 and theeconomy, which had been stalled during the late 19501s, has resumed itsgrowth. A large increase in herrine catches and higher world prices formost fish products exported by Iceland have been major factors in thisimprovement but stabilization enabled the country to take advantage ofthese better opportunities.
Internal price stability has proved more difficult to achieve.While the cnt of living nmputed in Tcland e anton thp riZe in
prices which has taken place and is due to be replaced by a more adequateindry thero can be no An t +hn+ the inerance in nrJceq nrhably of
the order of 6% a year, has been greater than in other Western Europeanc ount rieS. The 'increased prod-c-ti J -ty in-- ad ieE,T,'for fish have, so far, enabled the economy to absorb these price increasesbut a contin,uat.-n -- f 4h lrg rs- 4- -, -A ,cfturlpie
under less favorable conditions would be bound to lead to currency over-
return to financial instability will be avoided.
With the short-term situation well under control, it uas logical.LU1_ Wit; CdUU2ULL.~LV ) UV L res hesevesO th "LO.UrertlU LZUUO ±d.LLIG
the economy.
Icelandic opinion views a reduction in the dependence on fishingas thut over1Lurig UOnOm-f dnU indeeU UALLOUai UIbE U. I b buUtz;tli U U
apparent depletion of the cod fisheries is making the country increasinglydependent on the traditionally volatile herring ha5 been noticed win con-cern and has added urgency to the long-standing objective of developing thecountry's second largest national resource, water power. The interest ex-pressed by Alusuisse in establishing an aluminium smelter in Iceland offeredthe opportunity of making a beginning in the realization of this objective.
The Burfell project is a large undertaking for a country likeIceland but it can be carried out without dislocation to the economy andit is a self-liquidating project, since the foreign exchange earnings from
the smelter will fully cover the service of the external debt to be incurred,. L. U EIL.LUUL U it 4 U±LV : j.L±iLt.L l L U 1=.I ~uUU1iy W,LL I O i u u- P Lta
ular but there is no alternative project that would produce better results.
The improvement of the Icelandic economic situation is so recentthat the country has not yet had the time to establish fully its credit,rhile today's conditions in foreign capital markets allow limited scopefor raising funds, even to seasoned borrowers. Thus, Bank finaacing ofa substantial part of Burfell is a necessary condition for the carryingout of the project.
The Economy orP Iceland
1. Natural Conditions
1. Iceland is a large island of about 40,000 square miles (anarea more than twice that of Denmark), situated in the North Atlanticclose to the Arctic Circle. Nearly four-fifths of the area are notsuited to human habitation, consisting of glaciers, desert wastes, lavafields and rocky mountains, including numerous volcanoes. The climate ismaritime and therefore milder than suggested by the island's location.
2. The closeness of rich fishing grounds and the enormous schoolsof herring found in the seas around Iceland represent the country'sprincipal natural resource. Iceland has also ample land suitable forsheep grazing, two river systems with a large energy potential and vastgeothermal resources. Unlike the fisheries, however, these are resourceswhich are quantitatively large but whose economic contribution is at presentrelatively small.
3. The population, which numbered 194,000 at the end of 1965, isconcentrated in the lowlands of the south-west. with Revkiavik. thecapital, and its environs, accounting for about half the total.
4. In spite of this concentration, the sparseness of populationremainsq Ielndr1.s mostf sqtrikingarceitc Are-mgh calcuilation ofthe population and area in the inhabited parts of the country suggeststhat t.he dePnsityi is twee.Tmn 310 andl 0 perso!nsz pernr cinm il i n theisouth-west and 10 in the remaining inhabited districts (north and east).
These T ver- r - Ac.mc,- +4 .cm j +1,n n + n f,-c+--r .,f r 4h - n, ! -1 +A aQ
correspondingly high. This is particularly true with regard to transpor-both -4-thin an%UI.LL .JA V LWUVZ;U Vr.L VAQ
2. Political Background
5. After many centuries of Danish rule, Iceland was recognized by
itself virtually independent of Denmark in April 1940, after being occupiedLYU llt li. LLL.L U IULIUt aLEU LU~LL1T cL 1-E,jUL)J.LL J_Ei UUEM L ,74
6. Iceland became an important Allied base during the Second WorldWar and in 9-51, as a NAO member, granted permission for the reactivationof the U.S. base, following the outbreak of the Korean War. The presenceof U.S. troops on Icelandic soil became a hotly debated issue during the1950's but in recent years the opposition has subsided.
7. Another foreign policy issue, the extension of fishing limits,gave rise to a serious dispute with the United Kingdan but the matter wassettled to Iceland's satisfaction in March 1961.
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8. The Icelandic Constitution provides for a Presidbnt, electedevery four years by direct ballot, who has no executive or legislativepower, and for a Parliament, the Althing, elected every four years bya system of modified proportional representatation.
9. The President appoints the Prime Minister and ministers whomust enjoy the confidence of the Althing. The Althing is composed of 60members.
10. There are four major parties, which have accounted for thefollowing proportions of the total vote during the past two elections:
Oct. 1959 April 1963
Per cent of total
Independence Party (conservatives) 39.7 41.4Progressive Party (Agrarians) 25.7 28.2Social Democrats 15.2 1.2Labor Alliance (Communists) 16.0 16,0Other 3.4 0.2
Total 100.0 100.0
11- The nre.ent government is a nalition nf the ronservativns andthe Social Democrats which came into power in November 1959. New electionsare due in t.h nring of 1967
3. Economic Development
12. At the beginning of the century Iceland was still a nation ofpoo farmr anrd fishermen±~ LI~, livingt± Under hiar011 , y-1d primiivC condi,J ~t-onS.
Today it belongs to the high-income group of countries in Western Europe.The Avlomen+ -P +o he fihinn Ando+r hs been +he maint fn Jn +Jij hz
transformation. Starting with rowing boats and sailing vessels at theI-A4 -- F 4 -P 1- na- 4--v T-nl -A -, 41- - -.. nn ; -. A -1 -,., - -P- nc-; - l +-
modern trawlers and motor boats which, together with the adoption ofu -tolin, sitifico. aa, been1 and continues to b aarue
a high living standard on what has been, and continues to be, as a rule,". krU'U..LULn<a1 LUW LLUUMULt CLULLEILUU4..LVJ.Lk.Yq
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13. The following table illustrates the growth of the Icelandicfishing industry during this century:
Fishing Fleet Fish Catch ExportsGross regis- Year Annual m. tons Total Per Head
Year tered tons Average (000) Year Million $ $7(000)3
16. To the closeness of rich fishing grounds and the modern equip-rnent as fP.ctr -in Trlanrit., Anmic -nrnorP-i hrild added the humanelement which, as usual, has been decisive: the national cohesion,
deeopd%ii1 n-rania.t+ionn igch levetrls of educt-+inn, wvhichl we-re p-resc1ntbefore the country's economic modernization played a crucial part in the
- -1h1 -4-4+ - re.ha+hbee one --+ adv ncc proomes
V_J U v I. L J 94A. V %ULA. ILI W L l~ VLU 'Ji. tD r..U.
has been uneven and there have been many difficulties and setbacks.
16. The world depression of the 1930's dealt a heavy blow to the_Lce L U.LULo LJI. Ur I± L .LiUOUY CLiU UU W,it; L -L U.LU ~LdU c UCL V.L _LVL I 11Jt
Second World War, on the other hand, brought unprecedented prosperity toIceland due to the large foreign military expenditures and expanded salesof fish at high prices. As a result of these developments the nationalinuiute anu stanuard 0 .Lv.Llg niau more tInaU UOUU.U Utouv IU nUUU o±it warand large foreign exchange reserves had been accumulated. The reverseeiae of the picture was a very severe inflation throughout the war years,and a seriously overvalued currency at the end of the war.
17. An ambitious investment program was launched in 196 aiming atexpanding and modernizing the country's capital equipment and at provitingthe greatly increased urban population with high standards of housing andother social amenities. In less than two years the wartime accumulationof foreign exchange reserves was gone and prices continued to rise. U.S.aid under the European Recovery Program and borrowing from the InternationalBank and from other sources, together with good markets for fish, enabledthe country to maintain a high rate of investment in the following yearsand to continue the expansion and modernization of its economy. Duringthe seven year period 1950-1956 the value of exports increased by 57.5%
or nearly 7% a year and GNP by 34% or nearly 4.510 a year. Subsequently,however, a number of circumstances combined to slow down progress. Duringthe four years 1957-1960 the value of exports increased by only 6% or1.5% a year and GNP by 17% or Va a year. In the first place inflation hadcontinued, fanned by large increases in wages and excessive credit creationand, in spite of two devaluations, the kronur had become a seriously over-valued currency. A complicated system of differential export subsidiesand import surcharges, in addition to proving incapable of dealing withthe large external deficit, created serious distortions in the economy.Quantitative import restrictions, extensive bilateral trading, directcontrols and large price subsidies further distorted the structure ofprices and the pattern of expenditures. In the second place, the fishcatch, after reachit a peak in 1956. remained virtually unchanged in thefollowing four years. The sudden jump of the catch in 1961 and the con-tinued large increases in the herring catch since then seem. however, tosuggest that the stagnation in the fishing industry during this period wasnot unrnated to the arowing diMsonation of the economy Tn th third place,the dispute with the United Kingdom led to the loss of the important Britishmaqrket+ for ITeplandlie- fish.
rp~ +~-i 4A-'k+ - '. ~1 1n' 0-n +n~4 A t9 m4 11 n n
December 31, 1955, had increased to $51 million by December 21, 1959. The
terms but even so the service of the debt rose from $2.8 million in 1956VV P).1 LU.L-L-L.U.ll LL4 L 7t.JV 9 .),y Wit;; WAIU VJJ. .- 7 )7 L"ui C1±J LA UI dUk L
5
liabilities of the Central Bank exceeded its assets. By then it had become
function at all.
19. The coalition of conservatives and Social Democrats which cameinto power in November yy59 agreed on a stablization program woC.ied out incooperation with the International Monetary Fund and OEEC. The mainfeatures of the program were budgetary and credit restraint, the devaluationof the kronur from the nominal rate of 16 to 38 kronur to the U.S. dollarand abolition of multiple rates, and the gradual liberalization o imports.
20. The stabilization effort coincided with the large increase inherring catches, which is attributed primarily to the introduction of newequipment and techniques, but there can be little doubt that the restorationof more realistic price relationships and the elimination of the distortionscaused by inflation has played an important part in the large expansion ofthe fishing sector which has characterized the last five years. The thirdmajor factor in the improvement which has taken place since 1960 has beenthe rise in world prices for most fish products exported by Iceland, aresult of such developments as the sharp increase in the demand for fishmeal in Western Europe, the slower rise in production in Peru, the leadingworld exporter of fish meal, and the reduced world supply of cod due tosmaller catches.
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21. During 1960-1965 exports increased from $67 to $130 million orby 16% a year and this provided the basis for a growth in GNP of 5.5%a year and, if the improved terms of trade are taken into account, foran increase in real income of 7% a year.
22. Imports, on the other hand, which had been artificiallystimulated by currency overvaluation and excessive demand in the earlierperiod, rose by only 9% a year during 1960-1965. This enabled the countrjto rebuild its net foreign exchange reserves to the equivalent of fourmonths' imports without any significant increase in its external debtobligations.
23. Price stability has been more difficult to achieve but so far,as shown above, the rise in the domestic price level has neither pre-vented the crowth in exoorts nor caused an excessive demand for imports.
2L. Followine wage increases raneine between 13 and 19, in June1961, the authorities decided that a new devaluation (from 38 to 13kronur to the U.S. dollar) was necessary to prevent the inevitablelarge rise in domestic costs from frustrating the liberalization of theeconomy. Sub:nuPntiy_ the impact eof nnntinued larre increases in waesand in agricultural prices was cushioned by the increase in fish catchesnnrl +.hp ri , na wnrl A~ ni-i npz fn- -Nz A+th same time the ree-1izationnhas been growing among the public that excessive increases in moneyine-nmPQ ar-e illusoc^-r andl can onlyx diqnat Prnn A onr_ e-yea_vP:r urnag--agreement signed in June 1964 by the Federation of Labor, the Employers'AsSociation nd4 the- Tc-Indi-c -oe~ oie f-n..n+ >rjAn Pv muchl s-mallerC-tincreases in wages than in the past. The average increase caused by the
of living index (which is the only available price index and is unfortu-14.y an:L I CX% jUL%' UUUC, aso W-L..aL ut: di c s e UC;.jU;Vj iDLO, 1-J L %JLl
siderably during the 12-month period covered by the agreement.
25. In 1965 it proved impossible to arrive at a similar agreementUUQ lv goverumtU payou an evive pure Lo one nlayU anauti partemployers and unions and offered a number of inducements to preventexcess±ve wage increases. Ine effect of hUe negotiation5 .Le expecUt-to be less favorable than in 1964. The gains won by labor are estimatedto correspond to increases of between 6% and 19o in hourly wage rates,to which must be added an automatic increase of 7.3% due to the increasein the cost of living. A rough preliminary calculation shows that betweenJune 1965 when the new agreements came into operation and January 1966hourly wage rates increased on the average by 19%. Adjustments in agri-cultural prices, which followed the new wage agreements, were of the sameorder. The net effect of all these increases as well as of some otheradjustments on the cost of living has been an increase of 6% betweenJuly 1965 and January 1966 compared with 2.5% in the corresponding periodof 1965-1965.
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26. Thus the quest for greater price stability must continue andsuccess Is still fa1 from U-5-5uredo
27. Viewing, however, the period 191o-y9o as a whole, one mustconclude that a great deal has been achieved and that the economy istoday stronger and healthier than the most optimistic observers wouldhave dared to forecast six years ago.
4. The Fishing Industry
28. Although fishing and fish processing provide the bulk of thecountry's foreign exchange earnings and are the foundation of its highliving standard they employ directly less than one fifth of the laborforce. This is a measure of the high productivity in this sector of theeconomy.
29. The catch of some $7,000 per person employed in fishing andfish processing in 1963 and $9,000 in 1964 compares wTith $3,200 in theUnited States fishing industry in 1962.
30. Until the 1930's the Icelandic catch consisted largely of cod(over 7070 of the total) which was exported mainly in salted form toMediterranean and Latin American markets. The loss of these markets duringthe 1930's due to payments difficulties forced Iceland to concentrate onherring for the production of oil and meal, which were finding a readymarket in Western Eurooe. Thus. while between 1926-30 and 1936-40 the codcatch declined from 20,000 to 128,000 tons the herring catch increasedfrom h2.000 tons. or 1610 of the total. to 160,000 tons or 54% of the total.
31- Until the ePnressinn the main nrocessinr nativity had been thedrying and salting of cod, a relatively simple operation calling for littlein +ha Lvzir ^Pf cL-ill evn - An^~+In-r -i=qin ni-ii-Nr wasq theip n-rP.-paration of cod liver oil. Quick freezing of cod was developed duringthe 191O's nnd hv 19AO there were 31 nlants in the island- Herrin. mealand oil processing began in 1930 in a Government-owned plant and expandedg-atly dur-Ing +.he 1Q4001 sn hi-th nrira+e -and Ar^-nrPrnm.,4ent nLantts
-T)i,;-, ,n Tjn D-+n4- nn,A4-- to a 1- much smal er a- et,r +ii Tjni+.=rj
States provided a large and remunerative market for iced and frozen cod-A for herri ng oJ1 - mea . A "-s-14 *'1'- -- -+.ln 1%n, nnn r A^~ii1i1n
by 1944, the herring catch had increased by over a third and the quick-
33 * The ostwr yers,taken as a whle h1a1- ben0 pe6ooprosperity for Icelandic fishing but there have also been difficultiesdueton poo cain the y .d to sude c in mar4tin conditions in other years.
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34. The cod catch rose in 1955-1960 to an average of 6% over prewarbut during the past five years it has remained virtually unchangea, witha tendency to decline. It is believed that this inability to increasethe catch in spite of the increased tonnage of the rishing fleet and tneimproved equipment is due to depletion of the fishing grounds as a resultof overfishing and no improvement is expected in the coming years. (TheIcelanders point out that overfishing is caused in part by the methodsused by foreign vessels fishing in Icelandic waters.)
35. Until 1952 the United Kingdom continued to absorb a large partof the cod catch in iced form. The quarrel over fishing rights in Ice-landic waters led to a ban by British interests of landings of Icelandicfish in British ports and forced Iceland to search for alternative markets.Exports of frozen cod to the United States were expanded but over halfthe output during 1953-1959 was sold to the USS:' and otler Eastern Europeanmarkets under bilateral trade agreements. Since 1960, however, exports tothe United States have been rising, while exports to Eastern Eturope havebeen declining, but there has been no increase in the total quantitiesexported,
36. ExDorts of cod on ice to the United Kingdom have been resumed.
37. Cod exports in salted or dried form to Nediterranean. LatinAmerican and African markets are well below prewar and during the pastfive years have remained virtually unrhnnorl,
1- nn f.hp other hnnd- -nrincs haverp beePn -risqing7 steadqilyr_ nnci in1965 they were 22% above 1960 for stockfish and 4h for frozen cod.
39. Thus, the increase in the value of cod exports from some $38 mil-l iorn in 1960 +. toc$55 millio%n i n 196 refleoctalms n ntrel this -ris cinnprices:
1960 1964 1965(Millin$T
Frozen -i1-~176 A2. 23Chilled 3.2 f.0 4.1
dried-salted 7.7 10.0 11.6S+^l^-PA O 7,0 0 )
Cod-liver oil 1.8 2.1 1.6Other 2,7 0~ 5:
I JU .L -)2 .
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4o. A new variety of ground fish, the ocean perch, became importantduring the 1950's, reaching a peak of 110,000 tons in 1958 when it accountedfor 20O of the total catch, but a sharp decline took place in 1960 and 1961and there has been no recovery since then, the 1965 catch being estimatedat only 29,000 tons. Depletion of the fishing grounds off the Newfoundlandcoast due to overfishing is considered the principal cause of this develop-ment and no alternative fishing grounds have so far been discovered.
41. The fortune of herring took an opposite turn from that of groundfish. Catches were disastrously small during 1949-195' and had not re-covered to their prewar level until 1959. Since then, however, an enormousexpansion has taken place which has accounted for virtually the whole ofthe growth of the fishing industry during this period. In 1965 the catchreached 763,000 tons, compared with 183,000 in 1959. Herring is a migratingfish and the size of the catches has in the past tended to fluctuateviolently and not very predictably. The fisherman's experience is summedup in the old Norweian Droverb: "Tt. all denends on the herring-" Tt i.however, believed in Iceland that the recent large increase in catches re-flects not so much the oresence of larger aintities in Tcendicn watersas the introduction of modern techniques of detection and fishing andespecially the general adotion of such avancedin r dvics .s the sna(Azdic), bloc fishing, the use of larger nets made of synthetic fibers,etc. Whether the mxnerience of +he nsi+. fve ors al indaat+e +n+catches will fluctuate less in the future remains to be seen.
42. The increase in catches during the past six years has mainlyservP(i ton -,-,Ic: .b r+1~I ~ -A -41 -A
together with the improvement in the prices of most herring productsrin th f teer ea has account for weef th otal Icrease in
in the value of exports between 1960 and 1965.
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43. The following table shows the preponderant role played by herringin +he ofh of %rn^+r Ain-n thn nint five vt arq
Expo rt s
(Million $)NT 0 AAw
Oil 5.4 9.7 15.8S. a) 1 11v-ed4
Other 1.0 3.0 4.0
Total 13.0 38.6 53.2
Cod and products 37.5 52.7 55.2
Ocean perch andproducts 7.5 3.0 3.2
Other fish products 3.5 .1
Total fish 6l.5 102.4 ) 100Other exports 5.5 8.8 )
Total exports 67.0 1112 129.2
44. This growth of production and exports has required a substantialexpansion and modernization of the fishing fleet and of processing plants.Gross fixed investments in the fisheries and in fish processing are esti-mated to have amounted to about $60 million during 1960-1964 and to havebeen 68% higher in constant prices than the investment made in the precedingfive years,
45. Among the changes in the structure of the industry the mostdramatic has been the decline of trawling and the shift to motorboats,especially to the large ones. In 1964 motorboats of over 100 g.r. tonsaccounted for 35% of the total tonnage compared with 10% in 1958 whilethe share of trawlers was reduced from 505 to 35%.
45. Fish processing is a major economic activity, employing about 105of the labor force. Production facilities consist at present of 90 freezingplants, 33 fish meal and oil plants and a large number of other processinginstallations.
46. Conditions in the Icelandic fishing industry in the coming yearswill depend on the size of the catches, the maintenance of a competitiveposition and world market conditions. On all these counts prospects appearreasonably favorable.
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47. Thile the sharp rate of increase in herring catches of the lastfew years will probably not be maintained in the coming years, the oppor-tunities for further expansion cannot have been exhausted.
48. icelandis competitive position is inherently very strong. Theproximity to prolific fishing grounds reduces costs and increases thequality of the catch. High productivity ensures high incomes to fisher-men and thereby prevents the drift to other occupations which characterizesthe fishing industries of other kstern countries. It is only if economicpolicy veers away from the course followed during the last six years thata repetition of the difficulties encountered during the 1950's is likelyto take place. There is no reason, at this juncture, to expect such adevelopment.
49. World market prospects are more difficult to gauge.
50. During the past six years exports to all major industrial markets,where conditions are highly competitive, have been rising, while exportstoEastern Europe and other bilateral markets have been declining. Thereseems at present to be no reason to expect that Western markets will becomeless accessible in the coming years and, in the longer run, the more attrac-tive employment opportunities in other sectors in the major countries arelikely to lead to a contraction of their fishing industries and to greaterreliance on imports. The Dresent EEC tariffs have not prevented a largeexpansion of Icelandic exports to EEC countries and the proposed commontariff of 18% to 20% on frozen fish, even if enforced, may be taken instride by Icelandic producers. The same applies to U.S. tariffs and otherrentrictionR nn fish imnorts. On the other hand. demand may change, newcompetitors may emerge or other circumstances, which at present cannot beforesnn, may arise that ould mkF th qitmn-hion fnr Tn.Ilnnrin fi.-h P.nort.less favorable than indicated above. It is simply not possible to lookhpvnd thp npwf few var q.
. AgircultuireP is confinedto the+Ii hintePrlanndi of scatn+tePrrd coas-talsettlements and, although much of the land is naturally fertile, the lackovf reall -y oducti-veT _-Wri-me~. beatfl. -1J its arpr ult-11-ra" nctJviJ,-, rn inrlm +.n
the growing of grasses for cattle and sheep and to the raising of sheep
'ALA ~ba -lAn forJ --. er -r0 0
UILJngl
.L 1%A'4 .L0 V 4 J VU L LYU %A-.LJ A4. 1. .OLO 4 ._L ~AI1~4 J OO LA5
JA
feeding during the other seasons depends on hay cultivation which is
The major objectives of a 10-year program of agricultural development.. U J) Li LU LA-L 11 UCILM, L_LdiI.CLLkLL1 V . J W-L "LL.JULJ VVCL J.LUV.LL1tU;U,
- 11 -
was the expansion of the cultivated area by 60%, the mechanization ofhay-making and the reconstruction of the sheep herd whic hau bendecimated by diseases during the 1930's. The results in terms of in-creased production and productivity were satisfactory: the sheeppopulation rose from 400,000 in 1950 to 835,000 at the beginning of 1961and the output of sheep products more than doubled. Zxports or lambrose from 500 tons in 1955 to 3,245 tons in 1958, at which level theyheld until 1963. During that period exports represented 25' of totalproduction and thus the expectation held in 1950, that Iceland would beable to become an important exporter of lamb and thereby diversify itseconomy, seemed to be in process of realization. Exports of wool andsheepskins also increased in that period. Cattle numbers rose only from45,000 to 52,000, but milk output increased by over one-third due to higheryields. During 1955-1961 agricultural production as a whole is estimatedto have risen by h5% or by 55 per annum.
53. At the level of production reached by 1961, Iceland vas self-sufficient in all livestock products at a high dietary level. 3incc thenthere has been a shift from sheep to cattle and a large increase in milkproduction, well in excess of the increase in demand. Overall agriculturalproduction is estimated to have increased by 14% during 1960-1965, or byabout 2.5% a year.
54. The large increase in milk production, a phenomenon common tomost Western European countries, reflects the increase in yields resultingfrom better breeding and feeding, which in turn was in part a response offarmers to the high support orices for dairy products.
55. With rising domestic costs. ex-orts of lamb became unorofitableand have required an increasingly heavy subsidization. In 1965-1966 exportsubsidies are exnected to be nnivalent. to nearly twice the nrice obtainablein foreign markets. The milk surpluses have also been disposed of abroad,mainly in the forn of nowdered milk, cheeP. snq hntter. At heavy rst to
the budget. The total cost of export subsidies rose from 25 million Kr.in 1960-1961 to 176 million -Kr- in 196L-1964 Present, le.islation author-
izes the Government to grant export subsidies up to a total equivalent to101 o)f' theP ITAI IIP nf FAe-Pi-I t.iiurn pnroduioi+.in andl- it. i c-e~ +.ha. t.hi
limit (correspcnding to 220 million Kr. for 1955-1956), will fall shortof requi-re ssb jln *kl' 74 -41 Aii",n +1 I ~ r4 T,
to the export subsidies and high price supports, farmers receive sub-"V-A-t CL -LQO a LIV ULIL LI 61 LIC at v L±" J_.LL 1J AI _ ' 4.J .- -i.d E L±a.Jy'V,
consumer subsidies on food, although serving primarily the purpose of'Keepin dOwn~ t-h cot of4 -L&. V-L,,-g aLu hence41 wag clahims, UDenef-i. A. .L.J
the farmers since they presumably encourage consumption of the subsidized
;)U..ULL Suppo-fts ad subsiie are a. convion leciture ofarcltr
policy in most Western European countries, but the available informationsuggests Uat IeElandLc farmers are among TUe most costly to the coUMmu1ny.
- 12 -
A comparison of milk prices guaranteed to producers in a number ofEuropean countries shows that Icelandic prices are the highest.
57. The high prices secured by Icelandic farmers on the domesticmarket have been a major factor in the wage-price spiral which has preventedthe complete success of the stabilization program, while the cost of exportsubsidization has been imposing a growing burden on the budget. In 1964,export subsidies absorbed 7% of the total revenue of the Central Governient.
58. The value of agricultural production is estimated at $35 millionin 1963 and $37 million in 1964. This comoares with $87 and $108 millionrespectively for fishing and fish processing. Since employment in thelatter occupations is estimated to have been only 10% areater than in afri-culture and since fish products are sold at world prices while agriculturalproducts are sunnorted at levels which are cnnsiderablv hirher than inmany other countries, it may be concluded that the value of output per manin agriculture expressed t. world market nricn is nrobhhly t1 ess than
one-third of what it is in fishing.
59. Similarly, although agriculture supplies all the livestock pro-ducts cons,_,med domesticanllyr as Tell as somme nor heviy suidized exprtsimports of cereals, sugar, and other food products totalled $9.3 million
-1 -- Y -4 MIL. L A~L *11 L7'fl4, CUI%4, J.1dAt .IAhJL J.4Lj.4:u.
of feeding-stuffs and fertilizers totalling $2.5 and $3 million, respec--tjivel-. Thus, in -spite of the hea;v.y cost of agritr a U V-,
country's dependence on food imports is considerable.
60. Icelandic yields compare favorably with those in other countriesa.LiL LL1~ ~.±~Z OUJ9J U 11L ~JUIJt::U UV Lk;;L1U_L; _Lcumlz) lt ± _ 4 ti .LLI PZCLIj u~~lvz
fact that manpower in agriculture is excessive, and in part the politicalUrn U11 iti IacUl bIII aU d CQUIAIy VJ1 ta_ UJdL ' ,U IL.LO1i_LLJJ, 11GLO,
until relatively recently, been the traditional occupation of the greatmajority of the population and where consequently the political and socialorganization has been geared to the needs and attitudes of farmers.
61. The available census data, which, it should be noted, sufferfrom a number of ueicicies, indicate tnat agriculture acouuteu for20% of employment in 1950 and 175 in 1960, while estimates derived fromtax returns and other data show agricultural employment to nave represented1h.7% of total employment in 1963. In view of the growth of the laborforce during this period, these figures indicate that the actual number ofpersons engaged in agriculture has been declining rather slowly, probablyby no more than 1% a year. There can be little doubt that the presentoutput could be produced by a considerably smaller number of farmers.
62. The reason why labor does not move out of agriculture at a fasterpace in spite of the strong demand for labor in other occupations is twofold:first, a large proportion of today's farmers are too old to be willing tochange their occupations and, second, under the present system of price
- 13 -
supports and subsidies, agricultural incomes are too good for the farmers,especially the older ones, to have a sufficient incentive to give upfarming. It would seem that during the coming years farmers in Iceland,as in many other Western European countries, will continue to claim theright both of retaining their traditional occupations and of enjoyingincomes comparable to those earned in more remunerative employment. Theproblem will eventually solve itself as the present farm population agesand ties off but this will take time and meanwhile agriculture will con-tinue to be a major obstacle to the maintenance of price stability.
6. Industry and Power
63. Icelandic industry, other than fish processing, consists mainlyof small enterprises producing a variety of consumer goods but thereare also some large dairies and slaughter houses and several fairly largeestablishments serving the fishing industry. which include ship.,ards,engineering works and factories producing fishing gear, clothing, packingmaterials, etc. The construction industry is also well developed due tothe high rate of dwelling construction.
64. The first manufactures established in the country receivedtariff protection and durinv the 1930's inort restrictions and highertariffs further stimulated local industry. The continuation of importrestrictions in the nstwar neriov dn- to halanre of na-ments difficultiesand the fact that Iceland has remained outside the two major "Europeaneconomic gronnings RE and FPTA_ have mannt that it.: industry has _eceiveda nuch greater degree of protection than the industries of the other
Thengradal l -1Iiber " A7i-in of m-n+ cinn,n 10 andl somein tariffs have exposed local producers to greater foreign competition,
tariff protection enjoyed at the beginning of the stabilization program.Thne -n -nces hun o+- n sn -i+-ni+ Aniin r +ho -1 nQ+ fiv vm irn-rczn
been more selective than i.n the past. No index of industrial production
quantities produced by the principal manufacturing establishments. Thesestatistics,LL~ see to. .Li.dcate -thlUe -ULPV'" WV.L16 %AV Z_VUJh -L1U UU±.L.LI 1 _L ~.O U J. .. VL
years:
(a) industries which had depended on quantitativeimport restrictions u-e experLencoU wnarp UU-
clines in production;
(b) industries in the case of which tariff pro-tection has been offset by the rise indomestic costs have been unable to expandor have even had to cut down production;
- 14 -
(c) industries capable of meeting foreign com-petition due either to the very high ratesof duty applicable to their products or totheir ability to produce at world priceshave achieved very large increases in output.
66. Thus, there have been substantial increases in the he.vilyprotected food industries, in plastics and building materials, wthilethere have been declines in textiles and clothing and fishing equipment,and only small increases in chemicals and electrical goods.
67. Whether the combined effect of these changes has been a moderategrowth in manufacturing or relative stagnation of output cannot be deter-mined on the basis of the available data.
68. Icelandic import duties are high both for revenue and for pro-tective purposes. Since the revision of the tariff system in 1963 themaximum rate of duty has been reduced from 300% to 125/, but the presentlevel remains much higher than in any other Western European country.The following are some representative tariffs:
Ad valorem
Radio and television sets 80
Trucks 40
ment of competitive manufacturing is the high level of wages which is madeposxuxe by te u±gin pLouucLwv.Ly of LUe filng secour. 1us .LZ a U__L1-
culty faced by all countries whose economies are dominated by one sector
the case of Iceland the small size of the population is a serious handicap
7U In spite of thebe diclrUeL.s, Ht e desire fi ULU5Liriai(onULO,as elsewhere, is very strong and it is spurred by the feeling of insecuritycreated by the uepeuence on a single economic activity, fishing, especallywhen this happens to be an activity which can be so seriously affected byfactors over which the country itself has no control. The main manifet-tations of the desire for industrialization have been the setting up bythe government of fertilizer and cement plants ana tne search for possi-bilities of developing the country's power resources in conjunction withthe establishment of power-based industries.
- 15 -
71. Iceland has numerous rivers and lakes representing a very largehydro-electric potential, which is estimated at between 15,000 ana 0,uuumillion kwh a year (some 2,400 mw). Two glacial rivers, the Thjorsa andthe Hvita, account for the bulk of this potential. Local demand alonecan utilize only a small fraction of these resources so that their develon-ment depends on the possibility of producing low-cost power for electricity-using export industries, such as metal smelting and refining and chemicals.
72. The proposed agreement with Alusuisse and the construction ofthe Burfell project represent the first attempt to realize this possibility.
73. During the 1950's a number of small hydro-projects were builtto meet local demand and supply power to the fertilizer industry. Pro-duction has been increasing by about 7% a year and at its present levelof 3,500 kwh per head, it is as high as, or higher than, in most WesternEuropean countries. Future local demand will be met by Burfell which willbe the first relatively large hydro-plant to operate in Iceland.
74. Iceland has also large resources of natural steam and hot water(estimated to represent the equivalent of 500 mw) which have so far beenutilized only for the heating of buildings and of greenhouses. Eperinentsare being carried out for utilization of this energy in small scale powergeneration but so far no cost advantages have become aoDarent.
75. While the emnhasis at nresent is on nower development andpower-based industry, it is being increasingly recognized that a loweringof tariffs may also be an effective way of nrnmotinq sound industrialgrowth. This may sound paradoxical at first sight but it seems reasonableto assnme that reduced protction, v opning im the Pconomy txo forelgncompetition, would force producers to become more efficient and to specialize
mare ~ ~ ~ I- admgteeledte to rds finding a range of p-dut Ui+H oodexport possibilities. The net result of such rationalization of productionould wverunil he m vn+ +han lr1e Ande+4- l n-+4r +,r well +her
domestic market is limited while world market possibilities for a countryas small as Iceland are virtuanlly,nyhusil~ Production af ishequipment, for instance, could conceivably be developed on a competitivebasiS ndA could be cosierbl Td'he present diAuJ on bu
possible association with EFTA reflect to a considerable extent the rec-
to Iceland from the opening up of its economy.
I ranspo '
to. sasns uofe v. populau.Wo aUnu UUnLCLVU1eLLZ.U nl±auulaL UUL1"1_LuAUhave been serious handicaps to the development of inland transportation.
77. The road network was largely constructed after 1930. At present,lost inhabited areas are served by gravel roads which have been connected
to form a national system circling the island. The amounts spent on the
- 16 -
improvement of the network have been large but until recently the tendencyhad been to spread the funds over a great number of projects and accomplishrelatively little. In 1963 the Government submitted to the Althing proposalsfor a far reaching reorganization of the planning and execution of roadconstruction, including a four-year investment program aiming at concentratinexpenditures on a relatively small number of high priority projects. TheAlthing approved these proposals and the four-year program went into effectin 1965. Under the new act a Road Fund was set up to administar the pro-gram and was made financially self-sufficient through the allocation to itof the gasoline tax and the motor vehicle tax. Expexditures are estimatedat 350 million kr. for 1965 and 319 million kr. for 1966.
78. The state of the road network at the beginning of 1965 is shownin the following table:
Kilometers
Paved Gravel Unfinished ImpassableRoads Roads Roads Roads Total
79. As elsewhere, there has been a rapid expansion of road trans-nnr. in rot-pn+. -imn-rcz. T110 n11M}'h'e e-r 19 t'vc 'i Q ~in 1958 to 25,228 in 1964, while the loading capacity of trucks increasedfro-m iA6,n o 2900nr tons. In I1QA1 roa transpot conefr3Sftotal domestic freight transportaticn.
traffic of at least over 1,000 vehicles duricg the summer
or. more,U. C U U.LL16 ct U. 1,000
or more.
- 17 -
80. Coastal shipping has remained the principal form of internalCvscj , k+ +-n.rer~.M 'k-+ '!,c-tan-r,.r - I ,n.,e, n,.f Pr-1 +4-~ "-eA +'
port. Iceland has no railroads.
81. The bulk of public transportation for passengers is provideduy UJWQ 1iLr1J_ successul V dA4-W airlinLes~: Icelanzdair., fo iude
in 1957 (Flugfelag Islands), which serves 21 localities on domesticroutes and fIve European cities on international routes, and IcelandcAirlines (Loftleidir), founded in 1944, which since 19,2 has limiteditself to transatlantic flights, where its lower fares and efficientoperation have enabled it to compete effectively with the large inter-national airlines. Both companies operate without Government subsidybut the charges made by the state-owned airfields apparently do notcover costs,
82. A merchant fleet of 40 vessels totalling over 60,COu tonshandles over half of the country's foreign trade, without Governmentsubsidy.
83. Reykjavik is the country's principal port, handling virtuallythe whole of its foreign trade. There are numerous natural harbors allaround the coast (most of them free of ice throughout the year), whichare of great importance to the fishing industry. As in the case of roads,the tendency in recent years has been to undertake new construction inmany places at once and make slow progress on major projects, but a re-organization, somewhat along the lines of the road program, is now underconsideration.
84. The high cost of transportation in an economy like the Icelandicis shown by the fact that investment in transportation accounts at presentfor about 9' of GNP, a very high proportion in comparison with most otherWestern European countries.
8. Investment and Saving
85. A high rate of investment is to be expected in a northern.sparsely populated country like Iceland where public facilities arecostly and good housing a keenly felt need. The rate of investmentis also high because fishing has by now beccme a capital-intensiveindustry.
86. Using the estimates of investment exoressed in constant oriceswhich seem to give a better picture of the role of investment in theeconomy than the estimates exnressed in current nrices- one finds thatthe rate of investment was nearly 30%o of GNP before 1961, fell to somewhat1P. th.n 2< durina 1QA1 an 1QA2 q rq ult of the tightening in of
credit and fiscal policy under the stabilization program and rose again+o 0rro r< eiurin 1QAA_1Q(X as +.he corn+h of orts mnl. nn!-qblP alarge increase in domestic expenditures without balance of payments
87. The composition of investment has shown relatively few changessince 1959, the most important being the increase in the share of trans-portation and the decrease in the share of housing construction.
88. While the changes in the share of investment in available re-sources and in the composition of investment have been relatively small,there has been a striking change in the sources of financing.
89. During 1955-1960 net foreign borrowing had financed nearly20% of net investment. In 1961 and 1962 the restrictive financialDolicies oursued at the beginning of the stabilization nrogram Droduceda current account surplus which served to increase reserves and repaydebt. Sinen then- with the return to more normal conditions, net
foreign borrowing has again been necessary, but the amounts have been muchsqma;l IPr- in I OA qnri I QMi net. fo%reigPn bonirowing, ha,z c-,resPnnrPr +.n
only 9% of net investment. This improvement has been the result of thegeater nrofiti Ih14+.I -f- + -PJhin" -n + " ki+ !q I q^ ^ f + al j mi nn+i nn
of excess domestic demand and of the distortions produced by artificial
&L therU 4'1 LijvU.L Um~il, ulicl'. U l - Uw t U it, U-.VU YuL.iJuuo I1 L A VIA
increased share of savings deposits in domestic financing, which reflectsthe greater confidence in1- 4V-oa currc,r aandd 1d; B-Ahr in.t,e_- r-ateS sicM
stabilization. During 1961-64 savings deposits accounted for 20.5 of
;7L~ J_ U 1'1ULj'; U u 1 LL wlu UI UaJt LbL,± LLUL 1L aitLLLi L .L UL A
derelopments.
92. There is no reason to expect that investment needs in the futureWil be less thanE uIri thel pat decuade, nori that domsicufinncinwill be sufficient to cover the whole of these needs. A small country,prouucing mainly for tne world market, can normally take fller auvantageof its economic opportunities by financing part of the large investmentsrequired to maintain a competitive position through recourse to foreigncapital, and Iceland is no exception to this rule. With the strengtheningof its financial position during the past six years and its expanded pro-ductive base, Iceland should be able to raise the necessary amounts abroad
- 19-
when conditions in capital markets are reasonably liquid or other oppor-tunities for borrowing are available and, alternatively, would have toaccept a slower rate of growth when borrowing possibilities are limited.
93. Within this framework of the Icelandic investment and financingpicture, the Burfell hydro-plant and related aluminum, smelter appear tobe large projects that might seriously strain the country's economy.The first stage of Burfell, to be carried out during 1966-1969, willrepresent an investment of $31.5 million, while the smelter (first pot-line), to be built during 1968-1969, will cost another $27.4 million.These amounts compare with total net investment in 1964 and 1965 of about$90 million a year. In fact, however, two-thirds of the Burfell costand most of the cost of the smelter will consist of imported equipment,supplies, and services. The remaining local costs, which will probablybe of the order of $15 million, spread over a number of years, comparewith total net domestic investment which by then would probably exceed$100 million per annum. Thus, the impact of construction on the economywill on the whole be relatively small. It is only if local constructionis concentrated in a very short period that some strains in the labormarket and resultinL disruntion may occur but this could be prevented byslowing down some of the larger public investment projects.
0. Phlin Finanoes
9. Theo Cen.-nt ral r3overnment nrn-in.q-nrnmi.1 : nf' total1 tayrevenue, the local authorities for 251 and the social security system,which Ji on+ltsi +h-e -bgn+ fr t1he remaining 10%.
mi- ~ -,-~ k~4- ,-~, A .~ + n 4- n~,-. +ns +Iia-r xroniip e%f' +Jip.
Central Government is small, only 10% of the total, due in part tore. Jat-.± ive ly -1IJV- 4./ a t- e s.O 'I-,U- mit*C.l..J Ado. *AJ0S± 1.AAAI. AA _.. t-; +.' rp., "A
of direct taxes are collected by the local authorities. The large share-f -m av + AI+J 4 n rn.n+"n1 r rronmen+ -o r eahmo flf hat.h tH 197ae
share of imports in total national expenditures and the high rates of duty
as calculated by the Icelanders and to well over 30% of GNP as estimatedU37 WI r1L. L,;,_Lk,L1
authorities are heavily concentrated on social services and benefits/Lover I470 01 lne boL) ariu on UciV.L.LU .11 u juppulo U.L Uiiu auUu
subsidies are also a very large item in the Central Goverment budget,accounting for about 207 of total expenditures. This rel-eUts in part
the high cost of aid to agriculture and in part the attempt to containthe rise in prices through consumer subsidies. There are virtually noexpenditures for defence.
- 20 -
98. The principal change in the Central Government revenue during1961-1965 has been a desirable shift from import duties to direct taxationand sales taxes. Import duties accounted for 531 of total tax receiptsin 1961 and for 43% in 1965, while the share of direct taxes increasedfrom 6% to 9% and of sales taxes from 24% to 355.
99. The structure of Central Government expenditures shows verylittle change during this period:
Central Government Expendituree
Percent of Total
1961 196L 1965 1966
Social Services h3 h2 L2 h3Economy (current and capital)23 23 26 24Subsidies 20 18 19 18Other 1 17 13 15
Total 100 100 100 100
99. During 1960-1963 the budget accounts closed with large overallqiirn1m n ht ii 1 L rm- i n +.li he dnqnrand fnr imnrnvPr1 andalbenefits weakened while rising agricultural surpluses necessitated a
ve"r "7 nrni,i nvn% F n "ibndes -s_reilt te +ianoeral I -iir-
plus of 138 million kronur achieved in 1963 was converted into a 197 mil-
of the balances accumulated in the.earlier years but this drastic change.L ~ ~ u U LL~±J.L~L. Ue.J. _LU L.LLI Ml K-,.AVI1UL.1Y I~. whic rejuii.ed~ no1 Iiancia-1 U-1.
lation was clearly ill-timed. The situation was corrected in 1965 whenan ov%reraL-L surplus 0. 'L4 1f.L-miJUA1 Alt-Ullu[r Wej c1LU aulLeveu and U uLdimprovement is likely to be maintained in 1966, (See Statistical
'PpeA1U.L1 d.LC .LL *Lj
10,. The Banking System
100. Until recently the National Bank of Iceland, a government-ownedBank, performed both central banking and commercial bankIng functionsbut since 1961 the former functions were transferred to a new institution,the Central Bank of Iceland, which has gradually been given adequateinstruments of credit control.
- 21 -
101. There are six commercial banks (of which the three largest aregovernment-owned), and sixty savings banks, whose relative importance isindicated below:
Total Assets of Commercial and Savings Banks(kLillions of kronur)
1960 1961 1962 1963 1964
National Bank 2,525 3,018 3,674 4,016 4,645Fisheries Bank 1,195 1,222 1,356 1,580 1,851Agricultural. Bank 480 555 713 835 1,082Industrial Bank 152 193 235 309 373Bank of Commerce - 255 341 411 482Cooperative Bank - - - 187 292
102. The 14 insurance companies, the private pension funds and thecnpi Pr-mci+.-x c-%rcnz.+.vP,ve m -n r nn jmnev-r+..qnt. rnle n +h m Vh<l . .nn rf: ATina!-.
and provision of investment capital. In 1963 and 1964 the net increase intheir assets compared as followM-s T.Yith the netn inncs 4n then asst of'"thcommercial and savings banks:
103. A special characteristic of the Icelandic financial structure,reflecTig mainly a traditional preference for cooperative vertureS, isthe existence of a number of special funds, set up to meet the investmentneeds of particular sectors of the economy. The resources of these fundsco.nsist of special levies, usually on the groups which benefit from their
respective activities but also on the general public, and of grants andloans from the Government and credits from the banking system. Theprincipal institutions in this group are the following:
Funds available forlending in 1965(million kr.)
Agricultural Loan Fund 102Fisheries Loan Fund 128State Housing Fund 179Industrial Loan Fund 51
Total 460
104. The Iceland Development Bank, set up in 1953 to chanr,el offi-cial foreign borrowings into the economy, is now in process of reorgani-zation to serve wider purposes.
105. Before 1960 the banks and other financial institutions had hadeasy access to Central Bank credit and this had been a major factor inthe financial instability of that period. Since the stabilization pro-gram recourse to Central Bank credit has been gradually restricted andcredit expansion has averaged 12% per annum. i.e. has been of the sameorder of magnitude as in most other Western European countries. Re-course to the Central BRank increased sharnly during the last auarter of1965 in connection with the financing of the exceptionally large increasein the hRrring nath hut thi. i. n t.emnorary bule which will he corrected
as the catch is disposed of. Tables 14 and 15 in the Statistical Appendix1 1 n+ +hnQn Anl nmon+c
i06A Then heltyrise in deposits.c in s-pite, of t.he (n+.ni( rr,1nPin the purchasing power of money owes a great deal to the high level ofint.prPRt- rAtPq wici h n. hPAn mnini%ninp. .inen 1in hilpi-.ion
107 The nresent na+..rn nf rats is as follow:
Depo-sit rates
6-month deposits 8%1.C0 mlIL+h pos A t+ O
10-year savings deposits 9-1/2%
9u-day bills discounted 9aBills of over 90 days 9-1/2rSecured loans Y-L/e to 1uo
I- 23 2 4
1uo. Special lower rates appLy to Wne U ;AP%u D ou m
of agricultural production.
109. In order to stimulate further the investment of savings infinancial assets and discourage investment in real estate the authoraiteshave decided to introduce index-linking on a broad basis. In Novem-ber 1964 the Treasury floated a 75 million kronur issue of inde:-linkedsavings certificates and further issues of 47 and 28 million kro-urrespectively were made in May and November 1965, the proceeds to beused for the financing of public investment projects. These issues arereported to have met with an eager demand. Loans granted by the 1ousingAdministration have been index-linked since June 1966. A government pro-posal pending before the '.lthing extends index-tying to longer-term bankdeposits and bank credits. The exact features of the proposal, and espe-cially the level of interest rates and the types of bank deposits andcredits to which index-tying will be applicable, are still being discussed.
11, Prices and Wages
110. It is clear from the precedin,- -.nalysis th.t fiscal and creditpolicy has not been a major factor in the continued rise in prices since1960. As in most other estern European countries, the explanation forthe rise is to be found in excessive wage increases resulting from fullemololiment conditions and in the claims of farmers for comTparable increasesin agricultural prices. The Icelandic cost of living index seriously-exacferates the rise which has taen place in the Icelandic price level.This is disussed in Annex I of this report. But even if the rise has beenonly half ni' wh,t the inri(-x qhon i.eq -me _ am yea instead of 12 0during 1961--1965,l/ this would still be higher than the !estern Europeanaverage o)f about -A arcynar There-o aro. thr -nin -rnasro, f'nr tho, greaterprice increases in Iceland:
(a) The higher fish prices on world markets andthe laryer catches have made nossible a larreincrease in earnings in the fishing industrynrld thMi .has .set hp -r+.+t,-'n fnr' urap - nr--,-.n.qPq
in other sectors which are less able to absorbf-lin Y-acnil +.i ncy nr.v"c,pc in -1 nL-,^r nc _(z
1/ 1960 1001IUVe .LJ
Percent increase per annum
adjustments for their products than theirCU ULU~.LJd.. L.~ L.LI U L i esUC- lj.1 Ll J.JkA.L VP II 1,ULLI-
tries.
(c) The high tariff protection and smaller degreeof internal competition in the tiny domesticmarket have made it possible for employers topass on increases in labor costs to the con-sumers to a greater extent than in countrieswhere foreign competition is sharper and thedomestic market larger. The greater possi-bilities for raising prices have in turn madethe resistance of employers to wage demandsweaker and their efforts to absorb the increasein labor costs through better employment oflabor, more mechanization etc., less vigorousthan in other Western European countries.
111. The fact, however, that the rise in prices which has taken placeduring the past five years has been compatible with a lar,e growth ofexports and with external equilibrium clearly indicates that, under thecircumstances which have prevailed during this period, the rise in thedomestic price level has not seriously impaired the country's economicposition.
112. What is a legitimate cause for concern is whether Iceland cancount on a continuation of the circumstances which have kept its economyfrom becoming overvalued and, if not, whether it will be possible to re-strain sufficiently the demands for income adjustments to prevent anotherwise inevitable weakening of the country's competitive positionWorld market orices and herrinL catches are unlikely to continue risingat the rate of the past five years nor can setbacks be completely ruledout. Trade unions and the farmers may not recognize in time that cir-cumstances had become less favorable and may not agree to moderate theirdemands and thus orevent an excessive increase in the domestic pricelevel.
113. On the other hand, the following considerations suggest thatthere- isq no rAso.qn ton t.a aq pesmsin~f TI'-PlInril.qP fnnnial nro-spects: (1) less favorable catches and prices, by making the economyless buoyant, uld contribnute +to antinhere on reourcesand this should have some effect on labor market conditions; (ii) tariff
market, which are under consideration, could partly counteract the effecto- - - -- -- f-;4%,o,,1 -0...,, ,,'.Z L- L vo k4.L..L a n 1.,- ., devauatin A correct,, t-he efIfcts+
of excessive domestic price increases due to inability to check the demandso that&--h authritisr ci.N -P 4-touel-temen at ter4 cnon-.Lor wag ad.! pri.ce adJU UL1tLLU~ji k.LVJ bi VI LIIU UVA. Jl jJJ-.-0V 4. 4 -L Jl.A - -
shows that the authorities are certain to use all the means at their com-tiai opu u---- - --- _ - - -- -'-'--- - - - -- -mandto reveit a SU1-10us UUJ1*JQ1dtiU_0[ 1E1 UJJUz t:LUUJ.LU j_Lt,UCLUJ_Ut1.
12. Balance of Payments
114. During 1956-1960 Iceland experienced current account deficitsof some $10 million per annum which, together with debt amortization ofsome $3 million per annum, had created acute payments difficulties re-quiring repeated rescue operations by the U.S. Government. Since sta-bilization current foreign exchange earnings have been sufficient tofinance all imports of goods and services, other than ships and aircraft,as well as debt amortization, while credits for the purchase of shipsand aircraft have been easily obtainable and official. borrowing hasroughly been equivalent to the increase in reserves. Another importantdifference between the two periods is that while the years 1956-1960 hadbeen years of economic stagnation, the period since 1961 has been a periodof vigorous expansion when normally the need for foreign financing in-creases. Finally, the share of bilateral trade has declined from one-thirdof total exports before stabilization to about 15% today while the shareof exports to Western Europe and the United States has increased corre-spondingly, and at present accounts for 75% of total exports.
115. The large increase in the herring catch and high world pricesfor fish products account for this transformation on the exoort side(about $25 million of the $130 million of exports in 196' are estimatedto be attributable to the rise in exoort prices since 1960) but stabi-lization deserves the credit for the improvement on the import side.The restoration of confidence in the ennnmv Pxnlnins, the ease with whihforeign credits have been obtained.
116. As already shown, fish products account for the bulk of commodityexports- Fnrpian exc-nhnage rrcipts. f-rom serice are lae crrespyozndinto nearly half the earnings from exports of fish products, but paymentsare evinn lanrgepr soe- thq a ser4ie Ave inin invlvdnet- -- pqmet of' som $6, mIlion a year.
117. This calculation refers to ordinary services. The local expendi-tures n-' thp TI- - fn-rnp A ne in Icelandl have prorided thecoutrwith foreign exchange earnings of some $9 million a year during the past
1/ To measure the net foreign exchange benefit from the
made for the force should be deducted but these havebeen dec"lining and were onLLY $700,000 in1 -1Yu4
Thes~e deveopmentskb are Lutrdd Lin tab-le 2' ifl thfu Sta-
tistical Appendix. It should be kept in mind that the current accountsurplus of $6 million indicated for 1965 reflects maily the largeincrease in the herring catch during the second half of the year andconsequent exceptionally large increase in exports during the last monhsof the year, which had not had time to work its way through the economyand affect the demand for imports. A considerable increase in importsshould therefore be expected in the current year.
13. External Indebtedness
119 The improvement of the economic situation has greatly reducedthe burden of external indebtedness and at present Iceland has again asubstantial borrowing capacity.
120. The public debt has not increased since stabilizatior:
Public External Debt Repayable in Foreign Currencies
121. Iceland has also obtained from the U.S. Government loans equiv-
Icelandic kronur (of this amount $5 million are PL-480 loans), but whichin fa+ are being erwiced in TT Aollars (a+nl serrnce in 16Q ( 8 mil
lion) and will continue to be so serviced.
122. The service of the external public debt, which corresponded to
3.2% in 1965.
- 27 -
123. Private indebtedness, consisting mainly of suppliers' andbank credits for the purchase of ships and aircraft, amounted to $30 mil-lion in December, 1964 and its service was $7 million in 1965. The bulkof this debt is due to be repaid in the next five years.
124. By 1971 the service of the present external debt, both publicand private, will amount to only.57($3,2 million for the public debt and$2.5 million for the private debt) and by 1975 the service will be only$2.6 million. Even if foreign exchange earnings increase much slower thanthey have in the past five years it is clear that the burden of the presentexternal debt will become negligible by then.
125. Iceland's credit standing improved markedly after stabilization.In 1962 the Government made a successful 26-vear issue in London at 6-1/2,for 12 million and since then a number of credits were obtained by officialagencies from Rirnnan banks- However thp strenath nf the external nosi-tion which produced this improvement also reduced the need for borrowing.Thus- therp have nnt hen suffiniepnt -nnortmnities during the nast threeyears for testing the country's ability to raise significant amounts in
settled for any substantial recourse to public issues not only by Iceland'hii. 'kir mr%Q+. -Pe-,, crn I- onrra
14. Conclusion - Prospects
126. During the past five years good fortune and good policy haveUL.Med" t UU -j V I cela di ouU O.L Ul=i qLUdCt11j1t:; -Lliuu 4-VII-ll.i Lti Ouvji LL W-1iJ -
bogged down in the late 1950's, and to bring about a striking improvement
T.e role o poLicy in tnis improvement must not oe unuereu..mueu.Even with good catches and good prices, the distortions which existed inte icUanic economy at te uginui1g of yu, 11 alowdU to contueu,
would inevitably have kept the external position weak and would have pre-vented the country from getting the lull benefit of tle opportunitiescreated by more favorable circumstances for its major economic activity.
128. The change in course was far from easy and a great deal ofcourage, persistence and good judgment has been required on the part orthose who have been responsible for economic policy during the pastfive years to carry out the necessary reforms in the face or relentlessopposition.
129. Developments in the coming years will be determined by the samefactors which have accounted for the recent improvement, namely the sizeof catches, world market conditions for fish products, and degree of internal.financial stability.
- 2o -
130. As already stated, there is no way or predicting what the catcheswill be, but, in the light of continuing technical advances, it seemsreasonable to assume that the possibilities for expansion have not beenexhausted. Similarly, it is not possible to predict how world market con-ditions will develop but again it is unlikely that the trend towards largerimports of fish in the major industrial countries will be reversed.
131. Internal stability will depend in part on official policy and inpart on the attitudes of trade unions, farmers and other organized interests.
132. So long as it remains in office, the present government is certainto continue the policy of financial restraint and economic liberalizationwhich it has instituted and successfully pursued, but general electionsare due in the spring of 1967 and, after seven and a half years in power,the present coalition could well lose its tiny majority in the Althing.While the opposition parties have subjected the stabilization program tosevere criticism, it is difficult to believe that any new government wouldrelinauish the solid gains made for the sake of an illusory freedom fromfinancial restraint.
133. The attitudes of organized interests are more difficult to pre-diet but it may he honed that the futility of large money increases inincomes followed by large increases in prices will become increasingly
I3h II,n othepr rds,v1 Thepre anre goodi grondsri- fo-r ex tng, tl-it. thedegree of price instability in Iceland during the coming years will notbe much greater than in other Wdestern Ziropan counntriesz_
15. The Burfell Project
135. At this stage in the country's development it was logical forUthe aLUthoriti,_eS to address theMSel_VeO to Wte logeOtrmisUOs cnthe economy.
136. As already stated, Icelandic opinion views a reduction in thedependence on fishing as the overriding economic ana Indeed national issue.The fact that the apparent depletion of the cod fisheries is making thecountry increasingly dependent on the traditionally volatile herring hasbeen noticed with concern and has added urgency to the long-standingobjective of developing the country's second largest national resource,water power. The interest expressed by Alusuisse in establishing analuminum smelter in Iceland offered the opportunity of making a beginningin the realization of this objective.
In the light of the preceding analysis, the principal economic4ssues raised by the Burfell project may be summarized as follows:
1 m29
a The project is obviously too large to be financed primarilyout of the country's own resources, but Iceland now has a substantialborrowing capacity which can be used for this purpose.
(b) Although large, the project can be carried out without dis-ruption to the economy.
(c) The export of 60,000 tons of aluminum a year would add some$30 million to foreign exchange earnings, but of course the import com-ponent of these exports will be so large that the above figure grosslyexaggerates the economic contribution of the project., The benefits ofthe project to the economy will consist mainly of:
(i) The foreign exchange receipts from the sale of power andtaxes on the profits of the company, minus the cost ofservicing that part of the foreign debt which will havebeen undertaken for the financing of a project of a sizeexceeding local power requirements. The power contractwith Alusuisse provides for a minimum purchase of 450 Gwha year during the first stage of the smelter operation. i.e.1969-1972, and for a total of 900 Gwh by 1975, at the latest,which. toeether with the tax on the nrofits of the smelter.is expected to yield $3.45 million a year when all stages arein oneration. i.e. after 1972. Possible additional sales ofpower to the smelter could yield another $400,000 a year andthere would also be aMitinnnI +_y rin f enmp 52nn(nna year, Thus a total of some $4 million a year from theqmaPfI PY, n-nnon-rcz 14+rwn n-P+a" 1079
by the company both for construction and operation of thesm lt r T-h bu ld n J L..L.1 AJ Ub '.4 U11~ - Uu at 1. V L A..L.
capacity of 60,000 tons a year are estimated at about $18*1I.4jj~ t4.L. an'~ o7.UL7r£ cL L,L-- - ' . I -Id ue dL -eI-3
that at least $10 million will be for domestic labor and
local expenditures may be estimated at some $4 million a.Y __I'4
Against this must be set that part of the service ofthe foreign debt undertaken for the fiuanciug ofBurfell which exceeds the service of the foreign debtthat would have been incurred for the financing of thenew capacity required to meet local demand. It ispointed out by the Icelanders that the smaller plantsthat would probably have been built in the absence ofthe smelter would have been much more costly than Bur-fell and that consequently the difference in debtservice would have been much smaller than the differencein the size of the capacity involved. Assuming that thedebt service in the absence of the smelter would have been$2 million a year instead of $3 million, the net foreignexchange contribution from the smelter would be $7 milliona year. This may be considered modest when compared withexports of $130 million in 1965 but it should be kept inmind that exports have an import content of some 50, whilethe foreign exchange earnings from the smelter would re-present a net addition to foreign exchange earning capacity.If exports were calculated on a net basis, the contributionof the smelter would become more substantial.
(iv) Some important additional benefits from the smelter mayreasonably be expected but cannot be quantified. Theyare: the opportunities for secondary activities connec-ted with the existence of the smelter; the technical andmanagerial skills that would be acquired by Icelanderswho may be employed by the company; and the closer con-tact with the outside world that the operation of thesmelter may bring to the small and somewhat isolated Ice-landic community,
(d) In iudAing the adequacy of actual and potential benefits, itshould be kept in mind that there is no alternative project that wouldvield higher benefits or make a greater contribution to the desireddiversification of the economy.
(e) The fact that the contract with Alusuisse will provide suf-ficient foreign exchange earnings to cover the service of the debt meansthat, even if the benefits ultimately prove more modest than is atpresent exnected, the project will at least be self-liqnidating from thebalance of payments point of view. Thus, in spite of the large foreign
brTowr~ing i nvolv~ed, t.he pro ject is a safe one 4-to ndertake*
(f)rp, Th imprvemt of the~ I,eladi econom ~ict siuaio is~+ sor re-
cent that the country has not yet had the time to establish fully itscredit, while todayls conditions in foreign capital markets allow limitedscope for raising funds, even to seasoned borrowers. Thus, Bank financingout a sute ia j t fBur.fell is a. necesary condion for the carryiout of the project.
iU1-EX I
Icelandic price indexes, GNP and per capita income estimates.
Need for revision
Until recently Icelandic economic statistics and nationalaccounts estimates were, as the Icelanders themselves admitted, "intheir infancy" and the figures given as national income, savings, invest-ment, burden of taxation etc. were no more than rough approximations.The unrealistic price relationships added to the difficulties of com-piling meaningful estimates.
With the setting up of the Economic Research Institute andthe stabilization of the economy, a great improvement has taken placein recent years and detailed estimates are now being compiled on mostimDortant economic maLnitudes. There remain, however, some areas wherethe data are admitted to be inadequate or defective. One such area isthe calculation of changes in the price level. The principal indexcompiled is the consumer price index which, when adjusted for changes inindirect taxation minus changes in fnmily allowannes -nd in consumer sub-sidies, becomes the cost of living index. It is recognized that thisindex nffers from sevornl inadenanin nn +.hn. . net. ren1t of thesn
inadequacies is to exaggerate the rise in prices which has taken placeCinea 1Q60 Tn the f rnt placn iandv eive n excsine wraoiAht toexpenditures on food, i.e. to the group of commodities for which pricei, nnvc .e_a e h ve e_ n S Ian- M-, .,r. p - (fl- . M.o +- - 1a -n 1 oti+, o- -P-- _T- -v7 i n It 04A
show that 47% of total consumer expenditures went for food, which is
largely on prices of home-produced goods, although the share of importsin L toal expendliitures is probably of thle order Of )V/0 1LVV fnor pJ_riCs(expressed in current kronur) increased by 14% during 1961-1964 or only4.-> a year oLA tu.L g±v.ing uL1,zLuXeuv w u ou Lur venue oU mefo
the estimated price increases much greater than they were.
Another indication that the price increases calculated in thisway exaggerate the actual rise in pr ces l-4 lAid w usa e - -u -IUa--- Iw-_
by the cost of living index for 1960-1964 is only slightly less than theinceas inP 4an eCf 64 P_clclae fr 4 thi -4o -A
increase in wages is associated with a much smaller increase in the cost0vL -Lving anu L1J. Lhulu dave aloV veen tvue Cafee in ±I U, L1 VAC;W V
the large increase in the productivity of the fishing industry and thelikelihood unat productivity also increased in other secuors as a refZs.uof import liberalization. Judging by the experience in other countriesthe real rise in Icelandic prices during 1960-1Y4 was probably no morethan half that indicated by the cost of living.L/ One stipulation of the
I/ I196A)(IEloo)
TJo^ePo+ -P Ii iin-t
Sweden 159 119t11. 1 0OVior-.way _L4UA .'-
Denmark 169 125L' .1rlUanIILI) ALC 7
Germany 165 114France 10 13uIceland 167 160
(ii)
wage agreement of June 1964 was that the cost of living index would berevised and placed on a more realistic basis, and this is now being done,but the approval of the trade unions will have to be obtained before thenew index is adopted. Meanwhile the use of the present cost of livingindex in calculating national expenditures at current prices has resul-ted in increasingly inflated estimates for GNP which, converted at theunchanged rate of exchange of 43 kronur to the U.S. dollar, give a percanita income for Iceland Ps hiph as that of Switzerlqnd. almost ns hirhas that of Sweden, the two countries with the highest per capita income
and the United Kingdom:
Per CaDital Income; - ION.
U.S. dollars
Iceland 2,128
Switzerland 2,130n -1 0 r7n
1eimark,.±' .1I U I'-
Norway 1,680
Germany 1,780brance L,(,6uUnited Kingdom 1,640
A comparison of some indicators of per capita income, such asnumber of passenger cars and telephones per 100 inhabitants, ad hourlywages, also suggests that the Icelandic real per capita income cannot besignificantly above that of Germany or France.-'
Finally, it is significant that most of the exaggeration arisesin connection with nrivate consumntion. for which an im-nlicit nriceincrease of 67% during 1960-1964 is indicated, while the estimates ofinvestment ame an inreae in nrines nf only 0)i,. Sqh Iqredifference does not appear justified: the import component of investmentcannot he much g1reater than that o)f ann-iinmn+A nn nnri rn).ra n t-nczt
are unlikely to have risen less than retail prices.
The reason why the investment estimates are less inflated isp r0 . Jaly. t hSC.J t JC t h .ey ar C La.JL s 41 e A o mo e 3. , tCJIUOL,C 4 1 4 p - 4. +ih P.,''J.1,)t-
machinery and equipment, government expenditures on capital projects,
V11UI 11U_LV L L UU.L 11
m;il1ion kr.
Current prices >,3fo I I,uuConstant prices 5,376 6,610implicit price index 100 107
Gross fixed investment(1) Machinery and equipment
Current prices 1,101 1,906Constant prices 1,101 1,ho7Implicit price index 100 129
(2) Other
Current prices 1,398 3,063Constant prices 1,398 2,027Implicit price index 100 153
(3) Total
Current prices 2,499 4,969Constant prices 2,L99 3,474Implicit price index 100 12
The Icelandic authorities intend to revise the national accountsestimates as soon as the new price index has been adopted but meanwhilethe importance attached nowadays to per capita figures makes it necessaryto attempt to arrive at some more realistic estimates that would indicatemore accurately the probable position of Iceland in international com-narisons.
The RnV 'M.qn mnip qiirli qn ntt.pmnt and rp.ithpi tllp ronnlu-
sion that per capita GNP in 1964, even after allowing for a greater increasehves tha in most othel copas cunt es, chave been much above $1,700 in any meaningfu c prSon.
(iv)
This conclusion was based on the following calculations:
(a) It was assumed that the 1960 and 1961 estimates of GNP
most of the exaggeration has occurred since then.
(b) The estimates of exports of goods and services are thesame as the balance o01C -~ ~ *~"
reflect actual foreign exchange earnings.
(c) The difference between exports of goods and servicesanlu Uota.l it-ina. e)peUIL:.L,ue; idicates th UL41;U-,
expenditures on locally produced goods and services.These are shown to have increased by 16% in volume andby 70% in prices during 1961-64.
(d) Since the rise in the overall price level in this periodis unlikely to have exceeded 6% per annum or 19 in threeyears and since import prices are shown to have risen by14y, prices of locally produced goods for domestic con-sumption are unlikely to have increased by more than 21l.
(e) Adjusting the estimates accordingly and assuming that the1961 figures were also somewhat inflated, one obtains atotal for GNP at current prices of $329 million or $1,730per head in 1964:
1961 1964
GNP at current prices (million kronur) 9,427 17,254
of which:
Exports of goods and services(million kronur) 4,315 7,020
Other: (million kronur) 5.112 10.23L
Imolied increase in volume 100 12Implied increase in prices 100 170Assuming an increase in pricesof 24%,10,23L is reduced to: 7,900
Assuming that the 1961 estimatescontained a 10 exaggerationahnupv fiuire. isq rndcinn 7 -1Cfr
Other 166TotUal U1NP 329Population 190,000Per capita G14P $,7u
TABLE I
Price and W,ge Indices
Cost of ConsumeÆ Buildi ngYear Living Goods Costs I res
United States Government loans 16,580 16,580Export-Import Bank 494 94AID L2 16,086 16,086
Other Western Governments _5,056 5,056Denmark 1,062 1,062France 300 300Germany 2,615 2,615EPU consolidated credit 1.079 1.079
U.S.S.R. 761 _ 761
/1 Debt with an original or extended maturity of one year or more.
/2 Excluded from table are outstandini U.S. Government loans to thevalue of $ 8,049,593 which are actually being repaid in dollarsalthough the debtor has own option to pay in local currency.
I tAtistincs DivsintIBRQ-Economics Department
Novomber 15 1065
Table 26ICELAND - ESTIMATED ONTRACTUAL SERVICE PATMWTS ON
EXTERNAL MEDIUM - AND IONG-TEIRM PUBLICDEBT OUTSTANDING INCLUING
UNIRSWURSED AS OF JUNE 30, 1965&
Debt Repayable in Foreign urrency
(In thousands of U.S. dollar equivalents)
Pare 1
GRAND TITAL
DE8T OUTST(BEGIN OF PFRICD) PAYMENTS [URIN, PERIOD
INCLUDING AMORTI-YEAR UNDISBURSED ZATION INTEREST TOTAL
