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Economy of Iceland

By naveedmurad Oct 19, 2008 2395 Words
Introduction:

Iceland is located between Norway, Scotland and Greenland in the North Atlantic Ocean. It is also the 2nd largest island of Europe. Iceland's economy is based on the Scandinavian type capitalistic system, also known as the Nordic Tiger because of its rapid growth. With a population of only 312,872 people, it is ranked as a country with highest HDI and one of the highest GDP per capita PPP.

Iceland is a modern welfare state which provides health, education and security to all its citizens. Therefore, spending on health, education, social security and welfare amounted to one fourth of the GDP. Almost 40% of the GDP is the total tax burden in Iceland. All of these factors make Iceland the fifth-richest nation according to IMF, and the first according to the Human Development Index.

Iceland registered a healthy growth rate of 3% in 2003-2005 while in 2005 the economy boomed with 5.8%. In 2006, the growth rate was 4.2% while it declined to 4% in 2007. It is expected to decline further in 2008. The population of Iceland is 312,872 which grew at 2.6% annually. It has a workforce of 176,300 people. Inflation in the 1990's averaged about 4% while it rose in 2002 to 8.7%. The regulators were able to control it to 3.95% in 2005 and it stood at 4% in 2007.Gross National Income (GNI) per capita measured in terms of Purchasing Power Parity amounted to 36 thousand USD which is the eighth highest in the world and sixth highest among the OECD countries. While GDP per capita income in 2007 was US$ 39400. Agriculture Sector contributes 5.3% to the GDP while manufacturing sector contributes 26.3% growing at 9% and services sector 68.4%.

Exports have been heavily dependent on fishing industry but its importance has declined. Fishing industry employs 6% of the labors force while contributes 51% to the total merchandise exports (unlike 90% in early 1960's). Large extensive investment in the Aluminum and power sector in 2003 has been recorded that are equivalent to more than 1/3 of the 2003 GDP. Unemployment rate declined from 3.5% in 2003 to 1.9% in the 2007. Growth in manufactured goods (mainly aluminum smelting, medical and pharmaceutical products) has been recorded which now accounts for 38% of merchandise export in 2006. Current account deficit was 91 b.kr in Q4/2007 compared with 29 b.kr in Q2/2007.

Several years of rapid expansion has created both external and internal imbalances for the Icelandic economy.

GDP GROWTH

Over the last decade, there has been a high average GDP growth rate of 7%. This was due to an extended period of structural reforms, privatization, fiscal consolidation and huge investments in the manufacturing sector. Large investment has been poured in the aluminum sector. Since the 2002 recession which had a growth rate of -0.3%, the economy grew at 2.7 percent in 2003 mainly due to the investment in the aluminum sector. This was followed by a 7.7% growth in 2004 and as more and more investment was poured in; the economy grew more and reached 7.5% in 2005. While this rapid growth and huge investment for such a sensitive economy created troubles like inflation and the economy’s growth rate dropped to 3.7%. The recovery period started and the economy is now growing at 4.2% in 2007. The Icelandic economy generated GDP of $8.8billion in 2002 and $10.8 billion in 2003. Huge inflow of investments in Iceland in the aluminum sector helped to create a GDP of $15.4 billion in 2006 which grew to $18.8 billion in 2007.The projects are near completion which would not only create employment but would also increase the total production capacity of aluminum smelter from 270 tones per year in 2005 to 800 tones per year in 2009.

Iceland also has the eighth highest Gross National income per capita Purchasing power parity of USD 36,000 in 2006 to USD 50,580 in 2007. Economic activity in Iceland is growing since 2003 due to the huge investment which caused all economic indicators to show a favorable change. YEARGDP Growth Rate %

2002-0.3
20032.7
20047.7
20057.5
20063.7
20074.2

GDP Growth Rate in %

GDP - Per Capita Income

This is a measure of average standard of people living in country. Iceland has one of the highest GDP per capita, in terms of purchasing power parity, in the world and also has an equal distribution of income. The rapid growth of the economy resulted in an increase in the per capita income. Low average population growth rate of 1.1% in the last 10 years has also played a major role in maintaining standards of living. In 2003, per capita income was USD 25,000 where it was ranked 26th highest in the world. The next year (2004) it increased by almost 24% and was ranked 9th highest in the world at USD 30,900. Figures of 2007 by the CIA Factbook show an increase of almost 7% to USD 38,000 and is ranked 13th highest in the world. Year GDP – Per Capita IncomeRankPercentage Change

20032500026
200430900924%
200531900143%
2006357001212%
200738000137%

Marine Products

For centuries, fish and fish products have remained the main livelihood of the Icelandic people and act as a backbone for the economy. Though its importance in the recent years is declining as exports are diversifying and the economy has become more service-oriented. The marine products contributed 51% of the total merchandise exports as compared to 90% in the early 1960's. Cod is the most important and valuable fish in the Icelandic waters which accounts for 36% of the total catch value. Other marine products include haddock, saithe, redfish and herring. The industry is gaining efficiency with automated and modern management techniques like the ITC. For efficient use of marine resources, a fishery management system has been developed to manage fish stocks and promote conservation. Iceland has now become leader in the European seafood market. Fishing and fish processing contributed 5.9% to the GDP while employed 7.6% of the labor force in 2006 as compared to 9.6% of the GDP and 8.3% of the labor force employed in the marine sector in the year 2000.

Services Sector

The economy is becoming more service oriented. Services industries like hotel and restaurants, finance, real estate, insurance etc are 58.2% of the GDP in 2006 while it employed 49.1% of the labor force. Currently, there are only 5 commercial banks providing conventional banking and securities services that have total assets of 8,475 billion Krona by the end of 2006. Tourism is also gaining momentum and the number of visitors has increased from 140 thousand in 1990 to 410 thousand in 2006. Foreign exchange revenues earned from tourism were 12.6% of total export revenues which amounted to approximately 47 billion Krona.

Iceland's technological sector is also growing at a fast pace. Icelandic software houses and software developers are now engaged in development of software's for sophisticated equipments. An increase of more than 175% in the total exports of software products since 2000 has been recorded in 2006. As exports of software products now amount for 6.3 billion Krona.

Manufacturing Sector

The manufacturing sector of Iceland is dominated mainly by power-intensive aluminum smelters that account for 26% of the total merchandise exports which were 12% in 1997. These are exclusively produced for exports. Iceland has competitive advantage over the cost as it has large hydro and geothermal resources. Huge profits in the aluminum smelting sector have attracted investors to invest in Iceland. A large skilled labor force and low energy costs in Iceland have resulted in expansion of the aluminum smelting industries like the Century Aluminum Smelters who have expanded from 180 tonnes per year to 270 tonnes per year by 2008.

Other manufactured goods produced by small and medium size enterprises in Iceland include capital goods for fisheries and food processing, medical equipments, pharmaceuticals.
Manufactured Goods by Category

Inflation

Iceland's economy is prone to inflation. Inflation during the oil shocks of 1970`s effected Iceland's economy where it reached 43% in 1974 and 59% in 1980. The economy recovered and by 1987 inflation dropped to 15%. The governments since than have tried to keep inflation under control using tight fiscal policy.

Due to heavy investment and instability of the housing market, the Central Bank of Iceland failed to maintain inflation at a targeted rate of 2.5%. During the 2003 recession, inflation hit 5.2%. With raising interest rates and growth in the manufacturing sector, inflation was maintained at 2.1% in 2004. The economy wasn’t able to digest the huge amount of investment poured in the manufacturing sector and thus the inflation was marked at 4% in 2005 and 2006 as well. By 2007, inflation reached 6.8% and estimates of March 2008 show inflation at 8.7%.

Exports

Iceland has always been open to foreign trade and its share is of 80% of the GDP. With a large export base, total exports in 2003 were USD 2.3 billion. Exports grew by almost 12% in 2007 to USD 3.587 billion as compared to USD 3.215 billion last year. Between the 1950 and 1960, trade with Soviet Union started with the ban by the UK on Icelandic fish. Most of the marine products were than bartered with Russia for petrol, car and various machineries. With the collapse of the Soviet Union, the trade also declined to almost 1% in 1994. More than 3/5th of Iceland's exports now go to the European Union. Being a member of the European Free Trade Association (EFTA) since 1970 and joining the European Economic Area (EEA) in 1993, barriers of trades were eliminated as to strengthen trade between neighboring countries. In 2006, 75% of the merchandise export went to member EEA countries. About 18% of total exports went to Netherlands. Other trade partners include UK (16%), Germany (16%), Spain (6.8%), USA (6.6%) and Norway (4.2%). The economy for centuries has been depended on marine products that accounted for 51% of the merchandise exports and 34% of total exports in 2006. In 1991, fish and fish products accounted for 82% of the total merchandise exports and 60% of total exports. Exports have been diversifying in the recent years. Exports of manufactured goods like aluminum smelting and medical products have gained rapid growth and now account for 38% of the total merchandise exports. As the economy is becoming more service-oriented, there has been an increase of exports of services. Icelandic software houses are gaining recognition in the foreign markets while Icelandic musicians, filmmakers, prosthetics manufacturers, designers of fishing scales or customizers of giant jeeps are also on their way to success. 26% of the total export revenues were earned by the export of services .

Merchandise Exports by Category 2006
From: Economy of Iceland 2006 – Report by the Central Bank of Iceland. Imports

Iceland has a wide range of imports. From capital goods like machineries to consumer goods like automobiles, everything is imported into Iceland. This not only reflects the small size of the economy but also shows the limited range of natural resources. Imports in the recent years have been increasing as people can now afford to buy more imported goods. In 2003, imports were of worth USD 2.1 billion and by the end of 2007 have increased to USD 5.189 billion.

Imports of capital goods were 37% of the total merchandise imports. While consumer goods and industrial supplies are one-third of imports each. Germany is one of the major trade partner and German goods were 13% of the total imports. Other trade partners include USA with 9% share of imports, Norway and Sweden 7.6% of imports each, Denmark 6.6%, UK 5.6%, Netherlands 5.2%, China 4.9%, Japan 4.4% and France 4.2%.

Imports by Category in 2006
From: Economy of Iceland 2006 – Report by the Central Bank of Iceland.

Population and Labor Force

The total population of Iceland is of 312,872 people with a population growth of 0.824% in 2007. The population age structure shows that 66.8% people are aged between 15 to 64 years in 2007. The death rate is 6.77/1000 population. As a welfare state, Iceland provides free health services to all its citizens. This is why life expectancy is higher than the rest of the European countries of 80.43years. Education is free and therefore Literacy rate is 99% which is defined as people above 15 years old who can read and write.

Iceland's labor force consists of 173,000 people and has the highest participation rate among the OECD countries. Most of the labor force is employed in the services sector. Unemployment rate in 2006 was 2.1%. It decreased by almost 38% to 1.3% in 2007. The government has been able to maintain the unemployment rate and is lower than the rest of the countries in the region. OccupationLabor Force Employed

Agriculture5.1%
Industry23%
Services71.4%

Current Account

The wide current account deficit is considered to be instable. This large current account deficit was caused due to strong local currency, floating private consumption, higher interest rates and decline in the income from shares, mainly due to negative reinvestment. The current account deficit grew by 357% in 2006 to USD 2.61 billion from USD 570 million in 2005. It than grew by 12.5% in 2007 to USD 2.9 billion.

Glacier Bonds, the first Krona-dominated Eurobonds, were issued in 2005 to fund this deficit. Although this created more challenges for the monetary policy like the long-term interest rates and the policy rates started to move in the opposite direction.

Reference:

Economy of Iceland 2006 – Report by the Central Bank of Iceland (http://www.sedlabanki.is/lisalib/getfile.aspx?itemid=5387)

IndexMundi.com – Facts and Figures of Iceland (http://indexmundi.com/iceland/)

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