Friday, 26 April 2013

A plea to the future government of Iceland

Statistics Iceland released new figures on the labour market recently. According to them, the unemployment rate in Iceland continues to go down. It has reached 5.7% after having reached almost 8% in early 2011.

The unemployment in Iceland is slowly improving. I guess some nations would not complain too much about the rate of unemployment around 6%. 

But here is the catch: even though the rate of unemployment is coming down, the labour market is not improving much.

Next graph shows my point. We can see that during the boom years, the total working hours (estimated by multiplying number of people at work multiplied with the average working hours) increased sharply. This is to be expected as the real capital investments at the time (housing and dam construction to name just two) demanded a lot of labour. This demand for labour was answered by importing workers from e.g. Eastern Europe and China. 

Then came the crash and the total working hours collapsed along with the real capital investments. But so did the average working hours per individual in the workforce!

Despite the improvement in the rate of unemployment, the labour market does not show any other prominent signs of returning to normal levels. 

One reason why is the fact that not all of the foreign workers went back home. They stuck around, got an Icelandic passport, have assimilated into the Icelandic culture and have become Icelanders. Good for them!

The other more prominent reason is the fact that investment is all but gone! Investment as a proportion of the gross domestic product has never been at lower levels than now. I estimate that in order to get up to the more normal 20% ratio of investment to GDP, we need to expand real capital investments in Iceland by almost half: we currently invest around 245 billion ISK annually but we need 120 billion ISK more.

The level of investment in Iceland is puny compared to the level it should be at. We need roughly 120 billion ISK more to get up to the 20% ratio where we can expect the economy to be neither in an investment bubble a la 2005-2007 nor in a serious slump. 

The normal response of politicians in Iceland to too low level of investment has been to promise a new heavy industry project. An aluminium smelter is the classic!

But the track record of heavy industry investment in Iceland hasn't been that great. The energy is sold at too low prices (that was politics) and the negative environmental effects are affecting the more Thirlwall's Law friendly tourism sector. Basically, in the long run, the positive economic (and environmental) effects are more prominent in other major industries in Iceland. The classic "lets build a new smelter!" is a cheap get-out-of-jail card and shouldn't be used, again, if the long term prospects of the economy are to be held in high regards.

Rather, what is needed, is investment carried out by small companies, especially if they are domestically owned and operating in the export industry (as it would generate a much needed foreign currency income into the economy).

Tourism is an obvious choice, especially as it would generate a lot of long-term jobs (which the construction of yet another smelter does not). The long-term growth prospects of tourism are also excellent as the number of middle-income people, which can afford and want to travel, grows tremendously as the Chinese, Indian and other Asian economies grow (Thirlwall's Law kicks in).

Investing in more energy independence would also boost the long term prospects of Iceland tremendously! We have plenty of energy that can be used to fuel the car fleet of Iceland instead of running aluminium smelters. The net savings of foreign currency (less imports of oil-based fuels) and the consequential easing on the balance of payments constraint would be most welcome.

Other industries are waiting to expand and their expansion would be very beneficial for both the level of employment and the balance of payments: beer and alcohol brewing; computer games and other IT industries; and product development in food stuffs, especially fish and sea food, just to name a few.

But small industries need low level of uncertainty and access to cheap but steady supply of financial capital. And given the high level of uncertainty that is caused by the amount of capital that wants to get out of the economy ASAP, thereby killing the exchange rate and all cost-plans associated with real capital investments but only held back by the capital controls, we cannot be surprised that the level of investment is so low. What has killed investment in Iceland is uncertainty and that uncertainty is caused by the fact that still today, five years after the collapse in 2008, we do not know what will happen to the leftovers of the Icelandic pre-2008 boom. Those leftovers - financial capital - are waiting to get out but held back only by the capital controls.

There are general elections in Iceland tomorrow, Saturday. The most prominent problem of the post-elections government will be to fix the underlying problem of financial capital that awaits its chance to get out of the economy. While that problem is left on the table, employment, investment and the standard of living will not improve.

And beware, there are no easy ways out. Cheating on the problem by either pretending that it does not exist or by assuming that building another smelter - as some politicians unfortunately want to - will fix it will in fact not as what is needed is a long-term sustainable solution where other economically and environmentally friendly industries can maintain the level of investment; building a smelter without fixing the overhang of capital waiting to get out would be like putting a band-aid on a gunshot wound.

So I only have one plea to make to the future government of Iceland: fix the overhang of capital waiting to get out of the economy, get the level of uncertainty down and support small industries in their investment projects. Do this and you will probably be re-elected.


  1. What chance for the removal of capital controls? And how could they do it in a way which encouraged new investment in and kept some of the old?

  2. I sincerely do not know what the chances are for the removal of the capital controls at this stage. There is a new government in the making right now, let's wait and see what the outcome will be. It is important to remember that the lifting of the capital controls practically demands that the overhang of capital waiting to get out of the country is reduced somehow. A part of that necessary reduction will involve the old bankrupt banks, as a lot of the overhang is still on their balance sheets, and the new government.