Iceland: International Business (bus M 430) Country Analysis Research Project By Ronald Schoedel

Iceland Country Analysis Research Project Bus M 430 • Prof. Wright • May 4, 2009

Ronald Schoedel • [email protected] • © 2009 Ronald C. Schoedel III!

Table of Contents Executive Summary !......................................................................................................... 1 Country Description!.......................................................................................................... 2 Market Demographics!....................................................................................................... 2 Political System and Political Environment !...................................................................... 3 Economic Environment!..................................................................................................... 5 Trade and Investment Opportunities!.................................................................................9 Exhibits!........................................................................................................................... 12 Notes (Works Cited)!....................................................................................................... 17

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Executive Summary The Republic of Iceland, a small European nation of just over 300,000 inhabitants, offers numerous opportunities for the foreign investor. Blessed with long-lasting political stability, abundant natural resources, inexpensive geothermal energy, and a well-educated population, the nation is well-equipped to provide a suitable business environment or a ready market for exporters of goods and services. Iceland!s balance of trade has long favored foreign businesses, as Icelanders readily purchase most of their consumer goods from European, Asian, and North American producers. Cultural similarities with Europe, the United States, and Canada mean that a firm located in these areas is able to export goods with little modification necessary for the Icelandic market, beyond labeling and documentation. A solid command of English and similar social customs among the population eases the transition of European and North American personnel into the country, also. Opportunities for foreign direct investment abound. Foreign firms investing in Iceland will gain access to a healthy, well-educated workforce, who are largely cohesive and concerned about their collective well-being. Foreign firms need not concern themselves with politically-motivated violence, sectarian disputes, or ethnic strife, all of which are noticeably absent in Iceland. And, while Iceland is a social market economy, it features many of the best aspects of a market economy as practiced in the United States. Low corporate taxes, ease of establishing operations, and a national government that welcomes business are additional attractions for foreign investors.

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Country Description Iceland is a small European nation with a population smaller than many American cities. With a geographic area of 103,000 square kilometers, it is slightly smaller than the state of Kentucky. The Trade Council of Iceland promotes the nation as “the connection between continents,” as the capital, Reykjavik, is 4,200 km (about a six hour flight) from New York City and 2,100 km from Brussels (exhibit 1).1 Market Demographics Iceland!s population of 313,000, is predominantly urban: 92% live either in the capital or one of seven other urban settlements.2 With a low birth rate and a low immigration rate, the 2008 population growth rate was a mere 0.741%. The rate of urbanization has averaged 0.8% from 2005 to present. Population density is a low 3.0 persons per square kilometer, as glaciers and wastelands represent over 63% of the land area. Age structure among the population is divided at 20.7% 0-14 years old, 67.1% 15-64 years old, and 12.2% 65 years and older. The male/female ratio is 1.02 to 1 for the 15-64 year old range, but 0.83 to 1 for 65 years and up. Iceland is regarded as one of the healthiest and most advanced nations when it comes to social systems, education, and public health. Thanks to excellent health care extended to all citizens, infant mortality is a low 3.23 deaths per 1,000 live births, approximately half that of the U.S. The literacy rate is 99%. Life expectancy is an impressive 80.67 years (male: 78.53 years; female: 82.9 years). The fertility rate is below replacement level, 1.9 children born per woman, and significantly below the western European average of 2.4, but higher than Sweden!s rate of 1.71.3 Without net migration of 0.83 persons per 1,000

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population, Iceland would be shrinking. The low birth rate and a high life expectancy mean that Iceland!s population will continue to age overall in coming years. Iceland!s population is homogenous: 94% trace their lineage to the Vikings and Celts who first landed on Iceland in the 800!s A.D. Only 6% are of foreign extraction, mostly European. Icelandic is the official language and its adoption is required of all immigrants, but most of the population also speaks English. German is also spoken among some Icelanders. Iceland!s state Lutheran church claims over 79% of the citizens as nominal members (all Icelanders are registered as members of the church by default at birth). However, Icelanders are a largely secular people, with only 10% attending worship services regularly. A few other Christian religions are active, including several smaller Lutheran churches (5%).4 Catholics, Pentecostals, Seventh-day Adventists, Orthodox, Latter-day Saints, and a few smaller congregations total 4.9%.5 Iceland is home to a few dozen Muslims and Buddhists. The balance, 8%, claim no religion at all.

Political System and Political Environment Iceland has been an independent constitutional republic since 1944. Politically, the nation has been relatively stable and has the world!s oldest functioning legislative assembly, the Althingi, established in 930 A.D. Iceland!s government is led by a President, who assembles a cabinet based on input from the various parties. This ministerial cabinet typically stays in power until the next general election (every four year years), or as happened this year, until a new government is formed. These ministers sit in the Parliament and each oversees their particular area of concern.6

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Substantial political discontent arose after Iceland!s banking system collapsed in October 2008 under the weight of billions of dollars and euros in foreign loans. This turmoil was displayed in some violent protests, the first since Iceland joined NATO in 1949, as well as the more mild Busahaldabyltingin (“kitchenware revolution”)7: daily protests highlighted by banging of pots and pans in the streets as marchers demanded the resignation of Prime Minister Geir Haarde, himself a former central banker. So many people were displeased with the former coalition government!s perceived failure to deal with the mounting crisis that the government dissolved voluntarily two years before regular elections were scheduled to be held.8 This political turmoil has had the effect of uniting Icelanders. Despite unemployment rates of 8%, the resilient islanders have been rallying their historically collective feelings and forsaking what has been termed “the Greed Society,” a period where the gap between the rich and the poor grew substantially since 2003. Thor Thorarinsson of the Ministry of Social Affairs and Social Security wrote that “Icelanders have realised that you can!t, in such a small country, accept gigantic differences between the richest and poorest, as have arisen in recent years.”9 These collectivist leanings were evident when a new leftist prime minister and a leftist coalition government was elected in April 2009, including a majority of parliamentary members who advocate immediately applying for membership in the European Union.10 Business Week states that “the Social Democrats believe the crisis, or kreppa, has taught them that their small economy will only be battered again and again if they do not seek the shelter of the 27-country bloc.” Whether EU membership aspirations

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succeed is open to question, as many Icelanders advocate continued protection of their pristine fishing grounds from foreign use. Though not a member of the European Union, Iceland is party to a number of international political and economic organizations. Among its memberships are the North Atlantic Treaty Organization, European Economic Area, European Free Trade Association, Organisation for Economic Co-operation and Development, Interpol, World Trade Organization, United Nations, and the Arctic Council.

Economic Environment Iceland!s economy was the first casualty of the global financial meltdown begun in 2008. Iceland has a social-market economy, combining a capitalist structure and free-market ideals with a robust social welfare system, including housing subsidies.11 According to the International Monetary Fund,12 GDP (purchasing power parity) was $12.353 billion in 2007, up from $12.01 billion in 2006. After several years of GDP growth (4.9% in 2007, 4.4% in 2006) (exhibit 2), the GDP fell to $12.664 billion in 2008. The IMF projects a further decline of 9.8% in 2009, to $11.424 billion, minimal growth of 0.2% in 2010, 4% in 2011, and an average of 4.9% annually through 2014. OECD reports Iceland's economy and per capita income have grown at an impressive pace since the mid-1990s, making the country one of the most prosperous in the OECD….[R]eal GDP has grown by 4% per annum, significantly bettering OECD growth over that period making the country the fifth-wealthiest in the OECD.”13 Iceland!s per capita GDP, before the financial crisis, was the sixth highest in Europe according to IMF.14 In 2007, per capita GDP was $64,959. With the rapid increase in un-

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employment, 2008!s figure dropped to $55,462. Projections for 2009 are much lower, at $36,878. IMF analysis indicates that the high per capita figures of the mid-2000s will not be seen again in the next five years (exhibit 3). The domestic economy is largely service based. The wholesale, retail, repair, real estate, and financial segments account for nearly 30% of all workers.15 Other services account for 38%. About 7% work in the agriculture and fishing industries (including fish processing), while about 9% work in manufacturing. Social and health services accounts for nearly one of out every seven jobs (exhibit 4). In 2007, the labor force totaled 181,500, and was 54.5% male, 45.5% female. Unemployment in 2007 was a low 2.3%, but by February 2009 had reached 8.2%.16 The Directorate of Labour estimates unemployment will peak at 9.6% in May 2009.17 Agriculture accounts for 5% of GDP, industry 26.5%, and services 68.5%.18 With such a significant portion of the economy revolving around services, the vast majority of goods consumed are imported. For foreign businesses, Iceland represented the opportunity to tap a small but relatively affluent market with a reasonably strong currency, through the 1990s and 2000s. The standard of living enjoyed has noticeably increased over the past several decades. Iceland is considered to have gone from one of the poorest nations to one of the richest in the space of a single generation. Aggressive marketing of the newly privatized banks in the early 2000s led to a massive influx of foreign capital, including over $140 billion in deposits--largely from the United Kingdom, Norway, Sweden, and Germany, which fueled additional growth over the past half-decade.

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Expenditures on government operations are 37% of GDP, or $7.159 billion in 2008.19 Approximately 14% of this is spent on “social benefits” besides health (8.0%) and education (8.2%).20 The mixed economy will continue to rely on government expenses quite heavily, due to a marked decrease in Icelanders! incomes and foreigners! fears of investing heavily in the country during this time of severe economic crisis. Public debt was 29% of GDP in 2007 and 23% of GDP for 2008. However, with the recent nationalization of major banks and increased spending on social programs, gross government debt could rise to an astounding 109 percent of GDP for 2009. The chairman of the Central Bank of Iceland wrote, in a letter to the IMF last November, that “the banking crisis will significantly constrain the public sector and burden the public for years to come.”21" Despite the majority of employees working in service industry, Iceland is a thriving producer of goods for export. With a relatively small home market, most goods are produced for export. 2008 exports were $6.846 billion22, which represents the majority of the value of Iceland-manufactured goods. Along with fish, software services and (at least from 2003-2008, financial services) exports include aluminum (the biggest export since 2008), pharmaceuticals and medical products, ferro-silicon, petroleum and petro products, and food processing equipment. Over the last decade, Iceland has become one of the largest exporters of generic pharmaceuticals. Major trade partners are primarily EU members, due to geographical proximity, cultural similarities and shared product demand. The 27 nations of the EU receive 74.7% of exports. Other major export partners include the U.S., Japan, and Norway. Primary import partners include the EU, U.S., China, Norway, and Japan (exhibit 5). As

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might be expected, Iceland carries a negative trade balance. Just as no similarly-sized city or state in the U.S. can produce all of the products demanded by its citizens in this modern age, neither can Iceland produce everything that it!s well-educated, mostly affluent citizens demand. In analyzing data available, it appears that Iceland!s taste for foreign products ballooned when foreign currency was rolling into its banks during the banking heyday of 2003-2007. In 2003, the trade deficit was "400 million. By 2005 this had more than tripled to "1.5 billion, though in 2007, exports of aluminum had increased enough to reduce this somewhat to "1.3 billion (see exhibit 6). One problem to consider is the vulnerability of the balance of payments in relation to aluminum prices, as aluminum accounts for 22% of total merchandise export values. Iceland!s major task at the moment is to make it through the current financial crisis and maintain it!s valuable importing and exporting relationships. Thanks to $4 billion in loans from the IMF, Iceland has been able to maintain a normal standard of living--no “Great Depression” here. But absent those funds and some earlier loans from Russia, trade (and life in general) might not be as normal as they have managed to remain. #

The króna (ISK) has taken a major beating over the last six months, and for a

time Iceland had withdrawn it from active trading. After the collapse of local banks, few foreign banks were willing to hold krónur. Currently, the króna is valued at less than half of what it was a year ago (exhibit 7). As the local currency plummeted, inflation shot up to over 17% in 200823 (exhibit 8), since most consumed goods have to be imported. Food prices were up 30.6% over 2007. The Central Bank predicts the country will face two years of contraction before growth picks up again in 2011. #

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Trade and Investment Opportunities !

Iceland is quite welcoming to foreign investment. Corporate income taxes have

been cut drastically since the 1980s, to one of the lowest corporate tax rates in the industrial world, 15%. It"s no surprise then that these cuts (exhibit 9) have spurred a massive increase in economic growth and have allowed the government to maintain and even improve the social welfare system despite the lowered tax rates. !

A generation ago, Iceland was a poor nation, lacking technology and conducting

little business with the rest of the world. In the early 1960s, as the world raced ahead through industrial and technological advancements, Iceland reversed its course and discarded its decades-old policies that led to rationing of imported goods in the 1950s. Since joining EFTA in 1970, the country has maintained a very liberal trade policy and has strengthened its trade relationships. !

The world community has taken note, as foreign direct investment inflows in

2005 equaled about 15% of the GDP, much higher than other Scandinavian nations with much larger populations. In 2006, FDI totaled #6.2 billion (compared to outward investment of #0.6 billion).24 The U.S. presently accounts for 31.4% of FDI. According to the U.S. State Department, major U.S. investors include Alcoa and Century Aluminum in the aluminum trade and deCODE Genetics in the biotech field.25 Major U.S. tech firms Apple, Dell, IBM, Microsoft, and Oracle are all active in Iceland. !

Icelanders information technology skills are number one in the world, as are the

island"s energy infrastructure, and quality of life. Combined with the second-best educated populace in the world, being the seventh most competitive nation, and ranking sixth best in the world for “low corruption” in politics, Iceland provides a stable environ-

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ment for the foreign investor.26 While India has gained the lion!s share of data business so far, Iceland has seized upon its extremely cheap energy and natural cooling availability to promote itself as the ideal location for tech firms to locate data center activities (energy costs make up 50% of the operational expenses in such enterprises).27 "

Restrictions on FDI are few. Iceland derives such a large portion of its GDP and

export business from its fisheries, which remain under tight control of domestic interests. Foreigners are prohibited from owning more than a 25% interest in fishing fleets and fish processing plants. Exploitation of natural energy sources such as geothermal and waterfalls is limited to residents of EEA countries. Ownership of airlines must be at least 51% Icelandic. "

The government!s Invest in Iceland Agency provides free consultancy services

and the Film in Iceland Ministry provides a 14% rebate for movie and television producers who film in Iceland. Aside from these services, Iceland does not offer subsidies, but instead focuses on allowing the market to work through a favorable business environment that includes low corporate taxes, low payroll expenses, a highly skilled labor force, and low energy costs. "

Additional benefits of investing in Iceland include no municipal taxes on corpora-

tions, accounting in foreign currencies permitted, no branch profits tax levied on repatriated branch profits, publicly traded companies are allowed to issue their share capital in foreign currency, easy and inexpensive establishment of companies, advance telecom networks, a U.S./Iceland bilateral taxation treaty, and access to the EEA (30 nations).28 "

Risks of investing in Iceland are low. The U.S. State Department notes that “po-

litically motivated violence is not a threat to foreign holdings,”29 a problem encountered

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not infrequently around the world. Also according to the State Department “Icelandic law provides for full convertibility and transferability of dividends, profits, interest on loans, debentures, mortgages, lease payments and invested capital….As far as the U.S. Embassy is aware, the Icelandic government has never expropriated a foreign investment. No major investment disputes have occurred in recent memory.” American firms would be hard pressed to find other countries with such low risk. Unfortunately, some of those positives are balanced out by Iceland!s relative distance from the U.S. and other major world markets. "

With regard to exports to Iceland, laws and regulations are quite favorable.

Membership in the EEA and EFTA make exporting to Iceland a simple matter for European nations. As a member of EEA, there are no impediments to the free flow of capital, goods or labor between Iceland and other EU zone nations. However, under the EEA agreement, free ports and foreign trade zones are not permitted. "

In January 2009, the U.S. and Iceland signed a letter of agreement with the goal

of strengthening bilateral trade. In 2007, U.S. firms exported $630 million in goods and services to Iceland, including aircraft, chemicals, machinery, and vehicles, including $19 million in agricultural products.30 Popular U.S.-produced consumer goods include software, music, movies, fast foods, alcoholic beverages, and automobiles. The U.S. Embassy notes that Icelandic consumption of American entertainment products has a halo effect, increasing demand for other American goods. Due to the number of dual-income households and the level of disposable income, high-tech time-saving gadgets represent a growth market in Iceland as do American food franchises.31

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Exhibits

Exhibit 1: Iceland, the connection between continents (Map from maps.google.com)

Exhibit 2: Growth of GDP since 2000, compared to other Scandinavian nations. (Data from Statistics Iceland, graphic from http://en.wikipedia.org/wiki/File:Arsbreytinglandsfr2000-8_English.png)

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Exhibit 3: Per capita GDP in USD, 2001-2008, with projections to 2014 (Data from IMF)

Agriculture Fishing and Fish processing Manufacturing Construction Utilities Services Government

5% 3% 4% 9% 9% 1%

68%

Exhibit 4: Employed persons by industry (Data from Statistics Iceland)

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Imports 80%

Exports

74.7%

70% 61.0%

60% 50% 40% 30% 20%

13.7% 7.3%

10%

5.1% 3.7%4.3% 4.6%3.8% 2.0% 1.8%0.5% 1.3% 1.2%1.4% 0.8%

8.9% 5.9%

0% EU

USA

Canada

China

Japan

Norway

Switz.

Russia

Other

Exhibit 5: Iceland!s major trading partners, 2007 (Data from European Union Directorate General for Trade http://trade.ec.europa.eu/doclib/html/113389.htm)

Imports

Exports

Balance !4.8 bn

!5.0 bn !3.9 bn

!3.5 bn !2.5 bn !2.1 bn

!2.4 bn

!1.7 bn

!-0.4 bn

!-1.6 bn

2005 !-1.5 bn

2003

2007

!-1.3 bn

Exhibit 6: Balance of payments (Data from European Union Directorate General for Trade http://trade.ec.europa.eu/doclib/html/113389.htm)

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USD/ISK Exchange Rate 0.01700

0.01275

0.00850

0.00425

0 Ja 8 n0 Fe 9 b0 M 9 ar 09 Ap r0 9

ec

08 D

ov

08 N

ct

l0 8

O

8

Ju

n0

l0 7

Ja

7

Ju

n0

l0 6

Ja

6

Ju

n0

Ja

Ju

Ja

n0

5 l0 5

0

Exhibit 7: In January 2008, 1,000 krónur traded for 1.64 USD; at its low point in Nov. 2008, 1,000 krónur were valued at 0.70 USD (Data from Central Bank of Iceland).

Exhibit 8: Development of 12-month changes in the headline CPI against the Central Bank's inflation target. (Graphic from: Central Bank of Iceland, http://www.sedlabanki.is/?pageid=201)

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50%

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50%

33%

25%

18%

15%

0% 1989

1995

2002

2008

Exhibit 9: Iceland!s corporate income tax rate since the 1980!s (Data from Statistics Iceland and D. Mitchell, The Business)

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3

4

5 6

7

8

9

10 11 12

13

14

15

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Source

Trade Council of Iceland. “Facts and Figures 2007.” Reykjavík: Government of Iceland. accessed April 23-May 3, 2009 Central Intelligence Agency. "CIA World Fact Book 2009." Washington: U.S. Government. accessed April 23, 2009. Graff, James. "We Need More Babies.” Time Magazine. November 21, 2004. accesed April 24, 2009 Statistics Iceland. "Populations by Religious Organisations, 1990-2008". Reykjavík: Government of Iceland. accessed April 24, 2009. Ibid Iceland Trade Directory. “Political System in Iceland.” Reykjavík: Government of Iceland. accessed April 24, 2009. Phillips, Leigh. “Iceland Turns Left and Edges Toward EU.” Business Week. April 27, 2009. accessed April 28, 2009. "Iceland's government collapses under the weight of the credit crunch.” Daily Mail (UK). January 26, 2009. accessed April 28, 2009. Simic, Nino. “Icelandic welfare hit by the financial crisis.” Nordically. accessed April 29, 2009. Phillips CIA International Monetary Fund. “World Economic Outlook Database.” April 2009. accessed April 30, 2009. Mitchell, Daniel. "Iceland Comes in From the Cold With Flat Tax Revolution.” The Business. March 21, 2007. accessed April 28, 2009. “GDP per Capita: Iceland Compared to Continent.” Global Property Guide. accessed April 29, 2009. Statistics Iceland. “Wages, Income and Labour Market.” Reykjavík: Government of Iceland. accessed April 29, 2009. Elliot, Alex. “Iceland unemployment figures for February.” Ice News. March 15, 2009. accessed April 29, 2009.

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Elliot, Alex. “Unemployment outlook brightening?” Ice News. March 28, 2009. accessed April 29, 2009. CIA Ibid Statistics Iceland. “Public Finance.” Reykjavík: Government of Iceland. accessed April 25, 2009. Oddsson, Davíd and Árni M. Mathiesen. “Iceland: Letter of Intent and Technical Memorandum of Understanding.” November 15, 2008. Reykjavík: Central Bank of Iceland. accessed April 27, 2009. CIA “Iceland inflation soars to 17.1%.” BBC World News. November 26, 2008. accessed April 30, 2009. European Union Directorate General for Trade. “Iceland Trade Statistics 2007.” accessed May 4, 2009. U.S. Department of State. “2008 Investment Climate Statement - Iceland.” Washington: U.S. Government. accessed May 3, 2009. Trade Council of Iceland Invest in Iceland Agency. “Iceland: Outstanding Location for Data Centers.” Reykjavík: Government of Iceland, June 25, 2007. accessed May 4, 2009. Invest in Iceland Agency. “Tax Benefits and Other Advantages of the Icelandic Fiscal System.” Reykjavík: Government of Iceland. accessed May 3, 2009. U.S. Department of State U.S. Trade Representative. “United States and Iceland Sign "Trade and Investment Cooperation Forum# Agreement.” Washington: U.S. Government, January 15, 2009. accessed May 4, 2009. Embassy of the United States. Country Commercial Guide. “Leading Sectors for U.S. Export and Investment.” Reykjavík: U.S. Government, Dept. of State, Embassy of the U.S. accessed May 3, 2009.