This report is limited to those membfHS cf the staff to whose work it directly relates. NTERNATIONAL BANK FOR RECONSTRUC~rION AND DEVELOPMENT ICELAND - MISSION R.EPORT August 31, 1956 Department of Operations Europe, Africa and Australasia Currency Equivalents $1000 = 16.286 !okra 1 I.kr. = $0.061 100 Inillion I.kr. a $601 million ICELAND SUJnmary of Importa.nt Statistics Fish Catch (thousand metric tons) Whitefish Herring Total 1926-30 average 243 47 290 1936-40 n 155 160 315 1947 2~4 207 431 1948 276 133 409 19L!.9 266 71 337 19~O 261 62 323 ].951 286 85 371 1952 305 32 337 1953 293 70 363 1954 340 48 388 1955 357 52 409 Source: Landsbanki Islands Prices, Money_ and Cred.i.t Cost of Liv~~ Money Supp1l Total Bank Credit (March 1950 = 100) (million lcronur, end of previous month) 1950 March 100 301 904 July 115 329 1000 1951 January 128 352 1068 July 142 376 1239 1952 January 153 462 1251 July 157 433 1418 1953 January 157 432 1371 July 157 467 1661 1954 January 158 502 1598 July 159 528 1806 1955 Janu~U'y 161 559 1785 July 16.5 639 2107 1956 January 175 699 2166 July 185 712 2331 Source: Landsbanki Islands Estimated Gross Fixed Investment 1954 1955 (mi.Uion;cl kro:lur, at cmTe'nt prices) Agriculture 176 181 Fi.sheries 46 86 Industry, fuel and power liS 104 Transport and COmTffilliications 179 323 of which private automobiles (mission est.) (20) (170) Dwellings 245 365 other 68 75 Total 829 1134 Source: Ice1B-"11d Bank of Development. Bala..1'1ce of PaYlnents 2:949 192.0 1951 1952 1953 1954 1955 Exports (foo.b~) 40 26 42 39 44 52 52 Imports (fQoab.) Y -59 -33 ..50 3 -48 4 -63 16 -66 16 -71 17 Government (largely airbase) Other invisibles (net) 4 r) c- - 6 - 3 rn3 - 3 - 7 _r 8 Cur-rent baJ.ance -15 =-5 -11 - 6 - 1 - 9 Foreign aid and EPU grants 2 7 8 5 6 1 Foreign loans 1 3 3 3 2 2 1 Use or accumulation (-)of reserves 5 - 1 - 3 - 2 - 2 2 8 Other capital Total capital 7 15 I(~ 5 4 -1 II 8 2 6' - - 3 kl~ / "9- 1/ c.ief~ in 1949 and 1950. ~' Does not equal sum of components because of rounding. Source: 1949-1954: llIJ.F" Internatiop .,'- Fi.l1.ancial Statistics; 1955: Government-Submissio:.~ '~OEEe • ~~ate~ Public External Debt Service !I .. Total Debt of which $ Debt Interest Amortizrtion Total Interest Amorti~on Total millions of dollars equivalent) 1956 0..,7 1.8 2Q5 0.1 0.4 0.5 1957 0 7 0 2.0 207 0 1 0.4 0 0('5 1958 0 7 0 202 3.0 Oel 0.2 o~4 1959 0.7 204 3.1 0,,2 Oe4 006 1960 00 6 1 8 0 2,,4 0.2 0 44 0.6 1961 0 5 0 1.6 2.1 0.2 0.4 0.6 1962 Oc5 1.2 1.6 0.2 0.4 0.5 1963 0~4 1.0 1~4 0.1 0.4 0 5 0 Y Sum of items may not equal totals because of rounding. Source: 11lission estimate. A~56 ICELAND - MISSION REPORT Introduction l~ Between June 1951 and September 1953 the Bank made five loans, on which $5~7 million is now outstanm.ng, for projects in Iceland. A disagreement then arose when the Bank declined to finance a proposed Government-ovmed cement plant which Iceland declared its firm intention to build. The Bank took the position that it would not lend further to Iceland. until it knew hOi/v the cement plant was to be financed a..."'1d, thereafter, could not make any commitments about future loans until a mission had been to Iceland to review economic conditions. 2a In March this year the Bank was officially informed that foreign financ- ing for the cement plant had been arranged by means of a 15-year l:..;an from the Danish GO"\7~.rnment'l The request was renewed for a mission as 50011 as possible and the Bank agreed to send one. HOvJ8ver, v.Jith the fall of Prime 1·'Iinister Olafur Thors t ::ndependent-Progressive coalition at the end of II'larch, this vIas postponed until after the elections in June and timed to coincide with a Fund lnission, to avoid duplication of effort. In the event, a full month of negotia- tions elapsed before a new coalition, composed of Progressives, Social Democrats and the Communist-supported "Labor Alliance, II was agreed on. It had been in office only a day before the Bank and Fund missions arrived in Reykjavik on July 25. The Structure of the Econom~ 3~ Many of Iceland's problems, political, econo~ic, and even psychological) stem from her narrOillT reSO"ll!'ce base, extremely small population (only 160,000) and . isolated geographic position in the North . 4.tlantic. Much of the center of the country is uninhabitable. Apart from the grasslands in the long valleys rlIDUing inland from the many fjords which break the coastline, and a considerable hydro- electric potential, the island's resources are sparse. Its greatest assets have been its vigorous and v.Jell .... educated population and its location near some of the richest fishing grounds in the NorthAtla~tic~ 4. For about a thousand years after the Viking settlement, conditions of life on the island changed surprisingly little. But about 1900 the introduction of the steam trawler made possible a highly productive fishing industry, on which Iceland t s economy has since been based. This ushered in a period of rapid devel·· opment which is still going on. From time to time there have been serious set- backs, notably in the 'thirties when unemployment was extremely heavy. But the economy received another great stimulus during the second World vJar when Iceland - 2 - became an important allied base and large numbers of troops were stationed there and when there was a ready market in the U. K.. for fish at high prices. The real national product doubled in that period and has since continued to rise, supported by the use of accumulated foreign exchange reserves, by foreign loans and Marshall Aid, and, since 1951, by receipts from the NATO airbase at Kef1avik. 5. This rapid development has brought a striking change in the distribution of population. Although the population has doub:ed since the turn of the century, practically all the increase has been concentrated in the southwest corner of the island~ ReykjavikJ founded on the important fishing grounds of Faxa Bay, has, with the nearby towns and surrounding area including the airbase, continued to provide steadier emplo~rment and more attractive living conditions than the iso- lated farms and small towns around the coasij. 6. Today the fisheries have become a highly complex ~p50 million industry, accoUt'1.ting for a fifth of the gross national product and 90% of exportso Their development has r~ot always been smooth, for great uncertainty always surrounds both the catching of fish and their marketing. But Icelanders have adapted their methods to changing fishing conditions, and to great and sudden c!J.anges in markets and market requirements o In the past Iceland concentrated on exporting salt fish, and later fish-on-ice. Today, about one-third of fish exports (by value) are frozen; the balance is spread among a variety of products: dried salt cod, salt herring, stockfish, fish meal, fis~ oil, roes, and other products, each with a differer..t rr.arket and each requiring special processing facilities" The greater part of these fac,iliti8s has been built since the 't-rar. Although still virtually all fish products, Iceland's exports are in fact more diversified than ever before, and the fish processing industry is on the whole up-to-date and progressive. 7. In other sectors of the economy development is even more recent and perhaps even more striking. lJ1Jithin the last 30 years a net1rJork of roads has been laid out and coastal shipping services organized. For the first time, durable concrete houses have been built - using imported cement and timbeT - and con- struction activity has been brisk since the end of the second IrJorld vJar. Since that time, too, the farmers, whose share in the economic expansion had hitherto been small, have been draining their land, rebuilding their barns ru1d their houses and buying labor-saving machinery. The majority now have telephones and rural electrification is proceeding rapidly. lftThile the short §,Towing season and cool, moist summers must confine farmine very largely to the raising of sheep and cattle, productivity has risen rema~kably. Agricultural output has now practically recovered from &. disastrous outbreak of sheep disease which entailed the compulsory slaughtering of almost the entire stock after the 1far, and is now at an all-~ime high. Finally, the development of air transport across the Atlantic has brought Iceland into much closer contadt vnth the rest of the world than she had ever been before. 8. In short, Iceland today is a small, highly educated and progressive country, proud of its old cultural heritage and ,jealous of its newly-won inde~ pendence. Its people have made 1I1uch of their unusual and in some ways meager resources, and now have a standard of living comparable, say, to some of the Scandinavian countries. Long dependent on the vagaries of the fish catch and - 3 - accustumeci to livine dangerously, they have, on the whole, shown a remarkable ability to adapt their economy to difficult and quickly changing condit.ions. In viG~v of the country I s narrow resource base and extraordinarily high depend- ence on im.t->orts~ the national development effort has, from time to time J strained the cO-crltry 1 s foreign exchange position and resulted in bouts of inflation. ruring and since the war Iceland llas~ on balance, been favored by fortur~, since extraordinary sources of income from abroad have been large eno'lgh to prevent se~iolls or prolonged balance of payments difficulties from occurring. But, by the same token, these windfalls have increased Icel~~dersl appetite for imports and have led SOI:1e of them to rega!"d their fut'lTe more optimistically than they should,g Icelandic Politics 90 Icelandic politics has also many special features. :n kp.epine; with the country's ancient parliamentary tradition, it is a game played Wlth enthusiasm by the professionals and followed closely by the whole povulation. The Independ-· ence Party, now composed mainly of town dwellers and strong in the expanding Raykjavik area, still bears the mark of the energetic merchants 1-Jho were import- ant civic lea.ders in the early days. The };Jrogrescive .Party, whose rise is asso- ciated with the growth of a strong cooperative movement, particularly in small fishing tC1-Jl1S and in rural areas, draws its major sUPI:·ort from these sources. Broadly speaking, the Social Democrats - who have attracted a fair number of intellectuals - and the United Socialists (COIllInl111ists) - often 1..Jorking through thfJ trade unions - vie for the votes of the workers 1vho often show a radicalism typical of seamen and longshoremen v ' H01r:ever, political labels are rather loose in Iceland. Changes in l)arty affiliation are fairly corrunon and some surprising political switches have been made. Personal leadership is an extremely important factor, so that political parties often reflect the interests and loyalties of econo~ic groups, localities, and even families more than differences of doctrine or principle. 10. For more than a decade the relative strength of the variolls political parties has been such that, apart from a minori ty goverr~ment vJhich lasted a few months, Iceland has been governed by coalitions of tNO or more parties". On occasion) the combinations have been startling to the outsider, and the new government of ?rogressives, Social Democrats and the so-called f1~abor Alliance" - ~hich includes the Communists - is not unprecedented. ~~reover, whereas coali- ti04-makiDg in most countries involves allocating a few portfolios, in Iceland it is a c11.rnbersome process of redistributing among six ministers the responsibili t2 for several dozen government services. Further, except insofar as particular fWlctions are specifically allotted to the cabinet as a whole, collective cabinet resronsibility does not exist and each minister is fully responsible for the con- duct of the offices 1L."1der his jurisdiction Q 110 All this hardly makes for strong government:; particularly in internationa- affai~s and natiollal economic policy. In the former, Iceland's eA~erience is very recent" I-IeI' long isolation from the rest of the world was follm'ied by the sudden arrival of large numbers of foreign troops at a time when the country wa.s on the verge of w~nning the struggle for independence which had absorbed much of its intellectual energy' for a century_ Understandably enough, Icelanders have found it hard to adjust themselves to the implications of their ne'w strategic position. - 4 ... In matters of economic policy, governments have found it difficult, in the face of the national enthusiasm for G.evelopment, to reach satisfactory agreement in times of stress on h01.v the burden of readjustment should be shared. Recent Political Events 12. In Harch of this year the Foreign Ninister, a Progressive, presented to the Althing a resolution calling for a. revision of the arrangements at Keflavik airbase~ Iceland entered NATO in 1949 on condition that foreign troops would be stationed on her soil only in time of emergency. Such an emer- gency was deemed to exist after Korea, and in 1951 a Defense Agreement vJas con- cluded with the UoS., governing the operations of the airhase and providing for its staffing ~nth U~S~ forces 8 The recent resolution stated that the foreign policy of Iceland should continue to be based on cooperation in secur~ty matters 1'1!ith the NATO countries, but that in view of the lessened international tension since 1951, the system then adopted should be revised so that Icelanders should maintain the defense installations and the defense force should be with-· dravJYl" Unly the Inde . . :endence Party vot.ed against the resolution, the Government fell, and ne"w elections were scheduled for Jun8 24. The Progressives and the Social Democrats then entered into an electoral alliance, agreeing not to oppose each other and to put fOr1..Jard candidates from the one party or the other, depend- ing on their estimated strength in particular constituencies. By this procedure the two parties expected some loss in popular vote but hoped that-. th:ls would be offset by a gain in seats in the Althing~ Argttments about the future of the base were naturally prominent in the election campaign, with both sides painting a rather exaggerated l:>icture of their opponent's vie"ws. In a newly ind~pendent cOli..Yltry 1rU th a long background of isolatiGn. many people were bound to be sympa- thetic to the Althing resolution. But it would be wrong to infer that the pas- sage of this resolution and the subsequent election results reflected increasing anti-American and anti-NATO feeling in Iceland o Actually, the Independence Party polled 42% of the popular vote, 4% more thru1 at the previous electione 13. The real rnotives behind the Progressive-Social Democratic alliance and the call for elections lay rather in the field of domestic politics. The Pro- gressives had been concerned about the increasing power of tha Independence PartY8 They felt that the boom in the Reykjavik area, which was associated with the activity at the airbase, had benefited the Independents disproportionatelyo They were also worried, for instance, about the growing influence of the Inde- pendence Party at the Lands~anki, the largest cownercial bank and at the same time the bank of issue. Historically this bank has been associated "With the cooperatives, the farmers and the Progressive Party in much the same way as the Fisheries Bank had been linked to the Independents. On the other side, the Social Democrats had seen their power waning for several years. Not only had they lost seats in the 1949 and 1953 elections, they had also been weakened "~vhen one of their leaders, Hannibal Valdimarsson, chief of the Icelandic Trade Union Federation, had made co~~on cause ~dth the Communists. This new grouping, which appeared as the "Labor Alliance" in the recent elections, cut further into the strength of the Social Democrats. 14. In the elections the Progressive-Social Democratic Alliance had some success, but not enough to give it a. clear-cut victory. It gained three seats, although losing slightly in the popular vote, but its total of 25 seats left it two short of a majority. In spite of its increased popular vote, the - 5- Independence Party won only 19 seats, two less than in the previous election.. The "Labor Alliance lJ obtained the remaining eight, one less than the total held previously by the Communists (7) and the National Defense Party (2), a leftist, iaolationist and anti-NATO group, which did. not return any candidates. After a month of bargaining a new coalition was agreed on, including two minis- ters from the .l?rogressive Party responsible for the Prime Minister I s Office, the Departments of Agriculture and Finance, two from the Social Democratic Party responsible for Foreign Affairs and Education, and t1-.TO from the "Labor Alliance" responsible, broadly speaking, for Labor and Commerce. For the first time since 1949 a Comn~unist-supported group errcered the GovernmentQ l.5e It is not yet. possi.ble to say how the ne",r Government will act,. As regards foreign a.ffairs, the basis of policy will be the Althing resolution, which contemplates continued membership in NATO, at least until that body is due for renewal in 1959~ The mission wa.s assured that the "Labor Alliance lt had entered the coalition on the understanding that its representatives would have nothing to sayan foreign affairs. This is possible under the Icelandic system of ministerial responsibility and so far, at least, the eviden0e indicates that it is correct. On economic matters the Government has so far put forward only a very general statement. Progressive and Social Democratic ministers stated quite frankly to the mission that they had not yet worked out a detai.led program and that the coalition was an experiment in putting labor in a position of authority in the hope that with power would come a greater sense of respons- ibility.. Before taking such a risk they presumably had some indication that labor's attitude would be more cooperative than it had been in 1949 and 1950. Such a coalition could give Iceland stability. On the other hand, it is rather an uneasy marriage - based on a series of compromises. If these should prove untenable, the coalition 'Will break up and neH elections will determine its successor in accordance with Iceland's long democratic traditione The Problem of "" ---_. Inflation and the 'lalue of the Krona 16. The most urgent economic problem facing the new GoverrlInent is t hat of inflation9 Iceland experienced successive rounds of inflation during and after the war and devalued the krona twice, most recently in Barch 19.50. Relative stability was achieved in 1952 but not unt.il after the cost of living index (March 1950 = 100) had increased t,.) e.1most 160. Since the end of 1954, there has been a new bout of inflation.. From January 1955 to August 1, 1956 the cost of living.rose from·, 159 to 186, and is expected to go above 190 before the end 0 f the year .. 17. Even the stability of 1952-54 was precarious. During that period the air base was established, migration to the Reykjavik area was renewed (in part attracted by work at the base), and construction activities in the southwest rose as a consequence of t~e general ~rosperity to which the b~se contributed. All this was superimposed upon a high level of investment in other sectors of the economy. Even though employment of Icelanders at the base was in 1954 deliberately reduced from 3,000 to 2,000, a growing scarcity of labor developed in the economy, and workers in all sectors sought higher incomes, with their eyes on the high earnings from overtime that could be obtained at the base, and spl~red by the strong demand for their services. By the end of 1954 many skilled workers had obtained a rise in income by switching from hourly wages to piecework. - 6 - Unskilled workers, unable to supplement their incomes in the same way, struck for higher wage rates in lVIarch 1955. After a general strike lasting six 1rJeeks, they obtained a wage rise of some 15%, including fringe benefits. 18 0 The increase in wages started an inflationary spiral that is still going on. A nlli~ber of factors aggravated the situation: a) There is a series of automatic links between wages and the cost of living and between farm prices (and hence incomes) and urban 1..rage rates. Hhile a certain amount of bargaining can take place at the time of major adjustmen~js, the system is no,.; so .fiJ'mly 'estab2lSh9:r that it J 1oJould be harn to abolish altogether; the last Government was certainly not strong enough to do so. b) Bank credit, mainly to business, expanded continuously, and monetary controlc: were inadequate to check expansion. Central banKing is only one of the functions of the Landsbanki, and in any case it has not "been able to pursue a credit policy independent of government, and hence political, influence One of the vJeak links in th·:; credit svstem 0 is the obligation on the l,andsbanki, stemming from the Government. r s long-standing agreements 1..rith the fishing industry and 1rJith the farmers, to rediscount automatically and at preferential interest rates ~"5-day renewable bills secured by fish or farm products.... There is little doubt th(;. t credit created in this way has indirectly" financed a large pCirt of the current investment boom. c) In 1954 and 1955 the Government budget shoii\Ted a nominal surplus. How- ever, in both years the surplus was ap!?ropriated by the Althing to repay interim bank credit which had financed investrnGnt projects (especially in agriculture and the fish"3ries) The Government had 0 gone ahead with these projects hoping that foreign loans would be obtainable for themo ~vhen these failed to materialize, the budget sucplus had to be used, and thus failed to exert the anti-inflationary influence th~t had been intended o d) Toward the end of 19~5 there was a temporary accumulation of export- able ~oods, both fish and cnilled lamb, so that incomes vJere paid out to fishermen and farmers (financed by the banks) some time befo!'e there 1,,,ras a corresponding rise in available goods and services. This stocking unfortUJlately took place just when the demands on the econ- omy for fixed investment were at their height. e) Finally, inflation led to some speculative investment, in housing for example, and this bred more infla tion G 19. The previous Government failed to strike in time at the underlying causes of this inflation. In late 1955, it did attempt to check the growth in bank credit, and some forms of credit to sectors otheT than fishing and agriculture were reduced slightly. The main sources of credit e:cpansion were left untouched) hOlPT8ver. The Government also took steps to cut the loss in foreign reserves by stopping the importation of automobiles, 1-Jhich in 1954 had been liberalized, partly i.n order to provide a base for a large new tax to finance the trawler subsidy. To make up for the lOBS of these tax receipts, and also to cover the rise in public eX1.jenditures stemming from inflation, the - 7- Goverr.ment levied a number of ne~\T tuxes and increased others. It failed, how- ever~ to develop a budget surplus capable of having a real anti-inflationary effect. Although it waul:! have been desirable to take r;lOre rigorous steps, it is on ti18 whole Dot sur:prising that the Government failed to do so, for it would have been very difficult politically to impose additional restraints upon Icelanders at a time lj'Jhen construction at the airbase vIas in full s'Vnng o 20. The rise in prices since the last devaluation would make it :'mpossible for Iceland to export, were it not for an elaborate system of export subsidies and import taxes which is in effect a partial and ~)rogressive currency deprecia- tion. It enable3 fish and farm products to be sold at competitive prices abroad, while increasing the cost of most impo:'ted goods in terms of kronur" Present price and income relationships are quite artificial and this seri0 11s1y hampers a rational assessment of investment projects. On bal~nce, many imports remain art- ificially cheap.; almDst any proposal to substitute Icelandic fo"(' foreign goods seems unattractive. By the same token, activities liJhich use large quantities of in~orts (the construction industry, for exam?le) are unduly encouraged. 21.. The new Governme!lt' s statement of economic policy recoGnized the need to stop inflatio:.:l, and promised changes in the 1andsbanki", '1'he Goverament has just appointed c. special committee to investigate the facts, and report before the Althing reconvenes in October,> Actually, the Gover~'Tlent has l.mtil the end of the year, when the annual negotiations 1;~i th the fishing industry over the price of fish take s>lace, to make up its mind what it l\rill do., 22.. T:18ro are some grounds for hope that the present round of inflation will be brought urtder control fa.irly soon., The nei:J Government should be bett""'r able than its predecessor to exercise restraint upon the demands of labor an~ the farmers., .A relati"ITely small reduction in investment - such as might come almost of its ovm accord if the expectation of speculative profits were removed - would probably be sufficient to restore equilibrium Ci And the problem has been" made easier by the fact that the real national product has continued to gro'tv quite ral='idly tl1..roughout 1955 and 1956 0 If and when the underlying causes of inflat.ion were removed, devaluation of the krona would have to be considered .. Iceland's memoriGs of past devaluations are not pleasant ~ and the main sup- porters of the Government, labor a"'1.d the farmers, might suffer considerably - but it might be accepted if the burdens were distributed '\rJidely enough. How- ever, it is by no means sure that decisive steps will be taken and until the Government has formulated its policy not much more can be said about its chances of success" 23. Even if stability were achieved in the near future the threat of infla- tion 1-Jill probably recur from time to time e The continuing enthusiasm for invest- ment will put pressure on Icelandic resources, making it difficult to meet any extraordinary demands on the econonry or to adjust to a sharp drop in national out- put resulting J for example, from a poor fish catcha Icelandic governments have tended to react rather slowly to inflationary pressures. On the other hand, they have so far acted in time to prevent matters from getting completely out of hand. The Investment Effort __ ........ A~.............u.~ ~~"\: 24. Investment in Iceland has been high since the war and now amounts to between a quarter and a third of the national product. It has, unfortunately, from time to time outrun Iceland's fai~ly large capacity to save, and - 8 .• as at present, inflation has been tt, '"\ result. In view of the strong national desire for improvement, this tendency will per-sisto The Icelandic economy is not suited to the kind of overall planning that would limit investment in advance to available reS01ITCeS, simply because the level of resources from th8 country's main industr~r is unpredictable.. The problem is complicated by the small absolute size of the economy, so that a project 'which by foreign standards is not big, the proposed Sog hydroeleGtric extension, for example, looms very large in Iceland and produces unevenness in the rhythm of investment not exper- .~.0nced in larger countries. 2.5. The investment that has taken place has, however, strengthened the economy greatly in physical terms, and Iceland's postwar economic growth has been fully' as rapid as that in other European countries. The entire trawler fleet and much of the motor boat fleet have been renewed since the war, and though the herring catch has been much smaller, that of whitefish has increased by 40;b o And 1rJh8reas t.hree-quarters of Iceland's fish exports in 1945 were shi.pped on ice, in 1955 the entire catch was processed in one form or another, largely in new plants, before it was sent abroad. 260 The output of hay has risen from an average of 220~ 000 tons in 1936-40 to over 300,000 tons in 1956, and five-sixths of the crop is now grown on culti- vated land compared to one-·half before the war. The area of cultivated grass- land, on which yields are much higher than on natural meadows, has gone up by 50%. The stock of sheep hc.s been restored to the prewar level of 600,000 and is expected to reach 800,000 in two years. Mainly as a result of higher yields, hut also encouraged by subsidies desit-.';ned to keep d01ffi the cost of living, out- put of meat and dairy products has risen sharply, milk by 407~ in 10 years. And agricult.ural productivity, aid3d by mechanization and the greater use of fertil- izers, has increased considerably; the expansion of farm output has taken place at a time when the agricnltural .,;.,abor force was declining. 27. Electric l.)ower ,t:>roduction capacity has trebled since the war and ou.t- put increased fourfold, a fertilizer plant now produGes all of Iceland's nitro- gen requirements, and a cement plant is under construction~ In the field of transport the merchant marine grew from 14,000 to 38,000 gross registered tons between 1938 and 1955, largely under private ownership, and n01\1" carries the greater part of Iceland's foreign trade. ~vo private airlines have been estab- lished, carrying almost all of Iceland t s growing air traffic. And finally, great progress has been made in meeting the country's housing needs, high not only because of v,Jartime shortages but also because of the rapid r ate of family formation and the migration to Heykjavik. 28. VJith the price structure distorted as it is at present, it is difficult to measure the costs and benefits of many investment }iTOjectso One group of pro- jects was, in retrospect, a mist-3ke, namely, the nOttJ' unused herring factories built just after the war in the enthusiasm engendered by record herring catches, which were not repeated o Some of the record number of dwellings built in 1955 and 1956 are probably larger than necessary, or at least postponable. By anG large, however, Iceland's investment seems to have been channeled into the most useful sectors, and the country's output has greatly benefited a 290 There will continue to be reasons for Iceland to continue to invest as much as is consistent with financial stability. At the moment there is a - 9- scarcity of labor but as the population is growing at the rate of 2% per annu."U, in the long rlli1 new employment cpport1h~ities must be created at a fairly high rate. In'Testment ~n the fishing industry has recently been rather low, but it is now picking up again, and ought to be active if the country's main industry is to remain efficient. And though investment needs in agriculture may taper off som8't'lhat in a few years, other sectors, for instance transport and electric p01-Jer, will need to grow as the r est of the economy expands. There "hrill oe a mo:ce or less continuous groFth of light industries, and occasionally a larger scheme, like the fert~lizer and cement plant, will present itself. The i~terest of Icelanders in innovation will ensure that as many of these opportunities as possi,)le are seized,. This interest - one of the most striking features of present-day Iceland - is reflected in the great am0unt of O~~8r effort being put i:1to the rehabilitation of farms, the irnprov8ment of fishing boats and gear, and the construction of houses o It is also behind the ne'toJ Government t s first public ~tatement, expressing the intention of buying 15 new trawlers, expanding the Sog ~lant, building new port facilities and pressing on w~th agric~ltural development and rural electrification, all with the aid of foreign loans. Given Iceland t s large ii1vestment reqlJiren:ents, it is normal that she should seek to cover some of them by borro1,ort position. 011e is the fact that Iceland tends to be an outsider in many of her markets, and has suffered in the past - and may again in the futu:ce - from the protectionist policies of fish-importing countries, like the U.S., ruL~.OUs to protect or develop their O"Nn fishing fleets. The second weakness is the large share of e:>..rports at present taken by Russia. It is not inconceivable that for political or other reasons Russia nught suddenly cease fish purcilases in Iceland, as she did once before in 1948, after talcLng 20% of Iceland1s ex-ports in 1946 and 1947. Both these 't-Jealmesses suggest that Iceland may from time to time be faced 1vith the necessity of finding new markets quickly. The flexibility she has shown in the past augurs well for her ability to do the same in the future, though temporary difficulties may 1,,;rell occur. - 11 - 36. The third potential source of difficulty is domestic inflation. In the short run, equilibrium in the Icelandic balance of pay.ments depends on avoiding inflation} or at least in maintaining controls over its external effects. A very large part of anY increase in domestic spending power is quickly reflected in the demand for imports. In 1954, a year of Qomestic financial stability, external accounts were almost in balance, without very stringent controls over irr~orts. But in 1955, a year of inflation, imports rose and there was a balance of paylTIents deficit of $9 million, or 10% of total receipts, met by drawing on Iceland's already meager foreign exchange reserves. The deficit was mainly with EPU countries. The dollar accounts showed a surplus, thanks to receipts from the base. Trade and payments with clearing account countries such as Russia and Czechoslovakia, which have tended to grow in importance, were virtually in balance Q Iceland's clearing agreements nOl"mally provide for settlement of outstanding balances above the "swing" in sterling, but Iceland and her partners have preferred to alter the voluJne of trade rather than make substantial payments in transferable currency_ 37... F01V the Go-vernment will tackle its current inflation and balance of payments problams ""u.ll be clearer in a few months. There is little doubt that if it 1-Jere to take effective anti-inflationary steps, Iceland would be able to balance her external accounts ldthout much difficulty, the more so if at the same time the krona were devalued and imports were made more expensive. Even if SOfie inflationary pressure persisted, however import controls could and j would be tightened w~thout affecting production. Iceland possesses an effective mechaqism for preventing commercial arrears from piling up, administered by the banks~ An Ioelander is not allowed to contract for a foreign payment, even if he has an import license, until the banks have approved his applic at ion for exchange. If sufficient foreign exchange is not on hand, these applications are allowed t~ipile up and the dru1ger of default on contractual payments avoided. 38. Iceland t s public external debt amounts to about $24 million, of which $8 million is repayable in U.S. dollars and. the rest in various European cur- rencies. The Bapk holds ~;;5o 7 million of this, just over one-fifth of the total, all of it repayq.ble in EPU currencies. Annual payments of j_nterest and amortiza~ tion rise to about $3 nullion in 1959, but because much of Icelandts recent borrowing has tab3n the form of medium-term suppliers f credits, debt service falls off rather 'sharply after 1959. Debt servic . . in 1959 is 5% of 1955 non- military foreign ~xchange receipts; in 1962 only 2t%. Iceland has recently incurred a certain amount of private debt abroad for the purchase of merchant ships and fishing vessels. The mission was informed that the foreign exchange earned and saved by these ships would be about sufficient to repay the debt incurred in purchasing them. All in all, Iceland's debt service burden is not a heavy one, especially after 1959. It is much lighter than the burden of debt that she carrie!d before the war. 39. Because of her unique dependence on exports of fish, lending to Iceland iE fraught with risks of qn unusual kind. On the other hand, her relatively small debt burden, her record in givlng a high priority to debt service payments, her demonstrated abili.ty to develop the resources she has and to adjust to sudden and unpredictable changes in her export receipts, if need be by cutting imports