Doing Business In: Iceland
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THE BUSINESS ENVIRONMENT
The Icelandic business environment can be described as a modern western environment. Iceland is a member of the EEA Agreement and as such enjoys the benefits of the European Single Market. In a recent survey Iceland was ranked 7th in Europe in a country ranking measuring the ease of doing business. Furthermore, Iceland ranked 4th in Europe on labor market efficiency.
Traditionally, Iceland´s main and most important export has been fishing and fishing products. Iceland is rich of natural green energy harvesting both hydro power and geothermal resources. Energy extensive industries such as, aluminum smelters and ferrosilicon production have benefitted from those rich energy resources as well as data centers benefitting from the natural cooling the Icelandic weather provides.
In recent years tourism has become one of Iceland’s most important industries and more recently aquaculture has caught the eye of many foreign players in that industry, investing heavily in many of the remote parts of the country.
Iceland has a well-educated and innovation driven workforce. Information and communication technology and engineering are the most popular subjects in Icelandic universities.
Iceland’s economy is an open high-income economy combining a free market economy with a welfare state which is sometimes referred to as the Nordic model. It is the smallest economy within the OECD, with last year’s annual gross domestic production (GDP) of USD 24.6 billion (ISK 2.555 billion). The size of the Icelandic economy is approximately 0.65% of the German economy and 0.12% of the United States economy. Although the size of the Icelandic economy is comparatively small, with only around 348 thousand inhabitants, the aforementioned domestic production places Iceland among the top ranked countries in GDP per capita, 52.000 USD (PPP). Iceland, which in the first half of the 20th century was one of the least affluent countries in Western Europe, has over the last few decades consistently ranked among countries with the highest standard of living worldwide. Iceland GDP per capita rank fell in the aftermath of the financial crisis in 2008 but has climbed above its pre-crisis position ranking. In terms of GDP per capita, Iceland currently sits in 16th place globally.
Iceland’s success in building a prosperous and globally competitive economy can be attributed to factors such as a strong institutional framework, skilled workforce, high degree of economic freedom, sound democracy and low levels of corruption. Various competitive indices reflect these qualities. Iceland ranks number one in terms of gender equality and peace. Female labor force participation is at 86%, which is significantly higher than elsewhere in Europe. High labor force participation rate, the country’s openness and the economy’s flexibility are key strong-points of the Icelandic economy. For the peace index, Iceland has held its place as the most peaceful country in the world since 2008.
Small open economies are by nature often more volatile than larger economies. This is mainly caused by a lack of diversification and relatively large external influences. This has caused significant business cycle fluctuations. Recently the Icelandic economy has experienced a robust economic growth, greater than neighboring countries, as well as other high-income OECD countries. In fact, 2016 GDP growth in Iceland was highest among OECD countries and seventh highest globally. Recently, the export sector, particularly the fast-growing tourist industry, has been the main growth driver , along with strong contributions from business investment and private consumption. After a period of fast growth, the Central Bank of Iceland (CBI) predicts that the economy will continue to grow but at a slower pace. A large positive output gap and not as favorable external conditions have reduced growth from the peak of 2016.
The labor market continues to mature. The unemployment rate has gradually declined since the peak in 2010 and is now at pre-crisis levels. According to a 2017 study from the CBI, around 20% of Icelandic firms plan to recruit staff rather than downsize and 40% of firms consider themselves short-staffed. That trend has somewhat reversed and the share of firms considering themselves short-staffed has been decreasing and is today 27%, which is still above historical average. With an economic slowdown and continued immigration, that trend could continue.
Today, government debt is approximately 42% of GDP, which is a significant improvement from the peak of 2011 when it amounted to approximately 95% of GDP. The government debt level in Iceland has thus fallen rapidly and is for example below that of Germany, Sweden and Norway. Furthermore, the CBI predicts the trend to continue in the next few years, given the current government’s emphasis on further debt repayments and continued economic growth.
High inflation has long been a concern in Iceland. In March 2001, the CBI converted from an exchange rate targeting monetary policy and adopted an inflation-targeting policy with a 2.5% inflation target. Since the adoption of the policy, inflation has exceeded this target, averaging 5%, but after 2014 inflation has been close to or below its target. One of the characteristics of the Icelandic economy is the small and volatile currency, the Icelandic Króna, and the large impact of exchange rate fluctuations on inflation. Currently, imported goods account for roughly 30% of the consumer price index (CPI). Furthermore, the housing component, which includes housing prices, contributes 25% to the index. After the significant nominal wage increases of recent years, the Central Bank along with market analysts expected inflation to take off. As a precaution, the Central Bank raised interest rates from 4.50% in June of 2015 to 5.75% in November the same year. However, thanks to a strengthening Króna, low global inflation etc., interest rates have been lowered gradually and are now at 4.25%.
The small size of the domestic economy makes Iceland highly dependent on international trade. Since various goods and services are not produced domestically they need to be imported. To fund these imports, a strong export sector is required. Thus, international trade plays an important role when examining Iceland’s economic performance. Iceland’s balance of trade has seen drastic changes this century. Historically, Iceland had a significant trade deficit with a corresponding current account deficit, which contributed to a build-up of record high levels of external debt. That has turned around over the last decade, with Iceland running a consistent current account surplus, largely due to a strong trade surplus. This shift is largely explained by the Króna exchange rate. The Króna depreciated fast at the onset of the crisis in 2008 as investors pulled out of Iceland, reducing imports and boosting exports. Iceland’s economic recovery, led by export growth (particularly in tourism), helped the Króna to retain its value. Since late 2016, Iceland’s real exchange rate has been back at similar levels as in the years before the financial crisis. The country is still running a trade surplus, instead of large deficits, highlighting stronger fundamentals. In 2017, exports of goods and services amounted to around 47% of Iceland’s GDP and the trade surplus was 4.1%. The accumulated trade surplus in the past seven years following the financial crisis is equivalent to 49% of 2017 GDP, which is almost unprecedented in the country’s economic history. This large trade surplus has contributed to a current account surplus, although not as significant as the trade surplus. The underlying current account surplus has averaged about 5.6% of GDP since the crisis.
A key challenge for Iceland is to increase its exports and maintain a healthy current account to support an ongoing and sustainable growth. Two decades ago the country was heavily dependent on fisheries with more than half of exports originating from the fishing industry. Since then, fish-related exports have remained relatively stable, as the industry is limited by the quantity it can harvest, to preserve the size and sustainability of the fishing stock. In the past couple of decades, three additional export foundations have emerged: the aluminum industry, tourism and the international sector. Around the new millennium, the international sector grew rapidly. The sector engages in international competition but is not reliant on natural resources. Between 2005 and 2008, exports of aluminum took off following the construction of one new aluminum smelter and the expansion of another. Finally, in the last few years, Iceland has witnessed rapid growth in the tourism industry which now makes up two fifths of Iceland‘s total export. Overall, Iceland’s exports of goods and services have grown rapidly and become more diversified over the last two decades.
3. Current opportunities & future prospects
After eight years of continuous economic growth, largely fueled by a strong increase in tourism it is widely expected that the year of 2019 will be a year of stagnant economy and restructuring. It is widely known that operation conditions in the airline industry have toughened in Europe from that latter part of 2018 and heavy investment and expansion in the domestic tourism industry Iceland are likely to cause some growing pane. It is therefore expected that considerable operational and financial restructuring will take place in the tourism industry in the coming years followed by consolidation of many of the industry players to increase efficiency. As the tourism represents a considerable part of the Iceland’s GDP it can be expected that restructuring and consolidation will bring investment opportunities of scale that should interest international investors focusing on this sector.
Although the supply of electricity for new ventures is not as favorable as it has been in the past and major power companies in Iceland have kind of pulled back from the strategy of providing power to non-green industries, it can still be expected that the data center industry will continue to grow and offering new investment opportunities.
Even though there has been some political and judicial unrest associated with the aquaculture industry the sector is expected to grow at a relatively fast pace in the coming years. Total production of farmed fish in 2017 totaled 20.776 tons, of which production in salmon farming was 11.265 tons. In September 2018, issued operating licenses for production totaled 45.200 tons of salmon and 2.850 tons of rainbow trout. As these numbers show, the growth in the industry is substantial and if it continues to do so the aquaculture industry will have a significant impact in the Icelandic economy. In recent years foreign industry players have invested heavily in the Icelandic aquaculture, and it would not be surprising if further investments in this area would materialize.
One of the positive effects of the financial crisis that swept the world in 2008, is the vibrant start-up environment it created. Iceland was no different, and for the first time in this young country’s history it can be said that Iceland has an attractive start-up community. In recent years global investor have acquired tech companies such as the Black Desert Online developer Pearl Abyss acquisition of CCP Games, the creators of popular spaceship MMORPG EVE Online and the Fortune 500 company NetApp acquisition of Greenqloud. Several other smaller acquisitions have taken place in the technology sector in recent years, and that trend is expected to continue.
Although the short-term outlook in the Icelandic economy appears to be of stagnant nature, it is generally thought that the long-term outlook is of positive note. Iceland is rich of natural resources and Iceland is know for running them in a very sustainable manner as our fishery resources are a good example of.
4. Legal system
A new court level was introduced in Iceland on 1 January 2018, replacing the former two tiers with a three-tier system. The new court is called the Court of Appeal (Icel. Landsréttur) and is a court of second instance, situated between the District Courts and the Supreme Court. The introduction of the Court of Appeal is part of a major restructuring of the Icelandic justice system.
All court actions in Iceland commence in the District Courts (Icel. Héraðsdómstólar), which are eight in number and located around the country. The conclusion of a District Court can be appealed to the Court of Appeal, provided specific conditions for appeal are satisfied. In special cases, and after receiving the permission of the Supreme Court, it will be possible to refer the conclusion of the Court of Appeal to the Supreme Court, which will continue to be the country’s court of highest instance. In most instances, the judgement of the Court of Appeal will be the final resolution in the case. These changes to the judicial system will reinforce the role of the Supreme Court of Iceland in setting precedents in jurisprudence. There is a total of 64 judges in Iceland, 42 of whom preside over the eight District Courts. The Court of Appeal has fifteen judges and the Supreme Court has seven.
Iceland has a civil law legal system and thus Icelandic law is characterized by written law. Major sources of law in Iceland include the Constitution, statutory legislation, and regulatory statutes. Other legal resources are precedent, customary law and tradition of culture.
The Constitutional Act no. 33/1944 represents the highest national legal authority and is composed of seven Chapters and 79 provisions. Fundamental changes were made to the human rights chapter with Constitutional Act No. 97/1995. The bill accompanying the Act made several references to the European Convention on Human Rights as well as to other Council of Europe and United Nations human rights instruments to which Iceland is a party.
Statutory and Regulatory Law
Except with respect to constitutional issues, legislation enjoys primacy as a source of law. The area of private law is dominated by a range of individual statutory acts and the area of general criminal law is governed by the General Penal Code No. 19, February 12, 1940. In the last few years, numerous pieces of legislation have been adopted in certain fields of law, such as in banking, communications and corporations.
Frequently, statutory acts give the administration the authority to issue regulations. As sources of law, statutory acts prevail over regulations.
Precedents, Customary Law and Tradition of Culture
Court practice in Iceland does not have the same authoritative role as in Common Law countries. However, in matters of legal uncertainty, the decisions of the Supreme Court have considerable authority for the disposition of future cases. In certain areas of law, the decisions of the Supreme Court are a source of law of central importance, e.g. tort law.
In Iceland, a custom can become a source of law. For instance, customary law has been an important source of law in Constitutional matters.
Tradition of culture refers to considerations of fairness, justice and feasibility. Iceland courts have in some cases relied on Tradition of Culture when other sources of law have not been able to establish a rule of law.
Statements and Decisions by Administrative Authorities
Statements by an administrative organ can carry considerable authority in some areas. For instance, in the area of administrative law, the statements of the parliament´s Ombudsman carry considerable authority. Similarly, in the area of tax law, the decisions of the Internal Revenue Board can carry considerable weight.
The EEA and its Effect on Icelandic Legislation
Iceland is a member of the European Economic Area (EEA). The Agreement on the EEA, which came into force in 1994, extends the Single Market of the European Union (EU) to Iceland, Norway and Liechtenstein.
Membership of the EEA has affected Icelandic legislation considerably. To achieve homogeneity between the EEA and EU, the agreement incorporates hundreds of acts, largely identical to the relevant parts of the EC legislation, and these acts are made part of the internal legal order of the contracting parties. Each month a number of pieces of EC legislation, relevant for the EEA, are incorporated in the agreement by decision of EEA Joint Committee.
With respect to the relation between municipal law and international law, Iceland adheres to the principle of dualism. Therefore, ratified international treaties do not assume the force of domestic law, but rather are only binding according to international law. The Supreme Court of Iceland has sought to interpret Icelandic law, as far as possible, in conformity with Iceland’s international obligations.
The European Convention on Human Rights was incorporated into Icelandic law by Act No. 62/1994. Following its incorporation, its provisions can be directly invoked in court as domestic legislation.
5. Foreign investment restriction
In principle, foreign parties are permitted to invest in Iceland within the limitations imposed by law. The limitations are mostly laid out in Act. No. 34/1991, which addresses investments by non-residents in business enterprises, and in specific legislation. The limitations mostly stipulate that certain conditions must be met or that a specific license has to be obtained.
Because Iceland is a part of the European Economic Area, investment in Iceland by EEA residents is in principle unrestricted. All residents and entities within the European Union and EFTA, enjoy in most cases the same rights to invest as Icelanders do. However, there are some sector-based restrictions that apply to all non-residents, including EEA residents, and some requirements are made regarding investments of residents outside the EEA. These sector-based restrictions were mostly negotiated as they were considered to be of national political importance. The main sectors where restrictions apply in are in the field of real estate ownership, in the fishing industry and in the field of energy affairs. However, in the foreign exchange sector there have been major changes recently and a lot of restrictions have been abolished.
Foreign exchange transactions were subject to restrictions following the collapse of the banks in 2008. In October 2016 a major step was taken to amend the restrictions on financial transactions with legislation and on 14 March 2017 capital controls were almost entirely abolished with new rules on foreign currency matters. With the new rules, most restrictions on cross-border movement of domestic and foreign currency were lifted.
When it comes to ownership of real estate in Iceland, all Icelandic citizens and foreign citizens domiciled in Iceland are permitted to own real estate. The right to own real estate in Iceland is provided for in Act. no. 19/1966 on Ownership Rights and Utilization Rights. Special rules apply to those who enjoy rights based on the EEA agreement, EFTA agreement and Hoyvík Agreement between Iceland and the Faroe Islands. They are not required to apply for a special permission from the Minister of Justice to own property in Iceland. However, parties outside the EEA are required to have permission from the Minister. Large scale investment projects are generally exempt from the restrictions via a standard clause in an investment agreement with the Ministry of Industries and Innovation. The Minister of Justice can also grant exemptions to those that are permitted to run a business in Iceland when the property is to be used as business premises or a permanent residence, or when other reasons apply.
In the Icelandic fishing industry only those who fulfill certain requirements and conditions are allowed to conduct fishing operations within the Icelandic fisheries jurisdiction or own or run enterprises engaged in fish processing. Those requirements and conditions are laid out in Article 4 in Act. no. 34/1991. In short, the party must be an Icelandic citizen or an Icelandic entity. Icelandic legal entities must be wholly owned by Icelandic persons or Icelandic legal entities, and fulfill the following conditions: i) be controlled by Icelandic entities, ii) not under more than 25% ownership of foreign entities, 33% in certain circumstances, and iii) be in other respects under the ownership of Icelandic citizens or Icelandic legal entities controlled by Icelandic entities.
Lastly, when it comes to ownership of energy exploitation rights relating to waterfalls and geothermal energy for other than domestic use, only Icelandic citizens and other Icelandic entities, as well as individuals and legal entities domiciled in another member state of the EEA, are permitted to own such rights. The same applies to enterprises which produce and distribute energy.