by Silla Sigurgeirdottir and Robert H. Wade

Iceland is surfing a tourist boom. From 440,000 tourists in 2008, numbers started surging in 2011 to reach 1.3 million in 2015 and 1.8 million in 2016. The resident population is 330,000 in an area over 40% that of the United Kingdom. Having experienced the sharpest crash of all the OECD economies in 2008-2009 Iceland regained the pre-crash level of average income by late 2014. GDP grew super-fast at over 6% in 2016, and forecasts suggest annual growth of almost 5% between 2017 and 2019, one of the fastest in the OECD.

Pre-tax salaries rose nearly 10% a year in both 2015 and 2016. Foreign exchange reserves are ample. Inflation is low, at less than 2% through 2016. Household debt to income is low. The state is paying down public debt fast; the current level is around 50% of GDP. The banks have passed stringent stress tests, with unusually low leverage ratios, low loan to value ratios, strong liquidity positions (especially in foreign currencies) and high capital ratios (close to 30%). A repeat financial crash is very unlikely.

So what is not to like? Given what is happening in Europe and the United States, political leaders elsewhere would love to have Iceland’s problems. Still, those problems could develop badly for the population at large.

The tourist boom has produced a tight labor market, a tight rental accommodation market, and soaring house prices in the capital region. It has also produced krona appreciation of 15% against the US dollar in 2016, and 19% against the euro. For the first time ever, more than 10% of the labor force is foreign born. Many people are coming from southern and eastern Europe to take low-wage, long-hours jobs in tourism – which pay reasonably well when the appreciating krona is converted into home currencies.

The conservative government has adopted a laissez faire policy towards the tourist industry, beyond using public funds to advertise the country as a tourist destination. It has relied on tourist-driven krona appreciation to slow the growth in tourist numbers by making Iceland a more expensive destination – a “let the market work” solution. The central bank, aware of the economy-wide costs of continued krona appreciation, has been buying foreign exchange at huge cost in order to slow the rise.

Faced with a tourist-driven version of the Dutch disease, the government has resisted calls to levy taxes on tourists, whether in the form of an arrivals tax or a higher VAT rate on hotels and car rental companies. Whenever such measures are discussed, investors in the tourist industry shout, “No, you cannot destroy our investments”.

Giving priority to cutting public spending, the government has failed to invest in infrastructure necessary for sustainable tourism. Public toilets in popular destinations are few and far between. The police, rescue services, and park wardens needed to safeguard the tourists are seriously understaffed. The insufficient public investment in sustainable tourism is all the more damaging given that the government anticipates three million tourists a year by 2019.

Meanwhile the high krona is squeezing other export industries. Processing of fish for export to the United Kingdom – long the basic industry of Iceland – is making losses as the krona appreciates and the British pound depreciates. Many highly skilled Icelanders employed in information technology, engineering and pharmaceuticals are departing for operations overseas. Iceland could become an economy specialized in one volatile commodity, tourism.

Opponents of the government’s laissez faire policy argue that Iceland should follow the model adopted by Norway for its oil revenues. Establish a special fund financed by a tourist arrival tax, invest in overseas assets, and use the interest for improving the tourist infrastructure, including health services. Instead, to ease the tourist pressure on Iceland’s national health service, proponents of health privatization see an opportunity to build a new hospital dedicated to serve foreigners financed by their (foreign) health insurance, “at no cost to Iceland”, ignoring the drain of doctors, nurses, and capital investment from the already squeezed national health service.

A looming question is whether the tourist sector will hit a tipping point, a gestault shift from “hot place to go” to “too expensive, too hassling”. This might happen as the krona appreciates, as the oil price rises, and as long queues deter the tourists. There is no regulation of tourist numbers in specific places and walks. Currently 25 airlines fly to Iceland (up from five in 2005).  They could easily start to shift their traffic to cheaper holiday destinations. A slowdown in tourist numbers is highly desirable, but not a sudden fall.

Silla Sigurgeirsdottir is associate professor of political science, University of Iceland. Robert H. Wade is professor of global political economy, London School of Economics.

Photo: Karin Beate Nøsterud