Thorvaldur Gylfason

Lessons from norway and Iceland ThorvaldurGylfason IMF-Middle East Center for Economics and Finance (CEF) Course on Macroeconomic Management in Natural Resource-Rich Countries KuwaitCity, Kuwait, 6-17 January 2013

overview • From rags to riches • Norway and Iceland • Digression on Iceland • Norway and oil • Norway’s sovereign wealth fund • Natural resources and human rights

1 From rags to riches i • When it separated from Sweden in 1905, Norway was one of Europe’s poorest countries • Finland and Iceland were poorer, but caught up • In 2005, Denmark, Finland, Iceland, and Sweden formed an economic cluster with per capita GDP (at ppp) between $32K to $35K, compared with $42K in Norway and the US • Did natural resource wealth (timber, hydropower, oil and gas) catapult Norway from rags to riches? • No, not really, human resources did

From rags to riches ii • Poor countries nearly always catch up • Finland and Iceland caught up with Denmark and Sweden without natural resources offering a decisive advantage • True, Finland had timber and Iceland had fish • But they always had timber and fish! • Educated labor enabled Finland and Iceland to exploit their natural resources and catch up • Human capital came first, natural resource wealth was secondary • Likewise, Ireland caught up with the UK without a natural resource advantage

From rags to riches iii • Norway always had its natural resource wealth • Educated labor made the resource wealth exploitable • The decisive factor was the people • Consider Congo: Lots of natural resources, but few human resources • Recall Putin on Russia: Rich country, poor people • Even so, natural resource wealth may explain why Norway is richer than the rest of the Nordic countries

Norway and other nordics: per capita gdp 1980-2010 (ppp) Denmark Finland Iceland Norway Sweden

2 Norway and iceland 1980-2010 Cost of inflation Per capita GNI at PPP (current international dollars) Labor force with secondary education (%)

Norway and iceland 1980-2010 Cost of inflation Real Per Capita GDP (at 2000 prices) Life expectancy (years)

Norway and iceland1980-2010 Tertiary school enrolment (%) Fertility (births per woman)

Norway and iceland1980-2010 Labor force with tertiary education (%) Fertility (births per woman)

Iceland: Gini index of inequality 1993-2008 Increased inequality as a sign of pending crisis Nordics, including Norway, cluster around 25 to 27

More on Norway and iceland • With Switzerland, Norway and Iceland were, until recently, the sole European nations with no intention of joining the EU • Iceland applied for membership in 2009 • Norway remains opposed to joining • Switzerland is a special case • Joined the UN only a few years ago • Norway and Iceland have grown apart • Norway’s ppp-adjusted per capita GNI is $57K compared with Iceland’s $28K • Switzerland has $50K while US has $47K Figures refer to 2010

Norway and iceland: GNI per person 1980-2010 GNI per person (USD, PPP) GNI per person (USD, PPP)

Different policies • Both are rich, but in different ways • Norway has been well managed • Low inflation, stable growth, low unemployment, no external debt, efficient oil-wealth management • Iceland has been less well managed • High inflation, uneven growth, low unemployment, high external debt, overfishing, controversial fisheries management, financial crash in 2008 requiring IMF emergency assistance

Natural resources • Norway • Small fisheries sector • 1% of GNP and employment • Regionally important • Huge oil sector • Oil wealth: 50%-250% of GNP • Oil revenue: • 25% of GNP and investment • 33% of budget revenue • 50% of export earnings

Natural resources • Iceland • Large fisheries sector • 11% of GDP in 2011 • Up from 6% in 2007 • Downward trend until 2008 • Sharp reversal due to depreciation of currency in crash of 2008 • 26% of exports of goods and services in 2011 • Downward trend for decades • 5% of employment

Exports 1960-2010 (% of GDP) Long stagnant exports • Unique among industrial countries • Norway’s oil exports crowded out nonoil exports Iceland’s exports • Equivalent to about a third of GNP from, yes, 1870-2008 • Shot up after crash of 2008

Norway: background • Rejected EU membership twice • 1972 and 1994 • Political leadership wished to join EU • In 1994, all major political parties and interest organizations advocated membership • But the people said No! • Strong objections from rural areas • Fishing and farming communities along the coast, especially up north

iceland: background • No referendum was held • Until 2008 crash, political leadership did not want to join • Even if polls indicated public support for membership • Still, strong objections from rural areas • Fishing and farming communities around the coast are overrepresented in political arena • Since 2008 crash, political leadership wants to join • Referendum is promised, but now public opinion has turned against membership

3 Iceland’s Dutch disease symptoms • Persistent overvaluation and volatility of currency • Rural subsidies distort real exchange rate • High inflation leads to real appreciation • Sluggish exports and FDI • Lack of interest in full participation in European integration • Natural wealth: Fishy blessing? • Free catch quotas gave lots of money plus political power to boat owners

Iceland story i • Restricted access to fishing grounds in 1984 made catch quotas valuable, creating wealth • By international law, and later also Icelandic law, this wealth belongs to the people • Even so, politicians decided to give quotas to boat owners gratis based on catch experience 1981-83 • Boat owners drafted the legislation themselves • This was ruled discriminatory and unconstitutional by Supreme Court in 1998 and by UNHRC in 2007 • Violation of ICCPR as well as of human rights

Iceland story ii • Valuable common property catch quotas were handed out free of charge to vessel owners from 1984 onward • Quotas became freely transferable by law in 1990, so many quota holder sold out and made a killing • Those who had objected to fishing fees accruing to the state or to the people had no objection to fees accruing to boat owners • If the banks paid politicians, as documented by the parliament’s SIC report, how about boat owners? • Fishing fees accruing to the state were introduced into law in 2002, but they were only nominal

Efficiency and fairness • Good fisheries management must be both efficient and fair • Efficiency means maximizing revenue from fisheries and minimizing cost by allowing efficient (i.e., low-cost) operators to buy quotas from inefficient (i.e., high-cost) ones • Fairness means that, to insure equality, everyone must have a seat at the same table • Hence, free transferability of quotas is acceptable only if the initial allocation of quotas is fair • If not, universal principle of equality is violated, a principle enshrined in binding international legal agreements as well as in national constitutions and laws • Herein lies the fatal flaw in the Icelandic system

Serious consequences • In Iceland, free allocation of fishing quotas created a small class of rich boat owners who, through their wealth and political clout, changed the balance of power • In politics, it is “suicide” to rise against them • Boat owners now own what used to be the largest newspaper, and use it to fight against reform of the quota system • They used fishing quotas as collateral in bank deals with serious consequences • No one should ever be allowed to use other people’s property as collateral • Illegal for foreigners to own Icelandic catch quotas

4 Norway and oil 10 5 -4 12 13 -10 Per Capita GNI at PPP Democracy

Norway and oil 7 10 -6 29 25 -10 Real Per Capita GDP Democracy

Norway and oil Labor force with secondary education Education (secondary, %) Fertility

Norway and oil More corruption Corruption Fertility

Norway’s Ten oil commandments • Commandments include a commitment to • National supervision and control of all operations on the Norwegian Continental Shelf • Development of new industries based on petroleum • Respect for existing industrial activities and the protection of nature and the environment • Ban against flaring of exploitable gas • Except during brief periods of testing • State involvement at all appropriate levels, contributing to a coordination of Norwegian interests in Norway’s petroleum industry • Commandments underpin transparent ways in which Norway’s oil wealth has been allocated to its oil fund, now called pension fund

Norway’s sovereign wealth fund: from production to policy i 5 • 1969: First oil field discovered in Norway • 1971: Production starts • 1973-75: Ministries of Finance and Industry sponsor analytical work on Dutch disease issues, size of reserves, likely lifecycles of fields, and environmental concerns • Not much on long-run spending needs • 1983: Tempo Committee • Government should put its oil revenues in a fund and spend only the real return on the assets accumulated in the fund • Decouple oil revenues from public spending • Be patient and extract oil slowly to shield domestic economy

Norway’s sovereign wealth fund: from production to policy ii • 1988: Steigum Committee • Government spending should depend on the permanent income of total oil wealth comprising the financial fund plus the value of oil and gas reserves in the ground • Calculation of total oil wealth requires the prediction of an optimal depletion path given expected oil and gas prices, technology, and interest rates • Unlike Tempo Committee, Steigum Committee argued for setting up an oil fund,stressingthat the fund and the value of oil and gas reserves in the ground be viewed as part of the same portfolio

Norway’s sovereign wealth fund: from production to policy iii • 1990: The Government Petroleum Fund is established • 2001: Implementation of 4% rule • Four percent of the value of the Fund at the end of the previous year is allowed to be extracted from the Fund and to be used to fund the general government deficit • Real rate of return on the Fund is estimated to be 4% per year • Idea here is to preserve the principal, and spend the interest income

Norway’s sovereign wealth fund: from production to policy iv • 2006: GPF Global is part of the Central Bank, and manages the surplus wealth from the petroleum income (taxes and licenses) • Aim is to counter the decline of expected petroleum income and to smooth the disrupting effects of highly fluctuating oil prices • 2006: Pension reform • Pensions are no longer indexed to wage growth but indexed to the average of wage growth and inflation (typically less) • The lifetime value of the pension is a fixed amount calculated around age 60, and is based on expected average life expectancy for 60-year olds

A $480bn Fund with a link to fiscal policy Return on investments All revenues Petroleum revenues Fund State Budget Transfer to finance non-oil deficit Expenditures Key characteristics Gives the Fund high risk-bearing capacity • Very long investment horizon (perm. fund) • No claims for large and swift withdrawals • No direct link to liabilities Fiscal policy guideline (over time spend Fund real return, estimated at 4%)

Pension fund global governance structure Stortinget • Parliament – “Ultimate owner” • Political support on main policy choices in management of Fund • Ministry of Finance – “Formal owner” • Set benchmark asset allocation + risk limits • Monitor and evaluate operational mgmt. • Define responsible investment practices • Central Bank – “Operational manager” • Separate asset management entity (NBIM) • Implement benchmark asset allocation • Actively manage portfolio within risk limits to achieve excess return • Control and report risk • Exercise the Fund’s ownership rights Min. of Finance Norges Bank

Norway: Large and volatile oil revenues split between domestic spending and oil fund savings Gov’t oil revenues and non-oil budget deficit (% of trend GDP) Accumulated oil revenues, domestic use and fund savings (NOK bn)

Norwegian Model is the Result of a learning Process • Norway experienced a period of boom and bust in its oil revenues before setting up the Petroleum Fund • Oil revenues were used to support the expansion of public services and employment, not infrastructure as the country had already reached a high level of industrialization • The whole approach was gradual (Steigum, Tempo committees) • Institutions were carefully calibrated • Democracy was key

Norway: Oil revenues supported expansion of public services and employment 1970-90 General government spending (% of non-oil GDP) General government employment (% of total)

We are not all Norwegians

wealth of mineral- and oil-dependent economies in Sub-Saharan Africa (2005) 100 NTFR: non-timber forest resources Source: Hamilton (2010) Natural wealth dominates Subsoil assets are larger in value than produced capital Intangible wealth (human and social capital) is small: 35% compared with 60% to 70% in a ‘typical’ developing country – this suggests a low return on total assets

6 Natural resources and human rights • As a matter of near-universal principle, a people’s right to its natural resources is a human right proclaimed in primary documents of international law and enshrined in many national constitutions • Violations of the universal principle of equality and of human rights bring constitutional issues into the picture • Every constitution declares that we are all equal before the law, ruling out any kind of discrimination among individuals on whatever basis

Human rights • Key distinction between state ownership and national ownership • State ownership (e.g., public office buildings) means that the state can sell or pledge such assets • National ownership (e.g., cultural assets like the TajMahal and the pyramids or natural assets like fish and energy) means that the state cannot sell or pledge such assets • Like our cultural assets, we have inherited our natural resources from earlier generations and must preserve them for future generations • We do not have the right to squander them • Hence the link between human rights and nature

International covenant on civil and political rights (ICCpr) • ICCPR was made in 1966 to fortify the UN Human Rights Declaration from 1948 • Rules on effective remedy for victims of human rights violations • 165 signatories • Non-signatories: China, Cuba, Malaysia, Pakistan, Saudi-Arabia, Singapore, Vatican plus some very small countries • Iceland signed ICCPR in 1968 and ratified it in 1979 • The opinions of the UN Human Rights Committee (UNHRC) are binding, and cannot be appealed • However, UNHRC cannot enforce its opinions • It can only name and shame violators • Human rights are absolute rights and cannot be swayed or subordinated to other interests

IccpR and human rights • Article 1 of ICCPR defines common property resources as human rights by stating that • “All people may, for their own ends, freely dispose of their natural wealth and resources …” • Article 1 of the International Covenant on Economic, Social and Cultural Rights (ICESCR) is identical

Iccpr 2007 opinion on Iceland • 12 of 18 human rights specialists on UNHRC ruled that Iceland’s fisheries management system violates Art. 26 of the ICCPR stipulating that “All persons are equal before the law” • Article 26 of the ICCPR is essentially the same as article 65 on equality in Iceland’s constitution from 1944 • In 2012, UNHRC dropped the case against Iceland on the grounds that Iceland had promised to strengthen human rights provisions in its new constitution, awaiting ratification by Iceland’s parliament

United states under reagan • When oil was discovered in Florida and Louisiana, the Reagan administration and Congress decided in 1982 to auction off the drilling licenses and let the auction receipts accrue to the federal government • This is one of three methods advocated from the beginning by many Icelandic economists • The other two are fishing fees and gratis allocation to all like in Alaska • All three are, in principle, equivalent • Reagan respected the nation’s ownership of its oil resources

Case In point: iraq • Iraq constitution of 2005 states: • “Oil and gas are the property of the Iraqi people in all the regions and provinces.” • Also, the constitutions of Angola, Chile, China, Ghana, Iraq, Kuwait, Nigeria, and Russia stipulate that natural resources belong to the people or the state, some more clearly than others • Nigeria and Russia are rather vague

The way to go: norway i • From the beginning, the oil and gas reserves within Norwegian jurisdiction were defined by law as common property resources, thereby clearly establishing the legal rights of the Norwegian people to the resource rents • On this legal basis, the government has absorbed about 80% of the resource rent over the years, instead setting most of its oil revenue aside in the state petroleum fund the name of which was recently changed to pension fund to reflect its intended use

The way to go: norway ii • Government laid down economic/ethical principles (commandments) to guide the use and exploitation of the oil and gas for the benefit of current and future generations of Norwegians • Main political parties have from the beginning shared an understanding that national economy needed to be shielded from an excessive influx of oil money to avoid overheating and waste • The Central Bank, granted increased independence from the government in 2001, manages the oil/pension fund on behalf of the Ministry of Finance, maintaining a healthy distance between politicians and the fund

conclusion Fini • Norway has managed its oil wealth splendidly • Oil wealth was declared public property from the outset; democracy was key • Emphasis was put on sharing the wealth fairly across generations and avoiding common pitfalls such as overheating and rent seeking • Broad political consensus was reached on oil wealth management strategy • No signs of resource curse • Some indications of Dutch disease; e.g., no interest in EU • European way of pooling natural resources • Coal and Steel Community as precursor to EU • Pooling fish through CFP has worked less well • Norway’s fisheries policy is also inefficient

Thorvaldur Gylfason