Thorvaldur Gylfason

LESSONS FROM NORWAY AND ICELAND

IMF-Middle East Center for Economics and Finance (CEF)

Course on Macroeconomic Management in Natural Resource-Rich Countries

Kuwait City, Kuwait, 6-17 January 2013

OVERVIEW1. From rags to riches2. Norway and Iceland3. Digression on Iceland4. Norway and oil5. Norway’s sovereign wealth fund6. Natural resources and human

rights

FROM RAGS TO RICHES I When it separated from Sweden in

1905, Norway was one of Europe’s poorest countriesFinland 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

1

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 fishBut they always had timber and fish!

Educated labor enabled Finland and Iceland to exploit their natural resources and catch upHuman capital came first, natural resource

wealth was secondaryLikewise, 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)

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

0

10000

20000

30000

40000

50000

60000

70000

Danmörk

Finnland

Ísland

Noregur

Svíþjóð

Denmark

Finland

Iceland

Norway

Sweden

NORWAY AND ICELAND 1980-2010

Per capita GNI at PPP (current international

dollars)Labor force with

secondary education (%)

2

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

IcelandNorway

0

10

20

30

40

50

60

Iceland

NorwayCost of inflation

NORWAY AND ICELAND 1980-2010

Real Per Capita GDP (at 2000 prices) Life expectancy (years)

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

Iceland

Norway

68

70

72

74

76

78

80

82

84

Iceland

Norway

Cost of inflation

NORWAY AND ICELAND1980-2010

Tertiary school enrolment (%)

Fertility (births per woman)

0

1

2

3

4

5

Iceland

Norway

1971

1975

1979

1983

1987

1991

1995

1999

2003

2007

0

10

20

30

40

50

60

70

80

90

Iceland

Norway

NORWAY AND ICELAND1980-2010

Labor force with tertiary education (%)

Fertility (births per woman)

0

1

2

3

4

5

Iceland

Norway

0

5

10

15

20

25

30

35

40

Iceland

Norway

ICELAND: GINI INDEX OF INEQUALITY 1993-2008

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

0

5

10

15

20

25

30

35

40

45

Nordics, including Norway, cluster around 25 to 27

Increased inequality

as a sign of pending

crisis

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

MORE ON NORWAY AND ICELAND

Figures

refer to

2010

NORWAY AND ICELAND: GNI PER PERSON 1980-2010

GNI per person (USD, PPP)

GNI per person (USD, PPP)

0

10000

20000

30000

40000

50000

60000

70000

Denmark

Finland

Iceland

Norway

Sweden

0

10000

20000

30000

40000

50000

60000

70000

Iceland

Norway

Switzerland

United States

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 managedHigh inflation, uneven growth, low

unemployment, high external debt, overfishing, controversial fisheries management, financial crash in 2008 requiring IMF emergency assistance

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

NATURAL RESOURCES

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

0

10

20

30

40

50

60

Iceland

Norway

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

NORWAY: 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

ICELAND: BACKGROUND

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’S DUTCH DISEASE SYMPTOMS 3

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 1981-83Boat owners drafted the legislation

themselves This was ruled discriminatory and

unconstitutional by Supreme Court in 1998 and by UNHRC in 2007Violation 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 fairEfficiency 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

themBoat 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

NORWAY AND OIL

Per Capita GNI at PPP Democracy

10

-4

-10

5

13

12

1980

1983

1986

1989

1992

1995

1998

2001

2004

2007

0

10000

20000

30000

40000

50000

60000

70000

Norway

Algeria

Saudi Arabia

-12

-10

-8

-6

-4

-2

0

2

4

6

8

10

12

Norway

Algeria

Saudi Arabia

4

NORWAY AND OIL

Real Per Capita GDP Democracy

10

-6

-10

7

25

29

0

5000

10000

15000

20000

25000

30000

35000

40000

45000NorwayAlgeriaSaudi Arabia

-12

-10

-8

-6

-4

-2

0

2

4

6

8

10

12

NorwayAlgeriaSaudi Arabia

NORWAY AND OIL

Education (secondary, %) Fertility

0

1

2

3

4

5

6

7

8

Norway

Algeria

Saudi Arabia

1995

1997

1999

2001

2003

2005

2007

0

10

20

30

40

50

60

Norway

AlgeriaLabor force

with secondary

education

NORWAY AND OIL

Corruption Fertility

0

1

2

3

4

5

6

7

8

Norway

Algeria

Saudi Arabia

0

1

2

3

4

5

6

7

8

9

10

Norway Algeria Saudi Arabia

More

corr

up

tion

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 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

5

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, stressing that 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 II

1990: The Government Petroleum Fund is established

2001: Implementation of 4% ruleFour 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 III

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

NORWAY’S SOVEREIGN WEALTH FUND: FROM PRODUCTION TO POLICY IV

Return on investments

State Budget

A $480BN FUND WITH A LINK TO FISCAL POLICY

Fiscal policy guideline

(over time spend Fund real return, estimated at 4%)

All revenues

Fund

Expenditures

Petroleum revenues

Transfer to finance non-oil

deficitKey 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

Stortinget

Min. of Finance

Norges Bank

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

PENSION FUND GLOBAL GOVERNANCE STRUCTURE

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)

1975

1982

1989

1996

2003

2010

2017

2024

2031

2038

2045

2052

2059

0

5

10

15

20

25

Oil revenues

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

0

500

1,000

1,500

2,000

2,500

3,000

3,500

Oil revenues accumOil fund valueOil fund deposits accumUse of oil rev accum

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 calibratedDemocracy 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)

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

0

10

20

30

40

0

10

20

30

40

Employed persons

Hours worked

1970

1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

2009

0

10

20

30

40

50

60

Total spend-ing

Consump-tion

WE ARE NOT ALL NORWEGIANS

WEALTH OF MINERAL- AND OIL-DEPENDENT ECONOMIES IN SUB-SAHARAN AFRICA (2005)

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

Type of AssetWealth per capita ($)

% of total wealth

Sub-soil assets 1,688 19Timber resources 448 5NTFR 469 5Cropland 1,052 12Pasture land 593 7Protected areas 159 2Natural capital 4,409 50Produced capital 1,368 15Intangible capital 3,099 35Total wealth 8,877

NTFR: non-timber forest resourcesSource: Hamilton (2010)

100

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

6

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 Taj Mahal 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 othersNigeria 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 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

Fini

Classroom discussion