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Master Thesis MSc in International Business Department of Business Aarhus School of Business Analyzing Iceland economy and trade Author/Exam ID Haraldur Níels Sigurjónsson/402617 Supervisor: Philipp Schröder September 2011

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Page 1: Analyzing Iceland economy and trade - PUREpure.au.dk/portal/files/39965802/Master_Thesis_Haraldur_Sigurjo... · MSc in International Business Department of Business Aarhus School

Master Thesis

MSc in International Business

Department of Business

Aarhus School of Business

Analyzing

Iceland economy and trade

Author/Exam ID

Haraldur Níels Sigurjónsson/402617

Supervisor: Philipp Schröder

September 2011

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Table of Contents Abstract ................................................................................................................................................... 1

Introduction ............................................................................................................................................. 2

Brief Economic history of Iceland ............................................................................................................ 3

The rise of the Icelandic economy....................................................................................................... 3

The Meltdown ..................................................................................................................................... 5

2009-2011 Recovery ............................................................................................................................ 7

Methodology ........................................................................................................................................... 9

PESTLE Analysis.................................................................................................................................... 9

SWOT Analysis ................................................................................................................................... 10

International Trade Theories ................................................................................................................. 12

Ricardian model ................................................................................................................................. 12

The Heckscher-Ohlin Model .............................................................................................................. 14

Porter: The Competitive Advantage of Nations ................................................................................ 16

Iceland business culture and negotiations style ................................................................................... 22

Low Power Distance .......................................................................................................................... 22

Individualism ..................................................................................................................................... 23

Femininity .......................................................................................................................................... 23

Uncertainty of avoidance .................................................................................................................. 24

Fisherman and Viking mentality ........................................................................................................ 24

Icelandic business culture ................................................................................................................. 25

Chapter conclusion ............................................................................................................................ 26

Trade relations, agreements and trade policy ...................................................................................... 27

EFTA ................................................................................................................................................... 27

EEA ..................................................................................................................................................... 28

Other trade organizations ................................................................................................................. 28

General history of Icelandic foreign trade, policy and direction ....................................................... 28

Iceland: PESTLE analysis ........................................................................................................................ 30

Geography ......................................................................................................................................... 30

Opportunities and threats of Geography ...................................................................................... 31

Political environment ........................................................................................................................ 32

Threat and opportunities on the political environment ............................................................... 32

Economical environment .................................................................................................................. 33

Main sectors of industries ............................................................................................................. 34

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Foreign trade in figures ................................................................................................................. 36

Taxes and foreign investment laws ............................................................................................... 38

Threat and opportunities in the economical environment ........................................................... 39

Other industries ............................................................................................................................. 41

Social environment and Demographics ............................................................................................ 42

Threat and opportunities in the social environment .................................................................... 44

Technological environment and infrastructure ................................................................................ 44

Threats and opportunities in the technological environment ...................................................... 45

Environment ...................................................................................................................................... 45

Natural resources .......................................................................................................................... 45

Threats and opportunities in the Environment ............................................................................. 46

Legal................................................................................................................................................... 47

Threats and opportunities in legal environment .......................................................................... 48

SWOT Analyses ...................................................................................................................................... 49

SWOT by industries ........................................................................................................................... 50

Fishing Industry ............................................................................................................................. 50

Energy industry .............................................................................................................................. 51

Tourist Industry ............................................................................................................................. 52

Industrial Industry ......................................................................................................................... 53

IT and Software industry ............................................................................................................... 54

Agricultural industry ...................................................................................................................... 55

Conclusion ............................................................................................................................................. 56

Bibliography ........................................................................................................................................... 58

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Abstract

Iceland has been going through process of changes in the export sectors, from the industrial

revolution to the 1970s Iceland’s exports consisted almost of only by marine products. From

the 1970s becoming more diversified exporting nation. This master thesis has the objective to

analyze the general business environment in Iceland and describe the past to present and what

direction Icelandic business environment is heading. Next analyzing the characteristics of the

export sector, business culture and attractiveness of the Icelandic export industry.

Qualitative research and desk research are the primary methods develop PESTLE analysis and

SWOT analysis. SWOT analysis is used to analyze all of the main export industries in Iceland

and general business environment. Trade theories are used to get better understanding Iceland

international trading pattern, with Ricardian model and Heckscher-Ohlin model as main

focus. To get deeper understanding of the competitiveness of nations this thesis uses Diamond

method from Michael E. Porter. The trade theories and Competitive advantages of Nations

theory are used in this master thesis to getting better understanding of Iceland trade and

specialization.

This thesis is divided into six parts. The first part focuses on the history of the Icelandic

economy from the industrial revolution, the evolution and the rice of the modern economy.

The second part focuses on the trade theories and competitiveness of nations. Third part

describes Icelandic business culture and traditions. Fourth part shows the importance of trade

agreements and foreign relations for the export sector. Fifth part is about analyzing the micro

environment of the Icelandic economy by using PESTLE model. The sixth part uses SWOT

model to analyze general part of Icelandic economy and the six major export industries in

Iceland.

The main conclusion from this master thesis is that Icelandic economic environment even

though going through economic crisis has great possibilities to resolve and work through the

crisis with improved economic policies, more foreign investment and increased export values.

With innovation and diligence of the Icelandic people, they have the right characteristics to

work through theses kind crisis and improve exports values to improve quality of life. Using

PESTLE analyzes, it shows that the Icelandic market offers numerous business opportunities

in green energy and tourism and should continue to focus more factors that Iceland has to

offer in comparative advantage and competitive advantage in world market trade.

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Introduction

From the 1970s Icelandic government realized that they needed to diversify the economy and

the exports. Iceland economy was too much connected to the fish stocks, when only one bad

fishing season could shock the economy into depression. Icelanders realized that they had an

excess energy and abundant of possibilities to harvest hydro power and geothermal. This lead

to the building of the Iceland first aluminum smelting plant by Swiss company Alusuisse in

1969, this became a turning point for the Icelandic economy and first indicator of

diversification of the export sector. In the last decades Iceland has been harnessing their

energy resources to attract foreign power intensive companies that are seeking cheap

electricity to make their product.

The objective of this thesis to analyze the general business environment in Iceland and

highlight the attractive opportunities for investors, looking into export and imports statics,

history, business culture, trade agreements, trade theories and how all these factors are

connected to the Iceland trade and to get better understanding the direction and possibilities

for the Icelandic economy. Using mostly journals, news and internet articles, report papers

from the central bank and other institutions to help gather information about the Icelandic

economy. The Icelandic origin of the author of this master thesis has helped greatly to gather

information more quickly and getting better understanding of the reliability of the sources

which was gathered. The author tried to keep the data neutral and when it came to translate to

do it without bias. The value of this paper is great report for investors, institutes, embassies or

individuals that want better understanding of the Icelandic economy and possibilities that it

has to offer.

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Brief Economic history of Iceland

The rise of the Icelandic economy

Iceland was late bloomer compared with its neighbors in Europe and North America. The

industrial revolution arrived around 1900 with mechanization of the fishing fleet, they

accomplished that in only 20 years. From period 1900 to 1930 there was fivefold increase in

the size of the country's fishing fleet. The export sector became quite large compared to other

European economies during period 1900- 1930 with 40% of GDP and evening reaching 60%

of GDP (Eggertsson & Herbertsson, 2005).

In 1930 the state-managed financial system had already established several state-owned banks

that served Iceland almost until the end of 20th

century. All banks, except for the relatively

small savings banks, were now state owned. The banking system was specialized by industry

with priority given to farming and fishing. The system was augmented by government

controlled investment credit funds that were also specialized by industry. Foreign exchange

was strictly rationed (Eggertsson & Herbertsson, 2005).

Iceland became independent as sovereign state in 1944, during the Nazi occupation of

Denmark. The country's response was not unlike the response of many European colonies that

gained independence after World War II. In particular, the country did not trust foreign

investment and entrepreneurs. That meant outlawed direct foreign investment, foreign capital

entered the country primarily through government controlled financial institutions that

allocated the fund to favored projects (Eggertsson & Herbertsson, 2005).

During World War II several thousand British troops were stationed in and around Reykjavik

to defend the Iceland from possible German invasion. In 1941 the United States took over

Iceland's defense. The foreign forces built vital infrastructure, including roads and airports.

The Marshall Plan aid after the war helped to build more infrastructures, including hydro-

electric power plants and capitalize the fishing industry. In year 1949 Iceland joined NATO

and U.S soldiers built up military base and airport in Keflavik, with several thousand strong

stationed there. The base was withdrawn in 2006, Keflavik is the main international airport of

Iceland (Ólafsson, 2008 ).

The war caused variety of problems, market closet and imported goods became more

expensive or harder to reach. With some agreements with the Allies the situation was

alleviated, but in most other respects the economy was booming in Iceland. British and US

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military activity created demands for a variety of goods and services, having the need for

much manpower which replaced the unemployment of the Depression. The military forces

built roads and airports, strengthen the country's infrastructure. Demand for fish increased in

the UK, the most profitable outlet of fish for Iceland was for vessels to sail to market with

their catches. Marshall Aid and revenues from the US manned airbase enabled Iceland to

sustain a substantial trade deficit after the war. The economy was characterized by public

participation in business, and extensive state intervention with price controls. Inflation had

been a consequence of the war and became a persistent feature of the economy. The economy

experienced major operating difficulties in export industries and shortages of foreign

currency, also with inflation that all caused short-term economic management problems

(Central Bank of Iceland, 1996).

The economy continued to be closely regulated between the 1950s and the 1980s. The

government partially reduced exchange controls in the 1960s, but continued to set the

exchange rate and influenced the allocation of foreign exchange, set the price of domestic

agricultural products and the maximum rate of return in retail, and maintained imports

controls until the 1960s. Critics called it ―a dysfunctional socialist economy,‖ yet Iceland had

exceptionally good economic performance from the 1950s to the late 1980s, helping to bring

the average income into the same league as the other Nordic countries. Indeed, as early as

1980 Iceland was ranked number two in the UN’s Human Development Index (reflecting

GDP per capita, health, and education). (Ólafsson, 2008 )

During the period of 1970-1980 the economy faced growing problems of inflation, the oil

crisis and inflation hit the economy hard. Real interest rates were kept substantially negative

during the inflation period and loans became gifts, Icelandic banks had the role of deciding

who was to receive those gifts. When people’s savings would burn up in the inflation, people

would be reluctant to save money and invested all of their money in housing. Banks were

controlled by massive governmental intervention, both on the financial side as well as the

operational side of the banks. Indexation of loans was made legal as part of broad-based

economic reforms in 1979. Indexation slowly changed the landscape of the credit market,

encouraging savings and forcing debtors to pay back the real value of their loans (Mattiasson,

2008). In 1969 the first aluminum smelter built in Iceland, it was the first steps by the

government to diversify the economy and decrease the dependence on the fisheries. The

development of the natural energy resources is a major factor in this undertaking (Hilmarsson,

2003).

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According to the Frasier Economic Freedom Index in 1980, the country’s credit market

ranked number 62 of 102 markets in as many countries. In 2002 Iceland had moved up

dramatically and was ranked 14 of 123 countries. These measures indicate that in the post-

World War II period and until the 1980s the Icelandic financial market is best described as a

Third World phenomenon (Eggertsson & Herbertsson, 2005).This dramatically jump was

possible because of highly educated population, ready to leap into opportunities being opened

by the information technologies, and it produced an export commodity, cold-water fish with

unusual property of a high income elasticity of demand (Ólafsson, Taxation Policy in Iceland,

2007).

During the years 1991 and 2004 the economy went through radical deregulation and

privatization reform process, under Prime Minister David Oddsson. While the government cut

taxes on business and financial earnings drastically, it raised taxes on lower and average-

income earners enough to raise tax revenues from 39 percent to 49 percent of GNP(Gross

national product) between 1995 and 2006 (Ólafsson, Taxation Policy in Iceland, 2007).

The most unusual aspect of the reform process in Iceland is the extraordinary expansion of the

banking system, in the period from 1996 to 2003 the ratio of deposits to GNP has increase

from 36.7% to 60.1%, and the bank lending/GNP ratio has increased from 52% to 148% and

up to 206% in 2004. In the survey of The Banker that showed performance of the world's

1000 largest banks in 2004 reports that three of Iceland’s commercial banks are among the

fasted growing banks in the world, being the 3rd, 4th, and 13th places. This can be explained

that these bank no longer limit their activities to Iceland, the country’s largest bank was

conducting some 80 percent of its business abroad. These are some of the factors lying behind

the extraordinary expansion of Iceland’s financial organizations (Eggertsson & Herbertsson,

2005). See appendix 1 for lending/GNP ratio

The Meltdown

Iceland’s meltdown began at the end of September 2008, when the central bank refused to

bail out Glitnir Bank, which went into receivership under the central bank. Within a week

Landsbanki and Kaupthing, the other two big banks also collapsed. All these three major

banks went into public ownership. The Icelandic krona(ISK) fell about 100% in value in most

foreign currencies during the meltdown, a massive cut in purchasing power. The foreign

exchange market stopped working, international investors are unable to sell Icelandic krona or

ISK except in small quantities in a parallel offshore market and foreign exchange is available

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only for government-approved imports. The stock market collapsed by about 98 percent in

2008. IMF team arrived in October 2008 and prepared crisis-management program. To

stabilize the ISK and stop capital from fleeing the IMF offered a loan of $2.5 billion, and

other Nordic central banks offered the same amount. The Central bank of Iceland has

strengthens foreign exchange controls and government begin to restructure and recapitalize

the banking sector (International Monetary Fund, 2008). Below, on figure one, it is shown

how Iceland was affected by the crisis compared to other countries. (Figure 1)

Figure 1: OECD crisis estimation (OECD, 2011)

To simplify crisis, Iceland forced its over-leveraged financial sector into a painful debt

restructuring instead of bailing out its banks. The government had no other choices, because

Icelandic banks' assets were roughly 1,000% of GDP and with world's smallest currency area.

The central bank could not take on role of lender as last resort without causing a currency

crisis. Iceland would serve as cautionary tale of "Icarus economy" whose banks had grown

too big to save. Even though Iceland banking system defaulted, this year government remains

solvent, with debt levels close to the European average of between 80% and 90% of GDP.

(Jónsson, 2011) One of the measures to save the Icelandic economy was set by the Icelandic

parliament that accepted a emergency law enabling the government to stage extensive

intervention in Iceland’s financial system, the most radical economic measure that have ever

been taken in the country’s history. The emergency law was necessary to prevent the nation

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from falling into crippling debt or even national insolvency in the coming decades. According

to the law, the minister of finance would be empowered to act on behalf of the state to allocate

capital to establish a new financial company or assume the operations, of existing financial

operations and including banks. These actions gave deposits a priority in the bankruptcy and

making them entirely insured, deposits in the bank’s subsidiaries in UK and Netherland would

be guaranteed by British and Dutch state. Shareholders of the financial companies would

sustain the damage (icelandreview, 2008).

2009-2011 Recovery

Iceland is slowly emerging from a deep recession following the collapse of its main banks, it

is well advanced in implementing the comprehensive economic program agree with IMF to

overcome these problems. The banking system was recapitalized by the end of 2009 and steps

have recently been taken to restructure private-sector debts. Reforms have been made to

regulation and supervision to address shortcomings exposed by the financial crisis. A strategy

to relax capital controls (part of the emergency law) was recently adopted, with a period of

liberalization likely to span several years (OECD, 2011).

The economy stopped contracting by late 2010 and consumption and business investment-led

recovery is projected to gather momentum, lifting economic growth to 3 per cent by 2012.

Inflation is projected to remain low and the underlying current account surplus to be sustained

(OECD, 2011). Iceland's government raised $1 billion in June 2011 through an issue of five-

year bonds at yields just above 3%. This successful return to private debt markets presents the

best evidence yet that Icelandic financial market is gaining trust and the country is on the road

to recovery (Jónsson, 2011).

With successful implementation of the policies will pave the way for a modest but robust

GDP growth in the medium term around 3% annually. Investments should pick up from

extremely low levels, and in the latest Statistics Iceland forecast, business investment

excluding large scale energy intensive projects will increase gradually as share of GDP and

reach 12% in 2015 (Iceland economic ministry finance, 2011).

As seen on figure 2 below the massive trade deficit between years 2000-2008 was mainly

cause by domestic demand and private consumption that had been driven by overexpansion of

the country’s financial sector, and massive personal and corporate borrowing (QFINANCE ,

2011).

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Since the crisis export values have been rising rapidly for the past few years in Iceland, the

global recession has had a limited affect on Icelandic export volumes. Marine and aluminum

production has been at full capacity, which is the largest share of Icelandic exports. The weak

Icelandic króna has giving exports highly competitive advantage in international market,

revenue from tourism has grown despite the global recession due to a weak króna (Iceland

economic ministry finance, 2011). Below on figure 2 shows development in exports and

import in last 10 years, and dramatic change caused by crisis and weakening of the króna.

Causing dramatic increase in export and creating trade surplus for trade in goods.

Figure 2 – Adapted from Statistics Institute of Iceland (Statistics Institute of Iceland, 2011)

Export and imports by months 2000-2011

Total

Export Fob Import CIF

2000 149,272.8 203,222.1

2001 196,582.2 220,874.0

2002 204,303.0 207,607.5

2003 182,580.0 216,525.1

2004 202,373.0 260,430.8

2005 194,355.3 313,854.6

2006 242,740.0 437,086.3

2007 305,095.8 429,468.9

2008 466,859.5 514,739.3

2009 500,854.5 446,128.2

2010 561,032.2 477,222.3

2011 . .

Trade Export Fob The Fob (Free on board) value means the price for the item when it is on

board whatever means of transport in the country of export.

Trade Import CIF CIF(Cost, Insurance, Freight) value means the Fob value plus costs

induced until the item is unloaded in the country of import. This chiefly involves freight rates

and insurance costs. Unit: Fob and CIF million Icelandic-ISK, reference time: 2000-2011

(Statistics Institute of Iceland, 2011)

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Methodology

In this thesis two methods are used to order to analyze the Icelandic market: PESTLE analysis

and SWOT analysis. The second one is used in order to analyze the five major industries and

attractiveness. PEST will be used to analyze the general business, social, political, technology,

environment and legal environment in Iceland.

The goal of this thesis is to determine the attractiveness of the Icelandic market and

understand its evolving opportunities and threats as they relate to the strengths and weakness

of the Icelandic market, also analyze competitive advantages of Iceland on international level

as trader and performance of economy. PEST offers a great way to understand political,

economic, socials and technology factors that contributes to nations competitive advantages

on the international market. SWOT offers great ways to understand and sum up all the

external and internal factors of industry, then analyze the strengths, weaknesses, opportunities

and threats.

Qualitative research methods were used primarily to define the Icelandic market. The main

method involved the search of secondary data such as institutions data, government

publications, articles from scholars and international economic institutions. Secondary data

research is able to show outline changes in economical and social patterns in a country.

PESTLE Analysis

The PESTEL analysis divides the general environment mainly into six categories: political,

economic, social, technological, legal and environmental factors. All of these factors in the

macro-environment will affect the decisions of the managers of any organization and strategic

development of a business. PESTLE analysis provides critical insights by mapping Iceland’s

performance through prism of current strengths, current challenges, future prospects and

future risks.

These factors in the macro-environment could affect decisions for entering international

markets. To analyze these factors with the use of the PESTLE model with following:

Political section provides understanding about the political system, key policies relevant

to businesses and governance indicators. Like taxation policy, international trade and

relationships.

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Economic section shows evolution of the economy along with in-depth analysis of

significant macro-economic issues. Like interest rates, exchange rates, national

income, inflation, unemployment and stock market.

Social factors offers information and analysis of customer demographics through

income, rural-urban segmentation and centers of affluence, attitude towards work, it

also deals with healthcare and educational factors.

Technological factors provide information on state of technological and telecom

development, technological policies and outcomes, patents, innovation and new

product development.

Legal section provide information about the legal structure, corporate laws, health and

safety, employment law, regulations to start a new business and the tax regime

Environmental section provides information on the policies, laws and performance on

environmental indicators. (Oxford university press, 2007)

A PESTAL or PESTAL analysis is a useful tool for understanding the big picture of the

environment which an organization is operating. Especially useful tool for understanding risk

associated with the market growth or decline. A PESTAL analysis is often used as tool for

finding out where organization or product is in the context, the six elements form a

framework for reviewing a situation and can also be used to review a strategy or position,

direction of a company, a marketing proposition or idea.

(The Chartered Instiute of Personnel and Development, 2011)

SWOT Analysis

A scan of the internal and external environment is an important part of the strategic planning

process. SWOT analysis is a method to sum up all the internal and external factors and then

analyze corresponding strengths, weakness, opportunities and threats. With the analysis on

strengths and weaknesses focused on power of rivals, and opportunities and threats is

contributed to the changes in external environment and their possible impact on enterprises.

The SWOT analysis provides information that is helpful in matching the firm's resources and

capabilities to the competitive environment in which it operates (Quick MBA, 2010).

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Table 1 SWOT Analysis Example (Gliffy, 2011)

Strengths Weaknesses > Internal factors

Technological skills

Distribution channels

Production Quality

Management

Leading brands

Lack of skills

Poor distribution channels

Lack of Quality

Management

Weak brands

Opportunities Threats > External factors

Change in government politics

Technological advance

Social changes

New distribution channels

Lower taxes

Change in government politics

Technological advance

Changing customers base

Tax increases

Social changes

New distribution channels

The SWOT analysis method will be used to analyze the Icelandic market and the six major

industries of export in Iceland:

The Icelandic business environment: Offer great opportunities in these six major export

sectors

Fishing industry – Iceland most important export sector with about 70% of exports

Energy sector – At moment it is only indirect in exports through power intensive

industrial exporters, has possibility to export electricity through sea cable to main

market in Europe

Tourist sector – The fastest growing industry in Iceland, with 6% annual growing rate

since 2000

Industrial – Consists mainly of aluminum smelters, aluminum related products,

pharmaceutical products, ferrosilicon, diatomite and marine machinery

Software industry – Has six-fold in export values in the last 10 years

Agriculture – Mostly consists of salmon, live horses, sheep products and dairy products

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International Trade Theories

International trade is the exchange of goods and services between countries. This type of trade

gives rise to a world economy, in which prices, supply and demand, are affected by global

events. Nations are more closely linked through trade in goods and services, through flows of

money and investment than ever before. This chapter introduces some of the main concepts

and methods of international economics and trade theories. Some of the theories are old ideas

that are still as valid as ever, this chapter will attempt to convey the key ideas that have

emerged in recent years while stressing the continuing usefulness of old ideas (Krugman &

Obstfeld, 2003).

Countries engage in international trade for two basic reasons, each of which contributes to

their gain from trade. First, countries trade because they are different from each other. Nations

can benefit from trade as like individuals, nations can reach an arrangement to trade goods

that each does things relatively well in. Second, countries trade goods to achieve economies

of scale in production. Meaning that each country produces limited ranged of good in larger

scale and hence more efficiently that if it tried to produce everything. When looking into the

real world of trade, patterns of international trade reflect the interaction of both these motives.

The first step of understanding the causes and effects of trade, it is useful to look at simplified

trade models (Krugman & Obstfeld, 2003).

Ricardian model

The Ricardian model is the simplest way to illustrate comparative advantage and the gains

from trade in a general equilibrium settings, the model assumes that production uses only 1

input (labor), with constant returns to scale. This assumption means that the technology in

each country and each sector is entirely determined by the labor requirement per unit of

output (Berkley Business College, 2011). The international trade model attempts to explain

the difference in comparative advantage on the basis of technological difference across the

nations. The technological difference is essentially supply side difference between the two

countries involved in international trade. The model expects that all other factors to be similar

across the countries (Economy Watch, 2011).

Suppose, for example, that Icelandic farmers grow 10 million flowers each year for the

Icelandic market, and the resources used to grow those flowers could have produced 100,000

tons of aluminum. The flowers in Iceland must be grown in heated greenhouses, at great

expense of energy, capital investment, and other scarce resources. Those resources could have

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been used to produce other goods. In this case, there is a trade-offs. In order to produce

flowers, the Icelandic economy must produce less of other things, such as aluminum.

Economists use the term opportunity cost to describe this trade-off. The opportunity cost of

those 10 million flowers is 100,000 tons of aluminum. Conversely, if aluminum were

produced instead, the opportunity cost of those 100,000 tons would be 10 million flowers

(Krugman & Obstfeld, 2003).

Let say those flowers could instead have been grown in Spain. It seems extremely likely that

opportunity cost of those flowers in terms of aluminum would be less than it would be in

Iceland. First thing, it is much easier to grow flowers all year around in Spain without heated

greenhouses. It does not require much energy and investment, because the flowers can be

grown outside and with year around sunny days. Furthermore, Spanish workers and industry

are less efficient than their Icelandic counterparts at making raw aluminum (mostly because

cheaper energy in Iceland), so the trade-off in Spain might be for example like 10 million

flowers for only 30,000 tons of aluminum (Krugman & Obstfeld, 2003)

Table 2- Hypothetical changes in production (Adapted example for Iceland)

Millions of flowers Thousand tons of aluminum

Iceland -10 100

Spain 10 -30

Total 0 70

A country has a comparative advantage in producing goods if the opportunity cost of

producing that good in terms of other goods is lower in that country than it is in other

countries. In this case, Spain has comparative advantage in growing flowers and Iceland has a

comparative advantage in producing aluminum. The standard of living could be increased if

both places if Spain would focus on producing flowers for Icelandic market, and Iceland

would focus on producing aluminum for the Spanish market. This gives great insight about

comparative advantage and international trade. This shows that trade between two countries

can be beneficial for both countries if each country exports the goods in which it has a

comparative advantage (Krugman & Obstfeld, 2003).

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The Ricardian model of international trade is an extremely useful tool to understand the

reasons why trade happens between nations and the effects of international trade on national

welfare. The Ricardian model still makes accurate predictions about international trade flows,

but there are number of ways in which the Ricardian model makes misleading predictions.

The model is simple and it predicts an extreme degree of specialization that is not always

accurate to the real world. Also the model shows no effect of income, resources and

economies of scale within countries and its effects on international trade. The Ricardian

model of international trade illustrate the potential benefits from trade, the model focuses on

international specialization and each country shifting its labor force from industries in which

that labor is relatively inefficient to industries in which it is relatively more efficient

(Krugman & Obstfeld, 2003).

The conclusion from Ricardian model according to the Icelandic trade direction is that Iceland

should focus on producing and export products that are have a lower opportunity cost than in

other countries. Using their effort on producing the products which there are best at, not

products they don’t offer any advantage even though in create jobs. Because the total value

addition increase when nations specialize in sectors which they have lower opportunity cost.

Iceland has an advantage in products have requires huge among of energy and need to by

close to fishing resources. This theory does not take into account land, cost of labor, cost of

capital or food security of a nation. Even though this theory is very simple, it give good basic

idea why nations trade.

The Heckscher-Ohlin Model

This theory shows that international trade is largely driven by difference in countries

resources, this theory is one of most influenced theories in international economics. It is also

referred as factor-proportions theory, because the theory emphasizes on the interplay between

the proportions in which different factors of production are available in different countries and

proportions in which they are used in production of different goods (Krugman & Obstfeld,

2003). According to the HO theory, a country specializes in the production of goods that it is

particularly suited to produce. This specialization in production and trade between countries

generates, according to the theory, a higher standard of living for the countries involved

(Nobelprize.org, 2006).

Features of the model are that factors of production, that is land, labor and capital will

determine a country's comparative advantage. Countries have comparative advantages in

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those goods which they have abundant locally, for example a country where capital and land

are abundant but labor is scarce will have comparative advantage in goods that require lots of

capital and land, but little labor (cheap labor). In this case the country is better off importing

goods that are labor intensive, like clothing and textile. Good example is the United States

with abundant of land and capital, and they export mainly agricultural products, computers,

machinery, vehicles, military equipment, chemical products and aircrafts. All these goods

require abundant of capital (including skilled workers) and in some cases also land intensive.

Meanwhile China as abundant of labor and capital, they tend to export labor intensive goods

like clothing and capital/labor intensive goods like electronics. The US has comparative

advantage in land and capital, while China has comparative advantage in labor (Choi, 2010).

Figure 3 (Nobelprize.org, 2006)

According to the HO model, tariffs and quotas have redistributive effects but reduce

efficiency. When redistribution is the main goal, there is generally a better way to

accomplished it (Leamer, 1995).

If we put the theory in use from Iceland's point of view, they have abundant of land and

resources. But the labor is scarce and few inhabitants compared to other countries. Over the

last decades Iceland has invested in more capital intensive goods and has distanced itself more

away from labor intensive goods, like clothing factories and other labor intensive industries.

With more focus on capital intensive goods like aluminum, hydro/geothermal plants, high

tech fishing with freezer trawlers, machinery and pharmaceuticals. While labor intensive

clothing factories and fishery plants have been outsourced to other countries or displaced with

high tech and low labor intensive machinery, making it less labor intensive and more capital

intensive.

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Figure 4- See on picture

Country A – having more capital than labor – has specialized in producing more cell phones

Country B- having more labor than capital – has specialized in producing more jeans

In this case, trade may benefit both countries involved (Nobelprize.org, 2006)

The conclusion from this chapter is that countries should focus on products that require things

that they have abundant locally. This is true for many countries that produce much of the

world’s clothing; they have abundant of cheap labor. Also countries like China that have

abundant of labor and capital, resulting that they produce large share of world’s need for

electronics and clothing. USA which has abundant of capital and land, they produce more

capital intensive products like airplanes, cars, military equipment and agricultural. Iceland has

focus more on capital intensive products, Iceland has to offer educated workforce, abundant

of land (compared to population) and close to resources that require high capital investment to

harvest.

Porter: The Competitive Advantage of Nations

Why are certain companies based in certain nations and how do the nations attract these

companies. Nations ruthlessly pursue improvements, seeking more sophisticated sources of

competitive advantage, how are they able to overcome these barriers. With Porter's Diamond

of national advantage, the answer lies in four broad attributes of nations. The playing field of

each nation establishes and operates for its industries. These attributes are:

Factor Conditions. What factors does a nation have to offer the production, such as

skilled labor or infrastructure, necessary to compete in given industry

Demand Conditions. The nature of home market demand for the industry's product or

service.

Related and Supporting Industries. The presence or absence of suppliers in the nation

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or other related industries that are internationally competitive.

Firm Strategy, Structure, and Rivalry. The conditions in the nation governing how

companies are created, organized, and managed, as well as the nature of domestic

rivalry. (Porter, 1990)

Figure 5 - Diamond diagram

Each point on the diamond and the diamond as whole system affects the essential ingredients

for reaching international competitive success. First, the availability of resources and labor

skills is necessary for competitive advantage in an industry. The information that shapes the

opportunities that companies perceive and the directions that they take in which they deploy

their resources and skills. The most import goals of the owners, management, and individuals

in the companies are to pressure on companies to invest and innovate (Porter, 1990).

Factor conditions: According to standard economic theory, nation will export factors which it

has abundant of. Labor, land, natural resources, capital and infrastructure will determine the

flow of trade. These classic economics date back to Adam Smith and David Ricardo,

according to Porter these ideas are at best incomplete and at worst incorrect. The most

important factors of production involve sustained and heavy investment and are specialized.

The basic factors like cheap labor and abundant of local raw material source, does not bring

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advantage in knowledge-intensive industries. Companies can easily access those factors

through global strategy or bypass them through technology. Having a workforce that is high

school or college educated does not by itself present competitive advantage in international

competition. To support competitive advantage, the factors must be highly specialized to an

industry's particular needs. A nation needs a scientific institute specialized in certain areas, a

pool of venture capital to fund innovation and industry upgrade. These factors can be scarce

and more difficult for foreign competitors to imitate, takes sustained investment to create

(Porter, The Competitive Advantage of Nations, 1990).

Nations succeed in industries where they are good at factor creation. Competitive advantage is

result of the presence of world-class institutions that first create specialized factors and then

continually working to upgrade them. Iceland has two universities that concentrate on

studying and researching in fields of pharmaceutical, biotechnology, medical science and

engineering. The result is Iceland has managed to diversify its exports with goods in

pharmaceutical, food processing machinery, medical equipment and selling medical research

result to the pharmaceutical industry. Without the presence of strong universities and research

institutions in Iceland those factors creation would have been fraction of its current presence

(Porter, The Competitive Advantage of Nations, 1990).

Disadvantages can become advantages only under certain conditions. First, they must send

companies the right signals about circumstances that will spread to other nations, thereby

equipping them to innovate in advance of foreign rivals. Some countries that experience labor

shortages have responded to this disadvantage by upgrading labor productivity and seeking

higher value, more sustainable market segments. In other parts of the world where there is

abundant of workers, tend to focus their attention on other issues, which resulted in slower

upgrading. Case in point is the Icelandic fishing industries, they have experienced labor

shortage and high labor cost in processing fish. Instead of exporting the fish and process it in

countries like China, they have focused on improving productivity with better technology. Big

part of that is from innovation in Iceland, where high tech companies research food

processing technologies in partnership with the fishing industry (Porter, 1990).

Demand Conditions: Home market demand helps to build competitive advantage when a

particular industry segment is larger or more visible in the domestic market than in foreign

markets, and gives a clearer or earlier picture of emerging buyer needs that pressures

companies to innovate faster. Local buyers can help a nation’s companies gain advantage if

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their needs anticipate or even shape of other nations, if their needs provide ongoing ―early

warning indications‖ of global market trends. With countries like Sweden with long standing

concern for safety and handicapped people has spawned into industry focused on this special

need. Denmark environmentalism has led to success for companies in water pollution control

and windmills (Porter, 1990).

Related and Supporting Industries: International home suppliers can create advantages in

downstream industries in several ways. First, they deliver the most cost-effective inputs in

efficient way. Home based related and supporting industries provide innovation and

upgrading, that is based on close working relationship. Suppliers and end-users located near

each other can take advantage of short line of communication, ongoing exchange of

information and innovations. Companies have the opportunity to influence their suppliers,

technical efforts and can serve as test sites for R&D work, accelerating the pace of innovation.

Case in point, close relation of the Icelandic companies building food processing equipment

for the fishing industry in Iceland. This supports the industry to maintain its competitive

advantage on international market with higher productivity, faster upgrades and higher value.

Companies benefit most when suppliers are themselves, global competitors. Suppliers should

also serve foreign competitors, preventing them to be dependent on domestic industry (Porter,

1990).

Firm Strategy, Structure and Rivalry: National circumstances and culture create strong

tendencies in how companies are created, organized, managed and how domestic rivalry will

be. In industries where Italian companies are world leader, they tend to focus customized

products, niche marketing, rapid change and flexibility fits to both the dynamics of the

industry and the character of the Italian management system. Products like Ferrari cars,

designer clothes, furniture, and packaging machines. But the German management system

works well in technical or engineering-oriented industries, where complex products demand

precision manufacturing and disciplined management system. German success is rather on big

market consumer goods and services where image marketing, rapid new-feature and model

turnover are important. Nations tend to be competitive in activities that people admire or

depend on. In Denmark they are more environmentally intergraded and focused on health care

issues, which resulted in world leader in wind mills and insulin products. In Israel, highest

callings have been in agricultural and defense related products. In Iceland the big focus has be

on good health care system, harvesting fish and energy resources. Highest calling have been

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in the fishing industry, energy sectors, energy intensive industries and health related products

(pharmaceutical and bio medic products) (Porter, 1990).

A video interview was taken with Michael Porter the man behind this theory in 2010 about

Iceland competitiveness as nation:

―Iceland is remarkable, unique location because of geothermal resources in Iceland and what

has happen in Iceland is that this tiny country has built a world class technological position in

this new form of clean energy. Iceland has developed more than other single location

technology in this field. Iceland has remarkable broad ways of uses of geothermal power, not

only to make electricity, but to heat homes, to support agricultural and many other fields. The

opportunity is so big that in Iceland they have to organize themselves better and have a better

strategy. They have to move more quickly, because there is so much demand of clean energy

in the world, and there are so many opportunities to grow geothermal power all over the

world, but what are missing, is the technology and the skills, which Iceland has.‖

―Iceland has remarkable position in variety of interesting fields, of course tourism, which we

all understand. But in software and variety of fields where Iceland tiny little country has some

remarkable expertise and strengths. But the challenge is to improving the economic policy to

keep streamlining the business environment and also give people confidence that the country

can succeed.‖ (Porter, MICHAEL PORTER IS INSPIRED BY ICELAND, 2010)

If we go back to the theory and how this interview relates to his theory of competitiveness of

nations:

Factor conditions: ―Iceland is that this tiny country has built a world class technological

position in this new form of clean energy‖ Nations succeed in industries where they are good

at factor creation. Competitive advantage is result of the presence of world-class institutions

that first create specialized factors and then continually working to upgrade them.

Demand conditions: ―Iceland has remarkable broad ways of uses of geothermal power, not

only to make electricity, but to heat homes, to support agricultural and many other fields.‖

Home market demand helps to build competitive advantage when a particular industry

segment is larger or more visible in the domestic market than in foreign markets, and gives a

clearer or earlier picture of emerging buyer needs that pressures companies to innovate faster.

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Related and supporting industries: Porter does not directly mention supporting industries in

this interview. But he mentions ―variety of fields where Iceland, tiny little country has some

remarkable expertise and strengths.‖ In that case of the geothermal industry the supporting

industries would be machine shops, engineering firms, drilling companies and companies that

specialize in installation of pipes. Home based related and supporting industries provide

innovation and upgrading, that is based on close working relationship.

Firm strategy, Structure and Rivalry: ―unique location because of geothermal resources in

Iceland‖ Icelandic companies have turned dangerous environmental circumstances of volcanic

environment into energy industry that serves homes and companies. ―They have to organize

themselves better and have a better strategy.‖ Which has often been the problem with

Icelandic companies in expansion, and being part of Icelandic culture to be less organize than

other Western European countries as mention in Icelandic negotiations chapter. National

circumstances and culture create strong tendencies in how companies are created, organized,

managed and how domestic rivalry will be. Nations tend to be competitive in activities that

people admire or depend on, in this case Iceland is depend on geothermal energy to heat up

their homes.

To further illustrate his approach to Iceland; His presentation in November 2010 taken in

Iceland, he said that ―Iceland has all possibilities to be a large player in this market in the

future‖, and that it would be important to now look into the future and the competitiveness of

the country. He referred to that Icelanders need to find ways to utilize the opportunities

presented by geothermal energy and sell their experience and know-how internationally, not

only the energy itself. In the future Icelanders have the possibility to own and operate

geothermal companies around the world. In the export of know-how, Icelandic engineering

and technical consultants have done a good job and projects with the involvement of Icelandic

players abroad have been successful.

He also mentions that the cluster approach that would be important for Iceland as it would

bring together all companies active in the sector and beyond. The Icelandic government and

government organizations and agencies should be assisting the industry where they could. He

also mentioned cluster work done in the U.S. state of Nevada and New Zealand that could be

competition for the Icelandic sector, but could also represent opportunities for cooperation.

(Richter, 2010)

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Iceland business culture and negotiations style

Iceland business culture is in many ways much younger than most other cultures in Europe. In

fact, Iceland has developed in just on century from a poor agricultural economy to an

advanced economy with specializations in fishing and technology (Eyjólfsdóttir & Smith,

1997). Iceland has one of the highest GDP per-capital currently is number 17th

of the

International monetary fund ranking system (economywatch, 2011).

In analyzing of the Icelandic business culture, this chapter will use upon the dimensions of

Hofstede study of 53 nations and regions. Even though Iceland was not included in that study,

his dimensions gives a great framework further analyzes. Hofstede four dimensions

(Hofstede, 2009):

Power distance – How society handles the fact that people are unequal

Individualism/collectivism – Shows how strong ties are between members of a society,

individualism focus on that everyone is expected to look after him/herself and his/immediate

family. Collectivism are which people from birth onwards are integrated into strong, cohesive

in groups, often extended families which continue protecting them in exchange for

unquestioning loyalty.

Masculinity/Feminity – Masculine societies (assertive, competitive and tough) versus

feminine societies (tender and quality of life)

Uncertainty avoidance - ―The extent to which the members of a culture feel threatened by

uncertain or unknown situations‖

Low Power Distance

Iceland does not have a history of any class difference and it has one of the most equally

distributed incomes among its people. Most Icelanders are therefore middle-class and the

lower class or ―working class‖ has little feeling of inferiority, often skilled seamen and skilled

labor force are better off economically than public officials and professionals. People

therefore undertake higher education not only for the power or materialistic reasons, but

because they are driven by old idea that knowledge, individual excellence and artistic ability

is valued above all else.

Difference between managers and subordinates are not clearly market, as a result of the

informal and egalitarian attitudes towards those inside or outside an organization. Nobody in

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Iceland are referred by a last name, people address each other by first name. People are also

reluctant to add titles or status to their names for fear being ridiculed when modesty is the

norm. With small population of 320.000 inhabitants, most people know each other more or

less. This means that superiors are less likely to be autocratic. This creates more friendly and

relaxed atmosphere between the top and bottom of very flat hierarchy in companies

(Eyjólfsdóttir & Smith, 1997).

Individualism

With many ―collectivist‖ characteristics of Icelandic society, such as equality over individual

freedom, high level of organization commitment, the dominant role of the state in the

economy and representing collective interests. But individualistic characteristics are also

strong in the Icelandic mentality and may be growing stronger. Children in Iceland are

brought up to be very independent. The vast majority of high school and university students

finance most of their own studies by working during the summer holidays, also working on

weekends and other holidays during the semester. Icelanders in general are very hard workers,

they have one of the largest labor force relative to size. Many hold two jobs and most of them

own their housed (70-80%), cost of living in Iceland is high and many Icelander have

tendency to live beyond one's means. In last 20 years Icelandic society has turned more

towards individualism, because of more positive attitudes towards increased competition,

private ownerships and less market regulation (Eyjólfsdóttir & Smith, 1997). But some would

argue that collectivism has gone stronger after the crisis with high employment rate, more

financial regulation and government focus to protect the social welfare system with higher

taxation. All things that to focus more on the community and the well being of the nation as a

whole, but all previous individualism points mention before are still valid today in Iceland

society even though collectivism has some aspects gotten stronger.

Femininity

Like other Scandinavian countries, Iceland holds strongly feminine values and quality of life.

With high standard of living, that is enjoyed by the great majority of the population. This is

further supported with the highest literacy rate 99.9% in the world and also with the lowest

infant mortality rate 1,8 per 1000 (World Bank, 2011).Iceland remains the country that has the

greatest equality between men and women, according to an annual report by the World

Economic Forum (WEF), also electing the first female president in the world (BBC, 2010).

With low power distance and individualism, with touches on some of the aspects of cultural

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femininity: modesty in self-presentation regardless of one's excellence or status, the search for

consensus with organizations and acceptance of failure (Eyjólfsdóttir & Smith, 1997).

Uncertainty of avoidance

Icelandic people should be more used to uncertainty than most other nations, because of the

harsh environment in which the live. Used to frequent earthquakes, volcanic eruptions and

changing weather makes it hard to avoid uncertainty. Hofstede predicted that low-uncertainty

avoidance nations will report greater happiness. Surveys have shown that Icelanders are

among the happiest in the world, even though with possibly high uncertainty of avoidance.

This can partly be explained by optimistic and generally positive state of mind, they feel quite

comfortable in ambiguous situations. As a consequence, Icelanders tend to lack self-discipline

and are often not punctual or detailed. Sometime they tend to be overly optimistic to the

extent of appearing careless. This lack of self-discipline allows room for originality,

flexibility and innovation (Eyjólfsdóttir & Smith, 1997).

Fisherman and Viking mentality

To understand the short-term orientation of Iceland society, you also need to understand the

fisherman mentality. The fishing industry is and has been the most important sector of

Iceland's economy and it has the characteristic of being very unstable economic environment,

which make it sometimes complicated to run and predict future income. To briefly describe

the fisherman mentality. A fisherman is dependent on luck and therefore sees no need to plan

how long he will fish. He goes fishing and hopes for a fast result. If he does not catch any fish

soon, he will give up for the day and try to find another location to fish. A fisherman is not

constrained by punctuality or by much organization. He is flexible and will work hard when

the fishing season is good, also tend to think they know their job and are not eager to adopt

new fishing techniques .Still today many Icelanders have very pragmatic approach to

management, fisherman society to not have the same need for management as like in

industrial society (Eyjólfsdóttir & Smith, 1997).

Like their ancestors the Vikings. Icelanders tend to be restless, artistic, fearless, fiercely

independent and stubborn men of action and enterprise. This is in many ways a strange

combination, but it allows the individual to be original, influence the environment, be curious

and capacity to take risks in more daring than cautious way. This creative ways of thinking

has blossomed entrepreneurship in Iceland since their independence, but many entrepreneurs

have either been insufficiently cautious or overestimated their abilities to manage a business

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on their own, and thus went bankrupt (Eyjólfsdóttir & Smith, 1997). Iceland shows the

highest total early stage entrepreneurship(TEA) in the world in the innovation driven

economies according to 2010 Global Entrepreneurship monitor (Kelly, Bosman, & Amarós,

2010).

Icelandic business culture

Icelandic business culture follows low-power distance and there is not much hierarchy in

Icelandic organizations. Managers in Iceland can be regarded as informal, direct and even

arrogant when doing business with foreigners. The Icelandic managers are used to direct

communication because of the low power-distance that is typical in the Icelandic culture

(Davidsdóttir, 2006). With regards to uncertainty of avoidance, Icelandic managers are not

afraid of taking risks, are thought to improvise and are unpredictable which is confusing for

the Scandinavian countries. They also have tendency to not follow formal rules, they do not

rely on their subordinates but on the other hand they highly rely on unwritten rules, their co-

workers and their own experience (Smith, Andersen, Ekelund, Gravesen, & Ropo, 2003).

Iceland has some typical characteristics of management with low uncertainty avoidance.

According to Davidsdóttir report, some non-Icelanders think managing a company the

Icelandic way is all to do with speedy operations and fast decision-making. The leadership

style is often claimed by foreigners to be similar to the American business culture. Icelanders

have a reputation for using different methods of doing business than other countries, quotes:

―Icelanders are intense and good at catching opportunities‖ and ―Icelanders are unafraid go-

getters and want to conquer the world‖ and ―Icelandic managers are straightforward‖, this

gives an insight into how others view Icelandic business culture. In Davidsdóttir report also

finds that Icelandic management culture and business methods in many ways contracts the

way business is managed in the Scandinavian countries of Norway, Sweden and Denmark

(Davidsdóttir, 2006).

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Chapter conclusion

This chapter mostly relied on the data from article from ―Icelandic business and management

culture‖ by H.M Eyjólfsdóttir and Peter B. Smith. This data was collected from Icelandic

managers with questionnaire survey and comparing them with other comparable surveys

made in other countries. Even though this data is from 1997, most of the points are still

relevant today. This article was most accurate according to Hofstede dimensions, adding

newer articles as well to this chapter. This analysis has mostly relied upon Hofstede's

concepts and his terms. To characteristic the Icelandic business and management culture as

typically Nordic and unique is not far off. Icelandic managers resemble other Scandinavian

nations in their emphasis upon low power distance, low uncertainty avoidance, and strongly

feminine values. However, the manner in which their balance of individualism and

collectivism is expressed is distinctive. In north Europe, managers report frequently with their

subordinates and rather less frequent contacts with their bosses and with colleagues at the

same level. Managers in Iceland report frequent with their executives and colleagues at same

level, much less with their subordinates.

In recent years the Icelandic businses management culture shifted more towards American

management culture with fast decison making and more risking taking. But the management

culture still has Scandinavian abroach in lower power distance and femininat values in work

places. Icelandic business management offers mix of American and Scandinavian culture, that

can be mostly explained by Iceland geographic location and cultural relationships. This

management style has served them well in some areas, some not so well as the finanical crisis

indicates. The harsh and dangerous enviroment over the centuries in Iceland has shaped the

mentality of the Icelanders, were fast decsion making is necesary to survie the nature

elements. But Icelanders have not distance them self away from their Scandinavian roots, of

little class difference among people, importance of quality life and gender equality.

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Trade relations, agreements and trade policy

Free trade agreements, under which governments remove tariffs and other barriers to the free

movements of goods and services across borders, are important on many levels. They affect

unemployment, wages, market access for exports and imports, as well as investments and of

country's industry structure, and they have significant political importance (Kocic, 2010).

Market access and investment – Under free trade agreement firms get better access to

larger markets and consumers get more choices with lower prices. Leads to more

foreign directed investment.

Jobs – With increased competition and some production moving to other countries

leads to job losses in some sectors. But new market opportunities for exporters leads to

new job creation.

Wages – In sectors that are affected by cheaper imports, there is pressure downwards

on the wages and the bargaining strength of the workforce. Workers in other sectors

that experience extra demand by the free trade agreement may insist on higher wages.

Political Importance – Countries enter into free trade agreements hoping that

economic cooperation will improve political ties and demonstrate closer relationship.

Globalization has increased both their economic and political significance (Kocic,

2010).

The vast majority of Iceland's exports go to the European Union (EU) and the European Free

Trade Association (EFTA) countries, followed by United States and Japan. The U.S. is by far

the largest foreign investor in Iceland, primarily in the aluminum industry (CIA, 2011). To get

closer details on Iceland trade see appendix number 2.

EFTA

In 1970 Iceland joined EFTA (European Free Trade Association). At the time, the other

members were Great Britain, Denmark, Norway, Portugal, Sweden, Switzerland and Austria.

(3) Iceland, Liechtenstein, Norway and Switzerland are current members of EFTA. The EFTA

Convention established a free trade area among its Member States in 1960. In addition, the

EFTA States have jointly concluded free trade agreements with a number of countries in

Central and Eastern Europe as well as in the Mediterranean region, Mexico and Singapore.

Iceland, Liechtenstein and Norway entered into the Agreement on the European Economic

Area (EEA) in 1992, which entered into force in 1994. The current contracting parties are, in

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addition to the three EFTA states, the European Community and the 15 EC Member States. In

addition Iceland has bilateral agreements with its two neighboring countries Greenland and

the Faeroe Islands (Icelandic customs authorities, 2011).

EEA

Iceland's relation to the European Union is mainly based on the Agreement on the European

Economic Area (EEA) which came into effect in 1994. Iceland's most extensive trade

agreement is within the EEA, which forms the basis for a common market for goods, services,

capital and labor between the 15 member countries of the European Union (EU) and three

member countries of the European Free Trade Association (EFTA), which includes Iceland.

The EEA agreement unites the EU member states and the three EFTA EEA states (Iceland,

Liechtenstein and Norway) into one single market governed by the same basic rules (Ministry

of foreign affairs, 2011).

Other trade organizations

Iceland is also a member of WTO, OECD and a number of other trade related

organizations.(2) Iceland became an associated member the General Agreements on Tariffs

and Trade (GATT) in 1964 and a full member in 1968. Iceland was a founding member of the

successor organization, the World Trade Organization (WTO) in 1995 (Ministry of foreign

affairs, 2000).

General history of Icelandic foreign trade, policy and direction

Fish and fish products command an overwhelming share in Icelandic exports. This can be

both an advantage (by implying a high degree of specialization) and a disadvantage (due to

the vulnerability of such an undiversified economy).

Table 3- Iceland Exports percentage of marine products (Embassy of Iceland, 2011)

1960s 1970s 2006

Marine product 90% 75-80% 51%

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The importance of fish exports starts falling the in 1970s when export of aluminum becomes

new export for the Icelandic economy (Embassy of Iceland, 2011). The decreasing

importance of fish products in the export sectors can be explained by more diversified

economy and exports. Such as aluminum, ferro-silicon alloys, machinery, software,

pharmaceuticals, woolen goods and electronic equipment for the fishing industry (CIA, 2011).

Imports are very diversified. Iceland is totally dependent on imports for its demand of oil and

auto products, and other machinery. Also has high dependent on wheat, timber and other

food related stuff. (4) The agricultural sector remains heavily subsidized and protected.

Iceland does not import much of meat, dairy products and live animals because of this

protection (U.S. department of state, 2011).

The foreign trade of Iceland is reflected in its geographical location, midway between Europe

and America. There have been considerable fluctuations in the geographical distribution of

exports in the last decades and this reflects that certain important fish exports are closely tied

to certain market or countries. Thus export of salted fish is largely in Spain and Portugal, and

market for fresh fish on ice is mostly in Northern Europe (UK and Germany main outlets).

Politics, domestic or international, is a big factor of shaping the geographical distribution of

trade. Some of the cases to support this were increase trade with Soviet Union in the wake of

the Cod War with the UK in the 1950s and another in a smaller scale, the closing down of

export of stockfish to Africa during the Bianfran war. Also product prices and exchanges rate

are important determinant of the geographical distribution of Iceland's exports, one case of

Iceland's exports followed the strong dollar in early 1980 and later they avoided the US

market as the dollar weakened half decade later (Embassy of Iceland, 2011).

Iceland trading policy was strengthened by accession to the European Economic Area in 1994

(EEA) and by the World Trade Organization (WTO) Uruguay Round agreement, which also

brought significantly improved market access for Iceland exports and specially seafood

products.(6) Extensive trade is conducted with the European Union, which is by far the most

important market area. In 1998 no less than 65% of Iceland's export markets were in the EU

(Embassy of Iceland, 2011).

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Iceland: PESTLE analysis

The Icelandic economy is in need for more foreign investor and investment. That would

create more jobs and increase exporting. Foreign companies have mainly been interested

investing in energy demanding industries that are aimed for export to foreign markets. The

Icelandic market is small and does not attract many investors for domestic use that is not

aimed for export.

This PESTLE analysis will describe the macro environment factors that could affect

companies interested to invest or entering the Icelandic market. Also factors that could affect

the economy and the exporting factors, this chapter analyses political, economic, social,

technological, legal and environmental structure of Iceland. The PESTLE segments are

supplemented with relevant quantitative data to support trend analysis.

Geography

Iceland is a volcanic island located south of the Arctic Circle in the North Atlantic, around

300 km east of Greenland and 4000 km north-east of North America. The nearest countries to

the east are the Faroe Islands (around 400 km away), Scotland (around 800 km away) and

Norway (around 950 km away). Iceland has an area of approximately 103,000 sqkm and is the

second largest island in Europe after Great Britain (About, 2005).

Figure 6- The following map shows the location of Iceland in the North Atlantic (Google

Maps, 2011):

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Flight time from capital of Reykjavík (Keflavik international Airport is about 45 minutes

drive from Reykjavík) to the European capitals of London, Paris, Berlin, Copenhagen and

Amsterdam is approximately three to three and a half hours. Cities in the US like New York

and Minneapolis are around five to six hours away by air (Iceland Trade Directory, 2011).

The landscape of Iceland is dominated by strong contracts between sea and mountains,

glaciers are around 10% of total area, also many volcanic zones and hot springs. The large

part of Iceland is untouched and uninhabited. Iceland has a low population density, with

around 318,000 inhabitants in area of 103,000 sqkm (around 3 inhabitants per sqkem). Two-

third of the population lives in the capital of Reykjavik or in surrounding area (CIA, 2011).

Despite its northerly location near the Arctic Circles, Iceland enjoys a relatively mild climate

due to the Gulf Stream, with only minor difference between average temperature in winter

and summer. During the coldest month of January, Reykjavík has an average temperature of

around -0.4°C (which is roughly equal to the average temperature in New York in January),

while average temperatures climb to 11.2°C in the warmest month of July (Iceland Trade

Directory, 2011).

Opportunities and threats of Geography

Iceland has some geographic importance, its midway between North American and Northern

Europe. It has served has military base and strategic importance since the World War 2, but

the airbase has closet down (2006) due to spending cuts by the US military. But still has some

opportunities by its geographic location, here are some examples:

The Icelandair airline has transformed Iceland’s geographical location between North

America and Europe into a business opportunity by building an international route network

with Iceland as a hub.What Icelandair’s international expansion has accomplished for

Icelanders, apart from an increase in the number of tourists and the business activities that

have developed around the tourist industry throughout the country, is a system of outstanding

flight services between Iceland and other countries (Icelandair, 2011). This show the

geographic importance when comes for flights through the North Atlantic ocean, specially

flights from North America to Europe. More airlines could use this opportunity to use Iceland

as a hub for flight and airplanes.

The rapid melting of the North Arctic sea route is opening new possibilities for Iceland, this

would make new shipping route for goods coming from Asia to Europe or east coast of US.

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Iceland lies just in the pathway of the shipping route, this important geographic location could

bring investment in Iceland for servicing ships and uploading port (Seidler, 2010).

Threats are mostly concerning volcanic eruptions that usually happens every 5 years, 98%

percent of the inhabitants don't live close to those threats. This mostly affects airports and

roads being closed down due to ash. Iceland sits astride the middle of the Mid-Atlantic Ridge.

These eruptions are caused by the separation of the North American and Eurasian tectonic

plates (Iceland.is, 2011). Iceland an island in the North Atlantic and has some isolation

factors, and it brings some disadvantages in transportation and traveling. It takes bit longer

and cost more to travel to Iceland than other European countries (if traveling from London).

Political environment

In 1918, Iceland achieved independence from the Danish state by becoming a sovereign state

under the Danish Crown. However, Denmark still assumed control over Icelandic foreign

affairs. On 17th June (National Holiday) 1944, Iceland formally became an independent

republic after communication with Denmark had severed as a result of the German occupation

of Denmark in 1940. Today the country is a parliamentary republic with a president (head of

state), a prime minister (head of government), a cabinet with 12 ministers (including prime

minister) and a unicameral parliament with 63 members.

In the autumn of 2008, the Icelandic banking sector collapsed as a result of the worldwide

economic crisis, precipitating Iceland's own economic crisis. In the face of serious protests

and distrust from the public, the government, a coalition of the Independence Party (IP) and

the Social Democratic Alliance (SDA) under the Prime Minister Geir Hilmar Haarde,

resigned in January 2009.

In April 2009, a majority coalition between the SDA and the environmentally focused Left-

Green Movement (LG) was elected. Johanna Sigurdardottir (SDA) is the first female prime

minister in Iceland. The country is further represented by President Olafur Ragnar Grimsson.

The new government has initiated economic reforms and has also submitted the controversial

application for Iceland to join the European Union (Iceland Chamber of commerce, 2011).

Threat and opportunities on the political environment

With left wing government in control in Iceland at the moment, new tax ideas have been

proposed with increased corporate tax. This is also recommended by the International

monetary fund, they have been advancing that the government reform their tax system on

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natural resources and strengthen the corporate tax system (IMF, 2011). This could scare away

possible investors and even scare some large corporation away from Iceland and consequently

it could affect the export values in the long run.

On the other hand the government has initiated significant economic reforms and submitted

Iceland's application to join the European Union (EU), the application process will take few

years and after that the Icelandic people will vote on joining the EU (Traveldocs.com, 2011).

The government has been able to refinance the banking sectors and brought the economy

stable levels. They have brought back trust on the international finance market with successful

bonds issued for $1 billion in June 2011 (Wall street journal, 2011). This is a good indicator

that the Icelandic economic market is gaining back the trust form investors, who are willing to

invest in Icelandic bonds and see a brighter future ahead for Iceland.

Economical environment

Before the crisis Icelandic economy depends heavily on the fishing industry, which makes up

roughly 40% of the total export earnings and employs 7% of the workforce. However, in the

last decades efforts have been made to diversify the economy into manufacturing and

services, with new developments in the area of software production and biotechnology.

Tourism has shown steady growth rates and is becoming more and more important for the

country’s economy. In the years prior to the crisis of 2008, the Icelandic economy recorded

high growth rates with average growth of GDP from 2004 to 2008: 5.3%, virtually full

employment (unemployment of 1.0% in 2007 and 1.6% in 2008) and a remarkably even

distribution of income.

Foreign investors were attracted by emphasizing the low corporate tax rate of 15%, low

energy prices, also with Iceland being the only country in Europe with 100% of energy

consumption from renewable energies and with special incentives for companies willing to

invest in Iceland (IMF, 2008).

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Figure 7- Danske bank predictions % by Lars Christansen 14.04.2011 see below (Christansen,

2011)

According to the report from Danske Bank the Icelandic economy is recovering after the

collapse of the Icelandic banking sector in October 2008. They believe that recovery could

prove sustainable, as macro-economic imbalances have been reduced significantly.

It is expected that Icelandic GDP growth of around 3-4% in the coming two to three

years

Inflation is likely to continue to ease and should stay below the Icelandic central

bank's inflation target of 2.5% throughout 2011-2013

Purchasing power parity (PPP) estimates indicate the Icelandic krona is around 25%

undervalued versus the euro on the of shore basis. The offshore krona rate is much

more undervalued (Christansen, 2011)

Main sectors of industries

The fishing industry contributes the largest share of Iceland's exports. Next to fish and fish

products, exports include aluminum, animal products, ferrosilicon and diatomite. Iceland has

been a member of the European Economic Area since 1994, which has improved market

access for the country’s exports (CIA, 2011). The figure below shows percentage of

employment by industry (Central Bank of Iceland, 2010).

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Figure 8 - (Central Bank of Iceland, 2010)

As seen on figure, fishing and agriculture have been declining as total workforce since the

1963. This can be explained by better industry technology and some cases decline in

production. The economy of Iceland has become more diversified with more jobs in finance,

tourism, aluminum and other industries like software and pharmaceutical. The decline of

government services in 2000 can mostly be explained by privatization of some of it services,

like postal service, communication services, banks and other private companies take over

services that was previously done by the State. Also some public services are not categorized

as same as before, even though they are still owned 100% by the State. People in Iceland have

not seen much decline in public service, even though these numbers could indicate large

decline in public service.

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Foreign trade in figures

Figure 9 - Adapted from central bank of Iceland statics (Statistics Institute of Iceland, 2011)

As seen in year 2000 there is massive negative balance on trade, this negative balance

continues from 2000 to 2008. This is more clearly shown in first chapter ―Rise of the

icelandic economy‖ in figure 2. This was caused by boosting domestic demand, private

consumers, companies and public sector borrowed increasingly in foreign currency. Also

booming construction industry, financial sector becoming more privatized and expand rapidly

to foreign markets (Central Bank of Iceland, 2010, bls. 66). In 2009 is drastic positive change

in the trade balance due the significant drop value of currency (krona) and result of drop in

private consumption directed towards imported durable goods. This fall from previously high

level imports has led to a large positive contribution to growth from net exports, resulting in a

much smaller loss of output and jobs. Also affecting this is the fact that Icelandic export

volumes have not hit by the global demand contraction to the same extent as in many other

countries. This transfer of expenditure towards the domestic economy and the relative

strength of exports has facilitated by the plunge of the exchange rate (Central Bank of Iceland,

2010)

1990 1995 2000 2009

-1000

0

1000

2000

3000

4000

5000

16841925

3161

4565

1615 1728

3837 3767

69197

-676

798

Iceland: Trade in goods

Exports

Imports

Balance

Year

Mill

ion

s o

f E

uro

s

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Figure 10 - Geographic distribution of foreign trade (fob value) 2009, adapted from (Central

Bank of Iceland, 2010)

EU or the European Union is Iceland's main export partner. The UK, Netherlands and

Germany are Iceland's main export partners in the EU (as seen in appendix 3). Iceland is a

member of the European Economic Agreement which explains the high percentage of export

to the European Union. When including other European countries (Norway, Russia and

Eastern Europe) outside EU it is almost 90% of total exports of Icelandic economy. Iceland

has a great access to the European Union market, with the EEA agreement and constant

shipping routes to mainland Europe. Developing countries like China and India are becoming

more important export partners and USA is coming less import than it had been in the decades

before. (see in appendix 2 )

77,7

3,911,2 8,9

EU USA Other European countries

Developing countries

2009 Exports

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Figure 11 - - Geographic distribution of foreign trade (fob value) 2009 (Central Bank of

Iceland, 2010)

Iceland's main imports partner is EU, this is also explained by the EEA agreement which

allows imports of goods with none or less tariffs than other countries. But other European

countries and developing countries are much stronger in the import sector than export sector

of Iceland economy. To see more details and evolution of the import sector.(see in appendix

2)

Taxes and foreign investment laws

The Icelandic tax system is relatively simple and effective. Current objectives aim to reduce

tax rates further, broaden the tax base and conclude additional double taxation conventions.

These actions will further increase the competitiveness of Icelandic corporations and attract

foreign investors. Corporate income tax stands at 20%, one of the lowest tax rates within the

OECD member countries (Invest in Iceland Agency, 2011).

Some characteristics of Icelandic tax law:

Corporate income tax of 20% on net income only

No municipal taxes on corporate profits

Foreign tax credit available to avoid double taxation in the absence of tax treaties

No tax on dividends received by corporations

Individuals tax rate 37,22% to 46,12% depending on income

46,1

6,2

18,214,8

EU USA Other European countries

Developing countries

2009 Imports

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Individuals get reimbursement of ISK 44.205 pr. Month (About 400$)

The financial income of individuals is taxed at a rate of 10%

There are some restrictions by foreign investment in fishing, energy, and airlines. Other types

of foreign entities are free to establish and own any type of business enterprise and engage in

all forms of legal remunerative activity. If a foreign citizen from outside the EEA wishes to

purchase land or real estate in Iceland, a permit is required from the Ministry of Justice.

Icelandic law treats private and public enterprises with equality when it comes to market

access and other business operations. Foreign investors are permitted to participate in the

privatization of government-owned businesses, subject to restrictions imposed by the

government (Dimireva, 2010).

Iceland’s foreign investment framework is one of the world’s most restrictive according to

OECD reports. The reasons for Iceland’s poor performance are the limitations set on foreign

investor ownership share in fisheries and processing, harnessing and production of power and

distribution, along with ownership in flight operations. The restrictions are mostly directed at

countries outside the EEA, but in the fisheries sector, all foreign parties, regards of

nationality, are forbidden to own more than 25 percent of the share capital or initial capital in

fisheries companies and no more than 49 percent shall be owned indirectly (Ministry of

foreign affairs, 2011).

Threat and opportunities in the economical environment

Because of the crisis and currency exchange controls the rules restrict the outflow of foreign

currencies from Iceland unless the currency is used to import goods or services or to travel.

This means at the present time that foreign investors in Iceland cannot remove their capital.

The rules allow for purchasing foreign currencies to pay on interest, indexation, dividends,

capital gains, contractual installment payments and salaries. It is prohibited to settle

transactions of transferable financial instruments denominated in ISK in foreign currencies,

and to conduct cross-border prepayment of financial instruments (Dimireva, 2010).

Another threat for the Icelandic economy is the indexed- loans, these loans are most common

long-term loans for individuals and small businesses. Indexed loans are usually long-term, in

Iceland they are affected by inflation and consumption index. This is done in Iceland because

prices typically rise over time and the principal amount of the loan thus loses value with every

time period, benefitting the borrower and hurting the lender. But with indexed loans it's turned

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around, benefitting the lender and hurting the borrower (or borrower taking all the risk)

(Investorwords, 2011). It has been argued by some economists that these loans actually fuel

up the inflation and cause more damage to the economy. Indexed loans are common in

countries that have experienced problems with inflation and unstable currency (University of

Iceland, 2003).With these loans and high inflation it's hard for individuals and businesses to

plan ahead into the future and the tendency they will pay more for borrowing money than

those in countries without indexed loans.

Figure 12 – Inflation from 2003 to 2011 (Central Bank of Iceland, 2010)

Main opportunities

Tourism

Renewable Energy - Hydro/Geothermal

Fishing

Industries that require and are dependent on cheap energy

Industries that want clean and renewable energy for their service or production

Prosperity has been built largely on Iceland’s comparative advantages in abundant marine and

energy resources. Tourism has been among the fastest-growing industries in Iceland in recent

years. Over the past 10 years, the number of foreign tourists has risen by 60% to 495 thousand

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in 2009, becoming one of the main engines of export growth in Iceland (Central Bank of

Iceland, 2010). Cheap energy has attracted foreign investment in power intensive industries,

and now aluminum and ferrosilicon are important exports (Randburg, 2011). Iceland has

started to attracted new opportunities in software and computer services, especially in

growing market of data centers. That requires large amounts of land and energy, especially

renewable energy for the company image. This is what Iceland has to offer to those

companies:

Location, its placement between Europe and the U.S. means that companies in the U.S. can

run their web services for both continents in one location, potentially saving money. Secondly,

because of its abundant hydropower and geothermal power, Iceland can offer data center

services powered by 100 percent clean power for the same price or less than web services

powered by fossil fuel-based grids in other locations. Internet companies can use the clean

power to market their green services, or take advantage of green subsidies in certain markets

(Fehrenbacher, 2010).

The country's largest energy company Landsvirkjun, has started researching for a sub-sea

cable project which began last year and is estimated to finish by the end of 2011. The plan is

to see how profitable it is to sell energy through underwater sea cable to European homes. On

the drawing board for receiving such energy are Britain, Norway, Holland and Germany,

which means they need cable at least 745 miles long, with potential to stretch up to 1180

miles. Iceland can sell estimated five terawatt-hours, or approximately five billion kilowatt-

hours, annually enough to power 1.25 million European homes. At current prices, that's about

$400 million in revenues each year (Nusca, 2011).

Other industries

In other export industries like software and agricultural offers also great possibilities, the

strength of Icelandic software sector lies in entrepreneurial labor, small-scale teams, good

education and adaptability reinforced with sophisticated telecommunication systems.

Icelandic IT and software companies have specialist know-how and long practical experience

in creating solutions for food processing and fisheries, bank technology, multimedia, Internet

applications, electronic commerce, real-time telecommunications systems for aviation and

transport, medical software, and general office and database systems, In the last 10 years ITC

exports have been around 0,5 to 1% of Iceland total exports of goods. (Iceland Trade

Directory, 2011).

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The Agriculture industry has been as small scale industry in Iceland since the 1980; high

potential exist in Iceland for developing both land- and sea-based farming. Major advantages

include abundant supplies of clean fresh water and economical geothermal for heating, which

means that framing of warm water species, is equally viable. One of the key advantages of

farming in Iceland is the virtually disease-free environment. It is the only country in Europe to

be A-grade nationwide according to EU regulations. Agricultural exports have been increasing

in Iceland should expand significantly in the future and forecast for 2012 estimates exports of

36000 million isk, up from 1400 million isk in 2003 (Iceland Trade Directory, 2011).

Social environment and Demographics

Iceland is a modern welfare state that guarantees its citizens access to universal health care,

education, and a high degree of social security. 28% of the GDP in 2009 was spent on health,

education, welfare, social security and other social affairs. Life expectancy is one of the

highest in the world and with one of world's lowest infant mortality rate (2,5 per 1000 live

births in 2008) testify to the advanced status of health care in Iceland, both primary health

care and hospitals. Health care services are mainly free of charge, except from adult dental

services. Education is free of charge throughout all public levels, but some private schools

and universities charge extra fees or tuitions from students.

University enrollment has increased substantially in recent years. In 1997, 21% of population

had a university degree. But in 2007, 30% of the population held a university degree. About

one of every five university degree held by Icelanders is obtained in other countries. The ratio

of pre-school enrollment is also one of the highest among the OECD countries (Central Bank

of Iceland, 2010). This can be explained by that Iceland has the highest rate of women's

participation in the labor market among the OECD countries, or 82,6%. Women are 45,5% of

the Icelandic labor force. Women work 37 hours a week and men work 47 hours on average.

In spite of this active participation in the workforce and long working hours, Iceland has one

of the highest fertility rates in Europe, or 2,1 children per woman. Women started entering the

labor market at an increased rate in the 1970s. This development has been met with childcare

for pre-school children, also strong legal right for parents to return to their jobs after

childbirth and generous parental leave system (Ministry of Welfare, 2011).

Iceland remains the country that has the greatest equality between men and women according

to annual report by the World Economic Forum (WEF). The report measures equality in areas

of politics, education, employment and health. "Low gender gaps are directly correlated with

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high economic competitiveness. Women and girls must be treated equally if a country is to

grow and prosper." said Klaus Schwab, founder and executive chairman of the World

Economic Forum (BBC, 2010).

Iceland is considered to part of the ―Nordic Model‖ with mixed market economy and with

generous welfare system. The aim of the model is to enhance individual independence, human

rights and stabilizing the economy. It is distinguished from other welfare states with similar

goals by its emphasis on high labor force participation, promoting gender equality, education

and extensive benefit levels, large magnitude of redistribution and liberal use public funds

(Andersen, 1991).

Statistics below from (Nationsencyclopedia, 2000)

The population of Iceland was 318,452 1 January 2011, compared with 317,630 1 January

2010. Although increasing, the population growth of 0.3% was nevertheless historically low.

This is due to negative net migration in 2010, just barely outweighed by the natural

population growth (births less deaths) (Statics Institute of Iceland, 2010). The population has

nevertheless grown in the past five years by an annual average growth rate of 1.2%. Iceland

has a relatively young and middle-aged population—65 percent are between 15 and 64 years,

23 percent less than 14 years, and 12 percent aged 65 and older. It enjoys one of the highest

life expectancy rates in the world. Iceland also possesses one of the world's highest literacy

rates at 99.9 percent (1997 est.). Literature and poetry are a passion of the people and its per

capita publication of books and magazines is the highest in the world (Nationsencyclopedia,

23 %

65 %

12 %

Age structure percentage0-14 15-64 65+

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2000).

Threat and opportunities in the social environment

Iceland has young and educated workforce, with higher birth rate (2,1) than most European

countries it gives Iceland greater balance with longer life expectancy. Iceland is not

experiencing the same problems as other countries in Europe with aging population and low

birth rate. People in Iceland take later retirement, official age is 67 years of age (with good

health people tend to work longer), also with good healthcare and low infant mortality rate.

All these factors improve Iceland's competitiveness on the international market.

With the financial crisis not over and with many young students studying abroad, there been

indications that large number of medical students and other educated students don't move

back to Iceland, especially because of bad job market at the moment and better salaries

abroad. This makes it really important to speed up the recovery of Iceland economy so they

don't experience brain drain of young educated doctors and other skilled workers. Also young

families have moved to other countries for job opportunities because of the crisis, this can

mostly explain low population growth rate in 2010.

Technological environment and infrastructure

The communication market in Iceland is characterized to be one of the highest penetrations of

internet, mobile phone, and broadband and fiber optic connections in the world. In 2009, 90%

of households in Iceland had internet connection, as 67% in other European countries. Nearly

all internet connections are high-speed, and 90% of connected households are regular users,

compared to 62% in EU (Central Bank of Iceland, 2010). The country's state of the art energy

infrastructure is highly ranked on international business indices for reliability, efficiency and

cost (Invest in Iceland Agency, 2010).

Because of Iceland's isolation as an island in the North Atlantic it is highly dependent on both

imports and exports. Iceland has therefore developed extensive air and maritime services to

hand its cargo and passengers transportation needs, and both harbor and airport capacities are

being steadily increased. There are 57 sea ports in Iceland; all ice-free year round and 15 ports

have some cargo activity. The port of Reykjavik receives more than 79% of all imports to

Iceland, and direct scheduled to Europe is also operated from three main ports in the western,

northern and eastern regions respectively. Four international-standard airports are in Iceland,

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Keflavik is the main international airport (30min drive from Reykjavik) and a border point for

entering Europe under the Schengen Agreement (Iceland Trade Directory, 2011).

Iceland has an extensive road system that connects the various coastal communities around

the country and is kept open all year round. Trucking has increased dramatically in recent

years and there are now daily haulage services from Reykjavik to every major community

(Iceland Trade Directory, 2011). The road system around the island may not impressive

compared to typical European road system, but most of roads to all major communities and

towns are paved. But around the country side and in wilderness most of the roads are unpaved

and narrow.

Threats and opportunities in the technological environment

Icelandic companies have specialist know-how and long experience in creating solutions for

food processing and fisheries, bank technology, multimedia, internet applications, electronic

commerce, real-time telecommunications systems for aviation and transport, medical

software, and general office and database systems. These give possibilities to expand to other

foreign markets with new better technological communications to the mainland with

improved broadband data capacity (Icenews, 2011). Iceland relies on under water sea cables

to be connected to the world, if any of those cables would get damage to cut off Iceland’s

connection with the world.

Environment

Iceland is on a geological fault line. There are active volcanoes and the island experiences

earthquakes. Iceland is known for lava fields, hot springs, geysers and rocky mountains. Ice

fields and glaciers cover some of the highest areas. With majority of land mountains, rocky

shoreline it does not support huge areas for forest and woodlands. Vegetation and farming

areas are along the coastal lowlands. Arctic foxes and seals can be found in Iceland. Whales

can be seen along the coast. The island is also the home to large colonies of nesting sea birds

and colonies of puffins. Vegetables grown in Iceland include carrots, cabbages, potatoes and

turnips. Some vegetables and fruit, such as cucumbers, peppers, tomatoes, and even bananas,

are cultivated in heated glass houses (World info zone, 2011).

Natural resources

Iceland is endowed with abundant natural resources. These include the fishing grounds around

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the island, within and outside the country’s 200-mile EEZ. Furthermore, Iceland has abundant

hydro- electric and geothermal energy resources (Central Bank of Iceland, 2010). Iceland is

the only country in Western Europe that still has considerable resources of competitively

priced, renewable energy remaining to be harnessed. Only one third of the country's energy

potential will be tapped by the end of 2010. Hydropower and geothermal energy are the

sources of Iceland's uniquely sustainable electricity generating capacity. These

environmentally-friendly, green resources produce electricity without harmful atmospheric

emissions (Invest in Iceland Agency, 2010). Iceland has very few mineral resources, and a

small area of arable land, so mining and agriculture are not major parts of its economy. With

abundance of glaciers, clean fresh water and unspoiled nature. Also its location in the

unpolluted waters of the North Atlantic Ocean means that fishing has become prime

contribution to its economy (Maps of world, 2009).

Threats and opportunities in the Environment

As mention previously Iceland has threat of volcanoes and earthquakes, other dangers can be

avalanches and river floods. Icelanders have learned to adapt to the dangerous elements and

has an experienced emergency response team that organizes the response to every certain

situations. Most populated places posed no risk from those elements, but in the wilderness of

Iceland there can be more dangers. With a harsh landscape, narrow dirt roads, un-bridged

rivers, dangerous hot springs and dynamic weather, people need to be careful and prepared in

the Icelandic nature.

With the increased number of tourists visiting Iceland, the island could face threat in the next

decades with increased number of tourists in remote areas. Some of these places are fragile

and it takes sometimes many years to recover from the encroachment of men. These activities

include off-road driving, throwing garbage, over-crowded nature tourist places and other

damages cause by humans. Iceland needs to invest in better infrastructure to deal better with

increased number of tourists, like improve roads, national parks, road signs and improve

access to places of importance for tourists.

The environment of Iceland offers many opportunities, either if you want to invest in tourism,

energy, agricultural and fishing (highly restricted by foreign investment). The unspoiled

Icelandic nature give many possibilities in the tourist industry, for hotels, spas, sights seeing

or other tourist related activity where the Icelandic nature plays a big role. Piece of land is

relatively cheap in Iceland compared to most other European countries. This makes Iceland

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very suitable for fish farming, shellfish farming, raising fur animals, raising sheep and other

agricultural activity that requires large pieces of land and with minimum arable possibilities.

With abundant of geothermal and hydro energy, this has opened many possibilities for

Iceland, in agricultural the farmers are able to produce most of the domestic needs of

vegetables. Which some are grown in green houses that are heated by the near by hot springs.

Iceland clean energy has brought interest from many foreign investors; their interest is to

produce products with renewable clean energy to promote their products. Like solar panels or

related products, data storage centers and other activity. Previously energy-intensive

industries like aluminum and other mental smelting plants have invested greatly in Iceland

because of cheap renewable energy.

Iceland is reckoned as a forerunner in the field of renewable energy. The country is generating

around 81 percent of its primary energy needs and 100% of electric needs from renewable

sources. Figures in 2007 show that geothermal energy accounts for 66% of primary energy,

hydropower 15% and fossil fuels 19%(transportations, cars, ships and airplanes) (Eriksson,

2010).

The fishing industry gives a great opportunity for investment, even though it is bit difficult for

a foreigner to invest in this industry. Possible by some joint ventures, but is no direct

investment is allowed. Many of Iceland’s main fish stocks have been growing in last recent

years, also with higher market prices in Europe is giving this industry a boost. In recent years,

total Icelandic catches have ranged from 1,5 to 2,1 million tons (Iceland Trade Directory,

2011).

Legal

Although Iceland is not a member of the European Union, Iceland is signatory of the

European Economic Area (EEA) agreement and therefore incorporates all EU employment

and social directives into its national laws. Iceland is the most highly unionized country in

Europe and trade unions hold a great deal of political power. Special permission must be

obtained from the Ministry of Social Affairs before redundancies involving four or more

employees can take place. Extensive consultations must also take place with the trade unions

to discover if an alternative to labor shedding can be found. Sex equality is a serious issue,

both in labor relations and under Icelandic law. The same salaries must be paid for work of

equal value (National labour law, 2011).

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The Icelandic act on working environment, health and safety in workplaces is intended to

ensure a safe and healthy working environment which in general is in accordance with the

social and technical developments in society, and to ensure such conditions that within the

workplaces it is possible to solve safety and health problems in accordance with acts and

regulations, in accordance with guideline from employers and employees and in accordance

with guidelines and instructions from the Administration of Occupational Safety and Health.

This act covers all activities, where one or more person are employed, whether they are

owners of the company or employees. Employers are obliged to ensure that the working

environment, safety and prevention of hazards are appropriate and according to the safety act

(AOSH, 2011).

The main objective of the Icelandic antitrust law or the competition law is to promote

effective competition and thereby increase the efficiency of the factors of production of

society. This objective shall be achieved by (Ministry of Economic Affairs, 2005)

Preventing unreasonable barriers and restrictions on freedom of economic operation

Preventing harmful oligopoly and restriction of competition

Facilitating the entry of new competitors into the market

Threats and opportunities in legal environment

The most important factor in the legal environment is if Iceland fully joins the EU,

membership could mean threats for some industries like fishing and agricultural. Membership

could also mean opportunities for other industries in finance and better market access for

Icelandic companies, improved economic stability with euro currency and better finance for

home and companies.

Threats would be less economic independent nation and would be more up to EU regulation

how business environment in Iceland would be controlled. Iceland would lose some if it

controls if its territorial waters and need to stop subsidizing the agricultural industry.

Opportunities would be as member of EU, allowing Iceland to adopt the Euro. That would

mean more stable currency, it would help be export industries and make planning process

much easier. Most of exports go to Euro currency countries, so it would be suitable for the

export industry to have home currency in euro. Also Icelandic homes and companies would

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be able getting better finance with affordable loans from European banks, by having income

and loans in euro currency (idebate.org, 2009).

SWOT Analyses

SWOT Analyses was made of Iceland economic environment mostly based on previous data

in this thesis and from Global competitive rankings from the World economic forum

(weforum, 2011). See in appendix 3

Iceland business environment

Positive Negative

Internal Strengths Weakness

Little Bureaucracy

Competitive salary cost

Renewable energy

Little corruption

Abundant of fishing

resources

Low taxes on

corporations

Bridge between Europe

and US

Young and educated

workforce

Safe society

European legal frame

Innovation spirit

Gender equality

Small workforce

Small domestic market

Unstable currency

Unstable economic

environment

Strict foreign exchange

controls

External Opportunities Threats

Unspoiled nature

Green tourism

Energy sold to Europe

Good exchange rate

Power intensive

industries

Environmental hazards

Inflation

Unstable economic

environment

Exodus of educated

workforces to another

countries

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SWOT by industries

Fishing Industry

Positive Negative

Internal Strengths Weakness

High productivity

Technology leader

Close to resources

Strong brand image

Fast industry upgrade

Few big control the

market

High barriers for entry,

because of quota system

No foreign investment

allowed

Industry heavily in debt

External Opportunities Threats

Warmer ocean currents

– new species

High innovation in

industry

Main fish stocks have

been rising

Changes in fish stocks

Changes in ocean

currents

Changes in quota

system – Different

Political agenda

High oil prices

The Fishing industry has higher productivity and is technology leader in the fishing industry,

catch value per fisherman nearly 3 times that in any other country. Iceland has huge coastline

and closeness to the fishing resources (Iceland Trade Directory, 2011). With warmer ocean

currents new fishing species are entering Icelandic ocean territory, for example like tuna and

mackerel. The industry has high barriers because of quota system, it is expensive to contain

quota and makes barriers for new entry high. Industry is heavily in debt, especially because

many companies in the industry took loans in foreign currency and with the fall of the

Icelandic currency the total debts would double in Icelandic kronas. But what is saving the

industry it that most of their income is also in foreign currency. Also the current government

has bill in place (which has not passed yet), if the bill will pass in parliament take back the

quota in during period of 15 years and distribute back under new provisions (fishupdate,

2011). The industry is highly sensitive to changes in oil prices, the big fishing fleet uses large

share of Iceland import of oil.

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Energy industry

Positive Negative

Internal Strengths Weakness

Abundant of energy

Renewable clean energy

Competitive pricing

Long waiting list of

buyers

Dependent of domestic

market

Slow decision process

State and community

owners – Bureaucracy

in decision making

External Opportunities Threats

Abundant of

possibilities of

harnessing energy

Sell electricity to

Europe with underwater

sea cable

Improved technology in

geothermal drilling

Changes in

environmental polices

Changes in public views

on power plants and

their affects on

environment

Abundant of energy, only one third of Iceland hydro/geothermal power has been harvested.

Energy companies offer renewable and clean energy, both with geothermal and hydro power

and ability to offer competitive pricing. They have long waiting list of possible buyers of

energy, have already made agreements to sell most of future increase in energy before they

have started constructed new power plants. Dependent of domestic market, needs sea cable to

sell electricity to Europe. Government and community are owners, tend to create bureaucracy

and slow down decision making. Abundant of possibilities of harnessing hydro power and

geothermal around the island and sell electricity to Europe through under water sea cable.

There is already long list of possible buyers of unharnessed energy. Technology has improved

over the years in the geothermal drilling and harvesting. The big threats are changes in

government policies in protection of the environment, and changes in public views how far to

let the energy companies harness the energy of Iceland (Iceland Trade Directory, 2011).

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Tourist Industry

Positive Negative

Internal Strengths Weakness

Fasted growing sector in

Iceland

Strong brand for green

tourism

Good infrastructure

Huge contracts in

seasons

Island – only get there

by plane or ship

Inadequate road system

around the island

External Opportunities Threats

Weak currency – great

value for tourists

New Music and

convention center

Green tourism

Unstable currency

Natural disasters

Fragile ecosystem

One of the fasted growing sectors in Iceland economy and growing steadily at an average

annual rate of 6% since 2000, Iceland is a good international brand when it comes to beautiful

nature, clean environment and unspoiled nature. Good infrastructure, like airports, sea ports,

rescue teams and general services for tourists. The industry experiences huge contracts with

high season of 3 to 4 months in summer time, and low season for 8 to 9 months.

Iceland has some geographic disadvantages, can only get there by ferry or airplane. But also

offers advantages for people traveling between Europe and North American, making Iceland

great place for stop-over. Iceland has in some cases primitive country road system compared

to other Western Countries, the roads can be dangerous for those less experienced. Weakness

of the Icelandic currency has made Iceland a great value for money. With a new music and

convention center in Reykjavik, offer great opportunities to target groups in the low season.

Green tourism; Iceland is one of the best places in the world for green tourism, because of

unspoiled nature, clean environment and few habitants. Unstable currency, when currency

gets stronger it becomes less value for money for tourists. Natural disasters like volcano

eruption, earthquake or floods. With increased number of tourist, could damage the fragile

ecosystem of Iceland (Iceland Trade Directory, 2011).

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Industrial Industry

Positive Negative

Internal Strengths Weakness

Access to cheap clean

energy

Abundant of available

land

Access to well educated

workforce

High transportations

costs

Unstable currency

External Opportunities Threats

Bridge between US and

Europe

Improve brand image

with clean energy

source

Price of energy

Strong Workers Unions

They have access to cheap clean energy and abundant of available land to build factories, and

access to young and well educated workforce. Transportation cost is higher when for export,

because Iceland is not on the mainland, but offers great geographically placement right

between North American European market. Big international companies can improve brand

image by using green energy source from Iceland to make their products. Big threats are from

politicians that want to charge more for the energy sold to big power intensive industries in

Iceland. Unions are very strong in Iceland, and they are usually successful get salary increase

for workers by threatening to go on strike (Iceland Trade Directory, 2011).

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IT and Software industry

Positive Negative

Internal Strengths Weakness

Growing industry

Innovated workforce

Well educated

workforce

Require less capital

investment than other

industries

Unstable economic

environment

Profit takes longer

Outdated taxation

policies

External Opportunities Threats

Great possibilities for

entrepreneur

Iceland is great for

innovation

New internet sea cables

improves access

Easy to move jobs in

software industry

between countries

The values of exports have grown rapidly in last decade. The strength of IT- software sector

lies in entrepreneurial labor, small-scale teams, good education and adaptability reinforced

with sophisticated telecommunication systems. This industry requires less capital to create

jobs and has successful records of innovation projects. The industry is affected by unstable

economic environment and outdated taxation policies that are better suited to typical export

products. With better internet sea cables from the mainland, comes more possibilities to

expand services with more data broadband capacity. Big threat is that jobs in IT-software

industry can be easily moved between countries with minimum costs compared to other

industries, to follow the best suited taxation polices (Iceland Trade Directory, 2011).

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Agricultural industry

Positive Negative

Internal Strengths Weakness

Clean nature and soil

Little usage of pesticide

No imports of live

animals – little history

of animal diseases

Abundant of land

Highly regulated

industry

Subsidized industry

Higher barriers in some

sectors with quota

Not much land for

vegetation

External Opportunities Threats

Clean image

Growing organic

industry

Animals diseases

Changes in importation

policies

One of the key advantages of agriculture in Iceland is virtually disease-free environment.

Iceland is known for cleanness of nature and little or none usage of pesticide. There is

abundant of land for farm animals like cattle, sheep and other live stock. Regulation does not

allow imports of live animals, excepts for pets in rare cases. This has kept the live stock

almost free of all animal diseases. This industry is highly regulated and centralization by

industries leaders. Industry gets subsidized by the government and is one of the most

subsidized in Europe. Has some quotas systems in dairy and sheep production, makes it hard

for new beginner to enter with high barriers. Iceland does not offer much vegetation land for

growing grain, wheat and vegetables. On the other hand has created a strong industry for

growing vegetables in green houses for domestic market, using green energy to power the

green houses. Iceland has strong brand image for purity and cleanness and has been taking the

advantage of popularity of organic foods. Big threats in industry are animal disease and

changes in importation policies that could let to more competition from foreign suppliers

(Iceland Trade Directory, 2011).

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Conclusion

Iceland has gone through some dramatic changes over few decades, experiencing constant

unstable economic environment with inflation and devaluation of the currency. Icelanders

have shown success of utilizing and harvesting their resources, mostly in fisheries. Hardly

ever experienced high employment, expect in last two years. Economic controls and

stableness of economic environment has been Icelanders Achilles heel, but Icelanders have

always had strong work ethics and found ways to work through their problems. In beginning

of last century Iceland was one of the poorest countries in Europe and they managed to

become one of the richest in Europe (per capital) and offering one best living standards in the

world. Even though critics called it ―a dysfunctional socialist economy,‖ yet Iceland had

exceptionally good economic performance from the 1950s to the late 1980s helping Iceland

bring the average income into the same league as the other Nordic countries and 2th highest in

the human development index(reflecting GDP per capita , health care education).

The Ricardian model illustrates that Iceland has comparative advantage in catching fish and

access to cheap energy, making Iceland suitable for power intensive industries. Iceland has

access to abundant fish and energy resources that most other nations don’t have. Iceland is

according to Heckscher-Ohlin Model best suited to produce capital intensive goods that

require a lot of land, also with less focus on labor intensive goods. This is because Iceland has

few inhabitants, high income society and abundant of available land. According to Porter’s

competitive advantage of nations, Iceland has created good infrastructure of factor creation in

fishing technology and geothermal technology with strong home market and supporting

industries. Iceland has taken the two biggest characteristics of Iceland, the big ocean around

the island and the hot springs, and has made it a focus on specialization. With factors of

national circumstances and culture, Iceland has become a world leader in technology in

geothermal and fisheries.

Characteristic of the Icelanders managers resemble other Scandinavian nations in their

emphasis upon low power distance, low uncertainty avoidance, and strongly feminine values.

However, the manner in which their balance of individualism and collectivism is expressed is

their distinctive from other Scandinavian nations. With innovation spirit, fast decision making

and flexibility they have distinctive outtake on projects, but often lack in planning and

organizing.

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Trade agreements have improved Iceland’s market access and strengthen the export values;

they should be considered an important factor in Iceland’s improved economic performance

over the last decades and have shaped the direction of exports towards the EU.

The main conclusion from this thesis is that Iceland has all the possibilities to regain its

strengths and even go beyond that. Iceland is not facing the same problems as the rest of the

world will be facing in the near future: Iceland has enough renewable clean energy to fulfill it

needs into the future, the birth rate is still above 2 per women. Opposed to rest of Europe

(except from Ireland) and has younger demographic population, they have highest

participation of women on the job market and best gender equality. All the main

infrastructures are still strong, health care, universities and welfare system. All the right tools

and opportunities are available, only thing that left is to take the steps and move ahead.

The economic reforms have in some ways slowed down this process, with tight capital and

exchange controls. Because of this foreign investment has not been as attractive with tight

regulation of capitals controls, which where attended to protect the Icelandic currency and

stop capital fleeing after the financial crisis. But with reforms and remove of capitals controls

should help foreign investment to pick up in the next years, opening up great possibilities in

all export industries.

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Appendix

Appendix 1 - Sources: (Eggertsson & Herbertsson, 2005)

Appendix 2 – sources: (Central Bank of Iceland, 2010)

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Appendix 3 –Sources: World economic forum

Appendix 4 – Sources: EIE

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Appendix 5 – Sources: EIU

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Appendix 6 – Sources: World economic forum