BSc(B) 6.

Semester

Authors: Seminar Advisior:

Fannar Jens Ragnarsson Sds Gun Hilmarsdttir Philipp Schrder

Should Iceland apply for EU membership?

-in

light of current situation,

would the regular consumer gain from being part of EU?

Aarhus School of Business 2009

Abstract
In light of recent and still ongoing global financial crisis which did evidently hit Iceland hard. The Icelandic public has been worrying whether or not it is safer in the European Union, this paper looks at aspects of the European Union and the pros and cons for Iceland to make an application for membership. The situation is not the same in all Europe and Iceland has not been facing the same situation last years as the countries of the European Union, unemployment rate has been very low in Iceland until late last year, much lower than in the European Union. The European Union consists of 27 different countries and the European Monetary Union of 16 countries, is this area optimal? According to theory about Optimal Currency Area certain criterion needs to be fulfilled to have the same currency, like having the same language and labour mobility across regions. Price of food in Iceland had been among the highest in Europe. With high

proportion of the total import coming from European Union member countries, it could be assumed that prices would go down in Iceland with membership. Stability is one of the main arguments for joining the European Union, but the Union is still young and growing, it has not reached the state of stability. Sovereignty would decrease with the European Union getting increased power over various regulations and legislations but by being a member of the European Union Iceland could be a player in the making of those regulations and legislations instead of an observer as it is now with the EEA agreement. The main reason for Iceland wanting to join the European Union is to get a more stable currency as the Euro is. With the introduction of the Euro, monetary powers will be shifted to the European Central Bank, it might mean more fluctuations in unemployment since Iceland would lose its primary tool to tackle unemployment. There is a criteria that Iceland needs to fulfil to be accepted into the European Monetary Union and with current status of its economy, highly indebted, the adjustment time might take as long as 10 years.

Table of Contents
1. Introduction ......................................................................................................................................... 1 1.1 Problem statement............................................................................................................................. 2 1.2 Delimitation ......................................................................................................................................2 2. The European union............................................................................................................................. 3 3. Iceland today.........................................................................................................................................6 3.1 The Icelandic economy, recent activities............................................................................................6 3.2 agreements concerning the European Union....................................................................................10 3.3 Unemployment..................................................................................................................................11 3.4 Inflation.............................................................................................................................................14 3.5 Icelandic currency.............................................................................................................................16 3.6 Balance of trade................................................................................................................................19 3.7 Trade agreements..............................................................................................................................22 4. How does Iceland fit into the European Union..................................................................................29 4.1 OCA..................................................................................................................................................29 4.2 Optimal Currency Area Criteria.......................................................................................................30 4.3 Criticim to OCA........................................................................................................................ ......31 4.4 Simple example................................................................................................................................31 4.5 How does Iceland fit into the theory...........................................................................................32 4.6 Pros and cons of a common currency...............................................................................................33 5. Affect on consumers...........................................................................................................................35 5.1 Fishing............................................................................................................................................ .35 5.2 Agriculture.......................................................................................................................................39 5.3 Price stability...................................................................................................................................40 5.4 Tourism............................................................................................................................................42 5.5 Currency debates...............................................................................................................................44 5.6 Policy view.......................................................................................................................................47 6. Conclusion.........................................................................................................................................49 7. References..........................................................................................................................................52

Appendix A Appendix B Appendix C Appendix D

Who wrote what

This list does not mean that most of the chapters were fully divided, we made the thesis in collaboration and read over and made suggestions to each other.

1. Introduction - Fannar 1.3 Problem statement - Sds 1.4 Delimitation - Sds 2. The European union - Sds 3. Iceland today - Fannar 3.1 The Icelandic economy, recent activities - Fannar 3.2 agreements concerning the European Union - Fannar 3.3 Unemployment - Both 3.4 Inflation - Fannar 3.5 Icelandic currency - Sds 3.6 Balance of trade - Both 3.7 Trade agreements - Fannar 4. How does Iceland fit into the European Union - Sds 4.1 OCA - Sds 4.2 Optimal Currency Area Criteria - Sds 4.3 Criticim to OCA - Sds 4.4 Simple example - Sds 4.5 How does Iceland fit into the theory - Sds 4.6 Pros and cons of a common currency - Sds 5. Affect on consumers - Both 5.1 Fishing - Both 5.2 Agriculture - Both 5.3 Price stability - Both 5.4 Tourism - Both 5.5 Currency debates - Both 5.6 Policy view - Both 6. Conclusions - Both 7. References

1. Introduction
In light of the Icelandic public and mediums being increasingly talking and debating about the European Union in recent months and if Iceland, an island in the middle of the Atlantic Ocean, should make an application to the European Union. Those talks have been louder and louder after the enormous shock in late October 2008 when the financial crisis hit Iceland hard. This paper will look at the factors of importance when a country makes such a decision and the pros and cons for Iceland and the Icelandic consumers will be taken into account. Capacent Gallup made a survey in Iceland from 11th of February 25th of February 2009 where they rang and asked a sample of the population about how they felt about the European Union and a possible entrance of Iceland to the Union. The results are shown in the graphs below.

Figure 1: Results from a survey made in Iceland by Capacent Gallup

http://www.visir.is/article/20090308/FRETTIR01/149272940/1091

As can be seen from the figures a high proportion wants to start negotiations with the European Union or 64.2% but fewer want to join the European Union. That is because the people want to start negotiations and from that see how the final contract will be and base their judgement on joining the European Union on that specific contract. It is known that no contract will be made if Iceland does not make an application to the European Union.

In the end of January 2009 the Icelandic government which was run by the Independence Party and the Social Democratic Alliance collapsed. The following days the Social democratic Alliance alongside with the Left-Green Movement and the Progressive Party took control and announced

that the national elections will be moved up to April 20091. The Hot issues in those elections were regarding how the parties think the financial crisis should be resolved and if Iceland should apply for the European Union.

1.1 Problem statement

The last year or so, the Icelandic currency, ISK (The Icelandic Krna), has weakened a lot. In the light of the instability that is present in Iceland and high inflation, we have the following research questions; Should Iceland apply for membership to the European Union and therefore adopt the currency Euro? Is there any chance that the economic situation in Iceland could recover without making any drastic changes, like joining the EU? Would it be better for consumers to be members of the EU? Can we assume that prices would decrease, for food for example?

1.2 Delimitation
Due to size of this thesis, all aspects can not be covered. We will concentrate on the matters concerning the regular consumers and not organizations. Structure of the EU will not be discussed in details, nor will the cost that Iceland would face by joining the EU.

http://mbl.is/mm/frettir/kosningar/2009/01/27/falid_ad_mynda_stjorn/

2. The European Union

The European Union is a unique economic and political partnership between twenty seven democratic European countries with Croatia, Turkey and the Former Yugoslav Republic of Macedonia as candidate countries. The aims are peace, prosperity and freedom for its 495 million citizens in a fairer, safer world2. After the Second World War the Western European countries where enthusiastic to join forces in a better Europe but the values of the EU are to promote humanitarian and progressive values and to ensure that mankind is the beneficiary rather than the victim of the great global changes that are taking place3. A preface for the European Union was set in 1951 when European Coal and Steel Community, ECSC, was established by the six founding members; Germany, France, Italy, Belgium, Luxemburg and the Netherlands. In 1957 EEC, European Economic Community was founded by the same countries, this treaty is known as The Treaty of Rome. In 1973, three more countries joined in, Denmark, Ireland and The United Kingdom. In 1981 Greece joined the community and Spain and Portugal also in 1986. When Germany was united in 1990, after the Berlin Wall fell in 1989, and the Soviet Union fell in 1991 the political shape changed. A Treaty on the European Union (The Treaty of Maastricht) came into force in 1993 and the European Union, EU was created. More countries joined the EU in 1995, Austria, Finland and Sweden. The currency, the Euro, came into existence in 1999 as an accounting currency and was physically released in the Euro-Zone in 2002. In 2004 ten more countries joined the union some from the formal Soviet-bloc; Hungary, the Czech Republic, Poland, Slovakia, Estonia, Latvia, Lithuania, Slovenia, (one of the republics of former Yugoslavia) and two Mediterranean countries Malta and Cyprus. In 2007 Bulgaria and Romania followed which counts up to 27 member countries today. One of the candidate countries, Turkey, applied for membership in 1987. Because of its

geographical location and political history the union hesitated for a while before replying positively to its application. It was first in 2005 that the European Council opened accession negotiations with Turkey along with Croatia. No date has yet been set for the entry force of any future accession treaty for these two countries at the end of the membership negotiations.

2 3

http://europa.eu/abc/panorama/index_en.htm http://europa.eu/abc/12lessons/lesson_1/index_en.htm

European integration has always been a political and economical process that is open to all European countries prepared to sign up to the founding treaties and take on board the full body of EU laws and now there are more potential candidates; Albania, Bosnia and Herzegovina, Montenegro and Serbia. According to Article 237 of the Treaty of Rome any European state may apply to become a member of the Community4. There are some criteria each country needs to fulfil in order to become a member and by the time they join, each member must have5:

stable institutions guaranteeing democracy, the rule of law, human rights and respect for and protection of minorities;

a functioning market economy and the capacity to cope with competitive pressure and market forces within the Union;

the ability to take on the obligations of membership, including support for the aims of the Union. They must have a public administration capable of applying and managing EU laws in practice.

So far, Iceland is not a member or a candidate even though the country fulfils all criteria needed. Neither is Norway, Lichtenstein or Switzerland who are fellow members with Iceland in the European Free Trade Association. One of the European Unions greatest achievements is its single market6. Eliminations on

restrictions between member countries on trade and free competition have gradually been put in force with the result that standards of living have increased. But still the single market has not become a single economic area since some sectors of the economy are still subject to national laws. The single market is supported by a number of related policies put in place by the EU over the years but they help ensure that market liberalisation benefits as many businesses and consumers as possible. To show how the European Union works like a whole, citizens of member countries can travel, live and work anywhere inside the Union. If a citizen in one member country wishes to work in another member country, that should not be a problem but we should bear in mind that the languages in the Union are many and that could be problematic for the average citizen when seeking work outside his home country. As a union, Europe has more influence on the world stage when it speaks with a single voice in international affairs for example when it comes to trade negotiations.

4 5 6

http://europa.eu/abc/12lessons/lesson_3/index_en.htm http://europa.eu/abc/12lessons/lesson_3/index_en.htm http://europa.eu/abc/12lessons/lesson_6/index_en.htm

The criteria each new member has to fulfil when becoming a part of the European Union implies political changes in many countries. There has been difference in the political environment

between Eastern and Western Europe and this is one way to push Eastern countries to the same direction as in Western Europe. The union has increased fast, 27 members in only 16 years. Having in mind how different those countries are, one might ask how stable this union is. Will it last like the United States of America has lasted?

3. Iceland today
Iceland is a small modern society with the population of around 320 thousands, an island based in the middle of the North Atlantic Ocean. It has been in the highest ranks of GDP per capita for the past years. The Icelandic people enjoy renewable and none polluting energy which brings electricity to the households as well as warmth. Its economy has for most of the time consisted mainly of fisheries, but for the past years with the economy opening up to other economies and possibilities there has been a rapid change.

3.1 The Icelandic economy, recent activities

To understand the Icelandic economy today, it is needed to dig a little bit earlier to see how such a small economy managed to evolve from mostly relying on fishing to an economy with an enormous banking sector. In 1970 Iceland joined EFTA (European Free Trade Association)7 and in 1994 Iceland joined EEA (the European Economic Area)8 there will be more discussion on EFTA and EEA in the subsequent chapters.

In the 1970s the fishing limits for Iceland were extended to 200 miles. By that the fishing industry increased its wealth by catching more fish which led to higher output growth for the whole economy. In the early 80s the Icelandic government introduced the quota system; they gave out fishing rights which could be traded with on the market. It clarified how much an owner of given rights was allowed to fish. This system gave increasing profits and wealth creation; it should be mentioned as the potential start of the growth of the banking sector.9

Aluminium has been produced in Iceland for almost 40 years and is now alongside with fish products as the most exported good. Icelandic people enjoy the advantage of using renewable energy; it is a highly volcanic island with numerous hot springs, glacial rivers and waterfalls.

7 8 9

http://en.wikipedia.org/wiki/European_Free_Trade_Association http://en.wikipedia.org/wiki/European_Economic_Area http://risk.lse.ac.uk/rr/files/e.pdf

Geothermal energy is used in many ways, for instance to heat houses and swimming pools. It is harnessed straight from steamy fields where hot springs are found. Hydropower is harnessed from the glacial rivers and waterfalls. Aluminium production requires a lot of energy (electricity) and therefore it was a proficient way to export energy. The first aluminium plant was opened in 1970.10 Today there are three of them operating and aluminium exports surpassed fishing exports in 2008.11 There are two more plants on the horizon.

In the late 1990s and early 2000s the banking sector, which before that was mostly run by the government, was deregulated and fully privatized. At that time credit was cheap in the world and the new banks made much use of that by borrowing internationally and raising capital which was used to fund expansions domestically and abroad. Even when it became harder for them to gain credit they established high interest rate internet savings accounts in the UK, Netherlands and Germany. With this expansion they got around 300,000 customers in the UK and 125,000 customers in the Netherlands, bear in mind that the Icelandic population is around 320,000. All this led to an astoundingly high growth of the banks and in the end of 2007 accumulated assets of the three largest commercial banks (Glitnir, Kauping and Landsbanki) was nine-times the annual GDP of Iceland, compared to the end of 2004 when it was about the same as the GDP. Neither the Central Bank of Iceland (CBI) nor the financial regulator (FME) developed a strong enough infrastructure to cope with this drastic increase. For instance the CBI had foreign exchange reserves amounted to about 30% of Icelands GDP in September 2008. Compared to other countries this is a high amount but when the fact is put into the equation that the banks have together grown to almost 10 times the nations GDP this number is very weak, and makes it almost impossible for the CBI to chip in if the banks experience a financial crisis, which evidently did happen.12

In 2004 the inflation rate started growing from around 2% and up to 4%, CBI with its policy of holding an inflation target at 2.5% then began increasing interest rates. On the 7th of May 2004 CBI increased the interest rates from 5.5% to 5.75% in order to try to tackle the inflation. However inflation kept on rising and the CBI kept on increasing interest rates. In September 2008 the interest rates were up to 15.5% and the inflation was at 14%.13

10 11 12 13

http://is.wikipedia.org/wiki/%C3%81lveri%C3%B0_%C3%AD_Straumsv%C3%ADk www.hagstofa.is http://risk.lse.ac.uk/rr/files/e.pdf www.sedlabanki.is

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Interest rates of loans given to the public by banks in Iceland follow the rule of indexation, which means that with increasing inflation the rates of the loans increase. In the beginning of 2004 the commercial banks had begun giving mortgage loans and a little later they introduced 100% mortgage loans. Those loans were very appealing at that time, especially to people at the age of 2540 years old that were still renting or living in their parents house.14 This gesture made a drastic upswing in household loans given to the public, rising from around 186 billion ISK in January 2004 up to around 1030 billion in September 2008.15 Since those loans were given by the rule of indexation and inflation has been increasing during those years, as well as the loans have increased in numbers their capital and interest rates have also grown by the rate of inflation from month to month. On Monday morning the 29th of September 2008 CBI decided to buy one of the major banks. Glitnir bank had earlier confronted CBI and asked for help because of a liquidity problem they had coming up in October. Glitnir did rely on a loan from Bayerische Landsebank but the Icelandic Central bank got a loan from that same bank before Glitnir and therefore the quota for Iceland was full and Glitnir needed to ask the CBI for a loan16. CBI did not approve of the collateral provided and therefore decided to buy. This had many alarm bells ringing at the British Government because the other two Icelandic banks had substantial operations in the UK and they became afraid of depositors in the UK not being able to get their money back. So the UK authorities decided to use a clause in its antiterrorist laws to freeze the assets of Landsbanki they also took over the operations of Kauping in the UK. Since Kauping had already established a subsidiary it was a legal entity in the UK and therefore the use of the antiterrorist laws were not needed. Those actions triggered Landsbanki and Kauping to go down as well. It is likely that all the banks would have filed bankruptcy later on, even if those actions were not made by the UK but it is certain that it did happen more rapidly this way.

In anticipation the government made an emergency legislation which granted the FME power to deal with the banks. The FME took control over the defaulted banks Glitnir, Landsbanki and Kauping. And split them into new banks and old banks where domestic operations were put

14 15 16

www.mbl.is/mm/gagnasafn/grein.html?grein_id=827604 www.sedlabanki.is Sofandi a feigarsi: lafur Arnarson. Bls 32

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into the new banks and foreign operations into the old banks. In the old banks the foreign assets are supposed to be valuated and sold and the amount that creditors and depositors will get back will depend on the value of the sold assets. In the new banks the goal will be to recapitalize them and restore confidence. When the banks will be operating normally they will most likely be privatized again.17

Being in a very critical situation, Iceland applied for a loan from the International Monetary Fund (IMF) which was approved in November. The loan consists of around $5,2 billion where $2,1 billion comes from the IMF and the rest from Denmark, Finland, Norway, Sweden, Russia and Poland. In all it is around 600 billion ISK.18 The IMF made a program for Iceland to follow through; it consists of three main factors:19 1. To prevent a further sharp ISK depreciation. Since households and firms have high debts that are inflation-indexed and in foreign currency. Confidence in the ISK has lowered and therefore the IMF along with CBI decided to put restrictions on foreign exchange with the ISK to keep it from depreciating, later on when they think the time is right it will be fully put back on float. 2. Ensuring medium-term fiscal sustainability. Public debt is expected to increase by around 80% according to the IMF due to the cost of fulfilling deposit insurance obligations to foreign depositors in Icelandic banks and recapitalization of both CBI and the commercial banks. Therefore primary budget allocations have to be revised. 3. Developing a comprehensive bank restructuring strategy. By finding the value of their assets and recapitalizing them which are expected to be around 385 billion ISK and make a 5 year business strategy for the banks which will be reviewed by the IMF.

The Icelandic economy is clearly not in its best shape right now, being one of the countries where the financial crisis hit hardest.

3.2 Agreements concerning the European Union

17 18 19

http://risk.lse.ac.uk/rr/files/e.pdf http://www.mbl.is/mm/frettir/innlent/2008/11/19/imf_samthykkir_lan_til_islands/ http://www.sedlabanki.is/lisalib/getfile.aspx?itemid=6606

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In this part, The European Free Trade Association, The European Economic Area and The Schengen agreement will be briefly discussed and Icelands involvement in those agreements mentioned, since they are all in some ways connected to the European Union. The European Free Trade Association (EFTA) was first established on May 3rd, 1960. It was signed by seven states (Austria, Denmark, Norway, Portugal, Sweden, Switzerland and United Kingdom) those countries were often referred to as the outer seven, since they chose not to join the EEC and the founding countries of the EEC were referred to as the inner six. Hence, instead of joining EEC the outer seven made EFTA. As can be seen from the previous chapter about the EU; Denmark, United Kingdom, Portugal, Austria and Sweden did all later on join the EEC or the EU which ceased their partnership with EFTA. Finland and Liechtenstein also became members of EFTA but Finland joined the EU in 1995. Iceland became a member of EFTA in 1970 and has been a member since. Today there are only four members left; Norway, Switzerland, Liechtenstein and Iceland. The agreement gives the member countries free-trade between each other as well as they have made agreements with number of other countries outside the EFTA states.20 In 1992, Iceland along with two of their fellow EFTA members (Norway and Liechtenstein) signed the European Economic Area (EEA) agreement with the EU which was made to allow them to participate in the European single market, without directly joining the EU. This agreement allows Iceland to have free-trade of goods, service and capital and labour mobility in the Euro Area. It is often referred to as the four freedoms. Because of this agreement, Iceland can be considered a side partner to the EU. However with the agreement Iceland has to take up all regulations that are made to the EU single market and they will not have a voice since they are not members of the EU. Also Iceland will not be able to take part in organizations of the EU such as the European council, European parliament and the European Court of Justice and a very limited one to the European Commission. The agreement does not involve trade with agricultural products and it does not make Iceland a part of the EU fisheries policy. It does not involve collaboration in economic policies, tax- foreign- and security affairs and domestic and legislative affairs outside the Schengen agreement.21 The Schengen agreement is referred to two agreements made by European states in 1985 and 1990. It handles abolition of systematic border controls in the participating countries. This enables citizens of countries that signed the agreement and got a full membership to move freely to and from any of the participating countries. Iceland fully implemented the Schengen agreements in 2001. Along

20 21

http://en.wikipedia.org/wiki/EFTA http://www.ns.is/ns/upload/files/pdf-skrar/esbadild_neytendur1.pdf

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with Norway they are the only members outside the EU that has a full membership. Meaning; that Icelandic citizens do not require a visa when travelling inside the Schengen zone. However there were some exemptions made for Iceland, for instance when a private person is travelling to and from the EU, he can only bring with him small amounts of goods and alcohol tax-free.22

3.3 Unemployment
The Icelandic population consists today of about 319 thousands23 and has been increasing steadily the last 10 years, or for about 15.8% since 1999 when the population counted for about 276 thousands24. Foreign citizenship has increased from 6,521 people in 1999 or 2.4% of the total population to 24,379 people in 2009 or 7.6% of the total population25. Polish citizens counted for almost half of this number or 11,003 people26. Increase in industrial activity in Iceland over the last years can at least partly explain this high proportion of foreign citizens. In 1996; 9,200 people were employed in construction but that number was 14,700 in 2006 which makes up for an increase of almost 60%27. As mentioned in an outlook of the labour force in Iceland for 2009 which was published in December 2008 by the Icelandic Directorate of Labour, unemployement was expected to increase rapidly in 2009 and reach its highest form during spring going up to 9-10% in May, but declining during the summer with increases in wholesales, especially to tourists visiting the country. It is projected that average unemployment will be around 7-9% in 2009. Unemployment was expected to be most in construction with the labour force shrinking with foreign and Icelandic citizens working in that field moving away in hopes of better job opportunities as an effect from fewer projects being in force. The current situation does fit the projections from the Directorate of Labour most cases.28 Unemployment rate has for the past 10 years been relatively low, ranging from 1.0% in 2007 to 3.4% in 2003 as can be seen in table.

22 23 24 25 26 27 28

http://en.wikipedia.org/wiki/Schengen_Agreement http://www.statice.is/Statistics/Population/Overview http://www.statice.is/Pages/1135 http://www.statice.is/ http://www.statice.is/ http://www.statice.is/

http://www.vinnumalastofnun.is/files/Horfur%20%C3%A1%20vinnumarka%C3%B0i%20%C3%A1%20%C3%A1rinu%202009-

endanlegt_453162400.pdf

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Figure 2

www.statice.is

However since the crisis hit Iceland in 2008 and especially after the collapse of the three major banks unemployment has taken a rather drastic upswing. From September 2008 when it was around 1.3% it has steadily increased month by month and in March 2009 it was recorded to be around 8.9%. Since 1980 unemployment has never been even close to as high for any month of the year as it was in March 2009 and probably it was not in earlier years, for data reasons unemployment rates before 1980 could not be checked.

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Figure 3

www.statice.is

Unemployment has clearly hit hardest in the industry activity as can be seen on the left chart of figure 4 showing proportions for economic activity of the labour force for the year 2008 and when compared to the right chart of figure 4 which shows from which economic activity unemployed persons in March 2008 came from, activities are grouped in agriculture and fishing, industry and services. Unemployed persons that did not come from any economical activity were not included in the chart. Most unemployed persons in March 2009 came from the construction industry counting to around 22% as a part of the total industry unemployment of 38%.
Figure 4

www.statice.is

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Unemployment has also been increasing in the EU since the financial crisis hit. In February 2009 the unemployment rate for the EU27 was at 8.4% when it was 8.2% in Iceland, but as allready mentioned it was 8.9% in March. Data for the EU27 in March is not up yet and can therefore not be used as comparison. When looked at seperate countries in the EU27 for February 2009, unemployment was highest in Spain, Latvia and Lithuania with 16.1%, 15.8% and 14.8% respectfully. It was lowest in Netherlands, Austria and Czech Republic with 3.1%, 4.9% and 5.1% respectfully. From this it can not be expected that Iceland will be able to solve its unemployment problem by joining the EU, whereas the countries of the EU are facing similar problems. With Iceland being a member of the EEA, free mobility of labour is already intact.

3.4 Inflation
In this section, inflation will be shown from the measurements of Harmonised Index of Consumer Prices (HICP). The Icelandic Central Bank usually uses measures from Consumer Price Index (CPI) while measuring inflation but since the European Central Bank uses HICP to calculate inflation for the EMU and goes by that index when they check whether a country is ready to join the EMU. It is the most appropriate index to use.29 Those indices are very similar however there are two main differences; the HICP includes tourist expenses where the Icelandic CPI does not and owner occupied housing expenses are included in the Icelandic CPI where they are excluded from the HICP.30

Inflation has been increasing dramatically in Iceland and especially for the past 20 months as can be seen on the graph in figure 5. Rising to its highest point in January 2009 at 21.9% however inflation has started a downwards turn and was down to 19.9% in March 2009. Inflation is most likely to continue declining and there might even be a risk of a deflation in the near future according to Danielsson and Zoega the authors mentioned in previous section31. But there are factors that make those speculations hard, such as the exchange rate which could boost inflation again if the Icelandic Krna starts depreciating even more.

29 30 31

http://www.ecb.int/stats/prices/hicp/html/index.en.html http://www.hagstofa.is/Pages/2249#25 http://risk.lse.ac.uk/rr/files/e.pdf

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Figure 5

www.statice.is

The EMU consisting of 16 countries has very low inflation; in March 2009 there was a deflation in Ireland, Portugal, Luxembourg and Spain, consisting of -0.7%, -0.6%, -0.3% and -0.1% respectively. Highest inflation was recorded in Malta and Finland with 3.9% and 2.0% respectively. Inflation has been declining in the EMU and was down to 0.6% in March 2009. In the EU inflation was recorded at 1.3% in March 2009.32 There is some concern of a possible deflation in the EMU and the European Central Bank has been lowering interest rates in order to tackle this particular threat, now down to 1.25% which was made effective on the 2nd of April 2009. ECB interest rates will probably be lowered even further in the near future.

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http://epp.eurostat.ec.europa.eu/pls/portal/docs/PAGE/PGP_PRD_CAT_PREREL/PGE_CAT_PREREL_YEAR_2009

/PGE_CAT_PREREL_YEAR_2009_MONTH_04/2-16042009-EN-BP.PDF

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Figure 6

http:// ec.europa.eu/eurostat

3.5 The Icelandic Currency

For decades people have been doing business with each other. First there was a trade with goods but later money, coins and paper, came along. In 1886 the first bill was printed in Iceland and in the beginning, or until the year 1927, it had the same value as the Danish Krone (DKK)33. In 1873 the Scandinavian Monetary Union34 was formed by Sweden, Norway and Denmark. Since Iceland was a part of Denmark, it was also a part of this union. The three countries all had Krones as their currencies and pegged it to gold at that time. It provided fixed exchange rates and stability in monetary terms but the member countries continued to issue their own separate currencies. The outbreak of World War I in 1914 brought an end to the monetary union. All three countries used the same currency during the monetary union, but in 1914 the monetary union collapsed and their currencies drifted away from each other, they were not pegged to each other anymore.

The Icelandic Krna (ISK) is a derivative of the Danish krone established after Iceland was elevated to a separate kingdom in union with Denmark in 1918. The final ties were cut in 1944 when Iceland became a republic.
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E.B.Eirksson og J.. Sturluson. 2008. Hva me Evruna. http://en.wikipedia.org/wiki/Scandinavian_Monetary_Union

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The Icelandic Central Bank was first founded in 1961 but from 1927 and until that day, there was a department in a regular bank who served like a central bank. From 1989 to 2001, ISK was pegged to a basket of other currencies. Currencies of the countries Iceland did most business with. When the Euro was official in the twelve European Union member countries in 2001 the ISK was set free. The government decided to have a free floating currency and aimed at having the inflation rate at 2.5%. Since then, the ISK has fluctuated a lot and interest keep getting higher and on 28th of October 2008 the interest rate (nominal rate) was put at 18%. Since then interest rates have been put on a slow decrease and on 8th of April 2009 rates were set at 15.5% from 17%35 Some Icelandic companies who have their main income in Euros want to have all their accounts in Euros. They say that the fluctuation in the ISK is bad for business; it will be a lot easier to attract foreign investors if the accounts are all in Euros36. Exchange rate for the ISK will be shown in the narrow trading basket made by the ICB, it is a weighted basket with currencies that Iceland does most external trade in both goods and services with and the proportions decided from how much trade is done. From 2002-2007 the average was around 118.
Figure 7

http://www.sedlabanki.is

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http://www.sedlabanki.is/?PageID=8 E.B.Eirksson og J.. Sturluson. 2008. Hva me Evruna page 42

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However in March 2008 it started to depreciate substantially and kept on being undervalued compared to how it had been previous years and still kept on depreciating and the narrow trade exchange rate was down to around 200 after the collapse of the three major banks. In November 2008, fearing that the ISK could depreciate even more the Icelandic government passed a bill which allowed the ICB to get wider powers in controlling the currency and put capital restrictions on currency exchange. It was meant to fight against currency flowing out of the country and to make the ISK appreciate and was supposed to be relieved as soon as conditions were better. To this date it has not been relieved, it was even made tighter in the beginning of April with the government passing a more improved bill. Most international banks have stopped calculating the value of ISK because of the major uncertainties the currency is going through. The ISK is definitely in a very weak position and some solution is needed, whether current program will solve the problem or the introduction of another currency is the only way to go is not for certain but more and more people have been leaning towards a solution that does not involve continued use of the ISK because they believe it to be wrecked.

Figure 8

http://www.sedlabanki.is

3.6 Balance of trade

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After seeing the situation on the currency market, imports and exports will be looked at. It is safe to say that all imported goods will increase in price when the ISK is as weak as it is. The value of it has decreased the last months and that does affect the regular consumer who buys imported goods. In 2005, about two thirds of all foreign business was with EU countries or 75% of all export from Iceland was to EU countries and about 62% of imports came from EU countries37. Figure 9 shows how Imports CIF (Cost, Insurance, Freight), exports Fob (Free onboard) and balance of trade (exports CIF minus imports Fob) have been in Iceland for the past ten years, from 1999-2008. The numbers are in millions of ISK which means that the exchange rate during each year does affect the volumes traded with. If the ISK is weak exports & imports become more expensive meaning that lesser volumes are traded. Iceland has been running trade deficits all years charted. Highest deficit was in 2006, a deficit of 189,366.3 millions which made up to 16.21% of total GDP that year. In 2008 the deficit was at 46,721.1 millions ISK which made up to 3.19% of total GDP.38

Figure 9: Imports, exports and balance of trade in Iceland for a ten year period, 1999-2008

www.statice.is

With the ISK depreciating in 2008 imports became more expensive and exports gained value. This change of the currency rate made the exports rise, with imports rising as well. Figure 10 shows how

37 38

E.B.Eirksson og J.. Sturluson. 2008. Hva me Evruna page 78 https://hagstofa.is/lisalib/getfile.aspx?ItemID=9618

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exports Fob, imports Fob and balance of trade (exports Fob minus imports Fob, for data reasons monthly figures for imports CIF could not be used) was monthly for a twelve month phase from March 2008 to February 2009, values are again in millions ISK. Last six months of the chart show a surplus meaning that exports have been rising compared to imports. This will probably lead to a smaller deficit in 2009 than previous years.
Figure 10: Imports, exports and balance of trade in Iceland from March 2008 February 2009

http://www.statice.is

In figure 11 Malta will be shown as a comparison, Malta is a country that recently joined the EU, in May 2004 and did also introduce the Euro in January 2008. For those reasons and as well because Malta is a small state with a population of around 410,000 which is similar to the population of Iceland, around 320,000 it seemed fitting to choose Malta for comparison on trade balances. Values are in billions of Euros and notable from the graph is that from EU entry trading directions in terms of value seem not to have changed, imports have slightly increased and its deficit has increased as well.

23

Figure 11: Imports, exports and balance of trade in Malta for ten year period, 1999-2008

http://www. ec.europa.eu/eurostat

Lastly the balance of trade for the European Union as a whole will be looked at, EU27 with trades extra EU27. The EU has been running a deficit for previous years and in 2008 it had a trade deficit of 242.09 billions of Euros, exporting for 1306.60 billions of Euros and importing for 1550,69 which makes their deficit at 16.9% of total extra bilateral trade. Importance of trade for Iceland and the European Union will be closer looked at in the next section.

3.7 Trade agreements

The global economy has become more and more open in the recent years. This movement has made single economies to open up more by for instance changed regulations on the reduction of tariffs, free movement of labour, services and capital between countries or regions. Iceland has been a part of this movement and its first step was to join the GATT treaty in 1968. This treaty was made to start negotiations on reduction or elimination on tariffs between countries. Negotiations were held in rounds and in the Uruguay Round (1986-1994) the negotiation process was changed, tariffs on goods were not anymore the only thing discussed but also other factors such as services, capital and intellectual property. The Uruguay Round led to the establishment of the World Trade Organisation (WTO) on the 1st of January 1995. Iceland was one of the founding members of the WTO along with 74 other existing GATT members.39 Today there are 153 countries
39

http://www.si.is/malaflokkar/althjodlegt-samstarf/wto/

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within the organisation which counts up to over 95% of world trade40. Trade agreements that are administered by the WTO cover trade in goods and are assigned to government practices that directly relate to trade, for instance tariffs, subsidies, government procurement and trade related intellectual property rights. Iceland has by its membership to GATT and subsequently WTO exported goods with tariffs negotiated within GATT/WTO and also coordinated its import tariffs to regulations made within the organisation.41 The WTO encourages countries to make bilateral or multilateral trade contracts with countries within and outside the organisation to strengthen their international relationship even more.

Iceland by its membership to EFTA has made many bilateral and multilateral contracts that go beyond WTO agreements. Agreements made by the EFTA states are usually Free Trade Agreements. A Map of Free Trade Agreements that have been made for Iceland or are under negotiation can be seen in figure 12, also there is a larger sized map in appendix C. Currently EFTA has made FTAs with Canada, Chile, Colombia, Croatia, Egypt, Israel, Jordan, Lebanon, Macedonia, Mexico, Morocco, Palestinian Authority, Singapore, Southern African Customs Union (Botswana, Lesotho, Namibia, Swaziland and South Africa), The Republic of Korea, Tunisia and Turkey. The EFTA states are also currently under negotiations for a FTA with the following countries Algeria, Gulf Co-operation Council (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and United Arab Emirates), India, Peru and Thailand. They also have a joint declaration on co-operation which is the starting point of a FTA with Albania, Mercosur (Argentina, Brazil, Paraguay, Uruguay and Venezuela), Mongolia, Serbia and Ukraine. Furthermore EFTA is conducting dialogues on possible future FTAs with Indonesia, Malaysia and
42

Russia. and as

Additionally Iceland has made a bilateral free trade agreement with the Faroe Islands

mentioned in previous chapter has access to the European Economic Area (through EFTA all though there is one EFTA state that did not ratify the agreement, Switzerland) with an agreement that covers almost all main issues of free trade. Iceland is also currently under negotiations for a free trade agreement with China.43

40 41 42 43

http://www.wto.org/ http://www.nationalaglawcenter.org/assets/crs/98-928.pdf http://www.utanrikisraduneyti.is/samningar/friverslunarsamningar/ http://www.utanrikisraduneyti.is/media/Friverslunarsamningar/leidarvisirumfriverslunarsamninga.pdf

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Figure 12: Map of free trade agreements or negotiations for agreements in which Iceland is a part of

EFTA in most cases follows the EU with their choice of countries to negotiate with, meaning that when the EU makes a bilateral or multilateral agreement EFTA is most often under negotiations for a similar agreement, or planning to. EFTA has as well some times been ahead of the EU, for instance with the free trade agreement they made with Singapore and South-Korea. Since agreements made by EFTA are often following the EU, EUs trading policy will now be briefly discussed.

Being such an enormous economical force, the EU has great advance when they negotiate trades with third countries. Therefore they often make conditions that less developed countries have to fulfil in order for a free trade agreement to go through. One of their trading policies is the European Neighbourhood Policy which applies to its neighbouring countries.

The European Union began developing its European Neighbourhood Policy (ENP) in 2003/2004 which has the aims of strengthening EUs relationship with its neighbouring countries. The ENP was made because the EU wants those countries to make greater economic developments, enforce stability and better governance. This means that the EU negotiates with its neighbouring countries and promotes transformation and reform. Some of the transformations or reforms the EU emphasizes on are: Reduction on non-tariff barriers Increased mobility by improving security regarding justice and illegal migration Promoting green energy Keep fisheries sustainable

26

Integrate transportation systems Bring education systems to a higher degree Get closer co-operation on employment and social development Cooperation on health matters

Each country is looked at individually and its economy analyzed to see which transformation or reforms are needed. Following EUs recommendations may bring them closer to joining EU. Countries that ENP aims at are; Armenia, Azerbaijan, Egypt, Georgia, Israel, Jordan, Lebanon, Moldova, Morocco, The Occupied Palestinian Territory, Tunisia and Ukraine.44 Also EU has made and is under negotiations for many trade agreements with third countries, those countries and the agreements that have been made or are under negotiation are very similar to the ones made by EFTA as stated earlier.

Table shows exports, imports and bilateral trade for Iceland in 2008 with regards to countries and how much it is as a percentage of total trade. EEA + EFTA states were put together since Iceland is a member of the EEA and has similar trade agreements with the EFTA states, it was not called purely EEA because Switzerland is not a part of the EEA all though it has bilateral agreements with the EU that are almost identical to the EEA agreement. Trade between Iceland and the EEA + EFTA states counts to a high proportion of trade 82,30% for exports, 68,13% for imports and 74,88 for bilateral trade. As can be seen this area is highly important for Icelands exports. The US, China, Japan and Australia are the most important traders outside of the EU. There are no apparent distinctions from EU and Icelands trading regulations with US, China, Japan and Australia. However as was already stated, Iceland is under negotiations for a free trade agreement with China and if the agreement will be fulfilled Iceland will be the first European country to make such an agreement with China, which has an enormous and rapidly expanding economy.45 It is certain that this agreement would have great potentials on bringing new business opportunities to Icelandic companies for domestic purposes and by opening the route from China to the EEA through Iceland.46

44 45 46

http://ec.europa.eu/world/enp/pdf/com07_774_en.pdf http://mogginnminn.is/mm/frettir/innlent/2009/04/06/ekki_hlaupid_ad_thvi_ad_semja_um_friverslun/ http://www.ru.is/kennarar/al/kina.doc

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Table 1: Top exports, imports and bilateral trade in Iceland, classified by countries

ExportsFOB EEA+EFTA UnitedStates Japan China Russia Nigeria FaroeIslands Canada SouthKorea

82,30% 5,48% 4,38% 2,20% 1,30% 1,16% 0,73% 0,47% 0,28%

ImportsCIF EEA+EFTA UnitedStates China Australia Japan Canada Suriname Jamaica Russia

68,13% 8,03% 6,63% 4,43% 3,70% 1,03% 1,02% 0,98% 0,56%

BilateralTrade EEA+EFTA UnitedStates China Japan Australia Russia Canada FaroeIslands Nigeria

74,88% 6,82% 4,52% 4,02% 2,38% 0,91% 0,77% 0,56% 0,55% Thi

s table shows top exports, imports and bilateral trade for Iceland and shows how much proportion of total trade was traded in between Iceland and the selected country. Bilateral trades are calculated by adding exports to imports and then the sum divided by 2. Trade with EEA and the EFTA states was put together since Iceland is a part of the EEA and EFTA. www.statice.is

In 2004, Francis Breedon and rarinn G. Ptursson made an empirical paper for the Central Bank of Iceland. Their research was based on research that Andrew K Rose an economist at the University of California Berkeley made. His analysis was on countries with single currencies and if they would trade more than countries that do not share currencies. His results implied that countries with single currencies would trade three times more than countries that did not share currencies. He used an empirical research where he used the gravity model; he had a panel of over 190 countries from the time-period 1970-1990 giving him 33,903 bilateral trade observations. Roses analysis had some criticism and Breedon and Ptursson took note from that, for instance a dummy variable Rose used for countries that were in currency unions was said to be endogenous and therefore the currency union effect from higher trading could not be significantly proven. Breedon and Ptursson then added two instrumental variables to make the distinction more clear, co-movement of output and co-movement of price. Their empirical analysis consisted of 17 countries all of them being members of the European Economic Area and their internal bilateral trade over the period 19712002 giving 136 country pairs and 13,192 observations. The main difference from their sample and the sample that Rose used is that 55 country pairs or roughly 40% of the sample shared a single currency (euro) whereas only 1% of the country pairs Rose used did so. Table 4. Trade effects of entering EU and EMU (average increase in trade with EMU member countries as a result of joining EU and EMU)

28

Table 2: Results from the empirical analysis made by Breedon and Ptursson

EU effect (%)

Pure EMU effect (%)

Exchange rate volatility effect (%) 0 1 2 2

Total effect (%)

Denmark Sweden UK Iceland

28

29 29 29 29

29 30 31 59

The table gives the trade creation effects of EMU (and EU entry in the case of Iceland) from the IV estimates of the fixed effect model in Table 3. The pure EMU and EU effects are given as exp() 1 where is the estimated coefficients on the EU and EMU dummies. The exchange rate volatility effect is found by calculating the predicted increase in trade, given by the estimated exchange rate volatility effect, if exchange rate volatility had been zero since 2001. direct source: http://www.sedlabanki.is/uploads/files/WP-26.pdf

Their findings for Iceland was that by joining the EMU trade could increase by 29% and since Iceland is not a part of the European Union they used another dummy variable for the EU and found out that only by joining the EU trade could be boosted by 28% giving a total trading effect of 59%. What is most interesting is that by only joining the EU, not the currency union trade would still boost by almost 30% since Iceland is all ready a member of the EEA one would think that trading would not increase that much only by joining the EU. An EEA dummy was used to test the difference of countries joining the EEA and it showed no apparent increase in trade with the EMU. This does imply that total trade would increase with the EMU, other things being equal. Meaning that diversification of trade patterns are not supposed to happen. If those findings are used to calculate trading share of GDP it could mean an increase of 12%, from around 33% in 2008 up to 45%. The biggest question from those results as mentioned earlier is why would membership to the EU boost trade that much and why does not membership to the EEA do the same? Breedon and Ptursson did not give an answer to this but our thoughts would be that by joining the EU tariffs of goods would be reduced even further which might give impact on trade also EU membership could have more businesses looking to the euro area and foreign businesses looking to Iceland since they know that its future currency will be the euro. However since it has been stated that diversification from other trading partners would not happen, companies would then not be changing their previous trading relations from other countries towards the EMU.

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4. How does Iceland fit into the European Union?

Let us assume that Iceland would apply for membership, how does the country fit in the union? There are 27 member countries, each with their own specialties, and most of them members of EMU as well. When is an area optimal for a single currency? Is it just given that so many different countries as are part of the EU today can adopt a single currency as the best option? Let us look deeper into when an area is defined as an optimal currency area.

4.1 OCA
What is the optimal currency area? What criteria does an area need to fulfil in order to have a common currency and what is the limitation? The optimum currency area is not the world. 47

Why not? Is it not better for countries that trade goods between them to have the same currency? So what stops us from having one single currency in the whole world? This world is not a unity in a political sense, it consists of almost two hundred independent countries and many of them are further divided into regions. A single currency implies a single central bank (with note-issuing powers) and therefore a potentially elastic supply of interregional means of payments. But in a currency area comprising more than one currency the supply of international means of payment is conditional upon the cooperation of many central banks; no central bank can expand its own liabilities much faster than other central banks without losing reserves and impairing convertibility. This means that there will be a major difference between adjustment within a currency area which has a single currency and a currency area involving more than one currency; in other words there will be a difference between interregional adjustment and international adjustment even though exchange rates, in the latter case, are fixed. 48 In economics, an optimum currency area, OCA, also known as an optimal currency region, OCR, is a geographical region in which it would maximize economical efficiency to have the entire region share a single currency. It describes the optimal characteristics for the merger of currencies or the

47 48

The American Economic review, vol 51, no 4. (sep 1961. pp 659 The American Economic Review (Sep.,1961) pp 658

30

creation of a new currency. The theory is used often to argue whether or not a certain region is ready to become a monetary union, one of the final stages in economic integration. An optimal currency area may often be larger than one country. For instance, part of the rationale behind the creation of the Euro is that the individual countries of Europe do not each form an optimal currency area, but that Europe as a whole does form an optimal currency area. The theory of the optimal currency area was pioneered by the economist Robert Mundell,49 professor of economics at Columbia University. In theory, an optimal currency area could also be smaller than a country. Some economists have argued that the United States, for example really consists of two optimal currency areas and that the United States should have two currencies, one for the western half and one for the eastern half50.

4.2 Optimal Currency Area Criteria

An area has to fulfil some criteria to be optimal in order to efficiently being able to have a common currency. The principal characteristics of an OCA are three51. The first is labour mobility across the region. This includes physical ability to travel, get visas, the rights workers have and so on as well as lack of cultural barriers to free movement like different languages and institutional arrangements. Openness with capital mobility and price and wage flexibility across the region is the second criteria. This is so that the market forces of supply and demand automatically distribute money and goods to where they are needed. In practice this does not work perfectly as there is no true flexibility according to Ronald McKinnon52, An economist at Stanford University, California.53 Finally there is an automatic fiscal transfer mechanism to redistribute money to areas or sectors which have been adversely affected by the first two characteristics. This usually takes the form of taxation redistribution to less developed areas of a country or a region. This policy, though theoretically accepted, is politically difficult to implement as the better off regions rarely give up their revenue easily.

49 50 51 52 53

Robert A. Mundell A Theory of Optimum Currency Areas 1961. en.wikipedia.org (18.01.2008) en.wikipedia.org (18.01.2008) Ronald McKinnon Optimum Currency Areas and Key Currencies 2004 http://www.stanford.edu/~mckinnon/

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Peter Kenen54 suggested additional criteria, production diversification. But he argued that groups of countries with diversified domestic production are more likely to constitute optimum currency areas than groups whose members are highly specialized. Homogeneous preferences as well as commonality of destiny have also been added as criteria for the OCA theory.

4.3 Criticism to OCA

In a report written by Willem H. Buiter, Is Iceland an Optimal currency Area? He concludes that cross border mobility of real capital and of labour between Iceland and the Euro area is unlikely to be an effective substitute for nominal exchange rate flexibility. Furthermore, he doubts that even within existing currency unions (the USA or the Euro area) net interregional migration flows are quantitatively important at cyclical frequencies. This means one of two things. Either, these existing currency unions are not optimal currency areas or an optimal currency area does not require a high degree of labour mobility at cyclical frequencies. The primary criticism of Mundells theory is that the only area that has optimal conditions for a single currency is one that already has a single currency55. Furthermore, many existing currency areas do not fulfil these requirements.

4.4 Simple example

When two countries have wage flexibility and mobility of labour, they are more likely to have an optimal currency area, like is said before. Let us look at a simpler example. Let us imagine two countries, A and B, which form a monetary union. Something leads to higher demand of goods from country A both in countries A and B, which leads to higher unemployment in country B and decline of unemployment in country A since there is more production in country A than before and vice versa in country B. Increase in unemployment leads to decrease in wages, caused, among other reasons, by less bargaining power of the employees and decrease in unemployment leads to higher wages (wage flexibility). Because of something unknown, we have different situation in those two countries. To get them both back on track, they are in need for two different solutions.

54 55

http://en.wikipedia.org/wiki/Peter_Kenen http://en.wikipedia.org/wiki/Optimum_currency_area

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The wage flexibility leads the goods produced in country B to be more competitive because lower wage must lead to lower production cost and from that it is easy to push the prices down. And if those two countries do fulfil the criteria about mobility of labour, it should be easy for employees in country B to move to country A to find jobs. Then this situation would even out in time.

This is indeed very simple example, but in a way we can see that if those two criterias are fulfilled, then there is no need for the central bank to interfere or the government to come up with a master plan.

4.5 How does Iceland fit into the theory?

Iceland is rather isolated, meaning that it is an island with no neighbouring countries nearby. The official language is also Icelandic which is only used over there even though it is related to other Scandinavian languages. Being isolated and speaking a rare language does not indicate mobility of labour. So the big question is if the country is able to have anything else than its own currency? According to J. E. Meade56, conditions for common currency in Western Europe do not exist especially because of lack of labour mobility and a system of flexible exchange rate would be more effective in promoting balance of payments equilibrium and internal stability. Is there ever such thing as perfect mobility of labour? In the US, there are about 300 millions of people which talk the same language and have the same currency, US dollar. The 50 states have a monetary union similar to the one Europe has formed. But even if the language is the same, something more must be needed in order to have perfect mobility of labour. North America is not a small area. It is in fact quite big and even though a person from the east speaks the same language as is done in the west, it is a long way to go if there is unemployment in the east and lack of employees in the west. There is more than just the language that influences peoples preferences when it comes to making drastic changes in their lives. For example in the USA, there can be big difference between states. The legal system is not the same nor is many cultural matters anything alike.

Even though Iceland is isolated, one could easily argue for perfect mobility of labour. Last 10 years, the number of foreign immigrants has increased from 5,554 to 22,23657.

56 57

External Economies and Diseconomies in a Competitive Situation. J.E.Meade. The Economic Journal. Mar. 1952 http://www.statice.is

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If we now imagine that Iceland has wage flexibility and mobility of labour, what are the positive matters of being part of a monetary union? So far, Iceland is not a member of the EU but with recent political changes, Iceland might be on the brink to apply for membership to the European Union. In theory, if a country could adopt the Euro without joining EU (which would violate the Maastricht agreement, and has often been said not an option from the behalf of EU), there might be a concern for Iceland if the country joins the EMU regarding the monetary policy of the ECB, as was shown in the previous section about inflation, Iceland has not been showing similar fluctuations in inflation as the EMU countries, however with the adoption of the Euro and abolition of the inflation-indexed interest rates that might change. A connected thing of concern is unemployment, as monetary instruments of the Central Bank can be used to tackle unemployment it is not for certain that unemployment will remain stable and with the ECB having control over monetary policies unemployment might show more fluctuations. However as was shown in the section about unemployment, it is very high in Iceland now compared to recent years.

With the ISK being as weak as it is imports are more expensive and that means that prices of imported goods increase for the consumers. Since many businesses are doing worse than before wages are not set for an increase which means that the buying power of the consumers is declining.

4.6 Pros and cons of a common currency

After having looked at what the optimal currency area is, it is necessary to look at both pros and cons about having one currency in an area. The benefits are mostly situated at microeconomic level58. When a country drops its own currency and adopts a common one, it can lead to gains in economic efficiency. These gains in efficiency have two different origins, elimination of

transaction costs associated with the exchanging of national moneys and elimination of risk coming from the uncertain future movements of the exchange rate. The cost from exchanging one currency to another can vary between countries but the gains when countries move to a common currency in the Euro area has been estimated to be between 13 and 20 billion Euros per year59 by the EC Commission. In the same reference, it has been estimated that about 5% of bank revenues are the commissions paid to banks in exchanging currencies.
58 59

Paul De Grauwe. Economics of Monetary Union. 2005 Paul De Grauve. Economics of Monetary Union 2005 pp 65

34

When countries have the same currency it benefits consumers since it is much easier to compare prices between areas without calculating exchange rate. When travelling from one country to another, one saves the fee paid to the band when buying the foreign currency.

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5. Affect on consumers
In this chapter, we will look into what effect a membership would have on Icelandic consumers. How will it be different for consumers to be part of EU? Due to the collapse in fall 2008, the faith in the ISK is very low. How much will it cost the country and the consumers to gain that trust and what is the true value of the ISK? Are Icelanders underpaid compared to the neighbour countries? Is it even possible for the country to rise from this collapse on its own?

New government is being formed after the elections in April 2009. Two parties are most likely to form the new government, Social Democrats and Left Green Movement. Those parties disagree on one big issue, membership to the EU. The Social Democrats which is the biggest party today with 20 parliament representatives out of 63, wants to apply right a way. The Left Green Movement has said that Iceland is better off outside EU but they also say that it is up to the people. The reason for applying is mainly the stability needed and if starting negotiation, faith in the country will increase according to the Social Democrats. The Left Green Movements policy is to create more works in the public sector60 at the same time as there is no money to keep the workers already working. It will be very interesting the next few weeks which direction will be taken.

5.1 Fishing
Fishing has been and still is an important factor of the Icelandic economy, this section will take a closer look of it in the whole context of the economy. Figure 13 shows how much Iceland has been exporting for the past seven years and it has been classified by two of the strongest commodities exported and other commodities are grouped together.

60

Vg.is

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Figure 13: Total exports in Iceland classified by main commodities, 2002-2008

http://www.statice.is

It is quite obvious that the fish export weigh less and less every year while aluminium weighs more compared to the total export from Iceland. Even though the value in millions of ISK is very similar for 2002 and 2008, the exported tonnes of fish are only 696,897.3 in 2008 compared to 804,195.4 in 2002 and the percent of the total export did decrease from 62.9% in 2002 to 36.7% in 2008. The high value in 2008 can be explained by the exchange rate, but when the ISK is as weak as it has been lately, it benefits the export companies.

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Figure 14: Tonnes exported of marine products and aluminium, 2002-2008

http://www.statice.is

The decrease in tonnes of fish can also be explained by the quota system. For every year quota that is allowed to fish under Icelands fishing areas is made by a proposal from the Marine Research Institute of Iceland, these allocations are based on a research that gives the state of the Marine Stocks in Icelandic waters and by that try to hold a sustainable fishing policy.61 The graph also shows exported tonnes of aluminium and it can clearly be seen that aluminium exports have been increasing for the past seven years. This increase comes from the introduction of new aluminium plants and their respective increase in production capacity. However the fishing industry and the aluminium industry are very different from one another. Although value for export is now similar in both industries, everything that is produced in the aluminium plants is exported. Icelanders of course do also eat fish which means that some proportion of the fish is sold domestically. The aluminium plants are not owned by Icelanders, they are purely owned by foreign aluminium specialised businesses, the Icelandic government only sells the energy used in the manufacturing process of the aluminium to those corporations and gets income taxes. The following text is from the 4th article of the Icelandic laws on foreign investment in businesses:

61

http://www.hafro.is/index.php

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1. Eftirtaldir ailar mega einir stunda fiskveiar efnahagslgsgu slands samkvmt lgum um rtt til veia efnahagslgsgu slands ea eiga og reka fyrirtki til vinnslu sjvarafura hr landi: a. slenskir rkisborgarar og arir slenskir ailar. b. slenskir lgailar sem a llu leyti eru eigu slenskra aila ea slenskra lgaila sem uppfylla eftirfarandi skilyri: i. Eru undir yfirrum slenskra aila. ii. Eru ekki eigu erlendra aila a meira leyti en 25% s mia vi hlutaf ea stofnf. Fari eignarhlutur slensks lgaila lgaila, sem stundar veiar efnahagslgsgu slands ea vinnslu sjvarafura hr landi, ekki yfir 5% m eignarhlutur erlendra aila vera allt a 33%.62

Basically those laws are referring to the fishing industry and state that foreign ownership of a fishery that is based under Icelands jurisdiction can never surpass 33%.

Always when membership of the European Union is discussed in Iceland, fishing comes up. The fish industry is very important in Iceland, not only in economical view but in an historical view as well. It is a big part of the culture in Iceland. Even though the fish is becoming less and less important in figures, Iceland was rated number 13 for the biggest fishing nations in the world in 2004. Icelanders are afraid of losing the power over their fishing policies when joining EU. That could become reality, but the focus could be set on how different this industry is in Iceland compared to countries in EU. The fish industry in Iceland is self-sufficient and is not supported by the government or the EU as it is in many European countries. The main rule in EU is that all member countries should have equal rights to fish. But article 20 of the Common Fisheries Policy no 2371/2002 says: Allocation of fishing opportunities: The Council, acting by qualified majority on a proposal from the Commission, shall decide on catch and/or fishing effort limits and on the allocation of fishing opportunities among Member states as well as the conditions associated with those limits. Fishing opportunities shall be distributed among Member States in such a way as to assure each Member State relative stability of fishing activities for each stock or fishery.63

62

http://www.althingi.is/dba-

bin/unds.pl?txti=/wwwtext/html/lagasofn/136a/1991034.html&leito=fj%E1rfestingu%5C0erlendra%5C0a%F0ila#word 1
63

ttar Plsson og Stefn Mr Stefnsson (2003) p 65

39

If Iceland would join EU, historical fishing experience would be used to decide on how much and where they could fish. In order to protect the fishing area Icelanders already have, they could have some restraints like in UK. For example there are restraints that at least 50% of the fish is landed in UK and at least 50% of the crew has residency in the UK area.

If Iceland would join EU, there is nothing that says Iceland would lose control over the fish. On the contrary, due to the self-sufficiency, it may well be in favour for Icelanders. The industry would most likely open up for foreign investors, which has been a lot of debate about since many want ownership of the fisheries to stay Icelandic. However those things regarding the future of the Icelandic fishing industry if Iceland becomes a member of the European Union will never be for certain without applying and seeing what comes out of the negotiations.

5.2 Agriculture
The negative effects in agriculture is probably based on the fact that if we are members of the EU, then competition will increase in the agricultural products and would probably be damaging to some farmers, but bearing in mind that even though Icelanders would see more of imported agricultural products in Iceland, they are very proud of their own products and the purity that comes with it. The EU does subsidies its agricultural sector. According to agricultural policy in EU, even additional subsidies are allowed when the agriculture takes place north of 62nd latitude. Iceland falls under that condition so the farmers in Iceland should get more subsidies than they already get. In Finland, price to farmers decreased when they joined in 1995 but farmers in Finland get 35% higher subsidies than their fellow farmers in other EU countries. This is due to more difficult situations in Finland, which would probable apply in Iceland also. 60% of the subsidies paid to farmers in Finland come from the Finnish government but 40% from EU. In Iceland, most farmers get subventions calculated on how many kilos they produce. In EU it is calculated from the land area used. This is done in order to protect the land in use and to keep the production in correlation with demand. The numbers of farmers in Finland have decreased since they became part of the EU, today there are fewer farms but bigger64. Icelandic farmers will probably see drastic changes if Iceland would join EU. Pigs and Chicken could be imported for much lower price than the domestic production would cost. Out of 3,297 farmers in Iceland, 35 are either pigs or chicken farmers65. On the other hand, it could also open up for bigger markets in the Euro zone.
64 65

http://www.mbl.is/esb http://www.mbl.is/esb

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The Icelandic lamb has been for sale in Denmark for much higher price than lamb from New Zealand. Could that change? Being a member of EU, could sales of the Icelandic lamb increase in Europe? The fact is that Icelandic farmers rely on imported material in their farming process; the cost of those products is likely to go down if Iceland joins the EU.

5.3 Price stability

Since we want to reflect the consumers point of view, not the organisations, we interviewed Brynhildur Ptursdttir, an employee at the Consumers Association of Iceland. The interview itself can be seen in Appendix B, both in Icelandic and English but it was translated by the authors since the interview was conducted in Icelandic.

First of all, the stability Icelandic consumers would see if joining the EU is very feasible. Prices of food will go down according to Brynhildur, as it has gone down for instance in Finland and Sweden. This issue about food prices is very understandable, since the prices in Iceland are the highest in Europe.

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Table 3 Food prices (excluding beverages) in European countries the years 2003, 2004, and2005putinorderwithmostexpensivefirst 2003 2004 2005 1 Switzerland Iceland Iceland 2 Norway Switzerland Norway 3 Iceland Norway Switzerland 4 Denmark Denmark Denmark 5 Ireland Ireland Ireland 6 Sweden Finland Finland 7 Finland Sweden Luxembourg 8 Luxembourg Luxembourg Sweden 9 Italy Italy Italy 10 France France France
http://www.ns.is/ns/upload/files/pdf-skrar/esbadild_neytendur1.pdf

It is very interesting to look at the countries in the top three places, Iceland, Norway and Switzerland, none of them in the European Union. Eirkur Bergmann, Associate professor Director of Centre for European studies, Bifrst University, agrees with Brynhildur and in a report66 he did along with Eva Heia nnudttir, for Bifrst University and the Consumers Association of Iceland, he argues that prices of food would decrease and interest rate would be lower. Today there are customs and tariffs on products from EU countries. If Iceland would join EU it seems quite obvious that by discontinuing those customs and tariffs Icelanders could buy their food cheaper. As mentioned in the chapter on trade agreements, about 68% of all imports to Iceland in 2008 came from EEA + EFTA states which mostly consist of EU member countries. Not everyone is as convinced that prices would decrease. Bjrn Bjarnason, Minister of Justice, (until January 2009) does not agree with those who say that it is obvious that prices will decrease if Iceland would join EU. According to him67, food price depends on competition on the market. In Iceland there are only two companies that share the end buyer market which can hardly be enough competition. It is very difficult to see some change in that, being a member of EU or not, Iceland is small and there is unfortunately not room for many companies in each market. Another issue that is quite important, according to Brynhildur, is that today we follow rules and regulations made by the EU, but we can not take part in the makings of those rules and regulations. If Iceland would join EU, Iceland could fight for regulations as they want them to be instead of relying on other countries to do that.
66 67

http://www.ns.is/ns/upload/files/pdf-skrar/esbadild_neytendur1.pdf Appendix A. Interview with Bjrn Bjarnason

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For example Denmark managed to confirm few years ago that food products with more than 2% of a particular fatty acid threatened human health. At first producers brought charges against Denmark for not allowing products who contained more than 2% of this acid but Denmark won the case and now this is a regulation in the European Union. Iceland is just too small to be able to do something like this on its own, but in alliance with its neighbouring countries, Iceland could make an effort. However Iceland can file for an exemption through the EEA agreement, for instance if a regulation does not fully fit to the Icelandic economy. Iceland has already filed for exemption on some matters with success68. According to Bjrn, we are not using all the power we could as an EEA member.

Could it be that Icelandic consumers are so tired of the instability and are so eager to join EU that they cannot see or use the power they already have?

As said earlier, the food price in Iceland is extremely high compared to the EU countries. The reason for high prices is something not all agree on. Those who are willing to join EU say that membership would bring a decrease up to 25% in prices while those who are against joining EU say that membership would not influence food price since the market in Iceland is small and lack of competition is the reason for high prices. In the report, the price of food is looked at. It is a fact that in Iceland, food costs about 50% more than on average in other European countries. When Finland joined EU the food price decreased about 11% and after joining, prices have increased less than inflation69. This was mainly due to two facts. The farmers got their material for lower price and they faced more competition from foreign farmers.

5.4 Tourism
If Iceland would have the same currency as main part of Europe, it would be much easier for consumers to compare prices in other countries and decrease cost of buying other currencies when travelling. We see increase in tourists visiting Iceland and one could imagine that they would spend more money during their visit to Iceland if the prices were lower or/and comparison easier in the goods.

68 69

http://www.forsaetisraduneyti.is/media/frettir/SkyrslaEvropunefndar-.pdf http://www.mbl.is/esb

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Figure 15

Total amount of tourists in Iceland 1999-2008

600.000 500.000 400.000 300.000 200.000 100.000 0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

http://www.ferdamalastofa.is/displayer.asp?cat_id=503

Figure 15 shows the number of foreign tourists in Iceland, and figure 16 shows total expenditure in ISK what foreign tourists spend in Iceland and the expenditure made abroad by Icelanders. The number of tourists have been increasing since 2002 and were around 500,000 2008 but the Icelandic population is only around 320,000. The spending increases slower than the number of tourists apart from the year 2008 but then it looks like tourists spent a lot more than the years before, but having in mind the weak currency, foreign visitors are simply getting more for their money than the years before. We have reached the conclusion before, that Iceland is very expensive country to live in, by adopting the Euro, all comparison will get much easier and it is likely that the tourists would spend more in Iceland. Visitors to Iceland in summer 2009 are expected to increase and the expenditure is expected to increase as well due to the weak currency. Even though that means more foreign currency into Iceland, which is needed, it gives the wrong picture of the price and the producers in Iceland are not better off selling their product so cheap. The foreign currency spent in Iceland does not cover what Icelanders spend abroad. In 2008 the income from foreign tourists was 73,061 millions ISK but 91,749 were spent by Icelanders abroad.

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Figure 16: Expenses made by tourists visiting Iceland and Icelanders abroad, millions ISK

http://www.sedlabanki.is

The year 2009 will most likely be a lot different than the years before. Icelanders will travel less abroad and therefore spend less, and the number of foreign tourists will increase in Iceland. The conclusion will remain that it gives wrong picture of Icelandic goods and services when the currency is as weak as it is today.

5.5 Currency debates

As has been said, adopting the currency Euro without joining the European Union is not an option since the Union does not assume that the currency is used outside the Unions border. Even though there are few countries using Euro as their currency without being members of the union70. For example Monaco and Mayotte, both use Euro today but had the French Frank before the Euro became the currency in France, so the best solution for them was to switch to Euros as well. Montenegro is also using the Euro but that came into place because of disturbance and war in the country. This creates some problems for the Union, if Montenegro applies for membership the Union can not demand some requirements in order to take up Euro since they already have it.

70

E.B.Eirksson og J.. Sturluson. 2008. Hva me Evruna

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In the light of this it would probably be looked at very seriously if Icelandic authorities would on their own start to use Euro without any agreement with the EU. That kind of action could damage other agreements Iceland has to the European Union. The European Union can, on the other hand not do anything if Icelandic organisations and consumers start to use Euro instead of ISK, but if the Icelandic authorities are against adopting the Euro it is unlikely that they would allow the consumers and organisations to use it. When we look at adopting the Euro, we first have to look at membership in the EU. How could it benefit Icelandic consumers to join forces with 27 other European countries? Is there something that they would have to give up in order to join in? The main arguments from those against joining EU are that Iceland would lose domination over the fish and that Icelandic agriculture would be damaged, and if we would go so far as to join the EMU and adopt the Euro then Iceland would lose control over the monetary policy.

We have reached the conclusion before that in order to adopt the Euro, a country first has to apply for membership to the EU and then join the EMU. Bjrn Bjarnason has been looking into these matters and is trying to find some special regulations that allow a country to apply directly for membership to the EMU without full membership to the EU. In theory it would be possible, but there is no political willingness in the EU to do this. If Iceland would go ahead and adopt the Euro without permission in the EU, it would most likely be violation to the EEA contract. For EU members to join the EMU and adopt the Euro there are some requirement needed to fulfil. It is called the convergence criteria established in the Maastrich Treaty71.

the ratio of government deficit to gross domestic product must not exceed 3% and the ratio of government debt to gross domestic product must not exceed 60%;

there must be a sustainable degree of price stability and an average inflation rate, observed over a period of one year before the examination, which does not exceed by more than one and a half percentage points that of the three best performing Member States in terms of price stability;

there must be a long-term nominal interest rate which does not exceed by more than two percentage points that of the three best performing Member States in terms of price stability;

the normal fluctuation margins provided for by the exchange-rate mechanism must be respected without severe tensions for at least the last two years before the examination.

71

http://europa.eu/scadplus/glossary/convergence_criteria_en.htm

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Today it is really hard for Iceland to meet this criteria and now with the financial crisis it has also been getting harder and harder for countries that are currently in the EU and waiting to join the EMU to be accepted. Inflation in Iceland and the EU is very different but the inflation in Iceland is going down and might meet the criteria soon. The most quiestonable part for Iceland today regarding the criteria is the ratio of Government debt to GDP, since Iceland is now higly indebted and the public has not to this date gotten any concrete numbers of how high the debt actually is. Speculations have been varying from around 150%-230% of GDP. With the country so highly indebted it might take 5-10 years to fulfil those conditions. The monetary policy has also got to be taken into consideration, with Iceland joining the European Union the power of the Icelandic Central Bank diminishes Last years the unemployment rate has been very low and the central bank has been increasing the nominal interest rate in order to keep down the expansion. This has lead to very high interest rate, the opposite from what has been happening in central Europe where the EU has been struggling with high unemployment and keeping nominal interest rate low to avoid further unemployment. With the European Central Bank controlling the monetary policy unemployment fluctuations could be greater than they have been, currently the unemployment rate is at an historical high in Iceland but it has to be noted that it is strongly because of the financial crisis. If Iceland would be part of the EU, where would that lead the country when vested interest are not the same and maybe as different as it has been last few years? It is of course difficult and maybe impossible to say beforehand, but a country only counting for little over 300,000 residents may not have so much to say in a nearly half a billion community as the EU is.

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5.6 Policy view

In 2004, sitting prime minister, Dav Oddson, that was in 2009 forced to leave his place as chairman of the Board of Governors in the Central Bank of Iceland, organized a committee to look into the relationship between Iceland and the EU. In this committee, each political party in Iceland had a representative, and the committee hired an external expert in European matters to write the conclusions they reached. In this report72, the conclusion is reached that competition would most probably increase due to lower business cost towards European companies if Iceland would join the EU. Fluctuation in prices today due to the Icelandic currency would decrease a lot, and interest rate would decrease. Main problem of adopting Euro identified in this report is that the Central Bank of Iceland would no longer have any power; monetary power would no longer be in the hands of Icelanders but in the Union. For example the last years Iceland has been facing a boom, unemployment has been extremely low and in order to keep inflation low, the Central Bank has been increasing the interest rate up to the roof. This is the opposite of what has been happening in the rest of Europe. In Germany unemployment has been high last few years, around 10% on average but decreasing slowly73. It is obvious that different actions are needed. If little Iceland would be part of the European Union, it is not likely they would have much to say about actions made, if big countries like Germany and France are facing different problems. On the other hand, the Central Bank of Iceland has not been able to keep inflation down. So how important is the monetary power in Iceland? It is also difficult to say how different the environment will get if Iceland is a part of the union. The boom last few years has cost higher wages in Iceland due to the low unemployment and workers high bargaining power. The free mobility of workers has been in Iceland due to the EEA agreement so being part of EU it is not given that workers would come to Iceland any more than they have been doing.

Iceland is very big country compared to how many people live in it. About 103,000 square kilometres and around 320,000 people. Last decades the area around the capital, Reykjavk, has been increasing in citizens and fewer and fewer people live in small places around the country. It
72 73

http://www.forsaetisraduneyti.is/utgefid-efni/nr/2558 http://www.arbeitsagentur.de/

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could have bad influence for the country if this continues. It is every country necessesity to have people all around the country but not in one small place. Today, around 2/3 of the Icelandic population live in the south west part, around Reykjavk. Because of the size of the country, it is relatively expensive to live on the country side. Health care, universities and so on are mainly on the south west part. The people living on the country side of Iceland would most likely be better off if joining EU. The subventions from EU are additional to the subventions each country get from home. Legislation would not change much in Iceland, but 2/3 of the legislation already in use in the villages comes from EU74.

74

http://www.mbl.is/esb

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Conclusion
Writing about Iceland today is very interesting mainly because every morning something new has happened or is out in the open. The situation has been, safe to say, very special the last year. When asking whether or not Iceland should apply for membership to the European Union or not is not easy to answer. Big majority wants to see what would possible be in it for the country, look at the pros and cons which will not be clear without negotiation.

Europe does not fulfil the criteria for OCA, Optimal Currency Area. Many languages, different cultures and geographically, the criteria is not fulfilled. Perhaps adjustments can be made and will be made. As countries and societies open up, the cultural difference is less important, with respect for each other, each and every one of us can hold on to whom we are and where we are from. People can hold on to their own language and still communicate with people by using the English language which is becoming more frequently used in Europe.

Before the bank crisis, it was very popular to take loans in foreign currency in Iceland. House mortgages and car loans were very easy to get, even up to 100% of the house or car value. When the Icelandic currency collapsed, many families faced the fact that their mortgage had increased up to 100%. In few weeks, house price went down, due to less demand and the loans went up due to unstable currency. Unemployment increased and insecurity as well. Many people lost part of their monthly salaries since some companies reduced their wages. Having less money people now had to accept owing a lot more in their houses and cars. If Iceland would have been a member in the EU before the financial collapse, one could assume that the average consumer would be in a lot better financial state today. It is always easy to be wise afterwards, but the willingness from the people to start negotiation with EU is very clear. People are in need for stability and it looks like Icelandic consumers have lost faith in their own currency. While things were doing well, not many people wanted to join EU. It is now when the insecurity is so much that EU becomes feasible, like the child who wants someone grownup to look after it.

EU membership may not be seen as some magical solution. After looking into the situation as it is today, and how it has been last years, it is clear that a lot of changes would be made if Iceland

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would become a member of EU. If the changes would be for better or worse is highly depended on how negotiations would go between Icelanders and the EU. Price of food would most likely go down and competition would probably increase, both in favour for the average consumer. But, as mentioned, the situation has been very different in Iceland than in EU concerning unemployment and interest rate.

If Iceland joins the European Unions it is for certain that it will not be a member of EFTA anymore since it is an association that makes free trade agreements and by joining the European Union those agreements will be primarily made by the European Union. Not many agreements with third countries will be lost though since EFTA and the European Union do have similar agreements to this date. The only loss for Iceland would be the possible free trade agreement with China, however that agreement has not yet been made and the future prospects of it are not clear. Membership to the European Union and the entrance to the EMU might boost external trade by around 59% to the EMU without any diversification from other trading partners counting up to an 12% increase in bilateral trade as a proportion of GDP. Also it was noted that even though the EEA agreement does imply ease of trade it does not boost trade nearly as much as membership to the EU alone does. However sovereignty will not be at the same state as it has been, with the European Union getting increased power over various regulations and legislations but by being a member of the European Union Iceland could be a player in the making of those regulations and legislations instead of an observer as it is now with the EEA agreement. The Icelandic currency has been depreciating substantially, making the financial crisis deeper in Iceland. With foreign investors giving less interest in the country primarily because of the uncertainties that the Icelandic currency gives. With the introduction of the Euro this factor would be eliminated and could bring more appeal to the Icelandic economy by foreigners. It would also mean the shifting of monetary powers over to the European Central Bank, all though the Icelandic Central Bank has not been successful for the past few years with its object to tackle the inflation it might get in better shape in the future when the economy has been reshaped. With the European Central Bank in control unemployment might begin to fluctuate more than it has with the natural level of unemployment possibly increasing. The financial crisis is not only going on in Iceland, it is a global crisis and the Euro area has a very low inflation rate which has the risk of a possible deflation. Inflation has been high in Iceland but is now going down and some economists also fear a deflation in Iceland in the near future. The main reason for Iceland wanting to join the European Union is to get a more stable currency as the Euro

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is. There is though a criteria that Iceland needs to fulfil to be accepted into the EMU and with current status of its economy, highly indebted, the adjustment time might take as long as 10 years. One of the main issues while discussing possible membership to the European Union is fishing; some Icelanders want to maintain its fishing policy as it is and do not want foreign investors to have the chance to invest in this industry. This matter is of vital interest to many but it can never be fully known how this industry will be with membership to the European Union without applying and seeing the final agreement.

Addition, Personal thoughts:

Sds: As the situation is today, both in Iceland and in the world, joining the European Union is not the answer Iceland needs. Pegging the Krna to the Euro should be looked at, because Iceland needs to regain trust in its currency. Fannar: The financial crisis is a global thing and is affecting the European Union as well as Iceland, I think that even though the Icelandic currency is now at a low point, Icelanders should not start negotiations to the European Union. Instead they should concentrate on their own problems back home and try to get out of this mess. When order is restored in the Icelandic economy as well as the economy of the European Union then the question of a possible entrance to the European Union should be reraised.

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References

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The American Economic review, vol 51, no 4. sep 1961.

www.althingi.is www.arbeitsagentur.de www.ec.europa.eu www.ecb.int

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www.en.wikipedia.org www.epp.eurostat.ec.europa.eu www.europa.eu www.ferdamalastofa.is www.forsaetisraduneyti.is www.hafro.is www.hagstofa.is www.nationalaglawcenter.org www.ns.is www.mbl.is www.mogginnminn.is http://risk.lse.ac.uk/rr/files/e.pdf www.ru.is www.sedlabanki.is www.si.is www.stanford.edu www.statistics.is www.utanrikisraduneyti.is www.vg.is www.vinnumalastofnum.is www.visir.is www.wto.org

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