(Bloomberg) -- With Iceland's financial crash now in the rear-view mirror, the biggest challenge for the country's first governing coalition between the far left and two conservative parties will likely be to cool the island's red-hot labor market.
Left Green Movement leader Katrin Jakobsdottir is appointed prime minister on Thursday after reaching an agreement with the right-wing Independence Party and the centrist Progressive Party. The deal received formal approval from members of the three parties late on Wednesday and follows Jakobsdottir's failed attempt at a center-left government in the wake of the Oct. 28 elections.
In a move likely to reassure investors, outgoing Prime Minister Bjarni Benediktsson is widely tipped to become finance minister -- a post he held between 2013 and January of this year. Benediktsson appeared to confirm as much late on Wednesday, telling reporters he had "been in that ministry before."
Still, it's rampant wage gains and extreme labor shortages that worry local businesses the most.
“We can't continue like this and it would be a major disaster if they lost control of the labor market,” said Sigurdur Hannesson, the head of the Federation of Icelandic Industries. “This will be the number one factor” to watch, he said in an interview Tuesday in Reykjavik. “If they succeed, the economy will reach a balance and we can continue with reforms in health care, education, infrastructure and innovation.”
Labor Bottlenecks
Encouraged by an economic boom driven by record tourist arrivals, Icelandic workers have been demanding massive pay rises after enduring years of austerity in the post-crisis years. Annual wage growth peaked at 13.4 percent in April 2016 and has exceeded 7 percent since May of this year. The labor market is facing severe labor shortages, with the country unable to attract new immigrants. The headline unemployment rate was 1.9 percent in October.
Benediktsson himself described upcoming wage negotiations as “the biggest single challenge of the Icelandic economy” in a September speech that was delivered just two days before his nine-month-old government collapsed over a pedophilia scandal.
Meanwhile, there are signs that the economy may be cooling after growing at a whopping 7.4 percent last year. Economist surveyed by Bloomberg are forecasting gross domestic product growth at 4.2 percent this year, while the central bank recently lowered its forecast for 2018 to 3.4 percent from 5.5 percent.
Infrastructure Spending
The Federation of Icelandic Industries is also keen to kick-start investments, a popular theme on the political left. At the same time, it wants the new government to show fiscal rectitude. Balancing those competing aims is likely to pose another major challenge for the left-right coalition.
“It will be very interesting to see how the budget bill will look,” Hannesson said. “It was very positive to see a budget surplus of about 2 percent of GDP in the budget bill that was submitted this September. I surely hope that the bill they will put forward in December will not contain a smaller surplus for 2018.”
According to local daily Morgunbladid, the incoming government plans to use some of the proceeds of the sale of state-owned shares in the country's banks to help finance infrastructure projects.
But it's a big job. Hannesson's group estimates roughly 400 billion kronur ($4 billion) are needed to get Iceland's infrastructure up to where it should be. With the economy now reaching more normal growth rates, that's just what might be needed, he said.
“We have been importing workers and I suspect we will continue to do so if needed,” he said. “If done right it's unlikely that this build up will cause an over-expansion, since growth is already slowing down.”
To contact the reporter on this story: Ragnhildur Sigurdardottir in Reykjavik at rsigurdardot@bloomberg.net.
To contact the editors responsible for this story: Jonas Bergman at jbergman@bloomberg.net, Nick Rigillo
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