Nov 27 2009

Is Heavy Industry the Way Out of the Economic Crisis?

By Indriði H. Þorláksson – Economist

The economic effects of heavy industry must take into account both short and long term economic policies.

Statements put forth without reasoning sometimes obtain more significance than they merit. Two such statements that are held aloft about the building of energy plants and heavy industry are particularly dangerous.

On the one hand that they are necessary and that they might even be the way out of the crisis and on the other that the future of the Icelandic economic system is best insured by utilizing energy resources and with heavy industry. One looks to the short term and the other to the long term but both are questionable, probably wrong and even dangerous.

The economic impact of heavy industry must take into account both short and long term economic policies, In the short term, say 3-5 years the goal is to restart the economy. In the long term the goal is to promote growth in the economic system to provide citizens with the good things in life. To do so the economy has to provide the highest augmented value to the nation for its work, capital and resources.

Short term impact
In the short term the effects of heavy industry on the job market, construction and the related creation of jobs has mostly been looked at. Those effects must not be underestimated but one must bear in mind that these are mostly in the short term. The effect of each heavy industry project can be from several hundred to a few thousand yearly jobs but as experience has shown and as can be seen in economic predictions which take into account heavy industry projects, these effects wear off.

The effect of heavy industry, which is financed by foreign capital, on the currency is quite unclear in the short term. For a very short time they can strengthen the value of the Icelandic krona but it is quite likely that a longer term negative effect will soon become visible. First foreign loans would come into the country but payments and interest in the following years would very likely be higher than the income in foreign currency. It is worth pointing out that domestic loans to the energy industry will very likely be expensive in the next years. This is why heavy industry is not very likely to improve the currency situation or add to financial stability in the short or average term.

The short term effects of the power and heavy industry on state finances is not great. Temporarily there will be a higher income and less compensation indemnification but these effects will fade after the construction phase but then income in these areas become part of the routine operations. Because of depreciation of investments, among other things, there is not a marked increase in tax payments in the first 5-8 years after big construction projects as can be seen from the financial records of Icelandic aluminum company´s.

Economic effects in the long term
In the long term the value of heavy industry must take into consideration the permanent economic effects and in comparison with other choices in the utilization of man power, capital and natural resources, In general it is considered sensible to let the free market decide for the most part what is produced, where and how. So that the free market works and yields profitable results certain criteria must be met so that the pricing on the utilization of natural resources is normal and that negative effects such as pollutions is given a price that appears in the cost of the production. Transparency in these matters is the prerequisite of sensible decisions.

Many things point to the economic effects of heavy industry in the long term being a lot less than than generally has been believed and that it does not meet cost´s to grant economic concessions and by binding the use of natural resources far into the future. The economic value of heavy industry is largely based upon how the augmented value is split between domestic and foreign parties. As the situation is now around 2/3 of the augmented value goes to foreign parties but only about 1/3 to domestic parties in the form of wages, profits for domestic parties who sell there work and services to the industry as well as taxes of the profits of the operation.

It can be estimated that jobs and derived jobs from the average aluminum smelter in Iceland are only 0,5% to 0,7% of the whole labour force. It can be calculated that the economic impact of this labour force can hardly be more than 0,5% of the gross production for the country. Many believe that the economic effect of individual constructions on the work degree is none. That is they exclude other other job opportunities and the effect is decided by the operation increasing general productivity in the country or not.

The second part of economic effects is taxes that are paid of profit. The income tax for an average aluminum smelter after the period of depreciation is over could be 1-1,5 billion kronas a year. That is around 0,1% or even less of the countries gross production. The third part is the economic gain from energy sales to the industries. Little is known of this part but it is clear that the smelters have received a pretty good deal on the purchase of energy.

The long term economic effects of an average smelter could according to the aforementioned be between 0,1% to 1% of the gross annual production. Bearing in mind that heavy industry uses between 75-80% of all energy produced in the country the question of this being a profitable use of natural resources for the nation weighs heavy.

The economic effects of heavy industry in the short term can not justify the weight that they have been given as a response to the economic crisis. They have a limited temporary effect on the job market and no real positive effects on currency matters and state finances. Heavy industry construction is therefore not a real tool to get out of an economic depression. There are no real arguments for letting short term viewpoints have an effect on decisions on heavy industry construction.

Viewing the current pricing on use of natural resources, pollution issues and the taxing of foreign heavy industry it is questionable that economic arguments support further construction. The use of natural resources by its rightful owners call for a thorough examination and changes in these matters before decisions are made. The use of natural resources is such an important issue for the nation that decisions regarding it must not be taken on the basis of short term viewpoints, localized interests or uncertain economic terms.