2019 GDP growth courtesy of a contraction in imports?

To a large extent, we can thank the sharp contraction in imports coupled with modest consumption growth for last year’s GDP growth. Stronger household consumption and investment are carrying the weight at present, but the public sector will probably contribute to an increasing degree as well before the year is out.

Year-2019 GDP growth turned out robust, to the surprise of most observers, but the composition of growth was unusual in many ways. Growth surged in Q4, actually, measuring 4.7% year-on-year, according to new figures from Statistics Iceland (SI) — the fastest growth rate since Q1/2018. This uptick may seem odd to some, given an increasingly cloudy economic outlook, rising unemployment, and sagging expectations over the course of the autumn. A closer look at the numbers reveals, however, that it was due almost entirely to a plunge in imports. For instance, private consumption growth measured only 1% during the period, exports grew 0.5%, and public consumption was up 3.8%, whereas investment contracted by 3%. But imports contracted in volume terms by over 10% during the quarter.

Weaker imports, stronger consumption

In our small and volatile economy, it is often more illustrative to study annual data than quarterly numbers. GDP for 2019 as a whole measured 1.9%. Although this was the weakest annual growth rate since 2012, it was far stronger than most expected — ourselves included — after the shocks to Iceland’s export sectors. The composition of 2019 GDP growth was highly unusual in historical context, however. For the most part, growth was driven by a nearly 10% contraction in import volumes over the year. Private consumption grew 1.6% and public consumption 4.1%. But investment contracted by over 6% and exports fell 5% during the year. It is safe to say, then, that last year’s growth came courtesy of the contraction in imports, with a helping hand from moderate consumption growth. Yet the usual drivers of growth — i.e., investment and exports — which generally give an indication of where the economy is headed, contracted last year.

It is also worth bearing in mind that concurrent with the publication of 2019 figures, SI revised year-2018 GDP growth downwards by about 1%. Output growth in 2018 is now estimated at 3.8%. The change is due to a revision of business investment, which SI now estimates to have contracted by 11.5% in real terms instead of the previously estimated 4.1%.

Business investment has contracted by over a fourth …

Actually, the recent slide in business investment is cause for some concern. Since 2017, business investment has shrunk by nearly 27%, to 11.1% of GDP in 2019, the lowest ratio seen since 2012. Although it is certainly good news that businesses appear to have refrained from indulging in a leveraged investment spree as the business cycle advanced (the opposite of what happened just over a decade ago), it is also worth asking whether there is reason to put extra emphasis on stimulating business investment in the near future.

… while household investment and consumption fuel output growth

Alongside the slowdown in business investment, residential investment has skyrocketed, growing by 15% in 2018 and more than 31% in 2019. The increased supply of new homes comes as a breath of fresh air after the extreme shortages in the middle of the decade, although there still seems to be a degree of mismatch between the types of housing being built and the smaller, less expensive housing that is in such demand.

We have discussed the changes in Icelandic households’ consumption behaviour before: in recent years, household consumption has been countercyclical, whereas it used to be procyclical, in that households tended to splurge during boom times and then slam into reverse when boom turned to bust. Figures for last year confirm that this new-found moderation has continued, as private consumption grew at a measured pace even though overall domestic demand remained virtually flat. This turn to prudent behaviour, together with most households’ relatively strong equity position, will prove invaluable as the economy threads its way through the current complexities.

Will there be any GDP growth at all this year?

To be sure, 2019 GDP growth was much stronger than generally expected. But GDP growth alone does not tell the whole story about the state of the economy, nor does it provide unerring guidance on how to proceed from here. As is mentioned above, it was the contraction in imports that ultimately delivered nearly 2% GDP growth, while domestic demand stood still and exports were on the defensive. Given the circumstances reigning last year, it can perhaps be viewed as a welcome occurrence that imports should decline, but such a trend is not sustainable, as imported inputs are vital for the development of the economy and for lasting improvements in living standards.

In January, we projected that GDP growth would measure 1.4% in 2020, after measuring 0.3% in 2019. A number of factors now indicate that gowth is quite likely to turn out weaker this year. First are the base effects from last year’s plunge in imports, which increase the likelihood that the contribution from net trade will be significantly negative this year. Second, downside uncertainty about exports has increased as the COVID-19 virus has played havoc with the global economy. Furthermore, the surge in public consumption in 2019 suggests that growth will be limited this year. Nevertheless, we remain convinced that private consumption will prove invaluable in maintaining domestic demand and preventing a vicious cycle featuring operational difficulties for domestic firms, rising unemployment, and declining demand for domestic goods and services. Furthermore, there is a growing likelihood that the public sector will pitch in more than we had previously assumed, with countercyclical investment, including in infrastructure. As a result, the possibility of positive GDP growth in 2020 cannot be ruled out, despite the cloudy outlook.


Jón Bjarki Bentsson

Chief economist