The Economic Council Aningaasaqarnermut Siunnersuisoqatigiit

The Economy of Greenland 2014 Economic outlook Current economic policy Housing

The Economic Council was set up by Naalakkersuisut (the Government of Greenland) in 2009, and this is the Council's fifth report. The Economic Council is headed by a chairmanship of six people. The chairmanship is composed of a chairman, a vice chairman and four council members, all of whom are appointed by Naalakkersuisut. Since the last report, no changes in the composition of the chairmanship has taken place. In addition to the chairmanship, the Economic Council comprises members from interest organisations, the Naalakkersuisut administration, and research institutions. Members representing organisations and research institutions are appointed by the organisations concerned. The other members are appointed by Naalakkersuisut. The members of the Council can submit comments on the content of this report, but the chairmanship has the sole responsibility for the final content. The secretariat function of the Council is carried out jointly by the Ministry of Finance and Danmarks Nationalbank (the Danish central bank). The duties of the Economic Council are to carry out regular assessments of economic trends and of the sustainability of Greenland’s fiscal policy.

The chairmanship comprises: Chairman: Torben M. Andersen Professor in economics at Aarhus University and former chairman of the Taxes and Welfare Commission. From 2001 to 2003 he was chief economic adviser of the Danish Economic Council, and he is still active in the Council as a specialist expert. Vice chairman: Ulla Lynge Ulla Lynge has an MSc in Public Administration from the University of Greenland, and she is a director on the Sermersooq Business Council. She has extensive knowledge about Greenlandic society, and she has previously worked for the Greenland Home Rule and for the Municipality of Nuuk. Other members of the chairmanship: Other members of the chairmanship: Anders Møller Christensen is the former vice governor of Danmarks Nationalbank and has an MSc in economics. He was a member of the Consultative Committee for Greenland's Economy from 1988 to 2009. Anders Blaabjerg is Head of Statistics at Statistics Greenland and has an MSc in economics. He has previously been employed at the Ministry of Finance. Søren Bjerregaard is Head of Division at the Ministry of Economic Affairs and the Interior and has an MSc in economics. He has previously been a member of the consultative committee for Greenland's economy. Tønnes 'Kaka' Berthelsen, vice director at KNAPK, has an MSc from CBS and an MBA. He sat on the Knutzon Committee, he has been an executive director at Arctic Green Food and chairman of the board of directors of KNI.

Members of the Economic Council: Brian Buus Pedersen, Director at the Confederation of Greenland (Grønlands Arbejdsgiverforening) H.P. Barlach Christensen, managing Director of KANUKOKA Jess G. Berthelsen, Chairman of SIK Sivso Dorph, Chairman of IMAK and appointed by IMAK, AK and PIP Martin Kviesgaard, Director at Grønlandsbanken and appointed by the banks Tine Pars, Rector of the University of Greenland Lars Geraae, Statistics Greenland Jørgen Isak Olesen, acting Permanent Secretary at the Ministry of Fisheries, Hunting and Agriculture Jørn Skov Nielsen, Permanent Secretary at the Ministry of Industry and Labour Market Peter Hansen, acting Permanent Secretary at the Ministry of Finance and Domestic Affairs.

Monitoring group: Josef Kajangmat Karl Davidsen Klaus Møller Najaaraq Christiansen Samo J. Nielsen Maria Paninguak Kjærulff Mikkel Krogh Søndergård Inunnguaq Petrussen Ellen Rebekka Rosa Jacobsen Hanne Rasmussen Inoqut Kristensen

© Published by the Economic Council Layout: Info Design ApS, September 2014

Contents Summary ............................................................................................................................................. 4 Chapter 1 Economic climate .............................................................................................................. 7 1.1 Fisheries ........................................................................................................................................ 8 1.2 Resources exploration and tourism ............................................................................................... 9 1.3 Other investments ....................................................................................................................... 11 1.4 Consumption ............................................................................................................................... 12 1.5 Labour market ............................................................................................................................. 12 Chapter 2 Current economic policy .................................................................................................. 14 2.1 Employment policy ...................................................................................................................... 15 2.2 Public finances ............................................................................................................................ 17 2.3 Settlements ................................................................................................................................. 19 2.4 Self-sustainable economy ........................................................................................................... 20 Chapter 3 Housing ........................................................................................................................... 24 3.1 Demography and housing requirements ..................................................................................... 25 3.2 Public financing of housing ......................................................................................................... 27 3.3 Housing policy ............................................................................................................................. 31

Summary The 2014 report of the Economic Council contains the following themes: • Economic outlook • Current economic policy • Housing In the report, analyses are described in more detail in a number of technical background memos, which are all available at: www.naalakkersuisut.gl/da/OR

Economic outlook There was a drop in economic activity in Greenland in both 2012 and 2013, and the decline seems to have continued strongly in 2014. The decline is due to a combination of declining fishery, falling resources activities and a drop in tourism in addition to less building and construction activity. Seen in isolation, the experimental fishery for mackerel contributes to increased economic activity, but is not sufficient to prevent a drop in the entire economy in 2014. The outlook for 2015 shows that some large construction projects may contribute to a temporary increase in the activity level. However, much uncertainty surrounds the development, and there are no signs of a permanent recovery of the economy. The total economic activity is largely at the same level as at the end of the 2000s. This is mirrored in the employment problems, the increasing unemployment and net emigration of young people. Development over the past years shows that the economic growth potential is weak. The income gaps in relation to other countries is not being narrowed, and there are big differences within the boundaries of the country, and without new private business activities the outlook is very bleak. Development during the past years also stresses the very large vulnerability. The economy is very dependent on the possibilities and price development within the fishing industry. The past years have seen positive development both in terms of prices and catch, but the economic policy cannot be based on unexpected economic gains. Previous experience shows that falling prices and the loss of fishing possibilities occur periodically and lead to a worsening of both earnings potentials of fisheries and the public finances.

Current economic policy The employment and unemployment situation constitutes a major economic policy problem. The problem is not only due to the modest growth potential in the economy, but equally due to

structural challenges. In addition to the fact that a share of the highly educated and specialised labour comes from outside, a large share of foreign unskilled persons get jobs that do not require special qualifications. The structural challenges thus relate not only to improving the general qualification level of labour, but also to furthering conditions in relation to mobility and incentives. Reforms which increase the gains from working are required, and which tighten up the availability requirements to collect the unemployment benefits. It is positive that over the past years there has been progress in the educational sector where more young people are now completing an education. However, there are still great challenges in the area, and consequently continuous efforts are required. Public investments brought forward only provide a temporary employment effect and are therefore not the solution to structural employment problems in e.g. small towns and settlements. Attempts to solve structural problems through capital expenditures are unsuitable as they do not solve the underlying problems and merely strain the public finances.

Public finances The public finances are tight for both the Government of Greenland and the municipalities. Declining economic activity results in lower tax incomes. The income from the mackerel fishing has been an unexpected, but welcome positive development. This has contributed to ensuring a public finances surplus for 2014. In the Finance Bill for 2015, a deficit is planned at DKK 84 million for DAU (operating, capital and lending budget) and a total surplus in the same amount for the years 2016-18. This surplus should be ensured through a number of economic reforms at a total proceeds requirement of a little more than DKK 300 million for the years 2016-18. Also the Finance Bill for the last year contained such reform requirements, but the reform initiatives have been postponed, and in the meantime the need has grown. This relates to the fact that Inatsisartut (the Parliament in Greenland) has dealt with a number of cost-extensive proposals for decisions outside the total Finance Act prioritization. The outlook for the public finances is problematic. The importance of having a reform process initiated cannot be exaggerated. The absence of reforms not only postpones the problems, but makes them bigger and brings the economy into a more vulnerable position. It can be ascertained that after five years of self-government no major reforms have been implemented with a view to supporting a self-sustainable economy.

Self-sustainable economy A target of making the economy self-sustainable is ambitious if this is understood as to ensure a level and distribution of living standards in line with the Nordic countries and ensure a modern

welfare society – without transfers from abroad. The resources projects are necessary to a process towards a self-sustainable economy. These projects only trigger large socio-economic gains if translated into business development and employment without large import of labour. Reforms for supporting business development and reforms for solving the financing problems of the welfare society are not conflicting, but interrelated. A business development which increases production and employment presupposes an increased qualification level of the labour force, mobility and incentives to remain employed. If such process succeeds, it will also strengthen public finances through increased tax payments and fewer expenses for social benefits. Lately, the debate about a self-sustainable economy has had unfortunate focus on the number/size of resource projects which can render the economy independent of transfers from abroad. It is a passive strategy only to focus on other outside income sources to replace the block grant and other grants from abroad. It is not evident that in fact larger independence is created by dependency on financing contributions from multi-national companies. It is not realistic, within a very long time horizon, to build a resources fund of an adequate size so that the return on the fund can be equal to the transfers from abroad. This would require a resources fund which in relation to the size of the economy is five to seven times as large as the Norwegian oil fund (pension fund). This is no realistic scenario and underlines that a process towards a self-sustainable economy assumes business development.

Housing The housing situation is problematic for a number of reasons. Far too many dwellings are badly maintained. In the large towns there is a shortage of homes, which in itself is a problem, but it may also be a limiting factor in relation to education and business development. At the same time, it is the general view that housing is expensive, even if homes are supported by substantial amounts from the public, both directly and indirectly. The housing policy is expensive and does not meet its target. This applies in general as regards adapting the housing stock to demand and specifically in relation to targeting the support to the most disadvantaged in society. Housing subsidies are targeted at the financially most disadvantaged persons, but other types of support are primarily to the benefit of the more affluent.

Housing can be financed by very inexpensive loans from the Government of Greenland and the municipalities. This support in the form of interest constitutes about DKK 3-400 million and thus 3-4 times the expenditure for housing subsidies. Housing cannot be made more inexpensive for

all. The support must be paid either through higher taxes or lower expenditure in other fields. The high support level distorts the housing consumption and is far too large a burden on the public finances. There is a need to increase visibility and transparency of different types of support for housing. There are arguments in favour of public lending, but not that it should be made on more favourable terms in relation to interest and instalments than loans obtained on market terms. Already by virtue of granting public loans, support for housing has been granted.

Chapter 1 Economic climate There was a drop in economic activity in Greenland in both 2012 and 2013, and the decline seems to have continued strongly in 2014 as a sign of substantial economic problems. The decline is due to a combination of declining fishery, falling resources activities and a drop in tourism in addition to less building and construction activity. Seen in isolation, the experimental fishing for mackerel points to strengthening economic activity in Q3, but in itself it cannot prevent 2014 from being a year with economic recession. The prospects for 2015 show that some large construction projects may contribute to increasing the activity level temporarily. The estimated, and in the nature of things, uncertain growth is, however, no sign of any permanent recovery of the economy. At the moment, the sources for permanent and robust economic growth are not clear. The estimates for the economic growth are summarised in table 1.1. The negative growth in 2012 is especially due to a large decline in activities for exploration of hydrocarbon and to a smaller degree mineral resources, and the decline is assessed to have continued in 2013. In 2013 the quantity of shrimp catches fell by about 20% as against the quantities in 2012 and the preceding years.

Table 1.1: Supply and demand, annual real growth in per cent Growth rate in per cent 2009 2010 2011 2012

2013

2014

2015

Private consumption

Share of GDP 2012 45,8

-0,4

1,8

1,5

-0,2

-0,5

-2,0

0,9

Public consumption

51,5

3,7

-1,4

-1,0

-2,2

1,0

1,0

0,5

Total gross capital formation

37,6 23,9

-23,7 -23,4

75,2 4,2

31,0 20,2

-42,0 -13,3

-28,9 -15,0

-10,5 -6,5

4,1 10,2

Exports of goods and services

29,7

-11,3

12,5

-5,8

-3,7

-3,7

-4,7

0,8

Final demand, total

164,7

-6,7

16,5

7,9

-15,7

-7,4

-3,0

1,3

Imports of goods and services

64,7

-14,6

37,6

12,3

-31,1

-14,4

-5,1

1,0

Gross domestic product

100,0

-0,7

2,5

4,0

-0,9

-2,8

-1,9

1,5

exclusive of exploration investments

Note: 2009-2010 final figures from Statistics Greenland, 2011-2012 preliminary figures, 2013-2015 the Economic Council's estimate However, the drop did not damage the shrimp fishing economy because the prices in 2013 increased further and were about 50% higher as against 2010. The drop in quantities was partially counterbalanced by larger catches of Greenland halibut, and in addition experimental fishing for mackerel was started in 2013. Another important reason for the drop in 2013 is that

most investment types, including in building and construction, are assessed to have declined substantially. In 2014, the outlook is a further decline in the building and construction area. Development in tax payments, import duties and freight quantities indicates a very weak economic climate in the first part of the year. The increased experimental fishing for mackerel in 2014 will, however, increase the crews' incomes and thus the tax payments for Q3. Next year, in 2015, the prospect is increasing activity, primarily as a result of a number of large public investment projects, but also investments in connection with potential initiation of the ruby project at Qeqertarsuatsiaat. However, the outlook is no more than a modest increase in the economy, because there are no prospects of more growth neither in the fishing industry nor in tourism – and thereby exports – or private consumption. It is a special element of uncertainty that the municipal economy is under pressure as a consequence of falling tax payments, which seen in isolation may lead to declining building sector activity.

1.1 Fisheries In recent years the fishing industry has been favoured by increasing prices for many species. Prices of shrimp are about 50% higher than in 2010, whereas prices of Greenland halibut have risen by about 20% during the same period, see figure 1.1. Weighed with the export values in 2012, the prices remained unchanged from 2012 to 2013. Figure 1.1: Index of average price per kilo fish and shellfish

Source: Statistics Greenland

In terms of economy, shrimp is by far the most important species of the Greenland fishing industry. The fishery is MSC certified as sustainable. Quantitatively, the catches of shrimp in 2013 fell by more than 20,000 tons to 88,000 tons, corresponding to a drop of about 20%. It was partly counterbalanced by the increase in the catches of Greenland halibut by 2,000 tons or about 6%, and the cod catches increased by 3,500 tons corresponding to a little over 25%, see figure 1.2. Figure 1.2: Greenland fishermen's and vessels' catch in Greenlandic waters

Source: Statistics Greenland

In the experimental fishing, more than 50,000 tons of mackerel was caught in 2013, but the value per kilo was far lower than for the other species mentioned. In 2014, Greenland has set a quota of 100,000 tons of mackerel in the experimental fishing, corresponding to approx. 7% of the total mackerel quota for the North Atlantic.

By this fishery, Greenland seeks to be

recognised as a coastal state and thereby obtain a share of the joint quota between the EU, Norway and the Faroe Islands. If this proves successful, the seasonal fishing can be planned in a more rational way than in 2013 and 2014, and better prices can be obtained. The mackerel fishing has the potential to contribute with substantial growth to the economy for the coming years, as mackerel is a high-value fish if caught and stored carefully. However, it is also a requirement that the fish population is robust enough to cope with the heavy pressure on fish in 2014 in which the sum of the quotas for the North Atlantic exceeds the biological advice by about 30%.

In 2013, Greenlandic vessels caught 24,000 tons of fish (ex the catch of capelin) in the waters of other countries, an increase of 7,500 tons. The fishery is part of the Greenlandic fisheries agreements with other countries.

In 2014 the shrimp quota has been set at 85,000 tons. The 2015 quota will be set at the end of the year. The decline in the presence of shrimp is probably conditioned on climate. One of the signs is that shrimp is caught increasingly northwards, and there are increased stocks of cod for which shrimp is part of their food source. The increase in the catches of Greenland halibut in 2013 was primarily coastal. In 2014, a further increase of this fishing is expected in that the quotas were raised and, in particular as regards the Disco Bay, clearly exceed the biological advice. Therefore there is a risk that coastal catches of Greenland halibut will decline permanently over the coming years. But it is difficult to assess the risk of exceeding the biological advice markedly. With the reservation regarding the fishing of mackerel and other pelagic fish at East Greenland, the growth potential of the total fishing must be deemed to be limited in the coming years, with a drop for some species and progress for others. This underlines the importance of developing other private businesses in which extraction of raw materials is the most realistic, but in which tourism can also contribute. A higher degree of fish and shellfish processing in Greenland could help employment in the fishing industry, but the relationship between the prices of raw materials and the more processed products, in many cases, makes processing onshore unprofitable and requires public subsidies to implement. This strategy is not recommendable.

1.2 Resources exploration and tourism Resources exploration is of large importance to the local areas and in particular the transport sector. In addition, there are tax incomes from both local and foreign employees. The major part of the investments consists, however, of import of materials, labour and capital, but the spillover effect on local businesses within transportation, supplies and hotel operation has proved to be substantial. In 2010 and 2011, there was high activity in oil exploration off West Greenland. There has been no exploration drilling in neither 2012, 2013 nor 2014, but much other activity, for example seismic studies, and the companies have not totally abandoned their licences. The sharp growth in oil and gas production in North America through fracking or exploitation of tar sands has reduced US dependence on hydrocarbons from especially the Middle East, and thus also in

general reduced many oil companies' interest in hydrocarbons from areas with high extraction costs, which is the case in the event of an environmentally sound extraction in the Greenlandic waters. With regard to mineral resources, the number of exploration licences increased from 75 to 97 in 2012, but expenditure on exploration fell considerably, see figure 1.3. In 2013, the activity fell considerably by all accounts. In particular this reflects less field work than in previous years. The main reason is probably that many resources have fallen in price from a very high level in 2010-11, i.a. as a result of the global economic slowdown, including the Chinese economy. Figure 1.3: Exploration expenditure

Note: Expenditure on oil exploration has been translated from USD into DKK; 2012 has been estimated by the Economic Council. Source: Statistics Greenland, Statbank, Danmarks Nationalbank for exchange rates.

2013 saw the closing of a gold mine in South Greenland with about 80 employees after some years of operation showing a loss for most of the time. After the closing, there is no longer any mining in Greenland, but there are a number of advanced projects awaiting financing.

In 2014, a production licence was granted for a large iron project in the fjord of Nuuk and for a smaller ruby project at Qeqertarsuatsiaat. In connection with the latter project, an IBA agreement (Impact Benefit Agreement) has also been concluded on the use of i.a. local manpower and local deliveries. However, it is still not certain whether the iron project at Nuuk will be realized, as the company is still seeking investors for financing the project. The 2015 growth estimate includes capital expenditures in connection with the ruby project.

Previous expectations for the development of tourism have not been met. The number of airline passengers to and from abroad is falling, which may be a result of declining tourism, but it may also reflect the drop in i.a. raw materials activities. Also, cruise tourism is in marked decline. In 2013, the number of cruise passengers was almost 30% lower than in 2010 and a little lower than in 2006, see figure 1.4. Figure 1.4: Number of cruise passengers

Source: Statistics Greenland.

This reflects that even if Greenland has much to offer to tourists, the country is impeded by a high level of expenses, including taxes and telecommunications fees. The relationship between price and quality must no doubt be improved if tourism is going to play a bigger role than now. Another quality aspect is the education of local tour guides with good language skills in a number of languages and knowledge and with a wish to speak of what tourists are interested in. In the Finance Bill for 2015, Naalakkersuisut contemplates that the passenger duty of cruise tourism be reduced to the same level that applies to Iceland and Spitsbergen.

1.3 Other investments Capital investment by the Government of Greenland was DKK 795 million in 2013 as against DKK 1,051 million in 2012, when allowance has been made for changes in the construction and renovation fund. In 2014, capital investments are expected as in 2013, but the Finance Bill 2015 includes capital investments of about DKK 700 million. In 2015, there will be further public construction activity attaching to the Danish Government's building of a prison in Nuuk and the construction of a new container port in a private business framework. In return, the private construction investments will probably fall considerably. This is underpinned by lower growth than previously in the mortgage lending to Greenland, see figure 1.5. Figure 1.5: Banks' lending to and deposits from Greenland (left) and mortgage credit institutions' lending to Greenland analysed by category of property (right)

Note: Latest observation is Q1 2014. Source: The Danish Financial Supervisory Authority and Danmarks Nationalbank.

Owner-occupied housing has become more widespread in recent years. Among other things, this appears from the increasing mortgage-credit lending. More owner-occupied homes are good for housing standards, and in the long term it may slow down the maintenance backlog characterizing the housing stock. But the owner-occupied homes also give rise to problematic aspects attaching to the public subsidies for owner-occupied homes, and the financing of housing may create problems for economic stability. Often, the owner-occupied homes will also comprise loans from the Government of Greenland and the municipality. Many of these loans

carry no interest and repayment for 20 years, after which they carry interest at Danmarks Nationalbank's official discount rate plus usually 3%, and they must be repaid over 15 years. Even if a loan carries no interest and no repayment is made, the loan is a burden on the property despite the large subsidies in the form of no-interest or interest-only loans for some years. To the extent that this burden is not clear to the buyers, it will mean too high prices for owner-occupied homes and a risk of a subsequent economic decline. Buyers must therefore realise that no-interest and interest-only loans imply a burden even if no interest and instalment must be paid for a number of years, and even if the future payments on these public loans have not been stated in the particulars of sale. According to the preliminary foreign trade statistics, almost no vessels or aircrafts were imported in 2013, and the import of trucks and delivery vans was modest. Consequently, investments in means of transport have also been small. At the same time, Royal Arctic Line's purchase of vessels has also been delayed by the bankruptcy of a German shipyard, so in 2014 this type of investments is also expected to be low. Figure 1.6: Import duties

Note: 12-month sum. The latest observation is July 2014. Source: the Government of Greenland.

1.4 Consumption Private consumption is presumably on a weak downward trend. The current determination of the tax base shows falling nominal incomes, for the first half year of 2014 about 2.5% lower than the year before, and the proceeds from import duties also point downward, see figure 1.6. The decline is particularly large for the consumption of alcohol and tobacco, but almost all sectors of

private consumption point downward. However, not all forms of private consumption are subject to import duties. As the housing stock increases, the consumption of housing allowances (rent) excluding inflation will also increase. The private consumption drop is expected to stop this year, and a small consumption increase is expected in 2015 when incomes are expected to show a weak increase.

Public consumption is expected to show a weak increase in 2013 and 2014 according to financial statements and budget information. Falling tax incomes will, however, put pressure on the municipal economy, which may entail that the municipalities reduce both their investments and consumption in relation to plans. In that connection it is a risk that potential savings are aimed particularly at maintenance of public buildings and constructions. That will entail further deterioration of the building stock and thus worsen the sustainability problems.

1.5 Labour market The only source of data for ongoing assessment of the labour market is the number of registered job seekers. The statistic shows the number of persons who during a single month have registered at unemployment offices as job seekers.

This administrative practice of

registration may, however, have varied from year to year and from municipality to municipality, not least before 2012, when guidelines were issued about the criteria case officers have to apply for registration. Therefore it is not possible to assess developments in the number of job seekers over a longer period. In the first six months of 2014 the number of registered job seekers was 4,170 on average as against 3,860 the year before. Some of these 4,170 persons may well have had paid employment for some of the month, but they have also registered as job seeking at some time during the month. Irrespective of any reservations as to how much the figures may be interpreted, there is hardly any doubt that this reflects an actual increase in unemployment. For the most recent 12-month period, a total of 9,640 persons have been registered as job seekers at some time, which is an increase of also 300 persons when compared with the 12-month period ending on 30 June 2013. The number of persons who have been job seekers for at least 10 of the 12 months has risen from 1,170 to 1,290, which also indicates an increase in long-time unemployment. Statistics Greenland has started publishing an annual unemployment statistic. The statistic does not include persons, who in the same month have registered as job seekers and have had paid employment, among the unemployed. For 2012, the number of unemployed amounted to 2,655,

which was an increase of 130 as against 2011. In 2012, the 2,655 unemployed corresponded to 9.4% of the workforce. There are fears that the figures for 2013 will show an even higher unemployment rate. Figures for employment and unemployment for 2013 are planned for publication in December 2014. One of many signs of structural problems on the Greenlandic labour market is that in 2012 and 2013 there was immigration of unskilled labour, even though there was also high unemployment. This suggests that the unemployed do not have the qualifications required, or they do not seek the jobs available for geographic or professional reasons. Therefore, more initiatives must be taken to raise the level of education and enhance professional and geographic mobility. The benefits for the individual by remaining on the workforce must be larger than today.

Chapter 2 Current economic policy The economic activity has been on a downward trend since 2011. For 2015, the prospect is a small increase in economic activity, but to a large extent this is driven by temporary factors and cannot be interpreted as a sign of any decisive economic turn, see chapter 1. The overall picture is thus that the economic activity is largely at the same level as at the end of the 2000s. The underlying economic growth potential is weak. This is mirrored in the employment problems, increasing unemployment and net emigration of young people. Figure 2.1: Gross domestic product development, fixed prices

Source: 2007-2012 data from Statistics Greenland, 2012-14 from table 1.1 in chapter 1

When the economy is not undergoing a major crisis, it is highly due to a very favourable price development of fish and shellfish, see chapter 1. However, in the future the same large price increases of fish products cannot be expected. OECD-FAO has recently published a long-term prognosis for fish price development. The main conclusion is that going forward no large price increases of fish can be expected in relation to the general price development, see figure 2.2. An expected increase in demand for fish products will to a high degree be countered by a strong increase in the production of fish in aquaculture. Even if the prices of fish caught in the sea is higher than for fish from fish farming, then the price development is moderated by the increased supply of fish from aquaculture. The price development of fish products is affected by many factors, and according to experience there may be large fluctuations in the more long-term development trends. Figure 2.2: World market prices of fish, actual development and prognosis, price development corrected for inflation

Note: the figure shows the price development of fish caught in the sea corrected for general price increases (inflation) Source: OECD-FAO, 2014, Agricultural Outlook.

The possibility of mackerel fishing is a positive development in the fishing industry, not only for the industry, but also for the public finances. A duty revenue from the mackerel fishery in the amount of DKK 90 million is expected in 2014 and for each of the coming years 2015-18. When compared with expectations a couple of years ago, this is an unexpectedly large income which will be of material importance to the public finances. Development over the past years shows that the economic growth potential is weak. The income gaps in relation to other countries are not reduced, and there are big differences within the boundaries of the country. Without any new private business activities, the outlook is very bleak. Development during the past

years also stresses the very large vulnerability. The economy depends heavily on the possibilities and price development within the fishing industry. The past years have seen positive development both in terms of prices and catch (mackerel), but the economic policy cannot be based on the occurrence of positive events only. Previous experience shows that falling prices and the loss of fishing possibilities occur periodically and lead to a worsening of both earnings potentials of fishery and the public finances.

2.1 Employment policy The employment and unemployment situation is a major economic policy problem. Basically, there are two main reasons, namely both the modest growth potential in the economy and structural challenges. In the short term, it is politically difficult to do anything effective and appropriate to decisively affect the employment development. In the public finances there is only modest latitude to lead a more expansive policy. The possibilities are primarily concentrated on building and construction activities. It is well-founded to advance public capital expenditures in a period when activity in the private sector is low. In order that such initiatives become appropriate, a number of requirements must be met. The capital expenditures must meet the requirements in the debt and investment strategy to contribute to fiscal sustainability. This means that the projects must support development of businesses and employment. This implies that the capital expenditures must not necessarily be made where the employment problems are largest, but where the possibilities of a future employment development is the best. Public investments brought forward only provide temporary employment effect and are therefore not the solution to structural employment problems in e.g. small towns and settlements. New construction of homes must be focused on the areas in which there is evidence of business development and population growth either on the basis of existing activities or by actually commissioning mining projects etc. In other areas of the country, housing renovation may be required, but not an extension of the housing stock. Attempts to solve short-term employment problems through capital expenditures are unsuitable as they do not solve the underlying problems and merely strain the public finances. Using construction activities as an instrument for improving the economic outlook has also proved difficult as a limited number of activities can actually be advanced. It is problematic trying to solve structural problems by increasing the catch quotas in excess of

the quotas recommended by biologists.

The short term gains from such a policy is

overshadowed by the large and negative long-term consequences to both catch quantities and prices due to an increased risk of losing or not obtaining international certification.

In the present situation, the low growth means less employment and higher unemployment, but the main reasons for the employment problem is a number of structural matters. In a number of areas, jobs are filled by manpower called in. This applies not only to jobs requiring specialised or trained labour, but also to jobs without large qualification requirements, including unskilled jobs. The structural challenges thus concern the general qualification level of labour, but also issues in relation to mobility and incentives. Only little progress has taken place in the labour market policy. The match group system makes it easier to target the labour market policy. As previously pointed out in the Economic Council Reports, the economic gain from working is modest for large groups, see e.g. Economic Council (2013). This is the result of interaction between the social benefits and the tax regime. Regard for income safety creates modest gains from working. To a certain extent, the consequences of this problem can be countered by activation requirements in the labour market policy. When the paradox can be ascertained that at the same time there is shortage of manpower and idle manpower with the required qualifications, this is a sign that the availability and sanction mechanisms of the labour market policy are inadequate. In an economy that depends heavily on fisheries, large fluctuations in the need for manpower must be expected due to catch possibilities/weather conditions etc. The labour market policy must be designed so as to cater for such variations in the need for manpower. There are no quick and easy solutions to the structural problems attaching to the employment situation. Reforms which increase the gains from working are required, and which tighten up the availability requirements to collect the unemployment benefits. The basis for permanent high employment is related to the possibilities of business development and a general boost in the qualifications of the labour, see the Economic Council (2013). Over the recent years, progress in the educational sector has taken place in that more young people are completing an education. It is important to retain this development. Capital expenditures to support the educational policy should therefore be given high priority. Since 2005 when the education plan of Naalakkersuisut was initiated, there has been an increase of about 50% of the number of young people undergoing education and the number of graduates.

Table 2.1 shows that there has been a permanent increase in the number of

graduates in the period 2005-2013, and that the increase applies to both vocational education and training, upper secondary education and higher education.

Table 2.1: Number of graduates according to type of education 2005

2006

2007

2008

2009

2010

2011

2012

2013

Vocational education and training

246

265

295

309

332

319

390

410

389

Upper secondary education

146

183

199

206

204

236

275

314

334

Higher education

164

135

170

162

188

201

182

211

201

Total

556

583

664

677

724

756

847

935

924

Source: Statbank Greenland, Statistics Greenland

This development is encouraging and an indication that long-standing and systematic efforts to structural improvements may lead to results. But there is still a long way to go before a satisfactory educational level is reached. Only about half of a year group of young people get a qualifying education, and there is a long way to Naalakkersuisut's target that 70% of a year group of young people must have a qualifying education. The drop-out rate from the youth educations is still alarmingly high. In particular, it gives rise to concern that in 2012 about 62% of the persons between 16 and 18 did not undergo education. That is a sign of bad utilization of the potential represented by the year groups of young people, and it is a very bad start of the majority of the young people's lives after primary and lower secondary school when they have not started an education. It is a serious failure that municipalities and the Government of Greenland have not been able to solve this challenge. It is true that Naalakkersuisut has an objective to reduce this group to 57% in 2017 and 40% in 2020. But it must be considered an unambitious objective, and the chairmanship encourages the municipalities and the Government of Greenland to take initiatives to strengthen considerably the efforts vis-a-vis the youngest people at all levels so that a substantially larger share of a year group gets an education.

2.2 Public finances The public finances are tight for both the Government of Greenland and especially the municipalities. Declining economic activity results in lower tax incomes. The income from the mackerel fishing has been an unexpected, but welcome positive development. In 2014, a surplus of DKK 47 million is expected for DAU. In the Finance Bill for 2015, a deficit is planned at DKK 84 million for DAU and a total surplus of the same size for the years 2016-18.

The Finance Act for 2014 contained a proceeds requirement for the effects of the economic reforms at just under DKK 300 million over the years 2015-17. The 2015 Finance Bill contains a proceeds requirement for the effects of reforms at about DKK 300 million over the years 201618. No actual reform initiatives yet exist to meet this requirement. The need for reforms has increased slightly, while reform initiatives have been postponed. Since the enactment of the Finance Bill 2014, Inatsisartut has dealt with motions involving expenditure outside the total finance act priority, which can result in less fiscal sustainability. This applies e.g. to the construction of a new parliament building and an increase of grants to agriculture without simultaneously requiring structural adjustment and profitability in the business sector. In the 2015 Finance Bill, an amount has been earmarked for the establishment of an airport in Qaqortoq, which cannot be expected to improve sustainability. The underlying development of public finances is thus more problematic than the impression provided by the surplus on the DAU balance for 2014. In future, there will be much dependency on reforms not yet implemented. The Finance Act 2014 included budgets for incomes from sale of homes at DKK 30 million in 2014 and DKK 20 million in the subsequent years. In the Finance Act 2014, the mackerel duty was determined at DKK 90 million, whereas no incomes in the years covered by the Bill were included. As mentioned, the 2015 Finance Bill includes budgets for incomes from mackerel fishing at DKK 90 million per year. This unexpected income source is thus assumed to be permanent. The large and unexpected changes in income sources creating a connection in the public finances as compared to the continued postponement of necessary reforms only underline the large weaknesses of the public finances. Looking forward, there will be considerable pressure on the public finances. The Economic Council has previously analysed the development in income and expenditure as a result of the changed demography with a larger share of elderly citizens. Figure 2.3 shows an update of the 1

analysis . With unchanged welfare schemes, tax system etc., public spending will grow, while the incomes will fall slightly as a share of the gross domestic product. This will result in an increasingly large gap between income and expenditure, and the existing structure of the welfare schemes cannot be financed. This is not an external problem, but is basically driven by the positive fact that life expectancy is increasing and that consequently there will be more elderly people in society. The systematic difference between incomes and expenditures therefore gives rise to the question how much an individual should contribute to and receive 1

For further documentation of the update, see Technical background memo 2014-3: Updating of calculation of fiscal

sustainability 2014

from the welfare society over their lifetime. As life expectancy is on the increase, it is natural to discuss retirement age etc. This discussion also takes place in all countries with the prospects of an increasing number of elderly. At the same time, the calculations have as their basis the present policy. In a number of areas, there are big questions as to whether the structure of the policy meets its targets at the lowest possible expenditures, see chapter 3 on housing policy. Accordingly, there are a number of reform options which can contribute to solving the financing problem illustrated in figure 2.3 and which will make it possible to proceed with a system of modern welfare schemes.

Figure 2.3: Public income and expenditure as a percentage of GDP, 1994-2040.

Source: The sustainability model, own calculations

The calculations are based on a number of assumptions, and uncertainty is related thereto. Sensitivity analyses show that the actual number of course changes along with changed assumptions, but the result that a systematic financing problem occurs over time is valid for all realistic scenarios. Analyses of the sustainability of the public finances serve the purpose of identifying the problem and providing recommendations for possible solutions without providing a precise long-range forecast. The analysis is not a forecast, as large and systematic deficits will lead to comprehensive indebtedness which lenders will not accept. Therefore, lenders will make demands for financial tightening and reforms to remove the deficit at an early stage. The analysis is thus important input for the political decision-making process in relation to futureproofing the welfare schemes by implementing reforms in due time. In continuation of the 2013 report, the Political and Economic Report for 2014 announces a reform program to solve the financing problems of the welfare society. The ground is prepared for a stepwise procedure in which a reform of early retirement must be presented at the autumn session 2014. For the spring session 2015, reforms of retirement pension and business

taxations are planned, and at the autumn session 2015 reform proposals for social benefits, the housing area and personal taxation must be tabled. It is important to view the reform areas in a context. There is a close connection between many policy areas, and the effects of i.a. income distribution can only be assessed in a meaningful way by looking at a concerted reform package. Therefore, it involves a risk looking at the reform elements one by one. It must also be stressed that the alternative to reforms is not to continue existing schemes which, as mentioned, over time do not financially make sense. Some reform elements may also have immediate proceeds effects which must be compared with more longterm consequences. An important example thereof is reorganisation of the pension taxation, so that the possibility to deduct contributions is removed, and at the same time taxation on payment is removed. Such a reform must be viewed in connection with other reforms in the pension area and in the context of retirement age etc. The technical tax reorganisation of the pensions may advance considerable proceeds, and it is therefore crucial that any proceeds are not released for other purposes, but are used for mitigating the sustainability problem. As emphasized in the Finance Fill 2015, this presupposes that the funds are tied in a trust structure.

The importance of having a reform process initiated cannot be exaggerated. Without reforms, Greenland will never be financially self-sustainable, and the country will continue to be economically dependent on others and see a value creation which per capita is clearly below the level of neighbouring countries in Scandinavia and North America. The pending financial problems are exhaustive, and the reform areas are difficult, requiring time for both political processing and the subsequent implementation. It can be ascertained that five years after the introduction of the Autonomous Government of Greenland no major reforms have been implemented which will contribute to supporting any self-sustainable economy.

2.3 Settlements Settlement patterns are rapidly changing, and the population is concentrated in the major towns. At the same time, the age composition is changed towards there being more elderly and fewer young people. This trend is especially marked in the settlements. With still less people in the reproductive age it is difficult to prevent the population in the settlements to reduce further over the coming years. This development is no specific Greenland phenomenon. On the global level, increasingly more people live in towns. The changed settlement contributes to creating increased affluence and is

related to changes in production and social structures, including in particular education and health requirements, but also access to culture etc. However, there are big differences in the development. The towns are different. The settlements are different. These minor differences are not apparent when average figures for all towns are compared with average figures for all settlements in a simple manner.

The Greenland settlement pattern with a small population spread over a very large area has always been the subject of debate. The debate has intensified as a result of the requirements for creating a self-sustainable economy. Social structures are undergoing change, and better education, health and other welfare offers are required. At the same time, economic possibilities and structures change. There are ongoing changes in the possibilities of fishery and catch, and a self-sustainable economy presumes strengthened business development of other natural resources (minerals and hydrocarbons). This increases demands for education and qualifications and also affects settlement patterns. Regional differences and differences between towns and settlements can be seen from various 2

perspectives, but a number of problems attach to such comparisons . Living standards are usually measured on the basis of disposable incomes. But if informal economy plays a large role, a comparison based on registered incomes can only render a misleading picture of the level of and the distribution of consumption possibilities.

The tax proceeds form part of the welfare society's financing and depend on the registered incomes. In certain areas of the country, tax payments can be modest due to widespread barter economy. Sometimes, there is much focus on the benefits which individual groups derive from the welfare society. If an interest is taken in this issue, it is however necessary to look at both contributions to (the income side) and services from (the expenditure side) the welfare society. You must also respond to the fact that the public finances are under considerable pressure, see figure 2.3. Thus, there is a substantial financing problem for the existing welfare schemes, which requires increased payments of taxes and duties, limitation of the public expenditure, or reforms that decisively increase the financial basis of the public. These challenges also include the population in settlements and remote districts. The settlement discussion should therefore be seen in relation to the general challenges and need for prioritization.

There is less value creation in settlements than on the national average, also when an informal

2

For a further discussion, see Technical background memo 2014-1: The settlements in a socio-economic light.

economy is allowed for. This circumstance is closely connected to the educational level which is lower in settlements and small towns than in the large towns.

There is clear coherence

between education and being active on the labour market and incomes. At the same time, there are large differences both between towns and settlements - and among settlements. There are settlements that do at least as well as some towns. This relates to the fact that the settlements in question have an underlying business basis - e.g. fishing resources in settlements in North Greenland. Thus it underpins that settlement patterns should be seen in relation to occupational opportunities.

In the discussion about towns and settlements, the issue of economies of scale (large towns) and the disadvantages of operating smaller entities (small towns and settlements) is pivotal. It is difficult to quantify the extent of such effects. In studies about economic geography and international trade etc. it is generally acknowledged that there are material benefits of largescale production/disadvantages in relation to small entities.

Small-scale disadvantages are

evident in relation to schools and transportation and in the fields of supply of energy, water and commodities. The consideration for expenditure and quality is thus challenged with a small and dispersed population, which often leads to high costs and low specialisation. Consequently, it becomes both difficult and cost-intensive to ensure similar conditions and offers for the entire population across settlement areas. The tight public finances often necessitate that the funds are prioritised, and it must be taken into account where the options of business development and employment are. Settlements with a self-sustainable business base will thus also exist in the future – and all in line with the towns that rest on a self-sustainable business basis. Without this required business basis, even considerable direct or indirect grants can hardly prevent the trend of slow depopulation. That is e.g. the experience from Norway which has led a very active regional policy to ensure settlement particularly in northern Norway. The policy aimed at ensuring both fair living standards and trying to initiate a business development so that the areas are less dependent on grants. Examples of political steps are: exemption from labour market contributions, no income tax, higher child benefits, lower electricity prices etc. As a result of this policy, differences in living standards and other matters (education, health etc.) are not huge compared to the rest of the Norwegian population. Despite these measures, it has been difficult to start business development, and there is still migration from the areas. Norwegian experiences are thus that it has been difficult to counter underlying urbanization and settlement trends. Possibilities of education and occupation and economies of scale are of decisive importance to where the population settles.

2.4 Self-sustainable economy The implementation of self-government renders it natural to have an objective of ensuring a self-sustainable economy. This will be of great importance, not only in terms of economy, but also politically. It is important to apply a strategy for a process towards a self-sustainable economy. This presupposes a detailed indication of what should be understood by a selfsustainable economy.

Today, the economy depends heavily on transfers from abroad (Denmark and the EU). These transfers reflect dependency on other countries, including both economic and political dimensions. At present, the total transfers (block grants from Denmark, reimbursements from Denmark, grants from the EU) amount to approx. DKK 4.7 billion or more than 35% of the gross domestic product.

Making the economy independent of transfers from abroad is an obvious element in creating a self-sustainable economy. However, in itself this cannot be the definition of a self-sustainable economy. In principle, these transfers could be renounced, but of course it would have large consequences for the economy of Greenland and entail substantial deterioration of living standards in the country. Also, this emphasizes that a self-sustainable economy should be seen in relation to the living standards which the economy can support. A more inclusive definition of a self-sustainable economy is therefore that on a sustainable basis the requested living 3

standards can be obtained without transfers from abroad . Living standards should be understood broadly as both the general level of material living standards and the distribution thereof and consequently issues of social balance and inclusion. The organisation and financing of the welfare society are thus also encompassed as an element of the definition of a selfsustainable economy.

A target of making the economy self-sustainable is ambitious if this is understood as to ensure a modern welfare society with distribution of living standards in line with the Nordic countries without transfers from abroad. The ambitious elements of such a target is supported by the fact that all Arctic regions and many small countries depend on transfers from outside.

Dependency on transfers from abroad may be viewed from an absolute and a relative

3

The definition must also include any excessive exploitation of the natural capital, i.a that a short-term economic

recovery is not obtained at the expense of future generations. This aspect is not discussed further in the following.

perspective. A relative reduction takes place if the transfers become less important to the total economy, e.g. measured in relation to the gross domestic product. An absolute reduction is a decline in the amounts. A relative reduction is the primary target, whereas an absolute reduction is of less importance. Naturally, it would have large political signaling value being able to start a reduction of the transfers from abroad (the block grant), but in relation to living standards it is more decisive to ensure increased economic activity and thus reduce the relative importance of the transfers. There is considerable uncertainty attaching to the assessment of the economic development in the long term, including the effects of resources projects, for which reason it makes no sense to set a date of when the economy can be self-sustainable.

The resources projects are necessary for a process towards a self-sustainable economy. For a more detailed discussion, see the Economic Council (2013). The perspective and the large socio-economic gains are triggered if these projects translate into business development and employment for the population. To ensure such development, a number of reforms are necessary. Reforms to support business development and reforms to solve the financing problems of the welfare society are not conflicting, but interrelated. A business development which increases production and employment for the population presupposes an increased qualification level of the labour force, mobility and incentives to remain employed. If such process succeeds, it will also strengthen public finances through increased tax payments and fewer expenses for social benefits.

The question of economic independence has recently been analysed in the report "Til gavn for Grønland" (to the Benefit of Greenland) prepared by "udvalget for samfundsgavnlig udnyttelse af Grønlands naturressourcer" (the Committee for exploitation of Greenland's natural resources beneficial to society) set down by Ilisimatursarfik and the University of Copenhagen. The report concludes that the exploitation of resources is important to the development in Greenland, but that it is not realistic that this will provide such great yield that the economy may become independent of the block grant from Denmark. The report discusses economic selfsustainability, primarily on the basis of the question of the possibilities of generating adequate income corresponding to the block grant and financing of expected future deficits on the public budgets as a result of demographic changes. However, the report also emphasizes the need for economic reforms without this being explicitly linked to the requirements for a self-sustainable economy.

Lately, the discussion about a self-sustainable economy has focused on the number/size of resource projects which can render the economy independent of the block grant. It is a passive strategy only to focus on other outside income sources to replace the block grant and other

grants from abroad. It is not evident that in fact larger independence is created by dependency on financing contributions from multi-national companies. Without reforms, the economic development will make Greenland's negotiating position very weak, which will reduce the socioeconomic gains from the resources projects. It is correspondingly decisive that it is not realistic, within a very long time horizon, to build a resources fund of an adequate size so that the return on the fund can be equal to the transfers from abroad. Table 2.1 illustrates the requirement for the size of the resources fund measured as a share of GDP in order for the return to compensate for different levels of transfer from abroad. The return is based on the return of the Norwegian pension fund which is achieved for a very large fund capital with very dispersed investment activity outside Norway and a very large share of shares. It can be questioned if such high return can be realised looking forward.

For a resources fund to be able to counter the transfers from abroad, a very considerable asset accumulation is required. Table 2.1 shows that the assets must comprise between 900 and 1350% of Greenland's GDP depending on the transfers to be covered by the return. By way of comparison it can be stated that the Norwegian Oil Fund has a level of about 200% of Norway's GDP. This underlines very considerable requirements for the accumulation of a resources fund to thus ensure an income source that matches transfers from abroad.

Table 2.2: Assets requirements for the Resources Fund for the return to correspond to transfers from abroad, share of GDP. Block grants

Block grants

Block grants

Block grants

+EU

+EU

+EU

+repatriation

+repatriation +financing gap

889%

963%

1160%

1358%

Note: An actual return of 3% is assumed. Over the period 1998-2013, the Norwegian Pension Fund has had an average real return at 3.6%. The return on the Resources Fund must, however, be seen against the fact that the block grant is adjusted annually in relation to the PL regulation (prices and pay) in Denmark. Thus the return must be interpreted as the extra return which the means of the resources fund must yield in relation to the implicit nominal return on the block grant. Repatriation refers to assignments which today are performed with refunds from the Danish state. The financing gap refers to the cover of the financing problem illustrated in figure 2.3.

The requirements refer to both the accumulation of such a fund and the disposal of the means of the fund. Mining projects give rise to income from a number of channels, namely both the resource

interest taxation and usual personal tax incomes on the basis of production work and corporate tax income from derived activities. In principle, these incomes are very different.

The immediate resource interest taxation is in the form of royalties and corporate taxes and dividend taxes. According to the self-government agreement, it applies that the Danish state must receive half of this amount (beyond a certain level) in the form of a reduction in block grants. The other half accrues to the Government of Greenland and should accrue to the resources fund. If exploitation of the natural capital should not be made at the expense of future generations, living generations can only spend the return on the means of the fund. These are precisely the intentions behind the Greenland Mineral Resources Act from 2008. Possible applications of the funds are however very broadly worded, also even though it is specified that the application must contribute to ensuring that the Greenlandic society obtains the socioeconomic largest possible return and the most beneficial effects, in the long term. This leaves much room for interpretation in relation to which types of expenditure and activities can be financed citing that they will have long-term beneficial effects on society.

Ordinary personal tax income on the basis of productive work and corporate tax income from derived activities form an important element of the socio-economic gains from mining projects, see the Economic Council (2012). These incomes will indeed be bigger if it proves a success to exploit the projects as a basis for business development and employment, which will strengthen the earnings potential of the population and thus also the public finances. Focus in the economic policy debate should largely be on strengthening these opportunities. Incomes of this type should be expected to fluctuate considerably, which may have a destabilizing effect and lead to a zigzag course in the economic policy entailing large consumption of resources during periods with extraordinarily large incomes and a slowdown in the event of falling incomes. Therefore, there are solid arguments in favour of contemplating the establishment of a balancing mechanism or a form of balancing fund which can e.g. be authorised in a revised budget act.

Experiences from other countries with large natural resources underpin the problems of a passive strategy which solely focuses on tax incomes from exploiting the resources. In general, it is difficult to tie up the funds, and often they are spent on acute financing of various activities. There are very large fluctuations in incomes, which create very special management problems. Due to the short-sighted use of the funds, big economic problems occur when the resource activities are scaled down, and no basis for business development has been created.

The discussion about the Resources Fund emphasizes the lack of determining a general

economic strategy for a process towards a self-sustainable economy. If the economic strategy is that the return from the Resources Fund must contribute substantially to the public finances, it entails very heavy requirements on both the influx of funds and the investment of the fund capital. It is crucial that the funds are invested so that a market return is achieved, see the assumption in the illustrated calculations above. If the funds are used for other purposes, no market return is created, and thus the financing contribution to the public finances will be smaller. If the funds are used for investments in e.g. plants that give no market return, this assumption will fail.

As mentioned, in relation to the use of the funds it is important to ensure a market return to this way compensate for a reduced block grant. However, legislation provides the option of placing the funds in activities with no connection to a market return. In relation to activities to the benefit of society, it is important to distinguish between activities which will entail a direct economic return and activities with non-economic types of return. Both types of return are important to society and may give the grounds for political prioritization. However, only activities with an economic return in the form of e.g. increased incomes and tax revenue will relieve the public finances. In the wording of an application policy of the Resources Fund, such distinction between various types of return is therefore essential, and the present act on the resources fund is not adequately precise in that relation. Thus, there is a need for tightening the legislation on the Resources Fund and no relaxation.

There is considerable uncertainty as to which mining projects may actually be realised, and there is uncertainty surrounding the precise socio-economic implications. It is therefore not suitable to turn the discussion about economic self-sustainability into an issue of having to implement a certain number of projects (a few large ones or many small). This approach only focuses on finding other external financing sources as compensation for the block grant and to cover the expected systematic deficits on the public finances. This way, important questions are avoided both in relation to the present economic situation and structure and in relation to the socio-economic potential of the mining projects. Basically, problems cannot be solved through external initiatives in which payments from foreign businesses replace transfers from the Danish state and the EU. Experiences from resource-rich countries also underline that it takes more than foreign investments to ensure a self-sustainable economy, see Economic Council (2012). Economic reforms, especially those aiming at a higher educational level and strengthening the competencies of the manpower and the businesses, are vital to obtain adequate return on the resources.

Chapter 3 Housing The housing situation is problematic for a number of reasons. For a large share of the housing units there is a substantial maintenance and renovation backlog. There is a shortage of homes especially in the big towns, which in itself is a problem for families and young people without access to housing, but it may also be a restricting factor to education and business development. At the same time, it is the general view that housing is expensive, even if homes are supported by substantial amounts from the public, both directly and indirectly. Why is the housing policy not successful?

The brief answer is that the housing policy

contributes more to creating a large number of problems rather than solving them. First, the housing policy is complicated and non-transparent, which means that getting an overview of the entire policy and whether it reaches the targets is difficult. Second, the housing policy is based on the misconception that homes can be made cheaper for all. That is not possible, and the housing costs must be paid for one way or another. With the present housing policy, the real housing cost is not visible, neither to the occupant of the home nor the politicians. Finally, the housing policy means that the supply of homes is limited while at the same time the demand for housing is increased. The limitation of the supply takes place because a very large share of the home construction is either initiated or financed (in part) by the public. As the public finances are under pressure, that limits the construction activities. At the same time, considerable support – both direct and indirect – is granted to all types of housing, which contributes to increasing the demand for housing. In short, the housing policy becomes very expensive without it solving its tasks. Living in a reasonable home of an up-to-date standard is a material need for everybody. It is the primary target of the housing policy to support this. Housing policy is difficult in that homes are durables. Housing can be compared to a manufacturing enterprise. The building of the home (size, furnishing, facilities etc.) is an investment in production resources which on a daily basis produce a housing value to the resident. Owner-occupied homes thus require a substantial investment, and most families must borrow to be able to buy a home. The owner-occupied home has the advantage that people are masters in their own home and may dispose of it. It is also a risky investment in which the down payment (the equity) only constitutes a small part of the value of the home. The remainder is covered by borrowing. There is thus a risk related to owner-occupied homes in a negative and positive direction depending on the price development of owner-occupied homes. The public sector favours owner-occupied housing by not demanding lease of the building site, by giving grants to the financing (inexpensive loans and interest deduction) and by not taxing the produced housing value or capital gains when homes

are sold. In relation to owner-occupied homes it is an advantage that the owner has a financial risk attaching to the home and therefore a strong self-interest in maintaining and renovating the home. The disadvantages of owner-occupied homes are that costs and uncertainty attach to selling homes, that there is a requirement for self-financing, and a financial risk in the event of changing housing prices and changes to the interest level. In Greenland, mortgage credit is organised so that generally no adjustable-rate mortgages or interest-only mortgages can be advanced. This means that the uncertainty about future interest terms is considerably smaller than in e.g. Denmark. Rented accommodation has the advantage that it is more flexible to occupy and vacate the home (on the condition that rented accommodation is available), and thus it is especially advantageous to young people and young families that change workplace or where the family grows. People moving to Greenland will typically demand rented accommodation and not contemplate the purchase of an owner-occupied home until later. Rented accommodation may be both private or collective (public or housing associations), but in Greenland the majority of the rented accommodation is public/housing associations. Rented accommodation receives subsidies i.a. through the absence of payment for building sites or lease of land and more lenient financing terms. As the tenant does not bear the financial consequences of lacking maintenance, it is the responsibility of the housing association to ensure maintenance and renovation.

Thus, there are advantages and disadvantages attaching to both owner-occupied housing and rented accommodation. They allow for various needs, for which reason both types are important. The possibilities of establishing an actual market for homes (both owner-occupied homes and rented accommodation) are very different in the large towns and the small towns and settlements. Accordingly, the housing policy cannot be the same across the entire country. The job of social housing is to ensure that everybody can live in a reasonable home, regardless of income. This consideration is catered for by the housing subsidies scheme which through grants enables families with a modest income to afford a home. Of course this scheme may be discussed, but it takes up a crucial role, and it is therefore important to have a clear division between the housing and social policy. If the two considerations are mixed, the results will not only be a non-transparent and expensive system, but also an imprecise distribution system where large subsidies may flow to high-income families. This is the case with the present housing policy.

The problems on the housing market are about adjusting the housing stock to the needs

(demand). Over a number of years, there have been large changes in the settlement patterns of the population with an increasing population in the large towns and declining population in the major part of the rest of the country. It is expected that this trend will continue in the years to come. Section 1 looks further into the demographic development and its forward-looking importance to the housing market. Subsidies are granted to housing through a number of elements in the housing policy, including a very favourable public financing. Section 2 examines further the importance and extent of this type of support. Section 3 contains a summary and recommendations for policies.

3.1 Demography and housing requirements The housing needs depends on the size and age composition of the population. Young and elderly people are more often single, but many live in partnerships in other age groups. The more singles, the bigger the housing needs measured in housing units. The composition of the population is undergoing change, and in particular the age distribution is changed towards more elderly citizens. At the same time, ways of living together and geographic settlement patterns are changing. 4

This section shows the main results of an analysis of the importance of these demographic factors to the housing needs. The analysis uses new statistics prepared by Statistics Greenland for family patters in Greenland in the form of cohabitation frequencies by age distribution. These statistics are coupled with the population forecast to give a picture of the importance of the demographic factors to the housing requirements, both in relation to the entire country and regionally the four large towns, small towns and settlements towards 2040. The analysis only deals with the importance of the demographic factors. The demand for homes is influenced by many other circumstances, including also economic factors such as incomes, housing costs etc. The main results of the analysis are: • The need for homes has been on the increase for many years and is expected to increase further over the next couple of years. But afterwards, the overall housing needs will stagnate in line with the declining population. • Demands for housing will continue to increase in the four big towns - in particular Nuuk - over the coming many years. By contrast, the population development in the small towns and the settlement points towards a declining need for homes there, see figure 3.1. • The composition of demand will also change. Across the country, there will be a much greater

4

See Technical background memo 2014-2: Demography and housing requirements up to 2040.

need for homes which cater for the needs of the elderly. On the other hand, the need for family homes is declining, especially outside the large towns, see figure 3.2. • Seen in isolation, increasingly less young people points towards smaller requirements for youth residences. But as a starting point, there is a large unsatisfied demand for more student and youth residences etc. for young people. Figure 3.1: Development of housing requirements, towns and settlements, 2013-40

Source: Statistics Greenland and own calculations

Figure 3.2: Change in the housing requirements, distributed on age groups in 2013, entire country

Source: Statistics Greenland and own calculations

The future house construction cannot be planned solely on housing needs driven by demographic circumstances, as no allowance has been made for changes in incomes, interest, financing matters etc. which also play a role in the demand for housing. The demographic circumstances are, however, an important background factor, which should be included in the housing policy discussions and the planning of house construction. Population trends point towards having a prudent approach to future housing construction, where the need for increasing the number of housing units is not urgent. The public new construction of homes should not be performed in areas with a declining population. By contrast, there may be a need for renovation of homes and a gradual change in the composition of the housing stock towards more homes adapted to the needs of singles. To a high degree, the future housing construction will also depend on the scope and location of future business development. By way of example, any enhancement of tourism in the Disco Bay and the establishment of mines in the vicinity of existing dwellings will influence the distribution of demand for homes.

3.2 Public financing of housing The housing policy includes many elements and is very complicated. It is outside the scope of this chapter to discuss all elements of the housing policy. Box 3.1 provides a brief summary of the most important support elements for the various types of housing. In addition, there is the housing subsidy scheme which is not discussed in this chapter (for a discussion, see the Taxes and Welfare Commission (2011)).

Box 3.1: Overview of main characteristics of subsidies for various types of housing

Owner-occupied homes: • The Government of Greenland and municipalities finance up to 40% (maximum DKK 587,500 per home ) of the construction costs at no interest and payment for a period of 20 years. The loan is then settled over the subsequent 15 years as an annuity loan carrying interest corresponding to Danmarks Nationalbank's official discount rate plus three percentage points, and thus lower than the market rent. • Tax deductions on interest expenses and the absence of property value taxation • Capital gains are not taxed • No lease of land Co-operative dwellings: • The Government of Greenland and municipalities finance up to 50 % (maximum DKK 1,050,050 per co-operative dwelling) of the construction costs with no interest and repayment without time limitation • The possibility of conversion into owner-occupied homes with favourable financing as is the case for owner-occupied homes • Capital gains are not taxed • No lease of land Rented accommodation: • Rent determined on the basis of a return requirement at 1.5%, which is below the market return • Transfer of public rented accommodation at discounted prices and thus the possibility of untaxed -capital gain • The return requirement is calculated from values which are typically smaller than the actual construction costs and which have not been indexed. • No lease of land

Box 3.1 gives a summary view of the most important subsidy elements in the housing policy other than housing subsidies. The expenses for housing subsidies are visible and therefore often attract attention in the political debate. However, more support is granted to homes through a number of housing benefits both in relation to mortgaging and taxation etc. The Taxes and Welfare Commission (2011) estimated the total annual support level to constitute approx. DKK 440-470 million, of which housing subsidies amount to DKK 110 million (2009 figures). This corresponds to between DKK 7,800 and DKK 8,400 per citizen, young and old, each year. Public subsidies and loans for construction of homes appear from the budgets of the

municipalities and the Government of Greenland. However, a large share of the support for housing is "invisible" in the sense that it cannot be immediately read from the public budgets, but stems from a favourable treatment of homes. In terms of value, it amounts to a significant resource consumption, which related to the many problems in the housing area very much questions the present organisation of the housing policy. Both taxation and financing of housing can be questioned. The Taxes and Welfare Commission (2011) made a number of proposals for both areas. The subsequent sections deal only with public lending for housing on the grounds that considerable support is granted in this area and that therefore it is a natural point of departure for reforms in the housing area. The extent and complexity of support for housing means that reforms in the housing area must necessarily be implemented with relatively long transition periods so that changes in the framework terms will not result in major concern in the housing market. It would be appropriate if such reforms start with the financing of new homes. The public sector grants loans or subsidies to all types of housing, see box 4.1. There are several elements in this relation which are important to separate. First, the public has the role of lender. The reasons given are often that it is not possible to finance the construction of the homes without this public lending. This is an argument which has had much importance, especially in the light of history. Today, a number of homes are however constructed by means of private financing only. There may still be arguments in favour of public lending for part of the construction costs, as it lessens the risk of private lenders and thus makes it easier/cheaper to raise private financing for the other part of the construction costs. The other aspect is that the public grants loans on far more favourable terms than not merely private lenders, but also in relation to the prices at which the public may borrow. This is because the loans for e.g. owneroccupied homes are interest-free for a 20-year period and subsequently carry interest under the market interest.

Lending on more favourable interest terms than the market rent is in fact financial support to the home owner. The difference between the interest which the home owner/home user pays and the interest at which the public may borrow constitutes subsidies to the home user. In the public budgets these subsidies are invisible in that the subsidies are in fact lack of income equal to the difference between interest on market terms and the interest actually paid. Also, for owneroccupied homes there is a tax subsidy by virtue of the right of interest deduction, and there is no taxation of the current return on the housing, nor are capital gains taxed.

Subsidies for housing through lenient financing terms can be illustrated by an example. A house-owner receives a loan at DKK 587,500, interest-free over a 20-year period; the loan then

carries interest and is repaid over the subsequent 15 years. The exemption from repayment provides a liquidity gain through postponement of the dates of the instalments, whereas the lower interest (for a period no interest) gives an interest gain. The homeowner obtains a direct gain in the form of lower interest than if the financing was obtained on market terms. For a loan 5

of DKK 587,000, it corresponds to a gross saving of about DKK 230,000. If the interest deduction right is taken into account, the saving is of about DKK 135,000. However, the interest deduction right can be considered a grant to the homeowner applying to the entire financing of the home. The grant to the homeowner by virtue of the favourable financing of course increases in line with the loan amount (up to the lending limit), and therefore this part of the housing policy benefits especially families with high incomes who buy relatively large and expensive homes.

Similarly, subsidies are granted to rented accommodation with a return requirement on the public financing at 1.5%, which is far below the market rent. This 1.5% must in principle cover both return on the capital invested and depreciation on the value of the housing stock. In many cases it is doubtful if the return requirement at 1.5% covers the depreciation. Many rental homes have been fully written down, which corresponds to a write-down at about 4%.

6

The public (the Government of Greenland and the municipalities) has a large loan portfolio for homes. Table 3.1 shows the Government of Greenland's outstanding loan volume of a little less than DKK 1.9 billion at the end of 2013. In addition, the municipalities have granted loans which with some uncertainty may be estimated at about DKK 500 million in total.

Table 3.1: Public mortgage lending 2013 - loan volume outstanding

Illuut

BSU/partial do-ityourself construction of house

Total

56

423

648

1,892

1742)

433)

-

-

504

520

99

423

648

2,396

Owner-occupied homes and renovation loans

Co-operative dwellings

From tenant to owner

The lending of the Government of Greenland

4191)

346

The lending of the municipalities

287

Total

706

(DKK million)

Source: The Central Accounting Department, Economy and Personnel Agency, and the municipalities.

5 6

A market rent at 4% and an official discount rate at 0.5% are assumed. Annual depreciation at 4% will entail that the value of the building is reduced to about one fourth of the initial value

after 40 years, and in many cases it will not be worth preserving.

Note: 1) Renovation loans constitute DKK 40.9 million out of the DKK 419 million under "Owner-occupied homes and renovation loans" for the Government of Greenland. 2) Kujalleq, Qaasuitsup and Qeqqata calculate loans at a total of DKK 39 million under ’Co-operative dwellings’. The Ministry of Finance and Domestic Affairs estimates Sermersooq's lending at DKK 135 million. 3) The municipalities calculate loans at DKK 33 million under "From tenant to owner". In addition there is the economic outlook mortgage (konjunkturpant) which the Ministry of Finance and Domestic Affairs estimates at DKK 10 million.

The total loans of the public for housing purposes thus amount to DKK 2.4 billion.

The Government of Greenland and the municipalities have also tied considerable amounts in public rental apartments providing a very limited capital income for the owners of the buildings. The residents pay a total capital income of DKK 111 million, corresponding to 1.5% of the housing value totalling DKK 7.4 billion, see table 3.2.

Table 3.2: The valuation of public rented accommodation at a capital income of 1.5%, 2013

The Government of Greenland's rental accommodation

The municipalities' rental accommodation

Total

Capital income proceeds

Calculation basis

53.9 million

3.6 billion

57.1 million

3.8 billion

111 million

7.4 billion

Source: The financial statements of the Greenland Treasury, 2013, KANUKOKA and the municipalities.

Together the value of rented accommodation at DKK 7.4 billion and the lending at DKK 2.4 billion results in a public commitment totalling DKK 9.8 billion. At an interest level of 4% this would result in about DKK 390 million in gross interest income. The annual capital income and interest income are, however, not close to this level, and thus in fact considerable indirect subsidies are given through the low capital income requirement and the favourable lending conditions.

In the perspective of a distribution policy, the indirect subsidies for housing are not targeted and may even have a wrong distribution profile. No distinction is made of whether the subsidies flow to affluent families or families of limited means. Therefore, there is no security that the subsidies go to those having the greatest need. A large share of the financial support goes to families with high incomes, who pay low rent or live in a private home at a low cost. Also, for home owners there is the possibility of tax-free capital gains. Such capital gains are often created by developments in society in line with increasing demand for housing or certain areas becoming more attractive.

The public lending capacity for housing is determined politically, and thus construction activity is determined by the latitude of the public finances. This has large consequences for the supply of housing, but also means a tendency that maintenance is postponed as new construction is more visible and given more priority in the political process. This may also be worded in the way that there is a lack of visibility in relation to the annual change in the housing stock which is equal to new construction less wear and tear and plus renovation/maintenance. As only new construction is visible, it is given more priority with the result that the social costs of housing are in fact higher when the absence of maintenance/renovation reduces the utility value and thus lifetime of the housing. The housing policy can be summarised in the way that it limits the supply of homes while at the same time it increases demand by reducing living costs for the individual persons. The present situation on the housing market is therefore very much a result of the housing policy pursued.

3.3 Housing policy The housing policy is expensive and does not meet its target. This applies in general as regards adapting the housing stock to demand and specifically in relation to targeting the support to the most disadvantaged in society. Housing subsidies are targeted at the financially most disadvantaged persons, but other types of support are primarily to the benefit of the more affluent. Housing cannot be made more inexpensive for all. The support must be paid either through higher taxes or lower expenditure in other fields. The high support level distorts the housing consumption and is a substantial burden on the public finances. There is a need to increase visibility and transparency of different types of subsidies and regulation of housing. The housing policy should include a more clear division between i) reasons for distribution, ii) subsidies, for whom and why, and iii) public lending. There are arguments in favour of public lending, but not that it should be made on more favourable terms in relation to interest and instalments than loans obtained on market terms. Already by granting public loans, support has been granted to the housing as it may be difficult to raise private financing in the absence of the public co-financing. Financing is only part of the housing policy, and the tax benefit of housing should be included in considerations in relation to tax system reforms. It is appropriate that the tax system is neutral as regards the choice of type of dwelling and investment in housing. Taxation of socially created values may take place either through taxation of capital gains or through property value tax. As large values attach to (which are released when private homes are sold) location, payment of

lease of land should also be contemplated, in particular if gains from the sale of private homes are not taxed. Experience from reforms in the housing area shows that the immediate effects on home-owners' disposable income should be integrated (effect on disposable income after housing costs), but also the price effects (policy changes are capitalised in the prices for private homes). Both suggest gradual phase-in of reforms and makes due diligence with regard to reforms extra important. There is a very large need for reforms of the housing policy. Naalakersuisut has announced that in the autumn session 2015, proposals for reforms in the housing area will be tabled.

References The Taxes and Welfare Committee's report, Vores velstand og velfærd – kræver handling nu (Our affluence and welfare – require action now), 2011 OECD-FAO, 2014, Agricultural Outlook Til gavn for Grønland (To the benefit of Greenland), 2014, Ilisimatursarfik and the University of Copenhagen Gælds- og investeringsstrategien (Debt and investment strategy), 2012, Ministry of Finance Finance Bill 2015, Naalakkersuisut

Publications from the Economic Council The material is available at: http://naalakkersuisut.gl/da/OR Reports Economic Council Report, 2010 Economic Council Report, 2011 Economic Council Report, 2012, Naturressourcer som vækststrategi (Natural resources as growth strategy) Economic Council Report, 2013, Economic outlook, public finances and migration Economic Council Report, 2014, Economic outlook, current economic policy and housing

Background material Technical background memo 2014-1: The settlements in a socio-economic light Technical background memo 2014-2: Demography and housing requirements up to 2040 Technical background memo 2014-3: Updating of calculation of fiscal sustainability 2014