Agricultural Policy Monitoring and Evaluation 2018

Chapter 11. Iceland

Support to agriculture

Iceland’s level of support remains among the highest within the OECD, although it has fallen due to higher world market prices and a strong devaluation of the Icelandic Króna. Reforms of agricultural policies have been limited, with a shift towards more decoupled payments in the sheep meat sector in the mid-1990s and the establishment of a market for dairy quotas.

At 58% of gross farm receipts the PSE was more than three times the OECD average in 2015-17. The total support to agriculture (TSE) has averaged 1.2% of the country’s GDP in recent years, with support to farmers (PSE) being the dominant component (96%). Support to general services (GSSE) accounts for just over 4% of TSE, with almost half related to expenditures for inspection and public stockholding.

Most agricultural support continues to be provided through market price support measures, principally through high tariffs that help to maintain high domestic prices relative to world prices, and therefore lead to a large transfer from consumers to agriculture producers. In addition, market price support is complemented with the payment entitlements system which is directly or indirectly coupled with production factors. Market price support accounts for 55% of the support to farmers in 2015-17. Output payments for milk producers and the more decoupled payments to sheep meat producers represent most of the remaining PSE. As a consequence, 80% of farm support is provided through some of the potentially most production and trade distorting forms.

Main policy changes

Following the expiration of the previous agreements between the Government and the Farmers’ Association, new agreements were concluded for the ten-year period (2017-26), with extensive reviews scheduled in 2019 and 2023. The key changes in the agreements relate to the dairy and sheep sectors: i) the possibility of a gradual abolition of the milk quota system and reduction in support entitlements in dairy production, subject to the revision process until 2019; ii) reduction in support entitlements in sheep production and increased in support related to quality control. In addition, there is more emphasis on support that is not linked to specific agricultural sectors.

Assessment and recommendations

• Within the continued application of the multi-year agreements between the Government of Iceland and the Farmer’s Association, changes to the agricultural policy are limited. Despite the shift towards more decoupled payments in the sheep meat sector in the mid-1990s and the establishment of a market for dairy quotas helping to reduce efficiency losses, Iceland’s support to farmers remains well above that of most other OECD countries. Moreover, support to farmers continues to be provided in the form that is potentially the most distorting, thereby hindering agricultural producers from receiving market signals and responding to them. To reduce the level of support and its distortive effects in a sustainable manner, policies need to be changed away from border protection and in favour of measures less linked to production

• Despite some progress in reducing border protection of some agricultural products, tariffs on several agricultural product groups, particularly meat, dairy, plants and flowers remain high and are often complex non-ad valorem duties.

• Programmes, such as the quality control programme for sheep farming, which is subject to environmental compliance requirements, could contribute to sustainable land management.

• Progress is needed in supporting innovation, including by encouraging a well-functioning agricultural knowledge and information system, for which public expenditures have been declining over the past decade.

• The new agreements between the Government and the Farmer’s Association which provide the policy framework for the 2017-26 period, are an opportunity for fostering the reform process to make Iceland’s agricultural sector more responsive to market forces, including through phasing out of support to the dairy and sheep sectors, and the 2019 review of the production quota system.

• While the short-term effects of climate change could be favourable for agriculture, pests such as indigenous insects may become a greater threat, introducing new challenges to agriculture in Iceland.

Figure 11.1. Iceland: Development of support to agriculture

Source: OECD (2018), “Producer and Consumer Support Estimates”, OECD Agriculture statistics (database), http://dx.doi.org/10.1787/agr-pcse-data-en.

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Support to farmers (%PSE) has declined by 20 percentage points between 1986-88 and 2015-17. But at 56% of gross farm receipts, it remains high compared to most other OECD countries and the potentially most distorting support in total represents 80% of the total PSE (Figure 11.1). The level of support has decreased in 2017 due to the decrease in MPS. The decrease in MPS results from a smaller price gap brought about by lower average domestic prices and increased world prices in USD which more than offset the effects of the appreciation of ISK against the USD (Figure 11.2). Effective prices received by farmers, on average, have declined over time, but still remained twice as high as those in the world markets. The sectors with the largest divergence between domestic and world prices (NPC) in 2015-17 are poultry (4.36), eggs (3.58) and wool (3.3). MPS is also the main component of Single Commodity Transfers (SCT): poultry, eggs and wool had more than 70% of their gross farm receipts derived from SCT (Figure 11.3). Overall, SCT represent 98% of the total PSE. The expenditures for general services (GSSE), mainly on inspection and public stockholding, decreased relative to agriculture value added from 2.8% in 19986-88 to 0.9% in 2015-17. Total support to agriculture as a share of GDP has declined significantly over time. More than 95% of the total support is provided to individual farmers (PSE).

Figure 11.2. Iceland: Decomposition of change in PSE, 2016 to 2017

Source: OECD (2018), “Producer and Consumer Support Estimates”, OECD Agriculture statistics (database), http://dx.doi.org/10.1787/agr-pcse-data-en.

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Figure 11.3. Iceland: Transfer to specific commodities (SCT), 2015-17

Source: OECD (2018), “Producer and Consumer Support Estimates”, OECD Agriculture statistics (database), http://dx.doi.org/10.1787/agr-pcse-data-en.

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Table 11.1. Iceland: Estimates of support to agriculture

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Contextual information

Iceland is a small, sparsely populated economy with a GDP per capita slightly above the OECD average. Agriculture (excluding fish) is a relatively small part of the economy, contributed 1.1% to GDP and 2.2% of employment in 2016, and it remains small compared to fishing and aquaculture (Table 11.2). Approximately one fifth of the total land area of Iceland is suitable for fodder production and the raising of livestock. Around 6% of this area is cultivated, with the remainder devoted to raising livestock or left undeveloped.

Livestock and livestock products are the main farm activities, with milk and sheep meat being the most important products. The main crops are hay, cereals for animal feed and vegetables, which are cultivated primarily in greenhouses heated with geothermal energy. The main exports are pure-bred breeding horses, sheep meat products and raw fur skins. Iceland is a net importer of agriculture products (excluding fishery), mainly for final consumption. Imports are more diversified than exports and steadily increased in recent years.

Table 11.2. Iceland: Contextual indicators

	Iceland		International comparison
	1995	2016*	1995	2016*
Economic context			Share in total of all countries
GDP (billion USD in PPPs)	6	17	0.02%	0.02%
Population (million)	0.3	0.3	0.01%	0.01%
Land area (thousand km2)	100	100	0.13%	0.13%
Agricultural area (AA) (thousand ha)	1 899	1 872	0.07%	0.07%
			All countries analysed1
Population density (inhabitants/km2)	3	3	38	45
GDP per capita (USD in PPPs)	24 119	50 012	9 650	24 866
Trade as % of GDP	25	25	10.2	14.3
Agriculture in the economy			All countries analysed1
Agriculture in GDP (%)	11.6	6.3	3.0	3.1
Agriculture share in employment (%)	9.5	3.9	-	-
Agro-food exports (% of total exports)	6.8	5.7	7.7	7.3
Agro-food imports (% of total imports)	10.0	9.0	7.8	6.7
Characteristics of the agricultural sector			All countries analysed1
Crop in total agricultural production (%)	22	15	-	-
Livestock in total agricultural production (%)	78	86	-	-
Share of arable land in AA (%)	7	6	30	30

Note: *or latest available year. 1. Average of all countries covered in this report. EU treated as one.

Source: OECD statistical databases, UN Comtrade, World Development Indicators and national data.

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Iceland has made a remarkable turnaround since the 2008 crisis – helped by booming tourism, prudent economic policies and a favourable external environment – and is currently the OECD’s fastest growing economy. Iceland has high living standards and inclusiveness, the lowest poverty rate in the OECD area and life expectancy is among the highest in the world. Historically, Iceland’s prosperity has been built on the sustainable management of its abundant natural resources – including the comprehensive fisheries management system based on individual transferable quotas – renewable energy (geothermal and hydro) and carbon sequestration opportunities (afforestation, revegetation). After appreciating for two years, the króna began to weaken and fluctuate in 2017. Inflation has remained below the target of 2.5% for the past three years.

Figure 11.4. Iceland: Main economic indicators, 1995 to 2017

Source: OECD statistical databases.

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Figure 11.5. Iceland: Agro-food trade

Note: Numbers may not add up to 100 due to rounding.

Source: UN Comtrade Database.

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While output growth in agriculture has been slightly below the global average over the past decade, according to the estimates, agricultural total factor productivity has been growing by 2.9%. Harsh climate, lack of suitable land, small size of farms and the narrow genetic base for breeds of cows, sheep and horses, however, present significant constraints to the sector. Due to the relatively low livestock densities, Iceland’s nutrient balances show a comparatively low surplus of both nitrogen and phosphorous. The sector’s relative energy use has fallen significantly over the past twenty years. Agriculture continues to represent a significant share in the country’s total GHG emissions well above that for the OECD average, mainly due to the importance of the livestock sector. With just over 40%, the sector’s share in water consumption is comparable to the OECD average.

Figure 11.6. Iceland: Composition of agricultural output growth, 2005-14

Note: Primary factors comprise labour, land, livestock and machinery.

Source: USDA Economic Research Service Agricultural Productivity database. Available at: www.ers.usda.gov/data-products/international-agricultural-productivity/documentation-and-methods.aspx#excel.

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Table 11.3. Iceland: Productivity and environmental indicators

	Iceland		International comparison
	1991-2000	2005-2014	1991-2000	2005-2014
			World
TFP annual growth rate (%)	0.37%	2.93%	1.60%	1.63%
			OECD average
Environmental indicators	1995	2016*	1995	2016*
Nitrogen balance, kg/ha	8	7	33	30
Phosphorus balance, kg/ha	1.8	1.5	3.7	2.4
Agriculture share of total energy use (%)	2.3	1.4	1.8	1.9
Agriculture share of GHG emissions (%)	18	14	8.5	8.5
Share of irrigated land in AA (%)	..	..	-	-
Share of agriculture in water abstractions (%)	42	42	45	43
Water stress indicator	0.1	1.8	10	10

Note: * or latest available year. EU treated as one.

Source: USDA Economic Research Service. OECD statistical databases, UN Comtrade, World Development Indicators and national data.

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Description of policy developments

Main policy instruments

The strategic objective of Iceland’s agricultural policy is to maintain and strengthen a diverse agricultural sector, as far as natural and marketing conditions allow. The key goals of policy are: to meet domestic demand to the extent that this goal is realistic; to maintain sustainable production of high quality and healthy products; to improve efficiency and competitiveness; to improve farmers’ incomes; to improve creativity and create job opportunities; and to sustain livelihoods in rural areas.

Agricultural policies in Iceland are based on two main legal acts: i) Act No. 99/1993 on the Production, Pricing and Sale of Agricultural Products (now the Act on Agricultural Produce), which lays down the policy framework as well as provisions for production control, provisions for slaughter and processing, market measures and producer support; and ii) Act No. 70/1998 on Agriculture, which provides the legal basis for development projects, extension services and livestock improvements.

Under these Acts, there are a number of renewable multi-year agreements between the Government and the Farmer’s Association, which provide the general framework for support and production control for farmers in the cattle, sheep and horticultural sectors. There is also an agreement on horizontal support, such as technical development and improved land cultivation, livestock improvement, extension services, organic farming and the Agricultural Productivity Fund.

Following the expiration of the previous agreements between the Government and the Farmers’ Association, new agreements were concluded for the ten-year period from 2017 to 2026, with extensive reviews scheduled in 2019 and 2023. The key changes in the agreements, which came into force on 1 January 2017, relate to the dairy and sheep sectors: i) the gradual abolition of the milk quota system and reduction in support entitlements in dairy production, subject to the revision process until 2019; ii) reduction in support entitlements in sheep production and increase in support related to quality control. In addition, there is more emphasis on support that is not linked to specific agricultural products.

Iceland’s agricultural support is provided through market price support, maintained by border measures, and through direct payments, which are based on payment entitlements – directly or indirectly coupled with production factors. Market price support is provided for all livestock products and some horticultural products. Direct payments are provided to cattle (mainly dairy) and sheep producers, and on a smaller scale, to certain greenhouse producers.

For dairy, direct payments are based on the size of a producer’s quota and the current number of animals. Headage payments are provided for up to 180 dairy cows and 260 beef cows, with full payment for each of the first 50 dairy cows and 200 beef cows, then at a reducing rate for each additional cow. There is a national production quota, which is set each year by the Ministry of Fisheries and Agriculture and is divided among producers based on their present quotas, which, at the same time, determine the entitlements for direct payments. Production in excess of quotas is permitted, provided all such production will be exported. Wholesale prices are managed for approximately half of the dairy products. A government-chaired committee, representing both the Farmers’ Association and – on behalf of the consumer side – the labour union, annually determines guaranteed minimum prices for milk delivered within production quotas. Trade in support entitlements (basic payments to all active dairy and cattle farmers) between entitlement holders is not allowed. In 2017, the government began to redeem the milk quota and to redistribute it. The redemption price is determined by the present value of future entitlement payments throughout the duration of the agreement. Dairy producers also benefit from support for breeding, land cultivation and development programmes.

For sheep, direct payments are linked to payment entitlements that were originally based on historical production. Keeping a minimum of winter-fed sheep on the farm, in relation to the entitlements is, however, required for being eligible to receive full payments. Additional payments to sheep farmers are related to a quality control scheme for lamb meat, based on animal welfare, product quality and traceability, and sustainability criteria. Consumer subsidies are provided at the wholesale level for purchasers of wool and to processors for marketing and storage costs of sheep meat.

Imports of meat, dairy products, and some vegetables that compete with domestic production are subject to tariffs which are often compound duties with an ad valorem component of 30% and a specific duty component that varies from ISK 5/kg (USD 0.04/kg) to ISK 1 462/kg (USD 2/kg). However, products originating in partner countries of the European Economic Area (EEA) or in one of the 41 countries with which Iceland has free trade agreements may carry lower tariffs. In the new agreement for the cattle sector, the Minister of Fisheries and Agriculture will take action to amend the Customs Act so as to revert specific tariffs on milk and skimmed-milk powder and cheeses back to the real-price levels of June 1995. Export subsidies for agricultural products have not been provided since early 1990s.

According to the legislation on protection against animal diseases, imports of uncooked animal products require the permission of the Food and Veterinary Authority. Imports of live animals are prohibited, with exceptions regarding pet animals and certain animals for breeding subject to strict quarantine measures.

Concerning Iceland’s climate change commitments under the Paris Agreement on Climate Change, according to its National Determined Contributions (NDCs) submitted to the UNFCCC, Iceland aims to be part of a collective delivery by European countries to reach a target of 40% reduction of GHG emissions by 2030 compared to 1990 levels. A precise commitment for Iceland within such collective delivery is yet to be determined and dependent on an agreement with the European Union and other countries, but the participation in the EU Emissions Trading System would be key in that regard, considering that almost half of Iceland’s emissions are regulated through this scheme.

Iceland is a member of the European Free Trade Association (EFTA) and of the European Economic Area. While the EEA Agreement does not apply to most trade in agricultural goods, it opens trade in a number of processed agricultural products and encourages bilateral agreements on primary commodities. Two bilateral agreements with the European Union are in force in parallel with the EAA Agreement: a bilateral free trade agreement from 1972 and an agreement on trade in basic agricultural products from 2007. In September 2015, Iceland and the European Union signed a new agreement on trade in agricultural products – which will replace earlier agreements – and agreed on an improved market access for both processed and unprocessed agricultural products under the EEA Agreement, as well as on agreement for the of geographical indications for agricultural products and foodstuffs. In addition to the Free Trade Agreements under EFTA, Iceland has a bilateral Free Trade Agreement with the Faroe Islands, Greenland and China.

Domestic policy developments in 2017-18

In the new Agreement, key elements of the regulation on horizontal support for agriculture, include support relating to advisory services, breeding, animal welfare, environmental protection, sustainable land management, organic production, land cultivation, goat farming, investment support for pig farming. Further, the Agricultural Productivity Fund is set to allocate funds for development projects in the horticultural, cattle and sheep sectors and for increasing employment in rural areas. Under this agreement there is a scheme intended to stimulate recruitment of newcomers into the different sectors.

The regulation also includes sector-specific programmes for the pig and goat sectors, and forestry. These programmes are relatively small-scale compared to those for the dairy and sheep sectors. Support for the goat sector is divided among headage payments (up to 60% of the total), slaughter premiums (up to 17% of the total), goat-milk subsidies (up to 8% of the total), and support for breeding (up to 15% of the total). Support for the pig sector includes subsidies to improve pig housing including investment support for new construction and the demolition of existing buildings.

The new Agreement on the operating environment for the cattle sector opens the possibility to abolish the production quotas which have been in place over 25 years, to phase out the system of “support entitlements” (basic payments to active dairy and cattle farmers), to de-link output payments for milk from the support entitlements and to change the milk pricing arrangements. These changes, together with a new system for supporting beef production, will be considered by the 2019 revision of the agreement and subject to agreement by producers.

According to the new Agreement, for the period 2017 to 2020, the overall support entitlement for milk production, as well as the support entitlements of each registered farm, will be determined using the same method as for 2016; the level of production required to receive full payments based on support entitlements is to be decided annually.

Mainly in response to the increasing domestic consumption of dairy products, the milk production quota was increased from 136 million litres in 2016 to 144 million litres in 2017. Production in excess of the quota must be exported. Payments to farmers are made in equal monthly payments of one-twelfth of annual quota. In 2017, the minimum price paid by dairies for milk delivered within the production quota has been set at ISK 87.4 (USD 0.8) per litre.

For the beef sector, headage payments are allocated to owners of cows which are registered under the breeding records programme and which produce a calf at least every two years. Under the new Agreement, total headage payments are divided between the categories “dairy cows” and “beef cows”. Initially, the total payment are divided between the two categories based on the headage counts of 25 000 dairy cows and 3 000 beef cows. This division is set to be revised annually by the Committee for the Implementation of National Agricultural Agreements. Support is also available for breeding, investment (up to 40% of the capital costs, but limited by a fixed total amount) and for helping to balance production and demand (improved marketing of cattle products, support for diversification, compensation for the slaughtering and temporary support). The measures to balance production and demand are discretionary and are to be allocated when there is a need to respond to changes in supply and demand. In 2017, the measures for beef production include a slaughter premium and ISK 100 million (USD 0.9 million) for a quarantine facility for imports of genetic material.

Similar to the dairy sector, the support entitlements for the sheep sector are to be abolished over the duration of the Agreement and replaced by quality assurance premiums for farmers subject to meeting requirements relating to quality, animal welfare and sustainable land use. These changes are also subject to the revision to take place in 2019.

Headage payments are to be introduced for winter-fed sheep from 1 January 2020, with higher payments for new entrants. In the context of the 2019 revision of the agreement, a decision should be made on whether to make headage payments conditional on participation in a quality-assurance programme for sheep production. Moreover, beginning in 2018, producers are receiving farm support payments, also based on the number of winter-fed sheep, which are paid to producers keeping over 100 winter-fed sheep. The payments range from ISK 20 000 (USD 187) for farms with 101-120 sheep up to a maximum of ISK 320 000 (USD 2 996) for farms with more than 800 sheep.

During the term of the agreement, special regional support is foreseen for producers in certain regions which are particularly dependent on sheep farming. A complementing Regulation sets out certain requirements that need to be met in order to receive this support, such as the number of sheep and distance to urban areas.

Support is paid for the production of wool during the term of the agreement. Payments should be based on the quantities produced, although part of the support may also be used to subsidise the cost of collecting the wool. Applying specific coefficients, different premiums may be paid for individual categories of wool.

Investment aid is also available to promote better living conditions for sheep and more cost-effective farming practices. To be eligible, each project must have a cost of at least ISK 1 million (USD 9 362). Contributions may cover up to 20% of the capital costs, but no individual producer may receive contributions exceeding 10% of the total annual funds available for investment aid.

The agreement concerning the framework of support to horticultural producers remains unchanged and provides production-based payments to producers of cucumbers, tomatoes and bell peppers. Electricity subsidies are also granted for greenhouses (which are heated by geothermal energy) to cover up to 95% of the cost of the transfer and distribution of electricity. Support payments to each individual producer are capped. No single entity can receive more than 10% of annual total direct payments or 15% of total funds to electricity subsidies annually.

As of 1 January 2017, the levy on agricultural revenues – which was distributed within and between various agricultural bodies – was abolished.

Trade policy developments in 2017-18

In 2017, Iceland has eliminated tariffs of all non-agricultural products. Tariffs on cheese and powdered milk were updated by Act No. 102/2016, which resulted in increased specific duties in 2017. However, the specific duty was reduced in 1 March 2018 due to appreciation of ISK relative to the Special Drawing Rights (SDR). The tariff will be updated in March each year by the development in the exchange rate (SDR/ISK). The distribution of import quotas for cheese which refers to designations of origin and geographical indication is to be determined by a lot.

Under the EEA agreement, which will enter into force 1 May 2018, Iceland grants the European Union substantially increased tariff quotas on meat, cheese and processed meat products. In return, the European Union grants duty-free access for a range of products and opens or expands tariff quotas, including an expansion of the existing quota for skyr (a traditional dairy product) from 380 tonnes to 4 000 tonnes over four years.