Fiscal Relations In The Realm Of Denmark

Fiscal Relations In The Realm Of Denmark – The Case Of The Faroe Islands And Greenland

Torben M. Andersen

Introduction

The Realm of Denmark, Kingdom of Denmark, consists of Denmark, Greenland and the Faroe Islands. The latter two have been part of the Danish Realm since the 18th century. Previously they had the status of counties in Denmark, but they have been granted first home rule and later self-government status.

Both the Faroe Islands and Greenland are situated in the North Atlantic, and although the population sizes are approximately similar (2018: 56,000 persons in Greenland and 49,000 in the Faroe Islands), their geographies differ significantly. The Faroe Islands (consisting of 18 islands) are situated in the middle of a triangle spanned between Scotland, Iceland, and Norway and have an area of about 1,399 km2. Greenland is further to the north, having Canada and Iceland as its closest neighbors, and its northern parts reach close to the North Pole. The total area of Greenland constitutes 2,166,086 km2. The population density (inhabitants per square kilometer) is thus much higher in the Faroe Islands (36) than in Greenland (0.03). Today, the islands constituting the Faroe Islands are well connected by roads/tunnels. In contrast, the population in Greenland is scattered along the coast —mainly along the west coast— across 16 towns (the capital, Nuuk, has 17,000 inhabitants) and 58 registered settlements, and no two towns or settlements are connected by roads. While they both share a long distance to export markets, the geography in Greenland is much more challenging.

For both the Faroe Islands and Greenland, fisheries constitute the basis of the economy. Fish exports amount to 88% of all export of goods from the Faroe Islands, and 92% of all export from Greenland. The economies are thus highly specialized and thus displaying a high sensitivity to development in prices and catches in fishing. Both receive a grant from Denmark as part of the self-government agreements.

In both the Faroe Islands and Greenland, there are ongoing discussions on more political and economic independence, and the issue is getting increasing attention. In Greenland, a commission has been appointed to draft a new constitution, but the work has not progressed much so far. In the Faroe Islands the process is further ahead, and a referendum on a new constitution is announced to take place in 2019. A main element is more independence in foreign policies, including the possibility of making trade agreements with e.g. Russia, which is a growing export market. The Danish Government has expressed its respect for the two countries’ aim for independence. In both countries there is much debate on the speed at which such a process should proceed.

The following first outlines the self-government agreements the Faroe Islands and Greenland have, and then gives a brief overview of the economic situation. The role of the grants from the Danish State and thus the fiscal relations are then discussed. The chapter ends by a discussion of the notion of economic independence and the process towards reaching this goal.

I.  Self-government

The position of the Faroe Islands and Greenland has changed over the years to the current position with the self-government agreement granting political competence and responsibility to the Faroese and the Greenlandic political authorities. The agreements stipulate the tasks taken over from the Danish State, and the self-governments enact legislation and have the economic responsibilities in these tasks. The Danish State provides an annual grant to both the Faroese and the Greenlandic authorities; see below.

For the Faroe Islands, home rule was established in 1948, and the self-government arrangement was established in 2005. For Greenland, home rule was established in 1979, and the self-government arrangement was established in 2009. In the Danish Parliament (Folketinget) there are two representatives from both the Faroe Islands and Greenland (total membership is 179).

The Faroe Islands and Greenland are effectively self-governing as regards domestic affairs (see below), and they have their own home governments and parliaments. High commissioners (Rigsombudsmænd) act as representatives of the Danish Government in the Faroese Parliament (Lagting) and in the Greenlandic Parliament (Inatsisartut).

The preamble to the self-government acts recognises that the people of the Faroe Islands (Greenland) are a people with right to self-determination under international law. Accordingly, the act is based on an agreement between the Faroese (Greenlandic) Government and the Danish Government as equal partners. The acts also recognize the Faroese/Greenlandic language as the official language in the Faroe Islands/Greenland, although Danish may still be used in official matters.

Self-government does not include the Constitution, nationality, the Supreme Court, foreign defence and security policy, nor exchange rate and monetary policy. These fields belong to the jurisdiction of the central authorities of the Realm (the Danish Government and Folketing).

According to the Danish Constitution, the authorities of the Realm have the authority to enter into obligations under international law and responsibility for conducting foreign policy. The self-government acts include various agreements and procedures to be followed for issues with a special interest or importance to either the Faroe Islands or Greenland.

The purpose of self-government has been to facilitate the transfer of authority and thus responsibility to the Faroe Islands and Greenland. In the agreements, the responsibilities transferred are clearly delineated, and so are the tasks which can be taken over in the future. Taking over the responsibilities is under a right and duties principle; that is, the self-government then has all financial obligations related to the tasks taken over. The possibilities of such take overs expanded significantly in connection with the self-government agreements. The financial conditions for the take over of tasks clearly signal the principle that further movements towards independence require stronger economic self-reliance.

The self-governments in both the Faroe Islands and Greenland have taken over most tasks related to welfare and social arrangements (education, health care etc.) and finance these activities via various forms of taxes and the grants provided by the Danish State; see below. Examples of fields which have not been taken over are administration of justice, including the establishment of courts of law; the prison and probation service; the police; law of legal capacity, family law and succession law; aliens and border controls; and financial regulation and supervision. The specific tasks taken over differ between the Faroe Islands and Greenland.

Denmark, and therefore also Greenland, became member of the EU in 1973. EU membership was contested in Greenland primarily due to worries over access to fish stocks, and Greenland left the EU in 1985. An agreement between the EU and Greenland grants some fishing rights to fishermen from the EU, for which Greenland is compensated by an annual transfer. Greenland maintains a partnership agreement with the EU, providing some fishing opportunities to EU fishermen, and which also includes transfers directed at strengthening education.

For the Faroe Islands, the home rule government had decided not to join the EU, and hence it was clear when Denmark joined the EU in 1973 that the Faroe Islands did not. The Faroe Islands have a fishing and trade agreement with the EU. Neither the Faroe Islands nor Greenland are members of the European Economic Area (EEA) Agreement like e.g. Norway.

The strategic position of Greenland[1] both for meteorological observations and as a hub for transport between the US and Europe was essential during the 2nd World War, and the US army constructed 14 naval and air bases in Greenland.[2] Today, the US has an airbase in Thule (established 1943) on the northwest coast of Greenland. Greenland is important in international negotiations on territorial claims to the North Pole, and thus the rights to resources on or below the seabed. Finally, traffic along the Northwest Passage is potentially of importance to Greenland. The strategic position of Greenland is seen as bestowing Denmark with more international power than its size justifies. These issues are very controversial, and a viewpoint often made is that the terms for the Thule Air Base are too favourable and benefit Denmark more than Greenland, although Greenland also enjoys the protection offered, having no army itself.

II.   Economic Developments

Economic developments in both the Faroe Islands and Greenland have been favourable in recent years. While historically, there has been a large gap in GDP per capita, there has been catching-up in recent years as seen from Figure 1. An important factor has been favourable conditions in the fishing industry. The terms of trade have improved significantly due to a favourable price development for fish. This development thus underlines the importance of fishing but also the implied high sensitivity to developments in both prices and quantities.

A less diversified economy is also a more volatile economy. Both the Faroe Islands and Greenland have experienced deep crises due to problems in the fishing industry. The Faroe Islands were in deep economic crisis in the early 1990s. Falling fish prices and overinvestments in the fishing sector led to a deep economic recession, which also led to a banking crisis with bankruptcies and restructuring of banks. As part of this, the Danish State offered a loan (2.7 billion DKK). Greenland also had a deep crisis in the early 1990s following the collapse of the then dominating cod fishing industry due in part to overfishing and in part to changing sea temperatures. Economic activity fell significantly, and it took about ten years to recover to the same level of economic activity as prior to the crisis.

Figure 1: GDP per capita, Denmark, the Faroe Islands and Greenland[3]

Living standards cannot be judged directly from GDP per capita (Figure 1) for several reasons. First, living costs are different and generally higher in the Faroe Islands and Greenland than in Denmark. Second, the transfers received by both countries imply that the gross national income is larger than the gross national product, or phrased differently, the transfers allow the consumption possibilities to exceed the production result. Irrespective of this, there is no doubt that living standards are catching up to the levels seen in Denmark and thus the other Nordic countries.

As noted, fishing is the backbone of the economies of both countries. The fishing industry in the Faroe Islands is more diversified and efficient than in Greenland. Greenlandic fishery is thus highly concentrated on prawns (almost 50% of the export value of fish) and halibut (almost 25% of the export value of fish), whereas the Faroese fishing industry is more diversified as regards species, and they also have aquafarming of salmon.

Tourism is also of importance in both countries. A recent expansion of the international airport in the Faroe Islands to allow for larger airplanes has increased the number of tourists significantly. In Greenland a new airport structure is being planned, among other things, to strengthen tourism.

The economic structure of the two countries differs in a number of respects, partly due to their geographic differences. A key labour market performance indicator, the employment rate, differs significantly. The employment rate (age group 16-64) is 88.9% in the Faroe Islands and only 73.7% in Greenland, while it is 78.3% in Denmark.

The educational attainment of the population also differs quite a lot, see Figure 2. For the Faroe Islands, the educational attainment is very similar to that of Denmark, while Greenland has a large educational gap. Only about 40% has education beyond primary schooling in Greenland.

Figure 2: Educational attainment of the population[4]

Social conditions are difficult to compare since consistent comparable data is missing. Assessing income inequality on the basis of published statistics on the Gini-coefficient, inequality is higher in Greenland with a Gini-coefficient of 34 compared to 23 in the Faroe Islands and 29 in Denmark (2016 value). Considering the risk of poverty as the share of people with a disposable income below 60% of the median income, this is about the same in the two countries (FI: 17.4% and G: 16.3) and at about the same level as in Denmark.

Both the Faroe Islands and Greenland have a high fertility rate (above 2), although it is declining (as has been the trend in other countries). They also share a general tendency towards net immigration, and as a consequence, the population size has been roughly constant, see Figures 3 and 4. Net migration is closely correlated with economic developments, as seen more dramatically in the Faroe Islands in the 1990s.

For small countries, it is natural to expect a high level of immigration and return migration for the simple reason that many young people go abroad (mainly to Denmark) to educate themselves. As an example, roughly half the population have lived some period of their lives abroad (Greenland Economic Council (2013)). Going abroad for education and to acquire labour market experience is an advantage both for the individual and for society. However, the systematic tendency to net immigration can be taken as a sign of underlying problems, where a large share of those migrating do not return to their mother country.

Figure 3: Population dynamics – the Faroe Islands, 1985-2017[5]

Life expectancy in Greenland (2016: Men 69.6 years, women 74.1 years) is much lower than in Denmark (men 79 years, women 82.9 years) and much higher in the Faroe Islands (men 83.7 years, women 84.5 years). As in most other countries, the population is ageing. The prime driver is an increase in life expectancy reflecting improvements in living and health standards. As a consequence, the dependency ratio (number of children and old relative to the number of people in working ages) is going to increase steadily. This will have a significant impact on public finances. Projections of public expenditures and revenues are showing a path with a widening financing gap between expenditures and revenues in both the Faroe Islands and Greenland.[6] In short, the current welfare arrangements cannot be financed by the current taxation system (including transfers) as the population ages. The current situation is not economically sustainable. The aim of developing a self-sustaining economy is thus very demanding, since even the existing structure and arrangements are not financially viable.

Figure 4: Population dynamics – Greenland, 1985-2017[7]

As all countries, Greenland is experiencing a tendency towards agglomeration alongside economic developments and changes in the economic and social structure of society. However, due to the geography, agglomeration of the population is an important issue in Greenland. While close to 25% of the population was living in settlements in the late 1970s, the share is now down to about 15%, and according to Statistics Greenland’s population forecasts, it will decline further.  This process reflects both an adjustment to the geographical location of economic activity and the need to exploit the possibilities offered by bigger towns in terms of education, culture, sports, etc. However, in a small population with scattered and separate settlements, the agglomeration process takes a different form than in most counties. In many European countries, smaller villages and towns remain inhabited, while people commute to jobs in different areas. This is obviously not feasible in most cases in Greenland.

The agglomeration process is a particularly difficult issue in Greenland both due the cultural importance of the settlements and historic experience, including some compulsory relocation of inhabitants in settlements. With changing economic structures, it is increasingly difficult to maintain job opportunities in the settlements, especially if they are to offer incomes on par with the bigger towns. At the same time, settlements are rapidly ageing since the young move, which also reduces fertility in these locations. To this could be added difficulties in maintaining equal access to schooling in the sense that trained teachers are not available. Likewise, access to welfare arrangements like health and old age care is more problematic, although some progress has been made via tele-medicine. Even access to daily supplies can be a problem, and is in general more expensive due to transport costs and small markets. On the other hand, the settlements carry a strong cultural legacy going back to the Inuit hunting and fishing society. Accordingly, policy questions related to the settlements are very sensitive.

III.   Grants and economic independence

Both the Faroe Islands and Greenland receive a grant from the Danish State. Such economic transfers have existed for years, and the following comments on the current arrangements. It should be noted that Denmark has a rather elaborate scheme for revenue sharing and transfers across municipalities, which takes into account demographic factors and the like. Hence, transfers from parts of the country to other parts are common, and therefore also applied to the Faroe Islands and Greenland before home rule and self-government, although the setting was different.

For both the Faroe Islands and Greenland, it should be noted that the effective transfer from Denmark exceeds the grant, since Denmark finances activities for which the responsibilities have not be taken over by the self-governments. Moreover, students have access to the Danish educational system etc. Figure 5 shows the size of the public sector measured by total revenues as a share of GDP, and revenues split between foreign transfers and other revenue sources, which are mainly domestic taxes. Measured in this way, the public sector in the Faroe Islands constitutes about ½ of GDP (about the same size as in Denmark), while it is close to 2/3 in Greenland. A flipside of this is that public employment in Greenland is a large share of total employment (more than 40% of total employment).

There are a number of reasons why one would expect the public sector to play a relatively larger role in a country with a tiny and scattered population. A number of tasks have to be undertaken, and small-scale disadvantages tend to make them expensive. At the same time, there may be a need for public sector activities and involvement due to imperfections in the market mechanism due to the small and segmented markets. On top of this comes the political objective to have an extended welfare state of the Nordic type. It is a unique feature of Greenland that there is no private ownership to land. Land is public property, but individuals can attain land leases, which are basically free.

Figure 5. Revenue to GDP share and revenue composition, the Faroe Islands and Greenland 2017[8]

For the Faroe Islands, an agreement from 2013 determines the grant (to be regulated by price-wage developments in Denmark). However, on the initiative by the Faroe Islands, an agreement from 2015 froze the grant to 641.8 million DKK (approximately 100 million US$) for the years 2016-2019. This arrangement signals the intention of the Faroe Islands to become independent of the grant as a process towards independence. The grant amounts to 8.5% of total revenue.

The self-government agreement for Greenland stipulates a grant of 3.4 billion DKK, and this is regulated annually by price/wage developments in Denmark. In 2018 the grant was 3.8 billion DKK (approximately 600 million US$), amounting to almost 30% of total public revenue. Note that Greenland also receives a grant from the EU as part of a partnership agreement (in 2017: 350 million DKK).

Due to the potential for large-scale natural resource exploitation, an important element in the self-government act for Greenland is potential revenue from such activities. By the 2009 act, the Greenlandic Self-Government took over responsibility for the mineral resource area and thus has the sovereign right to utilize the mineral resources. According to a provision in the agreement on the grant from the Danish State, revenue from resource extraction over some threshold (75 million DKK) must be split 50-50 between Greenland and Denmark, but in such a way that the Danish part is deducted from the grant. Should the revenue be so large that the Danish share amounts to the grant, revenue above that level goes to Greenland, and the grant is discontinued. In short, the Danish upside is to be relieved of the payment of the grant. Should this situation arise, the Danish Government and Naalakkersuisut should negotiate future economic relations between the Danish Government and the self-government authorities.

In Greenland the discussion on the grant is vivid. On the one hand, it is a crucial revenue component, but on the other hand, it shows a lack of independence. Given the size of the grant, it is a huge challenge to replace it with other revenue sources. With the present level of economic activities, it is unthinkable to increase tax rates to generate an equivalent amount of revenue. Likewise, expenditure cuts are not realistic given the already problematic situation with health care and education. Hence, the only realistic process is that economic development increases economic activities and incomes and therefore tax bases. As a rule of thumb, current tax revenue (excluding the grant) is 34% of GDP —for an unchanged gross tax burden— GDP should increase by almost 100% to generate revenue equivalent to the grant (this reasoning assumes that all public expenditures are unchanged). In the debate, the build-up of a resource fund has been suggested —in a scenario where large-scale mining/oil extraction becomes a reality, but such a fund should be very large to generate a continuous income stream equivalent to the grant (the grant is a perpetual annuity), and hence this is not a realistic scenario either.

This discussion has recently been revived in relation to a large airport project. Given the geography, air transport is essential, and the current airport structure is such that all traffic from abroad enters via Kangerlussuaq Airport (an airport built by the US army in 1941) and then continues to e.g. the capital Nuuk or Ilulissat (the most well-known tourist destination) or other destinations. The new project involves expansions of the airports in Nuuk and Ilulissat to make Atlantic connections possible and a new airport in Southern Greenland near the town Qaqortoq and thus close to the most inhabited areas. The financing of this project has been an issue, and after a long debate, the Danish State offered financial support. There has been speculation whether this was motivated by the geopolitical importance of Greenland, and to preclude other nations from getting involved. The Danish State is now co-owner of the company responsible for the two airports and is also providing a loan and a guarantee to facilitate the financing of the airports.

IV.  The scope for independence

Political and economic independence are interrelated. The Danish position is that independence is an option for the Faroe Islands and Greenland, but it necessarily implies discontinuation of the Danish grants. Hence, economic development is a necessary condition for independence. For the reasons discussed above, this is a larger challenge for Greenland than for the Faroe Islands. The economy of the Faroe Islands is stronger, and the grants from Denmark are much smaller and thus less important than in the case of Greenland. However, it should be kept in mind that the implicit economic support via activities provided by Denmark is non-trivial. Moreover, independence can be defined in many ways, and ultimate independence involves complicated economic (like monetary policy and exchange rate policies) and political issues (military, foreign policies), etc. In the debate, there are thus various interpretations of the notion of independence and of the time horizon over which independence is realistic. The following discusses some of the economic aspects associated with independence.

The notion of economic sustainability is important in discussions on independence. Economic sustainability can be defined in a number of ways. A first and obvious criterion is that public finances should meet sustainability requirements, but this is in itself a loose definition of sustainability since this can be attained at various levels of living standards and welfare arrangements. Hence, it is a further part of the definition that welfare arrangements should be satisfactory, which in a Nordic context requires both a social safety net and provision of welfare services like health care and education.  Moreover, the notion of sustainability includes an aspiration with respect to living standards, meaning that they should be on par with those of, say, the Nordic countries (or at least the gap should not be too large).

Crucially, independence requires that the economy is not dependent on foreign transfers. Hence, a necessary step towards independence is to make the economy self-sustainable in the sense that alternative revenue sources are generated to replace the transfers. However, defining a self-sustaining economy solely in terms of independence of foreign transfers is not meaningful. Discontinuing the transfers at the discretion of the self-government is in principle possible, but would cause dramatic economic adjustments and a significant drop in livings standards, especially in the case of Greenland. This underlines that a self-sustaining economy also includes objectives concerning the living standards achievable for the population.

The economy of the Faroe Islands is stronger and less relying on foreign transfers than is the case for Greenland. The challenge of making the economy self-sustaining is thus particularly large for Greenland. What is the scope for making the Greenlandic economy self-sustaining? The starting point is to initiate a process with stronger economic development and thus a catching-up process. This would require a strengthening of the private sector. The comparative advantage of the Greenlandic economy is natural resources —renewable and non-renewable. What are the possibilities here?

Fishery is very important and will remain so. It is, however, not plausible that fisheries can provide a much larger economic base than at present. There is definitely scope for improvements, and productivity can be increased, but it is not realistic that the fishing industry can expand to an extent that can push the economy towards self-sustainability. Historically, there have been large variations in stocks and the species which could be used commercially. Earlier, cod was important, and currently prawns and halibut dominate. Mackerel has recently become an option. Sustainable fishing puts limits to catches, and for some species, there have been catches exceeding the biological advice.

Tourism is often mentioned as a possible industry for Greenland since nature is fantastic and offers spectacular options. Currently, the most well-known tourist location is Ilulissat, but southern Greenland is also a tourist destination. However, transport costs and the harsh climate make tourism a niche for individuals with a high ability to pay and great interest in nature. Developments in tourism have not grown much in recent years. The new airport structure is expected to allow for more frequent and shorter connections as well as lower fares, all of which should contribute to expanding tourism. Obviously, transport is a necessary condition, but hotels and other facilities are also required, and hence a significant increase in tourism also requires substantial investments.

The prospects of economic development thus depend on non-renewable resources (e.g. minerals and fossil fuels). Mining has historically been of some importance (e.g. cryolite, coal), and during WWII the economy was to a large extent sustained by the mining of cryolite. Geologically the scope for mineral extraction is good, but the geography and climate imply that extraction is costly, and hence activities depend crucially on world market prices of minerals. In recent years, mining has not been an important economic factor, but there are signs of changes. Two smaller mines are now in operation, and a few more are planned. A controversial prospect is a rare earth mineral mine in southern Greenland, which also involves the extraction of radioactive material. This, of course, brings in foreign policy issues and conventions related to the trade of radioactive material. Hence, although Greenland has the ownership of and responsibility for its mineral resources, foreign policy issues, which remain the responsibility of the Danish Realm, will inevitably follow.

In sum, for Greenland, the challenge is both to reduce its dependence on the grant from Denmark and to solve the sustainability problem arising from aging while making the economy more self-sustaining.

Notas Al Calce

* Torben M. Andersen is a Professor at the Department of Economics and Business Economics, Aarhus University. He holds an M.Sc. from the London School of Economics (1981), a Lic. Oecon from Aarhus University (1994), and a Ph.D. from CORE, Université Catholique de Louvain, Belgium (1986).

[1] The well-known Sirius Patrol in North-Eastern Greenland was established in 1941 to protect the Danish sovereignty in the area. This was a response to German attempts to set up meteorological stations in the area.

[2] Two of these airports —Kangerlussuaq and Narsarsuaq— remain important for air transport today.

[3] Statistics Denmark, https://www.dst.dk/en#; Grøenlands Statistik, http://www.stat.gl/?lang=en; Hagstova Føroya, https://hagstova.fo/en.

[4] Educational attainment of the population aged 15-74, Nordic Statistics database (2011), www.nordicstatistics.org.

[5] Hagstova Føroya, https://hagstova.fo/en.

[6] See Grønlands Økonomiske Råd, Grønlands Økonomi (2018); Færøernes Økonomiske Råd, Økonomisk rapport 2015 – Finanspolitisk holdbarhed for den offentlige sektor på Færøerne (2015).

[7] Grøenlands Statistik, http://www.stat.gl/?lang=en.

[8] Grøenlands Statistik, http://www.stat.gl/?lang=en; Hagstova Føroya, https://hagstova.fo/en.